SEC Puts Private Equity In Its Sights

An official in the enforcement division of the Securities and Exchange Commission said last month that the agency has its eye on several industry practices that could disadvantage investors, such as the charging of deal fees and the cherry-picking of deals.

Speaking in New York City Jan. 23 at a conference hosted by Private Equity International, Bruce Karpati, the chief of the SEC enforcement division’s asset management unit, observed that the agency has been bringing more cases involving private-equity firms or “private equity-like issues.” He pointed to eight recent cases, including ones involving employees of advisory firm Adams Street Partners and private-equity firms Brantley Capital, Onyx Capital and TPG Capital. The accusations range from insider trading to misappropriating funds to usurping investment opportunities to outright stealing.

“Much of the improper conduct in private equity arises out of conflicts of interest, which can lead to misappropriation, deal cherry picking and other forms of misconduct,” Karpati said. In addition, Karpati pointed to the overhang of capital available to be put to work by buyout firms as a potential “stressor,” since it “means that there is more capital chasing the same number of deals, which puts extra pressure on returns.” This, in turn, has led to an environment where many firms are fighting to survive and that could “incentivize managers to engage in aggressive marketing and may lead some to cross the line into inappropriate behavior,” he said.

Karpati went through several potential conflicts of interest that the SEC is particularly concerned about:

  • Karpati observed that the interests of management companies and investors, such as in the setting of management fees, can diverge at all firms. But, he said, the conflict “may be particularly acute” at firms that have listed theirs shares on public exchanges and are therefore subject to pressures from shareholders to produce short-term gains.
  • In their partnership agreements, private-equity shops spell out what expenses are absorbed by the management company and which ones are absorbed by the fund. Nevertheless, the commission is concerned that, in some cases, firms may be using the buying power of their funds to secure lower prices on services “at the expense” of investors…

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peHub contributor David M. Toll is editor-in-charge of sister Buyouts Magazine.

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