SEC charges firm with misallocating expenses

Despite not undergoing a presence exam, Lincolnshire Management ended up paying a $2.3m settlement for allegedly mishandling portfolio company fees split between two separately managed funds.

In one of its first major cases on private equity fund fees and expenses, the US Securities and Exchange Commission (SEC) charged Lincolnshire Management with misallocating shared expenses between two companies owned by two of its funds. The New York-based private equity firm agreed to pay approximately $2.3 million to settle the charges.

Lincolnshire purchased the first company, Peripheral Computer Support (PCS), through Lincolnshire Equity Fund (LEF) and acquired Computer Technology Solutions (CTS) through follow-on vehicle LEF II. Lincolnshire integrated the two portfolio companies in 2001 and managed them as one entity with shared expenses, despite the fact that they were owned by separate funds with distinct sets of investors.

According to the SEC order, from at least 2005 to January 2013, Lincolnshire improperly benefitted LEF II over LEF by allocating more expenses to PCS. The plan was to allocate expenses based on each company’s contributions to their combined revenue, however “there were times when a portion of the shared expenses were misallocated and went undocumented,” the order said.

For example, PCS paid for all third-party administrative expenses relating to payroll and 401(k) programs for all eight years and did not receive reimbursement from CTS. Moreover, there were employees that performed work benefiting both companies, but their salaries were paid out by only one of the two companies.

Oddly Lincolnshire did not undergo a presence exam before the charges were filed. The firm registered as an investment advisor in March 2012, a few months shy of when GPs managing north of $150 million were forced to register as part of Dodd-Frank.

“We have no idea why they took an interest in us,” said Lincolnshire’s in-house lawyer James McLaughlin in an interview with pfm.

The firm may have been on the regulator’s radar by virtue of previous issues with its expense policies. In 2011, an investor sued the firm for avoiding to pay investor distributions by wrongfully deducting fees, expenses and interest from a $99 million award won by a portfolio holding in another lawsuit.

Market implications  

The case highlights the level of detail SEC inspectors may wish to see in firms’ expense allocation polices and procedures.

“Most private equity firms are used to a certain way of doing business, but now with the increased SEC oversight, they really need to look at expenses,” Charles Lerner of Fiduciary Compliance Associates told pfm. “In this case, it’s clear that nobody was watching.”

The lesson to be learned from the Lincolnshire case, Lerner added, is that firms need a formal process, and every member of the financial and compliance teams needs to understand that process.

The commission’s top inspector, Andrew Bowden, sounded the alarm on fees and expenses earlier this May at the PEI Private Fund Compliance Forum. During a speech he disclosed that half of the 150 funds examined by the SEC uncovered “what we believe are violations of law or material weaknesses in controls.”

Last week at the PE VC Finance and Compliance Forum 2014, hosted by PEI in San Francisco, compliance officers mulled the SEC’s next steps as it nears completion of its two year introductory sweep of the industry. Speaking to pfm reporters on the sidelines, some said they expect at least one marquee name to be caught in the cross hairs.

“I’m sure there’s a number of cases in the pipeline, but expect one of the big players to be made an example of,” one compliance officer in attendance said.