News Analysis: Why the SEC’s good intentions may harm investors

The US private equity industry is again the subject of Securities and Exchange Commission scrutiny.

Last week, it emerged that the SEC and the US Department of Justice had begun examining sovereign wealth funds’ purchases of stakes in US banks and private equity firms. Reported recipients of inquiry letters include The Blackstone Group, which sold a stake in its management company to the China Investment Corporation ahead of its public listing.

It’s unclear if other firms received letters, but one imagines they were also sent to Carlyle Group, which is minority owned by Abu Dhabi’s Mubadala investment fund; and Apollo Global Management, in which the Abu Dhabi Investment Authority owns a stake.

“In terms of how widespread this inquiry is, it is hard to say. It seems to fit the pattern of a typical SEC sweep examination – an industry-wide look at a topic to discover facts,” Andrew Wright, a partner at law firm Kirkland & Ellis, told PEI. The regulator is likely looking for evidence of improper gifts or payments that suggest there was an attempt to influence and gain business in violation of US anti-bribery laws, he said.

An in-house counsel at a New York-based private equity firm tells us none of the private equity firms have been accused of any wrongdoing. “The letters were brief and the issue here is compliance – to make sure firms are dotting their ‘I’s’ and crossing their ‘T’s’,” the source said.

But as the SEC’s investment advisor registration deadline nears – which will result in an estimated 8,000 new registrants from the private equity and hedge fund industries – some market participants fear even greater scrutiny will befall US private equity firms.

Amanda Janis

Others, meanwhile, worry about the repercussions from a regulator ill-prepared to handle the influx of new registrants. “The SEC is not realistically equipped to begin overseeing this number [of new registrants],” said Harvey Pitt, former SEC chairman and head of advisory firm Kalorama Partners. About 800 SEC employees monitor the existing 11,000 registered investment advisors, and insiders say the SEC’s plan to hire 400 more people likely won’t be enough.

Speaking at PEI’s CFOs and COOs Forum in New York this week, Pitt – who chaired the SEC between 2001 and 2003 and previously was general counsel for the regulatory agency – said SEC staffers may find themselves stretched too thinly. That’s a worrying prospect for an industry that needs regulators to fully appreciate and understand their various strategies, or risk becoming targets of time-consuming (and expensive) audits or other compliance inquiries.

“My own belief is that private equity firms are the engine of economic growth and we are now imposing restrictions on them simply for the sake of restrictions,” Pitt said. “My concern is that we will lose this engine of growth.”

The SEC understandably must continue on in its quest to better monitor alternative investment funds, for as Pitt points out, no one wants another Madoff debacle harming investors and tarnishing reputations by association of upstanding, hardworking managers. Nor would private equity firms want any suspicion lurking as to improper relationships with their sovereign fund partners.

But regulation enacted simply to appease politicians and public perception – and without the appropriate resources to enforce it – is not just going to be a nuisance for fund managers. If it causes private equity firms to shift energy away from their primary focus – bettering portfolio companies to create outstanding returns for investors – it could ultimately harm the very people the SEC is trying to protect.