Transparency Matters: Advisers’ Responsibilities in Fee Disclosure

The Securities and Exchange Commission (“SEC”) charged a New York-based private equity fund focused on alternative real estate assets for failing to adequately disclose real estate brokerage fees it paid to a real estate brokerage firm owned by its CEO.

Lack of transparency and failure to disclose this arrangement properly resulted in misleading information in the fund's documents. This, in turn, resulted in significant penalties and disgorgement.

An SEC Settlement Reveals Undisclosed Affiliate Fees

The SEC announced a settlement enforcement action against the fund on September 5, 2023.

The fund launched in 2017 to acquire self-storage real estate properties. In seeking acquisition opportunities, it generally did not pursue self-storage properties offered through auctions; rather, it relied on deal teams composed of employees and independent contractors to source investment opportunities. The company compensated deal teams with a 3% brokerage fee for executing acquisitions of “off-market” properties.

The SEC found that the brokerage fees were paid to a real estate brokerage firm that was entirely owned by subject fund’s CEO, making it an affiliate of the subject fund. From 2017 to 2021, this real estate brokerage firm received almost $18 million in fees for helping the fund buy properties. The deal teams used the brokerage fees paid to this affiliate to compensate themselves in connection with acquisitions.

The fund allegedly failed to adequately disclose this arrangement in its offering materials, e.g., the limited partnership agreement, private placement memorandum, and due diligence questionnaires.

The SEC order found that the fund violated Section 17(a)(2) of the Securities Act of 1933. Without admitting or denying these allegations, the fund agreed to cease and desist from violating the charged provision and pay $20.5 million in civil penalties, disgorgement, and interest.

The Importance of Transparent Disclosures

The SEC’s action highlights the importance of clearly informing investors and others about related party arrangements. It also emphasizes the seriousness of omitting this information. Investors should make certain they have a proper understanding of related-party transactions and disclosures.

Additionally, auditors need to evaluate related-party relationships and transactions and their impact on the risk of significant errors in financial statements. AU-C Section 550 – Related Parties outlines this requirement, which applies to all audits of financial statements.

Finally, the SEC has implemented new rules for private fund managers. They must show proof of disclosure and report fees and expenses every quarter, including the arrangements mentioned above.