SEC charges private equity firm with misallocating broken deal expenses in breach of fiduciary duty


The SEC alleged that KKR misallocated due diligence and other expenses related to potential transactions that did not materialize, referred to as “broken deals”. These transactions would have involved KKR’s flagship investment funds as well as co-investment vehicles, which are composed of KKR executives and certain clients. In allocating its expenses, however, KKR allocated all of the expenses related to these potential transactions to the flagship funds and none to the co-investment vehicles, rather than sharing them with the co-investment vehicles involved. The SEC alleges that this accounting practice benefited KKR insiders, while harming KKR’s flagship fund clients by having these funds absorb the expenses for the potential deals.

The SEC investigation covered accounting practices relating to broken deals from 2006 to 2011. Despite incurring $338 million in broken deal or related expenses involving KKR’s co-investment vehicles, it did not allocate any of these expenses to those vehicles during this time, and it did not expressly disclose this fact in its fund limited partnership agreements or related offering materials, constituting a breach of fiduciary duty. In addition, the SEC found that KKR failed to implement a written compliance policy governing its fund expense allocation practices during this time and only put a policy in place in 2011.

KKR consented to the entry of the SEC’s order finding that the firm violated provisions of the Investment Advisers Act of 1940, as amended. KKR agreed to pay almost $30 million in settlement of the charges, including more than $14 million in disgorgement ($3.26 million was previously refunded to clients) as well as more than $4.5 million in interest and a $10 million penalty. KKR neither admitted nor denied the SEC’s findings.

In the SEC’s release on June 29, it indicated that the SEC Enforcement Division’s Asset Management Unit has been scrutinizing the private equity industry to ensure fund managers are not misallocating expenses or charging in appropriate fees and/or expenses to investors. The Dodd–Frank Wall Street Reform and Consumer Protection Act, enacted in 2010, gave the SEC new regulatory authority over private equity funds and its recent focus on these funds and their practices relating to fees and expenses have caused the private equity industry to become more cautious and to take a more robust approach to disclosure generally.

To view the SEC's release, please click here.

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