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SEC slams Blackstone over monitoring fees

The buyout giant will pay $39m for failing to fully disclose its accelerated monitoring fee practices and certain legal fee discounts it had received, representing the largest SEC settlement by a private fund manager to date.

Buyout giant The Blackstone Group will pay nearly $39 million to settle charges with the US Securities and Exchange Commission (SEC) for failing to fully disclose its policies around accelerated monitoring fees and discounts the firm received on certain legal fees, according to an order published by the SEC.

The settlement includes a $26.2 million disgorgement of ill-gotten gains, plus prejudgment interest of $2.6 million and a $10 million civil penalty. Without admitting or denying the allegations, Blackstone agreed to pay the fine and distribute the $28.8 million to affected investors.

The SEC found that Blackstone failed to adequately disclose the acceleration of monitoring fees paid by portfolio companies prior to their sales or initial public offerings from 2010 to March 2015. The payments to Blackstone “essentially reduced the value of the portfolio companies prior to sale, to the detriment of the funds and their investors,” the SEC order said.

The SEC order noted that accelerated monitoring fees were used in the 1997 vintage Blackstone Capital Partners III Merchant Banking Fund, the 2001 vintage Blackstone Capital Partners IV and the 2005 vintage Blackstone Capital Partners V.

The SEC also found that fund investors were not informed about an arrangement from 2007 to 2011 that provided Blackstone with a “much greater discount” on services from an outside law firm than the discount that the law firm provided to Blackstone's funds. The disparate legal fee discounts were not disclosed to LPs until August 2012, the SEC said.

“This SEC matter arose from the absence of express disclosure in marketing documents, ten or more years ago, about the possible acceleration of monitoring fees, a common industry practice,” a Blackstone spokesperson told Private Equity International's sister title pfm in an emailed statement. “Each accelerated fee was, however, as the SEC order acknowledges, disclosed when received and our Limited Partner Advisory Committee [LPAC] did not exercise its right to object.  Moreover, Blackstone voluntarily made changes to the applicable policies well before this inquiry was begun.”

The SEC did consider the steps taken by Blackstone to rectify matters prior to contact from commission staff. For example, in early 2011, Blackstone voluntarily ended the the legal fee arrangement and in 2012, disclosed the discounts to all LPs without any resulting complaints. 

For all funds formed after 2012, Blackstone has disclosed in its private placement memorandums that monitoring agreements may contain acceleration provisions that trigger lump sum payments. And in 2014, prior to the SEC investigation, Blackstone changed its business practices and further disclosed that it will not accelerate monitoring fee payments when it completely exits a portfolio company through private sale and will not accelerate more than three years of remaining monitoring fee payments in the event of an IPO. 

The Blackstone case represents the largest SEC settlement by a private fund manager to date, exceeding KKR's $30 million settlement for its broken deal fee policies in June. In its press release announcing the Blackstone settlement, the SEC hinted that this will not be the last of the cases the Division of Enforcement's Asset Management Unit brings against private equity managers for fee and expense matters.

“Full transparency of fees and conflicts of interest is critical in the private equity industry and we will continue taking action against advisers that do not adequately disclose their fees and expenses, as Blackstone did here,” said Division of Enforcement director Andrew Ceresney in the statement.

The SEC encouraged GPs that have identified such issues to self-report them to SEC staff, noting that self-reporting is one factor that regulator considers when evaluating cooperation and determining whether and to what extent to extend credit in settlements.