The SEC’s Andrew Bowden: A Regulator for Sale?

The head of the SEC’s examination unit, Andrew Bowden, created a furor last May when he described the widespread lawbreaking that the SEC was uncovering in its first examinations of private equity firms, now that virtually all were required by Dodd Frank to register as investment advisors. For one type of abuse alone, allocation of fees and expenses, Bowden stated that the SEC had found “violations of law or material compliance failures” in more than half the firms examined. Let’s not put too fine a point on this: The SEC said that most firms were stealing from investors, either by accident or design. Bowden confirmed that view, later telling the New York Times’ Gretchen Morgenson that “investors’ pockets are being picked.”

But after this unusually tough and detailed talk, the SEC went into retreat. Reports from speeches and statements by Bowden at private equity conferences and in interviews showed him making conciliatory remarks that were disturbingly inconsistent with the level and range of wrongdoing his unit had unearthed. The disparity was so striking that it went well beyond a walkback; we called it a coverup last September, and an example of enforcement cowardice in October. The agency appeared to be hoping, unrealistically, that if it merely told investors that there was gambling in Casablanca, that they’d shut it down on their own. This position looked naive given that Bowden himself had pointed out, in May, that the agreements between investors (the “limited partners”) and the private equity firms (the “general partners”) were vague on many critical points, which gave the general partners far too much latitude for misconduct. If the limited partners were willing and able to stop these abuses, they would have done so long ago.

One possible explanation of this striking reversal could be that private equity kingpins, who are often substantial political donors, told Congresscritters to call the SEC dogs off. Remember that the SEC is the lone financial regulator whose budget comes from Congressional appropriations, as opposed to fees and fines. Congressmen have not hesitated to threaten the SEC with budget cuts when they’ve deemed it to be stepping on important donors’ toes.

However, the reason for the apparent retreat appears to be far more troubling. Bowden’s previous appearances have been industry conferences, not open to the public, and not recorded. But an event earlier this month was taped, and the picture that emerges is disturbing.

At a minimum, Bowden reveals himself to be captured to an embarrassing degree. His remarks about the industry aren’t merely fawning; a former Goldman staffer called them “fellating.” Even worse, Bowden comes uncomfortably close to the line of offering to play the revolving door game at an unheard-of level of crassness, putting his son, and by implication himself, into the job market at an industry conference.

Bowden, along with Erin Schneider of the SEC’s enforcement staff in its San Francisco office, senior private equity investment professionals Sarah Corr from CalPERS and Margot Wirth of CalSTRS, and John Monsky, general counsel of private equity firm Oak Hill, appeared on March 5 at a conference at Stanford Law School, Emerging Regulatory Issues in Private Equity, Venture Capital, & Capital Formation in Silicon Valley. In a sign of undue chumminess, the moderator, former SEC commissioner and Stanford law professor Joseph Grundfest, didn’t see fit to disclose that he is a board member of KKR.

If you watch the entire segment, you’ll see that much of it surrounds who is and is not subject to SEC registration (venture capital firms are generally exempt, while private equity “buyout” firms with over $100 million in assets are subject), how the regulators try to judge intent and severity of misconduct (with the caveat that really poor processes for protecting investors can be as bad as malfeasance), how limited partners try but too often fail to get the information they’d like, and how the SEC allegedly has enforcement actions in the pipeline.

But the revealing part came in response to the final query in the Q&A section.

You can view the question and all of the responses here, or skip to 1:51:20 of the video of the full conference.* Here’s the transcript:

Questioner: It seems that one of maybe the unintended consequences of the new regulatory regime seems to be that it favors the scale economies of a large fund versus a smaller fund because of the fixed cost of compliance. Also, because there’s with the transaction fee offsets, there’s kind of less money there for the smaller funds to afford groups like operating partners and people like that. And it would seem that one of the consequences could be you will find over time less innovation, less creation of smaller GPs to the favor of the larger GPs because the economics because the economics of the industry because of all these fixed costs and changes in transactions are favoring the larger GPs. I’m interested from an LP perspective how you view that.

