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The Friday List: 10 Private Equity Practices that Cause Regulatory Problems

The Friday List: 10 Private Equity Practices that Cause Regulatory Problems

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The Friday List: 10 Private Equity Practices that Cause Regulatory Problems

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

The private equity industry has seen increased SEC scrutiny and several significant enforcement actions since the adviser registration requirement went into effect in 2012.  In today’s list, we offer 10 PE practices that have caused regulatory problems for registered PE firms.

 

10 Private Equity Practices that Cause Regulatory Problems

  1. Direct transactions with portfolio companies. The SEC will highly scrutinize affiliate loans to portfolio companies, consulting arrangements with affiliates, and insiders serving as officers.
  2. Varying seniority rights for LPs. Giving preferential treatment to certain LPs (especially insider co-investors) will violate a fiduciary’s obligation to treat all clients equally.
  3. Mis-allocating co-investor expenses. Insider co-investors must bear the same expense allocations as outside LPs.
  4. Accelerating portfolio monitoring fees.  The SEC has brought at least 2 significant cases for failing to fully disclose how LPs will absorb accelerated portfolio monitoring fees incurred after a liquidation event.
  5. Charging broken deal expenses. The SEC views this practice as another way for a fiduciary to illegally line its own pockets at the expense of LPs.
  6. Legal fee discounts. Getting lower rates from your law firm (and other service providers) because they work on the funds violates your fiduciary duty.
  7. Overcharging overhead expenses. Several firms have been cited for taking overhead expenses out of the funds without adequate disclosure.
  8. Cross-portfolio transactions. Transactions between funds including interfund lending or cross-trading will violate the Advisers Act.
  9. Not registering as broker-dealer.  Investment banking activities for portfolio companies require broker-dealer registration.
  10. Weak compliance program.  Several PE firms failed to hire a competent and dedicated CCO to implement a specific Advisers Act compliance program.