private equity history, governance, and operations © 2008 cendrowski corporate advisors chapter 10:...

Private EquityHistory, Governance, and Operations

© 2008 Cendrowski Corporate Advisors

Chapter 10:Professional Standards



Part 1:Introduction

Private Equity: History, Governance, and Operations© 2008 Cendrowski Corporate Advisors

Introduction• Though private equity (PE) appears to float under

the regulation radar of the Securities and Exchange Commission (SEC), it is not entirely unregulated

• The SEC proved it is willing to address fraud and deception of private firms by voting to adopt a new antifraud rule on July 11, 2007~ This rule, enacted under the Investment Advisors

Act, allows the SEC to bring enforcement action against all investment advisors who make false or misleading statements to investors or interested parties of a pooled investment vehicle. – Applies to both registered and unregistered advisors.


Introduction• Scope of the antifraud rule reaches beyond the

investment advisors of hedge funds, regulation that the other forms of PE have not experienced.

• Covered under the rule are investment advisors of:~ Hedge funds~ PE funds~ Venture capital funds~ Mutual funds

• The SEC’s willingness to extend fraud regulation into the private sector shows the importance of all companies keeping up to speed on government regulation

• We will now discuss governing bodies and professional standards that pertain to the PE arena



Part 2:Federal Trade Commission


Federal Trade Commission• The FTC is charged with investigations regarding federal

antitrust legislation and investigations involving federal consumer protection legislation~ Sherman Antitrust Act (1890)

– Deals with business monopolies

~ Clayton Antitrust Act (1914)– Amends Sherman Act by making illegal practices that lessen

competition

~ Federal Trade Commission Act (1914)– Prohibits price discrimination and misleading advertising

~ Robinson-Patman Act (1936)– “Anti chain store act”

~ Celler-Kefauver Antimerger Act (1950)~ Hart-Scott-Rodino Antitrust Improvement Act (1976)


Federal Trade Commission~ Celler-Kefauver Antimerger Act (1950)

– The Clayton Act prohibits stock purchases that result in reduced competition but does not prohibit asset purchases accomplishing the same end.

– C-K Act prohibited this

~ Hart-Scott-Rodino Antitrust Improvement Act (1976)– Requires a notice period of an M&A deal



Part 3:Federal Consumer Protection Legislation


Federal Consumer Protection Legislation

• The FTC is charged with enforcing consumer protection legislation as well as with enforcing antitrust legislation~ Wool Products Labeling Act (1939)~ Fur Products Labeling Act (1951)~ Textile Fiber Products Identification Act (1958) ~ Federal Cigarette Labeling and Advertising Act (1966)~ Fair Packaging and Labeling Act (1966)~ Truth in Lending Act (1968)~ air Credit Reporting Act (1970)~ Postal Reorganization Act (1970)~ Dolphin Protection Consumer Information Act (1972)~ Hobby Protection Act (1973)~ Fair Credit Billing Act (1974)



~ Magnuson-Moss Warranty–Federal Trade Commission Improvements Act (1975)

~ Consumer Leasing Act (1976)~ Petroleum Marketing Practices Act (1978)~ Drug Price Competition and Patent Term Restoration Act

(1984)~ Comprehensive Smokeless Tobacco Health Education

Act (1986)~ Fair Credit and Charge Card Disclosure Act (1988)~ Federal Deposit Insurance Corporation Improvement Act

(1991)~ Energy Policy Act (1992)~ Telephone Disclosure and Dispute Resolution Act (1992)



~ Telemarketing and consumer Fraud and Abuse Prevention Act (1994)~ Violent Crime Control and Law Enforcement Act (1994)~ Home Ownership and Equity Protection Act (1994)~ Home Equity Loan Consumer Protection Act (1995)~ Electronic Fund Transfer Act (1996)~ Telecommunications Act (1996)~ Credit Repair Organizations Act (1996)~ Identity Theft Assumption and Deterrence Act (1998)~ Equal Credit Opportunity Act (1999) ~ Fair Debt Collection Practices Act (1999)~ Gramm-Leach-Bailey Act (1999)~ Children’s Online Privacy Protection Act (2000)~ College Scholarship Fraud Protection Act (2000)~ Crimes Against Charitable Americans Act (2001)~ Sports Agent Responsibility and Trust Act (2002)~ Do-Not-Call Registry Act (2003)~ Do-Not-Call Implementation Act (2003)~ Fair and Accurate Credit Transactions Act (2003)~ Controlling the Assault of Nonsolicited Pornography and Marketing Act (2003)



