The SEC has been active in the private equity space recently after being relatively quiet for some time. A recent enforcement action serves as a reminder for fund sponsors that regulators are continuing to look at fund sponsors’ practices relating to “operating partners,” particularly in the context of disclosures to limited partners.

The SEC has long focused on conflicts of interest and disclosures relating to practices that involve compensation to the adviser or related parties. Most recently, a private equity sponsor agreed to a settlement alleging a failure to adequately disclose how its in-house group of operating partners was compensated for its services. The SEC found that instead of covering such costs through the sponsor’s management fee, the firm had billed portfolio companies for its operating partners’ services related to business improvements without “fully or fairly” disclosing the practice to, or obtaining consent from, its limited partners.

The SEC alleged that the practice was not adequately disclosed in the applicable limited partnership agreement. While the adviser did state in its 2014 form ADV brochure that the firm “may” be reimbursed for costs related to services provided to portfolio companies “under specific circumstances,” the SEC found that disclosure lacking. The settlement order alleged that the sponsor “routinely provide[d] such services, that it did, in fact, receive reimbursements from portfolio companies for such services, and that the reimbursement rates were designed to recoup most (but not all) of the firm’s costs of maintaining its operations group.” Along with an SEC censure, the sponsor agreed to a civil monetary penalty, disgorgement, and prejudgment interest for its failure to disclose.

In the absence of full disclosure, the SEC may view reimbursements to advisers for items such as operating partner services as additional compensation, ultimately paid by the fund (through its portfolio companies). For years, the SEC has been signaling that it is focused on disclosure and expense allocations relating to operating partners. Since former Director of OCIE Andrew Bowden gave a speech titled Spreading Sunshine in Private Equity in May 2014, OCIE supervisors have noted concern about operating partners who function as sponsor employees but whose services are expensed directly or indirectly to the fund rather than paid by the adviser. Based on this recent settlement, we can likely expect to see continued SEC scrutiny on fund managers’ historical practices and disclosure.

We have added this order to our database tracking SEC enforcement actions involving private equity advisers, available here.

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Photo of Hena M. Vora Hena M. Vora

Hena M. Vora is an associate in the Litigation Department and a member of the Asset Management Litigation practice and Products Liability group. Her practice encompasses a range of complex civil and commercial litigation matters, including securities litigation, partnership disputes, and consumer products.…

Hena M. Vora is an associate in the Litigation Department and a member of the Asset Management Litigation practice and Products Liability group. Her practice encompasses a range of complex civil and commercial litigation matters, including securities litigation, partnership disputes, and consumer products.

Hena has experience with various stages of litigation, including pitching clients, coordinating discovery, drafting dispositive motions and trial memoranda, and preparing witnesses for depositions and trial. She also has experience conducting highly sensitive and confidential internal investigations.

Hena maintains an active pro bono practice and has been awarded for creating a partnership between Proskauer’s Boston office and Minds Matter Boston, through which she helps high school students from low-income backgrounds achieve college readiness and success.

Hena earned her J.D. from Emory University School of Law, where she received the Pro Bono Publico honor and a Transactional Law Certificate. In addition, she was a national competitor on the Moot Court Society and served as president of Emory’s South Asian Law Students Association. While at Emory, Hena served as judicial intern for Judge Denny Chin at the U.S. Court of Appeals for the Second Circuit.

Photo of Joshua M. Newville Joshua M. Newville

Joshua M. Newville is a partner in the Litigation Department and a member of Proskauer’s White Collar Defense & Investigations Group and the Asset Management Litigation team.

Josh handles securities litigation, enforcement and regulatory matters, representing corporations and senior executives in civil and…

Joshua M. Newville is a partner in the Litigation Department and a member of Proskauer’s White Collar Defense & Investigations Group and the Asset Management Litigation team.

Josh handles securities litigation, enforcement and regulatory matters, representing corporations and senior executives in civil and criminal investigations. In addition, Josh advises registered investment advisers and private fund managers on regulatory compliance, SEC exams, MNPI/insider trading and related risks.

Before joining Proskauer, Josh was senior counsel in the U.S. Securities and Exchange Commission’s Division of Enforcement, where he investigated and prosecuted violations of the federal securities laws. Josh served in the Enforcement Division’s Asset Management Unit, a specialized unit focusing on investment advisers and the asset management industry. His prior experience with the SEC provides a unique perspective to help asset managers manage risk and handle regulatory issues.

Photo of Michael R. Hackett Michael R. Hackett

Mike Hackett is a partner in the Litigation Department and Co-Head of the Asset Management Litigation practice. An experienced litigator and trial lawyer, Mike’s practice focuses on complex commercial litigation, with a particular emphasis on asset management, financial services, M&A, shareholder, and life…

Mike Hackett is a partner in the Litigation Department and Co-Head of the Asset Management Litigation practice. An experienced litigator and trial lawyer, Mike’s practice focuses on complex commercial litigation, with a particular emphasis on asset management, financial services, M&A, shareholder, and life sciences disputes.

A significant portion of Mike’s practice concerns disputes and regulation involving private funds, including private equity, venture capital, hedge, real estate and private credit funds, as well as their sponsors, partners, investors, portfolio companies, and officers and directors. Mike’s experience representing private fund clients runs the gamut, from control contests within advisers, to disputes between limited partners and general partners, to representation of investment advisers in connection with regulatory examinations, investigations and enforcement matters. Mike routinely represents funds, fund sponsors, portfolio companies, and their officers and directors, including in significant post-closing M&A disputes.

Mike also litigates high-stakes commercial disputes in the life sciences and financial services areas, including for established pharmaceutical and biotechnology companies, emerging and innovative start-ups, asset managers, and other private capital investors, in areas such as M&A, breach of contract, indemnification, fraud, contested earnouts and royalties, securities and capital markets, and corporate governance.

Mike has been recognized by Chambers USA and was named a “Rising Star” by Massachusetts Super Lawyers.