KKR & Co. Will Pay Nearly $30M to Settle SEC Charges of Misallocating Broken Deal Expenses

The U.S. Securities and Exchange Commission announced that Kohlberg Kravis Roberts & Co. (KKR) would pay close to $30 million, including a $10 million penalty, to settle charges that it misallocated over $17 million in “broken deal” expenses to its flagship private equity funds. According to the regulator, over a six-year period ending in 2011, KKR incurred $338 million in diligence expenses, also known as broken deal costs, related to buyout opportunities that were unsuccessful, as well as other similar expenses.

This is the first time the SEC has charged a private equity adviser over the misallocation of broken deal costs. During the period in question, KKR was overseeing two money pools—the private equity funds and its co-investment vehicles. As the private equity funds invested $30.2 billion, KKR co-investors put in $4.6 billion alongside the funds. Yet even though the firm raised billions of dollars of deal capital from co-investors, it was the flagship funds funds that ended up bearing all the costs of these broken deals.

The SEC said that as a result of the firm’s allocation practices, firm insiders and certain major clients who had invested via the co-investment vehicles benefited as none of the broken deal costs were allocated them for years even as they also availed of deal sourcing activities. The regulator said that not notifying investors of its allocation practices was a breach of fiduciary duty by KKR.

The SEC’s order, which institutes a settled administrative proceeding, also found that KKR did not put in place a written compliance policy related to fund expense allocation practices until the end of the period in question. The SEC said that it was this failure to adopt and implement procedures and polices that lead the firm to breach its fiduciary duty.
The SEC said that aside from the $3.3 billion in misallocated broken deal costs from 2009 to 2011, another $14 million in such costs were improperly charged to the KKR funds going back to 2006. Without denying or admitting to the SEC charges, KKR will pay back fund investors $18.7 million for the misallocated fees ($3.26 million was refunded earlier to clients) plus prejudgment interest of over $4.5 million, along with the $10 million penalty to the SEC. KKR also consented to the entry of the order finding that it violated sections of the Investment Advisers Act of 1940, as well as Rule 206(4)-7.
It was just last year that the regulator chastised the industry for hidden fees in funds and the shifting of certain expenses onto investors without telling them. In January, KKR gave investors back money after the SEC accused the firm of wrongly charging them for certain expenses and not properly notifying them about certain fees.

Private equity firms typically invest money for endowments, pension funds, and rich individuals in private placements. At The SSEK Partners Group, we are here to help high net individual investors and institutional investors recover their losses from securities fraud. Contact our securities lawyers today.

Read the SEC Order (PDF)