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Zombie funds ripe for regulatory scrutiny: panel

  • Without new fund, firms lack incentive to keep interests aligned
  • Alignment “falls apart” in zombie funds, says SEC panelist
  • Panelists cite Fenway Partners as example

Private equity firms are more likely to deviate from their contracts with limited partners when they do not plan to raise a new fund, said panelists at a November industry conference .

The misalignment of interests between limited partners and general partners of “zombie funds” can lead firms to run afoul of regulators, said SEC Senior Counsel Christopher Mulligan on a panel called “Coping with Regulatory Change: What’s Next in IA Compliance,” hosted on November 17 by IA Watch and Buyouts Insider, publisher of Buyouts.

With little hope for a new fund, zombie fund GPs may lack incentive to give their best effort in servicing remaining portfolio companies.

“It’s common sense,” Mulligan said. “You do not want to upset your investors over a few dollars, or a few million dollars, because what’s important is that you raise that next fund and you get everyone back and everyone’s happy. All that kind of falls apart when there’s not going to be a next fund.”

Mulligan’s comments referenced a recent SEC enforcement action against Fenway Partners, which has not raised a new vehicle since Fenway Partners Capital Fund III in 2006.

The SEC found Fenway “rerouted” roughly $20 million in fund and portfolio company assets to a consulting firm, called Fenway Consulting Partners, which is majority-owned by current and former Fenway Principals Peter Lamm, Timothy Mayhew and Greg Smart.

The firm did not use its portfolio companies’ payments to Fenway Consulting Partners to offset management fees paid by its fund LPs, which “breached their fiduciary obligation to fully and fairly disclose conflicted arrangements to a fund client,” said Marshall Sprung, co-chief of the SEC Enforcement Division’s Asset Management Unit.

Fenway and past and former executives did not admit or deny any of the SEC’s findings. The firm declined to comment.

“This is exactly the scenario we’re concerned about,” Mulligan said on the panel. “You’re providing services, you’re charging a fee, and this is all negotiated, and the adviser can just reclassify things overnight.”

Fenway III netted just 2 percent as of June 30, according to Oregon documents. The firm planned to raise a fourth fund in 2013, but has not yet done so. It’s not clear if Fenway still has plans to raise a new flagship vehicle.

Fenway did raise $11.3 million for a single investment through a vehicle called Fenway HTM Partners in 2013.

Photo courtesy of Shutterstock

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