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SEC Private Fund Unit Focused on Conflicts, Real Estate Managers

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Despite perceptions, the Securities and Exchange Commission does not have a “laser focus” on private equity, rather the agency is now examining an industry that wasn’t regulated five years ago, bringing oversight up to the “level where hedge funds are,” Igor Rozenblit, co-head of the agency’s Private Funds Unit, said Wednesday.

Speaking at the Global Private Equity Conference in Washington, Rozenblit said that the SEC now has to “regulate this new asset class that we weren’t familiar with before.”

The Dodd-Frank Act modified some investment advisor exemptions and required many private equity funds to register with the Commission.

During the agency’s 2012 “presence exams” initiative to audit newly registered private fund advisors, the Private Funds Unit, housed within the SEC’s Office of Compliance Inspections and Examinations, said “‘let’s first understand what the incentives are [and] tease out where the investor protection issues may be,’” Rozenblit said.

After those exams, the agency decided to focus on “fees, expenses and valuations,” he said.

“We’ve taken an investor protection view of regulating private equity,” Rozenblit told attendees. “From us what it means is we really try to study incentives.”

The Private Funds Unit of 12 examiners, he said, is “studying” three areas:

Conflicts of interest “broadly is important,” Rozenblit said, and is “firm specific.”

The unit is also looking at real estate, he said. “We’ve been looking at real estate managers for a year.”

The third focus is on “stapled secondary transactions,” he said. “If you look at these structures the new capital is diluted to the secondary sale.”

Stapled secondary transactions occur where an investor provides capital to a private equity advisor in exchange for the advisor arranging for the investor to purchase the limited partnership interests of other investors in older funds. The fresh capital is “stapled” to the secondary purchase of other assets.

Marc Wyatt, deputy director of OCIE, said in early April that the agency has finished its “presence exams” of private fund advisors and will return to “risk-based exams” of these types of advisors.

Wyatt reiterated in a speech Wednesday in New York at the Private Equity International Compliance Forum that OCIE “will continue to apply our risk methodology to private equity exam selection.”

He said that through OCIE’s “risk-based” exam selection process, OCIE identifies “situations or behaviors which pose significant risk to investors or which, we believe, may violate federal securities laws and regulations.”

These risk factors and “other inputs help determine our exam candidates,” he continued. ”A firm may be operating in a key risk area but may have developed policies and procedures which address the related risks. An examination of an advisor, in and of itself, does not imply that we believe that the advisor has committed any securities law violations.”

By far, Wyatt said, “the most common deficiencies noted by our examiners in private equity relate to expenses and expense allocation. Many managers still seem to take the position that if investors have not yet discovered and objected to their expense allocation methodology, then it must be legitimate and consistent with their fiduciary duty.”