SEC Expands Police Squad – Fund Violations Surpass 50%

SEC Expands Police Squad – Fund Violations Surpass 50%

The Securities and Exchange Commission (SEC), in connection with the Dodd-Frank Act, has a dedicated team for the examination of private equity and hedge funds, and is now pushing to increase its 2015 budget and add up to 316 staff to this specialized group. This unit, based in the Office of Compliance Inspections and Examinations, currently numbers 450 professionals. The aim of the expansion is to significantly increase the number of private funds examined by the SEC every year.

The team of examiners will delve into the degree to which private equity and hedge funds are complying with current regulations. Their examinations will primarily focus on three areas: (1) methods used to value a fund’s assets, (2) disclosure of fees, and (3) general communication with investors. The increase in demand for examiners has undoubtedly stemmed from provisions of the Dodd-Frank Act which require midsize and large private equity and hedge funds to register with the SEC. Since the effective date of the Dodd-Frank Act, approximately 1,800 advisors to such private funds have registered with the SEC for the first time, with 150 private equity firms examined since October 2012 and a goal of 275 firms by year-end.

Historically, many private funds have held complex and illiquid investments – the value of which can be uncertain and subjective, and have the greatest potential to cause financial reporting misstatements. This is because fair value is determined by using inputs that are not currently observable. Valuation best practice calls on fund managers to rely on independent third-party valuation firms to value such illiquid investments. The expanding team of SEC examiners intends to scrutinize the valuation methods of funds to ensure that the fair values of assets under management are appropriately reported.

Another area under the SEC’s spotlight is the funds’ fee structure and payment of fees. Earlier this week, Drew Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, stated that in SEC examinations of private equity firms to date, material weaknesses in controls were noted over 50 percent of the time relating to fees and other compliance matters.

Instead of the typical 2/20 arrangement, some funds may use a complex fee structure that can be difficult for investors to fully understand. Further, there may be back door fees that investors may not expect. The Special Examiner unit will attempt to determine the transparency and ease of comprehension of a fund’s fee structure. The ultimate goal of the Special Examiner unit is to bring transparency to the market and protect investors from being misled or deceived. That goal is presumed to be achievable by putting private funds under a microscope. “If we’re not on the job, doing exams in this area and spreading sunshine”, said Bowden, “these problems, which involve significant sums of money, are more likely to persist.”

Houlihan Capital can provide critical valuation information to funds and their investors by rendering anindependent valuation opinion, which can supply the necessary support and documentation to stand up to SEC and other regulatory scrutiny. Houlihan Capital provides clients with independent valuations and has a history of working closely with clients’ management, regulators, auditors, legal counsel, and investors on financial reporting and tax compliance matters.

Houlihan Capital is a leading, solutions-driven valuation, financial advisory, and boutique investment banking firm committed to delivering superior client value and thought leadership in an ever-changing landscape. The firm has extensive experience in providing objective, independent and defensible opinions of value that meet accounting and regulatory requirements. Our clients include some of the largest asset managers, private equity funds, hedge funds, fund administrators, and both public and private operating companies, who benefit from our comprehensive valuation and financial advisory services. Houlihan Capital is a Financial Industry Regulatory Authority (FINRA) and SIPC member, committed to the highest levels of professional ethics and standards.

For more information on independent third party valuation services, please visit or contact Paul Clark ( at 312.450.8656.

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