In 2017, Donald Trump appointed private-equity lawyer Jay Clayton as the chairman of the Securities and Exchange Commission (SEC), one of the agencies that is responsible for policing the financial industry. Soon after getting the job — and only a few years after the SEC fined major private equity firms for bilking investors — Clayton was pushing to change federal law to let asset managers funnel more money from retirees to those high-risk, high-fee firms.
Clayton finally got his way last week when the Trump administration issued a letter letting 401(k) plans move the savings of 100 million workers and retirees to private equity billionaires, some of whom have been among big donors to Donald Trump’s political machine. Clayton publicly celebrated the change, insisting it “will provide our long-term Main Street investors with a choice of professionally managed funds” that would benefit workers and retirees.
But in a stunning move yesterday, Clayton’s law enforcement agency effectively blew the whistle on its own chairman, issuing a scathing report documenting a private equity crime spree that is fleecing pension funds, university endowments, and other investors.
The timing of the alarm is particularly important. The SEC’s report reads like career regulators’ last-ditch plea for help at the very moment they see private equity billionaires on the verge of creating a lawless autonomous zone for themselves.
In a little-noticed ruling last week, the Supreme Court restricted the SEC’s power to punish private equity firms. With the agency successfully neutered, Trump is now trying to move Clayton into the job of US Attorney, overseeing Wall Street.
If his nomination is confirmed by the Senate, Clayton would be positioned to defang the prosecutors who are the last line of law-enforcement defense against the very private equity wrongdoing that SEC regulators are now frantically trying to blow the whistle on.
“Expenses That Were Not Permitted”
Private equity firms are notorious for looting companies and torching the environment, while charging investors huge fees in exchange for middling returns.
In 2014, a top SEC official warned that there were “violations of law or material weaknesses in controls” in more than half of the private equity firms the agency had examined. The SEC’s new Risk Alert expands on that discovery, summarizing findings from hundreds of the agency’s examinations of private equity firms. It reads like a scathing rap sheet documenting a culture of abuse, misconduct, and theft — and it obliterates Clayton’s recent claims that the investments are good for workers and retirees.
For example: amid recent headlines about the private equity industry charging investors $230 billion in fees, one section of the SEC document shines a spotlight on fee gouging. Regulators report that private equity firms have “failed to follow their own travel and entertainment expense policies, potentially resulting in investors overpaying for such expenses.” The SEC also notes that firms are charging “clients for expenses that were not permitted” or not properly disclosed — including expenses for lavish annual investor meetings.
In practice, such fees and expenses are being paid for out of the money entrusted to private equity firms by investors such as pension funds, university endowments, and charities.
Similarly, SEC regulators seemed to bolster long-standing allegations that private equity firms mislead investors about the value of their assets. The agency reported finding private equity firms “that did not value client assets in accordance with their valuation processes or in accordance with disclosures to clients.”
The agency notes that in some cases, fraudulent valuations “led to overcharging management fees and carried interest because such fees were based on inappropriately overvalued holdings.”
“As A Result, Some Investors Were Unaware of the Potential Harm”
In recent years, critics have asserted that private equity firms secretly give preferential treatment to certain politically connected investors — preferences that are paid for by exorbitant fees and abusive terms imposed on “dumb money” investors like pension funds.
The SEC appears to confirm these allegations.
“The staff observed private fund advisers that preferentially allocated limited investment opportunities to new clients, higher fee-paying clients, or proprietary accounts or proprietary-controlled clients, thereby depriving certain investors of limited investment opportunities without adequate disclosure,” the agency wrote. “The staff observed private fund advisers that did not provide adequate disclosure about economic relationships between themselves and select investors or clients.”
One example of particularly predatory terms that critics cite are provisions that could let preferred investors bail out early on failing investments, leaving the other investors, like pension funds, with all the losses. Again, the SEC confirms that this is happening.
“The staff observed private fund advisers that entered into agreements with select investors that established special terms, including preferential liquidity terms, but did not provide adequate disclosure,” the agency wrote. “As a result, some investors were unaware of the potential harm that could be caused by selected investors redeeming their investments ahead of other investors, particularly in times of market dislocation where there is a greater likelihood of a financial impact.”
A Private Equity Takeover
In 2016, a group of Rhode Island retirees requested federal law-enforcement action to investigate whether special preferences were harming their state’s pension fund. To date, that request has gone unanswered — and moves by the Supreme Court and Trump suggest they will remain unanswered.
The high court last week limited government regulators’ power to punish financial firms that rip off investors. While the ruling preserved the Securities and Exchange Commission’s power to order companies to return ill-gotten gains from illegal schemes, it limits the size of those financial punishments in order to make sure they don’t end up being a “punitive sanction” — the kind that is designed to deter crime.
If Trump now successfully installs Clayton as US Attorney for the Southern District of New York, Clayton would be able to make sure there is no investigation or prosecution of the private equity industry that he worked with as a Wall Street attorney, that he personally invested in, and that is helping bankroll Trump’s reelection.
It would be the culmination of the private equity industry’s takeover of the federal law-enforcement system — at precisely the moment regulators are desperately trying to warn America about the industry’s crimes.