Now that the deadline has passed for sizeable private equity firms to register with the US Securities & Exchange Commission (SEC) the industry has wondered exactly what types of tests they will be expected to meet.
Carlo di Florio
Carlo di Florio, head of the SEC’s Office of Compliance Inspections and Examinations, said firms’ ability to address potential conflicts of interest with investors, portfolio companies and other stakeholders is one of those key tests.
Speaking Wednesday at the PEI Private Fund Compliance Forum in New York di Florio said firms should “clearly disclose to clients the fees that it is earning in connection with managing investments as well as expense allocations between a firm and its client fund”. He added that in the instance where two funds managed by the same GP co-invest in the same asset, expenses should be “allocated fairly across both funds”
di Florio noted potential conflicts of interest arise at each stage of the private equity fund lifecycle. During fundraising, he signaled the SEC’s interest in how funds portray the success of previous investments, the role of placement agents and whether some investors receive preferential treatment through the use of side-letter arrangements.
During the investment and management stage di Florio highlighted the risk of a fund manager serving on the board of a portfolio company engaging in insider trading – a risk similarly present in firms taking minority stakes in publicly listed companies. With respect to co-investment opportunities, preferential treatment for certain LPs was once again something to consider, di Florio said.
[The SEC has] seen instances where expenses that should have been paid by the management company were pushed to the funds
Carlo di Florio
At the time of realisation di Florio revealed the SEC was aware of the risk of GPs claiming “to need more time to divest the fund of any remaining assets, but have an ulterior motive to accrue additional management fees”.
On the matter of fees di Florio said the SEC had “seen instances where expenses that should have been paid by the management company were pushed to the funds and have also seen instances where questionable fees were charged to portfolio companies”.
In response to how firms can stay off the SEC’s radar, di Florio said firms “very proactive and thoughtful about identifying conflicts” coupled with “strong policies, procedures and risk controls” as well as “making sure that your firm has a strong ethical culture from top to bottom” where best positioned to survive an inspection.
To find out how you can prepare to deal with potential conflicts of interest, be sure to check out our US Private Equity Fund Compliance Companion, available here.