Introduction
Last month, the SEC settled an Enforcement action, TZP Associates, LLC, IA Rel. No 6908 (Aug. 15, 2025), that alleged an investment adviser overcharged private funds for management fees by improperly determining fee offsets and failed to disclose conflicts of interest. The TZP settlement is similar to actions brought by the SEC during the tenures of prior leadership that alleged improper fee charging practices and serves as reminder to private fund managers regarding the importance of maintaining an effective compliance program with respect to its fee-billing practices.
Facts of the TZP Settlement
TZP Management Associates, LLC (“TZP”) is a registered investment adviser to private funds (the “Funds”) that invest in lower-middle market companies. The Funds pay TZP management fees pursuant to their limited partnership agreements (“LPAs”). The LPAs also permit TZP to receive “Transaction Fees,” which are defined to include monitoring fees, transaction fees, advisory fees, and all other fees that TZP received for providing services to a Fund’s portfolio company. The LPAs state that the management fees owed by the Fund will be offset by an amount equal to all of the Transaction Fees paid by the Fund’s portfolio companies, except certain specified fees were excluded from the offset requirement. TZP and some of the Funds’ portfolio companies entered into agreements for TZP to provide services to the portfolio companies. The service agreements set forth the fees paid by the portfolio companies and permitted, in certain instances, the portfolio companies to defer paying TZP for these services and TZP to charge the portfolio companies interest on the deferred amounts. While some investors in TZP Funds who had also co-invested in the portfolio companies received copies of some of these service agreements, TZP did not disclose that it could receive interest on the deferred Transaction Fees.
The SEC alleged that between 2018 and 2023, TZP engaged in two practices related to fee offsets that were inconsistent with the LPAs and created conflicts of interest that were not adequately disclosed to Fund investors. First, five portfolio companies deferred paying TZP for Transaction Fees, and TZP collected interest on these deferred amounts. During the period that the Transaction Fees were deferred, the Funds that had investments in these portfolio companies paid TZP management fees, which were not offset by the amount of the deferred Transaction Fees. These deferrals resulted in the Funds’ management fees being higher than they would have been if the portfolio companies had paid the Transaction Fees. When the portfolio companies subsequently paid TZP the deferred Transaction Fees and interest on the deferred amount, TZP did not count the interest in determining the amount of the fee offset, even though the LPA did not exclude interest on deferred Transaction Fees from the fee offset requirement. This operated as an undisclosed, interest-free loan by the Funds to TZP.
Second, the SEC alleged at least one instance where TZP did not properly offset fees when multiple Funds were invested in the same portfolio company. The LPAs stated that in such a situation, each Fund would be allocated an offset amount based on “all” Transaction Fees that TZP received from the portfolio company. However, TZP initially allocated to each Fund a pro rata portion of the Transaction Fees instead of allocating “all” Transaction Fees received by TZP as required by the LPA, and then reduced each Fund’s allocation a second time based on its fully diluted equity ownership of the portfolio company.
TZP: Advisers Act Violation and Remedy
The TZP Order alleged that these improper fee offset practices resulted in TZP charging the Funds over $500,000 in excess management fees, and that this conduct violated Section 206(2) of the Advisers Act by operating as a fraud on the Funds.
Notably, the TZP Order did not also allege a violation of Rule 206(4)-8 under the Advisers Act for misleading Fund investors, or of Rule 206(4)-7 under the Advisers Act for compliance failures, even though many prior SEC settlement orders alleging similar misconduct by private fund managers did include such additional claims. However, the absence of additional claims in TZP appears to reflect a calibrated adjustment by the SEC rather than a fundamental change in approach, in light of a subsequent SEC settlement, Vukota Capital Management, LLC, where the SEC alleged violations of both Section 206(2) and Rule 206(4)-8 against a private fund manager. Moreover, the Vukota action was based on allegations of negligence by the investment adviser and its principal, which reaffirms the SEC’s willingness to bring such claims without alleging a more culpable mental state.
Compliance Reminders for Private Fund Managers
The TZP and Vukota actions illustrate the SEC’s willingness to bring actions against private fund managers for alleged misconduct that resembles activity that it has traditionally scrutinized, results in economic harm to funds or investors, or that entails conflicts of interest – such as overcharging or improperly offsetting fees. To mitigate their regulatory risk related to these issues, private fund managers should consider the following:
- Careful drafting of LPA provisions: When drafting LPAs, private fund sponsors/ managers should check that LPA language concerning fees and fee offsets clearly captures the fees that they intend to generate and sets forth how offsets will be determined. This is particularly relevant if the nature of the fund, portfolio companies, or the fund manager’s business are such that fees for services other than traditional investment management services are expected to be substantial. Moreover, the Vukota complaint underscores the potential importance of a limited partner advisor committee (LPAC) or similar body to consent to conflicts that may arise and are not addressed by the LPA, because the general partner typically cannot consent on behalf of the fund to a conflict of interest with the investment adviser.
- Monitor and Test Application of LPA Terms: In addition to careful upfront drafting of the LPA, the sponsor’s/fund manager’s relevant personnel need to remain informed of the key LPA terms and how these terms are applied during the fund’s operations. Moreover, periodic testing of the application of LPA terms, particularly related to fees and fee offsets, is typically a component of a well-developed compliance program. Such testing will be most effective when there is effective coordination between the compliance/legal function and personnel in other relevant roles, such as operations, accounting, and finance. While it is not clear from the SEC order whether TZP engaged in such monitoring activity, it is possible that internal testing of its fee billing and offset calculations could have identified potential issues and prompted remedial measures without an SEC enforcement action.
- Identifying conflicts of interest: An effective compliance program also includes mechanisms to identify potential conflicts of interest. This includes assessing whether ongoing and potential future revenue streams, activities, and transactions could result in situations where the interests of the sponsor/manager could differ from the best interests of the fund. For example, in TZP, the deferred payment of Transaction Fees combined with the process for calculating fee offsets meant that the investment adviser benefitted from the deferral of payments (by receiving an essentially interest-free loan from the Funds) whereas the Funds did not. Having such a process is critical because some conflicts of interest arise unexpectedly after LPA terms are finalized, and identifying such a conflict early can afford the best options to avoid, mitigate, or obtain informed consent to the conflict. Again, while the TZP order did not discuss what efforts, if any, the private fund manager took to identify conflicts of interest, it is possible that effective efforts to do so could have prevented or mitigated the conflicts at issue.
Private fund managers seeking advice on how to manage regulatory risk related to the issues discussed in this post or their operations generally are encouraged to reach out to Freshfields’ Private Funds and Secondaries team.
