Private equity law has been undergoing intense scrutiny ever since the financial crash, especially in the US. In the latest move, a number of US states and cities have asked the country’s Securities and Exchange Commission (SEC) to make sure private equity funds need to enhance transparency and improve their disclosures.
The Wall Street Journal first reported it had seen a copy of the letter. The letter had signatures from around a dozen comptrollers and treasurers from states and cities across the US. The comptrollers of New York state and New York City, Thomas P. DiNapoli and Scott M. Stringer respectively, are among the signatories.
According to the news agency, the signatories were asking SEC to speed up the process of creating a more transparent and detailed disclosure system for fees and expenses. The letter stated this would provide large retirement systems “a stronger negotiation position, ultimately resulting in more efficient investment options”.
Furthermore, Mr Stringer had said in a statement, “It’s time to take the detective work out of how private equity managers report their fees”.
For many pension systems, the current disclosure of fees seems too vague and pension funds are also accusing the industry of unbalanced fee structures as a whole.
Some of the country’s largest state pension systems have openly admitted they aren’t fully aware of the running costs of private equity investments. The California Public Employees’ Retirement System, the largest pension fund in terms of assets, announced earlier this year it has problems tracking performance fees.
The pension fund, called Calpers, announced later it will be reviewing the fees and said it would announce the findings by August.
The large pension funds had around 10% of their assets invested in different private equity funds. The proportion has increased rapidly since 2000. According to Wilshire Consulting, the allocation has more than tripled since the start of this millennium.
Scrutiny over private equity fund fees has been increasing in recent years. Investors are becoming increasingly aware of the value they receive through investments in these funds. Public pensions have especially been under the spotlight as they invest taxpayer dollars.
SEC made its first big accusations towards the industry last year, as it accused many private equity firms of charging “hidden fees”. The regulator also pointed out to problems in disclosures. We’ve previously reported on the regulators’ ramped up focus on the industry, especially on the fee structures of pension funds and how they are put in place in co-investment funds. At the time, Marc Wyatt, acting director at SEC’s Office of Compliance Inspections and Examination said, “Allocating co-investment opportunities in a manner that is contrary to what you have promised your investors can be material conflict and can result in violations of federal securities laws and regulations”.
In its most recent study, the SEC found $17 million worth of expenses to have been wrongly charged during a six-year period by different PE funds. This resulted in the regulator charging KKR to pay almost $30 million, with an additional $10 million penalty. The private equity firm didn’t not admit or deny the findings, but consented to the order.
Critique Against the SEC
Many industry analysts have also asked for further focus by SEC itself. Eileen Appelbaum, Senior Economist at Center for Economic and Policy Research, wrote in the Huffington Post about the limitations of the current SEC regulations and especially the Dodd-Frank Wall Street Reform and Consumer Protection Act.
According to Appelbaum, “reporting requirements for private equity are less stringent than for publicly traded companies”. She continued by stating, “PE fund advisers are not required to report the incomes of partners and senior managers, which companies their funds own, or the financial performance of the individual companies in their portfolios”. Furthermore, Appelbaum believes the SEC itself doesn’t provide enough transparency, as some of the reports it receives from private equity firms are not made public.
In her article, Appelbaum was highly critical of the ‘revolving door’ between the Washington-based regulator and many US-based private equity firms. “SEC staff often take high-paying jobs with the same companies they were formerly charged with overseeing when they leave the Commission,” she wrote.
Enhancing the Legislation
The Dodd-Frank Act recently celebrated its fifth anniversary and there has been plenty of talk looking at the achievements of the act. Investment News reported on the recent findings by Davis Polk & Wardwell, which looked at the implementation of the provisions. Only 63.3% have been satisfied with finalised rulings while 21.3% of the rules have not been proposed at all.
Thomas Gorman, a partner at Dorsey and Whitney, told Investment News the legislation has not seen any “real progress” in the SRO debate. “I think many advisers, particularly the smaller ones, are content with the way the SEC is conducting the examinations,” Gorman said.
On the other hand, Stacey Slaughter, partner at Robins Kaplan LLP, told in Pensions & Investments, the act has proved somewhat beneficial for institutional investors. “Dodd-Frank has done what it initially intended, which was to address issues that arose in the financial crisis, but it is not perfect,” Slaughter said. Naturally, to ensure the industry has a balance and transparent system, a global regulatory framework would make things a lot smoother. Professor Ludovic Phalippou from the University of Oxford Saïd Business School pointed out in a recent Financial Times article, that SEC’s focus alone isn’t enough, if other regulators are not following the lead.
The mood towards further regulations and improved transparency in the private equity sector remains muted. Some analyst don’t see much improvement in the near future, while others believe the intense scrutiny could provide an opportunity for firms, especially the smaller ones.
It will be interesting to see whether the recent letter by the state and city officials will give the SEC more incentives to look into the industry. Whatever the result, it is likely private equity firms will have face more scrutiny in the coming months and new legislative changes might well be on the way.