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October 2014 Archives

Misallocation of Company Expenses Cost Firm $2.3 Million

  images Lincolnshire Management, Inc. ("LMI") has reached a settlement agreement with the Securities and Exchange Commission ("SEC") for sharing expenses between two companies' portfolios in a manner that improperly benefited one fund over the other. This settles charges that the SEC brought against LMI for violation Section 206(2) of the Advisers Act, and for breaching its fiduciary duty to the private equity funds. Although the firm neither admitted, nor denied fault, LMI agreed to pay more than $2.3 million to settle the SEC's charges through disgorgement of $1,500,000, prejudgment interest of $358,112, and a civil penalty of $450,000. LMI's allegedly integrated two portfolio companies owned by different LMI-advised funds and managed them as one company. LMI disclosed to the two fund's limited partners, its intention to integrate the two portfolio companies, and later sell them together. However, "neither of the companies had any written agreements relating to sharing or allocating expenses, and there were no documents setting forth the parties' respective rights and obligations toward each other." Subsequently, part of the shared expenses was directed only to one company and went undocumented. During the eight-year period that LMI integrated the two companies, administrative expenses covered by one company were paid for by the other, but the expenses were never reimbursed. In addition to these administrative expenses, there were several employees who performed work that benefitted both companies, but their salaries were only allocated to one company. As a result, one of the portfolio companies paid more than its share of expenses, even though both companies were benefitted. Julie M. Riewe, Co-Chief of the SEC Enforcement Division's Asset Management Unit said, "Lincolnshire's decision to integrate two portfolio companies owned by separate private equity funds resulted in the misallocation of expenses between the two companies." This in effect breached LMI's fiduciary duty owed to both funds. Moreover, the SEC charged LMI with violating Section 206(4) of the Advisers Act and Rule 206(4)-7 by failing to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act arising from the integration of the two portfolio companies. This case is the SEC's first enforcement action against a private equity firm for misallocation of expenses in ordinary funds. Furthermore, the SEC has not alleged that LMI acted in bad faith or directly benefited from integrating these expenses. This fact further indicates a growing trend that the SEC intends to bring more non-fraudulent based cases in private equity and other industries. For more information on this and other related subjects, please contact us at [email protected]  or (619) 298-2880.

Washington-Based Advisory Firm Cited for Disclosure and Reporting Failures

SECpic The Securities Exchange Commission ("SEC") has recently charged Strategic Capital, LLC ("Strategic Capital") an independent advisory firm in the state of Washington, for violating rules 203(e) and 203(k)  the Investment Advisers Act of 1940,("Advisors Act"). Strategic Capital distributed "false and misleading advertisements" by failing to disclose that the published results were partially based on returns of an index rather than the actual returns.  In another advertisement, the firm printed results that did not reflect deducted fees, which overstated their investment performance.  "Investment advisers must be fully forthcoming about how they execute client trades and portray past performance," said Marshall S. Sprung, Co-Chief of the SEC Enforcement Division's Asset Management Unit. The thorough investigation by the SEC revealed also that Strategic Capital and its CEO N. Gary Price also had "engaged in more than 1,100 principal transactions" through its brokerage firm, RP Capital LLC without properly disclosing the information to clients.  When engaging in principal transactions, firms must not only disclose this information to clients, but must also obtain the client's consent.  In this case, Strategic Capital failed to do both.  According to the SEC, Strategic Capital clients did not receive best execution from the firm thereby further breaching their obligations under the Advisers Act. "Strategic Capital clients were not provided all of the information they needed to evaluate the firm's potential conflicts of interest and investment management skills," said Sprung. Although the firm and CEO did not admit or deny to any wrong doing, they have agreed to pay $368,459 to current and former clients.  The firm also must pay prejudgment interest of $17,831 and a penalty of $200,000. It is imperative for personnel of investment advisors to understand the regulatory provisions of the Advisors Act and how they apply to the business. For further information on this and other related subjects, please contact us at [email protected]  or (619) 298-2880.  

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