Andrew Bowden threw a grenade at the private fund industry three weeks ago when he spoke at PEI’s Private Fund Compliance Forum. He said that the SEC found violations of law or material weaknesses in over 50% of the exams they had conducted of private equity funds when it came to fees and expenses.
Mr. Bowden pointed to two particular types of fees and expenses: monitoring fees and operating partners. Although both of these are customary in private equity deal and disclosed in PPMs and financial statements, the SEC does not like them. He lumped them together with fraudulent expenses in the Camelot case.
Two recent news stories are carrying on Bowden’s view of private equity.
Last week, the Wall Street Journal ran a story on how KKR failed to credit certain fees back to investors because the unit was not an affiliate: KKR Error Raises Question: What Cash Should Go to Investors? KKR is required to share with investors in its largest buyout fund 80% of any “consulting fees” collected by any KKR “affiliate.” The unit in question was owned by KKR’s management and not considered an affiliate. The article specifically tied back to Mr. Bowden’s speech.
On Sunday, Gretchen Morgenson penned an article in the New York Times about monitoring fees: The Deal’s Done. But Not the Fees. The article highlighted $30 million in monitoring fees paid to Goldman Sachs, Kohlberg Kravis Roberts and TPG Capital for their oversight of Biomet. The unpaid fees under the 10-year monitoring contract became due on the sale to Zimmer Holdings. This article also specifically mentions Mr. Bowden’s speech.
In my view, it’s not that the fees are illegal or “fraudulent, manipulative or deceptive” under Section 206. It’s a matter of disclosure to investors and internal procedure. Investors deserve a right to know the fees they are paying, either directly through the fees by the fund, or indirectly by the fees paid by the portfolio company to the fund manager. Perhaps in some fund documents the fees can be laid out in more detail. Fund managers should have internal procedures for how fees are implemented and checked to make sure they comply with the fund documents.
Personally, I think Mr. Bowden is lumping a lot of customary fees and expenses into his 50% bucket. I’m offended that he is including the case of fraud, like the Camelot case, in with instances of fees that the SEC merely does not like.
References:
- The Deal’s Done. But Not the Fees by Gretchen Morgenson in the New York Times
- KKR Error Raises Question: What Cash Should Go to Investors? by Mark Maremont in the Wall Street Journal
- View from the SEC
- Private Fund Theft Through Diligence Payments
- PEI’s Private Fund Compliance Forum 2014
