Private equity firms would do well to heed the warning given bySEC Enforcement Director Andrew Ceresney during a May speech thatthe SEC was “intensifying” its focus on them.


Since hisspeech at the Securities Enforcement Forum West in SanFrancisco, at least one large settlement with private equityadvisors, totaling more than $50 million, has been announced, adding tothe pile of private equity settlements the agency startedaccumulating in 2015.


Private equity firms wondering how to avoid being caught underthe SEC’s microscope would be wise to examine the recentenforcement actions, as they demonstrate a number of dealcharacteristics that have been grabbing the SEC’s attention.


Some of these include:

  • Allocationof Transaction Fees
    In August 2016, the SECsettled with a PE advisor for a $2.3 million penalty followingvoluntary reimbursement, with interest, of nearly $12 million inmanagement fee credits. In providing various services to portfoliocompanies, the advisor earned certain transaction fees. Under theterms of the limited partnership agreements, the advisor was tooffset the management fee it charged the funds by 50% of the feesearned.

    The LPAs did not specify how the advisor was to allocate such feesin situations involving multiple funds and co-investors investingin the same portfolio companies. The advisor retained 60% of suchfee from a co-investor for negotiating, advising, and structuring atransaction. The SEC faulted the advisor for not disclosing itspractice and interpretation of LPA language the SEC conceded was“ambiguous.”
  • AcceleratedMonitoring Fees
    In a second settlement announcedAugust 2016, four private equity fund advisors paid $52.7 millionin an action which alleged that the advisors failed to properlydisclose to investors the practice of taking accelerated fees.Specifically, the private equity firm entered into “monitoringagreements” with portfolio companies that allowed the firm tocharge monitoring fees to the portfolio company in exchange forrendering certain consulting and advisory services. The monitoringagreements allowed the firm to terminate the monitoring agreementand accelerate the remaining years of monitoring fees, which itreceived as “termination payments.”

    While the firm disclosed its ability to collect these accelerationfees, it did not disclose its practice of taking acceleration feesuntil after it had already taken the fees. Notably, anothersettlementregarding accelerated monitoring fees was also announced in October2015 and a probe into another firm regarding accelerated fees wasreported this month.
  • BrokenDeal Expenses
    The SEC has also scrutinizedmisallocation of broken deal expenses (diligence expenses relatedto unsuccessful buyout opportunities) to an advisor's privateequity funds. Under some limited partnership agreements, fundmanagers are permitted to be reimbursed by funds for broken dealexpenses that are incurred “by or on behalf of” thefund.

    However, when firms fail to allocate broken deal expenses to thefirm’s co-investors or fail to disclose not allocating broken dealexpenses to co-investors, even if the co-investors participated inand benefitted from the expenses, the SEC takes issue.
  • ReroutingFees to Avoid Offsets
    In another case involvingmonitoring fees, a private equity firm and certain executives paid$10.2 million to settle an action that claimed the firm reroutedfees to an affiliate and avoided providing the benefits of the feesto the client through an offset. The firm originally had monitoringagreements with its portfolio companies to obtain monitoring feesfor providing management services, and those fees were to be offsetagainst the client’s advisory fees.

    Terminating those original agreements, the firm caused theportfolio companies to enter into monitoring agreements with thefirm’s affiliates and then failed to provide any furtheroffsets.
  • Allocationof Firm’s Registration Expenses to Investor
    Anaction alleging the misallocation of the private equity firm’sregistration expenses to client funds was settled in November 2015for $100,000. According to the SEC’s allegations, the firm incurredconsulting, legal and compliance-related expenses in the course ofpreparing for registration as an investment advisor, complying withobligations as an investment advisor and responding toinvestigation requests. The firm caused the client funds to pay foralmost $500,000 of those expenses.

    Although the limited partnership agreements disclosed that theclient funds could be charged for expenses in the “good faithjudgment” of the general partner, there was no disclosure that theclient funds would be charged for the firm’s legal and complianceexpenses.

Whether in limited partnership agreements, subscriptionagreements, Form ADVs or elsewhere, the SEC scrutinizes anydifference between what managers said they would do and what theyactually did—particularly when the manager enjoys a financialbenefit as a result. With the SEC pushing the legal envelopethrough settled actions, it pays investment advisors to stay wellwithin the lines.


JeniferDoan, an attorney with Paul Hastings, contributed to thisarticle.

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Nicolas Morgan

Nicolas Morgan is a partner at the global defense firm Paul Hastings and the founder and President of ICAN (Investor Choice Advocates Network). He focuses his practice on complex securities litigation in state and federal courts and representations involving government investigations and white-collar crime allegations levied against individuals and businesses. He routinely represents securities issuers, company officers and directors, investment funds, analysts and brokers in connection with SEC and FINRA investigations, litigation and arbitration. He also counsels public companies, funds and broker-dealers on securities compliance and corporate governance, conducts internal investigations and assists in regulatory examinations initiated by the SEC’s Division of Corporate Finance and Office of Compliance Inspections and Examinations.