On June 20, 2023, the SEC announced the settlement of administrative proceedings brought against a registered investment adviser that manages various private equity funds that was alleged to have charged excess management fees and to have failed to disclose a conflict of interest related to its fee calculations. The issue arose in connection with the adviser’s application of its permanent impairment policy, which involved the application of criteria developed and applied by the adviser to assess whether an investment was “permanently impaired.”

According to the SEC’s order, if the adviser were to determine that a fund’s portfolio investment was permanently impaired pursuant to its policy, the adviser would be required to reduce the basis used to calculate the management fee the fund pays to the adviser. The adviser thus had an incentive not to determine that an investment was permanently impaired, creating a conflict of interest. The SEC alleged that the adviser did not disclose this conflict. 

The SEC further alleged that the criteria used by the adviser to determine whether a portfolio investment was permanently impaired were “narrow and subjective,” and that the adviser applied the criteria inaccurately by assessing permanent impairment at the aggregated portfolio company level rather than at the individual portfolio investment level, as required by the funds’ limited partnership agreements. As a result, the SEC alleged that the adviser charged the funds $773,754.41 in excess fees during the relevant period. The adviser reimbursed this amount plus interest of $91,203.76 to the funds in May 2023 following the discovery of the matter in a previous investigation by the SEC’s Division of Examinations. 

The SEC found that the adviser willfully violated Section 206(2) of the Investment Advisers Act of 1940, which makes it unlawful for an adviser to engage in fraud or deceit upon any client or prospective client, Section 206(4) of and Rule 206(4)-8 under the Advisers Act, which make it unlawful for any adviser to make a materially false or misleading statement to, or engage in fraudulent, deceptive or manipulative practices with respect to, any investor or prospective investor in a pooled investment vehicle, and Section 206(4) of and Rule 206(4)-7 under the Advisers Act, which require advisers to adopt and implement written policies and procedures reasonably designed to prevent violations. Without admitting or denying the allegations, the adviser agreed to cease and desist from future violations, to be censured, to pay disgorgement and prejudgment interest in the amounts set forth above (which the May 2023 payments noted above were deemed to satisfy) and to pay a $1.5 million civil money penalty. 

The order is available here and the accompanying press release is available here.