Marc Wyatt had been on the job for 16 days as the Acting Director Office of Compliance Inspections and Examinations when he took his first shots at private fund managers. He took a shot directly at real estate fund managers and indirectly at other types of fund managers with vertical integration.
The Speech
While we found that sometimes these ancillary services are indeed not disclosed, a more frequent observation was that investors have allowed the manager to charge these additional fees based on the understanding that the fees would be at or below a market rate. Unfortunately, we rarely saw that the vertically integrated manager was able to substantiate claims that such fees are “at market or lower.”
In-House Counsel
I particularly noted that Mr. Wyatt included charges for a fund’s in-house attorneys as part of vertical integration. It’s tucked into the real estate advisers portion of the speech, but I’ve seen fund managers in many industries charge in-house lawyers’ time to funds and portfolio companies.
There is nothing inherently wrong with charging this expense, provided it is disclosed to investors. If it’s not disclosed, the explanation is that the services are being provided at less expense than if the fund manager engaged outside counsel.
Mr. Wyatt raises the concern that fund managers are not documenting the cost savings. If a fund manager is claiming that the expense is “at market or lower” the manager needs to be able to prove it.
For in-house counsel, that may be as easy as documenting the costs when using outside counsel and comparing rates.
Property Management, Construction Management and Leasing Agents
The specific concern in Mr. Wyatt’s speech was for real estate fund managers that have their own property management, construction or leasing divisions. Again, there is nothing inherently wrong with this integration and charging the expenses as long as it is disclosed to investors.
If the fund manager is claiming that it is charging these expenses “at market or lower”, the fund manager needs to prove this statement is true. The SEC exam team will be looking for good benchmarks to substantiate the claims. Anecdotal evidence will not suffice.
Sources:
- Private Equity: A Look Back and a Glimpse Ahead a speech by Marc Wyatt, Acting Director, Office of Compliance Inspections and Examinations
- What To Expect From The SEC In The Year Ahead
Boston Skyline is by Dennis Forgione
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