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News April 30, 2018 Issue

Private Equity Adviser Settles Purchasing Agreement Conflict of Interest Charges

Private equity advisers need to be careful before signing agreements with group purchasing organizations (GPOs). Those agreements may contain conflict-of-interest traps that amount to a breach of fiduciary duty and that should be avoided at all costs.

New York City-based advisory firm WCAS Management on April 24 settled charges with the SEC related to an alleged conflict of interest between itself and the private equity funds it managed. The adviser, with approximately $7.7 billion in assets under management, ran into problems when it signed an agreement with a GPO. GPOs aggregate companies’ spending on certain items, such as office supplies and car rentals, in order to provide group purchasing discounts.

Under that agreement, the WCAS Services Agreement, the GPO paid WCAS a share of the fees the GPO received from vendors as a result of the WCAS portfolio companies’ purchases through the GPO, the agency said. "WCAS did not disclose the conflicts of interest associated with the WCAS Services Agreement, and could not effectively consent on behalf of its private equity fund clients," the SEC said in its administrative order instituting the settlement.

The private equity adviser allegedly received more than $623,000 under the agreement over more than four years. It stopped accepting the fees in May 2017, after the SEC began its investigation. As part of the settlement, WCAS was censured and agreed to pay disgorgement of more than $623,000, prejudgment interest of more than $65,784, and a civil money penalty of $90,000.

"The SEC has had an issue with undisclosed compensation for a very long time, especially when an investment manager uses its authority over client assets to create the opportunity for such compensation," said Faegre Baker Daniels partner Jeffrey Blumberg.

"From a compliance standpoint," he said, "this case serves as a good reminder of one of the primary ways an investment adviser can identify conflicts of interest – ‘follow the money.’ As part of an investment adviser’s annual compliance review, the firm should review all of its sources of income to determine whether any of those income sources create a conflict of interest. If the firm’s compliance staff had done that in this situation, it would have been readily apparent that this income stream needed to be disclosed to the fund’s investors, at a minimum."

Stradley Ronon partner Lawrence Stadulis described the case as significant, because "while failure to disclose is a key allegation in the settlement document, so is the adviser’s alleged failure to obtain meaningful consent from the firm’s investment review committee. It shows that the SEC is not just a disclosure regime, but a disclosure plus regime."

The firm, the funds and the agreements

Investors in the private equity funds managed by WCAS collectively made a commitment to contribute approximately $7 billion to gain control positions in healthcare and information technology companies, referred to in the settlement order as the "WCAS portfolio companies," the agency said. The adviser’s goal was to generate capital appreciation of the companies, including improvement in their operations.

Investors in the funds were primarily large players, and included government pensions, colleges and universities, institutional investors, and charitable endowments, according to the settlement order. Their investments in the funds were governed by private placement memoranda, limited partnership agreements and management agreements. These organizational documents provided for the creation of an investment review committee "to approve in advance any transactions that give rise to potential conflicts of interest" between WCAS and its affiliates, on the one hand, and the WCAS funds, on the other, the SEC said.

The portfolio companies within the funds in 2008 began to use the services of the GPO, which is not named in the settlement order. There were also other ties between WCAS and the GPO that must be understood in order to see how the alleged conflict of interest developed:

  • The WCAS employee. Starting in 2008, a non-senior WCAS employee whose job responsibilities included advising the WCAS portfolio companies on their purchasing activities, provided certain services "for the benefit of the GPO," the agency said.
  • The GPO affiliate. Since 2006, an affiliate of the GPO had an agreement, known as the Portfolio Company Services Agreement, with a particular WCAS portfolio company, known as Portfolio Company A, under which the GPO affiliate directly provided services to Portfolio Company A and not through the arrangement between WCAS and the GPO.

These agreements eventually came up for renewal. Beginning in early 2011, Portfolio Company A, along with the WCAS employee, and representatives of the GPO affiliate began discussing renewing the Portfolio Company Services Agreement. At the same time, the GPO and the WCAS employee began negotiating the WCAS Services Agreement, under which "the GPO would provide WCAS with a share (25 percent) of the GPO’s (net) revenue generated by fees paid by the vendors to the GPO based on all WCAS portfolio companies’ purchasing," the SEC said.

The WCAS Services Agreement did not set a fixed annual payment. "Rather, the more purchasing done by the WCAS portfolio companies through the GPO, the larger the professional services fee WCAS would receive," the SEC said. The more than $623,000 WCAS received covered from September 2012 through December 2016.

One more element to be aware of: A GPO affiliate employee emailed the WCAS employee in October 2011 "to suggest that the WCAS Services Agreement would be approved by the GPO when Portfolio Company A executed the Portfolio Company Services Agreement with the GPO affiliate," the agency said.

Conflicts of interest spelled out

WCAS did not seek prior approval from its investment review committee for the conflicts of interest, as was required by the funds’ organizational documents, according to the settlement order. This was in breach of its fiduciary obligations to its clients, the SEC said. Specifically, the agency listed three conflicts of interest:

  • Receipt of fees. WCAS’s receipt of the professional services fees from the GPO from 2012 through 2016 "was not disclosed in the funds’ organizational documents," which had been drafted in 2005 and 2008;
  • Incentive to recommend. After execution of the WCAS Services Agreement, WCAS "had an incentive to recommend the GPO’s services to the WCAS portfolio companies because it stood to receive a share of revenue generated for the GPO by the WCAS portfolio companies’ purchasing activity;" and
  • Incentive to sign agreement. Following the GPO affiliate employee’s suggestion that the WCAS Services Agreement would be approved by the GPO when Portfolio Company A executed the Portfolio Company Services Agreement with the GPO affiliate (see above), "WCAS had an incentive to encourage Portfolio Company A to enter into the Portfolio Company Services Agreement. . . . Accordingly, WCAS could not effectively consent to the WCAS Services Agreement on behalf of the WCAS funds."

Division of Enforcement staff contacted WCAS and raised concerns about the WCAS Services Agreement, causing the adviser to cease its receipt of the professional services fees under that agreement in May 2017.


As part of the settlement, WCAS was charged with willfully violating Section 206(2) of the Advisers Act, which prohibits fraud, and Section 206(4) and its Rule 206(4)-8, which prohibits the making of untrue statements of material fact. A spokesperson for the firm, when reached, chose not to comment on the matter.