SEC Digging Into Fund Fees
March 19, 2013
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    Focus on Expenses Billed to Investors by Hedge Funds and Private-Equity Firms

    The Securities and Exchange Commission is closely scrutinizing the fees and expenses, including travel and entertainment, that hedge funds and private-equity firms charge to their investors.

    Many managers of hedge funds and private-equity funds—collectively called “private investment advisers”—had long been largely unregulated and therefore had less oversight in how they billed their investors.

    As part of the Dodd-Frank financial law, the SEC now oversees more than 1,500 additional such advisers that were required to register with the agency. In that capacity, the SEC is checking to ensure they are charging their investors reasonable expenses.

    “Exotic” expenses like travel, entertainment and consulting arrangements are more likely to attract the agency’s attention than routine charges like legal and accounting fees, say compliance consultants who advise funds on registration and reporting requirements.

    The hedge fund and private-equity industries are known for putting on occasionally-lavish events, such as SkyBridge Capital’s SkyBridge Alternatives conference at the Bellagio hotel in Las Vegas last year featuring the band Maroon 5.

    The agency asked one hedge fund for receipts of plane travel to a meeting, said Lindsey Simon, founder of Simon Compliance LLC, a Chicago-based boutique law firm. The SEC also wanted to see the meeting agenda in order to confirm the charge “really was the expense the fund was claiming,” Ms. Simon said.

    Robert Kaplan, a former co-head of the SEC’s asset-management enforcement unit, said in some cases, “examiners will ask for the general ledger and go through the expenses charged to the fund line by line. Mr. Kaplan is now a partner at law firm Debevoise & Plimpton LLP.

    Firms may be asked questions such as why they used a private jet or flew first class, when investors were paying for that expense, he said.

    The scrutiny comes as part of the SEC’s new “presence exam” initiative for the firms now falling under the agency’s regulatory umbrella. The program began last fall and is projected to last for two years. During the exams, SEC staff members choose one or two areas, such as conflicts of interest or portfolio management, and examine the books and records of the newly-registered adviser.

    There aren’t specific regulations about what qualifies as expenses that should be charged to the investors or paid by the adviser, but advisers do have a fiduciary duty to act in their clients’ best interest. Typically, in addition to management and performance fees, investors also will pay for legal and accounting charges.

    As long as a fund discloses to investors what they can be charged for, it is generally safe, consultants say. But sometimes the expenses aren’t broken out in investor documents, instead lumped generally under “other expenses” or “research expenses.”

    Some hedge-fund managers believe those disclosures, which are contained within limited-partnership agreements and the fund’s offering documents, should not be regulated by the agency.

    For now, the SEC is asking for a breakdown of those expenses, said people familiar with the agency’s operations, but aren’t necessarily telling firms they aren’t allowed to charge investors for certain items so long as the firm has made the disclosures.

    The agency can still recommend an adviser reimburse investors if the expenses are judged to be inappropriate, according to people familiar with the matter.

    SEC staff examiners may also make recommendations to policy makers at the agency over the next two years regarding expenses and fees.

    An SEC spokesman said fees and expenses have “always been an area of interest for SEC examiners. As fiduciaries, hedge fund advisers need to develop policies and procedures that allocate their fees and expenses fairly.” The advisers should also make clear disclosures, he added.

    Typical performance and management fees are 2% of assets under management and 20% of profits, and additional expenses can reach into the millions of dollars for multibillion-dollar funds.

    Some wealth managers take matters into their own hands. Jonathan Harris, president of Alternative Investment Management LLC, a New York-based investment-management firm that allocates money to hedge funds, says he asks prospective fund managers to break out the list of expenses listed in the investor documents.

    Even when inexpensive items such as newspapers or magazines were listed, Mr. Harris asked the managers not to charge them to the investors. In some cases, they complied.

    Tony Lissuzzo, director of hedge-fund research at Northern Trust Corp., NTRS +0.85% said the onus is on wealth managers and investors to do their own research into a fund’s fees. “At the end of the day, it’s my job to ask the right questions,” he said. “We have to rely on our own work.”