Investors’ Group Pushes for Cooperative Approach to PE Fee Transparency

Investment fees, particularly those charged by private equity fund managers, or General Partners (GPs), continue to be a point of contention within the industry. But ultimately, it’s not simply the fees themselves causing concern: it’s the lack of transparency surrounding these fees and the mechanisms that allow them to reach high levels.

According to one academic study, published by two professors at Oxford’s Saïd School of Business, private equity funds charged investors upwards of $20 billion in hidden fees between 1981 and 2013. These hidden fees, which can creep up due to vague terminology within master service agreements, offer GPs a certain level of flexibility to charge additional expenses above and beyond performance fees.

Setting a Standard for Fee Reporting

In response to these concerns and other recent events, the Institutional Limited Partners Association (ILPA), a global member-driven organization comprised of private equity investors, has released a fee reporting template. The template aims to act as a tool that helps GPs and Limited Partners (LPs) enter negotiations on the same page – with a set of standardized terms and definitions –  so both parties are clear on the meaning and practical applications of the language in their agreements.

The template is a component of the ILPA’s larger transparency initiative, which launched in September. According to the group, the initiative – comprising a number of senior investment and reporting professionals from a cross-sector of investor institutions and advisers – is “a broad-based effort that aims to establish more robust and consistent standards for fee and expense reporting and compliance disclosures among investors, fund managers and their advisors.”

The template itself aims to capture in greater detail the fees, fund expenses, offsets applied, carried interest amounts and other income paid to GPs and their affiliates.

Endorsing Funds Can’t Make Alterations

Signaling their commitment to the new reporting standard, there are a number of LPs, GPs and other asset managers that have endorsed the template. By endorsing the template, these groups agree to conform to the new standards to the best of their ability, using the form as a supplement to their standard financial disclosure.

The ILPA recognizes there are challenges to completely standardizing reporting requirements across the industry, given that internal systems vary from one group to the next. The template is intended to act as a baseline for reporting with the option to adopt it in full or adopt components of it depending on the needs or limitations of each reporting group. Funds that move toward the template, however, have been asked not to alter its components, even if that means only accepting partial components of the template. This is to ensure consistency across the board and move toward better standardization and a more cohesive industry.

‘Sunshine’ in Forecast for Private Equity?

While it may not solve all of the issues surrounding fees within the industry, it is a step toward bringing increased transparency to an area that has long been criticized. As the level of scrutiny continues to build, the industry is trying to proactively improve its efforts before the government steps in and imposes its own requirements – requirements that could possibly be more stringent than the industry wants.

Since 2012, when the Securities and Exchange Commission (SEC) started requiring that private equity funds register under the Dodd-Frank Act, the Commission has paid increased attention to the private equity industry. Further, in 2014, Andrew Bowden, a former director of the SEC’s Office of Compliance Inspections and Examinations, delivered a critical speech on the state of the private equity industry. In what is known as the “Spreading Sunshine in Private Equity” speech, Bowden condemned the industry, alleging that it mishandled fees and expenses more than half of the time. While Bowden’s speech was his own view, and not necessarily that of the SEC, it was evident that the private equity industry and its issue of hidden fees were now on the Commission’s radar.

Challenges related to fees and transparency within the private equity industry will not correct themselves overnight, and the ILPA recognizes this. It’s expecting that GPs that do embrace the new template could take up to a year or so before full implementation. Still, a cooperative effort between managers and investors is a move in the right direction, and this new reporting standard will help shed some light on the fee structure within the investment industry – and alleviate some of the compliance burden for both GPs and LPs.