Securities Enforcement Forum West 2016 Keynote Address: Private Equity Enforcement

Andrew Ceresney, Director, Division of Enforcement

Securities Enforcement Forum West
San Francisco, California

May 12, 2016

I. Introduction

Thank you for that kind introduction Bruce. At the outset, let me give the requisite reminder that the views I express today are my own and do not necessarily represent the views of the Commission or its staff.[1]

I am very excited to be here in San Francisco and am honored to be part of this terrific program for the second time. As you know, we have two offices here in California, the San Francisco and Los Angeles offices, and they are a critical part of our enforcement team. So I seize every chance I get to come out here, visit those offices and underline our presence on the West Coast.

Today, I am going to talk about the Enforcement Division’s focus on private equity, which has expanded significantly over the past three years. I am frequently asked how I measure the success of the SEC’s enforcement program. Among the several ways we measure our success is the impact of our actions on particular sectors or markets. Our work in the private equity space provides a concrete example of how our actions have led to real change in a market that has benefited investors enormously.

I plan to do three things today. First, I will share with you some background on Enforcement’s work in the private equity industry and our collaboration with our partners in the Office of Compliance Inspections and Examinations (OCIE) and the Division of Investment Management, and explain why it is important for the Enforcement Division to dedicate resources to this asset class. Second, I will highlight certain problematic conduct and practices we have uncovered through our private equity enforcement actions, and note some of the common arguments we have rejected that have been advanced by some of the defendants in some of these actions. Third, I will discuss how the industry has responded to our actions in altering certain practices and increasing transparency, all to the benefit of investors.

II. Background

Investments in private equity funds have increased significantly in recent years. Preqin estimates that, as of June 2015, private equity advisers worldwide managed $4.2 trillion, much of it in the United States, compared to just over $700 billion in 2000.[2] Many investors have invested in private equity based on their expectation that private equity returns would be uncorrelated with and/or exceed public equity market returns, and in certain cases, they have been proven correct.[3]

Private equity has certain unique characteristics, particularly in its investment structure. In most funds, on day one, investors are required to commit capital for investments that might not produce returns until 10 years or more down the road. Prior to committing capital, investors enter into certain agreements that are intended to govern the terms of their investment throughout the fund’s life. As we all know, a lot can happen in ten years, and, unlike other types of investments, should issues arise, it is extremely difficult for an investor to withdraw their capital from a private equity fund investment.

It is thus critically important that advisers disclose all material information, including conflicts of interest, to investors at the time their capital is committed. While most private equity funds have a Limited Partner Advisory Committee (known as a LPAC), or similar oversight body, made up of sophisticated investors, unaffiliated with the adviser that is sometimes explicitly tasked with reviewing conflicts of interest by the fund’s formation documents, as we will see, certain private equity fund advisers have failed to provide the LPAC members with sufficient disclosures to make such determinations.

In addition, private equity fund investments themselves are different than other asset classes. Private equity advisers typically purchase controlling interests in portfolio companies and frequently take a hands-on approach to managing those investments by serving on the company’s board; selecting and monitoring the management team; acting as sounding boards for CEOs; and sometimes stepping into management roles themselves. Advisers typically charge the fund and the portfolio companies fees to compensate for these services.

I think it is fair to say that the investment structure of private equity and the nature of private equity investments can lend themselves to some of the misconduct that we’ve observed. As you’ll see in some of the enforcement actions I reference, investors in certain circumstances do not have sufficient transparency into how fees and expenses are charged to portfolio companies or the funds. Sometimes fees are not properly disclosed, conflicts are not aired, expenses are misallocated, and investors are defrauded. Private equity advisers are fiduciaries and need to fully satisfy the duties of a fiduciary in all of their actions.

Now, why is the SEC spending its limited resources on the private equity industry given the sophistication of most investors? Because it is important to understand that retail investors are significantly invested in private equity. For example, public pension plans frequently invest the retirement savings of their plan beneficiaries — which include teachers, police officers and firefighters — in private equity funds. Similarly, institutional investors have increased their investments in private equity funds, often on behalf of retail investors who themselves are saving for retirement.[4] Further, university endowments — which fund scholarships and other important academic programs — invest in private equity funds. So, if an adviser defrauds a private equity fund, the underlying victims frequently include retail investors, who in many cases are not in a position to protect themselves. In addition, while the managers of these pension funds and other institutional investors who invest in private equity can be sophisticated, even experienced investors can be defrauded if they lack transparency into the various fees, expenses, and practices - which has been the case in the past. There is thus little question that private equity is an appropriate focus for the SEC.

