The SEC has increased its scrutiny of the private equity industry over concern that some private equity funds might overstate the value of their portfolios to attract investors for future funds. The industry historically has received minimal attention from federal lawmakers, in part because private equity clients–typically pension funds and the investment arms of foreign governments–are considered to be more sophisticated than average investors. The inquiry is also a result of the attention brought to the industry by the presidential campaign of Mitt Romney, who earned his fortune running Bain Capital, one of the world’s largest private equity firms.
The industry also drew heightened interest during the buyout boom of the last decade, as firms backed by loans from flush banks acquired major American companies. The favorable tax treatment that private equity executives receive on a large portion of their compensation came under attack. In addition, the Justice Department began investigating whether the world’s largest private equity firms colluded to drive down the prices of acquisitions that they teamed up on.
Under the Dodd-Frank financial reform law, most private equity firms must register with the SEC by the end of March 2012. The SEC already oversees many firms. The industry is large, with several thousand firms and more than $1 trillion in assets under management.
Industry critics argue that private equity’s core investment strategy–taking on large amounts of debt to buy companies–too often results in bankruptcies and job losses. Private equity officials counter that their acquisitions drive economic growth and make companies more competitive. They also note that they deliver superior investment returns to clients.
The SEC’s inquiry is focusing on more narrow issues such as firms’ fee structures and how they value investments. Valuation involves varying, complex methodologies that often involve subjective judgments. Because there are no easily ascertainable market prices for private companies, valuation can be a risk factor. Funds argue that they are rigorous in the valuation processes. Many use independent financial advisory firms that specialize in portfolio valuation.
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