Lincolnshire Management, Inc. (“LMI”) has reached a settlement agreement with the Securities and Exchange Commission (“SEC”) for sharing expenses between two companies’ portfolios in a manner that improperly benefited one fund over the other. This settles charges that the SEC brought against LMI for violation Section 206(2) of the Advisers Act, and for breaching its fiduciary duty to the private equity funds.
Although the firm neither admitted, nor denied fault, LMI agreed to pay more than $2.3 million to settle the SEC’s charges through disgorgement of $1,500,000, prejudgment interest of $358,112, and a civil penalty of $450,000.
LMI’s allegedly integrated two portfolio companies owned by different LMI-advised funds and managed them as one company. LMI disclosed to the two fund’s limited partners, its intention to integrate the two portfolio companies, and later sell them together. However, “neither of the companies had any written agreements relating to sharing or allocating expenses, and there were no documents setting forth the parties’ respective rights and obligations toward each other.”
Subsequently, part of the shared expenses was directed only to one company and went undocumented. During the eight-year period that LMI integrated the two companies, administrative expenses covered by one company were paid for by the other, but the expenses were never reimbursed. In addition to these administrative expenses, there were several employees who performed work that benefitted both companies, but their salaries were only allocated to one company.
As a result, one of the portfolio companies paid more than its share of expenses, even though both companies were benefitted. Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit said, “Lincolnshire’s decision to integrate two portfolio companies owned by separate private equity funds resulted in the misallocation of expenses between the two companies.” This in effect breached LMI’s fiduciary duty owed to both funds.
Moreover, the SEC charged LMI with violating Section 206(4) of the Advisers Act and Rule 206(4)-7 by failing to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act arising from the integration of the two portfolio companies.
This case is the SEC’s first enforcement action against a private equity firm for misallocation of expenses in ordinary funds. Furthermore, the SEC has not alleged that LMI acted in bad faith or directly benefited from integrating these expenses. This fact further indicates a growing trend that the SEC intends to bring more non-fraudulent based cases in private equity and other industries.
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