- SEC takes no stand on ‘propriety’ of certain fees
- Wants to ensure practices are fully disclosed
- Scrutiny has led to change in the industry
The Securities and Exchange Commission‘s focus on private equity has centered on disclosure — whether GPs are telling their investors in limited-partner agreements that they will do certain things like accelerate full payment of monitoring-fee contracts.
But the SEC has not yet taken a stance on the propriety of certain PE practices, like fee acceleration. That question comes up in conversations around the industry: Will the SEC take a stand on whether GPs should actually collect certain types of fees and expenses? Are certain types of fees simply wrong?
An answer does not appear to be forthcoming.
In a keynote speech on May 12, Andrew Ceresney, director of the SEC’s enforcement division, stressed that the agency is not interested in determining the morality of certain practices. It is interested in ensuring that limited partners know about these practices so they can make informed decisions.
“I have been asked before whether we will bring a case asserting that a particular type of fee constitutes a breach of fiduciary duty,” Ceresney said. “Whether we will or not, it is my belief that awareness and transparency of fees generally will lead investors and advisers to reach an appropriate balance in terms of types and allocation of fees.”
Disclosure and transparency
The SEC’s focus on disclosure and transparency has led to changes in the industry, he said. “While our actions have taken no position on the propriety of these fees, the increased transparency has fostered a healthy dialogue between investors and advisers on what sorts of fees are appropriate and who should receive the benefits of those fees,” Ceresney said.
Since the SEC began its intense scrutiny of private equity in 2012, certain practices have come to light that look bad to people outside the industry. But LPs have known about many of the practices and accepted them as the price of accessing potentially high-performing funds.
One of those practices is collecting so-called accelerated monitoring fees. An example might be a deal in which a GP agrees to monitor an investment for 10 years but exits the investment after only five. Accelerating the monitoring fee means the GP gets the whole fee even though his services were needed for only half the contract period.
The SEC has found that in some cases, the way this works was not explicitly spelled out in limited-partner agreements.
Blackstone and KKR cases
Accelerated monitoring fees were at the center of the SEC’s case against Blackstone Group, which agreed last year to pay $39 million to settle the case. Of that $39 million, $29 million went back to LPs.
The SEC had said Blackstone collected accelerated monitoring fees without disclosing its ability to do so. The agency also said the firm received discounts on legal fees not available to the funds and didn’t disclose the arrangement. Blackstone did not admit or deny wrongdoing.
Accelerating payment of monitoring contracts can lead to substantial payments by portfolio companies to GPs, Ceresney said.
“Because investors typically don’t have transparency into the agreements between advisers and the portfolio companies, they are often unaware of such payments and their terms, and therefore the adviser’s ability to collect this accelerated fee should be disclosed to investors at the time they commit capital,” Ceresney said.
“The message of this case is that full transparency of fees and conflicts of interest is critical in the private equity industry,” Ceresney said.
In his speech Ceresney also highlighted the SEC’s $30 million settlement with Kohlberg Kravis Roberts, which included a $10 million penalty. In this case, the SEC said KKR did not disclose that its GP-affiliated co-investment vehicles would not pay broken-deal expenses.
“This breach of fiduciary duty is particularly troubling because a sizable amount of co-investment capital came from KKR-affiliated vehicles, such that the firm had the funds foot the bill for deal-sourcing activity that inured directly to its benefit,” Ceresney said. KKR did not admit or deny wrongdoing.
More of these types of settlements are coming, Ceresney said. They will continue to “significantly increase the level of transparency into fees, expenses and conflicts of interest,” he said.
Action Item: Transcript of Andrew Ceresney’s speech: http://1.usa.gov/20xuDtW
Photo: U.S. Securities and Exchange Commission logo on an office door at the agency’s headquarters in Washington on June 24, 2011. Reuters/Jonathan Ernst