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(Bloomberg News) The U.S.
Securities and Exchange Commission’s review of how private equity firms
value assets and market their funds is so far looking at mainly smaller
firms, omitting some of the industry’s largest, publicly traded
companies, said a person familiar with the inquiry.
Blackstone
Group LP, the biggest private equity firm, and KKR & Co. haven’t
received the SEC’s December request for information, said the person,
who asked not to be named because the information is private. The
inquiry stems from a task force set up two years ago to look into
practices ranging from asset valuation to conflicts of interest at
private equity firms and hedge funds, said another person with knowledge
of the matter.
Officials for Blackstone and KKR, both based in New York, declined to comment.
The SEC late
last year sent letters to several firms asking for details on fund
investments and the valuation of assets, as well as communication with
clients, according to the copy of a letter obtained by Bloomberg News.
Among issues regulators are examining is whether firms use inflated
valuations to attract investors when marketing new funds, a person
familiar with the matter said last week.
Private
equity came under scrutiny in the aftermath of the financial crisis,
which forced firms to mark down holdings acquired during a three-year
boom that ended in 2008 when the collapse of Lehman Brothers Holdings
Inc. froze credit markets. Financial reform measures such as the
Dodd-Frank Act have proposed more oversight of the firms’ businesses.
Proactive Approach
SEC
enforcement director Robert Khuzami said in 2009 he would set up an
asset management task force to keep up with the growing number of
investment advisers it was tasked with policing. Robert Kaplan and Bruce
Karpati, who lead the unit, have said they will use proactive
investigative approaches and industry outreach to probe issues including
valuation and conflicts of interest at hedge funds, mutual funds and
private equity firms.
Khuzami has
said publicly that investigators are targeting asset managers who have
consistently reported above-market returns.
The SEC
typically polices public securities offerings and transactions. It
hasn’t traditionally focused on areas such as private equity that
involve sophisticated investors and private placements that are exempt
from registration with the regulator, although it can enforce private
equity managers’ fiduciary duty to their funds.
SEC
enforcement attorney Chad Alan Earnst said at an industry conference
last month that while general partners in private equity funds have some
discretion in how they value their portfolio, valuation is still
subject to the fiduciary duties the general partner owes the fund,
according to a report in Private Equity International.
Private
equity firms pool investor money to buy companies, using mostly debt,
with the intention of selling them or taking them public later for a
profit. They typically charge an annual management fee of 1.5 percent to
2 percent of committed funds and keep 15 percent to 20 percent of
profit from investments.
SEC
investigators are also teaming up with other agency staff who perform
routine examinations of asset managers to identify potential problems
with firms’ practices.
In May,
Carlo di Florio, head of the SEC’s office of inspections and
examinations, said the consistency and comparability of a firm’s
valuation methods, the disclosure of pricing methodology and unrealized
performance were areas that concerned the agency.
“There are
likely to be conflicts of interest over how investment valuation is
calculated, whether in reporting performance to fund investors or in
marketing materials for raising capital for new funds,” Di Florio said.
‘Census-Like Data’
“In addition
to such conflicts, there is also potential for more egregious conduct,
such as misleading reporting to current or prospective investors on PE
fund performance by selectively highlighting only the most successful
portfolio companies while ignoring or underweighting portfolio companies
that underperform,” he said.
The SEC in
June voted to require private-fund advisers to register with the agency,
although publicly traded private equity firms already provide detailed
information in quarterly and yearly filings. The mandate forces 750
advisers to disclose “census-like data” about their investors and
employees, the assets they manage, potential conflicts of interest and
their activities outside of fund advising.
In the
16-page letter dated Dec. 8, the SEC said its “request should not be
construed as an indication by the commission or its staff that any
violation of the federal securities law has occurred, nor should it be a
reflection upon any person, entity or security.”
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