SEC Enforcement Official Hints At Increased Actions Against Private Equity

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Bruce Karpati, Chief, of the SEC Enforcement Division’s Asset Management Unit, recently gave his views on certain matters related to private equity.

Mr. Karpati stated “Private equity went through a significant growth spurt in the run-up to the financial crisis and is a rapidly maturing industry. In terms of assets under management, it’s roughly equivalent to, and perhaps larger than, the hedge fund industry. Also, many private equity managers have only recently become registered investment advisers. As a result of these developments, it’s not unreasonable to think that the number of cases involving private equity will increase” (emphasis added).

Mr. Karpati also noted “Much of the improper conduct in private equity arises out of conflicts of interest, which can lead to misappropriation, deal cherry picking and other forms of misconduct. I’d like to discuss those conflicts and talk about the types of issues they present.”  Mr. Karpati cited the following frequent conflicts of interest:

  • The conflict between the profitability of the management company and the best interests of investors. This conflict exists at all firms, but may be particularly acute at firms that have publicly listed their management company shares and may therefore feel additional pressure from their public shareholders to generate short-term results.
  • The shifting of expenses from the management company to the funds including utilizing the funds’ buying power to get better deals from vendors — such as law and accounting firms — for the management company at the expense of the fund.
  • Charging additional fees especially to the portfolio companies where the allowable fees may be poorly defined by the partnership agreement.
  • Conflicts arising from managing different clients, investors and products under the same umbrella. Some specifics mentioned include:
    • Broken deal expenses rolled into future transactions that may be ultimately paid by other clients. The SEC has observed certain preferred clients incur no broken deal expenses at all, which are all absorbed by a core co-mingled fund.
    • Improper shifting of organizational expenses, where co-mingled vehicles foot the bill for preferred clients.
    • Complementary products supporting each other such as a primary vehicle making fund commitments to create deal flow for a more profitable co-investment vehicle.
  • Conflicts with a manager’s other business which may be run in parallel with the adviser and may incentivize managers to usurp investment opportunities or enter into related party transactions at the expense of investors.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

Topics:  Conflicts of Interest, Private Equity, SEC

Published In: Consumer Protection Updates, Finance & Banking Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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