Private equity firms can expect the US Securities and Exchange Commission (SEC) to bring more cases against them going forward for breaking SEC rules.
The regulator has the expertise and plans to aggressively continue pursuing fund managers, as it has done in recent months, SEC Division of Enforcement director Andrew Ceresney warned in a speech at the Securities Enforcement Forum West in San Francisco.
Ceresney blamed “the investment structure of private equity and the nature of private equity investments” for some of the misconduct in the industry. For example, the 10-year lifecycle of a typical fund is a long time in which “a lot can happen,” he said, noting it is very hard for investors to take out their money during this time.
The duration of funds makes it especially critical for fund managers to share all material information, such as conflicts of interest, to their limited partners off the bat, before the 10-year hold begins, Ceresney said. Certain general partners have not provided their Limited Partner Advisory Committee (LPAC) with enough information, he warned.
Ceresney added that the “anatomy of private equity” has also led to improper disclosure of fees, misallocation of expenses and defrauding of investors, which ultimately can include retail investors personally exposed to retirement plans or university endowments. He reminded the audience that GPs are fiduciaries that “need to fully satisfy the duties of a fiduciary in all of their actions.”
Regarding the SEC’s oversight of private equity misconduct, Ceresney broke down the enforcement actions into three categories: advisers that receive undisclosed fees and expenses; advisers that misallocate expenses or shift them without permission; and advisers that fail to adequately disclose conflicts of interests, including conflicts arising from fee and expense issues.
There have been enforcement actions across all these categories, he said.
Blackstone Group’s $39 million settlement with the SEC last year falls into the first category, he said. The GP failed to disclose to its funds and LPs at the beginning that it might accelerate future monitoring fees when certain monitoring of portfolio companies ended, according to the SEC.
In the second category, Ceresney referred to the 2015 case with KKR. The firm was fined by the SEC for misallocating over $17 million of broken deal expenses. He substantiated the third category by mentioning the 2015 case against Fenway Partners and its four executives, who failed to disclose many conflicts of interest, including $15 million in incentive pay given to three Fenway employees that was not known by investors.
SEC examinations into fund documents that were written before the Dodd-Frank Act are justified because firms “have always been investment advisors and subject to certain provisions of the Investment Advisers Act.” He added that, even if investors benefited from GP services, those GPs are a fiduciary and are required to disclose all material conflicts of interest. And even if GPs followed counsel advising on their disclosures, they are “still ultimately responsible for [their] conduct.”
The overall goal of the SEC enforcement, according to Ceresney, is to increase the transparency levels in private equity and cause tangible changes for the investors’ benefit. For example, after settling its case with the SEC, Blackstone altered its practice to stop taking accelerated monitoring fees when it exits a portfolio company.
“It is my belief that awareness and transparency of fees generally will lead investors and advisors to reach an appropriate balance in terms of types and allocation of fees,” he said.
Earlier this week, in contrast to Ceresney’s remarks, draft legislation introduced to ease regulatory requirements on private equity funds was presented at a congressional hearing in the US, as reported by Private Funds Management.