SEC slams KKR over broken deal expenses

Accused of breaching its fiduciary duty to investors, the alternatives titan agreed to an eight-figure settlement with the commission.

In its first case targeting a high profile private equity firm for fee and expense policies, the US Securities and Exchange Commission (SEC) has charged KKR with misallocating $17.4 million in broken deal expenses to its flagship private equity funds, resulting in a breach of its fiduciary duty.

KKR agreed to pay nearly $30 million to settle the charges—a refund to investors including more than $14 million in disgorgement and $4.5 million in prejudgment interest, and a $10 million civil penalty.

During an investigation that began in 2013, the SEC found that from 2006 to 2011, KKR incurred $338 million in broken deal or diligence expenses related to unsuccessful buyout opportunities for its KKR 2006 Fund and other flagship vehicles.

Even though KKR’s co-investors, including KKR executives, participated in the firm’s private equity transactions and benefited from deal sourcing efforts, KKR “did not allocate any portion of these broken deal expenses to any of them for years” and did not “expressly disclose” in its fund LPAs or related offering materials that it did not allocate broken deal expenses to the co-investors, the SEC order states.

“Although KKR raised billions of dollars of deal capital from co-investors, it unfairly required the funds to shoulder the cost for nearly all of the expenses incurred to explore potential investment opportunities that were pursued but ultimately not completed,” said Andrew Ceresney, director of the SEC’s enforcement division, in a statement.

Following the examination, KKR refunded investors $3.26 million in the first quarter of 2014, as previously reported by PEI's sister publication Private Funds Management. This amount was not enough to cover the total disgorgement, the SEC found. KKR is ordered to distribute the disgorgement and prejudgment fees within 90 days as a credit against other fees investors would have otherwise been obligated to pay to KKR.

The SEC order also faults KKR for failing to implement a written compliance policy governing its fund expense allocation practices until the end of the six-year period in 2011. KKR established a policy in 2011, and after revising its broken deal expense allocation methodology in 2012, the firm began to attribute a share of its dead deal expenses to KKR partner vehicles and other co-investors.

“This resolution, which relates to historical expense allocation disclosures and policies and not to any current practices, allows us to focus on delivering value for those who invest with us,” KKR said in an emailed statement to pfm. “We take our fiduciary responsibilities seriously and have strived to adapt our policies and practices to the changing nature of the industry, market and our business.” The firm neither admitted nor denied the SEC’s findings.