Charging Fund Investors For In-House Legal Staff

In house lawyers fall into two sections of typical fund documents. On one had, fund documents usually state that the fund pays for legal expenses. Another section states that the general partner is responsible for employee expenses.

Can you charge in-house legal staff as a fund expense?

It depends.

This was mentioned by Marc Wyatt, Deputy Director – Office of Compliance Inspections and Examination, US Securities and Exchange Commission, at PEI’s Private Fund Compliance Forum 2015.

It’s not that a fund manager is prohibited from charging its fund clients for in-house legal counsel. As with any fee or expense, it needs to be properly disclosed and properly documented.

I have heard that at least one real estate private fund manager has received a deficiency letter after an examination because of the way it treated legal expenses. The fund manager charged internal legal staff compensation and expenses to the fund.

The SEC relied on the provisions in the fund documents stating that overhead, including compensation of personnel, is to be paid by the general partner / fund manager.

The general partner / fund manager pointed to other language that stated it could charge the funds for legal expenses.

I think the SEC thinks that in the case of a tie, the fund investors should win.

If you charge in house legal fees to fund investors, there are some steps a fund manager should take:

• Disclose it on Form ADV.
• Disclose it in the financial statements for the funds. To be in accordance with GAAP, related party transactions must be included in the notes to the financial statements.
• Maintain timesheets and other documents to support the time or work of in-house legal staff.
• Maintain written policies and procedures to address when the expenses should be paid by the fund and when they should be paid by the fund manager.

It may not actually be costing the fund any more for in-house versus outside cost. In fact, it may actually be cheaper.  But it is extra revenue to the fund manager. The SEC has indicated that it cares about that difference.