Financial regulators are scrutinizing whether managers are reducing fees for investors when deals sour after billions of dollars of bets were erased by buyout firms.

People with knowledge of the matter say that the Securities and Exchange Commission is asking private equity firms if they adjust customer fees when bets are written off to zero or below their original price tags.

Regulators are now asking private equity firms about the issue frequently in routine exams and are looking for a level of detail that they didn't before. The goal is to make sure that private equity firms don't over charge state pensions, university endowments and other investors.

SEC officials are ramping up those inquiries to root out what they consider a chronic practice of firms charging more than contractually allowed.

One of the people said that inquiries are coming from both examiners at the SEC's private-funds unit and regional office staff. The SEC asked for internal emails to help it make determinations about whether firms have delayed write-offs to squeeze out more fees from investors, according to people familiar with the matter.

The SEC didn't want to comment.

Gary Gensler is the chair of the SEC. The finance industry has grown rapidly over the past decade, but has so far avoided the same level of regulatory oversight that banks and mutual funds do.

Complex Arrangements

Private equity firms tend to have complex fee arrangements, with most funds taking a cut of invested funds after a few years. Fees can't be charged on investments written off to zero or permanently impaired. Fees are usually reduced following write downs.

The SEC staff is very focused on the calculation of management fees and we are seeing more scrutiny of those calculations in recent exams.

SEC examiners can refer their findings to the enforcement division if they so choose.

Market declines and post-pandemic shifts in how people live and work are hurting valuations of once-high-flying technology darlings. The pace of dealmaking is being slowed by stock-market volatility and rising borrowing costs.

Strong Incentives

WestCap Management wrote down the value of its main investment funds by 20% in the second quarter. A net loss of $29.4 million was recorded by the world's largest alternative asset manager in the same quarter. There will be more market turmoil and valuation cuts as a result of the Federal Reserve raising interest rates.

There are strong incentives to hold off on writing downs. As pensions and endowments grow cautious with markets in flux, it's harder for firms to raise money.

Managers of private equity firms will feel pressured to not write off investments if the industry continues to struggle, according to a former SEC official. It's already on the radar of investors and regulators, and it's driving some of the increase in examinations focused on write-offs and management fees.

The SEC reprimanded Energy Innovation Capital for failing to account for write downs. According to an SEC order, the firm didn't reduce management fees when some investments were written down.

The venture firm paid penalties without admitting or denying wrongdoing. Messages and phone calls were not responded to.

Lydia Beyoud assisted.