In May of last year, the SEC rang the alarm bells after conducting sweep examinations of private equity fund managers. At that time, the SEC noted that the results of the sweep exams indicated significant and wide spread violations by equity fund managers of the “anti-fraud” provisions under the Investment Advisers Act of 1940.
The sweep examinations that started in October 2012 by the SEC’s Office of Compliance, Inspections and Examinations (“OCIE”) and covered more than 150 private equity fund managers, focused on among other things, the managers’ allocation of expenses, calculation of fees, and valuation of assets.
In a recent presentation to the Private Equity International Conference, Marc Wyatt, the OCIE’s Acting Director, provided the audience with the SEC’s current thinking about the state of compliance by private equity fund managers. The good news according to Acting Director Wyatt is that the SEC sees an uptick in increased compliance efforts while the not-so-good news is that there is still substantial room for improvement.
According to Acting Director Wyatt, the industry appears to be evolving into more transparency as to fees, and expenses. In addition, the staff has witnessed closer adherence to the provisions of formation documents and disclosure about the rights of the private equity fund investors. Some managers are engaging outside consultants to provide feedback on their fee practices and to ensure that all fees are properly and fully disclosed within the fund offering documents.
An area of concern that has seen some improvement (but not enough) by private equity managers is that the brunt of expenses are absorbed by the main fund instead of being shared by parallel funds. According to the SEC, disclosure does not cure this lack of fairness as the fiduciary obligations of the manager to the fund investors requires fair and impartial treatment of all parties who are being managed by the manager. In addition, the allocation of investments among the main fund and the parallel funds has not only been an area of inadequate disclosure but oftentimes lacks a written policy to be followed by the manager and fully disclosed to the investors.
According to Acting Director Wyatt, a common concern regarding private equity real estate manager is the amount of fees being charged and questionable claims that the fees are “of market.” The staff notes that oftentimes such managers are claiming “market-rate” fees when there has been no data collected by the managers to determine the market rate.
Approximately 25% of the registered private equity fund managers were examined during the OCIE’s presence examinations. It is likely that these managers will be subject to, in the near future, a full exam by the OCIE. In that exam, the staff will expect improvement in the areas of most concern as uncovered in the presence exams. In addition, the OCIE will especially be reviewing those private equity vehicles designed especially for “retail” type investors to determine if enhanced transparency and disclosure is present.