Abraaj's collapse is adding heat to the already hot topic of governance in private equity.
The Institutional Limited Partner Association, Washington, is working to persuade the SEC to force managers to improve governance in their fund documents by, among other things, including clear information regarding conflicts of interests as well as an explicit statement by GPs of the standard of care owed to limited partners, said Jennifer Choi, managing director, industry affairs at ILPA.
In February, a group of 32 institutional investors including the $360.3 billion California Public Employees' Retirement System, Sacramento; $145.4 billion Texas Teacher Retirement System, Austin; and $128.1 billion Washington State Investment Board, Olympia, signed a letter urging the SEC to act on ILPA and investor recommendations. The SEC is expected to release the results of its consultative process shortly, including issuing interpretive guidance regarding general partners' fiduciary practices and limited partner agreements.
ILPA is also seeking a congressional sponsor for a bill that would close a fiduciary duty loophole that general partners are increasingly adding to limited partnership agreements to limit their fiduciary duties of care, loyalty and good faith. The proposed legislation would include language providing transparency to fees and expenses charged to LPs and reinforce private equity managers' duty to act in the best interests of investors. ILPA spearheaded the effort because language is creeping into LP agreements restricting private managers' fiduciary duty by such things as broad clauses in these contracts "pre-clearing" conflicts of interests, Ms. Choi said.
Whether the Abraaj affair sparks a push by investors to require more transparency from their investment consultants as well as their GPs depends on how much limited partners want to push for transparency, said Gavin Farrell, New York-based director of business development at independent advisory firm Berkeley Research Group LLC that offers fiduciary services to investors.
Ten years ago, after the Bernie Madoff ponzi scheme came to light, "the hedge fund world changed," with investors demanding more transparency, Mr. Farrell said.
The Abraaj matter could be one of the catalysts for investors to demand independent oversight over the governance of their private equity portfolios. One of the alleged issues at Abraaj was that the valuations of its portfolio companies were overstated, said Finbarr O'Connor, New York-based managing director at BRG in the corporate finance group.
From a regulatory perspective, Cayman Island-based funds are required to have independent directors and more and more that standard is beginning to apply to onshore funds as well, Mr. O'Connor said.
"Independent directors will demand transparency … so they can get comfort that the fund's actions are in the best interests of investors," he said.
Institutional investors say they expect their consultants to share any information of potential wrongdoing known by them immediately. Even larger investors, many of whom monitor GPs in-house rather than hire a consultant to perform that function, expect their private equity consultants to share important information with them.
"The board has a private equity consultant that works on their behalf and acts as a fiduciary," said Sarah Corr, CalPERS' interim managing investment director, private equity, in an email. "While the consultant does not monitor the GPs in the portfolio, they do know which GPs we are invested with. We expect if our consultant has material concerns about the activity at a GP they would raise it to our staff."
CalPERS is not an investor with Abraaj.
Attorneys say the level of disclosure depends on what role the consultant is playing.
Investment consultants are fiduciaries because they have influence over their clients' investment decisions, attorneys say. However, to what degree Hamilton Lane and the other consultants with clients invested or that considered investment with Abraaj needed to share the unsolicited emails with those clients, in large part, depends upon the consultant's contract and the role it is playing. Many consultants including Hamilton Lane can be straight investment consultants, a discretionary money manager or a consultant with discretion. A manager or consultant with discretion, in general, has less obligation to share the information with clients unless there is a direct threat to the pension plan's assets such as in the case of an embezzlement, said an attorney in the pension world.
"The appropriate response is not to ignore it," the attorney said.
Investment consultants have a fiduciary duty to clients, said David Fann, New York-based president and CEO of TorreyCove Capital Partners LLC. Typically, due diligence includes verifying information from all sources, not just the money manager, he said.
"An unsolicited email is highly unusual and should have raised questions," Mr. Fann said. "A consultant typically would investigate the allegations, which may include discussions with the manager and based on findings, factor them into their investment decision."
None of TorreyCove's clients invested with Abraaj.