The Securities and Exchange Commission today announced that three private equity fund advisers within The Blackstone Group have agreed to pay nearly $39 million to settle charges that they failed to fully inform investors about benefits that the advisers obtained from accelerated monitoring fees and discounts on legal fees.  Nearly $29 million of the settlement will be distributed to affected fund investors.

An SEC investigation found that Blackstone Management Partners, Blackstone Management Partners III, and Blackstone Management Partners IV failed to adequately disclose the acceleration of monitoring fees paid by fund-owned portfolio companies prior to the companies’ sale or initial public offering.  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 investigation also found that fund investors were not informed about a separate fee arrangement that provided Blackstone with a much greater discount on services by an outside law firm than the discount that the law firm provided to the funds.

“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 Andrew J. Ceresney, Director of the SEC’s Division of Enforcement. 

“As the beneficiary of the accelerated monitoring fees, Blackstone violated its fiduciary duty by failing to properly disclose the fees,” said Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit.  “Blackstone further breached its fiduciary duty by choosing to negotiate a legal fee arrangement with greater benefits for itself than the funds it advised, without properly disclosing the arrangement.”

According to the SEC’s order instituting a settled administrative proceeding:

• Blackstone typically charges a monitoring fee to each portfolio company owned by its funds.  The fee covers advisory and consulting services to the portfolio company and typically is for a ten-year period. 
• Before the private sale or initial public offering of certain portfolio companies, Blackstone terminated monitoring agreements and accelerated the payment of future monitoring fees, including in some instances when monitoring services would no longer be provided.  Some of the accelerated fee payments were used to offset management fees. 
• Blackstone disclosed its ability to collect monitoring fees prior to investors’ commitment of capital but did not disclose its practice of accelerating monitoring fees until after it took the fees.
• Blackstone also failed to disclose a legal fee arrangement providing it with a much greater discount on its legal fees than the discount the funds received. 
• Blackstone negotiated the arrangement with a law firm that performed a substantial amount of legal work for Blackstone and its funds.  The funds generated significantly more legal fees than Blackstone did.   
• Blackstone also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act of 1940.

Blackstone consented to the entry of the SEC’s order finding that it breached its fiduciary duty to the funds, failed to properly disclose information to the funds’ investors, and failed to adopt and implement reasonably designed policies and procedures.  Without admitting or denying the findings, Blackstone agreed to cease and desist from further violations, to disgorge $26.2 million of ill-gotten gains plus prejudgment interest of $2.6 million, and to pay a $10 million civil penalty.  Blackstone agreed to distribute $28.8 million to affected fund investors.  The settlement reflects Blackstone’s remedial acts and its voluntary and prompt cooperation with the Division of Enforcement’s investigation. 

The Division of Enforcement’s Asset Management Unit is continuing its review of private equity fee and expense issues and encourages private equity fund advisers that have identified such issues to self-report them to the staff.  As noted in the Division of Enforcement’s Enforcement Manual, self-reporting is one factor that the Commission considers when evaluating cooperation and determining whether and to what extent to extend credit in settlements.

The SEC’s investigation was conducted by Donna Norman and supervised by Anthony Kelly of the Enforcement Division’s Asset Management Unit.  Joy Best, Dawn Blankenship, Karen Karakaya, and Igor Rozenblit conducted a related examination of Blackstone.

Related Materials

• SEC order