SEC tightens the screws

The Securities and Exchange Commission has unveiled a slew of new enforcement actions in recent months. Among the highest profile were cases involving Apollo Global Management, WL Ross and First Reserve.

They all, in one way or another, related to fees and expenses, conflicts of interest, and failure to properly disclose these issues to limited partners. They also all came with hefty penalties ranging from $2.3 million to $12.5 million.

These cases shouldn’t shock any registered fund advisors. They are reminiscent of the highly publicized enforcement actions the SEC undertook last year, which led to big-name firms such as Blackstone and KKR being fined. And the SEC has clearly outlined and repeatedly warned private equity firms which themes it would pursue during its exams.

In May, Andrew Ceresney, the director of the SEC’s division of enforcement, reiterated during an industry conference in San Francisco that the commission’s actions against private equity fund advisors fall into three related categories: advisors that received undisclosed fees and expenses; advisors that misallocate expenses; and advisors that fail to adequately disclose conflicts of interest, including those arising from fee and expense issues.

“Some areas are hot buttons for the SEC; I expect you’ll see more of these cases,” says Gary Kaminsky, managing director in BDO’s financial services advisory practice. General partners’ reactions to the enforcement actions seem to be varied. What they should be doing, say experts, is promptly reviewing their own treatment and disclosure of fees and expenses, making sure they disclose any potential conflicts of interests to their limited partners.

“One of the most critical things a firm can do before the SEC comes through the door is an assessment of its fee and expense practices to determine whether or not they appear consistent with their agreements and also whether or not they appear to give rise to any issues that have come out in recent enforcement cases,” says Eva Ciko Carman, managing partner of Ropes & Gray.

One Massachusetts-based GP complains these cases, along with the SEC scrutiny, are piling on extra compliance costs, but Kaminsky notes that firms should focus on the cost and risk of non-compliance rather than the cost of compliance. “For a $1 billion firm, an SEC enforcement case could be the end of it,” he says.

Some practices targeted in previous cases are already being addressed by GPs and are starting to disappear. For example, where GPs had multiple fund ‘classes’ for different groups of investor, leading to potential conflicts of interest, these are now being consolidated.

Most firms have also stopped collecting accelerated monitoring fees, according to Gary Swiman, a partner at BDO’s financial services advisory practice and head of regulatory and compliance consulting.

“There are hundreds of conflicts but the SEC is chipping away at some of the more prominent ones,” he says.

Outside the US, other regulators are starting to take the SEC’s lead. The UK’s Financial Conduct Authority has historically acted more as an advisor alongside private equity firms than an enforcer. But this stance is changing, says Swiman: “Regulators in the rest of the world, and especially the FCA, are following suit in terms of requesting and expecting firms to beef up their regulatory infrastructure.”

With that in mind, the industry is likely to see more of these cases making headlines across the globe.