The following actions highlight several deal/agreement characteristics that have been grabbing the SEC’s attention.
- Accelerated Monitoring Fees
In a second settlement announced August 2016, four private equity fund advisors paid $52.7 million in an action which alleged that the advisors failed to properly disclose to investors the practice of taking accelerated fees. Specifically, the private equity firm entered into “monitoring agreements” with portfolio companies that allowed the firm to charge monitoring fees to the portfolio company in exchange for rendering certain consulting and advisory services.
The monitoring agreements allowed the firm to terminate the monitoring agreement and accelerate the remaining years of monitoring fees, which it received as “termination payments.” While the firm disclosed its ability to collect these acceleration fees, it did not disclose its practice of taking acceleration fees until after it had already taken the fees. Notably, another settlement regarding accelerated monitoring fees was also announced in October 2015 and a probe into another firm regarding accelerated fees was reported this month.
- Broken Deal Expenses
The SEC has also scrutinized misallocation of broken deal expenses (diligence expenses related to unsuccessful buyout opportunities) to an advisor’s private equity funds. Under some limited partnership agreements, fund managers are permitted to be reimbursed by funds for broken deal expenses that are incurred “by or on behalf of” the fund.
However, when firms fail to allocate broken deal expenses to the firm’s co-investors or fail to disclose not allocating broken deal expenses to co-investors, even if the co-investors participated in and benefitted from the expenses, the SEC takes issue.
Whether in limited partnership agreements, subscription agreements, Form ADVs or elsewhere, the SEC scrutinizes any difference between what managers said they would do and what they actually did—particularly when the manager enjoys a financial benefit as a result.
With the SEC pushing the legal envelope through settled actions, it pays investment advisors to stay well within the lines.
Jenifer Doan, an attorney with Paul Hastings, contributed to this article.