First Private Fund Case of the New Administration Demonstrates Importance of Expenses and Testing

Summary:

On March 7, 2025, the United States Securities and Exchange Commission (“SEC”) reached a settlement with an investment adviser and an individual¹ in connection with violations of fiduciary duty, misappropriation of funds, breaches of the custody rule, and compliance deficiencies related to an investment fund under the firm’s management.
This case stems from a regulatory examination and demonstrates that, despite recent disruptions within the SEC and the broader federal government, the Division of Enforcement continues to be able to effectively bring private fund actions based on examination referrals.

Allegations and Conduct:

The Investment Adviser – The investment adviser oversaw approximately $353 million in assets across individual client accounts and managed a private fund that raised approximately $5 million from advisory clients. The private fund was established for the acquisition and development of franchise businesses, including dry-cleaning enterprises.
Breach of Fiduciary Duty
- The principals of the adviser jointly owned two portfolio companies with a former business partner. The fund subsequently acquired the former business partner’s interest in these portfolio companies and fully repaid all outstanding debt that the former business partner had extended to them. Although the principals of the adviser benefited from the reduced leverage resulting from this transaction, they did not contribute capital toward the repayment of the debt.
  - Analysis: Examiners conducted an analysis of the company’s capital structure and determined that a reduction in leverage enhanced the value of the principals’ holdings. However, the examination also revealed that the principals did not contribute to this reduction, thereby receiving an undue benefit.
- A principal of the adviser, who exercised partial control over the portfolio companies, misappropriated funds from both the portfolio companies and indirectly the private fund. This misconduct included, among other improper actions, obtaining unauthorized reimbursements for personal expenses such as travel, clothing, and vacations. The adviser failed to detect this fraud until it was uncovered during an examination, having lacked adequate oversight controls to prevent or identify such misconduct.
Compliance Failures and Failure to Supervise
- The principals of the adviser exercised significant operational control over the fund’s portfolio companies and simultaneously held ownership interests in those same entities. Despite this dual role, they lacked formalized policies and procedures to govern such control or to mitigate associated risks, including the potential misappropriation of expenses.
- The adviser failed to address several significant red flags, including: (i) a substantial and unexplained increase in expenses categorized as “customer garment replacement” in the portfolio company’s profit and loss reports; (ii) the principal’s failure to pay personal taxes and indications of financial distress, which ultimately culminated in the misappropriation of funds; (iii) an unexpected rise in travel-related expenses; and (iv) an admission by one of the principals that she had inadvertently used portfolio company debit cards to cover $18,000 in personal expenses.

Takeaways:

Potentially Increased Focus on Expenses: Although it may appear counterintuitive, the current administration may heighten its scrutiny of private fund expense practices. As regulatory attention shifts away from more complex private fund matters, the Commission may intensify examinations related to expenses, seeking to address potential misconduct in areas where violations are more readily identifiable. This shift would reflect a strategic reallocation of oversight toward issues with clearer implications for fraud detection and individual accountability.
Importance of Risk Based Testing: Testing programs must be designed to address the specific risks inherent to a firm. In this instance, the adviser’s principals exercised operational control over the fund’s portfolio companies, yet this risk was not identified, and no corresponding testing program was developed.
Sophistication in Exams: In this case, the EXAMs and Enforcement demonstrated their ability to scrutinize the expenses of portfolio companies, assess their operations, and identify potentially fraudulent expenditures. Furthermore, examiners conducted a thorough analysis of the portfolio companies’ capital structures, ultimately determining that the structuring of debt repayment improperly advantaged the adviser.

¹ In the Matter of Momentum Advisors LLC and Allan J. Boomer; In the Matter of Tiffany L. Hawkins a/k/a Tiffany Taylor Watson