Chief of SEC Enforcement Speaks About the Concerns and Initiatives of Private Fund Advisers

In a recent speech at the Private Equity International Conference in New York, Bruce Karpati, Chief of the Securities and Exchange Commission’s (“SEC”) Enforcement Division’s Asset Management Unit, addressed private equity enforcement concerns.

While the SEC has not traditionally brought many private equity enforcement actions, Mr. Karpati expects that to change. Mr. Karpati continued to explain that the industry has rapidly grown and now may rival hedge funds in terms of assets under management. Since private fund managers have only recently been required to register, the number of cases against such firms is likely to climb. This is further facilitated by the SEC’s efforts to hire industry professionals who are familiar with and specialize in various aspects of the industry.

Mr. Karpati highlighted that some of the concerns the SEC has about the private equity industry revolve around capital raising due to the number of funds that are chasing the same capital. Additionally, the lack of transparency seems to be of greater concern, especially with regard to the valuation of illiquid assets and the operations of portfolio companies. He continued to state that conflicts of interest are a big factor and that much of the improper conduct revolves around misappropriation, deal cherry-picking and other forms. To counter the trend, the SEC has implemented Risk Analytic Initiatives based on the data they have collected on the funds’ portfolios. An example is to look at a fund’s low liquidity compared to its peers. Mr. Karpati highlighted that a firm should “ensure that COOs, CFOs, CCOs and other risk managers are able to proactively spot and correct situations where conflicts may arise.” The easiest and most underutilized way is to use the Limited Partnership Advisory Committee for reviewing any conflicts. The Committee usually has the responsibility to resolve conflicts and having a vote when addressing a conflict goes far in demonstrating good faith.

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