The SEC’s Current Views on Private Equity
Key Takeaways of Marc Wyatt’s Recent Speech
By: Jason E. Brown, Joel Wattenbarger, and Lindsay Rutishauser, Ropes & Gray
As a follow up to last year’s “Spreading Sunshine in Private Equity” speech, in which then-OCIE Director Andrew Bowden stated that the SEC had identified a “lack of transparency” as a pervasive issue in the private equity industry, Marc Wyatt delivered a speech on May 13, 2015, reflecting on progress in the past year as well as identifying likely areas of scrutiny the private equity industry will face in the future. Although the speech has been widely reported, we wanted to highlight particular areas for further review. In this article, we examine the key takeaways from the Wyatt speech, and outline best practices for the private equity industry going forward.
1. Post-Closing Disclosures
Over the past two years, the SEC has focused enforcement actions on purportedly undisclosed fees and expenses charged by private equity sponsors to funds or portfolio companies. While supplemental disclosure of fees and expenses that were not explicitly addressed in a fund’s offering documents may help obviate problems down the line, Wyatt expressed the view that disclosure alone may not be enough. For example, many advisers have responded to the SEC focus on fees and expenses by modifying their responses to Part 2A of Form ADV to disclose certain fees, expenses, and other practices that had not previously been disclosed in detail. Although modifying Form ADV is good practice, Wyatt’s speech suggests that the SEC will not necessarily regard post-closing disclosure of such practices in Form ADV or elsewhere as sufficient. Instead, Wyatt encouraged GPs to affirmatively seek consent from advisory boards or investors for any changes in practices or previously undisclosed fees and expenses.
2. Allocation of Co-Investment Opportunities
Wyatt’s speech also suggests that private equity sponsors should make full disclosure of their policy towards allocating co-investment opportunities. Wyatt indicated that prioritizing larger investors when allocating co-investment opportunities is not problematic per se, as long as doing so is disclosed. However, he noted that instead of erring on the side of more disclosure, many sponsors in the industry have responded to SEC scrutiny by saying less about their co-investment policies, on the grounds that if no promises are made, the adviser cannot be held liable. But there is danger in such limited disclosure practice if in fact co-investment promises are made to certain investors orally or through e-mail, with the effect that some investors have been given priority rights to co-investments, unbeknownst to others. According to Wyatt, the SEC has identified instances where fund investors were not made aware that other investors had negotiated priority rights to co-investments, which OCIE views as improper. Although Wyatt did not go so far as to say that an adviser must allocate its co-investments pro-rata or in any other particular manner, he did caution that all investors deserve to know where they stand in the co-investment priority stack.
3. Charging Fees at “Market Rates”
Wyatt also indicated that private equity sponsors will be coming under increased scrutiny when they charge certain consulting and other fees to portfolio companies at rates that are represented as being “at or below market.” Wyatt noted that sponsors’ representations that fees for services are being charged “at market or lower rates” have not always been borne out by the evidence. Therefore, OCIE has encouraged sponsors to review their benchmarking practices to ensure they can support claims that their services are offered at market or lower rates. Although Wyatt’s comments were made in the context of real estate funds, the principles he described apply equally to consulting and other services provided by private equity firms and their affiliates to portfolio companies. Accordingly, sponsors and consulting affiliates should be ready to back up any contention that the rates charged by such affiliates are indeed competitive with third-party firms by obtaining third-party quotes.
4. More Enforcement Actions Are Coming
Going forward, Wyatt indicated that the private equity industry remains a high inspection priority, as evidenced by the OCIE’s creation of a Private Funds Unit and the hiring of industry experts to assist with examinations. The SEC has already engaged in a number of enforcement investigations against private equity sponsors and we anticipate that the SEC will actively seek to bring additional enforcement actions in the areas described above.
Ropes & Gray is a Tier 1 Associate Member of the Council
