As the Securities and Exchange Commission celebrates the fifth anniversary of an enforcement unit dedicated to the money management industry, people inside and out of the agency say the unit has led to a better understanding — and scrutiny — of that industry to the benefit of investors.
In 2010, after the financial crisis and missed enforcement opportunities symbolized by Bernard Madoff hurt the SEC's reputation, enforcement officials felt they had to do things differently. That led to creation of the division of enforcement's asset management unit to investigate activity at hedge funds, mutual funds, private equity firms and separate account managers and advisers. The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act that year added a major dimension by requiring money managers handling at least $100 million to register with the SEC.
“When you think about it, (the asset management unit) was a startup company that went from zero,” said Gary LaBranche, president and CEO of the Association for Corporate Growth, Chicago, which represents middle-market private equity firms. “I've definitely seen a growth in their depth of understanding. What they have been developing is a culture of compliance and transparencies, of being proactive with your investors to disclose fees and other charges,” Mr. LaBranche said.
The biggest first step was developing expertise in all aspects of asset management, which meant bringing in practitioners with asset management experience, said Bruce Karpati, who co-founded the unit in 2010 and now serves as global chief compliance officer and director for KKR & Co. in New York. “It was ingrained in all of us to make sure that we were looking at the right issues and protecting the market. It was always a priority that we were going to do this the right way,” Mr. Karpati said.
Five years later, the asset management unit's “industry experts have positively transformed the way we identify and investigate misconduct,” said unit co-chief Julie Riewe, who along with Marshall Sprung took over in July 2013. ”They enable us to hone in on potential issues and gather the relevant facts more quickly.”
Co-founder Robert Kaplan, a partner at law firm Debevoise & Plimpton in Washington since 2012, considers that effort to be the unit's biggest accomplishment. “They really have trained the staff to be much more knowledgeable about how the business works,” Mr. Kaplan said.
Before the specialized unit existed, private fund cases “were rarely about the relationship between the fund and the manager,” Mr. Kaplan said.
It was also important to create a self-sufficient unit that could generate its own referrals, while at the same time communicate more closely with the SEC's examination and investment management divisions, Mr. Karpati said.
Another innovation was the unit's aberrational performance inquiry initiative to monitor performance data of hedge fund managers. That has spurred wider use of quantitative analytics throughout the SEC. “That's something that people outside the agency are keeping an eye on,” Mr. Kaplan said, citing concerns that investigations launched solely on those analytics without corroboration could raise fairness issues for investment advisers.
Private fund managers and their lawyers now see the asset management unit as a growing influence on the Office of Compliance Inspections and Examinations, where examiners are increasingly likely to know what they are looking at when they visit hedge funds, private equity firms and other money managers, sometimes with enforcement staff present as well. “The interaction with OCIE has changed things. OCIE and enforcement are working more hand in hand. I don't think there is such a thing as a routine inspection anymore. They're getting more involved in the front end,” said Catherine Botticelli, partner at law firm Dechert LLP in Washington, who has seen the number of referrals from examiners for enforcement actions increase. “To me, that's the most important dynamic.”
It took six months to develop the first case, but by the time Mr. Karpati left in 2013, “we had cases left and right,” he said. At the beginning, “it was really with the notion that five years later we would have brought cases that were all over the map. All of those things happened. I think it's really taken hold.”
In some ways, the unit's priorities haven't changed that much since 2010. In a 2012 interview with Pensions & Investments, Mr. Karpati said the top concern for unit officials when it came to institutional managers was conflicts of interest, followed by fee arrangements, disclosure, valuation and performance results. Strong compliance programs are another priority, particularly as firms consolidate, increasing the chance that oversight could slip through the cracks.
“They want to see process and procedures that firms are taking,” said Amber Landis, Association for Corporate Growth's Washington-based vice president for public policy, who said increasing attention to cybersecurity measures is part of the focus on compliance.
What clearly has changed is that the industry has gotten the message, either through high-profile enforcement actions or more routine but probing questions being asked by examiners working closely with the unit.
“I think over the course of its five-year existence that it has sent messages to the industry. I think that people understand the consequences,” said Mr. Karpati at KKR. In June, the firm agreed to pay $29 million to settle charges that from 2006 to 2011 it charged investors in its private equity funds for deals it pursued but did not consummate.
Mr. Kaplan, his former co-chief, agrees. “It is certainly true that they've sent a lot more message cases. People are extremely responsive to the messages coming out of enforcement,” he said.
The SEC's enforcement statistics for the fiscal year ended Sept. 30, which are not broken down by units, show 807 enforcement actions and $4.2 billion in recovered profits and penalties compared to 755 actions and $4.16 billion in fiscal 2014.
“I have got to think that formation within enforcement has had an impact,” said Todd Cipperman, founder and managing partner of Cipperman Compliance Services LLC, Wayne, Pa., who sees increased enforcement in private equity, particularly real estate.
