The SEC Has Revealed Astounding Corruption in Private Equity

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The SEC Has Revealed Astounding Corruption in Private Equity

And, for once, the commission is not letting them get away with it

By Mike Konczal

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As a result of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, private equity firms must register with the Securities and Exchange Commission (SEC). This, in turn, allows the SEC to examine the behavior of private equity firms on behalf of investors. The SEC just completed an initial wave of 150 firms, and what it found is shocking...last week when Andrew Bowden, the director of the SEC’s examinations office, gave a speech titled “Spreading Sunshine in Private Equity.” The big takeaway: Half of the SEC’s exams find corruption in the way fees and expenses are handled. Or as Bowden forcefully describes it: “When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50 percent of the time.”

As Bowden notes, the business model of private equity, which manages almost $3.5 trillion dollars of our nation’s assets, has unique conflicts of interest built into the structure. Private equity firms use their client’s money to do leveraged buyouts of companies. Since this gives them major operating control of both the investment and a pool of other’s investment money, there are significant opportunities to shift costs and otherwise skim off their investors...One scam is to fire employees of the private equity firm and rehire them immediately as “consultants.” The investors are responsible for consultants’ salaries, where private equity employees are paid out of their own pockets. Another is taking what most private equity investors believe to be part of management fees, things like legal and compliance costs, and billing their investors for them without the investors properly knowing it. A third is private equity firms lying about the valuation methods they use to tell investors about the returns they make each year. All of these are ways for private equity firms to take money from their investors for themselves.

So what should people take away from this?

Unions, organizing, and playing the long game matter.

These revelations about private equity are directly the result of Dodd-Frank. And discussing with people familiar with how the bill progressed through Congress, there’s one big reason that this ended up in there: Unions fought for it. Especially the AFL-CIO, which fought to get this specific language into the bill. In 2007, the AFL-CIO issued a statement urging the SEC to be able to exam private equity firms this way. When financial reform came up for debate, they were able to make the case, and organizing groups pushing the agenda like Americans for Financial Reform also took up the cause.

In addition to having organizations fighting for transparency in financial markets, playing a long game matters. As Damon Silvers, Policy Director and Special Counsel for the AFL-CIO, told me, “certain policy ideas are kicked around for a very long time, and then there’s a window of opportunity. We fought for this for 15 years, and it’s a good lesson that you push for good ideas even when they don’t seem practical. Because when the window hits, you want to have solid ideas ready to go.”

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http://www.newrepublic.com/article/117735/private-equity-fraud-how-firms-are-ripping-their-investors

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