United States: A Compilation Of Enforcement And Non-Enforcement Actions - 09 September 2016


  • AXA Prevails in Excessive Fee Trial
  • Beware of Failing to Properly Disclose Fees and Assess Adequate Penalties


  • Business Continuity Planning
  • SEC Rule Designed to Assist Certain Investment Advisers
  • Two Will Oversee SEC's Examination Program of Investment Advisers and Investment Companies


Investment Companies

AXA Trial Fee Excessive in Prevails

The latest excessive fee case has ended with a win for the fund company and a loss for plaintiffs.

Key Takeaways

Among the key takeaways from the court's decision are the following:

  • The court rejected the plaintiffs' assertion that it was constrained to review only the services provided by AXA Equitable Life Insurance Company (AXA) pursuant to the explicit terms of the contracts between AXA and the funds. Instead it found that it was more appropriate to review the totality of the advisory and administrative services actually provided by AXA. The court concluded "the duties performed by FMG are far more extensive than plaintiffs' contention that FMG delegated all of its work" to sub-advisers.
  • The court rejected the plaintiffs' contention that treating the fees paid to sub-advisers and sub-administrators as expenses to the adviser for purposes of calculating the adviser's profitability in managing the funds was improper.

We will provide further analysis of the district court's ruling in a separate news release.


After listening to 25 days of testimony earlier this year in an excessive fee case against AXA, a federal judge in New Jersey dismissed the case whole cloth. The U.S. District Judge Peter Sheridan found plaintiffs' attorneys failed at every aspect in proving a breach of Section 36(b), which prohibits excessive investment advisory fees.

Investment Advisers

Beware of Failing to Properly Disclose Fees and Assess Adequate Penalties

The Securities and Exchange Commission (SEC) announced that four private equity fund advisers affiliated with Apollo Global Management agreed to a $52.7 million settlement for misleading fund investors about fees and a loan agreement, and failing to supervise a senior partner who charged personal expenses to the funds.

Key Takeaways

Investment advisers should note the following:

  • You cannot accelerate fees owed to you as an adviser unless clients consent to this practice. For a private fund, this means the ability to accelerate fees must be clearly spelled out in the fund's offering documents.
  • You must disclose the manner in which financial actions by a fund, like entering into a loan, will benefit you as an adviser. In this regard, disclosure in financial statements matters.
  • When you assess a penalty for violation of compliance policies and procedures, you may need to make it more severe that a slap on the hand, or the SEC might view your policies as being inadequate.


Acceleration of Fees. Apollo entered into certain agreements with portfolio companies that were owned by Apollo-advised funds (monitoring agreements). Pursuant to the terms of the monitoring agreements, Apollo charged each portfolio company an annual fee in exchange for rendering certain consulting and advisory services to the portfolio company concerning its financial and business affairs (monitoring fee). From at least December 2011 through May 2015, upon either the private sale or an initial public offering (IPO) of a portfolio company, Apollo terminated certain portfolio company monitoring agreements and accelerated the payment of future monitoring fees provided for in the agreements.

Although Apollo disclosed that it may receive monitoring fees from portfolio companies held by the funds it advised, and disclosed the amount of monitoring fees that had been accelerated following the acceleration, Apollo failed adequately to disclose to its funds, and to the funds' limited partners prior to their commitment of capital, that it may accelerate future monitoring fees upon termination of the monitoring agreements.

Because of its conflict of interest as the recipient of the accelerated monitoring fees, Apollo could not effectively consent to this practice on behalf of the funds it advised.

Financial Statement Disclosure Regarding Loan Agreement Inadequate. In June 2008, Apollo Advisors VI, L.P. (Advisors VI) — the general partner of Apollo Investment Fund VI, L.P. (Fund VI) — entered into a loan agreement with Fund VI and four parallel funds (collectively, the Lending Funds). Pursuant to the terms of the loan agreement, Advisors VI borrowed approximately $19 million from the Lending Funds, which was equal to the amount of carried interest then due to Advisors VI from the Lending Funds. The loan had the effect of deferring taxes that the limited partners of Advisors VI would owe on their respective share of the carried interest until the loan was extinguished.

Accordingly, the loan agreement obligated Advisors VI to pay interest to the Lending Funds until the loan was repaid. From June 2008 through August 2013, when the loan was terminated, the Lending Funds' financial statements disclosed the amount of interest that had accrued on the loan and included such interest as an asset of the Lending Funds. The Lending Funds' financial statements, however, did not disclose that the accrued interest would be allocated solely to the capital account of Advisors VI.

The failure by Apollo Management VI, L.P., the Fund VI investment adviser, to disclose that the accrued interest would be allocated solely to the account of Advisors VI rendered the disclosures in the Lending Funds' financial statements concerning the loan interest materially misleading.

