What’s really going on with fees?

If you were at the PEI Private Fund Compliance Forum in New York earlier this May, you’ll probably recall the collective intake of breath after Drew Bowden delivered his now-notorious speech “Spreading Sunshine in Private Equity”.

Bowden disappeared pretty quickly after his speech, leaving in his wake a crowd of compliance officers exchanging raised eyebrows and nervous stares. The revelation that the SEC had found “violations of law or material weaknesses in controls” at half of the 150 funds recently examined by Bowden’s team was quite an eye-opener.

We’ve reported since that the SEC’s call for more transparency is already having an effect on how GPs communicate with investors around fund expenses.

But it’s still not clear exactly what the SEC’s position is. Which expense allocations are considered safe, and which are considered unjustifiable in any circumstances? In light of Bowden’s warning, are you now wondering whether your firm should be picking up the check after dinner with a portfolio company executive? Compliance officers are no longer sure whether their current practice is in line with best practice.

With that in mind, we wanted to put this controversy in better context. In partnership with Pepper Hamilton and PEF Services, we asked CFOs and other industry professionals to tell us about their current fee and expense policies.

There’s an important objective here: to provide GPs with a benchmark that allows them to compare their procedures with others. A firm that finds itself too far removed from standard practice can change its ways accordingly before arousing the curiosity of SEC inspectors. Equally, firms can remove charges typically eaten by the management firm from the budget if the industry consensus is that it should be treated a fund expense.

The tough thing about compliance is you never really know where your blind spots are until something goes wrong. That’s why CCOs are usually quick to share their approach and rule interpretations, as a way of reaching an industry consensus on new regulations and enforcement actions. On fees and expenses, the time for that is clearly now.

Click here for the results.

======Methodology========

What is the pfm 2014 fees and expenses survey?

It is a benchmark to compare and review practices with others. More fund managers are asking who should pay for various fees and expenses, so we compared and reviewed industry practices.

How we created the benchmark

PEI’s Research & Analytics unit surveyed 104 US alternatives fund managers on their fee practices in August and September 2014.

First, we targeted CFOs to respond because they are the most informed of these practices. However, if the CFOs were unavailable, we asked responses from other professionals, including CCOs, Controllers, and COOs, as long as they were also aware of the firms’ practices.

Next, this is a benchmark covering the US, so we reached out to firms from every region across the country. There was a high response rate from the Northeast region. This looks reflective of the market due to the private equity hubs of New York, Washington DC and Boston.

Confidentiality

We never reveal the names or the firms of our respondents. Therefore this survey is entirely confidential.

Why alternatives and just not private equity firms?

We emphasized private equity firms but also included other alternatives such as mezzanine debt, real estate, and infrastructure. For mezzanine debt, one could argue that the strategy qualifies as private equity due to the equity option of its investments. And we included real estate and infrastructure because several of these private equity firms manage a diversified platform, and more importantly, much of the SEC scrutiny facing private equity firms is equally placed on other alternative asset classes that we cover.