Private equity preps for greater SEC scrutiny on fees and LP side letters


Industry experts estimate that investors pay private equity and hedge funds more than $250 billion a year in fees and expenses, which does not take into account additional ancillary fees from limited partners and portfolio companies (Source: JD Supra).

Let’s digest that figure for a moment. Think of the domino effect greater SEC or regulatory scrutiny will have on those that feed on the diamond-encrusted cake crumbs of private equity funds and their transactions. Will private equity as an ever-popular asset class have to change its recipe in 2022 to something more humbling to feed the appetites of the SEC and retail investors? And if it does, what impact will that have on all interconnected parties, including portfolio companies?

More scrutiny, more resources

SEC Chair Gary Gensler has many concerns over the inner workings of private equity funds

The ongoing regulation and oversight of the more than 32,000 private funds registered with the US Securities and Exchange Commission has increased at both the state and federal level, which has sparked the commission to allocate more resources to protecting traditional retail investors.

In a speech at the year-end Institutional Limited Partners Association Summit, SEC Chair Gary Gensler posed many concerns over not just the inner workings of private equity funds, but those of their limited partners, where he noted that some LPs are having an advantage by negotiating “side deals”.

Soon after the event, news broke of the Securities and Exchange Commission charging registered investment adviser Global Infrastructure Management, LLC for failing to properly offset management fees and for making misleading statements about the fees and expenses it charged. Global agreed to pay a $4.5 million penalty to settle the SEC charges and voluntarily has repaid $5.4 million to its affected private fund clients. 

According to the SEC’s order, “Global failed to offset certain portfolio company fees against management fees charged to clients, as it was required to do under the offering and governing documents. As a result, clients overpaid millions in additional management fees.”

The SEC’s order also found that Global provided investors with inconsistent statements about how Global would calculate management fees. In addition, the SEC’s order found that these violations were caused by deficiencies in Global’s compliance programme. So, who will ultimately get the blame behind closed doors? Could this have been avoided? And does this mean all funds will have to make sure their compliance is above board before an investigation finds otherwise tarnishing their reputation with LPs.

“Private equity fund advisers must ensure that investors do not pay more in fees or expenses than they bargained for and are given accurate information about fees and expenses,” said Adam S. Aderton, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “Robust compliance programmes are critical to help ensure that clients are not misled and receive full and accurate disclosure.”  

The message to funds and their LPs?

Anyone registered with the SEC, operating funds or portfolio companies in the US, must ensure compliance is coherent and in order. These are the areas where the SEC will most likely conduct more scrutiny and require more transparency:

  • Excessive Fees and Expenses
  • LP Side Letters and preferred liquidity terms or disclosure
  • Performance metrics
  • Market integrity when it comes to federal fiduciary duty
  • Freshen up Financial resiliency (Form PF)

What’s your take?

Are side letters deserving of this additional scrutiny?

And if anything is to change in this regard to create a more level playing field, what does that mean for fund strategies, an LP’s ability to do such deals and the target companies that attract the funding? Who has the most to lose?