The U.S. Securities and Exchange Commission is considering granting private-equity firms a reprieve after they collected billions of dollars in deal fees without being registered to do so, according to a person with knowledge of the matter.
The SEC staff is weighing a special exemption for private-equity firms to continue collecting deal fees in the future, said the person, who asked not to be named because the deliberations aren’t public. An exemption would mean the agency is unlikely to pursue enforcement action over past deals, the person said. A final decision hasn’t been made and the agency could still require the firms to register or seek sanctions for past deals.
The exemption would counter the stance of an SEC official, who signaled in a speech last year that transaction fees the private-equity industry had been taking for decades may have been improper because the firms weren’t registered as broker-dealers, a requirement under securities laws.
“I imagine that right after that speech there was reasonable blowback” from the private-equity industry, said James Cox, a professor at Duke University School of Law in Durham, North Carolina. “Regulation now usually embodies what the industry is willing to accept.”
The controversy over fees is one of the first issues that has come to light as the $3.5 trillion private-equity industry grapples with new regulatory scrutiny following the 2010 Dodd Frank financial legislation. The SEC said this month that it plans to take a closer look at advisory firms it hadn’t previously examined.
Some SEC officials argue privately that they should overlook the fees, even if they violate securities laws, because private-equity firms are now required by the Dodd Frank financial regulation law to register as investment advisors, imposing some similar investor protections.
The issue first flared up last April when David Blass, chief counsel for the SEC’s trading and markets division, said in a speech that private-equity firms’ routine practice of taking transaction fees appeared to “fall within the meaning of the term ‘broker.’”
The speech set off a flurry of calls from fund managers to securities lawyers to understand whether the speech raised issues for them and what new regulatory obligations may await, according to Amy Natterson Kroll, partner at Bingham McCutchen LLP in Washington.
Blass, speaking at an event in Washington yesterday, said SEC staff are “giving a lot of attention to the issue.”
Since Blass’s April speech, the industry has pressed for an exemption, arguing that investment advisor rules provide sufficient protections for investors, making the added broker-dealer requirements -- registration with a self-regulatory organization, training for staff and additional SEC inspections -- unnecessary.
SEC spokeswoman Judith Burns declined to comment.
‘Powerful and Successful Lobby’
“There is no question that the private-equity industry has a powerful and successful lobby, but historically, the commission has been immune from such influence, especially when it relates to past violations of the securities laws,” said Jordan Thomas, a former SEC enforcement attorney now representing a whistleblower who filed a complaint about the fees to the SEC almost a year ago.
Private-equity managers’ main compensation comes from an annual management fee of about one percent to two percent of committed capital. Beyond that, they generally receive payment based on a percentage of gains from investments, often 20 percent, after full repayment of investors’ capital.
Deal fees, which date back to the 1980s, give managers an immediate cash windfall when a deal closes, regardless of how well or poorly the investment performs over time. According to the industry’s main lobbying group, those fees still don’t turn private equity managers into broker dealers.
“Private equity investment advisers perform a fundamentally different service than broker-dealers, and should not be required to register as such,” Steve Judge, president of the Private Equity Growth Capital Council, said in an e-mail. “Layering broker-dealer regulations on private equity will be of no meaningful benefit to investors and would levy significant costs on private equity firms.”
The agency in the past hasn’t balked at pursuing people or firms that lacked proper registration or improperly took fees. Credit Suisse Group AG agreed yesterday to pay $197 million over SEC claims its relationship managers serviced thousands of U.S. clients without being properly registered to do so.
Last year, the SEC fined Ranieri Partners, founded by mortgage-backed securities pioneer Lewis Ranieri, $375,000 for paying a commission to an outside individual who raised money for the fund without being registered as a broker.
In 2001, the agency permanently banned Mark Snader, a former truck driver and welder, and fined him $25,000 because he acted as an unregistered broker-dealer.
Without Commission Approval
The decision on whether to give the industry a pass is being deliberated by SEC staff, not the presidentially appointed five-member commission, the person said. SEC staff are authorized to issue rule exemptions without putting it to a commission vote.
The staff’s position could still change. SEC Chairman Mary Jo White this week tapped Stephen Luparello to take over the division of trading and markets, the unit responsible for the possible exemption. Luparello has not spoken publicly in his new role about his views on the issue.
A survey by the association found that registration as an investment advisor costs an average of $1.86 million dollars.
More significant than the money may be the inspections. The SEC examined 9 percent of investment advisors in fiscal 2013 while the agency or organizations like Finra examined 46 percent of broker-dealers.
Many of the largest private equity firms, including Blackstone Group LP (BX) and TPG Capital, established brokerage units, while competitors such as Bain Capital LLC have not. Spokesmen for all three firms declined to comment.
Firms in the industry have also been passing through to their investors a higher proportion of transaction fees they take. Buyout funds that began investing in 2012 or 2013 pass through 87 percent of transaction fees to their investors, according to data from Preqin. That figure was 69 percent in 2007, according to the London-based research firm.
Some have moved to rebate fees fully. Apollo Global Management LLC completed raising an $18.4 billion buyout fund in January, the industry’s largest since 2008. The firm will rebate 100 percent of transaction fees to clients, Marc Spilker, Apollo’s president, said on an earnings call in August.
While transaction fees have been disclosed for many private equity deals, they have often been revealed well after they are paid.
The SEC would need to be convinced that private equity firms are being transparent in their fee arrangements before it decides on any relief from broker-dealer regulations, the person said.
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