Two men share securities regulation news

Breaking news and expert analysis on legal and compliance issues

[Back To Home][Back To Archives]

From Securities Regulation Daily, December 4, 2018

Adviser improperly made clients pay its rent and overhead

By Rodney F. Tonkovic, J.D.

An investment adviser has been sanctioned for improperly allocating expenses to former business development company clients, and failures relating to those clients' valuation models. According to the Commission, the adviser allocated its own rent, overhead, and compensation expenses to the clients. Further, the adviser's failure to properly conduct quality control review of the clients' quarterly valuation models caused them to include material misstatements in their financial statements. In addition to a cease and desist order, the adviser was censured and ordered to pay $2,33,660 in disgorgement and interest, plus a $1,650,000 civil penalty (In the Matter of Fifth Street Management, LLCRelease No. 33-10581, December 3, 2018).

Rent and overhead. Fifth Street Management, LLC was the investment adviser to two business development company clients (BDCs). Fifth Street and the BDCs shared office space, and a number of employees performed work for both the adviser and the clients. Under the advisory agreement, Fifth Street was responsible for paying the compensation and routine overhead expenses of its personnel while shared expenses were allocated to the clients.

Fifth Street, however, allocated all of the rent and overhead expenses associated with its own employees—over $1.2 million—to the BDCs. Further, Fifth Street improperly allocated over $100,000 to the clients for the compensation of two of its employees who performed tasks unrelated to the advisory work for the clients. This misallocation of rent, overhead, and compensation caused the BDCs to overstate their expenses during the periods at issue.

Valuations. Fifth Street was also responsible for conducting QC reviews of one of the BDC's quarterly valuation models for its debt investments. This process was a critical part of the client's quarterly valuation process and its internal accounting controls. Some of Fifth Street's analysts, however, did not understand the required level of review and failed to flag incorrect or unreasonable valuation model inputs. As a result, the client included materially inaccurate financial statements in its SEC filings and resulted in the issue of overvalued shares to the public.

Violations. The Commission found that Fifth Street violated the antifraud and policies and procedures provisions of the Investment Advisers Act. The adviser also caused the BDCs to violate Securities Act Section 17(a)(2) and the reporting, books and records, and internal controls provisions of the Exchange Act and the Investment Company Act. In addition to a cease and desist order, the adviser was censured and ordered to pay disgorgement of $1,999,115.86, prejudgment interest of $334,545.65, and a $1,650,000 civil money penalty.

The release is No. 33-10581.

MainStory: TopStory Enforcement InvestmentAdvisers InvestmentCompanies

Back to Top

Securities Regulation Daily

Introducing Wolters Kluwer Securities Regulation Daily — a daily reporting service created by attorneys, for attorneys — providing same-day coverage of breaking news, court decisions, legislation, and regulatory activity.

A complete daily report of the news that affects your world

  • View full summaries of federal and state court decisions.
  • Access full text of legislative and regulatory developments.
  • Customize your daily email by topic and/or jurisdiction.
  • Search archives for stories of interest.

Not just news — the right news

  • Get expert analysis written by subject matter specialists—created by attorneys for attorneys.
  • Track law firms and organizations in the headlines with our new “Who’s in the News” feature.
  • Promote your firm with our new reprint policy.

24/7 access for a 24/7 world

  • Forward information with special copyright permissions, encouraging collaboration between counsel and colleagues.
  • Save time with mobile apps for your BlackBerry, iPhone, iPad, Android, or Kindle.
  • Access all links from any mobile device without being prompted for user name and password.