In two recent cases, the Securities and Exchange Commission (the SEC) has made clear that it has increased its focus on private funds and their allocation of fees and expenses. In the most recent, the SEC entered an order on June 29, 2015 settling administrative proceedings against Kohlberg, Kravis Roberts & Co. L.P. (“KKR”) that alleged improper fund expense allocation. In April 2015, the SEC entered a similar order against Alpha Titans LLC (“Alpha Titans”), a hedge fund manager, making similar allegations of improper fund allocation practices. The hedge fund manager, Alpha Titans, was found by the SEC to have improperly charged the private funds for manager-related operating expenses without authorization by and disclosure in the fund documents. The registered private equity fund manager, KKR, on the other hand, was accused of improperly allocating to certain private funds broken deal expenses that the SEC alleges should have been shouldered by co-investors. These two regulatory actions, and the recent speeches made by senior SEC leaders addressing concerns about fee allocation practices by private equity funds, highlight the need for hedge funds, private equity funds and real estate funds to take prophylactic measures to address expense allocation issues.

On June 29, 2015, without admitting or denying the SEC’s findings, KKR agreed to pay close to $30 million (including a $10 million penalty) – a new high-water mark – to settle certain charges brought by the SEC in connection with improper allocation of broken-deal expenses in violation of its fiduciary duties. According to Andrew J. Ceresney, Director of the SEC Enforcement Division, “this is the first SEC case to charge a private equity adviser with misallocating broken deal expenses.” According to the SEC, KKR allegedly misallocated more than $17 million in broken deal expenses to its funds when those expenses should have been allocated to certain of its co-investors. The SEC alleged that KKR’s co-investors, including KKR management, benefited from the deal sourcing and, except for a partial allocation to certain co-investors in 2011, KKR did not allocate any portion of these broken deal expenses to co-investors for a period of six years ending in 2011. The SEC alleged that, instead of requiring the co-investors to pay their share of their cost of these expenses, KKR unfairly allocated all of the broken-deal expenses to the private funds it was advising.