Wed. Dec 1st, 2021


A $ 2.7 billion private equity manager named after the Monomoy Lighthouse in Nantucket Sound has been forced to return nearly $ 2 million to its investors after U.S. regulators decided last year that it had failed to “fully and fairly provide disclosure “about costs that were ultimately. paid by customers.

Monomoy Capital promises to help its clients navigate “rough waters”, but numerous similar examples of private equity executives exploiting opaque fees and expenses to increase their own profits makes investors feel uncomfortable.

Investors say they are regularly billed for extra costs, such as renting private jets, in addition to the standard “two and 20” – a 2 percent annual management fee and 20 percent performance fee – charged by private executives. equity groups, known as general partners or general practitioners.

“Expenditure is the biggest cause of misalignment between GPs and their clients,” says an investor who manages a multi-billion dollar private equity portfolio.

Public criticism of private equity managers by institutional investors remains extremely rare. Most large investors are reluctant to speak out in case they damage their own reputation as fiduciaries – guardians of their clients’ money – and because they are worried that they will be silently excluded from joining new funds run by private equity managers. collected.

But now rule changes may be on the way.

The Institutional Limited Partners Association, a commercial entity, calls on U.S. regulators to compel private equity executives to report all fees and expenses they charge to investors in a clear and consistent format.

“I have made allocations to more than 50 PE funds and there are a dozen where it is unclear what is charged as an expense, even with the help of an external auditor who hires us to provide the information provided by our GPs. provided, to try to verify, ”said the private equity investor.

Michael Frerichs, the Illinois state treasurer in charge of a $ 430 million private equity portfolio, called in October for the US Congress to succeed “new rules and meaningful reformsSo that a “dangerously unregulated” part of the capitalist system will not cause further damage to institutional investors, businesses and workers.

Clear and standardized fee and expense disclosures by private equity executives, who either own or invest in 8,000 U.S. companies, will drive “better decision-making” among investors, said Frerichs, a former Democratic member of the Illinois Senate.

Assets managed by private equity managers have grown rapidly to $ 4.5tn over the past decade and the contracts signed by investors allow general practitioners to charge additional fees for obtaining transactions, salaries for advisers and expenses for regulatory and compliance applications. .

Private capital industry exploded in scope

A quarter of investors pay for administrative expenses for private equity managers, such as internal legal services, accounting and computer software, according to ILPA.

The legal costs of setting up new private equity funds have more than doubled since 2011, a bill that is also paid by investors who also have to pay for new expenses such as cybersecurity services for general practitioners.

KKR, the world’s second largest asset manager for private markets, reported earning $ 480 million in capital market fees and a further $ 152 million in “additional fees” including monitoring and transaction fees in 2020.

“These fees include services provided by KKR that its portfolio companies are encouraged to use. Last year, they accounted for 30 percent of KKR’s fee – related income, ”said Eamon Devlin, a private equity lawyer.

Ludovic Phalippou, a professor of finance at Oxford Said Business School, said the expenses accrued to investors at the discretion of general practitioners show that the alignment of interests between private equity managers and their clients is “completely skewed”.

“It is astonishing that it is up to GPs to decide how much they will be paid after the contract with the investor has been signed. “It is effective what happens when a family doctor can choose what to bill as an expense,” he said.

Demands by investors for improvements in transparency standards have led ILPA to create a new cost reporting template in 2016 for fees and expenses, which the association says is “appraised”.

“All investors must have the necessary transparency to validate their fees and expenses with managers. Regulation can help achieve this, ”said Chris Hayes, general counsel at ILPA.

But a significant minority of general practitioners remain reluctant to provide more information to their clients.

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Only 60 percent of U.S. private equity funds raised since 2017 have used the ILPA cost template or a similar reporting framework, according to Colmore, a specialist data provider.

“Fee templates based on the ILPA guidelines are now standard features of the services of fund administrators and software vendors. We are moving to the point where ILPA-type reporting standards will apply to all new PE funds, ”said Ben Cook CEO Ben Cook.

Gary Gensler, chairman of the Securities and Exchange Commission, said in October that he supported reforms to improve fee disclosure through private funds.

“Any pension fund that invests in private funds will benefit if there is greater transparency and competition,” Gensler said.

His comments follow blatant criticism by the SEC last year of reprimanding private equity executives for overpaid investors and secretly favoring their own interests and those of high-paying clients over other clients, in clear violation of existing regulations.

Private equity managers are required to perform a fiduciary duty to act in the best interests of their clients. But most funds are domiciled in Delaware and the Cayman Islands where local laws allow general practitioners to dilute or eliminate key parts of their fiduciary duties. Investors pay for these contractual changes that weaken their own legal protection and strengthen the hand of general practitioners.

Nearly 48 percent of institutional investors have reported changes or reductions in fiduciary duties specified in PE funds where they have made new awards in the past 12 months, particularly in the North America and Asia-Pacific regions, according to ILPA .

“This goes to the heart of the issue of alignment between the GP and investors in a private equity fund,” said Chris Hayes, general counsel at ILPA.

The association strives for the SEC to tighten the rules so that the fiduciary standards applicable to general practitioners are not weaker than those covered by other types of investment advisers, such as mutual fund managers.

Not everyone thinks that PE should change the way it works.

“Transparency and accountability are important, but it is worth remembering that investors understand that PE is an expensive asset class. . . investors have shown that they are willing to pay those costs in exchange for the returns they can get, ”says Igor Rozenblit, founder of the Iron Road Partners Consulting for Private Market Managers and a former SEC regulator.

But Phalippou warns that regulators will have to sharpen their oversight of general practitioners to ensure they “play by the rules” such as opaque, complex private equity strategies moves deeper into the mainstream of investments.

“At the moment, investing in PE is like stepping into a jungle. All you can hope for is that the lions will be friendly, ”he says.



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