Fund Sponsor Failed to Create LP Committee to Approve Insider Transactions
The SEC fined and censured an exempt reporting adviser for failing to form an LP committee that could approve conflicted insider transactions. The SEC charges that the fund’s partnership agreement required the formation of an independent investor advisory committee to approve transactions involving conflicts of interest but that the respondents failed to charter a committee during the first six years of the fund’s existence. During that period, the GP failed to disclose, or obtain approval for, delays in making insider capital commitments and providing compensated services to portfolio companies. The SEC also charges the firm with defrauding clients by failing to deliver financial statements as required by the partnership agreement.
For private fund sponsors, an independent LP committee is the best disinfectant against conflicts of interest. We often hear GPs complain that an insider transaction is fine because it also benefits the LPs. While that is often the case, the best way to defend a transaction against regulatory review is to seek approval from independent LPs. It is also noteworthy that the SEC faulted the firm for failing to deliver audited financial statements, not because of the custody rule (to which an exempt reporting adviser is not subject), but because the partnership agreement required the delivery of audited financials.