Ex-SEC lawyer at Kirkland & Ellis sees regulatory pressure on GPs

Aaron Schlaphoff, who recently joined Kirkland & Ellis as a partner after working at the Securities and Exchange Commission, in an interview with Buyouts flagged compliance issues for GPs around zombie funds, accelerated monitoring fees and other potential sticking points.

Prior to joining the Chicago-based firm’s private-funds group in its New York office on March 7, Schlaphoff had been at the SEC for two years, during a time of increased focus on private equity.  His comments reflect his own opinions, not any official stand by the agency, he said.

“The private-equity industry sometimes feels like every six months there’s a big, new topic that the SEC highlights through a major enforcement action around it,” Schlaphoff said.

“From the SEC’s perspective, they think, ‘Look, we told you we were interested in conflicts of interest and fees and expenses and we think this enforcement action reflects what people should have known all along.’ The industry says, ‘True, but that’s a really big universe of issues and the reality is more complicated.’ The truth is probably somewhere in the middle.”

At the SEC, Schlaphoff contributed to its regulation of investment advisers and pooled investment vehicles, including private funds, mutual funds and exchange-traded funds.

He sees plenty of work ahead at K&E, which also hired Norm Champ, former director of the SEC’s Division of Investment Management, in February.

“There’s a lot of activity in private equity right now on the enforcement and compliance side, and that has placed a huge amount of pressure on managers,” Schlaphoff said. “Kirkland has a huge stable of private-equity clients, and I look forward to helping them navigate the regulatory landscape.”

He’ll also be working to help the firm grow its client base to hedge funds, registered funds and other areas, he said.

`Zombie Firms,’ Accelerated Fees

Recent comments from regulators on GPs with aging funds who don’t plan to raise another fund —  so-called zombie firms — suggest the SEC may be anticipating a turn in the economic cycle when older funds wind down and GPs have trouble raising fresh capital, he said.

“It’s hard to see how the SEC could literally force the liquidation of a fund – that’s not really how it plays out,” he said. “But they can certainly step in and put pressure on advisers in a number of ways, for example, by raising questions about whether an adviser is fulfilling its fiduciary duties when it continues taking fees from funds that could be wound down.”

The SEC has been clear about discouraging accelerated monitoring fees, which enable a GP to charge a portfolio company the full term of its contractual charges even if the company gets sold earlier, he said. Blackstone paid a $39 million settlement last year, in part over charges that it didn’t properly disclose accelerated monitoring fees to its fund investors.

The SEC “has said that they think this practice is falling out of favor,” Schlaphoff said. “But it’s more likely that it wasn’t that common of a practice in the first place, and managers are now changing their [SEC Form ADV] disclosure because they want to avoid the implication that they’re actually doing it.”

Overall, the SEC has worked hard to strengthen its knowledge of private equity, he said.

“They’re focusing on data-driven assessments, using the information that they collect on [regulatory disclosures] to help identify risk areas, and bringing in staff from the private-sector ranks,” he said.

“Big picture, in the long run this could help industry and the SEC work together better.”

Prior to the SEC, Schlaphoff was counsel in the New York office of Davis Polk & Wardwell LLP. He started his career at Sullivan & Cromwell LLP.

Action Item: Aaron Schlaphoff can be reached at aaron.schlaphoff@kirkland.com

Photo courtesy of Kirkland & Ellis