Recent media reports have detailed a confidential inquiry launched by the U.S. Securities and Exchange Commission (“SEC”) Division of Enforcement’s Asset Management Unit (“Asset Management Unit”) that requires various unnamed private equity fund managers to produce documents and information relating to multiple areas of their operations and practices, including, among others, fundraising and marketing materials, valuations of realized and unrealized investments (including support therefor), accounting policies and investor communications. The SEC’s nonpublic request for information included a standard statement that it should not be viewed as an indication that any specific securities laws violations have occurred. However, other recent public statements by senior SEC officials make clear that the Asset Management Unit is undertaking a broad industry review of private equity funds and managers to target those sponsors warranting further investigation. In particular, Robert Kaplan, co-head of the Asset Management Unit, recently stated in an interview with Law 360 that “there will be more private equity cases coming from the Division of Enforcement in coming years than there have been previously.”1
According to Mr. Kaplan and other senior SEC officials, the Asset Management Unit and the Office of Compliance Inspections and Examinations will focus on investment valuation and track record presentation issues relating to fundraising activities. To that end, the Wall Street Journal recently reported that the SEC and the Massachusetts attorney general are currently investigating, and multiple subpoenas have been issued in connection with, allegations that a private equity fund of funds managed by Oppenheimer Asset Management inflated or exaggerated the value of its investment holdings in 2009 in order to raise new capital commitments at that time.2
Other areas of focus include ensuring that firms have policies and procedures in place reasonably designed to avoid the misuse of material, nonpublic information, to implement consistent asset valuation methodologies and investor reporting, and to mitigate risks relating to potential conflicts of interest. For example, the allocation of co-investment opportunities among various clients of a firm, as well as the disproportionate allocation of broken-deal expenses among such clients, have been cited as potential conflicts the SEC staff may target. Another area of focus is whether or not portfolio company transaction or other fees are fairly determined and adequately disclosed to investors.
The timing of the SEC’s inquiry and the Asset Management Unit’s push to examine private equity fund sponsors coincides with the implementation later this year of certain Dodd-Frank Act provisions requiring most fund sponsors to register as investment advisers and file Form PF disclosure statements with the SEC, thus providing further information that the Asset Management Unit may utilize in determining whether to bring an enforcement action. Given this backdrop, all private equity fund sponsors are advised to review their compliance policies, procedures and practices to ensure that they are reasonably designed and consistently applied in a manner consistent with the legal obligations and fiduciary duties of such sponsors to their clients.