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A $40k reminder about fiduciary duty

A relatively small settlement with the SEC points to a much bigger issue of note for PE firms.

On April 23, the Securities and Exchange Commission fined fund manager Charter Capital Management and its founder, Steven Bruce, $40,000 for breaching their fiduciary duty [per the Advisers Act] to investors. The firm allegedly mischaracterized the amount of due diligence it performed before making a $4 million loan from its two funds to a Norwegian individual and his company.

“The Norwegian individual and his entity promised the funds would receive payment of $40 million in 90 days,” the SEC wrote in its document. “The Norwegian company made an initial payment of $1.5 million, but never paid the remaining $38.5 million it promised – leaving the funds with a loss of $2.5 million.”

Bruce’s due diligence consisted of 30 phone calls to the Norwegian individual to discuss his investment strategy between July and August 2016 before entering into a loan agreement on August 18 that same year. Along with the phone calls, which totaled between four and five hours, Bruce also performed “some Google searches on the Norwegian individual,” the agency stated. He then mischaracterized this as “a great deal of time doing […] diligence on the investment strategy and [the Norwegian individual’s] credentials” in an email to investors, according to the SEC.

Private fund managers will have their own opinions as to what would have constituted adequate due diligence on an overseas investment opportunity that promised a 10x in 90 days. Presumably, site visits would be high on the list.

There are a number of steps PE managers can take to avoid a breach of fiduciary duty and fulfill their obligation to investors to avoid any possible repercussions from the SEC.

Todd Cipperman, the founding principal of Cipperman Compliance Services, highlights the need to have policies and procedures around investment activity that can be tested by the compliance officer. He also points to a larger issue that has existed since the introduction of Dodd-Frank, which required firms to register under the Advisers Act, thereby triggering a fiduciary duty.

“Before Dodd-Frank, fund managers worried only about 10b-5: ie, that they disclosed all material information,” Cipperman says. “The fiduciary obligation is much greater than that. You must put the client’s interest above your own, and you can’t benefit in your position vis-à-vis the client. It’s a huge difference, and I think a lot of PE managers and fund managers don’t understand this higher standard of care; they still think that as long as the disclosure is sufficient, they have complied with applicable legal requirements. But they are wrong.”

The Institutional Limited Partners Association and 35 of its members wrote to the SEC in February with suggestions for the steps the SEC could take to “ensure that the fiduciary duties are meaningful in the private equity industry.”