News & Events

SEC Settles Charges with Private Equity Firm and Four Executives for Failure to Disclose Conflicts of Interest

SEC Settles Charges with Private Equity Firm and Four Executives for Failure to Disclose Conflicts of Interest

The SEC recently reached a settlement with New York-based private equity firm, Fenway Partners, LLC, and four executives related to charges that Fenway Partners and several of its executives (“Respondents”) failed to disclose conflicts of interest to a fund client and its investors. Unbeknownst to the fund, Fenway Partners made payments to former firm employees and an affiliated entity, Fenway Consulting, without disclosing the conflicts of interest. The transactions involved more than $20 million for consulting services and other services provided by Fenway Partners employees while still employed with the company.

Fenway Partners served as an investment adviser to a private equity fund called Fenway Partners Capital Funds III, L.P. (“Fund III”), for which services Fund III paid Fenway Partners an advisory fee. Fund III’s portfolio was comprised primarily of investments in branded consumer products and logistics companies. Fenway Partners entered into Management Services Agreements (each, an “MSA”) with some of the portfolio companies to provide management and other services in exchange for a fee (“Management Fees”). These Management Fees were offset against the advisory fee already being paid by Fund III to Fenway Partners.

Respondents caused Fund III to terminate their MSAs and enter into similar agreements (“Consulting Agreements”) with Fenway Consulting Partners, LLC (“Fenway Consulting”), which was affiliated with Fenway Partners and was owned and operated by three Fenway Partners employees. Although the services provided by Fenway Consulting were similar, the fees paid to it were not offset against the advisory fee, which resulted in a significant increase in the advisory fee to Fund III.

Additionally, Fenway Partners asked Fund III to provide $4 million for a potential investment in equity securities of a certain company and failed to disclose that $1 million of those funds would be used to pay its affiliate, Fenway Consulting. Fenway Partners also sold its equity interest in a second company, and did not disclose that two of its former employees were included in the company’s cash incentive plan, which resulted in a $15 million payout to those individuals from the proceeds of the sale and reduced Fund III’s return on the investment.

The SEC investigated these transactions and brought charges against Respondents. “Fenway Partners and its principals failed to tell their fund client that they rerouted portfolio company fees to an affiliate, and avoided providing the benefits of those fees to the fund client in the form of management fee offsets,” said Andrew J. Ceresney, Director of the SEC Enforcement Division. “Private equity advisers must be particularly vigilant about conflicts of interest and disclosure when entering into arrangements with affiliates that benefit them at the expense of their fund clients or when receiving payments from portfolio companies.”

The SEC charged that Respondents violated or caused violations of Section 206(2) of the Advisers Act, which prohibits an investment adviser from engaging in “any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” A violation of Section 206(2) can be proven by a finding of simple negligence, and scienter need not be established.

To settle these charges, Fenway Partners and three principals agreed to jointly and severally pay disgorgement of over $8.7 million. They and the fourth principal agreed to pay civil penalties of $1.525 million; the total of which will be placed into a fund for harmed investors. The disgorgement funds were required to be deposited within ten days of the cease-and-desist order’s entry.

This SEC enforcement action illustrates the SEC’s continued focus on disclosures related to advisers’ transactions with affiliated or related entities. Especially for private equity fund advisers, disclosures related to consulting, monitoring, and managing agreements should be carefully reviewed to ensure adequate disclosure of the relationship between the adviser and any affiliated company and any relevant compensation arrangements have been made. In the event a conflict of interest, as defined by Section 206(2), is identified, advisers should carefully document the disclosure of the conflict and all material facts.

Haley Fowler Gregory

GregoryHaley1705xc