These are my notes, live from the conference. Please excuse a more numerous supply of typos.
Drew Bowden, the Director of the SEC’s Office of Compliance Inspections and Examinations
(These are his views and not necessarily the views of the SEC. His speech is posted on the SEC website: Spreading Sunshine in Private Equity.)
He started off thanking Amtrak for the swift and timely travel from D.C.
OCIE is working on the best way to exam private funds and the private equity industry. There are 11,000 registered advisers and least 10% have a private equity fund. OCIE has a team of private equity experts to help with exams and provide training.
The private fund presence exam initiative is nearly over. The SEC is starting to wok on compiling its findings. The SEC was very upfront with the initiative because it thinks the majority of private funds are doing the right thing and OCIE is not trying to play “gotcha.”
OCIE has found LP Agreements to be lacking. In particular it feels that the LP Agreement needs to be clearer about what expenses are to be borne by the manager and which are borne by the fund investors. OCIE thinks LP Agreements can lead to opaqueness to investors instead of transparency.
OCIE is also concerned about the limited rights of investors with regards to the fund and the manager. This is especially true after the capital has been contributed.
OCIE is concered about Zombie Funds
He raised concerned about the allocation of expenses among co-investment vehicles in an investment. OCIE is concerned about fee and expense shifting.
He shared some findings from the 150 exams completed.
The number one problem is fees and expenses. He found violations of law or material weaknesses in over 50% of the exams. (This confirms the Bloomberg story: The SEC Expresses Its Displeasure on Fund Fees.
“When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time. ”
He expressed concern about “consultants” who work exclusively for the adviser/fund manager, but they charge all of their time to the portfolio companies. If they look and act like employees, they should be treated as employees. This is especially egregious when an employee is terminated but then re-hired as a consultant, with expenses charged to the funds.
He expressed displeasure with charging investor reports to the investors instead of the management company. For example charging the portal software costs that replaced an investor relations person.
He noted fees charged to portfolio companies that extended beyond the life of the fund. For example a 10-year monitoring agreement for a 7-year fund. Then the remaining balance becomes due upon the exit from the investment.
He noted a particular concern about valuations during fundraising. He noted cases where the fund manager was using different valuation methods for marketing materials than for investor reporting. Or shifting to a new valuation methodology during fundraising to raise returns. The SEC is not looking to second-guess valuations, but instead looking to make sure the valuation process matches the process disclosed to investors.
“Ultimately, a healthy compliance program should make your firm and the entire private equity industry more attractive to investors.”
Mr. Bowden’s discussion of OCIE’s concerns with private funds was a quantum leap forward in expertise than past year’s discussions with the prior Director of OCIE. Clearly, the SEC is rapidly learning about private funds and the area of conflicts and compliance.