In a move that may fuel debate about what types of fees private equity firms charge investors, high profile asset management firm Kohlberg Kravis Roberts reportedly refunded money to investors after US Securities and Exchange Commission (SEC) inspectors concluded the firm improperly allocated expenses to one of its funds.
Rebates have been a popular strategy for GPs at odds with SEC inspectors over fees, legal sources tell pfm, but the move has been kept discrete between LPs and fund managers. The Wall Street Journal, which discovered that KKR offered investors a fee rebate via a management fee credit, brings the issue in the public eye.
During an exam, the SEC found that KKR “wrongly charged investors for some expenses and failed to properly notify them of certain fees it collected,” according to the report. One set of KKR’s refunds amounted to less than $10 million, while another set may have been similar in size or smaller, according to a WSJ pension document analysis, retrieved through a freedom of information request act.
At the 2015 PEI CFOs & COOs Forum in New York, the head of the SEC’s private equity task force Igor Rozenblit discussed possible exam outcomes and said that when the SEC discovers that a firm has overcharged investors, there are two ways that the firm can respond.
The manager can issue a response letter stating that it disagrees with the SEC’s findings and move on from there. Or, if the manager is in agreement with the findings, they may voluntarily initiate “some sort of remediation,” said Rozenblit. In cases where there are findings around disclosures, processes or procedures, remediation can include, formally changing disclosures processes and procedures, while for violations that have a monetary component, the remediation could mean refunding money back to investors. “It is also important to understand that remediating an issue that is discovered during an examination does not mean that the registrant will avoid an enforcement investigation,” said Rozenblit.
The SEC put a spotlight on private equity fee disclosures last May when Office of Compliance Inspections and Examinations head Drew Bowden included fees and expenses in a laundry list of practices that the regulator finds questionable or downright fraudulent.
“Fees and expenses can be okay if the disclosures are right,” said Rozenblit at the conference. He noted that investor consent is necessary and the timing of fee disclosures is crucial. When managers change their fee practices in the middle of a fund’s life, for example, investors need to be aware of and consent to those changes. Some limited partnership agreements (LPAs) only require approval from the LP advisory committee in order to make fee changes while others require changing the LPA itself.