Keeping the faith

The anti-regulation rhetoric of Donald Trump’s election campaign has gathered pace since he won the election in November. Over the past few months he has repeatedly vowed to “do a big number on Dodd-Frank” and proclaimed excessive regulation is “killing jobs” and “driving companies out of America.”

Trump’s actions have spoken even louder than his words. He signed an executive order ordering a review of the act, and a second directing every federal agency to establish a task force to ensure each has a team to research all regulations and take aim at those deemed burdensome to the US economy.

And then there’s his pick to head the Securities and Exchange Commission, Jay Clayton. Commentators say the former private equity lawyer, who has previously drafted letters to the SEC advocating less onerous restrictions for foreign private companies, will support reduced regulations. To many, the Trump administration has sounded the death knell of the regulatory status quo.

Mary Jo White isn’t one of them. A month after leaving the SEC, the agency’s former chairwoman remains positive her legacy will remain intact.

Sitting down with pfm in late February, White said she did not think regulatory oversight in private equity is likely to change much. She says issues in the asset class – such as valuations and fee and expense allocations – will continue to be discussed and scrutinized, but the problems should be fewer.

“In terms of the industry’s changes in practices, policies and procedures in these areas, that’s ongoing, although I think lots of progress has been made there.”
She reminds pfm that enforcement is not confined to just the SEC, but is also the responsibility of other government entities such as the Department of Justice. And, she adds, enforcement should be a bipartisan issue.

“You might see some differences there conceivably in this administration, but I think for the most part, enforcement is a bipartisan issue and the SEC will remain strong,” she says.
The core provisions of the Dodd-Frank Act are part of a very important reform in the aftermath of the financial crisis, the lessons from which the financial industry should not forget, she adds.

“Maintaining the strong reforms does not mean that you refrain from reviewing it all to determine whether you can design something [that’s] more efficient but that still strongly protects the system and investors.”

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is, of course, the means by which the SEC was given the power to monitor the private equity industry for the first time.

A year after its entry into force, the regulator, under former chairwoman Mary Schapiro, introduced further provisions, including a requirement for private fund advisors to register with the agency and guidelines for specific exemptions to the requirement.
“I think it would be a huge mistake to go backwards in terms of the core reforms of [Dodd-Frank] regulation,” White says. “I think you have to very carefully proceed before you deregulate.”

This is perhaps not surprising given that White championed the post-crisis laws governing private equity and other sub-sectors of the vast world of finance on taking the helm of the agency in April 2013. Under her leadership, the regulator achieved a record number of enforcement cases, reaching over 2,850 actions and judgments, and a record amount of financial recoveries from such cases, totaling over $13.8 billion.
“With enforcement, we knocked it out of the park,” she says. “Not just in the number of cases but the kinds of cases and the way we went about our business, making much greater use of data analytics. So we were investigating more smartly, quickly and pointedly.”
White asserts it’s important to focus on both individuals and companies when engaged in an enforcement action, and to proceed against responsible individuals who violate the law and companies involved. However, she notes that others may argue that a penalty should not be sought against a company on account of the wrongdoing of its employees in cases where there hasn’t been a demonstrable benefit to the organization from the wrongdoing.

She notes that the regulator wasn’t all about enforcement. Through the Dodd-Frank Act, the SEC had new responsibilities affecting the private funds industry. And when there are new authorities in a space, some previously unidentified issues are bound to come up, she says.

In October 2012, the agency announced its examiners in National Exam Program would conduct what it calls Presence Exams – risk-based tests of private fund advisors newly registered with the regulator.

“A lot of what the SEC does isn’t really enforcement; it’s examining for compliance and bringing about corrections, not enforcement. The presence exams were really an effort to have us get to know each other in the private equity space,” White says.

It was an avenue for the regulator to learn about the industry, but also to educate fund managers on what the requirements are, she says, adding that several issues were identified as a result.

Those discoveries mainly dealt with fees and expenses disclosures, conflicts of interest disclosures, and allocations of fees and expenses among others, White notes. For the most part, the violations did not rise to the level of what the agency would call ‘knowing fraud.’

“Many of them were acting on the basis of advice of counsel, and acting pretty consistently with industry practice.”

Private equity action

The agency used a mix of guidance, exams, education and enforcement when the regulator found it necessary to act. Although her tenure saw the number of enforcement actions reach new highs, she notes not many were aimed specifically at private equity firms.
“I think we’re talking about around 11 cases [in private equity], but they were significant ones,” White says. “As the first enforcement cases involving a private equity firm, they were important for their impact.”

