Workshop: Private Fund Fee and Expense Allocations

Transcription

1 Workshop: Private Fund Fee and Expense Allocations November 10, 2015 Presented by Ann Gittleman & Sherif Assef

2 1. Introduction 2

3 Potential Risks for Private Funds Investor skepticism has increased as violations from SEC investigations come to light. SEC findings and potential risks for private funds include the following: During the SEC s examinations of newly-registered private fund advisers, the agency continues to find that advisers have either violated the law or demonstrated material weaknesses in their controls, specifically with regard to the allocation of fees and expenses. Similarly, the SEC has identified inadequate policies and procedures and disclosures to investors. Allocation of Internal Fees/Expenses: Allocations do not reflect substance of activities performed, services provided, and benefits received, thereby potentially diluting investor returns. Risks relate to management fees, related fee offsets, portfolio company fees, monitoring fees, broken deal fees, placement fees, financing fees, deal expenses, and co-investment vehicles. Allocations of third-party consultant costs and/or fund employee salaries. Transparency: Failure to meet fiduciary duties as a private fund by not disclosing information (e.g., fees and expenses) to investors that is required by the SEC. 3

4 Some Themes from Recent Settlements Longstanding industry practices have come under new scrutiny by regulators and investors. Misallocated expenses Lack of transparency Conflicts of interest Charges for additional services Co-investment vehicles Allocation of vendor discounts 4

5 Questions Have you had similar queries from regulators and/or investors? What sort of policies do you have to govern internal charges and allocations? What processes ensure that said policies are consistent with the fund s operating documents? What analyses have been done to support the internal charges and allocations? How do risks in this area stack up against other concerns? 5

6 2. What Should You Be Doing? 6

7 Looking Forward As the SEC continues its examinations of private funds, they will most likely continue to provide guidance to newly registered investment advisers. However, advisers should play an active role to ensure their funds are focused on compliance and due diligence policies and procedures in anticipation of an SEC Examination. Controls should be implemented and updated to assist in the following: Ensuring that disclosures in fund offering documents and partnership agreements are clear, accurate, and complete regarding fee and expense practices. Ensuring that the actual practice by the fund is consistent with the disclosures provided to investors. Identifying any conflicts of interest in expense allocations, such as allocations of an expense incurred on behalf of multiple funds, allocations of expenses that may be shared between the fund and the adviser, etc. Evaluating and supporting internal allocation and charging policies based on the activities of relevant entities and portfolio companies. 7

8 Duff & Phelps Approach Assessment Evaluation of the Allocation of Fees, Expenses, and Cost Bases Evaluate direct and indirect fees collected and expenses charged. Review legal documents to understand the fee and expense policies and procedures. Review the disclosures to investors to determine accuracy and appropriateness. Analysis Benchmarking of the Allocation of Fees, Expenses, and Cost Bases Interview key personnel to ascertain the nature of the functions performed and services provided among relevant fund entities. Determine the benefits conferred by the services performed and expenses incurred. Analyze and test the fees received and the expenses incurred. Assess fee and expense policies and procedures to determine risks and exposures. Communications Implementation a Documentation of Transparent Process Summarize findings. Assist in developing fee and expense policies and procedures based on robust and defensible practices. Prepare an assessment report to support existing or new policies. Perform periodic assessments to ensure that fee and expense policies continue to adhere to best practices and to the governing agreements. 8

9 3. Case Studies 9

10 Case Study 1: Investment Management & Related Fees Case Study Facts Fund advisor collects management fees. Advisor also charges for other defined services, such as for acquisitions, dispositions, break ups, etc. Fees for additional functions may or may not be offset against the management fee. Primary Considerations Nature and benefits of services provided. Compensation of investment management vs. other activities. Quantum of fees charged. Calculation & allocation of any offsets. Disclosures. Analysis Assessments of functions & benefits. Evaluation of related costs. Transactional vs. profit-based benchmarks. Determination of arm s length treatment. Ancillary Considerations Tax treatment of any fee offsets. 10

11 Case Study 2: Provision of Consulting Services to Portfolio Companies Case Study Facts Advisor arranges for consulting/ operational services for the benefit of its portfolio companies. Company has a mechanism in place to allocate the costs associated with the management consulting assignments to the respective portfolio companies. Analysis of Cost Base Analyze cost base allocated to portfolio companies. Analyze existing allocation metrics (e.g., headcount, revenues, compensation, estimated time spent) used to distribute fees and costs to portfolio companies. If necessary, modify cost base and/or allocation metrics. Analysis of Appropriate Profit Markup Third party fees are allocated to portfolio companies at cost as they already include a profit markup. It is appropriate to include a cost plus profit markup for intercompany management consulting services. Markup is derived by performing comparable company benchmarking. 11

12 Case Study 3: Provision of Real Estate Management Services for Portfolio Companies Case Study Facts Related party exclusively provides advisory and management services to real estate properties owned by portfolio companies. Fees charged to portfolio companies differ depending on service rendered. Primary Market Approach Compile market research on fees paid for similar services in the real estate industry. Search internal and external databases. Adjust market rates for relevant comparability factors. Corroborative Approach Rely on prior fees paid by tenants to unrelated service providers for servicing the same properties. Review the executed intercompany and third party contracts to ensure no differences between the services rendered. 12

