Editor’s Letter: SEC targets a fund revamp. Are the floodgates open?

The SEC finally came out with an action against a secondary restructuring deal, something I’ve been waiting for since agency officials started making public noise about these deals years ago.

In 2016, the agency’s co-head of its Private Funds Unit, Igor Rozenblit, said the opacity and complexity of PE-fund restructurings provided cover for a fraud tied to a large GP-led process.

The year before, Rozenblit said the SEC was scrutinizing such deals to ensure limited partners were not being offered two bad options: sell at a discount or reset economics for a GP who may not have performed up to expectations.

The scrutiny had not amounted to actual cases involving secondary deals — until this month. The SEC said middle-market firm VSS and Managing Partner Jeffrey Stevenson failed to inform selling LPs in its third equity fund that the value of the fund in which they were considering selling interests was likely going up. The rising valuation might have caused LPs to hold the assets rather than sell at the potentially lower valuation.

Like the majority of cases the SEC has brought against private equity firms, this one involves disclosure issues.

SEC wants to make sure all information is on the table, that investors understand all the details so they can make informed decisions. The disadvantage that LPs have, perfectly illustrated in the VSS case, is that they don’t have access to the same information as the GP does.

In the VSS case, VSS and Stevenson proceeded to pitch the deal to LPs even as the GP internally debated newly issued financials showing the fund valuation going up.

The firm never issued first-quarter financials or a reason for its delay to the 15 remaining LPs in Fund III, as it was required to do by the LPA, the SEC order showed.

In fact, first-quarter 2015 financials were never finalized and VSS never sent the financials to any Fund III investor, the SEC said.

Secondaries where the GP is the buyer come with an added layer of potential conflict issues, sources said.

“There’s nothing inherently wrong about a GP being involved in a secondary … the most important thing … is to identify those conflicts and have proper disclosure to the participants in those deals,” one person told me.

The SEC censured VSS; and the firm and Stevenson agreed to pay a civil penalty of $200,000. The firm and Stevenson did not admit or deny wrongdoing.

The agency is also on the lookout to make sure such deals are not coercive to existing LPs in that remaining status quo is the better option than alternatives being offered by the GP.

And the SEC also is scrutinizing expenses related to such deals and how they’re disclosed, sources said.

The SEC is looking for “very clear disclosure to investors about the various elements of expense incurred in deal like this and how those are being borne,” sources said.