SEC TO SRUTINIZE PRIVATE EQUITY FUNDS

I recently came across several articles discussing whether the SEC should get involved with the oversight of private equity (PE) funds’ valuation of their underlying investments (assets).  Under the Dodd-Frank Act, more regulatory requirements are being put forth to protect the public interest.  On the radar is the private equity industry. This industry has been flying under the radar as it has been determined that only the wealthy (accredited investors) can invest in these types of investment vehicles and these folks should be smart enough not to get burned.  Tell that to the owners of the New York Mets.

PE funds invest in entities with the hopes that they can exit these investments and make a profit within 5 to 10 years. Generally, the objective of both the fund and the investors is to make a profit, of which most funds typically charge a 20% fee. The profit is only made upon the ultimate sale of the investment, causing the value of the investment to mean very little from year to year.  Most PE funds do not allow investor redemptions until the fund terminates when all investments are sold or liquidated. Thus, there are those that question why valuations matter at all.

The SEC is not worried as much about protecting accredited investors (those individuals with annual income in excess of $200,000 and net worth in excess of $1 million) as they are with pension plans who have been allocating more of their funds in these “alternative” investments.  The obvious concern is that higher values cause higher payouts to retiring participants in a pension plan, leaving the possibility of the last retiree holding the empty bag when the valuations don’t pan out.

Another reason for increased concern, and where I think this is leading, is that there is a push to allow more funds to accept non-accredited investor funds.  A PE fund manager who uses his/her past performance to sell future funds to investors would cause these investors to base their decisions on these potentially over inflated values.

So, I get the SEC’s concern, but what I want to know is how they’re going to help “scrutinize” the valuation process.  I am an auditor of PE funds, and I look to generally accepted accounting principles to determine how these investments held by PE funds should be valued.  There are several different but acceptable methods for valuing assets. The methods are very subjective and can yield very different results.  I have seen three valuation experts come up with three very different values for the same asset.  Which is correct? I have no idea.  Until an asset is sold to a willing buyer who is not compelled to buy, the value is anybody’s guess.

I will leave you with one thought: how would you have valued Facebook before its public offering?

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5 replies

  1. Very frank and to the point! Someone has to tell the truth about these agencies.

    I should fill you in on what FINRA is doing to put us out of business although the examiners have confided (no, told me outright) they they KNOW that we can’t harm our customers. We are now doing about $18,000 worth of service fee revenue a month and they have spent ONE YEAR analyzing our business. We’ve answered everything and complied in every way so they are persisting still trying to find SOMETHING. I have a meeting at 1 pm today and they are coming back for two weeks starting on the 21st. Two or three people were in our office for five months. I’ve kept records.

    Frank and To the Point wrote: > WithumSmith Brown, CPAs posted: “I recently came across several > articles discussing whether the SEC should get involved with the > oversight of private equity (PE) funds’ valuation of their underlying > investments (assets). Under the Dodd-Frank Act, more regulatory > requirements are being ” >

  2. Frank,

    I am attaching a memo to my file, which will give you an idea of what’s been going on.

    Frank and To the Point wrote: > WithumSmith Brown, CPAs posted: “I recently came across several > articles discussing whether the SEC should get involved with the > oversight of private equity (PE) funds’ valuation of their underlying > investments (assets). Under the Dodd-Frank Act, more regulatory > requirements are being ” >

  3. Frank,

    I had dinner with Peter Fishbein, who was managing partner at Kaye Scholler–a well-respected law firm. I told him the story while FINRA was in our office in 2011 and earlier this year and he said that I should take it to the Wall Street Journal. The demands have been abusive and designed to harm us and keep us for providing a service that investors value.

    Frank and To the Point wrote: > WithumSmith Brown, CPAs posted: “I recently came across several > articles discussing whether the SEC should get involved with the > oversight of private equity (PE) funds’ valuation of their underlying > investments (assets). Under the Dodd-Frank Act, more regulatory > requirements are being ” >

  4. The SEC is misallocating their resources when they audit funds such as Vita’s with small amounts or fees. They need to look to get the biggest bang for the buck which won’t occur with smaller activities that also have reputable auditors. The SEC has been worthless in stopping tragedies such as Enron, Madoff, the mortgage backed derivatives debacles and other large and obvious frauds yet they have been rewarded with more oversight and responsibilities and then they spend our tax dollars on picky little things.
    As to the SEC concern with pension plan alternative investments, that is hogwash. Every pension plan is audited and the auditors have their procedures peer reviewed assuring adequate compliance. Also, pension plans have trustees that are responsible for the propriety fo the asset allocation and make up of the plan and the annual reporting forms are public information. Further, If the plan is a defined benefit plan then the employer stands behind it making up any losses – the only oversight should be the solvency of the employer, not of the plan!

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