Convergence Insight #7 – SEC Steps up Efforts to Improve Fund Disclosure Failures

Several Advisors affiliated with Apollo Global Management (NYSE:APO) updated their Form ADV filings on August 24th to disclose a series of SEC regulatory actions resulting in $52.7 million in investor reimbursements and related fines. The SEC action highlighted a number of expense disclosure and supervisory matters, including insufficient disclosure around the treatment of monitoring fees collected from its portfolio companies either sold or taken public.  With respect to the action taken on monitoring fees, it is common for private equity Advisors to enter multi-year monitoring fee agreements with the portfolio companies they purchase.  When it exits these companies, they determine how to treat monitoring fees post exit.  Depending on the nature of the exit and their ongoing involvement with the company, they may continue to collect the fees, accelerate the payment of these fees or terminate them altogether.
Although monitoring fees have long disclosed by private equity Advisors, the SEC action focused on the timing and manner in which Apollo disclosed monitoring fees to investors. And just 6 days after the Apollo announcement, the SEC fined the private equity Advisor WL Ross & Co. over $2.3 million dollars for inadequately disclosing management fee practices that led investors to paying higher fees between 2001 and 2011. Based on recent events, the SEC looks to be taking a hard-stance on expense disclosure practices of private equity firms.
Convergence’s Fund Expense Practices Analyzer (FEPA) benchmarks Advisors against their peers to highlight common versus uncommon expense disclosures.  FEPA is also used to ensure proper alignment among the ADV Part 2A Brochure, the fund’s Limited Partnership Agreement and the fund’s marketing materials.  Our monitoring tools found recently that Apollo added the following passage in the “Fees and Expenses” section of their brochure; “Monitoring fees typically consist of recurring fees by an Apollo Private Equity Manager for certain consulting services provided to portfolio companies. In the event of an initial public offering, monitoring fees may continue to be paid so long as the applicable Client continues to hold an other than de minimis position in such portfolio company.” Equipped with this data, investors and compliance personnel are better armed with industry wide disclosure information that will raise the right questions.
Expense disclosures are a key area of focus for the SEC.  Andrew Ceresny, director of the SEC Enforcement Division, recently said “A common theme in our recent enforcement actions against private-equity firms is their failure to properly disclose fees and conflicts of interest to fund investors… Investors in Apollo funds were not adequately informed about accelerated monitoring fees and separately allocated loan interest, and therefore were unable to gauge their impact on their investments,” (SEC[1]).  Six percent of the Private Equity Advisors in the Convergence database report a regulatory action and based on the observations we have gleaned from our database roughly 70% of similar Advisors may find themselves facing similar actions.

[1] Quote taken from SEC press release