Private Equity Fund managers anticipated a rollback in compliance regulations with the Trump administration, and in fact the House passed a bill early this year that would repeal the Dodd-Frank Act. The Senate, however, did not take a vote on the bill and chances are that it has little chance for passage in the upcoming 2019 Congressional session. This means that the move towards more transparency in Private Equity investing continues, as investors and fund managers alike see the benefits in clearing up the opacity that has defined this kind of investing for decades.
The Securities and Exchange Commission (SEC) has made no secret of its concern over conflicts of interest within PE funds—the rules governing private companies are vastly different than the ones that deal in publicly-traded securities—and the fact that the private funds are managed more like partnerships with a limited number of partners make it difficult for outsiders to ascertain accurate fund valuation and disbursal of monies. There are three areas of focus on advisors in the conflict of interest area, all having to do with individuals who aren’t on the up and up regarding fee disclosures.
The SEC has found that over half of the Private Equity firms active in the US capital markets today are guilty of some or all of the above compliance infractions, racking up fines over $25 million. The consensus among investment managers is that the solution to the problem is to have separate officers as General Counsel and Chief Compliance Officer – most PE firms combine the positions.
Common sense would say no. A firm’s CCO is their moral compass their lead attorney is, well, an attorney – whose job is to find and exploit the loopholes the CCO would rather sew shut. However, as many Private Equity funds are small in corporate structure and the legal and governance aspects of the firm frequently overlap, a dual role is not uncommon. Larger funds – like Blackstone and KKR – have an entire department of CCOs – each specializing in particular strategy or business sector, so there is already separation from the Counsel’s office.
The flip side of that is that when the positions are combined, nobody is ever out of the loop. There is some concern that with a CCO, they may not be dialed in to all the conversations that happen on a daily basis, while the GC and their staff are always included in strategic and investment discussions. The overlap in the purview between CCO and GC can also lead to miscommunications between the two, so again, one combined role or department avoids those problems.
Private Equity analysts have noted that the SEC is a proponent of splitting the roles, but also that going after large firms for compliance violations and encouraging a role split is fairly low-hanging fruit – it gets a lot of attention and puts PE firms on notice that the SEC is in a regulatory mood.
The real issue is fee disclosure. Investors want and need to know exactly where their money is going, and when there is anticipated return – also what is the expected return on the investment. As most of the Private Equity investors are large institutional groups – CaIPERS, TIAA, or ultra high net worth families – they have an obligation to their family members, pensioners, or employees to know as much as possible about the investment.
Since the fund manager acts as the General Partner in these funds and other investors are a small number of Limited Partners, it is imperative that everyone involved know where all the money is going and that fees are fully disclosed – a fee range from 2-20% is not going to fly with a sophisticated investor.
In any financial transaction, more transparency is always better, and Private Equity is not an exception.