The SEC is an Uninvited Guest
Title IV of the Dodd-Frank legislation enacted in 2010 requires investment advisers managing more than $150 million in assets to register with the SEC. This includes private equity firms like ours.
Once registered, advisers are subject to audit and enforcement actions by the SEC (often administrative procedures, instead of lawsuits where the defendant has a large body of law as precedent) and other broad investigative and administrative procedures.
I have written about recent fact finding audits the SEC uses to develop a short list of supposed abuses by private equity and hedge fund managers (WSJ article). That short list presumably would become the audit checklist for future audit practices. Not surprisingly, the audit checklist is focused on managers; their compensation, their discretion to set valuations and their latitude in deciding portfolio and transaction management fees.
As I stated in that blog, the sophistication of the investor class and their advisers who seek out alternative assets is a better protection against manager fraud or malfeasance than governmental auditors who may not even understand the context for the audit.
Notwithstanding this opinion, the SEC has recently persuaded Blackstone Group LP to end its practice of accelerating unpaid portfolio monitoring fees when a change in control occurs prior to the contract expiration date (Blackstone article). This is like taking down a wildebeest, and no doubt Blackstone’s capitulation will encourage more governmental scrutiny.
This regulatory climate may also impact the willingness of private equity fund sponsors and their investors to continue as currently constituted.
Family Offices Are Exempt
Dodd-Frank gives the family office a distinct advantage by exempting it from its registration requirements (found here). Under this exemption, the family office and its affiliated trusts, estates, charities and lineal participants can continue to own private assets without having to disclose anything. That exemption also applies to the managers of the family offices, who may own, but not control, the family office.
At first blush, this may not seem like a big deal. But if you are, say, the Koch brothers (think Freedom Partners), this means that the SEC cannot be unleashed to harass and investigate your family office as retribution for organized efforts to unseat many congressional incumbents. It also means that millennial assets can be owned and passed on from generation to generation without having to disclose key facts regarding profitability, revenues, or incentive compensation of managers; in other words, items that virtually no hedge fund or private equity firm had to worry about two years ago but now must.
Best and Brightest May Gravitate to Private Platforms
My prediction is that the best and brightest sponsors will gravitate to large family offices where they can be “owners” as long as they do not have governance control. It also may be compelling for family patriarchs to sell their businesses to family offices so that they can remain private and under family control. The exemption appears to apply to 10 generations of lineal descendants. In transition, for example, principals of Blackstone Partners might leave the firm vested in their legacy carried interest and finish their careers as architects of a family investor’s private equity strategy.
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