Before you get too excited, our SEC whistleblower filing is a minimalist version of the genre, but we thought it would be instructive to readers nevertheless.
We came across what looks like a slam-dunk securities law violation by sheer happenstance. When we were reading Eileen Appelbaum and Rosemary Batt’s important book, Private Equity at Work, we noticed an in-passing reference to Riverside Partners as an example of a private equity firm whose strategy emphasized making operating improvements in the companies it purchased. As Appelbaum and Batt pointed out, for smaller and mid-sized deals (up to roughly $350 million in transaction value), private equity firms can make a case that they have make a bona fide economic contribution, since companies in that size range that have growth potential often need to professionalize their operations or reach new markets. In theory, the private equity firm can help them fill those gaps via helping provide the needed systems and personnel, or via acquisitions or mergers (note that firms that target bigger deals often make similar claims, but Appelbaum and Batt found their returns depended largely on cost cutting and financial engineering).
On a whim, we decided to look at Riverside’s Form ADV. Investment advisers are required to make this filing as part of their registration process with the SEC and state securities regulators. Part 2 of the filing is a narrative, written in plain English, in which the adviser describes its fee schedule, conflicts of interest, whether it has been the subject of disciplinary action, and other important information. Investment advisers must provide their investors at least annually with an update of material changes to the brochure and deliver or offer to deliver an updated brochure to the client. The SEC’s site provides a link to the most current version of the Form ADV.
As you’ll see in the document we included with our online whistleblower filing, embedded at the end of this post, Riverside’s filing contained the remarkable admission that they were charging “costs” to investors that were not permitted by the limited partnership agreement in their 2014 Form ADV. As we contend, that isn’t in typical grey area of ambiguity that private equity firms like to exploit; it’s a straight-up admission of misconduct.
What is even more troubling is that even though the SEC has been giving warnings about all of the sharp practices it has been finding in private equity, Riverside has a virtually identical admission in its 2015 Form ADV, which was filed at the end of March. That means that Riverside hasn’t halted or changed the practices that it admits are not authorized in its contracts with investors.*
The fact that Riverside hasn’t stopped making impermissible charges, which we view as tantamount to embezzlement, speaks volumes about what it apparently thinks about the vigilance of the SEC and its investors. One has to assume that Riverside’s limited partners either didn’t look at the Form ADV filing at all or gave it such a cursory look that they missed the admission. That is damning in light of Andrew Bowden’s speech last May warning of widespread abuses in how private equity firms charge fees and expenses. The Riverside text at issue is in a section of the Form ADV called “Fees”; you’d think it would have been a must-review item for limited partners after the Bowden speech. This demonstrates how lax investors have been in taking steps to remedy abuses by private equity general partners, even when they have unambiguous evidence of malfeasance.
Needless to say, Riverside’s refusal to stop taking more than it is entitled to take also indicates it isn’t worried about the SEC taking action against them either.
We would also like to point out to the SEC that they seem to have a weird glitch in their online whistleblower submission process. The online questionnaire runs to only a few pages and allows whistleblowers to choose to file anonymously, to submit via an attorney, and also to tell the SEC what might tip the target off about who was making the complaint, if retaliation is a concern. That is all well and good. As part of the questionnaire, the whistleblower tells the SEC who he is, the usual basic stuff like name and contact information. When you try submitting that page, you get into a loop where the site apparently has the completed profile (it shows your name and whistleblower status and the ability to edit your information) but if you try going to the next page, the declaration page, it tells you that you need to create a profile. I got this error on a Mac and a colleague on a PC had similar problems, in that he also found the site asked him to submit a profile after he had already completed that page. We both found that resubmitting the page worked, but it was nevertheless frustrating and concern-making.
Since I am a Form ADV novice, but have looked at a few limited partnership agreements, in which the general partners go to considerable lengths to give themselves wriggle room for questionable practice, I’d hazard that admissions like those of Riverside are unusual. But the fact that there is even one instance of a decent-sized, established firm that it is open about its sharp practices, strongly suggests that Riverside is confident that nothing much will come of the SEC’s efforts to crack down on the industry. And given the way that Andrew Bowden walked back his stern words over the course of the summer and fall, it appears that Riverside’s conclusion is well founded.
* Note that even if Riverside had decided to stop its apparently verboten conduct after the SEC made clear it took a dim view of it, that would not remedy its past violations.