Building a SEC Compliant

Expense Program

Allocation Methodology for a SEC Compliant Expense

MyComplianceOffice and guest speaker Timothy Goodwin of Blueriver partners presents a discussion from our July webinar on Allocation Methodology for a SEC Compliant Expenses.



Timothy Goodwin

Mr. Goodwin has over 13 years of regulatory compliance, internal audit and management experience. Prior to joining Blue River Partners, Mr. Goodwin spent over six years with TPG Capital, LP, a leading global private investment firm with more than $70 billion in assets under management. He most recently served as Director of Enterprise Risk Management and Internal Audit with a focus on documenting and testing TPG’s fee and expense allocations across private equity funds and business platforms.


 You can download a full copy of the slides from this webinar.



Full video transcript available below:

Expenses during SEC Exams

We talked a lot about the current environment, the SEC's thoughts on all this. Now it's time to get into how you would actually go about allocating fees and expenses. That's the allocation methodology. The first point here is that prior to fund launch, you really have to do your best to identify all the categories of expenses that could be borne by the funds in the firm and to specifically, as much as possible, disclose those in your offering documents. Obviously you don't have a crystal ball, you may have a crystal ball but my guess is it's not looking into the future, so you're not going to be able to contemplate every single expense in many cases. I really think that the attorneys in the industry are getting better and better at this and reacting to all the enforcement actions and all the different questions they receive on a fairly frequent basis about how to allocate different expenses. Really work with your attorneys to make sure that your offering documents are as detailed as possible.

The next point here, after fund launch, is, to the extent necessary, document the category for each expense borne by the fund. When I put this down here and I told everyone to document a category for each expense, really you have to tailor this advice to your business. Obviously, if you're going into your general ledger and it's hundreds of pages long, this might be something that is not practicable so you're going to have to tailor your process to your situation.

The bottom line is that, as we mentioned earlier, the SEC is going to be going through your general ledger, so really the only full-proof way to have an answer for every question that they're going to have is to do the same thing they're doing and document why you decided to categorize each expense as either a fund or a management company or advisor expense. Now, when I say document the categories, what I'm talking about is tying it to the section of your offering document that states how that type of expense will be allocated. It can be from a very high level, depending on the complexity of your firm, and we'll get into that a little bit in the upcoming slides. You can either do it at a very high level and then categorize each expense or we've seen people go as far to, in a spreadsheet, include the relevant language of the limited partnership agreement on one tab and all the expenses on another tab and then referencing the relevant section of the LPA for which that expense was allocated for.

The area where this can get even more complicated is when you have multiple funds and it's hard to determine who the expense was incurred on behalf of. If it's multiple clients, you're going to have to figure out a way to allocate amongst the different clients. This is somewhere, when we start talking about multiple funds, where you're really going to need to have a section of your compliance manual that outlines how you do this. You don't want to be over restrictive and handcuff yourself into treating everything in a certain way, but you also don't want to be completely silent on your process for doing this. In almost all of the enforcement cases that I referenced earlier, the SEC sited each of those firms for a failure to having policies and procedures in this area. It's something that you have to think about carefully, especially when they're these tricky situations with multiple funds.

As far as the framework for categorizing expenses for multiple funds, first off you want to ask yourself if you have multiple clients, is it borne by all clients or a subset of the clients? Obviously, a one size fits all methodology is not going to work if only 2 of your clients are benefiting from the expense. What you want to do is, for the clients effected, you want to allocate appropriately. The example I showed here is pro rata, that's the standard in the industry but in certain cases it isn't appropriate for various reasons. The benefit of the expense may not be equal, and then of course certain fund documents can impose caps on different categories of expenses. Once again, what you want to do is ... Can we go back to that last slide? Once again, what you want to do in each of these cases is have a policy that describes the different methods that you would use to allocated those expenses. If you decide that it isn't pro rata in one case and, for instance we mentioned the example where in the enforcement action one fund was allocating expenses based on revenue or some other measurement, you're going to want to describe that in your policies and procedures so you can point to it in the event of an exam.

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