~ Telemarketing and consumer Fraud and Abuse Prevention Act (1994)

~ Violent Crime Control and Law Enforcement Act (1994)~ Home Ownership and Equity Protection Act (1994)~ Home Equity Loan Consumer Protection Act (1995)~ Electronic Fund Transfer Act (1996)~ Telecommunications Act (1996)~ Credit Repair Organizations Act (1996)~ Identity Theft Assumption and Deterrence Act (1998)~ Equal Credit Opportunity Act (1999) ~ Fair Debt Collection Practices Act (1999)~ Gramm-Leach-Bailey Act (1999)~ Children’s Online Privacy Protection Act (2000)



~ College Scholarship Fraud Protection Act (2000)~ Crimes Against Charitable Americans Act (2001)~ Sports Agent Responsibility and Trust Act (2002)~ Do-Not-Call Registry Act (2003)~ Do-Not-Call Implementation Act (2003)~ Fair and Accurate Credit Transactions Act (2003)~ Controlling the Assault of Nonsolicited

Pornography and Marketing Act (2003)



Part 4:Securities and Exchange Commission


Securities and Exchange Commission• Several federal acts are administered by the SEC:

~ Securities Act (1933)– Prohibits misrepresentations in sale of securities– Requires that investors be provided with information

regarding securities offered for public interstate sale

~ Securities and Exchange Act (1934)– Created SEC

» Has regulatory authority over brokerage firms, transfer agents, clearing agencies, security self-regulatory organizations (SROs), and the stock exchanges

~ Public Utility Holding Company Act (1935)– Designed to protect utility customers from, among

other things, utility company fraudulent behavior


Securities and Exchange Commission~ Trust Indenture Act (1939)

– Requires that registered debt securities be accompanied by a formal indenture agreement between the debtor and the creditor

~ Investment Company Act (1940)– Gives the SEC authority to regulate the organization

and operation of companies engaging in the trading of publicly traded securities

~ Investment Advisers Act (1940)– Requires investment companies operating as

agents for security purchasers and sellers to register with the SEC and to conform to appropriate SEC regulations


Securities and Exchange Commission~ Foreign Corrupt Practices Act (1977)

– Precipitated by the bribery of foreign officials by agents for U.S. companies or their employees, officers, or directors

– Act mandates that SEC registrants maintain an adequate internal control system

~ Sarbanes-Oxley Act (2002)– Covers six areas

» The Public Company Accounting Oversight Board (PCAOB)» Auditor independence» Corporate governance» CEO/CFO certifications» Enhanced financial disclosure» Civil and criminal penalties


Securities and Exchange Commission• The Public Company Accounting Oversight Board

(PCAOB)~ Protects the interests of investors in the preparation of

accurate and independent audit reports

• Auditor independence~ PCAOB prohibits CPA firms from offering certain services to

publicly held audit clients

• Corporate governance~ SOX mandates a board of directors–level audit committee

and the provision of whistle-blower protection rules

• CEO/CFO certifications• Enhanced financial disclosure• Civil and criminal penalties


Securities and Exchange Commission• CEO/CFO certifications

~ SOX requires these individuals personally certify financial statements

• Enhanced financial disclosure~ Off balance sheet liabilities

• Civil and criminal penalties ~ SOX outlines harsher penalties



Part 5:Private Equity Going Public


Private Equity Going Public• Some PE firms are contemplating going public

~ The Blackstone Group’s decision to go public was not accomplished overnight

~ Blackstone needed to overcome an array of issues that are shrouded for private company counterparts

• Even PE groups that have no aspirations of hitting Wall Street need to be knowledgeable of public company regulations.~ A common strategy for PE funds is to offer

investments to the public~ Before making an IPO, an investment needs to be

compliant with public company regulations



Part 6:PCAOB Standards


PCAOB Standards• PCAOB has 5 standards

~ Auditing Standard No. 1, “References in Auditors’ Reports to the Standards of the Public Company Accounting Oversight Board”– States that the PCAOB has adapted as standards, on an

initial, transitional basis, the generally accepted auditing standards, described in the AICPA’s Auditing Standards Board’s Statement on Auditing Standards (SAS) 95

