On September 2, 2024, the SEC settled charges against Colony Capital Investment Advisors, LLC (“Colony”), a registered investment adviser, for breaches of its fiduciary duty relating to Colony’s failure to follow certain contractually agreed procedures governing the timely disclosure of and consent to expenses that Colony allocated to eight private real estate investment funds it managed.
Key Takeaways
Do what you say. The SEC heavily scrutinizes affiliated party transactions. Given the volume and prevalence of Colony’s affiliated party agreements, this was an area of compliance Colony should have been focused on but clearly wasn’t.
Summary
Colony is a private equity real estate firm with its principal place of business in Boca Raton, Florida. The firm registered as an investment adviser with the SEC in 2015 and had approximately $802 million in regulatory assets under management. Colony’s advisory business consists primarily of advising several private equity funds (the “Funds”).
Between 2017 and 2021, Colony routinely caused the Funds to enter into agreements with entities affiliated with both Colony and the general partners of the Funds (the “Affiliated Service Providers”) for certain services. The services provided included, among others, fund-level administrative services (such as tax, accounting, and legal support), as well as asset-level services (such as loan servicing, property maintenance, and property-level accounting). Colony directed the Funds to pay approximately $3.6 million to the Affiliated Service Providers.
The LPAs for the Funds permitted Colony to enter into transactions with affiliates of Colony, which may pose conflicts of interest. Accordingly, the LPAs generally required that, with respect to any transaction between any of the Funds and affiliates of the general partner, the compensation of the affiliates and the services to be provided to the Funds be (i) fully disclosed in writing with the limited partners in advance and (ii) consented to in writing or approved by the Funds’ LPAC, or in the case of one of the Funds, the majority-in-interest of the limited partners. The LPAs further required that the terms and conditions of the agreements with affiliates be at least as favorable as those generally available in arm’s-length transactions with qualified independent third parties.
Policies and Procedures
The SEC further alleged Colony failed to adopt and to implement written policies and procedures reasonably designed to prevent violations of the Advisers Act or the rules thereunder in connection with the use of Affiliated Service Providers by its private funds (including the Funds), the process for review and approval of agreements between the private funds and Affiliated Service Providers, the determination of the arm’s-length nature of transactions with Affiliated Service Providers that was required by the Funds’ LPAs, or otherwise complying with requirements in the LPAs related to analyzing the terms and conditions of or approving transactions with affiliates. Specifically, until approximately November 2021, Colony’s Code of Conduct and Regulatory Compliance Manual did not address the use of Affiliated Service Providers, the disclosure and approval requirements for Affiliated Service Providers with respect to the Funds, the determination of market or arm’s length rates regarding Affiliated Service Providers, or the review and determination of whether the terms and conditions of Affiliated Service Provider agreements complied with the LPAs.
Violations
The SEC Settlement Order details Colony’s specific violations for each Fund. However, at a high-level Colony failed to comply with specific provisions of the LPAs by not providing advance disclosure to the limited partners of the Funds or obtaining approval of the Funds’ LPACs (or majority-in-interest of the limited partners) for any of the agreements with the Affiliated Service Providers. In certain circumstances, Colony generally disclosed the existence of agreements with Affiliated Service Providers and the expenses charged under these agreements in the Funds’ audited financial statements as well as in certain presentations to these Funds’ LPACs, but only after the agreements were entered into and expenses incurred and paid each year.
As a result of the conduct described above, Colony willfully violated Section 206(2) of the Advisers Act, which prohibits investment advisers from directly or indirectly engaging “in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client” and Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder, which make it unlawful for any investment adviser to a pooled investment vehicle to “make any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading to any investor or prospective investor in the pooled investment vehicle” or “engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle.”
How Trillium Can Help
Testing and Surveillance: A key component of Trillium’s ongoing compliance support and compliance health check work is reviewing your firm’s practices in key risk areas against policies and procedures and firm disclosures. LPAs and other investor disclosures, such as side letters, become compliance obligations when made. Trillium helps track compliance with these terms as part of standard compliance support.