Officer's Violations of Compliance Policies and Procedures. From at least January 2010 through June 2013, a former Apollo senior partner (Partner) improperly charged personal items and services (collectively, personal expenses) to Apollo-advised funds and the funds' portfolio companies. In certain instances, the partner submitted fabricated information to Apollo in an effort to conceal his conduct. In other instances, the personal expenses on their face appeared to have a legitimate business purpose.

Notwithstanding his efforts to conceal his conduct, in October 2010, the partner's then-administrative assistant became suspicious of his expense reports and reported the issue to an Apollo expense manager, who reviewed the partner's expenses for the prior six months and discussed them with the partner. Subsequently, in November 2010, the partner admitted that he had improperly charged certain personal expenses and reimbursed Apollo. In response, Apollo verbally reprimanded the partner.

Despite the partner's conduct and Apollo's Travel and Expense Reimbursement Policies and Procedures (T&E Policies and Procedures), which explicitly state that certain types of charges for which the partner sought reimbursement are non-reimbursable, Apollo did not take any additional remedial or disciplinary steps in response to the partner's expense reimbursement practices.

In early 2012, based on renewed suspicions, Apollo initiated a second review of the partner's expenses for the prior six months. In May 2012, as a result of this second review, the partner again reimbursed Apollo for certain personal expenses that he improperly charged. While Apollo issued another verbal reprimand to the partner and instructed him to stop submitting personal expenses for reimbursement, Apollo did not take any other remedial or disciplinary steps at that time, or further supervise the partner.

In August 2012, Apollo, on its own initiative, engaged outside counsel, which then engaged an independent audit firm, to conduct a firmwide review of expense allocations. As part of this review, Apollo requested that the independent audit firm review the partner's reimbursement practices. In June 2013, the independent auditor singled out the partner's expense reports for further review, which entailed an in-depth examination of the partner's expenses, as well as the partner's emails and calendar entries.

On July 1, 2013, Apollo's internal and outside counsel met with the partner concerning his expenses. During that meeting, the partner acknowledged that he had improperly charged a number of personal expenses. As a result, Apollo placed the partner on unpaid leave.

On July 8, 2013, Apollo's outside counsel retained an accounting firm — at the partner's expense — to conduct a forensic review of the partner's expenses from January 2010 to June 2013. That review revealed additional personal expenses that the partner improperly charged to Apollo-advised funds and the funds' portfolio companies.

Apollo thereafter voluntarily reported the partner's expense issues it had discovered to the staff of the commission.


Investment Companies

Business Continuity Planning

The SEC has issued guidance that stresses that the board of directors (Board) needs to mitigate operational risks related to significant business disruptions through proper business continuity planning.

Key Takeaways

The SEC observed the following notable practices in recent discussions with fund complexes about business continuity planning:

  • Business continuity plans ("BCPs") typically cover the facilities, technology/systems, employees, and activities conducted by the investment adviser and any affiliated entities, as well as dependencies on critical services provided by other third-party service providers. In the SEC's view, critical fund service providers likely would include, but would not necessarily be limited to, the investment adviser, principal underwriter, administrator, and transfer agent, as well as each custodian and pricing agent.
  • The fund's Chief Compliance Officer (CCO) and/or the CCO of other entities in the fund complex typically participate in the fund complex's third-party service provider oversight process as conducted by key personnel.
  • Service provider oversight programs generally incorporate both initial and ongoing due diligence processes, including review of applicable business continuity and disaster recovery plans for critical providers.
  • The fund complex typically seeks a combination of information to conduct its oversight, including, but not limited to, service provider presentations, on-site visits, questionnaires, certifications, independent control reports, and summaries of programs and testing, where appropriate, including with respect to BCPs.
  • BCP presentations are typically provided to fund boards of directors, with CCO participation, on an annual basis and are given by the adviser and/or other critical service providers.
  • Business continuity outages, including those incurred by the fund complex or a critical third-party service provider, are monitored by the CCO and other pertinent staff and reported to the fund board as warranted.

In the SEC's view, a fund complex's BCP should contemplate arrangements with third-party service providers, and consider the following lessons learned from past business continuity events and the SEC's outreach efforts, when formulating fund complex BCPs as they relate to critical service providers.

