Why is the SEC Not Enforcing Federal Regulations over State Regulators to Protect Investors in Private Equity Funds?

Market Commentary
by James M. Johnson

The SEC’s Division of Enforcement shockingly brought a complaint in March 2022 against Laurence Allen, Managing Principal with ACP X, LP, a top performing private equity fund of which I am an investor and serve on the Fund’s Limited Partners Advisory Committee. 

It appears the SEC is attempting to pile on to a New York state court decision, that in the opinion of a December 2022 independent investigation report by Greenberg Traurig commissioned by investors in the fund, ignored the contractual provisions of the fund. Further, the report concluded that the state court decision was based on a misguided investigation by New York Attorney General Tish James, that lacked a fundamental understanding of how private equity funds operate. 

In this case, the core issue is whether ACP X, LP, a Delaware limited partnership, had the authority to make private investments in affiliates, a contractual provision in the fund’s operating agreement to which I relied upon as an investor in this fund. 

For reference, in February 2003, the SEC issued a Notice entitled “Transactions of Investment Companies with Portfolio and Sub-Advisor Affiliates, which formally reiterated that investment advisors (such as ACP) were authorized to make investments in affiliates. Numerous attorneys in the United States have relied upon this SEC Notice, when advising private equity fund clients.   

However, in 2020, a year in which NY AG Tish James attempted to run for election to be Governor of New York, she brought a complaint against the fund’s managing principal and issued several damaging press releases, outrageously calling this practice “self-dealing” under the nonsensical NY Martin Act, which for years has been a blunt instrument of the NY AG, widely criticized as unjust, authorizing penalties that are unfair and arbitrary, and giving prosecutors a significant advantage over defendants – as it does not require intent to defraud. 

I am extremely disappointed that the SEC has refused to enforce its own federal regulations over a state regulator and state court – each of whom appear to lack sufficient knowledge as to how private equity funds operate. As a sophisticated investor in private equity funds, I have relied on the protections provided to me under SEC federal regulations, Delaware law and its courts – none of which have been applied here by the State of New York. 

As a result, I believe the NY AG and the NY state court system have significantly damaged investors in this fund for reasons which include – their restriction of our accounts and preventing distributions to investors in ACP X, LP for over 4 years since December 2018. Why? Thank goodness depositors in SVB Bank, First Republic Bank and Signature Bank could depend on a federal regulator, the FDIC, and federal regulations – to access their accounts within just a few business days.   

What is also baffling, and another indicator of possible SEC abuse of its prosecutorial powers, is that is that in 2021, the SEC’s Boston office concluded its investigation of ACP X, LP and Mr. Allen, issuing a close out letter stating – we do not intend to recommend an enforcement action. Therefore, I do not understand why the SEC Division of Enforcement in Washington DC would proceed to issue a complaint and issue press releases – which have significantly damaged the fine reputation of this fund, its managers and my investment. 

Could the SEC’s rationale in this case be to show the House Financial Services Committee and the Senate Finance Committee that the SEC appears to be protecting investors? If that is the case, I want to emphatically state – that the SEC is not protecting my fellow investors or I in this fund, but rather has significantly damaged us – as it prolongs and complicates this dispute.     

Speaking on behalf of the Limited Partners Advisory Committee, which I believe represents the views of the majority of 76 investors in ACP X, LP, we recommend that the House Financial Services Committee and the Senate Finance Committee commence an investigation into SEC prosecutorial practices and ask (a) how exactly is the SEC protecting investors in ACP X, LP, a private investment (whereas the SEC’s mandate is to protect investors in “public securities”), and (b) why is the SEC attempting to pile on to a New York state court decision that appears to be politically motivated and based on lower standards than federal regulatory standards? 

Lastly, to emphasize the absurdity of this situation that our investors have been subjected to by both state and federal regulators, if Warren Buffett and Berkshire Hathaway decided to make a follow-on investment in the Nebraska Furniture Mart, of which it controls, that would be an “investment in an affiliate”, which is permitted under SEC federal regulations. However, this same investment could be called “self-dealing” under the NY Martin Act, and a NY state court could agree – that Mr. Buffett committed “securities fraud”. Thereafter, the SEC could pile on to this hypothetical New York state court decision, with its own SEC complaint. This analogy describes what investors in ACP X, LP have been subjected to by political state regulators and lazy federal regulators not doing their jobs.   

It is well past the time, that the House and Senate finance committees stop this insanity and hold the SEC and FINRA accountable for their prosecutorial practices and discourage the issuance of self-serving press releases that only damage investors – that our federal regulators are supposed to be protecting. 

James M. Johnson is an investor in private equity funds and Member of the Limited Partners Advisory Committee in ACP X, LP. Formerly, a portfolio manager with an asset management company.