SEC Targets NY-Based RIA for Failure to Disclose Conflicts of Interest

Investment advisers continue to get into regulatory trouble when it comes to failing to disclose conflicts of interest and related party transactions as required by both federal and state investment adviser law. Recently, the Securities and Exchange Commission (SEC) initiated proceedings against Fenway Partners, a New York-based registered investment adviser which served as adviser to three private equity funds. The conflicts arose around two related entities: Fenway Partners Capital Fund III, L.P., an affiliated fund, and Fenway Consulting Partners, an affiliate largely owned by the executives and owners of Fenway Partners.

Fenway Partners and Fenway Consulting Partners were both owned and managed in large part by respondents Peter Lamm, William Smart, Timothy Mayhew, and Walter Wiacek. The fund in question, Fund III, was operated by an Advisory Board consisting of independent limited partner representatives, pursuant to its organizational documents. According to the SEC allegations, the respondents failed to disclose several conflicts of interest and related party transactions to both the Advisory Board of Fund III and their fund investors.

Fenway Partners had entered into contracts with certain portfolio companies held by Fund III L.P. by which monitoring fees were paid to Fenway Partners. Those fees were initially offset against the advisory fees paid by Fund III to Fenway Partners. However, in December 2011 Fenway Partners and several of the respondent executives terminated those agreements and replaced them with consulting agreements with their affiliated entity, Fenway Consulting. The payments to Fenway Consulting were not offset against the advisory fees paid by Fund III to Fenway Partners. Furthermore, Fenway Consulting Partners provided nearly identical services to the portfolio companies as Fenway Partners had, and often through the same employees. The Fund III Advisory Board was not informed of the conflict at the time of agreement, and the conflict was not disclosed to fund investors as related party transactions.

Additionally, Fenway Partners also failed to disclose a conflict of interest when it issued a capital call notice for $4 million to invest in a portfolio company without disclosing that $1 million would be used to pay Fenway Consulting, which in fact it was. Finally, respondent executives received $15 million in compensation under a cash incentive plan regarding a sales transaction in which Fund III sold its equity interest in a portfolio company. This reduced the amount received by Fund III and was not adequately disclosed to fund investors.

The SEC issued an order instituted an administrative proceeding alleging violations of Advisers Act Sections 206(2) and 206(4). Respondents consented to the entry of a cease and desist order and to a censure, except for one of the respondents. In addition, they agreed to pay disgorgement in the amount of $7,892,000, prejudgment interest, and a civil penalty.

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