Prior to 2010, private equity fund advisers typically did not register with the Commission, and the Commission staff often had limited visibility into their practices. However, in 2010, two significant events occurred: (i) Dodd-Frank was enacted; and (ii) the SEC’s Division of Enforcement announced the creation of specialized units — including the Asset Management Unit. Dodd-Frank required many private equity fund advisers to register with the Commission and be subject to periodic examination by OCIE, giving us increased visibility into the advisers. At the same time, the Asset Management Unit began developing the expertise necessary to understand private equity fund advisers and their practices. In October 2012, OCIE launched the Presence Exam Initiative, which included extensive engagement with the private equity industry, and created its own specialized unit — the Private Funds Unit. OCIE examined many private equity advisers (often for the first time) and identified a number of deficiencies. And we have continued our focus on private equity firms under Chair White’s leadership.

In 2014, Andrew Bowden, then-Director of OCIE, publicly identified a number of industry practices that OCIE had observed during these examinations.[5] He observed that over fifty percent of the examined private equity fund advisers had compliance issues.[6] Among the problematic practices he identified were advisers’ allocation of expenses, hidden fees, and issues related to marketing and valuation.[7] OCIE shared its findings with the Asset Management Unit and, where appropriate, the Unit opened investigations. The AMU has now brought eight enforcement actions related to private equity advisers — with more to come — and it is an appropriate time to step back and evaluate what we have learned thus far.

III. Enforcement Actions

Our actions against private equity fund advisers fall into three interrelated categories, which I will discuss in turn:

  1. Advisers that receive undisclosed fees and expenses;
  2. Advisers that impermissibly shift and misallocate expenses; and
  3. Advisers that fail to adequately disclose conflicts of interests, including conflicts arising from fee and expense issues.

A. Undisclosed Fees and Expenses

One issue we have seen in our cases is undisclosed fees and expenses and the Blackstone case vividly illustrated these issues.

In 2015, the Commission charged three private equity advisers within The Blackstone Group for two distinct breaches of fiduciary duty, and Blackstone paid approximately $39 million to settle the matter, $29 million of which was distributed to harmed investors.[8]

First, according to the SEC Order, Blackstone terminated certain portfolio company monitoring agreements between Blackstone and its funds’ portfolio companies, and accelerated the payment of future monitoring fees. Although Blackstone disclosed in its offering documents that it might receive monitoring fees from portfolio companies, it failed to disclose to its funds, and the limited partners prior to their commitment of capital, that it might accelerate future monitoring fees upon termination of the monitoring agreements.

In most instances, Blackstone terminated the monitoring agreement upon a portfolio company’s IPO, and accelerated monitoring fee payments, while maintaining some ownership stake in the company. In some instances, Blackstone terminated the monitoring agreement, and accelerated monitoring fee payments, even where the relevant Blackstone-advised fund had completely exited the portfolio company, meaning that Blackstone would no longer be providing monitoring services to the portfolio company. In other words, the payments to Blackstone essentially reduced the value of the portfolio companies prior to sale, to the detriment of the funds and their investors.

It is important to emphasize that our action took no position on the propriety of accelerated monitoring fees. Instead, our concern was making sure that the adviser complied with the fund offering documents and made timely, accurate and full disclosure of conflicts of interest and other material facts. In many cases, private equity fund advisers enter into agreements with their portfolio companies to provide monitoring services in return for a fee. Many of these agreements provide that, upon the company’s IPO or sale, for example, the remaining payments due under the agreement — which could be up to an additional ten years of fees — accelerate, allowing the adviser to receive the net present value of these fees. This payment is often substantial and is not the customary monitoring fee to which the parties agreed in the fund organizational documents. Because investors typically don’t have transparency into the agreements between advisers and the portfolio companies, they are often unaware of such payments and their terms, and therefore the adviser’s ability to collect this accelerated fee should be disclosed to investors at the time they commit capital.

