1. In what areas are you seeing the SEC taking the most interest?
A large part of their focus continues to be on how expenses are allocated within the fund, and how those expenses are disclosed. For example, are the expenses allocated to the fund actually fund expenses? Or, under the partnership agreement, should they have been management company expenses?
Another area is financing opportunities. If a fund sponsor is going to go out and seek financing for the acquisition of a portfolio company, are there any conflicts in connection to its awarding of these opportunities? For example, do they favor limited partners in the fund, who may be in a position to provide financing? Are they being provided those opportunities in order to somehow benefit the sponsor of the fund, in locking in future investments?
2. You see that a lot with insurance providers where, say, they have one arm that’s a mezzanine lender, then the insurance company itself is a fund LP. Is that just a matter of disclosure, or does the SEC view this as an inherent, unacceptable conflict of interest?
It does present a conflict of interest, particularly if the manager has some expectation that they will be raising a new fund and they want that limited partner to participate in the new fundraising. There could be — at least the appearance — that they favor giving that limited partner the financing opportunity in order to incentivize them to invest in the new fund. I don’t think the [SEC] staff would view this as an unacceptable conflict, but they are looking for some process around the identification of potential financing parties to make sure that the conflict is addressed and mitigated.
3. Have any of the SEC’s areas of focus surprised you?
Not really. You can give credit to the SEC staff for being fairly transparent — over the course of the last year and half [to] two years — in talking about the issues that are of interest to them. They have been fairly candid in identifying the types of issues they would be looking at, and what they’re concerned about.
Now, two years ago, would I have thought broken-deal costs would be a particular focus of the SEC? No, maybe not, but the fact they were looking at expense allocation issues shows that. I think it was pretty clear that [this could] be an area of focus.
4. Were you expecting more or fewer enforcement actions at this stage?
I think there may have been some sense of expectation [from] some speeches that were made back in 2014, concerning what OCIE found in their initial examinations of PE fund sponsors. I think it’s unfortunate because, if you read [Andrew Bowden’s “Spreading Sunshine in Private Equity” speech] carefully, I think that expectation was somewhat unwarranted. At least over the past year, I think some people were surprised there haven’t been more. I wasn’t surprised.
5. Have the enforcement actions taken in the last year affected GPs’ willingness to pursue certain strategies, like co-investment?
I don’t think so. It’s my sense that fund sponsors continue to offer co-investment opportunities and that limited partners expect these co-investment opportunities will be offered. I think there may be more focus on the disclosure around the process for making co-investment opportunities available… I don’t think that’s an outgrowth necessarily of enforcement actions, so much as the issues that have been raised in SEC speeches and SEC exams.
Action Item: Kenneth Berman can be reached at firstname.lastname@example.org.
Q&A edited for clarity by Sam Sutton