In the proposed Private Fund Reform Rules, the Securities and Exchange Commission had contemplated a ban on charging a portfolio investment for monitoring, servicing, consulting, or other fees in respect of any services the investment adviser does not, or does not reasonably expect to, provide to the portfolio investment. This was an attack on a practice of some private equity firms to enter into a long term agreement with a portfolio company to enter into long term contracts, then have unexpired terms paid at exit.
That ban was dropped as an explicit rule from the reforms package. Instead the SEC made it an implicit rule.
The SEC stated on page 250:
“We believe that charging a client fees for unperformed services (including indirectly by charging fees to a portfolio investment held by the fund) where the adviser does not, or does not reasonably expect to, provide such services is inconsistent with an adviser’s fiduciary duty.”
The SEC also points out that it has brought actions in the past under Section 206(2) against private fund managers for improperly charging monitoring, servicing, consulting, or other fees, which may accelerate upon the occurrence of certain events, to a portfolio investment.
It did so again this week with charges against American Infrastructure Funds because it accelerated a portfolio company monitoring fee without timely disclosure to clients or investors. The SEC’s order also finds that American Infrastructure Funds violated its duty of care by failing to consider whether the fee acceleration was in its clients’ best interest.
I’m not sure why the SEC pulled back and didn’t make the accelerated fee ban explicit. The whole purpose of the series of 206(4) rules is to allow the SEC to “define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.” Instead, the SEC is relying on regulation by enforcement under the fiduciary standard.
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