As we noted last year in our memorandum focused on 2013 developments, Securities and Exchange Commission Chair Mary Jo White has called for the SEC to be more aggressive in its enforcement program. By all accounts, the Enforcement Division has responded to that call. The past year saw the SEC continue the trend, started under Enforcement Director Robert Khuzami in 2009, of transforming the SEC’s civil enforcement arm into an aggressive law enforcement agency modeled on a federal prosecutor’s office. This should not come as a surprise since both Andrew Ceresney, the current Director, and George Cannellos, Ceresney’s Co-Director for a brief period of time, like Khuzami, spent many years as federal prosecutors in the Southern District of New York. And the Commission itself is now led for the first time by a former federal prosecutor, Mary Jo White, the US Attorney for the Southern District of New York from 1993 to 2002. Given the events of the past decade involving the Madoff fraud and the fallout from the 2008 financial crisis, we believe both the aggressive tone and positions the SEC has taken in recent years will continue.
Posts Tagged ‘Private Equity’
US federal laws and regulations, as well as the rules of self-regulatory organizations, impose numerous yearly reporting and compliance obligations on private equity firms. While these obligations include many routine and ongoing obligations, new and emerging regulatory developments also impact private equity firms’ compliance operations. This post provides a round-up of certain annual or periodic investment advisory compliance-related requirements that apply to many private equity firms. In addition, this post highlights material regulatory developments in 2014 as well as a number of expectations regarding areas of regulatory focus for 2015.
After a year of “first ever” actions targeting private equity, fund managers should be vigilant, even about seemingly small issues.
In reviewing the results of SEC Enforcement’s fiscal year that ended on September 30, the agency congratulated itself on its comprehensive approach to enforcement and its “first-ever” cases. Private equity fund managers should consider a number of important takeaways.
The SEC Continues to Pursue a Broken Windows/Zero Tolerance Approach
Although the Enforcement Division announced a record number of enforcement actions, and the largest aggregate financial recovery, 2014, unlike in years past, did not include a headline-grabbing case such as Enron, Worldcom or Madoff. More recently, the agency has chosen to emphasize its pursuit of smaller cases as a way of improving compliance in the industry. SEC Chair Mary Jo White and Enforcement Director Andrew Ceresney have each touted the agency’s “broken windows” approach to enforcement. A “broken windows” strategy means that the SEC will pursue even the smallest violations on the theory that publicly pursuing smaller matters will reduce the prevalence of larger violations. Ceresney has described “broken windows” as a zero tolerance policy. This past year illustrated the agency’s commitment to applying enforcement sanctions to what some might consider “foot fault” incidents. For example, in September 2014, the SEC announced a package of three dozen cases involving a failure to promptly file Section 13D and Section 13G reports, as well as Forms 3 and 4. Many of the filers charged were just days or weeks late in disclosing their positions. In announcing the cases, Ceresney emphasized that inadvertence was not a defense to late filings.
There is no doubt that innovation is a critical driver of a nation’s long-term economic growth and competitive advantage. The question lies, however, in identifying the optimal organizational form for nurturing innovation. While corporate research laboratories account for two-thirds of all U.S. research, it is not obvious that these innovation incubators are more efficient than independent investors such as venture capitalists. In our paper, Corporate Venture Capital, Value Creation, and Innovation, forthcoming in the Review of Financial Studies, we explore this question by comparing the innovation productivity of entrepreneurial firms backed by corporate venture capitalists (CVCs) and independent venture capitalists (IVCs).
Are private firms more efficient than public firms? Jensen (1986) suggests that going-private could result in efficiency gains by aligning managers’ incentives with shareholders and providing better monitoring. In our paper, Do Going-Private Transactions Affect Plant Efficiency and Investment?, forthcoming in the Review of Financial Studies, we examine a broad dataset of going-private transactions, including those taken private by private equity, management and private operating firms between 1981 and 2005. We link data on going-private transactions to rich plant-level US Census microdata to examine how going-private affects plant-level productivity, investment, and exit (sale and closure). While we find within-plant increases in measures of productivity after going-private, there is little evidence of efficiency gains relative to a control sample composed of firms from within the same industry, and of similar age and size (employment) as the going-private firms. Further, our productivity results hold excluding all plants that underwent a change in ownership after going-private, alleviating the potential concern that control plants may undergo improvements through ownership changes.