~ Auditing Standard No. 2, “An Audit of Internal Control Over Financial Reporting Performed in Conjunction With an Audit of Financial Statements”– Replaced by AS 5

~ Auditing Standard No. 3, “Audit Documentation” – Provides audit documentation guidelines


PCAOB Standards~ Auditing Standard No. 4, “Reporting on Whether a

Previously Reported Material Weakness Continue to Exist” – Applies to engagements geared solely to reporting

on whether a previously reported material weakness has not been corrected

~ Auditing Standard No. 5, “An Audit of Internal Control Over Financial Reporting that Is Integrated with an Audit of Financial Statement”– Contains new standards and guidelines for

independent auditors to attest to and report on the effectiveness of an organization’s internal control over financial reporting under Section 404(b) of the 2002 Sarbanes-Oxley Act



Part 7:AICPA Standards


AICPA Standards• There are several Statements on Auditing Standards of

interest to a PE firm when evaluating a potential investment.~ SAS 99,– “Consideration of Fraud in the a Financial

Statement Audit”– Emphasizes that auditor consider the client’s

susceptibility to fraud in the planning of an audit of the client’s financial statements» Descriptions and characteristics of fraud» Professional skepticism» Discussions of fraud with audit engagement personnel» Fraud risks» The evaluation of audit evidence» Auditor communication with client management, the audit

committee, and others


AICPA Standards» Documenting the auditor’s consideration of fraud during

the audit engagement

~ SAS 104, “Amendment to Statement on Auditing Standards No.1, ‘Codification of Auditing Standards and Procedures(“Due Professional Care in the Performance of Work”)’”– Expands the SAS 1 definition of reasonable assurance

~ SAS 105, – “Amendment to Statement on Auditing Standards No. 95, ‘Generally Accepted Auditing Standards’”– Changes the scope of the second standard of field

work from “understanding the entity’s internal control system” to “understanding the entity and its environment, including its internal control.”


AICPA Standards~ SAS 106, “Audit Evidence”

– Notes that “audit evidence is all the information used by the auditor in arriving at the conclusions on which the audit opinion is based and includes the information contained in the accounting records underlying the financial statements and other information.”

~ SAS 107, “Audit Risk and Materiality in Conducting an Audit”– Provides the auditor with guidance regarding the

documentation of risk and materiality considerations encountered in the conduction of a financial statement audit

~ SAS 108, “Planning and Supervision”– SAS 108 states that planning is an interactive process


AICPA Standards~ SAS 109, “Understanding the Entity and Its Environment

and Assessing the Risks of Material Misstatement”– Covers the procedures and tests that the auditor should

perform in obtaining an understanding of an entity’s environment and internal control system and in assessing the risks of material misstatements.

~ SAS 110, “Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained”

~ SAS 111, “Amendment to Statement on Auditing Standards No. 39, ‘Audit Sampling’”– Amends SAS 39 by incorporating SAS 99 fraud considerations,

SAS 107 risk and materiality considerations, and SAS 110 audit procedure considerations in the design and implementation of audit sampling procedures


AICPA Standards~ SAS 112, “Communicating Internal Control Related

Matters in and Audit”– Replaces Statement on Auditing Standards No. 60

~ SAS 113, “Omnibus Statement on Auditing Standards”– Clarifies the terms used to describe professional

responsibilities imposed on auditors by SASs 99 and 104 through 112.

~ SAS 114, Auditor’s Communication with Those Charged with Governance”– Provides guidance on matters that should be

communicated with those charged with governance



Part 8:AICPA Accounting and Review Standards


Accounting and Review Standards• SSARS 10

~ Provides for inquiries regarding fraud in a review engagement

• SSARS 12~ Requires the external accountant to have an

understanding with a compilation or review client regarding the reporting to the client of fraud or illegal acts that come to accountant’s attention during the performance of the compilation or review engagement



Part 9:IIA Standards


IIA Standards• SIAS 3

~ Provides guidance for the performance of financial, compliance, and operational audits by internal auditors

~ The standard notes:– Effective internal controls is the principal way to

deter fraud– The control system is management’s responsibility– The role of the internal auditor is to assist

management in deterring fraud



Part 10:ISACA Standards


ISACA Standards• P7

~ Details provisions of an effective internal control system.

~ The standard states that the “IS Auditor should be aware that management can override controls and this may facilitate fraud by senior management.”

private equity history, governance, and operations © 2008 cendrowski corporate advisors chapter 10:...

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