The Securities and Exchange Commission has charged an Arizona-based private equity fund manager and his investment advisory firm for orchestrating a scheme to misallocate their expenses to the funds they manage.
The SEC enforcement division alleges that Scott A. Brittenham and Clean Energy Capital (CEC) improperly paid more than USD3m of the firm’s expenses by using assets from 19 private equity funds that invest in private ethanol production plants.
CEC and Brittenham did not disclose any such payment arrangement in fund offering documents.
When the funds ran out of cash to pay the firm’s expenses, CEC and Brittenham loaned money to the funds at unfavourable interest rates and unilaterally changed how they calculated investor returns to benefit themselves.
“Brittenham betrayed investors in the funds he managed by burdening them with more than USD3m in expenses that his firm should have paid and the funds could not afford,” says Marshall S Sprung, co-chief of the SEC enforcement division’s asset management unit. “Private equity advisers can only charge expenses to their funds when they clearly spell that out for investors.”
According to the SEC’s order instituting administrative proceedings, among the expenses that CEC and Brittenham have been misallocating to the funds are CEC’s rent, salaries, and other employee benefits such as tuition costs, retirement, and bonuses. Brittenham even used fund assets to pay 70 per cent of a USD100,000 bonus that he awarded himself. The money taken from the funds for firm expenses was in addition to millions of dollars in management fees already being paid to CEC out of the funds.
According to the SEC’s order, the expense misallocation scheme shrank the funds’ cash reserves. So CEC and Brittenham made unauthorised “loans” to the funds at exorbitant rates as high as 17 percent in order to continue paying the improper expenses with fund assets. The loans jeopardised the funds because Brittenham had pledged fund assets as collateral. CEC and Brittenham further profited at the expense of fund investors by making several changes to how CEC calculated distributions to investors in order to pay out less money. Brittenham also lied to a fund investor about his “skin in the game.” Brittenham claimed that he and CEC’s co-founder had each invested USD100,000 of their own money in one of the funds, but the actual amounts invested were only USD25,000 each.
The SEC’s order alleges that CEC and Brittenham willfully violated the antifraud provisions of the federal securities laws and also asserts disclosure, compliance, custody, and reporting violations.
