Reviewing the receipts

GPs that review the reasonableness of fund expenses, provide appropriate training for staff and establish formal controls around expense allocations are impressing SEC inspectors.

There are various things fund managers can do that will score points with the US Securities and Exchange Commission (SEC). In past Monitors, we’ve mentioned how GPs can put a smile on SEC inspectors’ faces by cutting their vacations short, creating comfortable work environments and showing PowerPoint presentations that explain the firm’s structure and operations. 

But one thing half of GPs still don’t do is write out formal policies to ensure that only reasonable expenses are charged to investors. 

Most limited partnership agreements contain vague expense guidelines, and set caps on how much the fund can be charged for certain items. But generally speaking, limited partners just have to trust their fund managers to fairly allocate expenses like dead deal costs or travel between the management company and its funds.

But the SEC is all about playing it safe, and removing any opportunity for short-cuts. So although it's not a requirement, having a written expense allocation policy is increasingly becoming an “expectation of the SEC and a good practice,” according to Jack Rader, an ACA compliance consultant. Add this to the fact that limited partners are becoming more interested in the way GPs bill due diligence costs or Form PF reporting (for example), and the argument for introducing more formal policies and procedures on expense allocation becomes increasingly compelling.

…although it's not a requirement, having a written expense allocation policy is increasingly becoming an expectation of the SEC and a good practice

Some fund managers have controls in place that would be easy for peers to mimic. For instance, having the chief financial officer, controller or someone else in the finance team review expenses is one practice that's becoming more commonplace. What the CFO can then do is provide staff with a 'cheat-sheet' of key LPA terms that outline how different types of expenses should be allocated between the funds and the management company, as well as specifying any fee caps in place. 

Reviewing the 'reasonableness' of an expense is another control some GPs have introduced. Take dead deal expenses. The CFO can go back and check exactly what due diligence has been completed, and then take a view on what is reasonable to charge to the fund. Billing LPs for the copy of the Wall Street Journal where you first read about attractive energy investment opportunities in Brazil is unlikely to pass that reasonableness test.

Formal, across-the-board staff training is another potentially useful control. After all, it's not just investment professionals involved in this process; often they'll get their associates or assistants to submit expenses on their behalf. And it may not be clear to everyone when an airplane ticket should be billed to the fund (if it's for a portfolio monitoring trip, say) or to the management company (if it's for an executive away-day in another city, say). So having written procedures and policies to follow, and even more importantly, making sure staff understand them – perhaps via case studies or ways to code expenses – reduces the risk of an expense being accidentally charged to the wrong entity.   

Again, it's worth stressing that none of this is technically required – yet. But when the inspectors knock on your door, measures like these may help to get them back out of the door more quickly.