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Torys’ Private Equity in Focus in 2016: transparency takes centre stage

Torys LLP released its Private Equity in Focus 2016 report in February.

In a PE Hub Canada exclusive, Torys is sharing report findings with readers in several installments. In our fourth and final installment, Cameron Koziskie, Shannon Gotfrit, André Nance and I discuss legal and market trends that favour greatly increased transparency in the private equity fund industry.


Increased scrutiny from regulators is driving a trend toward greater transparency in the private funds industry. More detailed and frequent disclosure of fees and expenses and more information and reporting around conflicts of interest and allocation policies are good examples. With regulators signaling a need for funds to continue to improve disclosure, and investor advocacy groups separately working on a set of industry standards on fee disclosures, the push toward transparency is expected to continue on both sides of the Canada-U.S. border.

Regulatory oversight

In the United States, the Securities and Exchange Commission has a more complete picture of the private fund industry five years after the Dodd-Frank Act required many managers to register and report their practices. In those five years, the SEC has gone from not knowing how many funds or firms exist to having insight into almost 30,000 private funds and 4,500 registered advisers.

This insight resulted in some notable SEC enforcement actions in 2015. In June, one fund manager agreed to pay almost US$30 million to settle charges that it improperly allocated more than US$17 million in “broken deal” expenses to its flagship funds. In August, another manager agreed to pay US$20 million to settle charges that it failed to disclose a US$50 million loan that a senior executive received from an investor. In October, a third manager agreed to pay US$39 million to settle charges that it inadequately disclosed accelerated-monitoring fees and legal discounts it had received that were substantially higher than discounts received by its funds.

A running theme in these enforcement actions is inadequate disclosure to investors, ranging from a failure to describe practices in marketing materials or—in cases where disclosure occurs, but the relevant fees and expenses or practices are not highlighted to investors—a failure to disclose information to investors in a sufficient way.

While increased regulatory oversight of the private funds industry has largely been a U.S. phenomenon, the practical effect is also being felt by Canadian funds. They are also facing growing disclosure pressures from investors.

Fees and expenses

Historically, the information investors received with respect to fees and expenses has been limited, with any disclosures provided often buried in annual financial statements. As highlighted by recent enforcement actions, regulators have been concerned about the payment of accelerated-monitoring fees to managers upon the sale of a business, but without adequate disclosure of such practices or the amounts of the fees involved.

The amounts in question have been material: According to one recent estimate, as much as US$3 billion in these types of fees (out of a total of US$20 billion in portfolio company fees) have been received by private fund managers from portfolio companies over the past 20 years.

As of May 2014, the SEC had found illegal fees, compliance shortfalls, or material deficiencies in controls in more than half the private funds it examined.

In October 2015, SEC Chair Mary Jo White emphasized the SEC’s concern that some fund managers may be improperly shifting expenses away from the manager by charging salaries to the fund, and outsourcing services to be performed by the manager and charging inappropriate third-party fees to the fund (for instance, by hiring former employees as “consultants” paid by the fund, but whose compensation does not offset the management fee), without disclosing any of this to investors.

Marketing: We are now seeing managers include more detailed fee disclosures in their marketing materials, in particular with respect to their practices regarding administrative fees and portfolio company fees.

Fund formation: In fund governance documents, we are seeing expanded fee and expense definitions, and clarifications around which fees are to be paid out of the management fee, as opposed to fees paid by a portfolio company (but not subject to offset against the management fee).

Information rights: Periodic notices to investors of fees that both offset the management fee or are carved out of the offset, and increased information regarding expenses, as well as broader access to information rights to request information on such fees, are also being included in fund governance documents.

These developments have increased investors’ ability to track these types of fees and the management fee offset, as well as to track expenses that are charged to the fund.

Conflicts of interest and allocation policies

Transparency has also been historically limited with respect to how fund managers deal with conflicts of interest and allocation of investment opportunities across multiple funds. In the United States, the SEC has observed that some managers are not adequately disclosing conflicts of interest—for instance, hedge fund advisers allocating profitable trades and investment opportunities to their own accounts rather than client accounts. The latter is in contravention of existing policies and procedures.

Investors are focusing more on conflicts of interest (including how investment opportunities are allocated among funds), and are pushing for enhanced conflict management procedures and/or disclosure obligations. Managers are often responding by adding greater detail in marketing materials and fund governance documents with respect to conflicts of interest, while at the same time asserting their discretion and flexibility in dealing with these conflicts.

What’s next: fee disclosure standards

Looking ahead, the Institutional Limited Partners Association has circulated a proposed set of standards outlining how fund managers should disclose fees on a quarterly basis, an initiative that is expected to enhance transparency and reduce the number of individual information requests that managers receive.

From the investors’ perspective, adoption of these standards will better enable them to compare fees charged by different fund managers. In addition to ILPA’s efforts, investors in the United States are petitioning the SEC to push for more transparent and frequent information on fees and expenses, as evidenced in a letter sent to the regulator in July 2015 by 13 U.S. state and city treasurers and comptrollers.

Spotlight on U.S. real estate funds

As of October 2015, the SEC has been completing a review of private fund real estate advisers and their practice of hiring related parties to perform services for fund investments. In particular the SEC is concerned that “disclosure about these arrangements may be non-existent or potentially misleading, particularly with regard to whether or not the related parties charge market rates.”

In response, we are seeing fund managers add enhanced disclosure in marketing materials specifying the services, the relationship between the manager and the related party, and the terms of these engagements. Managers are also revising fund governance documents to expressly permit such transactions, but within parameters to protect investors’ interests; for example, such engagements will be explicitly indicated as being on arm’s-length terms and/or subject to market checks, and there is typically enhanced disclosure with respect to amounts paid to such affiliates.


In 2016, we expect investors will keep advocating for enhanced disclosure while fund managers work to preserve their flexibility and discretion. In the meantime, increased transparency in fund marketing materials and governance documents is reflective of the overall shift toward enhanced scrutiny of the industry by both regulators and investors. As managers continue to respond to these changing dynamics, we expect the growing transparency trend will bring with it tangible administrative and strategic considerations for managers in the year ahead.

To download the entire Torys’ report, please visit Private Equity in Focus 2016.

Amy Johnson-Spina is a Torys LLP partner and advisor to institutional investors and fund sponsors. Other contributors to this article include Cameron Koziskie, a partner focused on corporate and commercial law who deals with private asset management, private equity and M&A; Shannon Gotfrit, a partner focused on corporate law with an emphasis on private equity; and André Nance, a senior associate in Torys’ Private Equity practice.