The Institutional Limited Partners Association backed up the US Securities and Exchange Commission on its inclusion of fiduciary duty obligations and cost disclosures for GPs in its finalized Private Fund Advisers Rule, while suggesting further tweaks.
The group recently published a new analysis including a survey of member LPs, which stresses the importance of the two items and calls for them to be “off the negotiating table” with GPs.
The report found that disclosure of fees and expenses was first among responses in negotiation “must-haves” at 51 percent, with fiduciary duty second at 43 percent.
‘Minimum standard’ solutions
ILPA proposes what it calls a “minimum standard” for both fiduciary duty and cost disclosures so that they are removed from negotiations. The intent is to enable LPs to shift attention on other terms during their talks “such as strong key person provisions, no-fault removal and diligence letters.”
The report also found that 59 percent of LP respondents believe that fiduciary duty in negotiations has shifted in GPs’ favor, and 22 percent feel the same about disclosure of fees and expenses.
The organization noted that LPs can push for inclusion of ILPA’s preferred terms in their LPAs or side letters, but wants them to be regulatory requirements.
While the SEC would require GPs to share fund-level data with all LPs every quarter, ILPA wants them to be required to provide investor-specific data upon request.
ILPA’s survey shows that LPs are dissatisfied with cost disclosure. A majority of LP respondents (55 percent) said that GPs have not been transparent enough in revealing expenses, fees and performance.
And LPs take issue with the long-time trend of GPs piling costs onto partnerships.
“There has been such a shift in the industry as far as costs getting put onto the partnership that were previously covered in the management fee,” Neal Prunier, ILPA senior director of industry affairs, told Private Funds CFO.
Thirty-four percent of investor respondents said that waterfall structures for carried interest have also become more friendly to GPs over the past three years.
On the fiduciary duty side, ILPA wants the SEC to impose “a minimum articulated standard of care” on GPs. Under the proposed rule, the regulator would merely bar GPs from requesting exculpation or indemnification for a fiduciary duty breach.
And the group proposes a higher threshold for legal liability than the agency proposes, applying gross negligence as the base threshold for GPs generally, where the SEC only applies that threshold to side letters and in “material breaches” of LPAs. The trade group is willing to compromise on the threshold because it doesn’t want it to negatively impact GPs’ risk tolerances, and thus returns.
Investors feel that GPs have the edge in talks
ILPA’s analysis depicts a deck that is stacked in GPs’ favor during fund negotiations. It found that a sizable majority (65 percent) of respondents disagree with the notion that LPs can land favorable contractual terms through their leverage and expertise.
Overwhelming majorities of survey respondents said that both draft LPAs (97 percent) and final ones (87 percent) have shifted to favoring GPs over the past three years.
That’s in part due to the breadth of knowledge about LPs and their concerns that GPs and their counsels have.
LPs engage in bilateral talks with GPs during LPA drafting, unaware of the issues raised by their fellow investors. GPs, on the other hand, are aware of the concerns of every LP in a fund, giving them the upper hand. And their counsels have even more advantageous knowledge, Prunier said, since they negotiate many funds for numerous GPs, meaning they have access to details of past negotiations between a broad range of GPs and LPs to help clients gain the upper hand.
And consolidation in the pool of outside counsel means more GPs are starting with the same draft LPAs, ILPA said.
“In effect, LPs are not only negotiating with the GP and GP external counsel, they are also directly negotiating against themselves and what they have agreed to in historical fund negotiations with an entirely different GP,” ILPA said.
The trade group also cited investment opportunity concerns among LPs. Its survey found that most respondents (83 percent) have accepted contractual terms that they weren’t satisfied with because they didn’t want to lose investing allocation.
GPs often see this issue as a result of technical supply and demand dynamics, resisting changes that legally embed LP advantages in negotiations since it is widely accepted in other markets that high demand gives suppliers the upper hand.
– Graham Bippart contributed to this article.