As as aside, it’s hard to have much sympathy with this “compliance costs money” complaint. Any long-only asset manager with $150 million in assets under management faces similar compliance obligations, yet has a vastly less rich fee structure than private equity. Moreover, it’s true across the entire asset management industry, and not just in private equity, that there are very large returns to scale at the individual fund level. So even though the question was not directed at him, Bowden was correct to interject and take issue with what amounts to whining about profits. But look at how he makes that response:

Bowden: Let me throw my two cents in, which is this is something I ran into for like 25 years in the industry. So when I was in the industry and I’d be on panels like this, a lot of the older people would talk about growing regulation, ’cause it has increased, right, over the last couple of decades, I don’t think there’s any two ways about it, and they’d sort of lament and say, I have money to get out of the business, there’s too much regulation, it’s not worth it any more.

And even when I was in the industry, I’d always look at them and say, like, “What are you talking about? This is the greatest business you could possibly be in. You’re helping your clients.”

I think if you look at McKinsey studies, the average asset manager, I’m not even talking about private equity, the average asset manager has margins of 25 or 30 percent. Like what, who else out there is in a business that’s that good? And I reckon, it’s sort of interesting for me for private equity in terms of all we’ve seen, and what we have seen, where we have seen some misconduct and things like that, ’cause I always think like, to my simple mind, that the people in private equity, they’re the greatest, they’re actually adding value to their clients, they’re getting paid really really well, you know, if I was in that position, the one thing I would think to myself as I skipped to work was like just “Let’s not mess it up. You know, this is the greatest thing there, I’m helping people, I’m doing OK myself.”

And so my view on the small ones is, I still think this is one of… I tell my son, I have a teenaged son, I tell him, “Cole, you want to be in private equity. That’s where to go, that’s a great business, that’s a really good business. That’ll be good for you.”

So for me personally, as we share our opinions…

Questioner [interrupting]: I’d love to hire your son, by the way. That’s a deal.

This is disturbing on multiple levels. First, even though Bowden and industry loyalists will depict this response as a successful attempt at levity at the end of a dry panel, Bowden’s tone and his word choice say a lot more is at work. There’s a nose-against-the-toy-store window quality to his awe of private equity industry profitability. The words come tumbling out of his mouth, with Bowden at points not even finishing a thought before he rushes off to the next. He can barely contain his enthusiasm and admiration. Rest assured that this is not his normal speaking style; see his measured, composed discussion of conflicts of interest at 1:24:20 by way of contrast.

I’d be put off by this level of gushiness in a prospective service provider, like an attorney or an accountant. It’s cringe-making coming from a regulator.

And remember, unlike banking, where all the regulators are prudential regulators, and thus actually do have to worry whether regulatory costs and burdens hit industry profits too much (which, over time, can hurt capital levels and thus put institutions at risk), the SEC has no such conflicts in its mandate. The SEC is tasked strictly with protecting investors and the integrity of markets. For instance, when it regulates broker-dealers, it cares about whether the firms’ customers are at risk of losing money, and not about lender or shareholder exposures. So while it might be politic to take the position that the SEC is not out to get the firms it regulates, it has no business acting as if it were a booster.

But even worse is the way, in what was the closing remark for this panel, that Bowden effectively dismisses the work his exam group has done. The abuses, which include what amounts to embezzlement, are “some misconduct” by an industry that Bowden repeatedly depicts as “the greatest.” This is a textbook example of what I’ve called the “big producer syndrome,” when a high-performing individual or unit is given undue latitude and misconduct goes undetected or is ignored. This is precisely the sort of thing that regulation is meant to stop. Yet Bowden is presenting, unabashedly, precisely the “nothing that terrible can be happening if the results look so good” mindset that allows bad behavior to grow into organizational cancer.

Moreover, Bowden’s belief in the industry’s “adding value” and “helping people” is based on having taken a very big swill of industry Kool-Aid. He twice parrots the position that private equity firms are a boon to their clients and the economy overall. He might want to make more study of the industry, or even reread his speech from last May, before acting as a PR agent.

The most extensive, careful study of the private equity industry, Eileen Appelbaum’s and Rosemary Batt’s Private Equity at Work, based on a bending-over-backwards-to-be-fair reading of academic research and numerous case studies, finds pervasive problems with the private equity model, the biggest being that it extracts from creditors, taxpayers, pension funds and employees. Their book also, contrary to Bowden, cites considerable academic evidence that private equity does not deliver returns adequate to cover for its risks. That’s before you get to the fact that it uses a valuation method, IRR, which is widely criticized as unduly flattering.

