LPs dig deeper into fund expenses

GPs are being asked to explain their fee and expense allocations in more granular detail as investors dig deeper into their limited partnership agreements and side-letters.

Sparked by comments made by Securities and Exchange Commission (SEC) chief inspector Drew Bowden at PEI’s Private Fund Compliance Forum earlier this month, one portfolio manager at a European insurer said he’s holding more conversations with GPs about operating partner fees specifically.

He said the “best [way] to tackle [operating partner fees] would be to not allow the GP to appoint direct or indirect advisors, operational experts or any third party linked to the GP.” Instead he argues for a “separation of duties”, meaning it should be up to the portfolio company to decide if an outside advisor is needed. If not the GP may have to bear the cost, but certainly so if the advisor is working across multiple portfolio companies, he argued.

One of the industry’s biggest backers, the Oregon Investment Council (OIC), is also digging deeper into GPs’ fee practices. “We take seriously recent reports regarding the SEC’s investigations,” said Richard Solomon, chairman of the Oregon Investment Council, in a statement.

“Accordingly, we have directed our consultants and Treasury staff to continue to verify that the private equity firms with whom we invest have assessed only those fees allowed by the terms and conditions of their contracts.”

The $87.5 billion OIC allocates 21.3 percent of its assets under management to private equity, just north of its 20 percent target. GPs who’ve received commitments from Oregon include TPG, Kohlberg Kravis Roberts and Vista Equity Partners, according to PEI’s Research and Analytics team.

Fueling LPs’ fee inquisition is findings that about half of 150 or so newly registered private equity advisors recently examined by the commission have exhibited “violations of law or material weaknesses in controls” with regard to fee allocations, Bowden said at the conference.

Compliance officers speaking to pfm on the conference sidelines said his comments would lead many firms to review their fund’s governing documents now that they had a better understanding of what types of issues the SEC was looking into.

“It also means LPs want a better understanding of the process that happens when a questionable charge or receipt comes down the pipeline,” according to one LP consultant who performs operational due diligence on fund managers. “Who decides who pays for what? Are their controls in place?”

Operating partners portrayed as employees of the management firm but who are actually compensated by the fund or portfolio company is one of the most common deficiencies cited during presence exams, said Bowden during his speech. “Since these professionals are presented as full members of the adviser’s team, investors often do not realize that they are paying for them a la carte, in addition to the management fee and carried interest,” said Bowden. This allows GPs to grab a marketing advantage by showcasing in-demand operating professionals without having to foot the entire bill for their services, he added.

However, the insurer added the SEC findings are also a sign of a maturing industry. “GP’s behave like investment banks have in the past and charge on many silo’s and at the same moment tell their investors they have strong internal Chinese Walls.”