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PE Firm KKR to Pay SEC $30M for Misallocating ‘Broken Deal’ Expenses

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The Securities and Exchange Commission today charged Kohlberg Kravis Roberts & Co. (KKR) with misallocating more than $17 million in so-called “broken deal” expenses to its flagship private equity funds in breach of its fiduciary duty.

KKR, a private equity firm with $99.1 billion assets under management as of March 31 specializing in buyout and other transactions, agreed to pay nearly $30 million to settle the charges, including a $10 million penalty.

“This is the first SEC case to charge a private equity advisor with misallocating broken deal expenses,” said Andrew J. Ceresney, director of the SEC Enforcement Division, in a statement. 

An SEC investigation found that during a six-year period ending in 2011, KKR incurred $338 million in broken deal or diligence expenses related to unsuccessful buyout opportunities and similar expenses. 

“Although KKR raised billions of dollars of deal capital from co-investors, it unfairly required the funds to shoulder the cost for nearly all of the expenses incurred to explore potential investment opportunities that were pursued but ultimately not completed,” Ceresney said in a statement.

According to the SEC, KKR did not allocate any portion of these broken deal expenses to co-investors — even though KKR’s co-investors, including KKR executives, participated in the firm’s private equity transactions and benefited from the firm’s deal sourcing efforts. 

The SEC states that KKR did not expressly disclose in its fund limited partnership agreements or related offering materials that it did not allocate broken deal expenses to the co-investors.

KKR also failed to implement a written compliance policy governing its fund expense allocation practices until the end of the six-year period in 2011, according to the SEC’s order instituting a settled administrative proceeding.

Marshall S. Sprung, co-chief of the SEC Enforcement Division’s Asset Management Unit, said it was KKR’s failure to adopt policies and procedures governing broken deal expense allocation that “contributed to its breach of fiduciary duty.”

“A robust compliance program helps investment advisors ensure that clients are not disadvantaged and receive full disclosure about how fund expenses are allocated,” said Sprung, in a statement. 

KKR agreed to pay more than $14 million in disgorgement ($3.26 million was previously refunded to clients) as well as more than $4.5 million in prejudgment interest and the $10 million penalty. 

KKR neither admitted nor denied the SEC’s findings.

In a statement sent to ThinkAdvisor, KKR said: “This resolution, which relates to historical expense allocation disclosures and policies and not to any current practices, allows us to focus on delivering value for those who invest with us. We take our fiduciary responsibilities seriously and have strived to adapt our policies and practices to the changing nature of the industry, market and our business. KKR is firmly committed to upholding the highest governance and transparency standards, and we remain dedicated to continually enhancing our practices on behalf of our fund investors.”

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