The United States Securities and Exchange Commission (SEC) announced on April 7, 2014, that it was launching a new private fund unit dedicated to the examination of private equity and hedge funds.
The new group is another example of increased regulatory oversight of the financial services industry following the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), Pub. L. 111-203, H.R. 4173. Dodd-Frank’s changes to the exemptions available under the Investment Advisers Act of 1940 for investment advisers has meant that many investment advisers to hedge funds and private equity funds (private funds) have had to register with the SEC for the first time. Registration means that these advisers have “submitted” to the jurisdiction of the SEC, which has the right to conduct periodic compliance and other examinations without cause. Prior to Dodd-Frank, the SEC was generally limited to so-called “for cause” examinations of unregistered advisers. As a result of the Dodd-Frank change, and as expected, there has been increased government scrutiny of the advisers that manage private funds.
An important issue for the SEC is that many advisers to private funds maintain portfolios of complex and illiquid investments that are more difficult to value than investments traditionally managed by registered advisers. At the 2014 Compliance Outreach Program, the SEC identified several areas of concern with private funds and their practices, including "vague" limited partnership agreements, insufficient disclosures, shifting of fees and expenses to investors, and unclear performance and valuation metrics.
The SEC has historically focused on the regulation of asset managers with large numbers of institutional and retail clients – such as those advisory firms that manage mutual funds – that have been regulated since the 1940s. Following the "Great Recession of 2008-2009," the agency had been criticized for failing to detect and thwart certain violations, including the Ponzi scheme perpetrated by Bernie Madoff, and others.
Recognizing that specialized examination procedures are needed to address the complexities resulting from the passage of Dodd-Frank, the SEC has recently responded by calling for the addition of specialist examiners at the agency who understand how private equity and hedge funds value their assets and connect with investors, and the manner in which they disclose their fees.
The SEC has requested that Congress provide it with greater resources for fund inspections and regulatory oversight. In fact, the SEC has asked Congress to increase its staff by adding 316 members to the Office of Compliance Inspections and Examinations.
This significant addition of resources – if approved – will include additions to the new private fund unit.
The new group will be dedicated to the examination of private equity and hedge funds. It is co-chaired by industry veterans and is set to be comprised of existing SEC staff in four of the agency’s regional offices, with the possibility of further expansion to additional offices in the coming months.
Pepper Hamilton has helped clients for years to manage and stay abreast of the flood of regulatory changes and enforcement actions, including Dodd-Frank, and the more recent JOBS Act. Pepper's Securities and Financial Services Enforcement Group combines the experience and efforts of former federal prosecutors and financial services regulators who concentrate their practices in various areas of corporate, securities, and tax law, as well as in financial services matters. The Securities and Financial Services Enforcement Practice works hand in hand with the firm’s Funds Services Group to position clients for positive outcomes from regulatory examinations. Together, they are a part of Pepper's Investment Funds Industry Group (IFIG), an interdisciplinary industry group comprised of more than 60 lawyers who focus their practices in areas vital to the success of all types of investment funds throughout their entire life cycle. The group counsels funds and advisers on the formation of investment vehicles and all aspects of their regulatory compliance, and in the enforcement area, in defending clients at every stage of these matters – from the informal inquiry stage up through investigations and hearings. Our attorneys can advise and help you prepare for what lies ahead in this increasingly changing area of the law.
Jay A. Dubow, Ivan B. Knauer and Christina O. Hud
For more information, contact Pepper’s Securities and Financial Services Enforcement Group leaders Jay A. Dubow and Ivan B. Knauer.
More Resources on the Dodd-Frank Act
For additional information, please visit Pepper's Financial Services Reform Resource Center.
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