The Securities and Exchange Commission will always be focused on charges to a private fund that get paid to the fund adviser or affiliate. OCIE placed this warning flag in the sand back in 2015. A fund manager has to clearly disclose affiliate fee in the fund documents. If the fee is based on a market rate, the fund manager needs to document the market rate.
The Securities and Exchange Commission fined Rialto Capital Management LLC for misallocating some affiliate costs.
The first failure stated in the SEC order is that Rialto did not properly allocate some expenses between the fund and some co-investment vehicles. It’s not clear what happened from the order. I suspect that some investments had co-investors. Some expense for the investments was paid by the fund rather than the investments. The co-investor was not getting charged for its proportional share and the fund was overpaying its share.
The second failure was not proving that some of its affiliate fees were at market rate. If the fund documents state that a fee will be at or below market rate, then its up to the fund manager to prove it so.
In 2012 Rialto conducted a market rate analysis. However, the firm did not update it from 2013 to 2017.
To compound the problem, Rialto added an 11% overhead factor to the charges for its employees to cover general expenses. Then it increased the factor from 11% to 25% and did not fully disclose this to the funds’ advisory committees.
Although this could have been an accounting oversight, the SEC added in a “willfull” standard to the violation. The SEC also added a hefty fine of $350,000.
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