Second, according to the Order, Blackstone fund investors were not informed about a fee arrangement that provided Blackstone with a substantially greater discount on legal services provided by an outside law firm than the discount that the law firm provided to the funds. The law firm performed a substantial volume of work for Blackstone and the funds, and, despite the fact that the funds generated significantly more legal fees than Blackstone, Blackstone negotiated an arrangement with the law firm where it received a discount substantially larger than the discount it negotiated for the funds. The issue here was that Blackstone breached its fiduciary duty by securing greater benefits for itself than the funds it advised, without properly disclosing and obtaining informed consent for the arrangement. The message of this case is that full transparency of fees and conflicts of interest is critical in the private equity industry.[9]

B. Expense Shifting

We have also been focused in our enforcement actions on expense shifting. Today, I will highlight three enforcement actions touching on this issue: the first concerning an adviser that allocated broken deal expenses entirely to its flagship funds; a second concerning an adviser that misallocated portfolio company expenses between two funds that it managed; and a third concerning an adviser that misallocated expenses between the adviser and the fund.

In June 2015, the Commission charged KKR with misallocating more than $17 million of “broken deal” expenses to its flagship private equity funds in breach of its fiduciary duty.[10] Broken deal expenses are diligence and other legal costs related to unsuccessful buyout opportunities and can run into the tens of millions of dollars. In many cases, broken deal expenses are paid by the fund, but that dynamic is more complicated at large advisers where there may be co-investors, separate accounts, friends and family vehicles, and others contemplating investing alongside the funds in portfolio companies. Unless otherwise disclosed to investors, it is important for advisers to ensure that the costs of each potential investment are paid by those that might benefit from that potential investment’s return.

In KKR’s case, that did not happen. According to the SEC Order, KKR did not allocate any portion of these broken deal expenses to its separate accounts or their own investment vehicles, even though KKR invested alongside the funds. Nor did KKR disclose in its offering materials that the flagship funds would pay all broken deal expenses. This breach of fiduciary duty is particularly troubling because a sizeable amount of co-investment capital came from KKR-affiliated vehicles, such that the firm had the funds foot the bill for deal sourcing activity that inured directly to its benefit. KKR ultimately paid a total of $30 million to settle the matter, including a $10 million penalty.

In 2014, the Commission charged Lincolnshire Management for misallocating expenses between two portfolio companies.[11] Lincolnshire had integrated two portfolio companies — each owned by a different Lincolnshire-advised fund with different investors — and managed them as one company. However, according to the Order, Lincolnshire caused one portfolio company to pay more than its proportionate share of the companies’ joint expenses. As a result, one fund bore a disproportionate share of the expenses, to the detriment of that fund’s investors, and Lincolnshire breached its fiduciary obligations to the funds. A key takeaway is that when an adviser manages multiple funds and engages in any transactions across those funds, it must be mindful of the fact that it owes a separate fiduciary duty to each fund, and must ensure that its actions do not fraudulently benefit one fund at the expense of another.

The misallocation that occurred in Lincolnshire could be described as horizontal misallocation, as the misallocation occurred across funds. Another enforcement action — Cherokee[12] — could best be described as vertical misallocation, as the misallocation occurred between the adviser and the funds it managed. In Cherokee, the Commission charged two private equity fund advisers with improperly allocating their own consulting, legal, and compliance-related expenses to their private equity fund clients in contravention of the funds’ organizational documents. Cherokee ultimately reimbursed the funds for such expenses, and paid a $100,000 penalty.

C. Failure to Disclose Conflicts of Interest

Finally, I will focus on two cases in which the respondents failed to disclose conflicts of interest to their funds’ LPAC. As I had discussed earlier, private equity funds typically have LPACs consisting of independent investors with the authority to approve or disapprove of conflicts of interest on behalf of the fund. In each of these cases, however, the respondents failed to disclose conflicts of interest, which arose after the initial capital commitments by the investors, to the LPACs.

In 2015, the Commission charged Fenway Partners and four executives with failing to disclose several conflicts of interest to a private equity fund they advised.[13] In this case, we could trace the failures to particular individuals who we found had failed in their duties to investors in a number of ways and therefore charged individuals as well, which is a priority for us.

