The Securities and Exchange Commission ("SEC") initially focused on newly registered hedge fund and private equity fund managers once private fund managers were required to register as investment advisers as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act. But Igor Rozenblit, co-head of the SEC's private funds unit ("PFU"), signaled at Private Equity International's CFO and CCO Forum in New York in January 2015 the PFU's intention to look "beyond buyout funds" and examine "adjacent illiquid asset classes."

This was followed up on May 13, 2015, by Marc Wyatt, the then acting director of the SEC's Office of Compliance Inspections and Examinations ("OCIE"), when he addressed the Private Equity International Private Fund Compliance Forum in New York. Wyatt noted that while progress has been made toward addressing a number of important issues in the private equity fund industry, there is still room for improvement, including in the areas of fee and expense allocation, co-investment allocation, and the practices of real estate fund advisers. With respect to real estate fund advisers, he noted that in addition to focusing on traditional private equity, OCIE's PFU undertook a thematic review of private real estate fund advisers, especially those executing an opportunistic and value-add strategy, on the basis that such managers tend to be more vertically integrated than traditional private equity managers.

For example, in addition to providing investment management services, such vertically integrated managers often provide property management, construction management and leasing services for additional fees. Wyatt also observed that some managers in this space also charge back the cost of their employees who provide asset management services and their in-house attorneys. The PFU's examination of such fees and expenses illustrated that in some instances those services were not disclosed. In addition, investors frequently allowed the manager to charge such additional fees based on an understanding that the fees would be at or below a market rate. In the PFU's view, managers were rarely able to substantiate such claims, and in some instances the manager collected no data to justify its fees, collected informal data, did not adequately document the data or presented the information in a misleading manner.

This latter concern was reiterated by SEC Chair Mary Jo White on Oct. 16, 2015, at the MFA's Outlook 2015 Conference in New York. White indicated that the SEC's concerns with fee and expense allocations "go beyond private equity advisers" and that the PFU is completing a review of private fund real estate advisers, many of which "may be hiring related parties" without disclosure of these arrangements, particularly as to whether these related parties charge market rates.

It is important to note that a recently settled enforcement action illustrates the SEC's focus on fee and expense allocations and undisclosed conflicts of interest. In this action, the SEC charged that private equity firm Fenway Partners LLC and a number of its executives failed to disclose conflicts of interest arising from transactions involving payments from fund assets or portfolio companies to a consulting company affiliated with the fund's adviser. In light of the common use of firms that are affiliated with the adviser of a real estate fund, it will be important for real estate fund advisers to disclose the use of such affiliates and their compensation or assemble documentation that substantiates the arm's-length nature of the compensation paid to such affiliates.

As the SEC's focus on private fund managers continues to progress, real estate fund managers, who have generally been deferred until now in favor of hedge fund and private equity fund advisers, should ensure that they prepare and implement adequate compliance policies, accurately disclose any fee and expense and co-investment allocation policies, and review their disclosures regarding other arrangements that may give rise to conflicts of interest.

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