Reuters seemed to discover this week that the SEC has been looking into how GPs allocate co-investment activity and how that gets disclosed to limited partners. Reuters couched it as certain big investors like GIC getting secret co-investment deals with GPs behind smaller LPs’ backs.
Which is an interesting way to present the story, but it doesn’t explain that this isn’t a new focus for the SEC, that GPs have been concerned about this issue for some time and that the SEC’s focus has likely led to better disclosure across the industry, sources told me this week.
The timing of the Reuters piece makes me wonder whether this is a signal that some sort of enforcement action around co-investing is imminent. The SEC didn’t respond to my request for comment Thursday.
“GPs [have been] pretty good about this because they knew it was an area of focus,” said one source who works with LPs. “I have felt as though GPs state their process pretty clearly and [I] haven’t heard LPs complain about this recently.”
The concern the SEC has had goes back to one of its overriding themes established when it began regulating PE: making sure some LPs aren’t benefiting at the expense of other LPs.
This was laid out in a January 2014 SEC presentation that highlighted the category of “favoritism,” which the agency explained as “favoring certain clients or funds or favoring certain investors without proper disclosure.”
Igor Rozenblit, co-head of the private funds unit of the SEC, said at a public meeting in 2014 that GPs should let LPs know on what basis they are going to offer opportunities for LPs to co-invest in deals alongside sponsors. He also said GPs should disclose to all LPs when a co-investment is going to happen.
“Let them know in a timely enough way, so if someone didn’t get a co-investment opportunity, it gives them a chance to call and complain” and try and convince the GP to allocate them a piece of the co-investment, he said, according to a Buyouts article at the time.
Sources told me in 2014 there was concern the SEC was going to simply tell GPs how to allocate co-investment, like notifying all investors of an opportunity in advance and giving them all an equal chance at buying in. Nothing like that has happened, sources told me this week.
One investor relations professional at a large firm said the firm continues to gather data about how other firms allocate and disclose co-investments, looking for best practices. Generally GPs will favor those LPs who ask for access in their legal documents; then LPs with whom the GP has worked in the past; then LPs, like large institutions, who can react and transact quickly; and then to other LPs.
Some LPs simply forgo asking for access to co-investments because they don’t have capacity to take part, which is helpful to GPs, the IR professional said.
This is a big, important issue because so many LPs want access to juicy co-investments on a no-fee, no-carry basis. It’s like little gems a GP can offer to investors, but the question is, who gets what? As is usually the case with PE regulation, GPs should make sure they have a written policy they can point to if the agency comes knocking. (And make sure to follow that policy, natch.)
Another example of “favoritism” is GPs giving lending business to certain LPs in their funds, like insurance companies, without proper disclosure, Buyouts reported last year. This is all to make sure all LPs in a fund are aware that certain LPs have the benefit of an enhanced relationship with the GP, sources told me last year.
The idea of keeping the playing field as level as possible for all LPs, big and small, makes sense.
Enhancing disclosure around how a GP allocates co-investment opportunities really shouldn’t be that burdensome and seems like a positive — as long as the SEC is simply looking for more transparency, and is not interested in regulating exactly how GPs should go about allocating co-investment opportunities.
Photo: Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky