Private Equity Enforcement Concerns


Bruce Karpati, chief of the SEC’s Enforcement Division’s Asset Management Unit laid out a clear picture of the SEC’s expectations and concerns about private equity in a recent speech. He was speaking at Private Equity International’s annual CFOs and COOs Forum. The speech was centered around five main questions.

Q1:  How has the creation of the Asset Management Unit impacted the Commission’s activities in the private equity space?

Q2: The Commission hasn’t traditionally brought many private equity enforcement actions. Do you expect that to change?

Q3: What are some of the Unit’s concerns about practices in the private equity industry?

Q4: You’ve spoke before about AMU’s Risk Analytic Initiatives. What are they and are there any currently under way in the private equity industry?

Q5: What can a private equity COO or CFO do to reduce the risk of inquiry by the Division of Enforcement?

It seems clear that the SEC is focused on two area: valuations and fees.

Private equity investments are inherently illiquid and therefore requires the fund manager to make judgment calls about pricing. Poor judgment can lead to poor valuations. Fraudulent judgment can lead to fraudulent valuations.

Fees and revenue generation are always a focus of the SEC for investment advisers and funds, whether private or public mutual funds. Private equity merely has some additional ways of generating revenue. It seems clear from Karpati’s speech that that SEC has been looking closely at those revenue streams.

  • The shifting of expenses from the management company to the funds including utilizing 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.
  • Charging additional fees especially to the portfolio companies where the allowable fees may be poorly defined by the partnership agreement.
  • Broken deal expenses rolled into future transactions that may be ultimately paid by other clients.
  • Improper shifting of organizational expenses, where co-mingled vehicles foot the bill for preferred clients.