The Securities and Exchange Commission’s Enforcement Division had a very busy year. In total, the agency levied $4.3 billion in monetary penalties in fiscal year 2019, with 191 cases brought against investment advisors and investment companies – 36 percent of the total and a nearly 77 percent increase on FY 2018.

“The SEC basically is the Enforcement Division, at this point,” says Todd Cipperman, a compliance consultant. On the other hand, says Alma Angotti, a former senior SEC enforcement official: “They are focusing on the basics… It’s a direct shift from the ‘broken windows’ approach they had taken for a while that had gotten so much criticism.”


Increase in SEC actions against private funds in 2019

Actions against private funds, and individuals associated with them, appear to support that theory – most were for fundamental compliance failures, along with one for a major alleged fraud.

Here, we give a timeline of major enforcement actions against private funds in FY 2019, and summarize some key takeaways, but it’s going to get more complex in 2020.

Industry players also noted actions against firms and individuals for improper valuations, as well as a high-level instance of a former SEC enforcement agent getting caught in the revolving door. He was federally indicted for allegedly leaking details of an ongoing SEC investigation into an alternative asset manager, in order to obtain a job at that manager as… CCO.

With the increase in SEC actions, proposals to loosen restrictions on retail access to private investments and to change marketing rules in the Investment Advisers Act, private fund managers would do well to get their compliance houses in order.

Expensive fee fines

NB Alternatives Advisers (December 17, 2018)
Disgorgement and prejudgment interest: $2.36 million
Civil penalty: $375,000
Total: $2.74 million

Lightyear Capital (January 3)
Civil penalty: $400,000
Total: $400,000

ECP Manager LP (September 27)
Disgorgement and prejudgment interest: $122,304
Civil penalty: $75,000
Total: $197,656

Yucaipa Master Manager (December 13)
Disgorgement and prejudgment interest: $1.93 million
Civil penalty: $1 million
Total: $2.93 million

Topping the list by volume of private fund enforcement actions (especially as regards private equity), were those taken against firms for misallocation of fees and expenses. The SEC made claims against four PE firms for alleged misconduct in that area in FY 2019.

It isn’t a new phenomenon. Some of the most notable settlements with PE firms in recent years have been around misallocation of fees and expense. In 2017, TPG partners was fined $13 million for taking accelerated monitoring fees coming from the sale, IPO and exit of portfolio companies. In 2016, it was Apollo stumping up, at $53 million, and KKR paid out $30 million to the regulator for an alleged $17 million in misallocated fees in 2015.

“They are focusing on the basics… It’s a direct shift from the ‘broken windows’ approach”

Alma Angotti, former SEC official

Lightyear became the most recent private equity firm to fall afoul of rules protecting investors from unfair fees and expenses in December of 2018, settling with the SEC in January over charges it misallocated expenses to its flagship funds. The firm settled without admitting wrongdoing, and voluntarily agreed to reimburse investors for the relevant expenses and fees after a 2016 SEC exam found misconduct.

But Lightyear paid $400,000 to the SEC, which accused the firm of allocating expenses associated with broken deals, legal, insurance, consulting and other fees to its flagship funds between 2000 and 2016. These should have been proportionally charged to co-investors and funds that Lightyear’s employees invested in. All in, the SEC said the flagship funds lost out on $1 million in management fee offsets as a result.

Cipperman Compliance Services suggested that, with a reasonable compliance program, the firm could have avoided overcharging altogether – or discovered the problem and reimbursed investors before the SEC examination. “C-suite executives should re-think the cowboy mentality that ignores compliance until the SEC or a client makes them change,” wrote the firm’s founder, Todd Cipperman.

Fines for this kind of misconduct can get much bigger than $400,000. Just a month before Lightyear’s settlement, a unit of Neuberger Berman settled for $2.73 million for allegedly misallocating compensation-related expenses to three private equity funds it advised. In the same month, Yucaipa settled for just under $3 million over claims it failed to disclose financial conflicts of fees to funds it advised, as well as misallocation of fees and expenses.

