Agent of change

This article originally appeared in the December 2009 Private Equity Manager Monthly, a monthly printer-friendly publication delivered to subscribers to Private Equity Manager.

The Securities and Exchange Commission is currently in the process of reviewing the 170 responses – mostly negative – it received over a plan to prevent investment firms from hiring placement agents to solicit public pensions for commitments. The SEC, along with New York Attorney General Andrew Cuomo, has engaged in a multi-year investigation of pay-to-play practices at the $109 billion New York State Common Retirement Fund, in which political operatives allegedly strong-armed investment firms into paying sham finder’s fees in exchange for commitments from the pension. 

Placement agents are hoping that if the comments raise enough questions, the SEC may have to issue another version of the proposed rule that does not include a ban on contacting public pensions. There is still a large degree of uncertainty about what the SEC’s decision will mean for the placement agent industry, including whether it will still be a viable business.  

One of the biggest questions for both funds and agents is how a ban would affect work that an agent has done or is doing on behalf of a fund but has not yet been paid. Private Equity Manager spoke with representatives from both sides to get their perspective on how such questions will affect the agent-fund relationship in the future:  

If there is a ban on placement agents, how would it affect the work that has been done or in the process of being done for a fund? 

If a ban becomes law, everyone currently engaged with a placement agent will be forced to rewrite the contract to account for any changes. If the payments cannot be done above board within the letter of the law I do not see how a fund manager can pay them. After the contracts are rewritten to reflect the changes it will be up to the two parties to agree to continue the mandate.  

Not well I presume. They are commercial enterprises and as such if they cannot be compensated for the work they do they will need to find other work that they can do that they can charge for or they will cease to exist. It will be interesting to see, if there is a ban, how the legislation will handle mandates that were under way before the ban. If a legitimate agent has already performed their work and assisted in a fundraising, how will the law accommodate the performance portion of the contract? The work was done, the fund was raised and the agents will feel that they need to be paid. I imagine this could result in many billable hours for the lawyers. The bottom line is that if legislation is passed we will abide. 

Another interesting aspect will be how the ban will affect fund of fund relationships. If there is a ban on public funds being solicited by third parties such as placement agents, how will the law affect fund of fund mandates that are given to them by the public funds? Will they also be banned from having placement agents as intermediaries? If a ban becomes law, all of these issues will have to be vetted and new contracts will have to be drawn to redefine the relationship if indeed a commercial relationship can continue.  

This is a difficult question given the unknowns. In fairness, the agent who is to receive payment in the future for work already done could be jeopardised by such a restriction. We would have to see the actual regulations, but it is troubling to consider. Say you have a contract that was signed five years ago on a re-up fee and now a GP is not going to honour that contract because the SEC says you’re not to do such a thing. Or you could be getting paid over time for a recently completed fundraise. Now what do you do? I suppose some sort of grandfathering arrangement would be granted, otherwise you have a legal case over the sanctity of a contract. It’s pretty amazing that we have gotten this far, but it is what it is.

It is unclear how folks will restructure things. It appears a retainer, minus a success-driven fee is acceptable, but it all comes down to structure. There are some agents who get paid on the revenues and performance, there are others who get paid for doing docs, and still others get paid for maintaining a dialogue with LPs. It’s so variable that I imagine there are enough varieties of options out there that everyone will find something that works for them, but there might be an area where a GP could pick a placement agent off. 

From our perspective, if a GP tried to pick us off on a re-up fee like that for work previously done, the fee would be owed regardless because the work was done, the fee is an extension of such work and so long as you are not earning additional fees today, the original contract would rule. I don’t think it’s in anyone’s interest to overcomplicate past fee agreements. Most of our clients would say we had an understanding and a structure that worked then. The world has changed; you did a good job; this is a success-oriented fee; it should survive. If the SEC feels otherwise, then we’ll have to be adults about it and come up with a structure within today’s guidelines. Unfortunately, however, not everyone exhibits mature behavior in situations like this, and a GP that expected a trajectory AUM growth that they are not experiencing might start to nickel and dime.

Not yet, it is too early. There isn’t any point in discussing with clients until we know what the new regulations are. Where we have tails, the contract stands given it is an extension of work previously delivered. But people do peculiar things with the passage of time; it would be disappointing if a GP that we killed ourselves for were to turn and pick us off but you never know. I would never do it and I know some of our clients would never do it, but certainly they are not going to pay us in outright violation of the law and that’s going to mean that the confusing and ambiguous situation in limbo today may become more complicated tomorrow.

That’s a very interesting question. Let’s look at alignment. If a GP is in demand and there are rules prohibiting compensation to agents, I can tell you which LPs will not likely see the opportunity, or at least won’t see the fund first. GPs have a keen memory, some might avoid these LPs altogether simply because they were dinged by them back when the sole fiduciary or board members had another agenda. Why get involved with a system that has such issues if you don’t have to? It isn’t always about the money, especially when other investors will fill the hole. Ironically it seems, the alleged fraudulent, unregistered “finders” that were in bed with the alleged corrupt political officials are not being held to the rules historically in place. The problem resides in the political structure moreso than the agent world. It takes two to tango. Instead of enforcing those rules that had been in place and clarifying them, a new ban is being proposed.  

The misinformation resulting in this movement towards an agent ban is exemplified by a piece in the news the other day that showed  [New York Attorney General Andrew] Cuomo reportedly saying his programme has not been impacted by the pensions restrictions. This reaction is not surprising but it does highlight how many do not fully understand the business. First, the statement came at the end of what was a nearly dormant nine months in the fundraising market, so the time period was an outlier to begin with. Second, it is impossible for an LP to know if it missed a good deal or not as many of the best deals go to a short list of loyal LPs and don’t have room for many large new LPs, let alone one with allegations of corruption – even in a difficult market where messages to GPs are cloudy. Finally, these are 10-year partnerships. Even if an LP committed to each of what they deem the best GPs out there, the plan will not know what it did not see or what it should have not chosen for years to come.