The cases brought by SEC’s Division of Enforcement during fiscal year 2024 underscore the agency’s focus over the last several years on post-commitment management fee calculations, recordkeeping and off-channel communications, fee and expense disclosures, controls related to material non-public information and conflicts of interest generally. We highlight below several notable cases and sweeps conducted over the past year involving these issues. In light of the U.S. presidential election results, however, we expect enforcement activity involving private fund advisers to slow in certain of these areas.

Post-Commitment Management Fee Calculations

Over the last several years, the SEC has brought a number of cases focusing on advisers’ calculations of post-commitment management fees, in which the SEC has alleged that advisers have overcharged clients by failing to adhere to the disclosed fee calculation methodology. These cases have also alleged insufficient policies and procedures used for calculating post-commitment management fees. Prominent among these cases is the 2023 settled action against Insight Venture Management LLC. Insight developed and applied criteria in order to assess whether an investment was permanently impaired. In applying these criteria, however, Insight analyzed permanent impairment at the “portfolio company” level rather than at the “portfolio investment” level, as required by the funds’ LPAs. As a result, Insight did not correctly apply the funds’ LPAs in making a permanent impairment determination and, consequently, failed to accurately calculate the management fees it charged. In addition, Insight allegedly failed to adequately disclose conflicts related to its portfolio impairment calculation methodology. Because determining the appropriate management fee base and performing the correct fee calculations (which can be operationally challenging) directly affect what investors pay the adviser, we expect the SEC will continue to examine and investigate in this area, but that matters that result in enforcement actions will generally involve fraud rather than technical concerns about the adequacy of disclosure, as we have seen in recent years.

Recordkeeping

Registered investment advisers are required to maintain certain books and records related to their businesses and keep them easily accessible under the Investment Advisers Act of 1940 (and, depending on the firm’s business, under other statutes and rules, such as the Securities Exchange Act of 1934 and FINRA and CFTC rules). Through fiscal year 2024, the SEC continued its scrutiny of firms’ violations of recordkeeping requirements. For example, on August 14, 2024, as part of its off-channel communications sweep, the SEC announced that 26 financial firms agreed to pay more than $390 million in combined penalties to settle charges related to recordkeeping failures. The SEC alleged that these firms inadequately maintained and preserved electronic communications on personal devices used by their employees and that this recordkeeping failure limited the agency’s ability to gather evidence, conduct investigations and enforce compliance with securities regulations. It remains to be seen whether a new SEC Chair and his or her Director of Enforcement will continue to pursue alleged recordkeeping violations as standalone cases; at a minimum, we expect the number of these standalone cases to decline, with those being brought likely involving lower penalty levels. Off-channel communications charges may continue as ancillary charges in matters involving substantive securities laws violations.

Custody Requirements

As crypto assets continue to make headlines, the SEC has shown an interest in ensuring that investment advisers that hold crypto assets do so with qualified custodians as defined by Rule 206(4)-2(d)(2). In this regard, on September 3, 2024, the SEC announced settled charges against Galois Capital Management LLC, which included the alleged failure to ensure that a qualified custodian maintained certain crypto asset securities. Custody is a perennial topic for the Division of Examinations and is an area of review in most private fund adviser examinations. While we expect that private fund adviser examinations will continue to focus on custody rule compliance, we anticipate fewer, if any, enforcement cases focused on technical violations of the custody rule.

Whistleblower Rule

The SEC in FY 2024 showed an ongoing interest in pursuing violations of Rule 21F-17(a), also known as the whistleblower rule. Historically, much of the SEC’s enforcement efforts in this area have been directed toward cases involving employment agreements. More recently, however, the SEC has pursued whistleblower rule violations beyond the employee-employer context, extending the risk of enforcement broadly to any agreements with individuals, including customers, investors and other third parties.

For example, on January 16, 2024, the SEC announced settled charges against J.P. Morgan Securities LLC (JPMS) for Rule 21F-17(a) violations in which JPMS agreed to pay an $18 million penalty. JPMS’ violations related to covenants in a confidential release agreement shared with certain retail clients/customers that limited their ability to affirmatively report information to the SEC. Similarly, on September 9, 2024, as part of a whistleblower rule sweep, the SEC announced that seven public companies agreed to pay penalties ranging from $19,500 to $1.3 million (and totaling more than $3 million) to settle charges of whistleblower rule violations. The violations stemmed from the firms’ alleged failure to appropriately carve out whistleblowing activities from confidentiality and other restrictive covenants in their employment agreements, separation agreements, or independent contractor agreements. Under a new SEC Chair, we expect these cases, and the current effort to expand enforcement activity beyond the traditional scope of employer-employee relationships, to slow.

Material Non-Public Information

As it has over the past few years, the SEC has continued to bring cases related to firms’ failures to establish, maintain and enforce internal policies and procedures to prevent the misuse of material non-public information (MNPI). Cases in fiscal year 2024 included settled charges against Marathon Asset Management LP, which included the alleged failure to have policies and procedures that were reasonably designed to address risks related to the firm’s receipt of non-public information from interactions with third parties, and against Sound Point Capital Management LP, for allegedly failing to adequately assess and update its compliance frameworks to address potential risks regarding use of MNPI, among others. Under a new SEC Chair, we expect to see a significant pullback in the SEC’s willingness to bring enforcement cases triggered by alleged failures involving policies and procedures, absent allegations of other substantive violations of the federal securities law.

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The cases brought by the SEC in fiscal year 2024 against private fund advisers reflect a continued focus on matters including post-commitment management fee calculations, private fund adviser recordkeeping and off-channel communications, fee and expense disclosures and adviser controls related to material non-public information. While we anticipate that the results of the U.S. presidential election will lead to a general slowdown in SEC enforcement activity, we nevertheless expect to see continuing examinations and enforcement investigations involving private fund advisers, even if ultimately those investigations do not result in enforcement cases.

The Private Equity Report Fall 2024, Vol 24, No 3