Review of 2016:On the SEC radar

In October, the Securities and Exchange Commission warned private fund managers it would be examining staff confidentiality agreements to make sure they didn’t contain clauses that may prevent whistleblowers coming forward.

It was the latest in a long line of risk alerts issued by the agency, which in the 2016 fiscal year doubled the number of fines it handed out to private equity firms compared with a year earlier.

The cases included a first-of-its-kind charge, brought against Maryland-based Blackstreet Capital Management. The firm was fined $3.1 million after it was found to be engaging in brokerage activity, and charging fees, without registering as a broker-dealer.

While it’s not thought to be the biggest focus for the SEC, the Blackstreet case has put broker-dealer registration back on the agenda at a number of alternative fund houses.

“It’s clearly on the watch list, but it’s not being viewed as a priority,” one GP said. “It is an idea to carry out an assessment of whether or not you should register broker-dealers; even if you decide not to, having evidence that you have analyzed it will be helpful in the case of an SEC exam.”

Elsewhere, 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.

It has taken action against those flouting the rules in these areas. New York-headquartered Fenway Partners was fined $20 million after its principals failed to tell their fund client they rerouted portfolio company fees to an affiliate, and avoided providing the benefits of those fees to the fund client in the form of management fee offsets.

Blackstone was charged almost $39 million for failing to fully inform investors about benefits advisors obtained from accelerated monitoring fees and discounts on legal fees. Around $29 million of the settlement was distributed to affected fund investors.

Repeated warnings coupled with these actions have led many firms to review their fee and expenses policies, with many opting to pen detailed statements of their rules, and to carry out checks on most, if not all, travel and entertainment expenses.

Firms are also reviewing their valuation policies as the SEC is placing increasing demands on firms to produce documentary evidence of their efforts in this area.

Not only are firms now required to produce written valuation methodologies, but also document the testing of those methodologies. GPs concur the SEC is more concerned that there is a tried-and-tested methodology in place, rather than whether the resulting valuations are accurate.

“Some areas are hot buttons for the SEC; I expect you’ll see more of these cases,” Gary Kaminsky, managing director in BDO’s financial services advisory practice, told pfm earlier in the year. GP 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.

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. 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.