The regulatory eye in the sky (the SEC) has apparently locked onto private equity firms, sensing valuation problems and conflicts of interest. Generally, private equity firms purchase troubled companies with mostly borrowed funds, cut costs, improve operations, and sell them for a profit, taking a management fee (typically 1.5% to 2.0%) in the interim, plus 15% to 20% of any profits. Private equity firms and how they do business made news recently in the Republican primary presidential debates.
Last year, the SEC commenced a nonpublic “informal inquiry” asking several private equity firms for documents and information about their business, including how they value assets and potential conflicts of interest (“SEC Looking Into PE Firms’ Valuation of Assets,” Bloomberg; “SEC Launches Inquiry at Private Equity,” Wall Street Journal). The SEC appears to be investigating whether private equity firms “use inflated valuations to attract investors when marketing new funds,” according to the Bloomberg article. The documents being requested include documents that would show “support for valuations of the fund assets,” and those “setting forth a value for any assets owned by the fund” in the last three years.
“I think that private-equity law enforcement today is where hedge-fund law enforcement was five or six years ago,” Robert Kaplan, co-chief of the SEC’s asset-management unit, was quoted as saying, adding that the SEC is looking at potential conflicts of interest and fees, among other issues. Chad Earnst, assistant director of the SEC’s asset-management unit, was quoted as saying: “We’ll focus on whether there’s a systematic and consistent way the valuations are applied.”
Regulators have expressed concerns regarding valuation of all kinds of private, illiquid investments, including private placement (Reg D) offerings, hedge funds, and nontraded REITs. Sellers and issuers often maintain valuations of these investments at the purchase price despite the fact that they may have lost intrinsic value. That was a major problem with nontraded REITs that finally prompted the Financial Industry Regulatory Authority to step in and prohibit the practice.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.