Building a SEC Compliant

Expense Program

SEC Priorities around Expense Allocation

MyComplianceOffice and guest speaker Timothy Goodwin of Blueriver partners presents a discussion from our July webinar on SEC Priorities around Expense Allocation



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:

Background & Industry Practices

Here I have highlighted the now infamous Spreading Sunshine in Private Equity speech given by Andrew Bowden. This occurred in May of 2014. If I go briefly into my background. Prior to joining Blue River, in February of this year, I was with TPG Capitol, a private equity firm based here in Texas. I spent 4 years in the compliance department there and at the time that Andrew Bowden gave the speech that I have referenced here, I was actually in the audience at the private equity, private fund compliance forum.

At the time, I had switched from compliance to an internal audit role. Because the fee and expense allocation issue had been highlighted prior to this speech, it was something that was on my radar and I had done some work on it. As I sat in the audience and I listened to Andrew go through his thoughts on their initial responses to the SEC presence exams that went on and he stated that there were material weaknesses and controls of over 50% of the private equity managers that they examined, I sensed that my next few months might be focused solely on fee and expense allocation issues and I was wrong. It was probably the better part of 2 years.

It seems like every month a new speech or a new enforcement action came out which made me realize how much deeper and just another layer of complexity on this issue and how much more time we had to spend and how much more documentation and disclosure we had to improve across the entire firm. That is the background that I bring to this subject matter. The speech itself, I call it infamous because, at the time, it really was a complete game changer in the fact that Andrew took the position that the entire industry was not disclosing fee and expenses in a sufficient matter. That set the tone, and since that time the SEC has followed through numerous enforcement actions which we will get into shortly.

Next slide. Typically when I discuss a compliance issue, we get into the legislative framework. Here it's not that complicated. There really aren't any regulations specifically covering fees and expenses. I show there the section 206 of the Advisers Act, but the point here is that ... And there are other things, other parts of the legislative framework that you could throw in here to talk about your general obligations with regards to your clients and correctly allocating fees and expenses. The point here is that because there are no specific regulations, all managers have had to adopt their own approaches and they've had to disclose them individually in each of their funds offering documents. In this case, it's less important to worry about the legislative framework and more important just to be completely familiar with your funds offering documents.

On the next slide, just to give you an overview of typical industry practice in this area. The relative benefit principle, which is something to talk about when we talk about correctly allocating fees and expenses. It means that you should allocate expenses based on the relative benefit of the product or service purchased. That means, obviously, a product purchased for the fund should be allocated to the fund itself and an expense that benefits a management entity should be allocated to the management entity itself. It seems like a pretty simple idea, but just because of the complication of the various structures and depending on if a manager has multiple funds or if a manager has agreements with their funds to pay additional expenses for either portfolio companies or research or any other thing, this can get incredibly complicated, just the basic idea of the relative benefit principle.

On the next slide, I took a stab at categorizing your typical fund and management company expenses and where they would typically go into. Candidly, these are the easy ones, pretty obvious in many cases where these types of expenses should end up. You'll see that I have not listed the tougher ones because sometimes the tougher expenses are harder to categorize. Later on in the presentation, I'll start, I'll walk you through a little bit of a framework that we developed to help you categorize those harder expenses. The type of expenses that can be more difficult to categorize, things like travel, investment research, marketing, areas where there can be a perceived benefit for both the fund and the management company. We will get into that a little bit later.

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