Abraaj's fall putting heat on consultants

Abraaj Group's demise amid fraud allegations is shining a light on the extent of investment consultants' duties to inform their clients about potential issues with general partners with whom they invest.

Hamilton Lane Inc. and other consultants and potential investors received a tip in the form of anonymous emails alleging that Abraaj had overvalued its portfolio companies to boost returns as it raised a new buyout fund, five months before Hamilton Lane shared the information with clients, sources close to the situation said.

Hamilton Lane executives said publicly that firm executives and Hamilton Lane clients had been aware of issues at Abraaj since February 2018, but sources with knowledge of the situation acknowledged Hamilton Lane had received the emails earlier than that.

However, Hamilton Lane executives have said they were not aware of credible reports of wrongdoing at Abraaj until February 2018 when allegations of questionable conduct at Abraaj's health-care fund began to emerge publicly, these sources said.

By the time some investors were informed of potential wrongdoing at Abraaj in February 2018, the emerging markets private equity manager was already releasing investors from their commitments to the $6 billion fund Abraaj executives had been raising. By June 2018, Abraaj was forced into liquidation as a result of an audit by some investors in an earlier fund, the Abraaj Growth Markets Health Fund, including the $50.7 billion Bill & Melinda Gates Foundation, Seattle. On April 11, the Securities and Exchange Commission filed a civil lawsuit against the defunct private equity firm and Abraaj founder and CEO Arif Naqvi for fraud. Also in April, Mr. Naqvi, Sev Vettivetpillai, a former Abraaj managing partner, and Mustafa Abdel-Wadood, managing partner of Abraaj, were arrested.

Hamilton Lane executives and SEC officials declined comment.

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.

Hamilton Lane executives "undertook substantial additional investigation and diligence work" after receiving the emails, sources said. Hamilton Lane shared the allegations with Abraaj's senior management and challenged them to respond to them in detail, which they did, these sources said. Hamilton Lane also reviewed the due diligence they had already conducted, including audited financials and portfolio valuations. Hamilton Lane also reviewed Abraaj's auditor KPMPG's audit of the management company.

What Hamilton Lane executives didn't do was tell the firm's clients that had made commitments or were about to make commitments about the emails or the issues raised in them until February 2018, five months after it received the tip.

In its earnings call Nov. 6, Hamilton Lane CEO Mario Giannini said the private equity industry, Hamilton Lane and Hamilton Lane's clients had been aware of the issues at Abraaj only since February 2018.

"Let me begin with the fact that while the Abraaj situation may be new for some of you, the private equity industry, Hamilton Lane and our clients have been aware of it since early February of 2018, when stories first hit the press about potential cash management issues at Abraaj Holding Company," he said.

During the call, he said Hamilton Lane had not publicly spoken about the Abraaj situation until November 2018 because, "This matter is simply not material to our business in any way."

Between September 2017 when the emails arrived and February 2018, several investor clients of Hamilton Lane including the $145.4 billion Teacher Retirement System of Texas, Austin; $20.1 billion Louisiana Teachers' Retirement System, Baton Rouge; and the $16.6 billion Hawaii Employees' Retirement System, Honolulu, made commitments to Abraaj Fund VI.

Plan officials could not be reached by deadline to comment for this article.

It is common for investors and their investment consultants to rely on the representations of their general partners' auditors regarding portfolio company valuations, industry sources said.

"Everybody likes to rely on auditors of the private equity funds but I am not sure it is appropriate," said the attorney with pension expertise.

It does not meet the fiduciary standard of care requiring a fiduciary to act solely in the best interests of the beneficiary because the GP's auditor works for the general partner and not the GP's investors, the attorney said.

"Investment managers know their assets extremely well, but there is a significant conflict of interest for the manager to be pricing the assets for purposes" of computing internal rate of returns, BRG's Mr. O'Connor said.

"There is a growing tendency but not a rush of investors seeking independent portfolio company valuations," he said.