anton4.jpg

SEC Enforcement Focus Areas for Private Equity Fund Managers

In a speech before the Private Equity International Conference yesterday, Bruce Karpati, the chief of the Asset Management Unit of the SEC Enforcement Division reiterated the focus of the Division on private equity and other fund managers. This speech is a sequel to the one delivered by Mr. Karpati last month before the Regulatory Compliance Association which we discussed in our previous communiqué. After reiterating the Division’s increased attention on fund managers and the fact that Enforcement Staff is participating in exams along with OCIE, Mr. Karpati explained the unique characteristics of private equity funds that make them more susceptible to fraud.

He cited, in particular, the ability of private funds to control portfolio companies in a way that is not completely transparent to investors. He also mentioned that private equity funds have long lives and, as a fund ages, investors become less engaged and devote fewer resources to monitoring the fund. Diminished investor oversight opens the door to fraud and warrants more attention by the SEC.

Mr. Karpati focused on certain practices and common conflicts that the Enforcement Division is scrutinizing closely. Among others:

  • Overvaluation of assets especially during the fund raising stage. One type of misconduct that Enforcement observed is the practice of writing up assets during a fund raising period and writing them down as soon as the period closes. This practice highlights the importance of interim valuations.
     

  • The conflict between the profitability of the management company and the best interests of investors, a conflict particularly acute at publicly-traded management companies that feel pressure from shareholders.
     

  • The shifting of expenses from the management company to the funds including using the funds’ buying power to get better deals from vendors — such as law and accounting firms — for the management company at the expense of the fund. It appears that Mr. Karpati is referring here to practices whereby the management company negotiates discounted rates for work done on behalf of the management company and higher rates for the funds, having effectively higher rates charged for fund work to subsidize the work done for the management company.
     

  • Charging additional fees especially to portfolio companies where such fees are not clearly described in the partnership agreement.
     

  • Conflicts arising from managing different clients, investors and products under the same umbrella. According to Mr. Karpati, the Enforcement Division has observed troubling behavior caused by side-by-side management. He gave three examples:
     

    • Broken deal expenses rolled into future transactions resulting in certain preferred clients incurring no broken deal expenses at all, while such expenses are absorbed by a core co-mingled fund.
       

    • Improper shifting of organizational expenses, where co-mingled vehicles foot the bill for preferred clients.
       

    • Complementary products supporting each other such as a primary vehicle making fund commitments to create deal flow for a more profitable co-investment vehicle.
       

  • Conflicts with a manager’s other businesses which may be run in parallel with the adviser and may incentivize managers to usurp investment opportunities or enter into related party transactions at the expense of investors.

Mr. Karpati also spoke about the Division of Enforcement’s risk analytic initiative which is paying close attention to “zombie managers”, i.e. managers of funds that continue to charge management fees, even though the funds are inactive or not actively managed. Mr. Karpati focused on zombie funds and managers in previous speeches as well (http://www.sec.gov/news/speech/2012/spch121812bk.htm). Inhiswords, "[t]here has been concern, widely cited in the industry, that managers of what are called ‘zombie’ funds are delaying the liquidation of their holdings because the income derived from these assets is their only source of revenue.  Using certain data sources, [the] risk analytic initiative seeks to identify those private equity fund advisers that may be improperly failing to liquidate assets, or have been misrepresenting the value of their holdings to investors. This initiative has brought attention to a practice that went undetected for many years."

 

The SEC speech can be found here: http://www.sec.gov/news/speech/2013/spch012313bk.htm

Newsletter

Get the latest compliance news and insights - delivered weekly. The SEC3 Communique covers all compliance topics. CCO3 focuses on CCO topics.
tip: check both to keep informed!

Communiques

Two Recent Enforcement Actions Against Private Fund Advisers

The industry should not misinterpret the SEC’s 2018 National Exam Program Priorities as a shift away from private fund advisers. As discussed during the SEC’s recent National Compliance Outreach Seminar... read more »

2018 - Are you ready for your next SEC exam?

The pool of registered investment advisers that will be subject to an SEC exam in 2018 is at the highest level seen in years. The SEC projects it will examine... read more »

Navigating the Changes to Form ADV

On August 25, 2016, the U.S. Securities and Exchange Commission adopted numerous substantive and technical amendments to Form ADV. While the adopting release required advisers to begin complying with the... read more »

Overlooked Benefits of E&O/D&O

While asset managers should always be aware of the protections provided by their E&O/ D&O coverage, there are more reasons than ever to think about it now. The SEC continues to... read more »

SEC3 Newsletter

Commentary: How Compliance Officers & Firms Can Help Limit CCO Personal Liability This article originally appeared on the Thomson Reuters Regulatory Intelligence subscription service for compliance and risk professionals and is... read more »

Wishing One-and-All a Happy, Healthy and Prosperous New Year

We hope each of you found some peace and tranquility in the company of loved ones this holiday season and want to wish one-and-all a happy, healthy and prosperous New... read more »

Events

Webinar: 2018 SEC Exam Priorities & Recent Exam Highlights

Don’t miss the opportunity to meet with us in person to discuss the topics that matter most to you. Tobin S. Cochran, Managing Member/President of Focus 1 Associates, LLC and...

