September 16-October 6, 2015 —
COLORADO REAL ESTATE JOURNAL
— Page 25
Law & Accounting
A
mong changes that
came to the private
equity industry after
the market crash are the Dodd-
Frank provisions, which gen-
erally brought fund managers
under Securities and Exchange
Commission scrutiny. Andrew
Bowden, until recently the
head of the enforcement divi-
sion tasked to look into fund
managers, caused an uproar in
the private equity industry last
year when he disclosed that its
first round of examinations had
found “what we believe are
violations of law or material
weaknesses in controls over 50
percent of the time.” (The nar-
rative of the speech is available
There were a number of
issues, but the takeaway is that
the SEC is concerned about fees
charged or expense allocations
to investors or the fund invest-
ments that might not be fully
disclosed. This was of particu-
lar concern for funds, which
are struggling and have not
had success with new capital
raise-up. These so-called “zom-
bie” funds are at particular risk
of a misalignment of interests
between the manager and the
investors, which is at the crux of
the SEC concerns. For instance,
will a fund manager decide to
keep an asset beyond the point
when it could have been sold
at a good price in order to keep
assets under management, and
therefore management fees, at a
higher level rather than deliver-
ing invested capital back to the
investor?
As noted, one of the other
general concerns is that fees are
charged for ancillary services
provided by the manager or
related parties of the manager
in addition to the basic man-
agement fee (perhaps services
that should be provided as part
of the managers basic responsi-
bilities). The suggestion is that
the SEC believes some fund
managers are being disingenu-
ous with investors by fully dis-
closing the basic fee arrange-
ment but not so much the addi-
tional fee arrangements.
Subsequently,
Bowden
seemed to back off of some of
his comments, but it does not
appear that the SEC has done
so. Bowden’s
current suc-
cessor, Marc
Wyatt, has
reiterated its
concerns in
this area with
a promise of a
commitment
of resources
(more exami-
nations). The
n a r r a t i v e
of
Wyatt’s
speech can
be found at
The SEC vs. private equity
industry issues will sort them-
selves out over time – likely in
slow motion, but the private
equity industry has seemed
to take notice and is offering
more complete disclosures of
fee arrangements. Of course,
largely what is driving this
is investors themselves have
taken notice of the SEC’s com-
ments and are, let’s say, curious
about the existing fee arrange-
ments in the deals they are
invested in.
I suppose it is easy to pre-
dict that investors, particularly
large investors in private equity
deals, will adjust their due dili-
gence procedures to make sure
they are fully aware of the com-
plete fee structure and practices
of the firms they do business
with. Many have embarked
on their own investigation of
existing deals. All this is at a
time where interest in invest-
ing in real estate is peaking.
Obviously, if you are in this
industry or have institutional
investors, you can expect at
least a conversation with them
around this issue, if not now at
least when you are next raising
capital.
With this type of news being
fairly broadly disseminated,
it is likely that even investors
in private deals (nonregulat-
ed) may have a heightened
sense of concern about their
arrangement with the invest-
ment sponsor/operator. Most
agreements give investors the
right to examine the books of
the investment entity, so it is
possible investors will investi-
gate on their own. In any case,
whether you are a private equi-
ty group or a developer with
individual investors/partners,
it would be prudent to be pre-
pared for questions around the
issues outlined above. A review
of fees paid or reimbursements
to managers and related parties
to verify compliance with con-
trolling agreements (manage-
ment, development and oper-
ating) would be appropriate.
Having ready answers to inves-
tor questions is a very powerful
response.
Most investors would like to
think that they are investing
in fully regulated investments
with layers of oversight and
review to assure (as much as
is practical) that the investor
is getting what they bargained
for. Historically, the private
equity and direct investment in
commercial real estate has been
somewhat of an exception. Cer-
tainly there is oversight and
reporting, but the levels of
oversight for many real estate
investors has been light relative
to most of the rest of the invest-
ment markets (think stocks
and bonds). It seems the SEC,
certainly on the private equity
side, is determined to change
this. It is hard to say what kind
of bleed-over to the private real
estate investor side of the equa-
tion will result, but it would be
prudent to be prepared.
s
Zane Dennis, CPA
Tax partner and real
estate practice leader,
Richey May & Co. LLP,
Englewood
The suggestion
is that the
SEC believes
some fund
managers
are being
disingenuous
with investors by
fully disclosing
the basic fee
arrangement but
not so much the
additional fee
arrangements.
Because no two clients
are ever the same.
TM
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