Recently, the United States Securities and Exchange Commission sanctioned a registered investment adviser for violating antifraud provisions of the Advisers Act. The violations stemmed from the adviser overcharging limited partners of a private equity fund it managed.
When the fund was formed in 2010, the adviser entered into a limited partnership agreement (LPA) with investors, which outlined how management fees were to be charged to the fund. The fee schedule stated that “on a quarterly basis, a management fee equal to one and one half percent (1.5%) per annum of the total invested capital contributions” was to be paid to the adviser. The LPA included an exception that certain events would trigger a reduction in fees, including write downs of portfolio securities.
Between Jan. 2016 and Oct. 2019, several of the fund’s portfolio securities were subject to write downs, as directed by the LPA. However, the adviser did not calculate subsequent management fees to include the effects of the write downs. This error turned into the fund being over charged during 13 quarterly billing cycles.
Because of the miscalculated fees, the fund’s limited partners were collectively overcharged by more than $900,000. The SEC determined that the adviser was engaging in fraudulent behavior by subjecting the fund to these fees; this resulted in violations of sections of the Advisers Act which prohibit defrauding clients or defrauding investors of a pooled investment vehicle.
Among other things, the SEC acted to censure the firm and order it to pay disgorgement and fees amounting to over $1 million. By reviewing the terms of its LPA and through additional oversight of the supervised person or persons calculating the fees, the firm could easily have prevented these miscalculations and the eventual enforcement action.
WHAT DOES THIS MEAN FOR ME?
In every client engagement, your firm must ensure all terms of every agreement are adhered to, especially with regard to valuation and fee calculation. If not, issues can arise during SEC examinations and possibly lead to enforcement action. Having a strong compliance program and tracking the terms of all agreements are essential to firms’ operations.
Fairview offers a host of solutions for your compliance program and our affiliate Side Letter Vault offers services to maintain and securely store your firm’s agreements. Contact us today for more information about Fairview’s compliance support services and Side Letter Vault’s digital business solutions.