Chief Compliance Officer Roundtable: Breakfast Briefing - February 7, 2018

When: February 7, 2018 Where: Blank Rome LLP | The Chrysler Building | 405 Lexington Avenue | New York, NY 10174 | 22nd Floor Boardroom | Phone: 212.885.5000 Schedule: 9:00-9:30am - Networking...

Upcoming Events - September & October 2017

Upcoming Events Don’t miss the opportunity to meet with us in person to discuss the topics that matter most to you. SEC3 is teaming up with industry experts in NYC to discuss...

May 23, 2017 - Webcast: WannaCry Ransomware: Were You Really Protected or Just L…

When: Tuesday, May 23rd, 2017 | Schedule: 12pm - 1pm EST Who: Paul Caiazzo, CEO and Co-Founder, TruShield Security Solutions Michael Brice, Founder, BW Cyber Services John Lukan, Managing Director, SEC Compliance Consultants, Inc. We...

June 14, 2017 - Compliance Breakfast Briefing

8:30-9:00am - Networking and Continental Breakfast 9:00-10:30am - Program Location: Willkie Farr & Gallagher LLP | 600 Travis Street | Suite 2310 | Houston, TX Barry Barbash from Willkie Farr & Gallagher LLP,...

June 13, 2017 - Compliance Breakfast Briefing

8:30-9:00am - Networking and Continental Breakfast 9:00-10:30am - Program Location: Haynes and Boone, LLP | 2323 Victory Avenue | Suite 700 | Dallas, TX 75219 Validated parking is available in the garage attached...

May 31, 2017 - Chicago

9:00-9:30 a.m - Networking and Continental Breakfast 9:30-11:00 a.m - Program Location: Baker & McKenzie LLP | 300 East Randolph Drive | Suite 5000 | Chicago, IL 60601 Kristin Gonzalez and Jerome Tomas...

May 17, 2017 (NYC WIMF)

This event is by invitation only. Please email info@seccc.com to learn more.

May 15, 2017 (NYC Chief Compliance Officer Roundtable)

9:00-9:30am - Networking and Continental Breakfast 9:30-11:00am - Program Location: Blank Rome LLP | The Chrysler Building | 405 Lexington Avenue | New York, NY 10174 | 22nd Floor Boardroom | Phone:...

Webcast: The Most Insidious Cybersecurity Threat Is Also The Least Understood

When: Tuesday, April 25th | Schedule: 12pm - 1pm EST Who: Paul Caiazzo, CEO and Co-Founder, TruShield Security Solutions Michael Brice, Founder, BW Cyber Services John Lukan, Managing Director, SEC Compliance Consultants, Inc. Ransomware, the...

CCO Liability (Part III): Managing Liability Webinar

In this webinar, panelists discuss indemnifications and insurance as potential remedies to address the direct financial risks to a CCO. Attendees will learn: What terms and conditions should Chief Compliance Officers be...

Webinar: CCO Liability (Part III): Managing Liability: Navigating Indemnities an…

When: Tuesday, February 21, 2017 Schedule: 11:00am ET / 10:00am CT / 9:00am MT / 8:00am PT / 7:00am AT Description of Webinar: The National Society of Compliance Professionals is pleased to host...

Webcast: SEC 2017 Examination Focus Area – Cybersecurity Testing

Penetration Testing & Vulnerability Assessments - Examining the SEC & FINRA Requirements When: Wednesday, January 25th | Schedule: 12pm - 1pm EST Who: Paul Caiazzo, CEO and Co-Founder, TruShield Security Solutions Michael Brice, Founder,...

Chief Compliance Officer Roundtable: Breakfast Briefing

When: October 20, 2016 Where: Blank Rome LLP | The Chrysler Building | 405 Lexington Avenue | New York, NY 10174 | 22nd Floor Boardroom | Phone: 212.885.5000 Thomas Westle and Janaya...

Practicing Law Institute - Hedge Fund Management 2016

When: September 15, 2016 Where: New York & concurrent webcast | 1177 Avenue of the Americas | New York, NY 10036 Schedule: 9:00 am – 5:00 pm Janaya Moscony, President of SEC3 will...