The cases that did take a hit at private equity managers, however, were indeed headlining actions. In October 2015, the SEC slapped a $39 million fine on the industry’s largest firm by assets, Blackstone.

The regulator had charged that the New York-based firm failed to fully disclose to its investors the benefits received by Blackstone Management Partners I, II and III from accelerated monitoring fees and legal fee discounts.

In response, Blackstone, without admitting or denying the charges, paid $26.2 million in wrongful gains plus $2.6 million of interest and a $10 million civic penalty, according to the regulator’s announcement at the time.

Other large managers fined by the SEC within a year of the Blackstone case included KKR, for alleged misallocation of broken-deal expenses; and Apollo Global Management, for allegedly misleading investors about fees and interest payments and failing to detect a former senior partner’s allocation of personal expenses to Apollo funds.

White says the private equity industry responded diligently to the cases, and says she found that the industry corrected the practices that were found by the SEC to be problematic. For example, there are better disclosures being made on the Form ADV, which is the template investment advisors use to register with the agency, or report their registration exemptions.

She also points to better disclosures made to limited partners about fees and expenses and heightened attention paid by the advisors to valuation issues, such as best practices for accurately representing the values of their investments.

This latter point was echoed at a recent roundtable event hosted by pfm at which CFOs and experts noted increased focus on valuation models. For example, mid-market firm Saw Mill Capital’s chief financial officer Blinn Cirella said d her firm has been serious about its valuation policy and communicating with the investment team to adjust the models in place.

Tom Angell, audit partner in Withum’s financial services group, added during the roundtable he has seen more detailed valuation policies and consistency in following them.

Cybersecurity: a known threat

Another area where White believes regulators and firms must be particularly vigilant is cybersecurity, which she cites as a top concern.

White reiterates her point made during a speech given at the 2016 Investment Company Institute conference in May by telling pfm: “I think the biggest systemic risk to the financial system is cybersecurity. No one’s immune from these risks and the fallout from them if they come to pass.”

Through the SEC exams, White found some private fund managers were further ahead in addressing cybersecurity than others. The purpose of the exams in this topic was to show the marketplace what organizations were doing to tackle cybersecurity and so better assess which practices seemed to be most effective.

She warns that no one is immune from cybersecurity risks, even if an advisor is not the direct subject of an attack, and she has witnessed heightened concern about cyber risks among fund managers of all sizes.

“In terms of examining private fund advisors, that is a core responsibility of the SEC, and I would expect it to continue,” she says. “But again, I think private equity is a very responsive, constructive industry where we have seen a uniquely quick transition between enforcement and change of practice in the private advisors’ space.” ?

Back to her roots

White said her decision to leave the agency was made well before the US presidential election, citing a decades-old precedent that the SEC chair would step down when a new president took office – regardless of party.

“There was never a question about staying on longer as SEC chair. The president appoints the chairman, and all chairmen have for decades stepped down when there is a new president to give him that choice,” she says. “I never intended to stay as long as I did, frankly.”

On January 20, she returned to the life of a private citizen to work at Debevoise, where she had first set foot in 1973 as a summer associate. After serving as the Assistant US Attorney for the Southern District of New York between 1978 and 1981, White became a litigation partner at Debevoise.

Several alternations between the public and private sector later, White is back in the position in the Debevoise litigation department – which she led just before becoming the SEC chair.

“You’re a better regulator and a better prosecutor if you’ve seen it firsthand [in the private sector],” she says. “When you come into the private sector with the public sector experience, you are better able to advise your clients and know better about how to comply with the law and meet their regulators’ expectations.”

White, a New Yorker for more than four decades, is thrilled to be back after four years of commuting between the Big Apple and Washington, DC, via Amtrak’s Acela Express train.
“I should have a seat on the Acela with a plaque on it,” she jokes. “It’s actually quite an easy commute but after four years, it gets a little old. So I’m delighted to be back.”

Pull Stats

> 2,850
Actions and judgments under Mary Jo White’s tenure at the SEC

$13.8bn
Record total of financial recoveries from enforcement actions during her tenure

1973
Year White joined Debevoise

$39m
Fine regulator slapped on Blackstone in 2015

30
SEC chairs who preceded White