On April 22, 2020, the Securities and Exchange Commission (“Commission”) entered a settled order1 against private equity fund adviser Monomoy Capital Management, L.P. (“Monomoy”) for Monomoy’s failure to disclose adequately certain fees charged to fund portfolio companies for the services of its in-house operations group (“Operations Group”) and related conflicts of interest, in violation of § 206(2) of the Investment Advisers Act of 1940. In the order, the Commission rejected as inadequate certain permissive or “may” disclosures made by Monomoy regarding the fees, underscoring the risk of reliance on such disclosures after the recent decision by the U.S. Court of Appeals for the D.C. Circuit in Robare.2
From April 2012 through December 2016, the Commission found, Monomoy charged portfolio companies of a fund it advised, referred to as Fund II, fees for the services of its Operations Group, which related to making business improvements for the companies’ operations, without fully and fairly disclosing the fees or related conflicts of interest. Monomoy charged an hourly rate designed to recoup most but not all of the costs of maintaining its Operations Group. During the relevant period, the Commission noted, such reimbursements accounted for approximately 13.3% of all revenue Monomoy received from Fund II.
Monomoy had provided fund portfolio companies with the services of its Operations Group since 2007. However, by the time Monomoy had begun to market Fund II, it had an established practice of billing fund portfolio companies for such services, rather than covering the costs out of its management fees. Monomoy made reference to the Operations Group in Fund II’s private placement memorandum and a due diligence questionnaire, but did not disclose its billing practices. Fund II’s limited partnership agreement disclosed that portfolio companies were responsible for certain fees, but it did not mention the Operations Group, or fees for operations-related services to the companies as among those for which the companies would be responsible.
In March 2014, Monomoy filed a Form ADV which disclosed that “under specific circumstances, certain Monomoy operating professionals may provide services to portfolio companies that typically would otherwise be performed by third parties,” and that “Monomoy may be reimbursed” for costs related to such services (emphasis added). However, in the Commission’s view, as stated in the order, these permissive disclosures were inadequate: “These disclosures did not fully and fairly disclose the fact that Monomoy did, in fact, routinely provide such services, that it did, in fact, receive reimbursements from portfolio companies and that the reimbursement rates were designed to recoup most (but not all) of Monomoy’s costs of maintaining its Operations Group.”
Monomoy invests in middle-market businesses in the manufacturing, distribution, and consumer sectors. As of December 2019, Monomoy had approximately $1.2 billion in regulatory assets under management. Under the terms of the settlement, Monomoy was censured, and ordered to pay more than $1.9 million in disgorgement and prejudgment interest, and a $200,000 penalty. The Order further creates a fair fund from these amounts for distribution to current and/or former limited partners of Fund II, with Monomoy responsible for all costs related to the administration and distribution of the fair fund.
S&K Observations
SEC has long focused on conflicts of interest and fees and expenses in the private funds space, including fees charged to private equity fund portfolio companies. More recently, the SEC has begun to focus on the accuracy and adequacy of permissive or “may” disclosures. This case illustrates how the intersection of these issues can create compliance risks and challenges, and even lead to an enforcement action, for private fund advisers. We recommend you take this opportunity to review your fee and expense, conflict of interest, and permissive language disclosures. Fee and expense related practices can change over time. Related disclosures in offering and fund documents may not be as accurate as they once were. The SEC’s standards evolve over time. Once customary permissive language disclosures, in the SEC’s view, may no longer be acceptable today.
Please contact your primary attorney at Seward & Kissel if you have any questions or would like assistance in connection with your disclosure review.
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1 In the Matter of Monomoy Capital Management, L.P., Release No. 40-5485 (Apr. 22, 2020), https://www.sec.gov/litigation/admin/2020/ia-5485.pdf.
2 Robare Grp., Ltd. v. SEC, 922 F.3d 468 (D.C. Cir. 2019). See Securities and Exchange Commission, Standard of Conduct for Investment Advisers (July 12, 2019) (“Similarly, disclosure that an adviser ‘may’ have a particular conflict, without more, is not adequate when the conflict actually exists.”), https://www.sec.gov/rules/interp/2019/ia-5248.pdf.