SEC Sees ‘Violations Of Law,’ ‘Material Weaknesses In Controls’ At P.E. Firms

May 7 2014 | 12:12pm ET

The Securities and Exchange Commission has been using its new oversight powers to look more deeply into the private equity industry—and it does not like what it sees.

More than half of the p.e. firms to undergo an SEC examination over the past two years have been charging illegal fees or suffer from serious compliance issues, the agency’s Drew Bowden said yesterday. Bowden, who leads the SEC’s exam program, called the figure a “remarkable statistic.”

The SEC has examined fees and expenses at 112 firms and found “violations of law or material weaknesses in controls” in more than half of them.

“For private-equity firms to be cited for deficiencies involving their treatment of fees and expenses more than half the time we look at the area is significant,” Bowden said. In particular, the SEC has found fault with how firms pay operating executives, often with investor money.

“This effectively creates an additional ‘back door’ fee that many investors do not expect,” Bowden said. “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.”

In addition, investors may not be adequately informed about monitoring fees, paid by portfolio companies to p.e. firms, as well as termination fees when the company is sold.

“There is usually no disclosure of this practice at the point when these monitoring agreements are signed, and the disclosure that does exist when the accelerations are triggered is usually too little, too late,” Bowden said. 

Bowden’s remarks to the Private Fund Compliance Forum in New York follow similar testimony to a Congressional committee by SEC Chairman Mary Jo White last week.

Private-equity firms have been subject to SEC scrutiny since the passage of the Dodd-Frank financial reform law in 2010.

“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,” Bowden said. “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.”


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