Keep records of expenses for SEC scrutiny

An industry executive says the regulator wants to ensure that expenses aren’t excessive and investors aren’t billed inappropriately.

Private debt firms should keep records of their expenses available in case of an inspection from regulators, an industry executive cautioned at the inaugural CFOs & COOs Forum of sister publication Private Debt Investor this week.

Speaking at the event in New York, the executive said that the Securities and Exchange Commission could scrutinize certain expenses billed to the fund as excessive if it comes knocking. This person used dinner expenses as an example; in the SEC’s view, the dinner itself could be justified as an expense to the fund, but billing for after-dinner expenditures such as drinks taken from a minibar at the hotel room may not be appropriate.

Investors have been seeking greater transparency on fees and expenses. Some states such as California have laws that mandate general partnerships disclose such charges to state pension funds.

The executive said the SEC will look at a firm’s policies and procedures, and ensure that the expenses were made accordingly. Regulators also look at expenses not only on the sense of accuracy of allocation or disclosure but also to make sure of no excessive expenses, he said.

“Very often, a business person would travel to check a deal, or spend money to vet a deal and the deal could be allocated to a number of funds. And when the deal is done, the regulators will look to make sure that the expenses were allocated appropriately and not necessarily to the fund that made more money and less expenses were allocated to the fund that made less money,” he said.

In addition, the Tax Cuts and Jobs Act eliminated the deduction on entertainment expenses from this year, so that creates additional challenges for how companies such as private credit firms tackle expenses tied to entertaining clients.

Tax structures

There was a separate discussion on the use of tax structures for non-US based investors. In a poll of 25 respondents at the conference, 40 percent said they used leverage blocker the most for tax structures. That was followed by real estate investment trust (20 percent), season and sell (16 percent), treaty-based structure (16 percent) and business development company/registered investment company (8 percent).

The leverage blocker structure shields non-US investors from effectively connected income taxation and return filing obligations, and US tax-exempt investors from taxation on unrelated business taxable income.

One fund manager has deployed some of the structures listed in the poll, but said that as his firm takes up more credit, it could use the season and sell structure. That strategy is designed to allow non-US investors the benefit of US statutory trading safe harbors.