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Headaches for Private Equity Funds

The private equity industry has been taking it on the chin.  First, the Dodd-Frank bill imposed a number of new regulatory requirements on the private equity industry, including the requirement that fund managers register with the SEC by March 30, 2012 under the Investment Advisers Act.  Second, the SEC has been focusing a number of enforcement actions on private equity managers, especially in the area of conflicts of interest.  If that has not been hard enough, anti-corruption enforcement agencies are focusing their efforts on the private equity industry.

 In the anti-corruption arena, in 2008, the Justice Department and the SEC warned financial institutions, and private equity and hedge funds to conduct  appropriate due diligence of their foreign customers and partners for potential anti-corruption risks.  DOJ and the SEC meant what they said.  Two years later, the SEC followed up on its warning and issued inquiry letters to at least ten separate financial institutions, and private equity and hedge funds.  The SEC letters included questions concerning interactions with Sovereign Wealth funds, and general anti-corruption compliance policies and procedures.  The inquiry was later expanded to include interactions with foreign public institutional investors.  Notably, the Justice Department was not involved in the issuance of these inquiry letters, in stark contrast to those issued by the Justice Department and the SEC to pharmaceutical and medical device industry. 

 In recent months, the UK’s Serious fraud Office Director Richard Alderman has made a number of statements indicating the SFO’s intention to investigate the practices of private equity funds, particularly with respect to acquisition and operation of portfolio companies.

 The US enforcement agencies mean what they say.  The SEC has initiated an inquiry into Goldman Sachs’ interactions with the Libyan Sovereign Wealth fund.  This inquiry is ongoing.  It is likely that the SEC’s  interest in and access to information concerning the Libyan Sovereign Wealth fund will increase with the toppling of the Ghadaffi  regime.

  Private equity funds are most at risk in their interactions with foreign fund managers and in acquisition of companies.  The risk of buying an FCPA violation in acquiring companies is significant.  Private equity managers are ramping up anti-corruption compliance programs and in particular due diligence screening of potential acquisitions.  A Deloitte survey conducted last year found that 63 percent of the respondents from banks, and private equity and hedge funds had to delay, modify or scrap potential acquisitions because of anti-corruption concerns. 

  The prospect of buying an anti-corruption violation when acquiring a company is real and problematic.  The only real way to minimize risk in this area is to conduct a thorough due diligence of a potential acquisition.  This is difficult when private equity companies are used to acting quickly in the marketplace when buying and selling companies.  The best way to keep the marketplace flowing is to adopt real and meaningful due diligence screening programs, and designing post-acquisition compliance protocols for reducing any real risks.  Due diligence does not guarantee any type of legal immunity but it does give an accurate assessment of risk from a transaction. 

 With so much regulatory and enforcement focus on private equity funds, managers should be reviewing and revising their compliance programs to address these risks.

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