DealLawyers.com Blog

Last month, the SEC announced a settled enforcement action against Insight Venture Management LLC alleging that the fund advisor charged excess management fees & failed to disclose a conflict of interest relating to its fee calculations.  This excerpt from the SEC’s press release describes its allegations:

According to the SEC’s order, Insight’s limited partnership agreements for certain funds it advised allowed it to charge management fees based on the funds’ invested capital in individual portfolio investments and required Insight to reduce the basis for these fees if Insight determined that one of these portfolio investments had suffered a permanent impairment. The order finds that, from August 2017 through April 2021, Insight charged excess management fees by inaccurately calculating management fees based on aggregated invested capital at the portfolio company level instead of at the individual portfolio investment security level, as required by the applicable limited partnership agreements.

Further, the SEC’s order finds that Insight failed to disclose to investors a conflict of interest in connection with its permanent impairment criteria. Because Insight did not disclose its permanent impairment criteria, investors were unaware that the criteria Insight used were narrow and subjective, making them difficult to satisfy.  Therefore, the order finds that Insight’s investors were unaware that Insight’s permanent impairment criteria granted Insight significant latitude to determine whether an asset would be considered permanently impaired so as to reduce the basis used to calculate Insight’s management fees.

Without admitting or denying the SEC’s allegations, the fund advisor consented to an order finding that it had violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-7 and 206(4)-8 thereunder. It also agreed to a cease-and-desist order and censure and to pay a $1.5 million penalty and $864,958 in disgorgement and prejudgment interest.

A recent Weil blog on the enforcement action offers some recommendations to PE fund advisors to avoid finding themselves in a similar situation:

In response to this enforcement action, advisers should (i) review, and carefully adhere to, (a) any implemented impairment or write-down policies, especially with respect to fee reduction practices, and (b) the relevant provisions set forth in their fund documentation, including any distinctions between “investments” and “portfolio companies” and any interplay with write-downs and, if applicable, (ii) disclose to investors (a) all relevant criteria used in the impairment analysis and (b) the fact that the adviser has a conflict of interest in applying any subjective impairment criteria, as an impairment may reduce management fees and/or impact a fund’s carried interest waterfall.

– John Jenkins