• Concerns Noted During Private Equity Adviser Exams
  • June 6, 2014 | Authors: Peter D. Fetzer; Terry D. Nelson
  • Law Firms: Foley & Lardner LLP - Milwaukee Office ; Foley & Lardner LLP - Madison Office
  • Routine examinations by the SEC at advisory firms who manage the assets of private equity funds have uncovered some serious concerns about the way such advisers calculate fees and allocate expenses. According to Andrew J. Bowden, the director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), recently reported on the results of examinations conducted to date by the OCIE of nearly 150 newly SEC registered private equity advisers.

    According to Director Bowden, the private equity adviser model presents certain types of violations not usually associated with advisers who do not manage private equity funds. One example noted by the Director is that the limited partnership agreement for a private equity limited partnership oftentimes lacks specificity as to what expenses the fund will be responsible for versus the fund manager. Consequently, the staff of the OCIE oftentimes finds that the adviser is billing the fund for expenses that are typically the responsibility of the adviser. In addition, the private placement memorandum for the fund may not clearly itemize for prospective investors the expenses to be covered by the fund versus the adviser and also sometimes lacks a clear methodology of how assets will be valued by the adviser on behalf of the fund. The methodology for valuing the fund’s assets is important as the adviser’s management fee is generally a percentage of the asset value at the end of each quarter. The adviser may be receiving a higher advisory fee based on an inflated value of assets. The OCIE forewarns that such concerns result in violations of the “anti-fraud” provisions under the Investment Advisers Act of 1940.

    Another common deficiency found by the staff according to Director Bowden is the expense of covering undisclosed third party fees that are typically charged to the fund and, of course, absorbed by the investors on a pro rata basis.

    The examination results of the private equity advisers underlines the industry’s need to do a better job in disclosing accurately and fully to investors the coverage of expenses, calculations of fees, and methodologies for determining asset values. According to Director Bowden, a more robust compliance program is what is needed in the industry.