Private Funds Face Increasing Scrutiny on Expense Disclosure and Practices

Regulators, news media and investors continue to sharpen their focus on the types of expenses borne directly and indirectly by private funds.  While much of the attention has fallen on private equity funds, managers of hedge and venture funds should also cast a self-critical eye on the expenses they charge to their investment vehicles.  We advise them to pay close attention to any revenue or benefits they or their affiliates receive in addition to normal management fees.

The U.S. Securities and Exchange Commission’s Office of Compliance, Inspections and Examinations has found that more than half of examined private equity managers have inadequate controls around expenses or are actually in violation of regulations or applicable governing documents.  SEC officials, in public comments and through enforcement actions, have raised concerns regarding a variety of practices, including:

• allocation of expenses (such as consultants and other service providers that report to the manager) that should be borne by the manager to funds or portfolio companies;
• lack of specificity in disclosure documents (such as offering memoranda or ongoing investor reports);
• funds or portfolio companies paying unnecessary, excessive or inadequately disclosed transaction and service fees (for “monitoring”, administrative or consulting services) to the manager or its affiliates;
• use of fund assets to pay for the personal expenses of a manager’s personnel; and
• misallocation of expenses between funds

Along with the SEC, investors have increased their attention to managers’ practices.  Various industry news outlets, including The Wall Street Journal and Fortune, have highlighted and criticized certain funds’ general and specific practices, leading to negative publicity for the profiled managers.  The consequences for managers’ use of inappropriate expense and revenue practices, or even suspicions of such practices, can range from distraction and embarrassing attention to reputational damage, or to enforcement action by the SEC (which has indicated plans for continued aggressive examinations and enforcement action in this area).

In this environment, investment firms should use all available resources to stay on the right side of this trend toward greater financial transparency.  Given the risks of hindsight evaluations by regulators, journalists, investors and the plaintiffs’ bar, managers of all private investment vehicles should regularly consider how their expense and revenue practices compare to the relevant disclosure and governing documents, as well as evolving industry practices and reasonable investor expectations.   We recommend that fund managers evaluate in detail their current practices, and any contemplated changes to those practices, to avoid inconsistency with offering documents, partnership agreements, investor reports, Forms ADV, etc.

For assistance and advice regarding expense and revenue policies and practices, as well as specific allocations, please contact a member of Rimon’s Private Investment Funds team.