Appelbaum’s and Batt’s reservations were confirmed by CalPERS’ panelist Sarah Corr earlier in the Q&A, who pointed out that CalPERS has cut its allocation to private equity. That is apparently the result of private equity failing to meet CalPERS’ benchmarks over the last one, three, five, and ten year periods. If CalPERS, which can negotiate the best terms and has better deal access to funds than anyone, can’t get great results out of private equity, how can other investors expect to do better?

But the icing on the cake was the overly-eager, overly-long discussion of how Bowden really wants his son Cole to work in private equity. Even though Bowden can brush his remarks off as a joke, there are some words you just can’t unsay. As a Congressional staffer who looked at the segment put it, “It looks like he’s soliciting a bribe.” And the private equity questioner, in the same bantering-but-maybe-not manner, seized immediately on the opportunity to do a favor for an influential regulator.

Bowden’s most attractive career option, assuming he does not move into a more senior role at the SEC first, would be to join a private equity firm as a chief compliance officer. The fact that Bowden made such an unabashed statement of his real loyalties, to his future meal tickets, is a strong and troubling sign that this sort of cozying up is a non-issue at Mary Jo White’s SEC. Bowden was hired during her tenure and presumably reflects her priorities. Recall that White is trying, with mixed success, to make a good appearance while doing as little as possible to rock the boat of powerful incumbents.

Zephyr Teachout, in her celebrated book on corruption, depicted it as public officials putting private interest over the general good. Bowden, who clearly sees himself as an upstanding person, is nevertheless a textbook case by virtue of how deeply captured he is, and his refusal to scrutinize the comfortable, career-advancing assumptions that have worked so well for him.

* Update 3/19/15, 1:30 PM: We learned that Stanford Law School has made the full conference video on YouTube private, effectively taking it down. Our Richard Smith, based on his considerable experience with scammers removing incriminating evidence from the Internet, had already had the presence of mind to download the entire presentation. NC has restored the full conference video to YouTube here and has a clip of the segment with context of Bowden’s troubling remarks (the question and the responses that preceded his) here.

As we wrote:

One has to wonder: what sort of academic institution hides the record of a session, initially open to the public, posted on the Internet, only after it is seen to show a public official stepping well outside the bounds of proper conduct?

We also encouraged Stanford alumni to call the dean of the university and law school and demand an explanation for this conduct. We hope you’ll join in our effort to promote transparency in this powerful, furtive industry.

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  1. theinhibitor

    Stopped listening when Bowden mentioned that private equity is the “…best business to be in because you help clients make money”. Also cause he sounds high. Must be that Nor Cal og….

  2. JohnnyGL

    Wow, that’s a ridiculous video clip. It’s like we’re watching the revolver door actually spin right in front of us.

  3. Llewelyn Moss

    Let’s hope his son becomes a Dirty F**king Hippie rather than a private equity manager — and that drives Bowden into the loony bin.
    Still waiting for someone to go to jail for collapsing the economy (and subsequent looting of the taxpayers to save their corrupt azzes).

  4. MichaelC

    Not to put too fine a point on it, but Bowden is part of the regulatory vanguard assessing risks and rulemaking over a previously unregulated corner of financial markets. Not a very promising start for investors hoping for some regulatory protection.

    And that corner is preparing to go downmarket to retail investors (Yikes!) in size, and soon,

    The challenge for the private equity industry is to find a way to bundle much smaller capital commitments from individual investors so that PE funds can accept them.

    Carlyle, KKR and Blackstone are at the forefront in developing new financial products that will facilitate investment in PE by individuals. Blackstone has launched a new fund, managed by an affiliate called Blackstone Total Alternatives Solution Advisors, to attract investments by wealthy individuals. These investors can put up as little as $250,000 and the fund is then able to make multi-million dollar investments in alternatives like private equity and real estate where Blackstone has a large presence. For the moment these new financial products are aimed at individuals with a net worth of $5 million or more. But if this type of retail fund raising is to expand, it will need to reach the much larger pool of people whose tax-sheltered retirement savings qualify them as accredited investors.

