On June 20, 2023, the SEC announced the settlement of an enforcement action against Insight Venture Management (“Insight”). The SEC found that Insight charged excess management fees through “inaccurate application of its permanent impairment policy” and failed to disclose a conflict of interest to investors related to that same policy.
Key Takeaway(s): The SEC continues to focus on private equity funds generally and, more specifically, private equity funds’ application of fees and expenses policies. Whether through rule making, Risk Alerts and other enforcement actions it is clear the SEC examination staff and enforcement division are increasingly scrutinizing private equity funds’ practices around (1) valuation, (2) calculation of management fees, (3) disclosures to investors specifically related to valuations and management fee calculations and (4) conflicts of interest transparency.
Background
The focus of the enforcement action was Insight’s calculation of management fees on funds during the post-commitment period (i.e. the period after the funds were permitted to make investments). The SEC found Insight overcharged investors management fees by miscalculating the basis on which the management fees were charged due to misapplying the criteria used to determine when an investment was “permanently impaired.”
The specific practices the SEC found problematic were:
- Lack of written criteria in the limited partnership agreement. Insight did not disclose to investors in the funds’ LPA how Insight would make a “permanent impairment” determination.
- Insight’s permanent impairment criteria was subjective. In practice, Insight applied a four-pronged approach to determining whether an investment was permanently impaired. However, the SEC found the criteria to be overly subjective.
- Insight applied their permanent impairment criteria incorrectly. Insight’s LPA indicated permanent impairment would be assessed at the portfolio investment (i.e. any debt or equity investment made by the fund) level. Instead, Insight assessed permanent impairment at the portfolio company level.
- Conflict of interest. Insight’s management fees decreased if an investment was determined to be permanently impaired using the subjective criteria applied by Insight. The SEC determined Insight failed to disclose to investors the conflict of interest related to Insight’s application of the subjective permanent impairment criteria and the relationship to Insight’s receipt of management fees.
Conclusion
Insight was ordered to reimburse its investors over $4.6 million for the excess management fees and interest. In addition, despite Insight’s prompt remedial efforts and cooperation during the SEC’s investigation, Insight was assessed a $1.5 million civil penalty.
How Trillium Can Help
Compliance Program Development
Trillium helps you put in place policies and procedures that work for your firm. Developing and applying consistent policies and procedures is paramount to fulfilling a firm’s regulatory obligations and fiduciary duty.
Disclosure Practices
Trillium can help ensure your investor disclosure documents reflect actual practices. By building a close partnership, Trillium identifies idiosyncratic areas of risk and helps firms manage, mitigate and disclose conflicts of interest to investors.
Testing
A key component of Trillium’s ongoing compliance support is reviewing your firm’s practices in key risk areas against policies and procedures and disclosures. The ability to identify and rectify problematic areas prior to an examination has the ability to prevent significant time and expense later on.