Recent proposals to enhance the enforcement powers of the US Securities and Exchange Commission may also help address concerns about a lack of understanding of the private equity model by SEC examiners.
In a speech in early August to the New York City Bar Association, SEC Enforcement Division director Robert Khuzami outlined a number of initiatives to restructure the group, reduce bureaucracy and allow it to more efficiently enforce federal securities laws. The speech came amid an ongoing effort by the SEC to atone for its inability to detect the fraud perpetrated by Bernie Madoff – Khuzami recently told a Senate Banking Committee that the SEC “deeply regretted” its failure and would reform its operations to protect investors.
Most significantly for the private equity industry, such reforms could include an Asset Management Unit that would focus on private equity funds, investment advisers, hedge funds and investment companies, and would address issues such as disclosure, valuation, portfolio performance and due diligence. The creation of a dedicated private equity-focused enforcement team would come as many more firms are expected to have to register with the SEC should recent legislation calling for a $30 million assets-under-management threshold get passed.
One of the biggest concerns for firms when it comes to registering with the SEC is the opening up of their funds to expensive, intrusive and time-consuming random audits. One CFO of a firm that has been registered for several years said that although the process has become more efficient, many problems that have come up have often centred around the fact that investigators in the past were not as knowledgeable about the private equity model as other areas, and needed to be educated on certain unique characteristics.
David Hoffner, a partner at Dechert, said the move by the SEC to develop homegrown experts focused on designated areas is intended to address the perception that a lack of relevant experience among enforcement attorneys allowed Madoff to go unchecked.
“The SEC enforcement division has many young lawyers and it has had difficulty developing and retaining specific expertise, in particular with respect to financial products,” he said. “One of the clear failings in the Madoff investigation identified recently by the SEC's Inspector General was attorneys assigned to the investigation did not have previous experience with Ponzi schemes or in regulating and reviewing broker dealers. So I think this enforcement approach is clearly an effort to remedy that by marshaling particular expertise within a certain area.”
Hoffner says that the SEC may have been caught short-handed by the growth of complex investment vehicles and products and the rise of private equity funds over the past decade, with the experience of its examiners being limited mainly to hedge funds. Rather than using a one-size-fits-all approach and continually putting new people on cases, the asset management unit would be able to conduct investigations much more efficiently.
“I think it is clearly going to be geared toward assembling a core group of expertise so that when an investigation comes down it’s not the first time that somebody has looked at an asset custody issue, how do you smoke out a Ponzi scheme, how do you ascertain when you have a valuation problem, etc,” he said.
However, such proposals are still in the early stages, and details still need to be worked out. How successful they are, Hoffner says, may depend on how well the SEC trains and is able to retain a new batch of private equity experts. “That often means finding money to compensate them, and that can be a problem with the budgetary issues that have arisen in Washington,” he said.