Thursday, April 2, 2015

More Poorly Chosen Words by and Pictures of an SEC Regulator

More Poorly Chosen Words by and Picture of an SEC Regulator

More Poorly Chosen Words by and Pictures of an SEC Regulator

In the past two of weeks I’ve written a couple of times about ill-considered remarks made by Andrew Bowden, the SEC’s Director of Inspections and Examinations.  At a private equity conference, Mr. Bowden spoke positively about the economics and performance of private equity.  As I’ve said before, the director’s comments were inappropriate.  It turns out that Mr. Bowden made similar comments in the September 2014 edition of the publication, Private Equity International[1]:   

Broadly speaking, private equity has a great business model. Over the last 20 years or so the returns are strong on an absolute basis and relative to most other asset classes. So when you sit back and think about all of the people in the world who are engaged in money management private equity has added a huge amount of value. On the whole, they’ve delivered for their clients. Because of that and the business model they’re also doing well for themselves.

As the blog Naked Capitalism aptly pointed out yesterday, the article in PEI shows that the views expressed by Mr. Bowden at the private equity conference weren’t just an impromptu statement.  A regulator shouldn’t be praising an industry’s business model. Since private equity takes on some of the biggest risks in asset management, you’d expect it to generate the highest absolute and relative returns.  Thus Mr. Bowden’s comments about performance and adding value are inaccurate.  Either Mr. Bowden is pandering to the industry, or he doesn’t understand risk. 

In addition, Mr. Bowden doesn’t understand the economics of the private equity business.  While many practitioners are doing well for themselves, many small firms don’t make a great deal of money.  Even though these firms are earning two percent or more in management fees, these firms don’t have the scale to earn a great deal for themselves.  In addition, their performance doesn’t earn much of anything for investors.   As with many other industries, a small number of executives at large firms are generating massive windfalls irrespective of performance.

The good news is that Mr. Bowden isn’t employed by the SEC to evaluate the economics, performance, or risk of private equity.  Mr. Bowden’s job is to measure an asset manager’s compliance with the SEC’s rules.  The PEI article demonstrates that Mr. Bowden understands the SEC’s role in examinations, which is limited.  The SEC isn’t supposed to have an opinion on the level of fees or carried interest.  It’s not supposed to eliminate potential conflicts of interest in the manager’s business practices.  It doesn’t define the contractual terms between the manager and its investors.  The SEC’s job is to make sure that the manager makes appropriate and fair disclosure of fees, conflicts, and contractual terms.    So long as the manager doesn’t make misleading or fraudulent statements to the investors, the SEC has no role in regulating the manager’s assertions. 

The SEC is not a substantive regulator, but rather a process and disclosure regulator.  If a manager follows the process and makes the disclosures, it can solicit, charge fees, and attempt to generate returns even if its strategy is ill-considered and/or highly risky.  In other words, if a manager puts the appropriate footnotes and disclosures in all its documents, Mr. Bowden’s team of examiners have no reason to admonish it or refer it the to the Enforcement Division of the SEC.    

Last week, I questioned Mr. Bowden’s (as well the chairman’s) attendance at conferences.  In most cases, the SEC attendance serves no valid purpose.  The article in Private Equity International is also inappropriate.  The public is poorly served when Mr. Bowden or any public servant poses for glossy photos in an industry publication and talks about the memorabilia in his office.   The private equity industry probably gets a warm and fuzzy feeling after looking at Mr. Bowden’s photo spread and reading his comments.   However, there’s nothing in Mr. Bowden’s job description or the SEC’s mission about making the industry feel comfortable.  When Mr. Bowden poses for pictures and extols the virtues of private equity, he isn’t working for us.

[1] or

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