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News December 5, 2005 Issue

Adviser Hit With $100K Penalty For Improperly Computing Performance Fees

The SEC has sued another investment adviser for incorrectly calculating performance fees.

Last week, the SEC announced that Dallas-based Renn Capital Group agreed to pay a civil penalty of $100,000 and disgorge close to $4 million in fees and interest to settle charges that the firm received performance-based compensation greater than that permitted by the formula set out in Advisers Act Section 205.

Specifically, the SEC alleged that for a seven-year period, Renn violated Section 205 by charging performance-based compensation that did not comply with subsection 205(b)(3). Under that subsection, which applies to only to performance fee arrangements with business development companies (BDCs), the performance fee canít exceed 20 percent of the BDCís realized capital gains over a specified period. Those gains must be computed net of all realized capital losses and unrealized capital depreciation. The SEC alleged that when calculating its performance fee, Renn used unrealized capital appreciation to offset unrealized capital depreciation, thus violating the statutory formula.

In addition, the SEC brought related Securities Act charges against the adviser, alleging that the BDCís Form 10-Ks and Form 10-Qs omitted material facts concerning the use of unrealized capital appreciation and the calculation of performance-based compensation. The SEC also alleged that the adviser failed to file a preliminary proxy statement prior to amending the BDCís advisory contract, as required by ICA Section 20(a) and Rule 20a-1.

Although the specific facts of the case were tied to a narrow subsection of the Advisers Act performance fee rule applicable only to BDCs, the case highlights the SECís recent focus on fee arrangements. In light of this case, and a similar case last year against Bridgeway Capital Management and its founder John Montgomery, advisers would be well served to confirm that their advisory fee arrangements are being calculated as disclosed in their contracts. Moreover, firms that charge performance fees should confirm that the fee arrangement is in conformance with applicable provisions of Section 205 of the Advisers Act.