    About 8.5 million people meet the current criteria to be an accredited investor: they have a net worth, alone or with a spouse, greater than $1 million excluding the value of their home or an annual income of $200,000 ($300,000 with a spouse) — thresholds set in 1982 and not adjusted since for inflation. Many professionals as well as airline pilots, police and fire department officials, and others not normally thought of as wealthy have retirement savings — especially in two-earner families — that meet this net worth criterion.

    The Securities and Exchange Commission (SEC) is charged with establishing the accredited investor definition, and is currently considering whether to revise it. The agency has a responsibility to act to prevent a situation in which financially less sophisticated individuals are tempted to respond to solicitations from PE firms and undertake risky investments with their retirement nest eggs. In 2011 the accredited investor definition was changed to exclude a person’s home from the calculation of net worth so that individuals cannot bet their house on a risky investment. Now it’s time for the SEC to exclude tax-advantaged retirement savings from the calculation.

    Those extraordinary 25-30% returns Bowden gushes about pretty much prove his earlier findings that there are some pretty egregious violations of investor protections occurring in that space.

    Those practices are heading for your IRA if the Bowden’s behavior is emblematic of the SEC’s intent to (not really) regulate or offer investor protections from private equity machinations.

    1. Lambert Strether

      “Carlyle, KKR and Blackstone are at the forefront in developing new financial products that will facilitate investment in PE by individuals.”

      That’s obviously how we should “fix” Social Security.

  5. Ed Walker

    The failures of the SEC are spectacular. They didn’t investigate the largest fraud in history, they don’t impose serious penalties on repeated lawbreakers, they show up at these meetings where they pal around with the people they are supposed to regulate, and they never work for anyone but themselves. Shameful.

    Time to clean house.

  6. steelhead23

    Actually, the part of this whole ugly story where we could make a difference is first stop on the quid pro quo gravy train – the use of threats to the agency budget to achieve acquiescence. I want to know who is doing this. I want it to be a campaign issue for them to deal with. In no way do I wish to exonerate Mr. Bowden, but if Mary Jo told him that his investigation was rankling feathers on the Hill, mentioning that the agency budget was being targeted, Bowden would likely respond in the manner displayed in that video. Two things happen to an individual when such political interference occurs – they’re team players, big dogs, and they don’t want to let the agency down – and they become disenchanted with the agency mission. So what the hell, if he is to be a prostitute, he might as well be high paid. Yeah, I think I would enjoy Teachout’s book. My point is that most of us are corruptible – the public needs to be active in limiting the opportunities for public agency corruption.

  7. The Insider

    I actually know Drew – not very well, but well enough to know that you’ve got this wrong.

    In my experience, Drew is sincere in his efforts to regulate the industry. He’s genuinely proud of how he’s highlighted abuse of fees in the private equity industry, and makes a point of it at every opportunity. For him, it’s his biggest accomplishment since joining the SEC.

    He’s not angling for a job here. He could get one in the industry any time he wanted – he already worked as counsel at a large financial institution, he has a perfect resume for a position at any financial firm of any size and doesn’t have to make stupid jokes someone hiring his son to get someone to consider his application.

    I saw the account of this meeting, and it’s classic Drew: off-the-cuff remarks with a little humor thrown in to try and build a rapport with the audience. I don’t think he seriously intended anything by it – but it does reveal something, and there is a problem here.

    The problem isn’t that he’s trying to get on the good side of the industry because he’s hoping for a job – the problem is that he’s trying to get on the good side of the industry. Drew, like pretty much all of us, wants people to like him. That’s a perfectly natural feeling, but it’s not at all an appropriate mindset for a regulator.

    I am reminded of some timeless words which regulators would do well to keep in mind:

    ” . . . love is preserved by the link of obligation which, owing to the baseness of men, is broken at every opportunity for their advantage; but fear preserves you by a dread of punishment which never fails.”

    Again, I don’t think this is evidence that Drew is looking for a job. But I think it is evidence that he is more beholden to the industry’s opinion than he should be – very likely for its own sake, which is as problematic as for any other reason.

