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SEC Fines Advisers for Allocating Compliance Expenses to Funds

On November 5, 2015, the SEC settled its action against two affiliated investment advisers to private equity funds concerning allegations that the advisers had misallocated $455,698 of their own consulting, legal and compliance costs to its funds.

Despite the disclosure made in the funds’ limited partnership agreements that the funds would be charged for the legal and consulting expenses of the funds, the SEC alleged that the advisers breached their fiduciary duties to their fund client (in violation of Section 206(2) of the Advisers Act and also violated Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder) because the funds’ limited partnership agreements did not permit the funds to be charged for the advisers’ legal and compliance expenses. The types of expenses that the SEC alleged that the advisers charged to the fund included:

  • consulting, legal and compliance-related expenses in the course of either preparing for registration as an investment adviser under the Advisers Act (including the fees charged by the compliance consultant);

  • complying with legal obligations arising from registration;

  • preparing for examination by the staff of the SEC’s Office of Compliance Inspections and Examinations (including consulting and legal services); and

  • responding to an investigation of its conduct by the staff of the SEC’s Division of Enforcement (including paying for legal services in connection with responding to the SEC Enforcement staff’s investigation).

The SEC also alleged that the advisers had failed to adopt written policies or procedures reasonably designed to prevent violations of the Investment Advisers Act arising from the allocation of expenses to the funds or to adequately review the adequacy and effectiveness of its policies and their implementation. To settle the allegations, the advisers agreed to pay a civil monetary penalty in the amount of $100,000 and to reimburse the funds for the full amount of expenses previously misallocated to them.

Please see here for the SEC’s order on the misallocation of expenses.

CCO Takeaways

– The recent SEC scrutiny is further evidence that the SEC continues to examine the expenses charged by private equity funds. Any RIA that wishes to have Advisers Act compliance expenses reimbursed by its clients should clearly disclose, and accurately characterize, all expenses that will be charged to clients, and carefully consider the conflicts of interests and allocation of such costs among clients.

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Copyright © 2020, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume V, Number 324
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About this Author

Associate

Angela Kim is an associate in the Corporate Practice Group in the firm's Los Angeles office. Prior to joining the firm, Ms. Kim was a legal counsel at CJ E&M Corporation, the largest entertainment and media conglomerate in Korea.

Ms. Kim focuses her practice on mergers and acquisitions, private equity, venture capital and general corporate law matters. 

213.617.5453
Thomas M. Devaney, Corporate Attorney, Sheppard Mullin Law firm
Partner

Mr. Thomas Devaney is a partner in the Corporate Practice Group in the firm's New York office.

212-634-3042
Jung Son, corporate, investment, finance, attorney, Sheppard Mullin, law firm
Partner

Jung Yeon Son is a partner in the Corporate Practice Group in the firm's Palo Alto office. Ms. Son’s practice is focused on the formation and operation of private investment funds, including private equity, venture capital and hedge funds, as well as on advising companies and sponsors with respect to mergers & acquisitions, securities offerings, corporate governance, SEC reporting, and general corporate matters. 

650-815-2676
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