Securities & Exchange Commission plans to expand its ongoing alternative investment examination program to other alternative investment managers including credit advisers, infrastructure and timber managers, said Marc Wyatt, acting director of the SEC's office of compliance inspections and examinations, in a speech on Wednesday at the Private Equity International Compliance Forum in New York.
The OCIE unit has now completed presence exams of 25% of the newly-registered private fund managers including private equity and hedge funds, he said. It also started examinations on real estate firms last year.
Since there is a two-year or more lag between the completion of an exam and enforcement action, “it is reasonable to assume that the next year may bring additional private equity actions by the SEC's Division of Enforcement,” Mr. Wyatt said.
Since the program began in October 2012, the SEC has announced enforcement actions against Lincolnshire Management Inc., Clean Energy Capital LLC and Oppenheimer Asset Management Inc.
Mr. Wyatt said that while private equity managers are becoming more transparent and have beefed up their disclosure policies, the industry needs improvement.
“Many managers still seem to take the position that if investors have not yet discovered and objected to their expense allocation methodology, then it must be legitimate and consistent with their fiduciary duty,” he said.
One of the most common problems is managers shifting expenses away from parallel funds created for insiders, friends, family and preferred investors to the firm's main commingled fund, he said. These expenses include operational expenses and broken deal expenses of an active fund, which “can be quite large,” Mr. Wyatt noted. “This practice can be a difficult for investors to detect but easy for our examiners to test.”
He also said there were issues regarding disclosures of co-investments.
“We have detected several instances where investors in a fund were not aware that another investor negotiated priority co-investment rights,” Mr. Wyatt said. This information not only has “a very real and tangible economic value” but can also be a source of conflicts of interest, he said.
In exams that started last year, SEC officials have discovered that some real estate managers that also provide property management, construction management, and leasing services to properties they manage for their limited partners charge the cost of the employees who provide those services to investors. Many times investors have agreed to these charges based on the understanding that investors will be charged below market rates. However, SEC officials have found that real estate managers often cannot adequately substantiate those claims.
“Unfortunately, we rarely saw that the vertically integrated manager was able to substantiate claims that such fees are 'at market or lower,'” Mr. Wyatt said.