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I believe the SEC is responding to investment complexity with specialized examination groups. This is straight out of the SEC playbook going back to 2010, when it underwent a complete reorganization. (See our previous coverage of this here.)
Background
To understand why this is happening now, we have to go back to the passage of the Dodd-Frank Act in 2010, which removed registration exemptions for private equity and hedge funds. Previously, these funds were covered under the so-called “15 client exemption” which allowed private fund advisers to count each fund as a client and thereby bypass the purview of the SEC.[2]
In testimony to the U.S. House Committee on Financial Services, SEC Chair Mary Jo White provided insight about the SEC’s private fund examination efforts. Some of the more salient points she made include:[3]
- Since Dodd-Frank has passed, approximately 1,800 advisers to hedge funds and private equity funds have registered with the SEC for the first time;
- Staff is currently conducting “focused, risk-based” exams on this pool of new registrants;
- So far, some of the problem areas that have arisen are as follows: “misallocating fees and expenses; charging improper fees to portfolio companies or the funds they manage; disclosing fee monitoring inadequately; and using bogus service providers to charge false fees in order to kick back part of the fee to the adviser.”
Focusing on Complex Businesses and Complex Investment Strategies
While the SEC has not publicly defined how it is using its “risk-based exams” it appears it is using complexity as a key determinant of risk. The result is that the SEC is focusing on funds that have complex businesses and complex investment strategies.[4]
The Complexity of Regulating Complex Investments
How complex is this task? One indicator is the amount of staff required to carry out the examinations. As part of the fiscal 2015 budget request, the SEC is looking for funding to add 316 examination staff to its Office of Compliance Inspections and Examinations.[5] This would increase the current 450 examination staff by over 70 percent.[6]
To put the size and scope of their mandate in perspective, the SEC has so far only examined about nine percent of RIA firms.[7] Their goal is to have examined 25 percent of these newly registered advisers by the end of 2014.[8]
As the evolutionary speed of investments continues to increase and change the landscape, the SEC will have to match it with the speed of change in its organizational structure. This will require great flexibility, creativity, and managerial savvy.
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The Accelerant roster of securities experts with complex investment backgrounds includes: Steve Pomerantz, Ph.D., Tom Boczar, Esq., CFA, Tom Brakke, CFA, Gerry Guild, CFA, and John Duval, Sr.
[1] Reuters. “Exclusive: SEC forms squad to examine private funds – sources”; Available at http://www.reuters.com/article/2014/04/07/us-sec-privatefunds-idUSBREA360M420140407; Accessed June 4, 2014.
[2] SEC.gov. “SEC Adopts Dodd-Frank Act Amendments to Investment Advisers Act”; Available at http://www.sec.gov/news/press/2011/2011-133.htm ; Accessed June 4, 2014.
[3] SEC.gov. “Testimony on ‘Oversight of the SEC’s Agenda, Operations and FY 2015 Budget Request’”; Available at http://www.sec.gov/News/Testimony/Detail/Testimony/1370541674457 - .U34-vlhdWht; Accessed June 4, 2014.
[4] PE HUB. “Some PE firms chosen for early SEC exams based on risk: Buyouts;” Available at http://www.pehub.com/2014/05/some-pe-firms-chosen-for-early-sec-exams-based-on-risk-buyouts/; Accessed June 4, 2014.
[5] See Supra note 1.
[6] Id.
[7] Id.
[8] Id.
