Kohlberg Kravis Roberts & Co. was charged with misallocating more than $17 million in so-called broken deal expenses to its flagship private equity funds in breach of its fiduciary duty, the first such case to be brought, the Securities and Exchange Commission said Monday.
KKR agreed to pay nearly $30 million to settle the charges, including a $10 million penalty, the commission said in a statement.
The SEC Enforcement Division’s Asset Management Unit has been scrutinizing the private equity industry to make sure that fund managers aren’t misallocating or unfairly charging fees and expenses to investors. It found that during a six-year period ended in 2011, KKR incurred $338 million in broken deal or diligence expenses related to unsuccessful buyout opportunities and similar expenses.
Even though KKR’s co-investors, including KKR executives, participated in the firm’s private equity transactions and benefited from the firm’s deal sourcing efforts, KKR did not allocate any portion of these broken deal expenses to any of them for years. KKR did not expressly disclose in its fund limited partnership agreements or related offering materials that it did not allocate broken deal expenses to the co-investors.
“This is the first SEC case to charge a private equity adviser with misallocating broken deal expenses,” said Andrew J. Ceresney, Director of the SEC Enforcement Division. “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.”
The SEC’s order instituting a settled administrative proceeding also finds that KKR failed to implement a written compliance policy governing its fund expense allocation practices until the end of the six-year period in 2011.
KKR consented to the entry of the SEC’s order finding that the firm violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7. KKR agreed to pay more than $14 million in disgorgement ($3.26 million was previously refunded to clients) as well as more than $4.5 million in prejudgment interest and the $10 million penalty. KKR neither admitted nor denied the SEC’s findings.
