Apollo Charged With Disclosure and Supervisory Failures

 

On August 23, 2016, the Securities and Exchange Commission announced that four private equity fund advisers affiliated with Apollo Global Management (the “Apollo Advisers”) agreed to pay $52.7 million in settlement for (i) reportedly misleading fund investors about fees and a loan agreement, and (ii) failing to supervise a senior partner who improperly charged personal expenses to the funds and the funds’ portfolio companies.  The SEC’s press release announcing the enforcement action and settlement is available here.  The SEC’s Order is available here.

The Commission’s order references two distinct fiduciary breaches along with the supervisory violation.  First, the SEC found that the Apollo Advisers failed adequately to disclose the benefits received when the fund accelerated payments of future monitoring fees owed by the funds’ portfolio companies upon the sale or IPO of those companies.  According to the SEC, the lump sum payments received by the Apollo Advisers as a result of acceleration reduced the portfolio companies’ value prior to their sale or IPO and thus reduced amounts available for distribution to fund investors.

Second, the SEC found that one of the Apollo Advisers failed to disclose certain information about interest payments made on a loan between the adviser’s affiliated general partner and five funds.  The purpose of the loan was to defer taxes on carried interest due the general partner.  The loan agreement obligated the general partner to pay interest to the funds during the course of the loan, and the funds’ financial statements disclosed that interest was accruing as an asset of the funds.  But that interest was instead ultimately allocated solely to the general partner, which made the disclosures in the financial statements misleading, according to the Commission.

As for the alleged supervision violation, the Commission found that Apollo failed reasonably to supervise a then-partner who improperly charged expenses to Apollo-advised funds and to certain of the funds’ portfolio companies.

This action is notable for several reasons:

Disclosure of Fees and Conflicts of Interest:  First, the Apollo action reflects the Commission’s longstanding focus on the disclosure of fees and conflicts of interests in the private equity space.  As Andrew J. Ceresney (Director of the SEC Enforcement Division) noted in the Apollo press release, “A common theme in our recent enforcement actions against private equity firms is their failure to properly disclose fees and conflicts of interest to fund investors.”  According to Ceresney, the failure to disclose the acceleration of monitoring fees and the allocation of loan interest prevented investors from gauging the impact of these practices upon on their investments.

Supervisory Obligations:  Second, the Apollo action speaks to an investment adviser’s supervisory obligations, especially with regard to potential loyalty breaches. As detailed in the Order, Apollo’s supervisory violations involved a then-senior partner who improperly charged personal items and services to Apollo-advised funds and their portfolio companies.  The SEC’s order reports that Apollo had investigated the partner’s expense practices in the past, and had twice reprimanded him.  Eventually, following an investigation by outside counsel, the partner repaid improperly charged expenses and was separated from the firm.  Apollo also self-reported the partner’s misconduct to the SEC.  Even so, Anthony S. Kelly (Co-Chief of the SEC Enforcement Division’s Asset Management Unit), commented that “Apollo failed to take appropriate action to protect its clients upon first learning that a partner was improperly expensing personal items and services to the funds, and its failure resulted in repeated misconduct.”  This statement suggests that the duty to supervise includes an obligation swiftly and vigorously to investigate and (if necessary)  remediate misconduct, especially when the misconduct involves a senior employee or owner, a loyalty breach, or both.

Separation from Employment and Disclosure to SEC Not Enough to Avoid Finding:  Notably, Apollo was not able to avoid a supervisory violation despite the steps it took to investigate, remediate, and report the partner’s expense-related misconduct.  The chronology is important:

– Apollo first became aware of a possible issue with the partner’s expense practices in 2010, after the partner’s administrative assistant raised concerns about expense reports with Apollo’s expenses manager.  After investigating the partner’s expenses for the prior six months, Apollo’s expense manager verbally reprimanded the partner.

– In early 2012, based on renewed suspicions, Apollo instituted a second review of the partner’s expenses.  This led to a second verbal reprimand.

– In late 2012, on its own initiative, Apollo engaged outside counsel.  Outside counsel then engaged an independent audit firm, to conduct a firm-wide review of expense allocations.  As part of this review, Apollo requested that the independent audit firm review the partner’s reimbursement practices.  On July 1, 2013, during a meeting between the partner and Apollo’s inside and outside counsel, the partner reportedly admitted that he had improperly charged a number of personal expenses.  Apollo immediately placed the partner on unpaid leave. The partner later repaid Apollo for the expenses that he had improperly charged.

-On January 20, 2014, the partner and Apollo executed a formal separation agreement.

– Apollo thereafter voluntarily reported the partner’s expense issues to the Commission.

I have recounted all of this to show that while Apollo — while perhaps not as aggressive as the Commission might have liked — did respond to the improper conduct.  Nevertheless, the Commission found that Apollo committed a supervisory violation — i.e., that it failed to adopt and implement policies and procedures reasonably designed to prevent violations of the Investment Advisers Act of 1940 and its attendant rules.  As this suggests, the degree to which investigation, remediation, or cooperation with the Commission impacts — or not — enforcement outcomes in SEC matters remains a “hot topic.”

As set forth in the Order, Apollo consented to the entry of the SEC’s order finding that it violated Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8.  The order also found that Apollo failed reasonably to supervise the then-partner pursuant to Section 203(e)(6) of the Advisers Act.  Apollo agreed to cease and desist from further violations without admitting or denying the findings, and must pay $37.527 million in disgorgement, $2,727,552 in interest, and a $12.5 million penalty.  Apollo agreed to distribute the disgorgement and interest amounts to affected fund investors.

Christine Chung

Christine Chung

This blog is edited by Christine Sgarlata Chung, Associate Professor of Law at Albany Law School, and Co-Director, Institute for Financial Market Regulation. In addition to her work in academia, Professor Chung previously served as a Branch Chief in the Enforcement Division of the Securities and Exchange Commission and as a partner at a large Boston-based law firm.
Christine Chung