It's been five weeks now since the SEC’s Andrew Bowden delivered his now-notorious speech at PEI’s 2014 Private Fund Compliance Forum on hidden fees and expenses. There's been plenty of talk about the impact on limited partners (whose interests the SEC is theoretically trying to protect). But the important question remains: how have GPs reacted to this extra heat?
Many of private equity‘s standard practices have developed over years, even decades; what this can mean in practice is that the industry is sometimes slow to change. But what's become clear to us at pfm in the last few weeks is that Bowden’s words have had an immediate and signifcant effect on the way some registered fund advisers disclose fees and expenses to their investor base.
To be clear, these GPs don’t necessarily believe they’ve been doing anything wrong. it’s just that if the SEC does come knocking, they want some hard proof to show that the right types of disclosures are being made. Fund lawyers tell us that process is being kicked off with a review of the limited partnership agreement and private placement memoranda to try and determine how LPs (and the SEC itself) might interpret the language. Subsequently documents like due diligence questionnaires, side-letters and marketing materials are being examined for the same purpose.
And if an adviser reaches the conclusion that more disclosures should be in place, they’re enhancing their transparency by reaching out to their LP advisory committee, by updating their Form ADV Part 2, or by doing something else that can be documented and shown to curious inspectors. Spring is generally the time when GPs hold their annual investor meetings, so many are planning to use this forum as an opportunity to discuss fees and expenses candidly with their LPs.
Not all of these managers have acted entirely of their own volition. Some GPs have been forced into it as a result of information requests sent by LPs. Providing a single, uniform response to all such requests can be a more sensible approach than multiple, customized responses, according to Goodwin Procter funds partner Brynn Peltz.
From our perspective, this additional transparency is to be applauded – whatever the reason for it. There’s no doubt private equity investors are (in most cases) a sophisticated bunch. But it’s still possible for GPs to bury potentially controversial fees deep in the fine print. One particularly egregious example we heard about recently involved a GP who was able to shift legal expenses to the fund by outsourcing his legal team, something that was permissible after tweaking an indemnity provision in its latest LPA (most partnership agreements contain such enabling language, although it’s never really clear which managers take advantage).
If these fees were better disclosed, it would probably mean more LP scrutiny for managers – but it would also make for a fairer process during LPA negotiations. And just as importantly, it will give the SEC less reason to suspect that GPs have something to hide.