Reed Smith Client Alerts

The Securities and Exchange Commission (the “SEC”) has been scrutinizing transparency of fees and expense allocations by fund managers for several years. Such transparency is required of any fund manager in the United States, as well as any non-US fund manager / adviser that markets its fund(s) to U.S. investors. In 2015, the SEC had charged Kohlberg Kravis Roberts & Co. L.P. (“KKR”) with misallocation of broken-deal expenses. Even though KKR’s co investors, including KKR executives, participated in the firm’s successful transactions efforts, KKR largely did not allocate any portion of these broken-deal expenses to them. In that instance, KKR agreed to a $10 million penalty and to pay more than $14 million in reimbursements.

On September 21, 2017, the SEC announced that it had settled an enforcement proceeding against a private equity fund manager alleging that the manager’s private equity funds were inappropriately allocated, and charged broken-deal expenses attributable to affiliated co-investors.

According to the SEC’s order, from 2004 to 2015, the three main private equity funds of the fund manager (the “PE Funds”) invested in 85 companies, and several co-investors participated in these investments. During this time, the PE Funds incurred expenses attributable to investments that did not proceed to completion. Such expenses are typically defined in the fund documents as “Broken-Deal Expenses” or “Abort Costs.” While the co-investors participated in the fund’s successful transactions and benefited from sourcing of investments (and were allocated proportionate expenses), the fund manager did not allocate any of the broken-deal expenses to the co-investors.