Updated with clarification
Except for an early stint with corporate securities law firm Dechert in Washington, Bruce Karpati has spent his career as a government enforcer since joining the Securities and Exchange Commission's New York office in 2000. Two years ago, the Enforcement Division underwent a major reorganization that produced five strategic units dedicated to targeting the most sensitive and abuse-prone areas of investment. The largest unit, asset management, got plenty of resources, including two co-chiefs: Mr. Karpati and Robert Kaplan, who recently left for private practice. Mr. Karpati is more excited than ever about the government's mission to stop, and prevent, questionable asset management practices.
What attracted you to “government work” and enforcement in particular? In enforcement, you really get to do public service. You're doing work that has a public impact. When you can do the work you're doing and have that impact, it's a great job to have.
What was the purpose of restructuring the Enforcement Division and how has it changed the way the SEC enforces the law? About 20% of the staff now are specialized, and that makes all the difference in the world. Our unit has 75 people in 10 offices, and we have lawyers, supervisors and, now, (asset management) experts. We've hired a hedge fund portfolio manager, a private equity analyst and people in due diligence, mutual fund operations and trading. And we are hiring two more experts in mutual funds and hedge funds. For me, it's a no-brainer. Specialization helps with investigations, policy-setting, exams and risk analytic initiatives. There are real benefits to being specialized, including enabling us to better understand the issues and the industry.
With expertise, we can focus our investigations on different aspects of the industry. We're the asset management experts: About one-third (of our focus) is private funds, one-third registered investment companies and one-third separately managed accounts.
We've covered the waterfront of potentially problematic practices, and staff work across offices to coordinate and develop their expertise.
How will the asset management unit change now that there is only one chief? Now that we have two deputies, in the east and west, I think we're going to get a lot of coverage with with the three of us ... The deputies have grown up in the unit.
We get our investigations in a variety of ways. One is through tips. We are also being proactive, through our risk analytic initiatives. We look for anomalies. For example, we'll look at performance numbers and then we'll look for outliers. That's a pure form of data analytics. And there's been a lot of talk lately about private equity and zombie funds ...
We also pursue referrals generated by the commission's examination staff ... Exam staff are the eyes and ears for the commission and when they identify wrongdoing, we work closely with them to ensure that enforcement actions are brought ...
What are the most pressing issues on the institutional investment side? We are looking at fee arrangements, aberrant performance results and compliance programs. We're also looking at ETFs, wrap fees, and disguised distribution agreements.
In the fee area, there are a lot of obligations on these money managers. I think most people do try to be compliant with the law. There are always going to be bad apples who mislead investors. Especially in this low-yield, low-revenue environment; how do you do it (survive)? You increase fees. ...
I don't think there will ever be a checklist when it comes to disclosing fee arrangements; but we want to ensure that fees are reasonable and investors aren't being deceived.
It's incredibly challenging. ... It's very fast-paced. That's been the joy of the asset management unit. We do have the freedom to think: What are the issues that we think are problematic?
If you were an institutional money manager, what SEC priorities would be on your radar? Conflicts of interest. Everything (a manager) does has the potential for conflict. For example, valuation. With conflicts of interest, it's being aware of your conflicts and disclosure, and ensuring investors know when there are conflicts. And it's knowing that we'll be on the lookout.
Which cases stick out in your mind on the institutional side? We filed a number of compliance cases last year, and next year we'll have another set of cases. I certainly think that we've gotten the message out.
The AXA Rosenberg case, where they failed to disclose a software error.
Martin Currie, where they used one (registered fund) to bail out a (hedge) fund. Here you have a perfect example of a conflict.
Morgan Stanley, where they violated their obligations under the 15C process, where they were supposed to advise their board (of fee arrangements with a subadviser).
The fiscal 2013 budget calls for 191 new positions in enforcement alone. What impact will that have? For the most part, we have the staff resources to do what we need to do. But we are always seeking to build expertise, and that takes significant resources.
Where are you in your effort to build more understanding of the asset management industry? We do a large amount of industry outreach. We do engage the industry, and we put a real emphasis on that. You have enforcement people who are on the beat who are educated in these issues. I do think we've sent that message.
What challenges does the continued consolidation of the money management industry bring? There is a lot of consolidation in the industry, and that brings up worries for us. We have concerns about appropriate oversight and compliance.
What are your biggest concerns? I think what you'll see from us now is a much more balanced approach. ...
With institutional money managers ... the big issues are conflict of interest, fee arrangements, valuation and performance, compliance and controls.
One of the big risk areas is pension funds' investments in alternative assets. Increasingly, you see pension funds looking for outsized returns, investing in alternatives that are not transparent to investors. We worry in particular about the smaller, less sophisticated pension funds that are not capable of performing the necessary due diligence before making investments in alternative assets.
Now that advisers under $100 million (in assets under management) are regulated by states, we have real worries about that regulatory gap. One of our objectives is to try to help the states and the criminal authorities.
We have also developed a risk-analytic initiative called “Operation ADV.” It helps to have more information being reported. We're looking at (advisers') education, business background and disciplinary history. When you start to look at that, you learn a lot. We're taking it another step, which is going out there and trying to find anomalies, to identify possible red flags ...
There are a number of cases in the pipeline on performance advertising, vetting of adviser fees and wrap fees.
I think we've become much more refined about what we're looking for. We're bringing a lot more significant cases. n