SEC Settles With Blackstone On Disclosure Issues
The SEC’s Asset Management Unit continues to review and analyze fees, expenses and the related disclosure at private equity firms. The Unit has encouraged advisers to self-report these issues. The most recent action emanating from the review involves three Blackstone Group L.P. investment advisers. In the Matter of Blackstone Management Partners L.L. C., Adm. Proc. File No. 3-16887 (October 7, 2015).
Respondents Blackstone Management, Blackstone Management Partners III L.L. C., and Blackstone Management Partners IV L.L.C. are subsidiaries of publically traded Blackstone Group (collectively “Blackstone Management”). Each is a registered investment adviser. Blackstone Management advises a number of private equity Funds.
This proceeding is based on two issue: 1) The failure to disclosure to the Funds or their limited partners, Blackstone Management’s practice of accelerating the payment of certain fees; and 2) its failure to disclose the fact that Blackstone Management received a much larger discount on legal services from Law Firm than was given to the Funds by the same firm.
First, Blackstone Management failed to disclose the acceleration of certain fees. Each Fund owns multiple portfolio companies. Blackstone Management typically entered into monitoring agreements with each portfolio company. Under those agreements each portfolio company paid an annual fee in exchange for certain consulting and advisory services regarding its financial and business affairs. Those fees are in addition to the annual management fee, although a certain percentage of the monitoring fee offsets a portion of the annual manage fees. Before 2012 the monitoring agreements typically had a term of ten years.
The monitoring agreements stated in part that the agreement could be terminated, and the fees accelerated, if there was a private sale or IPO of a portfolio company. In some cases the fees for additional renewal periods could be included. The payments were present valued and paid in a lump sum. While there were certain offsets to management fees, the payment also reduced the value of the funds’ assets when sold or taken public. That in turn reduced the amounts available for distribution to limited partners. The monitoring fees were disclosed to partners prior to their commitment of capital. The practice of accelerating those fees was not. Thus limited partners had already committed capital and the fees were paid before the disclosure was made. Blackstone Management could not consent because if its conflict.
Second, from 2007 through 2011 Law Firm performed legal work for Blackstone Management and the Funds. The Funds generated more work than Blackstone Management. Nevertheless, Law Firm extended a larger discount for its services to Blackstone Management than the one received by the Funds.
In 2011 Blackstone Management voluntarily ended the disparate legal fee arrangement. The next year the prior arrangement was disclosed to the Funds’ limited partners. In view of this practice, and the failure to disclose its acceleration of monitoring fees, Blackstone Management breached its fiduciary duty and failed to have in place policies and procedures reasonably designed to prevent violations of the Advisers Act. The Order alleges violations of Advisers Act Sections 206(2) and 206(4).
In determining to accept an offer of settlement the Commission considered the remedial acts and cooperation of Blackstone Management. That included voluntarily ending and disclosing the legal fee issue and, since 2012, disclosing the acceleration of monitoring fee practice. The firm also provided factual summaries of relevant information to the staff and promptly responded to each inquiry.
To resolve the proceeding Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the firms will pay disgorgement of $26,225,203, prejudgment interest and, on a joint and several basis, a penalty of $10 million. The disgorgement and prejudgment interest will be paid into a fund to compensate the Funds and their limited partners.