SEC exams find bad behavior at variety of firms, not just ‘fringe’ shops

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One of the narratives rolling around the private equity industry about the recent findings of assorted bad behavior by the U.S. Securities and Exchange Commission is that this stuff is likely only happening at small firms that no one has ever heard of.

Let’s put that to rest right now. The SEC says its first wave of private equity examinations—about 150 so far—included firms of all shapes and sizes. And the questionable behavior found by the SEC occurred across the board and not just in “fringe” firms.

“The idea that this is isolated to the fringe is not accurate,” Igor Rozenblit, co-head of the Private Funds Unit at the SEC’s Office of Compliance Inspections and Examinations, said in a recent interview with me and my colleague David Toll, editor of Buyouts.

“It’s also not limited to small, medium or large private equity advisers; we’re seeing it across the industry,” added Jane Jarcho, national associate director of the Investment Adviser/Investment Company examination program in the Office of Compliance Inspections and Examinations.

There have been rumors and uncertainty swirling around the private equity industry in the wake of some unusually descriptive public speeches by SEC officials regarding the examination process.

Andrew Bowden, director in the SEC’s Office of Compliance Inspections and Examinations, made a now infamous speech earlier this month in which he said out of the 150 private equity examinations completed so far, more than half found “violations of law” and “material weaknesses in controls” involving GPs’ treatment of fees and expenses.

Most private equity firms have had to register with the SEC for the first time as part of the 2010 Dodd-Frank financial reform law. The deadline to register was 2012, and most firms are only now experiencing heightened regulatory scrutiny for the first time in the form of examinations.

The natural question has been: What kind of firms are we talking about? For example, many of the firms that have so far faced charges based on issues the SEC has been examining are either small or not well known.

One of the more recent cases that started from an examination where a firm has actually faced criminal and civil charges was Clean Energy Capital, a private equity firm that most people have likely not heard of.

The SEC in February accused Scott Brittenham and his firm of allegedly improperly using fund capital to pay off expenses such as rent, tuition, salaries and bonuses, despite collecting millions in management fees. When the funds ran out of money, the SEC says Brittenham and the management company allegedly lent the funds money at a high interest rate.

Brittenham’s attorney, Aegis Frumento of Stern Tannenbaum & Bell, has argued that paying expenses with fund capital was allowed through the limited partner agreements. The loans were necessary to keep the funds afloat during the global financial crisis, he said.

“Partners can’t come in after the fact and say it’s improper and, also, you can’t call that fraud,” he told peHUB in a prior interview.

Another firm that is accused of wrongdoing involving expenses and fees is The Camelot Group, run by Lawrence Penn III, managing director. The SEC accused Penn of misappropriating $9.3 million, using the money for personal expenses like dry cleaning and groceries but claiming it was for due diligence. Penn was arrested on criminal charges related to the SEC charges in February, and pleaded not guilty.

Camelot Group is perhaps better known than Clean Energy Capital, but is still a relatively minor player in the industry.

The SEC declined to be too descriptive in terms of exactly which firms have had lapses, or even how many examinations have resulted in recommendations to the agency’s enforcement division. However, GPs of all stripes should be on alert that the SEC has scoped out a broad cross-section of the industry.

Photo courtesy of Shutterstock.

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