The U.S. Securities and Exchange Commission’s review of how private equity firms value assets and market their funds is so far looking at mainly smaller firms, omitting some of the industry’s largest, publicly traded companies, said a person familiar with the inquiry.
Blackstone Group LP (BX), the biggest private equity firm, and KKR & Co. haven’t received the SEC’s December request for information, said the person, who asked not to be named because the information is private. The inquiry stems from a task force set up two years ago to look into practices ranging from asset valuation to conflicts of interest at private equity firms and hedge funds, said another person with knowledge of the matter.
Officials for Blackstone and KKR, both based in New York, declined to comment.
The SEC late last year sent letters to several firms asking for details on fund investments and the valuation of assets, as well as communication with clients, according to the copy of a letter obtained by Bloomberg News. Among issues regulators are examining is whether firms use inflated valuations to attract investors when marketing new funds, a person familiar with the matter said last week.
Private equity came under scrutiny in the aftermath of the financial crisis, which forced firms to mark down holdings acquired during a three-year boom that ended in 2008 when the collapse of Lehman Brothers Holdings Inc. froze credit markets. Financial reform measures such as the Dodd-Frank Act have proposed more oversight of the firms’ businesses.
SEC enforcement director Robert Khuzami said in 2009 he would set up an asset management task force to keep up with the growing number of investment advisers it was tasked with policing. Robert Kaplan and Bruce Karpati, who lead the unit, have said they will use proactive investigative approaches and industry outreach to probe issues including valuation and conflicts of interest at hedge funds, mutual funds and private equity firms.
Khuzami has said publicly that investigators are targeting asset managers who have consistently reported above-market returns.
The SEC typically polices public securities offerings and transactions. It hasn’t traditionally focused on areas such as private equity that involve sophisticated investors and private placements that are exempt from registration with the regulator, although it can enforce private equity managers’ fiduciary duty to their funds.
SEC enforcement attorney Chad Alan Earnst said at an industry conference last month that while general partners in private equity funds have some discretion in how they value their portfolio, valuation is still subject to the fiduciary duties the general partner owes the fund, according to a report in Private Equity International.
‘Conflicts of Interest’
Private equity firms pool investor money to buy companies, using mostly debt, with the intention of selling them or taking them public later for a profit. They typically charge an annual management fee of 1.5 percent to 2 percent of committed funds and keep 15 percent to 20 percent of profit from investments.
SEC investigators are also teaming up with other agency staff who perform routine examinations of asset managers to identify potential problems with firms’ practices.
In May, Carlo di Florio, head of the SEC’s office of inspections and examinations, said the consistency and comparability of a firm’s valuation methods, the disclosure of pricing methodology and unrealized performance were areas that concerned the agency.
“There are likely to be conflicts of interest over how investment valuation is calculated, whether in reporting performance to fund investors or in marketing materials for raising capital for new funds,” Di Florio said.
“In addition to such conflicts, there is also potential for more egregious conduct, such as misleading reporting to current or prospective investors on PE fund performance by selectively highlighting only the most successful portfolio companies while ignoring or underweighting portfolio companies that underperform,” he said.
The SEC in June voted to require private-fund advisers to register with the agency, although publicly traded private equity firms already provide detailed information in quarterly and yearly filings. The mandate forces 750 advisers to disclose “census-like data” about their investors and employees, the assets they manage, potential conflicts of interest and their activities outside of fund advising.
In the 16-page letter dated Dec. 8, the SEC said its “request should not be construed as an indication by the commission or its staff that any violation of the federal securities law has occurred, nor should it be a reflection upon any person, entity or security.”
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