On April 7, 2014, it was announced that the United States Securities and Exchange Commission (SEC) has created a new private fund unit dedicated to the examination of private equity and hedge funds.
The new group is another example of increased regulatory oversight of the financial services industry following the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), Pub. L. 111-203, H.R. 4173. As a result of Dodd-Frank, many investment advisers, hedge funds, and private equity firms are now subject to registration requirements with the SEC. This has resulted in increased government scrutiny of hedge funds, funds managed by private equity firms, and real estate and venture capital funds.
An important issue for the SEC is that many hedge funds and private equity firms maintain complex and illiquid investments that are more difficult to value than investments at traditional asset managers. Additionally, at the 2014 Compliance Outreach Program, the SEC identified several areas of concern with private funds, including vague limited partnership agreements, insufficient disclosure practices, shifting of fees and expenses, and unclear performance and valuation metrics. Moreover, the SEC has historically primarily focused on the regulation of public asset managers – such as mutual funds – that have been regulated since the 1940s. As a result of its lack of specialized regulation and examination, the agency has been criticized for failing to detect and thwart certain violations, including the Ponzi scheme perpetrated by Bernie Madoff.
Recognizing its lack of specialized examination procedures needed to address the complexities resulting from the passage of Dodd-Frank, the SEC has recently responded by calling for the addition of specialist examiners at the agency who understand how private equity and hedge funds value their assets, connect with investors, and the manner in which they disclose their fees. The SEC has requested that Congress provide it with greater resources for fund inspections and regulatory oversight. In fact, the SEC has asked Congress to increase its staff by adding 316 members to the Office of Compliance Inspections and Examinations.
This significant addition of resources will include the new private fund unit. The new group will be dedicated to the examination of private equity and hedge funds. It is co-chaired by industry veterans and is set to consist of existing SEC staff in four of the agency’s regional offices, with the possibility of further expansion to additional offices in the coming months.