Andrew Bowden, Director of OCIE, recently shared some examination findings in a presentation to the PEI Private Fund Compliance Forum. This was the first time the industry has been provided with key insight into staff findings gathered from recent private equity examinations conducted by the SEC.
OCIE has examined 150 of the 275 private equity firms it plans to visit in 2014. According to Mr. Bowden, almost one half or 75 of the firms examined had significant findings in the area of fees and expenses. This is an extraordinarily high percentage for such as small sample size of the private fund industry.
Key violations found involve the following subject areas:
- Limited Partnership Agreements – vague disclosures regarding expense allocations between the fund, general partner, and manager; opaque disclosures surrounding valuation methods and investment allocations; insufficient information rights for limited partners.
- Zombie Advisers – firms that continue to assess monitoring fees long after the life expectancy of the fund has expired.
- Side-by-Side Management – the introduction of co-investments and separate accounts complicates the firm’s investment model and compliance programs do not always keep up with these changes.
- Operators – the increased use of “operators” in the private equity model has led to improper allocations of the associated expenses of these individuals or their non-disclosure to investors, creating a “back-door” fee charged to investors.
- Expense Shifting – moving of expenses from the adviser to the fund once the fund reaches “middle age” without disclosures to investors.
- Hidden Fees – accelerated monitoring fees that become fully due and payable by the fund upon certain key event triggers such as mergers, acquisitions, or IPOs; occurring without timely and appropriate investor disclosures.
- Valuations – firms using a different valuation method than as described in the offering documents or changing valuation methods frequently without reasonable explanation or disclosures; cherry picking comparables.
- Marketing Materials – performance-based upon projections as opposed to actual valuations without appropriate disclosures; misrepresentations regarding key team members.
Several SEC Enforcement investigations were highlighted by Mr. Bowden, some public cases and some still in the investigation phase. It’s clear that the SEC is concerned about the private equity industry and Mr. Bowden hopes that by making some of OCIE’s findings public it will steer the industry in the right direction.