SEC Charges Private Equity Fund Adviser With Misallocation Of Portfolio Company Expenses

On September 22, 2014, the SEC announced that Lincolnshire Management Inc. agreed to settle charges that it breached its fiduciary duty to a pair of its private equity funds by sharing expenses between a company in one fund's portfolio and a company in the other fund's portfolio in a manner that improperly benefitted one fund over another. Lincolnshire agreed to pay over $2.3 million in the settlement, including disgorgement of $1.5 million and a $450,000 civil penalty.

This case follows a recent, well-publicized speech in which Andrew J. Bowden, director of the SEC's Office of Compliance Inspections and Examinations (OCIE), noted that when OCIE examined how fees and expenses were handled by private equity fund managers, OCIE identified what it believed to be "violations of law or material weaknesses in controls" more than 50 percent of the time. Our May 12, 2014, Legal Alert discusses that speech in more detail.

The Portfolio Companies

According to the SEC and public filings, Lincolnshire manages multiple private equity funds that make investments through leveraged buyouts and recapitalizations. In April 1997, Lincolnshire Equity Fund LP (Fund I) acquired Peripheral Computer Support Inc. (PCS) for approximately $5 million. Management of PCS later brought to Lincolnshire an investment opportunity involving Computer Technology Support Inc. (CTS). However, by 2001 Fund I's commitment period had expired. Recognizing that the two companies would complement each other, Lincolnshire caused Lincolnshire Equity Fund II LP (Fund II) to acquire CTS for approximately $8.5 million.

Upon the acquisition of CTS, Lincolnshire disclosed to investors of Fund I and Fund II that it intended to integrate PCS and CTS where feasible and ultimately market the two companies for a combined sale. Additionally, in its quarterly disclosures to investors of Fund I and Fund II, Lincolnshire provided regular updates on the two companies and on the progress toward their integration and joint sale.

The Integration of the Two Portfolio Companies

According to the SEC and public filings, from at least 2005 to January 2013 PCS and CTS were integrated and, in certain respects, operated as a single business, though they remained separate legal entities. By 2005, the companies had integrated their financial accounting systems and a number of business and operational functions, including payroll and 401(k) administration, and substantial parts of human resources, marketing and...