Private-equity firms, after decades of operating with limited regulatory scrutiny, are facing possible sanctions and tighter oversight after the Securities and Exchange Commission uncovered improprieties at most firms.

The SEC found illegal fees or severe compliance shortfalls in more than half of the firms it examined since starting a review of the $3.5 trillion industry two years ago, Drew Bowden, head of the SEC’s exam program, said in a speech yesterday. Bowden’s remarks foreshadow significant changes in how the industry operates, said Jay Gould, head of the investment-funds team at law firm Pillsbury Winthrop Shaw Pittman LLP in San Francisco.

“There will be several significant enforcement actions, enough to where the message will be pounded home loud and clear as to what is acceptable and what is not,” Gould said.

Private-equity firms have enjoyed limited oversight since gaining prominence in the 1970s as partnerships of investment managers who raised money to take over companies. That changed in 2010 when the Dodd-Frank Act gave the SEC greater oversight of private funds, which are typically only open to institutions and wealthy investors.

“Because of the structure of the industry, the opaqueness of the private-equity model, the broadness of limited partnership agreements and the limited information rights of investors, we are perceiving violations despite the best efforts of investors to monitor their investments,” Bowden said. “If we’re not on the job, doing exams in this area and spreading sunshine, these problems, which involve significant sums of money, are more likely to persist.”

‘More Emphasis’

The SEC, which created a special unit of staff to inspect buyout firms, started the exams in October 2012 and plans to have scrutinized 275 groups by year-end. Private-fund managers are also now required to file confidential reports, allowing regulators to monitor activity that could threaten the broader economy.

“There are more compliance considerations because it’s an industry that historically hasn’t been regulated by the SEC,” said Dwight Quayle, a partner at law firm Ropes & Gray LLP in Boston. “While there’s a bit of wait-and-see attitude about some of these things, certainly there is more emphasis on compliance.”

Ken Spain, a spokesman for the Private Equity Growth Capital Council, which represents more than 30 firms, declined to comment on the SEC’s findings. Among the PEGCC’s members are the world’s biggest buyout firms, including Blackstone Group (BX) LP, Carlyle Group LP (CG)Apollo Global Management LLC (APO) and KKR & Co. Bowden didn’t name any of the firms that have been examined.

Stock Reaction

“We do not anticipate that that would be an issue for us,” Adena Friedman, Carlyle’s chief financial officer, told investors and analysts on a conference call last week. “We have actually had a recent visit from the SEC, just on a normal five-year basis, and we feel confident that that we have done things the right way.”

Washington-based Carlyle fell 2.9 percent to $30.19 at the close of trading in New York, after falling as much as 7.4 percent. Blackstone dropped 1.6 percent, Apollo slid 0.7 percent and KKR declined 3.9 percent. Blackstone, Apollo and KKR are based in New York.

The stock reaction was “unwarranted,” Sterne Agee & Leach Inc. analyst Jason Weyeneth said in an e-mail. He said illegal activity probably isn’t taking place at the largest, publicly traded private-equity firms.

Compliance Costs

“While there has been no indication whether the publicly traded firms have been examined, we would expect considerably stronger compliance standards than at smaller firms,” said Weyeneth. “The publicly traded firms have large legal and compliance departments, have been SEC registered and regulated for a meaningful period of time and generally have larger, more sophisticated and demanding limited partners.”

Blackstone President Tony James said on a call last month that the firm’s legal and compliance staff has grown as the company adapts to the heightened regulatory oversight.

“Legal and compliance is our fastest growing part of the firm by far,” James said. “We’ve been dealing with this for a long, long time, it’s just there’s more and more and more of it, in more and more jurisdictions.”

The most common issues SEC examiners have identified in the inspections are improper fees and the allocation of expenses to investors that should be paid by the firm, Bowden said. More than half of the firms inspected had “violations of law or material weaknesses” in one of those areas, he said.

’Back Door’

SEC examiners have repeatedly found problems with how firms pay operating executives, who help find growth opportunities and potential efficiencies in companies, Bowden said. Private-equity firms often tout the role of those executives as a service and then pay them with investor funds or money from portfolio companies rather than the buyout firm, he said.

“This effectively creates an additional back door fee that many investors do not expect,” said Bowden. “The adviser is able to generate a significant marketing benefit by presenting high-profile and capable operators as part of its team, but it is the investors who are unknowingly footing the bill.”

Bowden said he hopes regulation will help improve investor confidence in the private-equity industry. The oversight is necessary, he said, because those underlying investors include public pensioners and other U.S. workers who are often unable to detect wrongdoing by investment managers overseeing their money.

Transaction Fees

The SEC has separately questioned whether private-equity firms that charge transaction fees have violated requirements to register as broker-dealers. Those deal fees, which date to the 1980s, give fund managers a cash windfall when a deal closes, regardless of how well or poorly the investment performs over time. The SEC is now weighing an exemption for private-equity advisers that would allow them to avoid registration as a broker-dealer.

“There is a long history in the private funds world — not just private equity, but hedge funds and real estate private equity — of managers picking and choosing what rules they wanted to apply to them,” Gould said.