Sep. 1, 2016

Proper Disclosure of Fee and Expense Allocations Is Crucial for Managers to Avoid SEC Enforcement Action

SEC scrutiny of fee and expense practices by private equity fund managers continues unabated with its recent enforcement action against publicly traded private equity firm Apollo Global Management, LLC (Apollo). See “SEC Enforcement Director Highlights Increased Focus on Undisclosed Private Equity Fees and Expenses” (May 19, 2016). The SEC identified three issues resulting in securities law violations, including inadequate disclosure of accelerated monitoring fees paid by portfolio companies to Apollo-controlled investment advisers; material misrepresentations in a fund’s financial statements regarding the allocation of interest on a loan from the fund to its general partner; and failure to supervise a partner who passed personal expenses through to funds and portfolio companies. This article summarizes the facts precipitating the SEC’s action, Apollo’s alleged violations and the terms of the settlement. The SEC’s action against Apollo is one in a string of recent enforcement actions that have addressed a variety of fee and expense practices, including legal fees, monitoring fee offsets, broken deal expenses, failure to follow allocation policies and allocation methodology. For coverage of another SEC enforcement action involving the undisclosed acceleration of monitoring fees, see “Blackstone Settles SEC Charges Over Undisclosed Fee Practices” (Oct. 22, 2015). For best practices on allocating expenses between managers and their funds, see “Expense Allocation and Fee Practices Fund Managers Should Avoid to Reduce Risk of SEC Scrutiny (Part One of Three)” (Aug. 25, 2016). 

Former SEC Senior Counsel Offers Insight on SEC Enforcement Focus and Priorities

Jamie Lynn Walter recently joined Kirkland & Ellis in Washington, D.C., to help build the office’s investment funds group. Walter last served as a Senior Counsel in the Private Funds Branch of the Division of Investment Management at the SEC, where she provided legal advice and guidance on a wide range of matters involving the regulation of investment advisers and investment funds, including private funds, mutual funds and exchange-traded funds. She made significant contributions to several agency rules and was integral in developing the SEC’s December 2015 proposed rule entitled “Use of Derivatives by Registered Investment Companies and Business Development Companies.” In connection with her joining Kirkland & Ellis, the Hedge Fund Law Report recently interviewed Walter about several topics important to hedge fund managers. This article sets forth Walter’s thoughts on the current regulatory landscape, including current areas of SEC focus; the interaction between the Commission and fund advisers; patterns in SEC enforcement; and regulatory priorities. For additional insight from Kirkland & Ellis attorneys, see “Portability and Protection of Hedge Fund Investment Track Records” (Nov. 10, 2011); and our two-part series on remote SEC examinations: “What Hedge Fund Managers Can Expect” (May 12, 2016); and “How Hedge Fund Managers Can Prepare” (May 19, 2016).

CFTC Proposes Rule to Clarify Registration Obligations of Foreign CPOs and CTAs

The Commodity Futures Trading Commission (CFTC) recently proposed to amend its rules to resolve ambiguity regarding whether certain commodity pool operators (CPOs) and commodity trading advisors (CTAs) located outside the United States are required to register. In a guest article, Nathan A. Howell and Joseph E. Schwartz, partner and associate, respectively, at Sidley Austin, review the recent rule proposal by the CFTC, along with the legislative history preceding it, and examine how the proposal would clarify the regulation requirements of foreign CPOs and CTAs. For additional insight from Sidley Austin partners, see “E.U. Market Abuse Scenarios Hedge Fund Managers Must Consider” (Dec. 17, 2015); “Recommended Actions for Hedge Fund Managers in Light of SEC Enforcement Trends” (Oct. 22, 2015); and coverage of Sidley Austin’s private funds event in New York City: Part One (Sep. 25, 2014); and Part Two (Oct. 2, 2014). For discussion of other CFTC regulatory matters, see “Hedge Fund Managers Face Imminent NFA Cybersecurity Deadline” (Feb. 25, 2016); and “CFTC Allows Hedge Fund Managers to Advertise” (Sep. 18, 2014).

Practical Guidance From Former SEC Examiners on Preparing for and Surviving SEC Examinations

With the SEC continuing to focus on investment adviser compliance, a recent presentation hosted by compliance solutions provider MyComplianceOffice (MCO) and compliance consultant NorthPoint Compliance offered timely and practical guidance on preparing for SEC examinations, the examination process and examination trends. The program was moderated by Stephen Taylor, chief commercial officer at MCO, and featured Victoria Hogan, NorthPoint’s president, and Colleen Montemarano, a NorthPoint consultant, each of whom has more than six years’ experience as an SEC compliance examiner. This article highlights the key insights from the presentation. For another discussion of the exam process, see our two-part series: “What Hedge Fund Managers Need to Know About Getting Through an SEC Examination” (Jun. 16, 2016); and “Fees, Conflicts, Investment Allocations and Other Hot Topics” (Jun. 30, 2016).

How Managers May Address Increasing Demands of Limited Partners for Standardized Reporting of Fund Fees and Expenses

In an attempt to regulate the private funds industry, the SEC has set various disclosure requirements for general partners. Unless properly communicated to limited partners through disclosure meeting these requirements, even perfectly legal activities and management fees may result in penalties for general partners. Furthermore, limited partners often seek disclosure exceeding SEC requirements to properly ascertain the actual cost – beyond the stated management fees – of investing in a fund. In addition to requiring more fulsome disclosure, limited partners, whose informational needs can be widely disparate even in the context of a single fund, are increasingly seeking standardization of the format of fee and expense disclosures from general partners. To facilitate this objective, a new template for reporting and disclosing information was recently introduced and has been positively – yet tentatively – received by the industry. These developments were addressed in a recent installment of the monthly webinar series provided by the Investment Management Due Diligence Association. The presenters were David B. Parrish, a partner at Jackson Walker, and Lorelei Graye, a consultant for Conifer Financial Services. This article outlines the key takeaways from the discussion. For more on expense allocations and disclosure, see “Battle-Tested Best Practices for Private Fund Expense Allocations” (Oct. 10, 2014); and our two-part series entitled “How Should Hedge Fund Managers Approach the Allocation of Expenses Among Their Firms and Their Funds?”: Part One (May 2, 2013); and Part Two (May 9, 2013). 

Reed Smith Gains Investment Management Counsel in New York

Reed Smith has expanded its investment management and financial services practice in New York with the hiring of Avi Navo as counsel. Navo has broad expertise in the funds space, particularly in transactions involving domestic and international hedge funds and funds-of-funds. Navo is the latest in a string of former in-house practitioners to join Reed Smith. See “Reed Smith Financial Industry Group Adds Matthew J. Bromberg in New York” (Aug. 27, 2015); and “Reed Smith Adds Former General Counsel of UBS Global Asset Management’s Alternative and Quantitative Investments Group” (Apr. 18, 2014).