Americans for Financial Reform Calls Out Private Equity Broker-Dealer Abuses as Latest Example of SEC’s Weak, Selective Enforcement

It’s gratifying to see that more and more organizations are recognizing the need to make private equity adhere to long-established regulations, their own disclosures, and widely-accepted norms in investment management, such as acting as a fiduciary. The latest example, a letter by Americans for Financial Reform, urging the SEC to take action on long-standing broker-deealer abuses by private equity firm. This document, which we’ve embedded at the end of this post, points out that even though the investors in private equity are typically major institutional investors like public pension funds, these monies are being deployed on behalf of large numbers of individuals of modest means, so this is clearly a matter of public interest.

We’ve written about the peculiar failure of the SEC to target private equity firms for acting as unregistered broker-dealers. The agency finally roused itself in June and fined a tiny firm, Blackstreet Capital Management. Given how selective the agency’s private equity enforcement actions have been, despite senior officials saying they found serious misconduct at half the firms included in its first round of exams, it’s likely that the SEC simply putting the industry on notice. In fact, as the AFR argues, this approach is inadequate in light of other private equity abuses that it describes in considerable. In other words, this is the last group that deserves “Trust me” treatment.

As we wrote in 2013:

The violations result from the long-established practice of PE firms charging “transaction fees” to investors in their funds when the PE firms, as managers of various funds, buy and sell of portfolio companies. They also levy transaction fees when portfolio companies issue debt or equity securities. Bear in mind that these fees are not in lieu of fees paid to investment bankers and brokers; they are additional charges, on top of both those third party fees and the private equity firm’s management fee, the famed “2 and 20” (2% annual management fee, 20% of the gains, although the management fee is lower for the very large funds). And these transaction fees are typically comparable in size to the fees paid to investment bankers.

This controversial practice has been going on for decades, and it is no secret. The PE firms collectively have reaped billions of dollars through this ruse. Dozens, if not hundreds, of articles have been written about it. Typically, these stories depict these transaction fees as an abuse of both the portfolio companies and the private equity fund investors, since portfolio company revenues are diverted into the pockets of private equity managers. For instance, a account about the whistleblower published last week by the usually pro-industry CNBC, where the headline itself described transaction fees as “private equity’s ‘crack cocaine.’

But as scandalous as this ongoing looting ought to be, the whistleblower focuses on another glaring problem with the private equity firm transaction fees: the private equity firms are not registered broker-dealers.

Anyone who has been in the securities industry will know how big a deal being a broker-dealer is. Even as a small firm consultant, I’d take care with how my engagements were defined so that there was no way they’d be considered to be securities dealing and hence oblige me to register my firm as a broker-dealer. Being a broker-dealer involves not just registering with the SEC but complying with a long list of requirements to make sure you are dealing with customers fairly, including:

Becoming a member of a self-regulatory organization (usually FINRA)

Training and licensing principals and staff

Obeying state securities laws

Being subject to SEC inspections and disciplinary actions

Complying with customer protection and commission disclosure rules, recordkeeping, financial reporting requirements, and Treasury anti-money laundering requirements

See this Davis Polk discussion for more detail….

Recent SEC enforcement actions show that, in other contexts, the SEC views it as a grave infraction to not pay broker-dealer fees to the broker-dealer unit of a business. Just last Friday, the SEC fined Credit Suisse $196 million for, among other things, unsupervised broker-dealer activities in the U.S. The SEC did not claim that Credit Suisse had no registered broker-dealer unit in the U.S. — the firm has had one for decades. Rather, the SEC based the fine on the fact that Credit Suisse was diverting revenues that should have been credited to the registered broker-dealer unit in order to keep those revenues from being properly regulated.

The AFR letter is short and well-argued; I urge to to read it in full.

It would also be of great help to press key Representatives and Senators. If your Senator or Representative is on one of the Congressional committees overseeing the SEC (the Senate Committee on Banking, Housing and Urban Affairs or the House Financial Services Committee), please drop them a short e-mail linking with the AFT letter attached or a link to this article.

Say that you are glad to see the SEC finally engage in long-overdue enforcement by fining unregistered broker-dealers in private equity, but there are much bigger firms engaged in precisely the same conduct. The SEC’s track record of highly selective enforcement suggest the agency will let them off the hook.

Republicans are generally unsympathetic for calls for the SEC to do more. You might point out that this sort non-enforcement is a classic example of the sort of rigged system that has led small business owners to overwhelmingly support Trump. Retail brokers are required to hold securities licenses and comply with the SEC requirements because one of the lessons of the Great Crash was that it took over two decades for investors to regain trust in the stock market after the abuses of the Roaring Twenties. It’s galling for these law-abiding businessmen to see much richer private equity barons thumb their noses at the law.

The time is long overdue for making private equity play by the same rules as everyone else. Tell them you expect them to push the SEC to enforce the law.

Thanks again for your help!


