SEC 'must stand firm' on private equity warnings
The US Securities and Exchange Commission (SEC) has been urged to stand firm on the warnings it issued to the private equity industry regarding treatment of clients in 2014.
Two years ago, the SEC made use of new powers granted as a result of the Dodd-Frank financial reform act and investigated the private equity industry in detail. In particular, the SEC's compliance office looked at the ways in which private equity firms were managing conflicts of interest and how they were treating their investors.
After investigating 112 private equity companies, "violations of law or material weaknesses in controls” were uncovered at 50 per cent of them, confirmed the body.
The private equity industry – which is worth around $4 trillion – has long sparked concerns regarding contracts that are not transparent and hidden charges. The watchdog said that it would take serious action against those private equity firms that did such things, or only made use of certain valuation measures in order to post inflated return reports.
Indeed, the SEC has carried out enforcement cases against some major industry names including Blackstone and KKR, with the cases totalling more than $150 million. Recently, Apollo Global Management paid out the biggest settlement so far, handing over $52.7 million, while the Wilbur Ross-founded WL Ross was forced to pay out $14.1 million.
Apollo Global Management had allegedly informed its clients that it was levying 'monitoring' fees, however, according to the SEC, the private equity firm did not disclose in enough detail that it also levied a fee when it sold the companies to cover the gap in any more monitoring fees. The firm argued that it had merely followed “common industry practice” and was already working to boost its disclosure practices. Meanwhile, WL Ross is said to have overcharged its investors by more than $10 million over the course of a decade by not following the correct route in terms of transaction fees.
While the SEC has not said it plans to ban any of these practices outright, it is calling for everything to be made transparent and properly disclosed, meaning that investors must ensure they know exactly what they are getting before doing business with private equity firms.
However, while in the past investors were experienced and knowledgeable enough about the sector to make sure they knew all the ins and outs, the face of the private equity investor is changing and that assumed knowledge of the arena may no longer be the case. Public pension funds are becoming bigger investors in the sector as they go hunting for higher yields and such managers are far less experienced overall with the private equity arena. Indeed, in 2015, the major California-based pension fund Calpers reported that it was unable to keep track of the private equity fees it was paying. The clients of the pension funds, which include teachers, police officers and Government workers, also do not have anywhere close to the same wealth levels as the more traditional investor in private equity, meaning that any additional fees that are being levied will have a bigger noticeable impact than on those with sky-high levels of wealth.
The overall message seems to be that, while improving disclosure will no doubt help the sector's investors, it may not be enough in the long term to ensure that the sector remains honest. As such, the SEC must continue with its work to bring transparency to the arena and to make it clear to private equity firms that they must toe the line.