Settlement Concerning a Vertically Integrated Real Estate Adviser

On September 3, 2024, the SEC reached a settlement in an administrative proceeding involving a vertically integrated private equity real estate manager. The charges centered on the manager’s failure to adequately disclose and obtain required approvals for the use of related-party service providers.¹
The investment manager was found in violation of Sections 206(2) and 206(4) of the Investment Advisers Act and Rules 206(4)-8 and 206(4)-7, voluntarily remediated the conduct by reimbursing funds and paid a $350,000 penalty.

Vertically Integrated Real Estate Manager: The adviser managed private equity real estate funds and, through affiliates, provided various services at both the fund and asset levels, including tax accounting, legal support, loan servicing, property maintenance, and property-level accounting.
Disclosure Requirements: Certain fund Limited Partnership Agreements (LPAs) mandated that relationships with related service providers be fully disclosed to limited partners in writing and receive either written consent or approval from the Funds’ Limited Partner Advisory Committee (LPAC), or in one case, from a majority of the limited partners before the commencement of services. One fund LPA allowed “reasonable costs and expenses” to be charged without prior disclosure.
The Violations:
1. The adviser charged some related party fees without complying with the pre-approval requirements of its LPAs. Instead, the fees were disclosed in fund financial statements.
2. One related party fee was not disclosed in financial statements.
3. For the one fund that had an exception for “reasonable costs and expenses”, fees were charged which were not “reasonable costs and expenses” likely because they were not structured as cost reimbursement.
4. No policies and procedures existed to manage related party service provider conflicts.

Policies and Procedures – This enforcement action highlights the ongoing debate about the necessity of policies and procedures versus reliance on LPA provisions alone. While every situation is different, the more detailed an LPA is, the less value additional policies may add, as they would merely restate existing terms. Instead, managers might find it more effective to invest in a comprehensive testing program to ensure strict adherence to LPA requirements.
Following LPA Provisions is a Basic Requirement – The SEC interprets LPAs strictly and will expect advisers to follow each provision without deviation. There is very little flexibility when LPAs have strict requirements as they did in this case.

_{¹ In the Matter of Colony Capital Investment Advisors, LLC Administrative Proceeding File No. 3-22044}