On September 5, 2023, the SEC announced settlements related to separate charges against (i) a real estate focused private equity firm (“Firm”) for failing to adequately disclose to investors millions of dollars of real estate brokerage fees that were paid to an affiliate, and (ii) a group of investment advisers for failing to comply with the requirements of Rule 206(4)-2 under the Advisers Act (“Custody Rule”).
Inadequate Disclosure of Fee Payments to an Affiliate
With respect to the first settlement, the SEC’s charges stem from “certain inadequate disclosures and materially misleading statements” made by the Firm in connection with nearly $18 million in brokerage fees paid by one of its funds (“Fund”) between 2017 and 2021 to a real estate brokerage firm owned by the Firm’s CEO (“Affiliate”). For purposes or sourcing new investment opportunities, the Fund primarily relied on deal teams comprised of Firm employees as well as independent contractors. The costs and compensation of the deal teams were paid, in part, through a 3% brokerage fee received by Affiliate from the Fund on acquisitions sourced by the deal teams.
The SEC’s order noted that the Fund’s offering materials, including its limited partnership agreement, private placement memorandum and due diligence questionnaires, all contained misleading statements and omissions concerning fees and conflicts of interest because such materials failed to adequately disclose that Affiliate would receive brokerage fees. Specifically, such materials downplayed the frequency with which the Fund utilized affiliated service providers, failed to disclose the payments of brokerage fees to an affiliate as well as the attendant conflicts of such payments and, in certain instances, failed to disclose the engagement of an affiliated brokerage firm entirely. The SEC’s order further noted that the Firm similarly failed to adequately disclose such fees and conflicts during meetings with, and in response to questionnaires and other requests for information received from, investors.
As part of the settlement, the Firm agreed to pay a $6.5 million civil penalty and more than $14 million in disgorgement and prejudgment interest.
This settlement is yet another example of SEC scrutiny of relationships between investment advisers and affiliates. Advisers should carefully review all arrangements with affiliated service providers and ensure the details of such arrangements, including all fees and related conflicts of interest, are adequately disclosed to investors.
Failure to Comply with Custody Rule
The SEC separately settled allegations of violations of the Custody Rule with five investment advisers. The advisers failed to do one or more of the following: have audits performed; deliver audited financials to investors in a timely manner; and/or ensure a qualified custodian maintained client assets. The SEC’s orders additionally cited two of the firms for failing to promptly file amended Forms ADV to reflect their receipt of audited financial statements. One firm was also cited for improperly describing the status of its financial statement audits for multiple years on its Form ADV. 
As part of their settlements, each of the advisers agreed to pay civil penalties ranging from $50,000 to $225,000.
These settlements reflect the continuing focus on violations of the Custody Rule and are the second set of cases regarding such violations brought by the SEC in under a year. The SEC has also proposed revisions to the Custody Rule (which it intends to redesignate as the “Safeguarding Rule”) designed to enhance investor protections relating to client assets.
- 1. A press release related to the settlement can be found here. The full SEC Order can be found here.↵
- 2. A press release related to the settlements can be found here. Links to the full SEC Orders for the five charged advisers can be found here, here, here, here and here.↵
- 3. On September 9, 2022, the SEC announced charges against a number of investment advisers for failing to comply with the requirements of the Custody Rule. A press release related to such charges can be found here.↵
- 4. A previous alert discussing the SEC’s proposed Safeguarding Rule can be found here.↵