U.S. regulators found illegal collections of fees or severe compliance shortfalls in more than half of the private-equity firms it has examined since 2012, a signal the industry could face tougher oversight or sanctions.
“By far, the most common observation our examiners have made when examining private-equity firms has to do with the adviser’s collection of fees and allocation of expenses,” Drew Bowden, director of the SEC’s office of compliance inspections and examinations, said today in a speech at the Private Fund Compliance Forum in New York. “We have identified what we believe are violations of law or material weaknesses in controls over 50 percent of the time.”
The SEC’s review of the $3.5 trillion private-equity industry started after the 2010 Dodd-Frank Act authorized greater oversight of money managers, putting many firms under regulatory scrutiny for the first time. Private-fund managers also were required to file confidential reports allowing regulators to monitor activity that could be a threat to the broader economy.
The agency, which created a special unit of examiners to inspect firms with more than $150 million in assets, has reviewed more than 150 private-equity firms since October 2012. The SEC intends to have examined 275 of the firms by year-end, Bowden said.
Ken Spain, a spokesman for the Private Equity Growth Capital Council, which represents more than 30 firms, declined to comment on the SEC’s findings. Among the PEGCC’s members are the world’s biggest buyout firms, including Blackstone Group LP, Carlyle Group LP, Apollo Global Management LLC and KKR & Co. Those firms haven’t been mentioned by the SEC.
“We do not anticipate that that would be an issue for us,” Adena Friedman, Carlyle’s chief financial officer, told investors and analysts on a conference call last week. “We have actually had a recent visit from the SEC, just on a normal five-year basis, and we feel confident that that we have done things the right way.”
Blackstone President Tony James said on a call last month that the New York-based firm’s legal and compliance staff has grown as the company adapts to the heightened regulatory oversight.
Bowden didn’t name any of the firms that have been examined.
“Legal and compliance is our fastest growing part of the firm by far,” James said. “We’ve been dealing with this for a long, long time, it’s just there’s more and more and more of it, in more and more jurisdictions.”
SEC examiners have repeatedly found problems with how firms pay operating executives, who help find growth opportunities and potential efficiencies in companies, Bowden said. Private-equity firms often tout the role of those executives as a service and then pay them with investor funds or money from portfolio companies rather than the buyout firm, he said.
“This effectively creates an additional ‘back door’ fee that many investors do not expect,” said Bowden. “The adviser is able to generate a significant marketing benefit by presenting high-profile and capable operators as part of its team, but it is the investors who are unknowingly footing the bill.”
Bowden said he hopes regulation will help improve investor confidence in the private-equity industry. The oversight is necessary, he said, because those underlying investors include public pensioners and other U.S. workers who are often unable to detect wrongdoing by investment managers overseeing their money.
“Because of the structure of the industry, the opaqueness of the private-equity model, the broadness of limited partnership agreements and the limited information rights of investors, we are perceiving violations despite the best efforts of investors to monitor their investments,” said Bowden. “If we’re not on the job, doing exams in this area and spreading sunshine, these problems, which involve significant sums of money, are more likely to persist.”