And private equity fund advisor ECP Manager LP settled with the SEC for more than $120,000 in September for allegedly charging excessive management fees to investors in its ECP Africa Fund II.

Dubious claims

Abraaj Investment Management (April 11; Amended August 16)
Ongoing. SEC asking federal court for disgorgement, interest and civil monetary penalties. Abraaj Group collapsed in 2018; biggest private equity insolvency in history.

Bluepoint Investment Counsel, et al. (September 30)
Ongoing. SEC asking federal court asking for disgorgement of any ill-gotten gains, civil penalties and other appropriate relief.

As far as compliance imperatives go, “don’t commit fraud” is the most straightforward. The SEC charged Dubai-based Abraaj Growth Markets Health Fund and its founder Arif Naqvi with misappropriating $230 million of money raised for investment in emerging markets health care-related businesses. The SEC claimed the money was used to cover cash shortfalls at Abraaj IM and its holding company parent. Abraaj Group folded in 2018, before any charges were levied, after investors complained about misuse of their funds, according to reports.

“C-suite executives should re-think the cowboy mentality that ignores compliance until the SEC or a client makes them change”

Todd Cipperman, Cipperman Compliance Services

Navqi was arrested in London in April. In June, a judge unsealed an updated indictment that included several other executives, laying out details of alleged deceit, bribery and personal enrichment. That indictment claimed the group manipulated the valuation – conducted internally – of another fund, prompting speculation that LPs may renew calls for LPAs to mandate external valuations and valuation reviews. And in July, Dubai’s financial regulator fined Abraaj IM and Abraaj Capital Limited a combined $315 million – but that is surely not the last Abraaj will hear from regulators and prosecutors.

Abraaj wasn’t alone in being charged with fraud. Bluepoint Investment Council, its co-owner Michael Hull, his Greenpoint Asset Management, as well as Christopher J Nohl and his firm Chrysalis Financial were all charged with fraud in September for their operation of Wisconsin-based Greenpoint Tactical Income Fund. The SEC claims, among other things, that the men and their entities were paid $6 million in fees even as they told investors that the fund was illiquid and couldn’t meet redemption requests.

Too many hats

Corinthian Capital Group (May 6)
Civil penalty: $100,000
Civil penalty (CEO): $25,000
Civil penalty (former CFO-CCO): $15,000
Total: $140,000

ED Capital Management (September 13)
Civil penalty: $75,000
Civil penalty (managing member, sole owner and CCO): $25,000
Total: $100,000

Two cases illustrate that the SEC harbors a special distaste for failures in compliance at firms where the CCO also plays another executive role. “The SEC hates dual-hat compliance officer model, where an executive assumes the CCO role but doesn’t really know what he or she is doing,” says Cipperman. It is also the kind of thing the SEC likes to fine both firms and individual executives for.

Corinthian settled with the SEC for $100,000 and chief executive officer Peter Van Raalte was ordered to pay $25,000 for not properly overseeing its former CFO-CCO David Tahan, who agreed to pay $15,000. All settled without admitting guilt.

The case grew out of a 2014 exam by the Office of Compliance Inspections and Examinations. In 2017, Corinthian’s auditor withdrew its unqualified opinion because the advisor had misclassified expenses (though “most of these expenses were misclassified before Tahan joined the firm,” the SEC said). That resulted in overcharging one of its funds. For three years, the firm also missed its 120-day deadline to issue audited financials to investors, violating the custody rule.

The list of alleged offenses went on: the SEC said Tahan arranged an improper loan between the fund and the firm to meet a clean-up provision on a bank credit line.

In September, Elliot Daniloff (aka Ilya Olegovich Danilov), the Brooklyn-based managing member, sole owner and CCO of ED Capital Manager settled with the SEC for allegedly failing to provide audited financial statements for four years. The firm, a small investment advisor and manager of private funds, was also fined and censured. Neither the firm nor its many-hatted CCO admitted guilt.