In the challenging private equity fundraising market, the US Securities and Exchange Commission will be watching for general partners who tout misleading track records to try and attract limited partners, a group of SEC officials said Wednesday at an industry conference in New York.
The idea of misleading track records is part of the agency’s overall focus on how GPs value their investments, a source of tension between LPs and GPs.
“We’re cognizant of the fact that … GPs have some discretion on how they value the portfolio, but valuation is still subject to the fiduciary duties the GP owes the fund,” said Chad Alan Earnst, Assistant Regional Director with the Asset Management Unit in the agency’s Division of Enforcement. “This market is tough to raise capital and we expect to see even more valuation issues.”
Importantly, the SEC will be scrutinising even those valuations that have been vetted by a third-party auditor.
In 2010, the SEC formed a team specifically to look into alternative investments, including private equity, in 2010. SEC veterans Robert Kaplan and Bruce Karpati, who founded the agency’s hedge fund working group, lead the team.
The team is focused on various aspects of private equity, with valuations being one area but also including issues of conflicts of interest and also accounting issues like matters such as the calculation and application of fees, the SEC officials said.
Specifically, the SEC will be looking to see how fees are calculated and applied, the officials said.
“If you’re a GP, you can’t take for granted anymore that your accounting department or auditor will properly make sure an expense incurred for reason X is properly allocated for that activity,” said Igor Rozenblit, asset management specialist with the Division of Enforcement. Rozenblit and Earnst spoke on a panel with Kaplan at Dow Jones’ Private Equity Analyst Outlook conference Wednesday.
Valuations have been a source of tension between GPs and LPs, who worry in some cases that valuations are being inflated, especially when managers are fundraising. Exacerbating the issue is the lack of information LPs get from managers about the values of portfolio companies, one LP told sister title Private Equity International in an interview last year.
“There’s a huge incentive to … push the level of what is reasonable,” the LP said. “It’s hard for LPs to really see if the valuations are right or not. You could drive a truck through the difference between reality and what they’re providing.”
The SEC's scrutiny should not affect the way GPs do their jobs, however. “Nothing we do should affect how firms do their deals or the amount of capital that is available to do deals,” Rozenblit said.