In recent weeks, the Securities and Exchange Commission (SEC) has revealed that it is closely reviewing how private equity fund advisers disclose the allocation of fees and expenses to their investors. The SEC is primarily implementing this review through the Presence Exam Initiative (the Initiative), which has been initiated through the SEC’s Office of Compliance Inspections and Examinations (OCIE).  Under the Initiative, the SEC has examined more than 150 newly-registered private equity advisers. According to the OCIE, the goal is to examine 25% of the new private fund registrants by the end of the year. The SEC has indicated that over 50% of the newly-registered private equity fund advisers that it has examined to date have either violated the law or have demonstrated material weaknesses in their controls related to the allocation of fees and expenses. The SEC has identified inadequate policies and procedures and inadequate disclosure as related issues, with deficiencies in these arenas running between 40% and 60% of all adviser examinations conducted, depending on the year. This sheer number of perceived deficiencies likely will result in increased regulatory investigations, enforcement activity and possible sanctions, as well as increased exposure to investor-initiated lawsuits. As a result, (i) sophisticated fund investors will likely start asking questions to determine whether their fund managers engage in these practices and (ii) private equity firms should consider compliance and disclosure practices that can help limit this exposure.
Schedule 13D Ten-Day Window and Other Issues: Will the Pershing Square/Valeant Accumulation of a 9.7% Stake in Allergan Lead to Regulatory Action?
As widely reported, a vehicle formed by Pershing Square and Valeant Pharmaceuticals acquired just under 5% of Allergan’s shares after Allergan apparently rebuffed confidential efforts by Valeant to get Allergan to negotiate a potential acquisition. The Pershing Square/Valeant vehicle then crossed the 5% threshold and nearly doubled its stake (to 9.7%) over the next ten days, at which point it made the required Schedule 13D disclosures regarding the accumulation and Valeant’s plans to publicly propose an acquisition of Allergan. The acquisition program has raised a number of questions.
In our paper, Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds, which was recently made publicly available on SSRN, we use detailed cash-flow data to study the persistence of buyout and VC fund performance over successive funds. We confirm the previous findings that there was significant persistence in performance, using various measures, for pre-2000 funds—particularly for VC funds. Post-2000, we find that persistence of buyout fund performance has fallen considerably. When funds are sorted by the quartile of performance of their previous funds, performance of the current fund is statistically indistinguishable regardless of quartile. At the same time, however, the returns to buyout funds in all previous performance quartiles, including the bottom, have exceeded those of public markets as measured by the S&P 500.
The importance of small businesses in America is unquestionable—they are the foundation of today’s economy and are responsible for many of the new jobs created each year in the United States. And angel investors play a vital role in the development of small businesses by nurturing them at their earliest, most vulnerable stages when they may have little more than the next great idea. For early stage entrepreneurs, angels often are the only ones willing to listen to their business pitch, provide advice, and put in that crucial infusion of capital that is needed to transform an idea into a thriving new business. Yahoo, Google, Facebook, Home Depot—these are just some of the titans of today’s corporate America that, at an earlier stage of their development, were first backed by angel investors.  Equally impressive are some of the statistics about the impact of angel investing—by one estimate, in the first half of 2013 alone, angels invested approximately $9.7 billion in over 28,000 ventures, with over 111,000 new jobs created as a result of these investments. 
It has been argued that the best private equity partnerships do not increase fund size or fees to market-clearing levels. Instead they have rationed access to their funds to favor their most prestigious investors (e.g. Ivy League university endowments). Further, industry observers (e.g. Swensen (2000)) have often argued that endowments are better equipped to assess and evaluate emerging alternative investments, such as private equity, in which asymmetric information problems are especially severe. Lerner, Schoar, and Wongsunwai (2007) document that improved access as well as experience of investing in the private equity sector led endowments to outperform other institutional investors substantially during the 1990s. However, private equity is no longer an emerging, unfamiliar asset class, and the distribution of private equity fund returns has also changed over time. In particular, venture capital returns fell dramatically after the technology bust of the early 2000s.