  • Back-Up Processes and Contingency Plans. The SEC believes that fund complexes should consider examining critical service providers' backup processes and redundancies; the robustness of the provider's contingency plans, including reliance on other critical service providers; and how these providers intend to maintain operations during a significant business disruption.
  • Monitoring Incidents and Communications Protocols. The SEC believes that fund complexes should consider how they can best monitor whether a critical service provider has experienced a significant disruption (such as a cybersecurity breach or other continuity event) that could impair the service provider's ability to provide uninterrupted services, the potential impacts such events may have on fund operations and investors, and the communication protocols and steps that may be necessary for the fund complex to successfully navigate such events.
  • Understanding the Interrelationship of Critical Service Provider BCPs. The SEC believes that fund complexes should consider how the BCPs of a fund's critical service providers relate to each other to better ensure that funds can continue operations and/or promptly resume operations during a significant business disruption.
  • Contemplating Various Scenarios. The SEC believes that fund complexes should consider how a critical service provider disruption could impact fund operations and investors, and generally have a plan for managing the response to potential disruptions under various scenarios, whether such disruptions occur internally or at a critical third-party service provider.


Rule 38a-1 under the Investment Company Act of 1940 requires funds to adopt and implement written compliance policies and procedures reasonably designed to prevent violation of the federal securities laws. In the SEC's view, fund complexes should consider their respective compliance obligations under the federal securities laws when assessing their ability to continue operations during a business continuity event. Because fund complexes increasingly use technologies and services provided by third parties to conduct daily fund operations, the SEC believes such dependencies and arrangements should be considered as part of comprehensive business continuity planning.

Mutual funds are generally externally managed and do not have employees of their own; they typically are organized by their primary investment advisers (also known as the funds' sponsors), who often manage a number of funds within a fund complex and coordinate the activities of other fund service providers. Due to this structure, business continuity planning generally is conducted at the fund complex level, and typically business continuity plans address fund activities in conjunction with the activities of the primary investment adviser and other service providers that are part of the fund complex.

Business continuity planning is critical to a fund complex's (or any business entity's) ability to continue operations during, and recover from, a significant business disruption. The development of policies and procedures reasonably designed to ensure that an entity's critical functions and business activities can continue to operate in the face of a significant business disruption has long been considered an essential aspect of operational risk management.

Fund complexes should consider how to mitigate exposures through compliance policies and procedures that address business continuity planning and potential disruptions in services (whether provided internally at the fund complex or externally by a critical third-party service provider) that could affect a fund's ability to continue operations, such as processing shareholder transactions. Because fund complexes vary in activities and operations, their policies, procedures, and plans generally should be tailored based on the nature and scope of their business. Additionally, because fund complexes also outsource critical functions to third parties, consideration should be given to conducting thorough initial and ongoing due diligence of those third parties, including due diligence of their service providers' business continuity and disaster recovery plans.

Investment advisers of fund complexes, CCOs, and the fund board play a key role in the selection and ongoing oversight of critical fund service providers. Key business functions and related activities may be performed by an affiliate of the fund complex, a third-party service provider, or some combination thereof.

The SEC believes that funds will be better prepared to deal with business continuity events, if and when they occur, if fund complexes consider the robustness of their BCPs, as well as those of their critical third-party service providers. The SEC also believes that fund complexes' preparedness likely would be enhanced if they consider their service providers' interrelationships to one another and how the fund complex will respond to significant business disruptions that may impact their internal operations and/or a critical third-party service provider of the fund. The SEC recognizes that it is not possible for a fund or fund complex to anticipate or prevent every business continuity event. However, appropriate planning includes consideration of these issues and various scenarios in advance of a significant business disruption.

Investment Advisers

SEC Rule Designed to Assist Certain Investment Advisers

In a recent letter to the executive vice president of the Securities Industry and Financial Markets Association, David Grim, director of the SEC's Division of Investment Management, stated that SEC Rule 206(3)-3T under the Investment Advisers Act of 1940 will expire at the end of 2016. Further, the SEC will not act to extend it.

Some registered investment advisers who are also registered broker-dealers under the Securities Exchange Act of 1934 rely on the rule to effect securities transactions on a principal basis for its advisory clients. According to Director Grim, only a few registrants still rely on the rule, and those registrants may apply for an exemption order with the SEC in order to continue with relief from the prohibition under Sec. 206(3) of the Advisers Act.

Registrants that will need regulatory relief for the principal transitions after the end of the year are urged to contact the division's chief counsel's office about filing an exemption order application.

Two Will Oversee SEC's Examination Program of Investment Advisers and Investment Companies

The SEC recently announced that Kristin Snyder will join Jane Jarcho as co-directors of the SEC's Investment Management Adviser/Investment Company examination program. Ms. Jarcho has led the program for the last three years. The two co-directors will direct about 500 lawyers, accountants, and examiners in conducting examinations of the SEC registered investment advisers and investment companies.

Ms. Snyder is not new to the SEC's examination program, as she has been the associate regional director for the examination program in the SEC's regional office in San Francisco for the past five years. She will continue that role while serving as the program's co-director.

It is not expected that the new co-director of examinations will materially alter the program's risk-based approach of the examinations of the SEC–registered investment advisers, investment companies, and broker-dealers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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