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  1. TC

    As a Registered Investment Advisory Representative (Series 65) and a Registered Rep (Series 7) as well as a licensed Insurance and Annuity agent, I find it galling and offensive that I pay literally thousands of dollars in fees and many hours in compliance testing (which I personally pay for) and administrative duties such as auditing of my office and computers, while these PE firms are skirting the laws and making millions upon millions in trading private companies stocks, loans, bonds, and other financial instruments, which should be regulated at both state and federal levels. Thank You AFR and thank you Yves Smith and Naked Capitalism.

    The SEC, FINRA, and other agencies should pay close attention to this letter, as well should our elected representatives. This is how our markets get manipulated, crash and burn- when assets get dislocated, dis-liquefied, and end up in mal-investment vehicles like Air-BnB, Uber, etc, because so-called “sophisticated investors” (accredited/qualified) can be a totally ignorant person with an initially high net worth, and yet subsequently be sold an investment in a private equity that drains them in one fell swoop. Furthermore, they could be investing in a public company with a Business Dev. Corp structure and lose it as well, without being classified as a natural person qualified/accedited investor thanks to lax rules on some public entities which act in practice as a PE firm.

  2. Scrooge McDuck

    Yves makes a great point on why so many Americans support Trump, and while I am not a Trump supporter, I do understand some of their frustrations. In particular I understand their frustrations with elites, such as lawyers, accountants, politicians, regulators, eye., who over the years have lost their moral compass or have put their own personal enrichment ahead of their upholding what is legally and morally right. This is exactly what has happened at the SEC, an institution that can no longer even enforce its own laws, and whose employees are terrified to upset their future bosses. The little guy is tired and the Trump movement is a direct revolt against the elites and yuppies that Clinton represents.

    1. sunny129


      The system is RIGGED and the SEC (DOJ ++) is a part of that system!

      The little guy is NOT just tired but mad like hell!

      1. sunny129

        Very naive for a CIA agent to think that just ‘listening’ is a panacea for the outrage going on. Sorry.

        People in power with a remote button doing their thing at a flick of a second, listening is NOT in their agenda.

        It just doesn’t suit the vested interests and the 0.01% (400 rich people in USA have more wealth of bottom 50%, 62 rich-billionaires have more than bottom 50% of the global population).

        When folks have no hope, no future and NOTHING to lose, they act in desperation and irrationally.

        STRESS is a reality for only those in touch with it

  3. polecat

    the SEC…after considering the positive arguments made by the AFR, will do………..

    jack shit !

  4. RUKidding

    Thanks for the info. Always good to see someone taking on the Sisyphean task of attempt to push the SEC to do it’s damn job. Gah. I won’t hold my breath.

    Great post. I cannot stand Trump – he’s a phony-baloney Con Man. Sad that so many citizens are gulled into believing that somehow he’s “different” from all the rest and will “help” them or be on their side. Hardly.

    I get the disgust with the political establishment, including the SEC. I, myself, dislike Clinton intensely. But somehow believing that Trump’s gonna save us? Well I’ll be polite and say: highly unlikely.

    Yeah, I’m as disgusted as anyone out there. Duly noted that Warren EFFEN Buffet has endorsed Clinton and suggests that Jamie EFFEN Dimon should be Treasury Secretary (or something like that). EGAD. Yeah, Warren: let’s just put the damn fox in the damn hen house and make it easier for him to loot, pillage and plunder.

    But vote for Trump? No thanks. Simply a bridge too far. Sigh. We’re so screwed.

    Keep pushing those boulders, however.

    1. Isotope_C14

      You can always vote Jill Stein or Gary Johnson. Help the greens get 5% or Johnson in the debates (which would be hilarious)…

    2. sunny129

      ‘Trump – he’s a phony-baloney Con Man’

      Which of the politicians out there ( past & present with a very few exceptions) is NOT a CON wo/man? They all are the CON man of one kind or the other.

      The whole system is rigged from top to bottom. Hilabama will perpetuate it. No question, Trump is a con man, but who else out there. who has decided to stand against the system and challenge it. Little guy sees this is the only chance s/he has to make his/her chance to ‘strike’ at the system for his/her helpless condition.

      Desperation is expressed in many outrageous actions. BREXIT was one of them!

  5. flora

    “…It’s galling for these law-abiding businessmen to see much richer private equity barons thumb their noses at the law.”

    Yes. Glad to see AFR’s letter. Thanks for your continued reporting on PE abuses.

  6. steelhead23

    OT. A bit of fuel for your flamethrower. Democracy Now presented a discussion of how PE is buying out emergency services (ambulance, fire fighting) and creating high costs for poor service when they do. The stories told by the author were frightening. Seems that PE might be feeling a bit of heat.

    1. Yves Smith Post author

      We wrote up the underlying NYT story, which we depicted as weak given how much the paper had clearly invested in it and its failure to draw any conclusions. We got a lot of positive e-mails from reporters and experts who felt the same way. But I gather the Democracy Now piece reflected the weakness of the original. See this reader comment:

      David Green
      August 3, 2016 at 11:42 pm
      The NYT series inspired this story on Democracy Now!, which I also found strangely vague and inadequate about what PE really is.

      Thanks for letting me know.

  7. TheCatSaid

    Thanks Yves for making it easier for us to take constructive action. I need that extra encouragement–seeing what legislation is coming up, understanding the implications, who to contact if I want to act on it, and some key points.

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