Private equity investors asking tougher questions
Private equity groups say they have been inundated with questions from concerned investors about fees and expenses in the wake of an early May speech from a senior official at the Securities & Exchange Commission.
The investor relations departments of a range of private equity groups contacted by the FT said they had fielded an increasing number of queries from investors in recent days. These queries included levels of disclosure over fees, how expenses had been allocated by the private equity groups and whether the SEC had raised red flags about the private equity group’s internal workings. “What are the fees I don’t know about?” asked one.
The increased interest follows a speech in May by Andrew Bowden, director of the Office of Compliance Inspections and Examinations at the regulator. He identified potential conflicts of interest between the private equity groups and their fund investors over fees, expenses and portfolio company valuations.
The comments were initially dismissed by many of the big private equity groups and some public pension fund investors. But the speech, which follows increasingly rigorous SEC examinations of the private equity groups, has since led many investors to express concerns that private equity firms are taking advantage both of them and of investee companies.
One of the biggest fears is that investors have been unfairly charged for expenses that the private equity groups should bear, or that firms are not passing to investors all the fees to which they are entitled.
The pressure to generate fees is particularly great for the publicly listed groups – Apollo, Blackstone, Carlyle and KKR – since shareholders value the steady fee income these companies collect.
“The line on many of these issues is very blurry,” said one lawyer specialising in private equity funds. “What is a real fund expense and what should be covered by the management fee needs to be disclosed clearly.”
Mr Bowden’s speech comes as the SEC examines the books and practices of hundreds of private equity groups. Its probe could ultimately affect their profits, analysts said.
It may also boost those groups, including Hellman & Friedman and Warburg Pincus, that do not charge investors fees for doing deals, monitoring portfolio companies, financings they arrange and for other services provided to the companies they control.
“A private equity adviser is faced with temptations and conflicts with which most other advisers do not contend,” Mr Bowden said. “We have seen limited partnership agreements lacking clearly defined valuation procedures, investment strategies and protocols for mitigating certain conflicts of interest. We have identified what we believe are violations of law or material weaknesses in controls over 50 per cent of the time.”
Examinations from the SEC taking place within the last six months have involved increased scrutiny, with the regulator asking for information on deals, fees and other information dating back to about 2007.
“In many cases, the fee split has changed but the magnitude of fees has increased,” says the head of investor relations at a private equity group. “When the share to LPs [limited partners] increases, they add more fees.”