Written by Robert Quinn
Founder & CEO
September sees familiar enforcement actions from the Commission – overcharging management fees, Custody Rule violations and Form ADV violations.
The back-to-school season shows the SEC tutoring firms for violations of requirements that the regulator has raised many times before.
On September 2, 2022, the SEC charged Energy Innovation Capital Management, LLC (“EIC”), an exempt reporting adviser, with charging excess management fees on two venture capital funds. EIC’s fund documents allowed the firm to charge management fees during certain times based on the funds’ invested capital in individual portfolio company securities while also requiring EIC to reduce the basis for these fees if certain events occur, such as write-downs of such securities.
The SEC found that EIC overcharged management fees from 2020 through 2022 by:
EIC agreed to pay a $175,000 penalty after the SEC order found that it violated Sections 206(2), 206(4) and Rule 206(4)-8 of the Investment Advisers Act of 1940 (the “Advisers Act”).
The SEC highlighted that the anti-fraud provisions of the Advisers Act apply to both registered investment advisers and exempt reporting advisers, specifically noting that management fees must be accurately calculated consistent with offering documents.
In addition, on September 9 the SEC charged three registered investment advisers for failure to comply with requirements relating to the safekeeping of client assets or failure to timely update their Form ADV disclosures to reflect the status of audits of financial statements for the private funds they advised. A further six advisers violated both obligations.
The SEC Order noted that the investment advisers failed to have audits performed or to deliver audited financials to investors in certain private funds within 120 days of their fiscal year, which violated Rule 206(4)-2 of the Advisers Act. Further, certain investment advisers failed to promptly amend their Form ADV reflecting that they had received audited financial statements after having initially reported that they had not yet received the audit reports. One adviser did not properly describe the status of its financial statement audits when filing its Form ADV, nor did it update its response in its Form ADV Annual Updating Amendment for several years.
Without admitting or denying the findings, the firms all agreed to be censured, to cease and desist from violating their respective charged provisions, and to pay civil penalties collectively totaling more than $1 million.
Further, on September 12 the SEC charged Hudson Advisors L.P. and Lone Star Global Acquisitions Ltd. for including Hudson’s owner’s anticipated income tax liability as a component of certain fees charged to 14 private equity funds being managed.
According to the SEC’s order, between at least 2005 and 2017, Hudson included $54.6 million of its owner’s anticipated U.S. tax liability in fees charged to the funds. The SEC’s order finds that Hudson and Lone Star Global failed to disclose the inclusion of these tax liabilities to their clients, finding also that Hudson and Lone Star Global were not authorized to charge this fee component without full and fair disclosure to the funds.
Without admitting or denying the SEC’s findings, Hudson and Lone Star Global agreed to a cease-and-desist order finding that they violated Sections 206(2) and 206(4) of the Advisers Act and Rules 204(6)-7 and 206(4)-8 thereunder. Hudson and Lone Star Global have agreed to pay $11.2 million in civil penalties and have reimbursed the affected funds $68.5 million, which includes interest on the undisclosed tax liability charges.