Former SEC lawyer: 'Aggressive enforcement' to continue

The rise in the number of Securities and Exchange Commission’s enforcement actions against private equity firms is a result of an increase in subject matter experts, knowledge from examinations and investment in technology, according to Robert Rice, former chief counsel to SEC chair Mary Jo White. Rice left Ropes & Gray this month to become a litigation and enforcement partner at Clifford Chance.

“SEC enforcement actions are on the rise across every facet of the industry, including private equity firms. I think this is due to number of general factors, including the increased sophistication of SEC enforcement staff,” Rice told pfm.

In the 12 months up to September 2015 – the most recent data available – there has been an increase in the number of SEC enforcement actions and sanctions imposed of the securities industry from the previous two years. Last year, there were 807 enforcement actions and approximately $4.2 billion dollars in financial sanctions ordered, according to a statement from the SEC.

“I suspect that fiscal year 2016 which ends on September 30 of this year, will show that this trend is continuing,” said Rice.

Over the last few years the SEC has dedicated significant resources to technology and data analytics, which gives it and its Office of Compliance Inspections and Examinations the ability to collect, digest and analyse massive amounts of data very quickly.

“This enables teams to collect data from a single firm or across a number of firms and identify suspicious activities. They can also analyse industry metrics and identify both positive and negative changes that may be ‘red flags’ warranting investigation. For example, comparison of performance against peers and assets under management may be ‘red flags.’”

In addition, the SEC has hired subject matter experts from the securities industry. “The enforcement team is now populated with former private equity, trading, hedge fund and sales experts. All of which combine to make a very sophisticated staff that understand the industry, asset classes and products very well,” he added.

The combination of new hires and examinations of private equity firms has made the SEC more knowledgeable about the private equity industry. Inspections are getting tougher as the regulator's knowledge of private equity and that of its examiners' deepens.

In mid-2015, KKR was penalized for the pre-2011 misallocation of broken deal expenses in its private equity funds and fined $30 million. It was followed by Blackstone, which paid $39 million in October to settle charges related to disclosure failures.

“The regulator better understands the business and the issues that are common to the industry such as fees and expenses, conflicts of interest and valuations, and is examining these practices to ensure that they are fairly disclosed to investors,” said Rice. “All of these factors have combined to create an aggressive enforcement environment that is likely to continue, and has increased the breath of enforcement activities across all spectrums of the securities industry and asset classes, including private equity, and is likely to continue,” he added.

The regulator also recognizes the differences between private equity and other asset classes, however this has made the industry more of a target.

“Private equity has some unique characteristics that make it different from other asset classes, such as the length of time investors commit capital to funds, agreements that are signed early on in the capital commitment process, which makes the industry a focus for both the OCIE examinations and inspections teams, and Enforcement,” said Rice. “Deficiencies identified in the OCIE examination process can be referred to the attention of enforcement for investigation.”

Despite its increase in knowledge and resources, the SEC is still not able to cover as much ground as it would like, said Rice: “The challenge with private equity is part of the challenge that the regulator faces on the investment advisor front with respect to examinations – it is difficult to cover the landscape,” said Rice. “Over the years there has been a concerted effort to beef up SEC staff or reallocate existing resources to conduct more examinations of investment advisors, however this continues to be a challenge for the SEC.”