Regulators are taking a closer look at how private equity managers assess fees paid by limited partners. The misallocation of fees is the controversy du jour in the private equity space and, justified or not, it shows no signs of letting up. The Securities and Exchange Commission has promised more enforcement actions in the coming months against private equity firms over fees and other disclosure issues.
But this doesn't have to be the start of an inquisition. Private equity general partners can get ahead of the game if they follow these steps:
nErr on the side of disclosure. Big data rules the day and there's no set of data too granular to examine. It will help for GPs to be very specific in its disclosures to their limited partners concerning all fees. Even when there is no attempt to be misleading, the lack of complete disclosure of charges and fees raises a red flag to regulators.
nAgree on operating partner expenses ahead of time. Some of the problems with fee disclosures revolve around executives or consultants that general partners put in place to aid portfolio companies. While operating partners might add good value to the companies, how they are paid for must be set out well ahead of time. Marketing materials for the fund should state explicitly how they are being paid.
nAllocate expenses to the right vehicle. Today there is an increasing number of co-investment vehicles and managed accounts that will make investments alongside more traditional funds. Ensure fees are divided properly among all related vehicles involved in a deal regardless of whether it ultimately goes ahead.
nStick to the LP agreement. Deviating from a limited partner agreement in any way is going to not only bring more scrutiny from regulators; but also your bosses. If you charge any undisclosed fees that are not detailed in the agreement or exceed the limits that are set in the agreement, you're inviting misery upon yourself.
nSupport your valuations. Valuation policies and methods should be robust encompassing current market conditions, calibration procedures, relevant comparables and benchmarks. Documenting policies, obtaining and retaining supporting data take time and effort, but support your position in the face of regulatory scrutiny. The key is to ensure the valuation mark is realistic and reasonable. Any perceived inflation of valuations that boosts performance and fees is going to be considered suspect by regulators. While it sounds prudent to promise low and deliver high, excessive conservatism should be avoided.
Private equity is going to be under a microscope for the foreseeable future from both regulators and limited partners alike. Managers should follow the cautious path and disclose, disclose, disclose and you will weather the storm. n
Brendan Tyne is New York-based managing director, Augentius (U.S.) Inc.