    That relates directly to the larger issues in the private equity industry. Every time he brings up the issue with fees in private equity, Drew emphasizes all the changes that have occurred in the industry since he very publicly raised the issue, and the role the agency has played in helping them see the error of their ways and make corrections. In his mind, that’s the accomplishment.

    But that’s not the job of the regulator. It’s actually the responsibility of the industry to decide to mend its ways and figure out with its lawyers and consultants how to get on the right side of the law. The job of the regulator is not to convince the industry to do better going forward – the job of the regulator is to identify misconduct and see that it is punished. The regulator is a police officer, not a rehab counselor.

    The “rehabilitate, don’t punish” approach toward regulation has only grown in the last few years, and unfortunately, much of that has happened under Drew’s leadership. And there’s a reason it’s an appealing approach: it’s less confrontational. It feels like an “everyone wins” approach, where the regulator can claim successes while the industry promises next time they’ll do better and consultants and lawyers collect their fees and everyone’s happy (except of course for clients, who in most cases are not made whole from past bad behavior). But it’s not justice, and it’s not what the regulator was tasked to do.

    For someone who may be too beholden to the industry’s good favor – again, as much for its own sake as for any other reason – the rehabilitation approach is deeply appealing, because it avoids the nasty public battles that unfold in courtrooms as defense attorneys rant about overreach and regulators gone wild, and reduces the level of confrontation at industry conferences and even private events (and don’t underestimate how much of an impact private social settings can have on public decision-making).

    I don’t think Drew is looking for a job so much as he is looking for people to like him – but unfortunately, that alone has a profound impact on how seriously the regulator is viewed and how effectively it can do its job. I think at some level he is a sensible person, and can only hope that he eventually realizes that he does not need the industry’s approval to do his job, and in fact will be only the more respected the more attention he pays to punishing bad behavior and the less attention he pays to winning the audience over at conferences.

    1. Yves Smith Post author

      Thanks for weighing in. I know we are on the same page generally in terms of our view of Bowden’s strategy, but I have to differ with you on the message he sent in that segment. Whatever his intentions might be, his remarks at the close of that panel completely undermine any credibility he has as a regulator. And whether he is consciously and actively setting up his next move or not, his discussion of his son, even as a supposedly lighthearted illustration, can’t be treated as a casual remark, given his preamble and the audience.

      Everyone I’ve asked about that clip, and I’ve been sure to include people who are sophisticated politically, as well as ones who have considerable senior level experience in the financial services industry, has rated it a 10 on a one to 10 scale of impropriety. Ironically, the only exception is a private equity person (and a relatively upstanding one) who volunteered that this didn’t seem all this bad to him. So the fact that Bowden clearly has no idea how improper his conduct was is another proof of how deeply captured he is.

      Moreover, as we’ve pointed out in our past posts on what we can infer about the SEC’s stance on private equity, this is an industry where it’s a mistake to believe that rehabilitation is the right approach. For instance, one apparently widespread violation is getting discounts for law firm work for the GP entity, but letting the law firm charge the rack rate (or even a premium) to the LPs and the portfolio companies. Now in terms of significance, this is tantamount to cheating on your T&E. Yet most firms will fire an employee if they catch him doing that. The GPs have the best attorneys and they are fiduciaries, and are held to an even higher standard of conduct. The fact that they’ll engage in penny-ante stealing on top of the bigger abuses that are being identified reveals an attitude that they’ll find and exploit ever opportunity there is to fatten their bottom lines at the expense of the LPs. You can’t rehabilitate for that. This is fundamental to the industry. You can only ride herd on it. And having the GPs quit doing some of the most egregious abuses to get the SEC off their back is a strategic concession, and not a sign of a fundamental change in attitude.

      In other words, Bowden looks to be a classic example of the Upton Sinclair saying, “It is difficult to get a man to understand something if his salary depends on his not understanding it.” Bowden’s entire career has been in the asset management industry in some form. He’s fallen for the industry PR that private equity, the most lucrative part of the business, comes by its profits fairly and squarely and even does social good. And he continues to persuade himself of that despite the evidence his own examiners are turing up. This is not virtuous conduct. It’s willful blindness.

    2. Lambert Strether

      Shorter: “Drew” is about as captured as it is possible to be and still retain the self-image of being one of the good guys.

      Adding… And his “sincerity” is one of the bigger problems.

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