First, Fenway Partners had initially entered into monitoring agreements with its portfolio companies, and the resulting fees paid to Fenway Partners were offset against Fenway Partners’ management fee paid by the fund. According to the SEC Order, Fenway Partners and four executives caused certain portfolio companies to terminate their payment obligations to Fenway Partners and enter into consulting agreements with an affiliated entity named Fenway Consulting Partners LLC. Fenway Consulting Partners provided similar services to the portfolio companies — often through the same employees — but the fees paid to Fenway Consulting Partners were not offset against the management fee that the fund paid to Fenway Partners. This altered arrangement was not disclosed to the LPAC or investors.

Second, Fenway Partners and three respondents asked fund investors to provide $4 million in connection with an investment in a portfolio company without disclosing that $1 million of the investment would be used to pay its affiliate, Fenway Consulting.

Third, without disclosure to the LPAC or investors, Fenway Partners and two respondents caused three former Fenway Partners employees to receive $15 million in incentive compensation from the sale of a portfolio company for services that they had almost entirely provided when they were Fenway Partners employees.

Finally, Fenway Partners failed to disclose each of these payments as related-party transactions in the financial statements they provided to investors.

This case illustrates the multiple ways in which advisers can, through relationships with affiliates and portfolio companies, benefit themselves at the expense of their investors. None of these payments that benefited the adviser, its former employees, and its affiliate were transparent to investors. Ultimately, the parties agreed to pay approximately $10.2 million in disgorgement, pre-judgment interest and penalties into a fund for harmed investors.

In the second case, the Commission charged JH Partners with failing to disclose and obtain fund advisory board consent for a series of transactions, including: (a) a series of loans to the funds’ portfolio companies, resulting in the adviser obtaining interests in portfolio companies that were senior to the interests held by the funds; (b) causing more than one of its funds to invest in the same portfolio company at differing priority levels, potentially favoring one fund client over another; and (c) causing certain of the funds’ investments to exceed concentration limits set forth in the funds’ governing documents. JH Partners agreed to a cease and desist order and a $225,000 penalty as part of its agreement to settle the case.[14]

These two cases drive home a fundamental principle: as fiduciaries, private equity fund advisers must make full disclosure of all material facts relating to its advisory services, including all material conflicts of interest between the adviser and its clients. This obligation requires private equity fund advisers to disclose sufficiently specific facts such that the client is able to understand the conflicts of interest and business practices, and can give informed consent to such conflicts or practices.

Now, during the course of private equity investigations, we have heard a number of arguments advanced by the private equity fund advisers, each of which we have ultimately found unavailing.

First, some potential defendants have argued that it is unfair to charge advisers for disclosure failures in fund organizational documents that were drafted long before the SEC began its focus on private equity and before many advisers were required to register. But, although private equity fund advisers typically did not register until after Dodd-Frank was enacted, they have always been investment advisers and subject to certain provisions of the Investment Advisers Act. All investment advisers, whether registered or not, are fiduciaries[15] and are subject to the Advisers Act antifraud provisions.

Second, potential defendants have argued that, even if the adviser failed to disclose a conflict of interest, the investors benefited from the services provided by the adviser. While this may be a factor to consider when assessing any potential remedy, it is not a relevant argument for assessing liability. As a fiduciary, an investment adviser is required to disclose all material conflicts of interest so that the client can evaluate the conflict for itself. The fact that a conflicted transaction or practice might arguably benefit the client simply does not relieve an adviser of its duty to inform and obtain consent.

Third, some advisers have pointed to advice they received from counsel, for example in connection with disclosures to investors. The involvement of counsel varies in each case, and assuming the adviser waives the privilege and discloses the advice completely, we will consider this advice in evaluating the appropriateness of an action and the remedies we will seek. However, the adviser is still ultimately responsible for its conduct — including its disclosures of conflicts to its clients — and cannot escape liability simply by pointing to the actions of counsel.

IV. Impact on the Private Equity Industry

To close today, I want to focus on the impact that our actions have had on the private equity industry. Our sense is that through the Commission’s focus on the industry, we have helped to significantly increase the level of transparency into fees, expenses, and conflicts of interest, and have prompted real change for the benefit of investors.

