The activities of the United States Securities and Exchange Commission (SEC) have been well documented throughout this year in respect of the scrutiny placed on the private equity industry.
Previous coverage relating to the SEC on DealMarketBlog.com includes fallout from a speech given by an SEC official earlier in the year, and the SEC highlighting failings in the private equity industry a short time later.
The SEC has now turned its focus to private equity consultants, according to the Wall Street Journal. This represents a shift from putting firms under scrutiny, although previously the likelihood of consultants and fund managers coming under the microscope has always been high, particularly as there had been mentions of unlimited fines and jail terms for those deemed to be complicit in breaching regulations.
It should be noted that, at this stage, the SEC is looking at external consultants, in effect partners of the private equity firms, and specifically at how they are paid. The Wall Street Journal notes that a particular area of interest for the SEC revolves around how the consultant’s involvement with the firms is reported.
Usually, a consultant’s salary is paid by the company that has been invested in, or by investors in the particular fund involved in the deal. However, these consultants’ profiles are often used in company materials in order to highlight expertise or attract investment. The SEC is concerned this represents a lack of transparency, both on the part of the consultant and the firms themselves.
The Wall Street Journal says it has examined the filings of approximately 80 private equity firms, with only half of them disclosing that consultants were paid from investors or the companies being advised. The other half made no mention of the consultants or their salaries at all. All of the firms are confirmed to be using consultants in some form within their operations.
The SEC’s increased level of scrutiny is in line with investors asking more questions of the firms they invest in. Private equity fees, in particular, have long been a source of controversy, with investors increasingly asking why they are so high, and pressuring firms for a breakdown of what their fees were covering.
Private equity firms have increasingly used consultants as it gives them access to an industry expert without necessarily needing to appoint someone to the board or elsewhere within the business. As well as being able to use the consultants as a selling point to investors, firms have been able to make better strategic decisions around the investments they wish to target, as well as being able to pull out of investment opportunities at later stages owing to having greater knowledge at their disposal.
Speaking about the role of the private equity consultants and operating partners, Ron Sansom of Riverside Co. told the Wall Street Journal, “The deal partner works to find the deal and get the deal done, whereas the operating partner is there to really dig in and affect those strategic levers.”
While the SEC’s focus on the private equity marketplace has undoubtedly driven change in the industry over the last year, it will be interesting to see how quickly firms and consultants react to the increasing pressure in this area.