In the early days of SEC oversight of private funds, “presence exams” revealed gaps with how advisers disclosed and allocated expenses, especially in private equity, where advisers often manage both fund assets and portfolio companies. In a seminal 2014 speech that explained how the structure of private funds could drive problems with expense allocations, the Director of the SEC’s Office of Compliance, Inspections, and Examinations (now the SEC Division of Examinations) reported that examiners were finding:
- Undisclosed fees and expenses
- Impermissible shifting or misallocation of costs
- Inadequate disclosure of conflicts, especially around adviser overhead and consulting fees
These practices raised serious concerns about transparency and fairness. In response, enforcement actions were taken, reinforcing a clear expectation for advisers to provide detailed, transparent disclosures about all fees and expenses charged to funds or the portfolio companies held by funds, especially those tied to the adviser’s operations.
The analysis in that 2014 speech became a blueprint for an evergreen element of the SEC’s private fund examination program. Today, the 2025 Examination Priorities continue to note that examiners will review “The accuracy of calculations and allocations of private fund fees and expenses (both fund-level and investment-level).”
Key Expense Allocation Issues
When reviewing fund allocation practices, compliance officers should pay particular attention to the following issues:
- Operating costs and overhead: Advisers must disclose when fund assets are used to cover legal, accounting, or compliance costs that primarily benefit the adviser.
- Employee costs: Restructuring compensation for the adviser’s staff as consulting fees chargeable to funds or portfolio companies require clear disclosure.
- Outsourcing fees: Costs for services that governing documents assign to the adviser cannot be shifted to clients without disclosure and consent.
- Luxury expenses: Costs for private jets, fine dining, or other high-end travel must be disclosed in offering documents and, if applicable, to limited partner advisory committees (LPACs). Ideally, these offering documents should include spending caps adjusted for inflation.
- Shared expenses: When expenses benefit multiple clients or both adviser and clients, fair allocation and documented policies are essential.
- Cybersecurity: As cybersecurity costs rise, more advisers are allocating these expenses to funds. This change requires clear disclosure and, depending on the fund’s governing documents, may require consent of the limited partners or the LPAC.
Policies, Procedures, and Testing
Examiners scrutinize not just disclosures, but also the policies, procedures, and methodologies used to allocate expenses. Advisers must maintain:
- Policies and procedures that reflect fiduciary duties to each fund
- Detailed, testable allocation records
- Clear documentation of how expenses align with disclosures
Use of corporate cards, ambiguous expense categories, and less than meticulous recordkeeping can lead to errors. Advisers need policies and procedures outlining the specific calculations and related records to demonstrate the propriety of allocations.
Balancing Detail and Flexibility
A key challenge when drafting allocation policies is deciding on granularity. Whether using high-level categories or detailed lists, the guiding principle should be: Would an investor be surprised to learn the investor paid this expense, either directly as part of fund expenses or indirectly by charging the expense to a portfolio company?
The Role of LPACs
As private equity governance has matured, LPACs have become more common. They typically oversee:
- Conflicts of interest
- Valuation methods
- Key hires and fund strategy
If a fund has an LPAC, advisers must follow the fund’s governing documents regarding expense approvals, document LPAC decisions, and ensure transparency by sharing all relevant materials with limited partners.
Testing and Examiner Expectations
Advisers should regularly test compliance with their expense policies. Effective testing may include:
- Reviewing travel itineraries, meeting notes, and work product to confirm that expenses are actually business-related
- Documenting exceptions and corrective actions
- Maintaining records that demonstrate compliance with disclosures in Form ADV and fund documents
Strong controls over the allocation of fund expenses are now table stakes, but they remain difficult to implement. Mistakes persist, and the SEC continues to bring enforcement actions against advisers with poor expense controls. Prospective investors conducting operational due diligence reviews will also take an interest in the adviser’s controls over expenses.
Ensure Expense Allocation Compliance
ACA consultants can help you design and test your expense allocation policies and procedures. Our Mock Exams team offers targeted reviews to ensure your practices align with regulatory expectations and fiduciary standards.
Contact us to speak with our experts about ensuring your firm is in compliance.