As a preliminary matter, beginning in 2014, a number of advisers revised their Form ADV filings to more fully disclose their fee and expense practices.[16] Perhaps more significantly, certain private equity advisers have taken affirmative steps to change their fee and expense practices and bring them in line with their organizational documents. For example, as the Commission noted in the Blackstone enforcement action, in 2014, Blackstone announced certain changes to its business practices, including that it would no longer take accelerated monitoring fees when it completely exits a portfolio company through a private sale. I hope that these actions will lead other advisers as well to proactively change their practices to seek to avoid conflicts of interest with clients and to ensure, at a minimum, that they are in line with their organizational documents.

Finally, there has been a significant and encouraging uptick in investors seeking additional transparency concerning advisers’ fee and expense practices. For example, the Institutional Limited Partners Association (ILPA) released a Fee Transparency Initiative in 2015 which aims to establish consistent standards for fee and expense reporting and compliance disclosures.[17] Similarly, a group of comptrollers and treasurers has sought clearer and more consistent disclosures in order to strengthen their retirement systems’ negotiating position, which they believe will result in more efficient investment options.[18]

Indeed, some have said that the Commission’s actions have shined light on private equity practices, including fees that investors believed were not appropriately charged to funds and portfolio companies and, by extension, investors. While our actions have taken no position on the propriety of these fees, the increased transparency has fostered a healthy dialogue between investors and advisers on what sorts of fees are appropriate and who should receive the benefits of those fees. I have been asked before whether we will bring a case asserting that a particular type of fee constitutes a breach of fiduciary duty. Whether we will or not, it is my belief that awareness and transparency of fees generally will lead investors and advisers to reach an appropriate balance in terms of types and allocation of fees. In short, I think our private equity actions have led to significant change in the private equity industry, all to the benefit of investors.

V. Conclusion

I hope that this has given you a better sense of the SEC’s recent enforcement work concerning the private equity industry. The message should be clear: we have the expertise and will continue to aggressively bring impactful cases in this space. We also hope that our actions send a clear signal to industry participants that their practices must comport with their fiduciary duty and disclosures in their fund organizational documents.

Thank you for the opportunity to speak with you today.

[1] The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues on the staff of the Commission.

[2] See “2016 Preqin Global Private Equity and Venture Capital Report Sample Pages” available at

[3] See, e.g., “Private equity begins to entice ordinary investors,” (May 26, 2015), found at (“Investors able to take a long-term view, who are seeking returns potentially higher and uncorrelated to the equity markets, could find private equity an intriguing, if risky, alternative.”)

[4] See “’Wall of Committed Capital’ Heads for Private Equity,” found at

[5] Andrew J. Bowden, Director of OCIE, “Spreading Sunshine in Private Equity,” May 4, 2014, available at; see also Marc Wyatt, Acting Director of OCIE, “Private Equity: A Look Back and a Glimpse Ahead,” May 13, 2015, available at

[6] See, e.g., “SEC Finds Illegal or Bad Fees at 50% of Buyout Firms,” (May 6, 2014), found at

[7] See id.

[8] In the Matter of Blackstone Management Partners, L.L.C., et al., Advisers Act Release No. 4219 (Oct. 7, 2015).

[9] Press Release 2015-235, “Blackstone Charged With Disclosure Failures” (Oct. 7, 2015), available at

[10] In the Matter of Kohlberg Kravis Roberts & Co., L.P., Advisers Act Release No. 4131 (June 29, 2015).

[11] In the Matter of Lincolnshire Management, Inc., Advisers Act Release No. 3927 (Sept. 22, 2014).

[12] In the Matter of Cherokee Investment Partners, LLC and Cherokee Advisers, LLC, Advisers Act Release No. 4258 (Nov. 5, 2015).

[13] In the Matter of Fenway Partners, LLC, et al., Advisers Act Release No. 4253 (Nov. 3, 2015).

[14] In the Matter of JH Partners, LLC, Advisers Act Release No. 4276 (Nov. 23, 2015).

[15] See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963).

[16] E.g., “Buyout Firms Disclose More Fees,” (Nov. 20, 2014), found at

[17] “ILPA releases Fee Transparency Initiative,” (Sept. 3, 2015), found at

[18] “States, Cities to Ask SEC to Beef Up Disclosures for Private-Equity Firms,” (July 21, 2015), found at