SEC Chairwoman Mary Jo White today testified in front of the U.S. House Committee on Financial Services, to discuss the Agency’s recent activities and 2015 budget request. As part of that overview, White suggested that recent examinations of hedge fund and private equity fund managers have uncovered some very unsavory activities. Namely, charging improper fees to investors and portfolio companies.

This is an issue we discussed earlier this month, upon news that the SEC had formed a dedicated group to examine private equity and hedge funds. Specifically, we wondered if certain private equity firms were collecting fees from portfolio companies that were not explicitly enumerated in their limited partnership agreements (i.e., fees they needn’t share with investors).

Mary Jo White didn’t identify any phantom fee perpetrators, not did she explain what the SEC plans to do about its findings. It might have helped if any Congressmen chose to ask her, but they largely focused on budgetary issues. Nonetheless, the fact that she discussed the issue so early in her testimony seems to indicate that this is an issue to which she is paying very serious attention (or she just figured that these newfound abuses would help support her request for extra funding).

Here is the relevant part of White’s statement (full comments here):

In 2014, the NEP launched an initiative to engage with the roughly 20% of investment advisers that have been registered for three years or more, but have never been examined (the never-before examined initiative). This initiative includes both risk-assessment and focused reviews. The risk-assessment approach is designed to obtain a better understanding of a registrant and may include a high-level review of an adviser’s overall business activities. The focused review approach includes conducting comprehensive, risk-based examinations of one or more higher-risk areas, which could include, among others, the compliance program, portfolio management, or safety of client assets.

In addition, since the effective date of the Dodd-Frank Act, approximately 1,800 advisers to hedge funds and private equity funds have registered with the SEC for the first time. Throughout 2013 and continuing into 2014, Commission staff has launched an initiative to conduct focused, risk-based exams of newly registered private fund advisers. These “presence” examinations are more streamlined than typical examinations, and are designed both to engage with the new registrants to inform them of their obligations as registered entities and to permit the Commission to examine a higher percentage of new registrants. Some of the common deficiencies from the examinations of these advisers that the staff has identified included: misallocating fees and expenses; charging improper fees to portfolio companies or the funds they manage; disclosing fee monitoring inadequately; and using bogus service providers to charge false fees in order to kick back part of the fee to the adviser. Ongoing presence exams and continued identification of these types of deficiencies inform the NEP’s analysis of new and emerging risks, OCIE is on track to complete its goal of examining 25% of these newly registered advisers by the end of 2014. It should be noted that many of the investors in these funds are public and private pension funds as well as charities, academic institutions, and foundations.

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