Hedge fund and private equity managers can expect increased attention from the Securities and Exchange Commission, as the agency builds staff expertise in both asset classes and the regulator takes sharper aim at others that present opportunities for abuse.
The SEC's approach to alternative investment managers has changed in the past year. It hired former hedge fund managers, private equity analysts, due diligence professionals and other practitioners in all of its divisions; the specialized enforcement unit for asset management — created in 2010 — matured; and divisions within the regulator coordinated more closely with each other. The changes come after the Dodd-Frank Wall Street Reform and Consumer Protection Act required some 1,500 hedge fund and private equity managers to register with the SEC in 2012.
“In the SEC's view, there are a lot of assets under management at these firms, and they are quite varied in their nature such that it warrants extra scrutiny. They present on their face control risks that are different, so it makes sense,” said attorney John Sturc, who co-chairs the securities enforcement practice at Washington-based Gibson Dunn & Crutcher LLP, which has seen a recent uptick in cases against hedge funds and private equity firms.
Thanks to the added expertise, “we are now able to identify promising cases earlier (and) we are much better able to take on cases that have a variety of complex and technical issues,” Bruce Karpati, chief of the SEC's enforcement division's asset management unit, said at a recent private equity conference in New York. “You won't see (us) shy away from cases that involve illiquid asset valuations or that require us to dig into the operations of a portfolio company.” The increased attention is driven partly by higher allocations from public-sector pension funds, particularly by those with $1 billion or more in assets, Mr. Karpati said.
Since 2010, the SEC has brought more than 100 cases against hedge fund managers for conflicts of interest, questionable performance or inadequate compliance controls, and is beginning to do more with private equity.
One practice drawing particular attention now is how alternative fund managers handle valuation. On March 11, Oppenheimer Asset Management and Oppenheimer Alternative Investment Management settled charges that inflated valuation of one private equity holding caused two Massachusetts pension funds and other investors to lose more than $2 million. While the $333 million Brockton Contributory Retirement System and the $290 million Quincy Contributory Retirement System lost a legal claim against Oppenheimer, the SEC prevailed in a settlement with the firm that, without admitting or denying the charges, agreed to give back the pension funds $2.23 million in management fees and interest, and to enhance its valuation procedures.
The Oppenheimer action was a signal to alternative investment managers that their valuation practices need to be more transparent, particularly with pension funds and endowments increasing their exposure to those asset classes, said Julie Riewe, the SEC's asset management enforcement deputy chief. Those investors must be able “to understand private funds' valuation methodologies,” Ms. Riewe said in an e-mail.
Along with enforcement, the SEC's investment management division is also paying attention to how private funds handle valuation, developing guidance for fund managers and directors and hiring more examiners and risk experts from the industry to visit firms and compare notes with their enforcement colleagues.
That shouldn't be a problem for reputable firms, said David Fann, CEO of TorreyCove Capital Partners LLC, San Diego, a private equity consultant to pension funds and other investors representing $20 billion in assets. Most firms use multiple valuation techniques and have controls in place, including outside advisory boards to protect against overvaluation, and most mark down values for underperforming investments, he said.