13 Case Study 4: Cross-Border Responsibilities Case Study Facts Fund management responsibilities are shared among related parties in different countries. Primary investment advisor located in the US; support or co-investment management services provided by a related party overseas. Arm s length compensation required for those related functions. Primary Considerations Nature of services provided routine? Valueadd? Integrated? Market compensation for the services. Impact of different policies on investor returns, risks. Analysis Transactional vs. profit-based methods. One-off payments vs. profit splits. Market practices. 13

14 Case Study 5: Provision of Real Estate Leveraged Finance Services to Portfolio Companies Case Study Facts Related party provides financing services for leveraged deals in real estate fund. Related party charges a percentage fee on the value of the deal. The fee represents a reduction to the returns earned by the investors (and income to the related party). Transactional Approach Search of publically available databases for fees paid to third parties for arranging financing (e.g., M&A deals, debt issuances, and equity issuances). Agreement Approach Search of publically available databases that mine fees (e.g., royalty rates or commissions) paid between third parties from publically available resources (e.g., SEC filings). Market Approach Compile market research relating to fees paid for financing services in the real estate industry. Look to benchmarks for similar services outside of RE sector. 14

15 4. Speakers 15

16 Ann E. Gittleman, CPA, CFF, ABV, CIRA, Esq. Managing Director, Disputes and Investigations Ann Gittleman is a managing director within Duff & Phelps Disputes and Investigations practice. Ann focuses on clients in the asset management sector (including hedge funds, private equity funds, traditional asset managers, investment banks, insurers and regulators). Specifically, Ann is involved in providing expert forensic and dispute assistance in white collar matters, U.S. Securities and Exchange Commission (SEC) investigations, internal investigations, international asset tracing engagements, purchase price and post-acquisition disputes, accounting and auditor malpractice matters, financial advisor in U.S. Bankruptcy and assisting companies with complex accounting matters and financial statement restatements. She has over 15 years of forensic accounting experience during which time she led substantial international projects in the U.S., Europe, the Caribbean and China. Duff & Phelps, LLC New York Ann.Gittleman@duffandphelps.com Ann joined Duff & Phelps with the acquisition of Kinetic Partners where she was a director and co-head of the New York Forensic & Dispute Services practice. Prior to this, Ann was an attorney at a prestigious New York law firm practicing securities litigation and providing in-house forensic accounting consulting services. Previously, Ann was the in-house forensic accountant at the Office of the General Counsel at Pricewaterhouse Coopers (PwC), working on auditor negligence matters. Immediately prior to that, she was an auditor in the alternative investment management group at PwC in New York City. Ann has been retained as a testifying expert in numerous matters including those involving asset tracing, financial reporting and the application of Generally Accepted Accounting Principles and Generally Accepted Auditing Standards. She also frequently consults on complex accounting reporting and SEC matters. Ann received her J.D. from Brooklyn Law School and her B.S./B.A. in both accounting and computer information science from Bryant University. She is a Certified Public Accountant, Certified in Financial Forensics, Accredited in Business Valuation, and a Certified Insolvency and Restructuring Advisor. Ann is also a licensed attorney (admitted in both New York and Massachusetts) and a member of the American Institute of Certified Public Accountants, the Association of the Bar of the City of NY and the Association of Certified Fraud Examiners. 16

17 Sherif Assef Managing Director, Valuation Advisory Services Sherif Assef joined Duff & Phelps in 2012 and is a Managing Director in the New York office. He has been named as one of the world s leading transfer pricing professionals by Legal Media Group and has extensive experience advising clients on a variety of transfer pricing matters in a number of industries over an 18-year career. Prior to joining Duff & Phelps, Sherif helped build Ceteris US LLC into a world-class transfer pricing firm as one of its founding members. Previous to Ceteris, Sherif was with Ernst & Young LLP, working with clients in the financial services, publishing, commodities, software, retail goods, real estate, telecommunications, energy, engineering, and construction industries. At both Ernst & Young and Ceteris, he has supervised and overseen transfer pricing planning, documentation, and audit support engagements covering a variety of intercompany issues, including: Duff & Phelps, LLC New York Sherif.Assef@duffandphelps.com Headquarter and other service charges Tangible property transactions Loans and guarantees Intellectual property issues Risk transfers Sherif has served as transfer pricing expert in a number of tax authority proceedings involving intercompany interest and guarantee payments. He has also performed activity-based costing analyses of intercompany and interdepartmental charges. As lead economist in E&Y s financial services transfer pricing practice in New York, Sherif assisted clients in analyzing a variety of related party transactions including the global trading of financial instruments, asset management services, brokerage services, the sharing of banking fees, insurance and re-insurance transactions, loans, guarantees, management services, and administrative services. Sherif holds a PhD in economics from Fordham University and has spoken at numerous conferences and seminars regarding transfer pricing, as well as authored a number of publications. 17

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