The Securities and Exchange Commission has unveiled a slew of new enforcement actions in the past few months. Among the highest profile were cases involving Apollo Global Management, WL Ross and most recently First Reserve.
They all, in one way or another, related to fees and expenses, conflicts of interests, and failure to properly disclose these issues to limited partners. They also all came with hefty penalties ranging from $2.3 million to $12.5 million.
These cases shouldn't shock any registered fund advisors. They are reminiscent of the highly publicised enforcement actions the SEC undertook last year, which led to big-name firms such as Blackstone and KKR being fined.
And the SEC has clearly outlined and repeatedly warned private equity firms which themes it would pursue during its exams.
In May, Andrew Ceresney, the director of the SEC's division of enforcement, reiterated during an industry conference in San Francisco that the commission's actions against private equity funds advisors fall into three inter-related categories: advisors that received undisclosed fees and expenses; advisors that misallocate expenses; and advisors that fail to adequately disclose conflicts of interest, including those arising from fee and expense issues.
“These types of cases should not come as a surprise to the private equity industry,” says Todd Cipperman, founding principal at Cipperman Compliance Services. What is perhaps more surprising is the frequency with which the cases have been brought, showing private equity is clearly in the sights of the US regulator.
“Some areas are hot buttons for the SEC; I expect you'll see more of these cases,” says Gary Kaminsky, managing director in BDO's financial services advisory practice.
The SEC has been scrutinising the private equity industry more than most other areas of the capital markets for several reasons. In the past few years, the Dodd-Frank Act has required private fund advisors to register with the SEC, which has given the regulator the authority to enforce the Advisers Act.
The commission is also protecting individual investors whose retirement money is ultimately managed by public pension plans and heavily invested in private equity.
General partners' reactions to the enforcement actions, however, seem to be varied. Some are taking a chance on the fact that – due to the relatively small number of firms being inspected each year – they can remain under the radar. What they should be doing, say experts, is promptly reviewing their own treatment and disclosure of fees and expenses, making sure they disclose any potential conflicts of interests to their limited partners.
“One of the most critical things that a firm can do now before the SEC comes through the door is an assessment of their fee and expense practices to determine whether or not they appear consistent with their agreements and also whether or not they appear to give rise to any issues that have come out in recent enforcement cases,” said Eva Ciko Carman, a partner at Ropes & Gray.
One Massachusetts-based GP complains these cases, along with the SEC scrutiny, are piling on extra compliance costs, but Kaminsky notes that firms should focus on the cost and risk of non-compliance rather than the cost of compliance. “For a $1 billion firm, an SEC enforcement case could be the end of it,” he says.
Some practices targeted in previous cases are already being addressed by GPs and are starting to disappear. For example, where GPs had multiple fund 'classes' for different groups of investor, leading to potential conflicts of interest, these are now being consolidated.
Most firms have also stopped collecting accelerated monitoring fees, according to Gary Swiman, a partner at BDO's financial services advisory practice and head of regulatory and compliance consulting.
“Same with double dipping for directors, that's starting to disappear too,” he says, referring to directors being paid both though the management fee and by a portfolio company. “There are hundreds of conflicts but the SEC is chipping away at some of the more prominent ones.”
Outside the US, other regulators are starting to take the SEC's lead. For instance, the UK's Financial Conduct Authority has historically acted more as an advisor alongside private equity firms than an enforcer.
“The FCA has been more principle-based and not as aggressive as the SEC on enforcement,” says Kaminsky.
But this is changing as the FCA now falls under the authority of the Bank of England, adds Swiman.
“Regulators in the rest of the world, and especially the FCA, are following suit in terms of requesting and expecting firms to beef up their regulatory infrastructure,” he says.
With that in mind, the industry is likely to see more of these cases making headlines across the globe.