The US investment industry’s top regulator has called for sweeping reforms of the rapidly growing $4.2tn private equity industry, proposing rules to ensure clearer disclosures of funds’ expenses and their performance metrics.
Gary Gensler, chair of the Securities and Exchange Commission, said he wanted to simplify and standardise the disclosure of fees, which have become increasingly complex as private equity firms introduce new layers of charges for consulting and handling their portfolio companies’ capital markets transactions.
“It is time that we take stock of the rapid growth and changes in [private funds],” said Gensler, speaking at a conference in Washington on Wednesday arranged by the Institutional Limited Partners Association, a trade body representing investors.
“I wonder whether limited partners have the consistent, comparable information they need to make informed investment decisions,” he added. “I think we can promote additional transparency around fees and expenses to fund investors.”
The call to increase transparency and strengthen investor protection comes as many private equity firms are adding multiple layers to their standard management and performance fees. Additional expenses include charges for the “monitoring” of portfolio companies, “transaction fees” for acquisitions or public offerings, as well as “advisory fees” on their operational recommendations.
Gensler cited a recent Financial Times report that highlighted investors’ frustration with these layers of additional fees, which can even include the costs of hiring private jets.
The SEC’s review, Gensler said, is aimed at lowering overall private equity fund costs as private markets play an increasingly important role in overall US financial markets. Private equity and hedge funds together manage about $9tn in assets and charge about $250bn in expenses annually.
“In aggregate, that’s pretty significant to our economy and our capital markets. Hundreds of billions of dollars in fees and expenses are standing between investors and businesses,” said Gensler. “More competition and transparency could potentially bring greater efficiencies to this important part of the capital markets.”
Gensler also pointed to private equity fund performance and its relative performance to equity and bond markets as a possible area of scrutiny. “[Basic] facts about private funds are not as readily available — not only to the public, but even to the investors themselves.”
The SEC chair also called for reforms of the so-called side letters that allow institutional investors to negotiate specific terms with private equity managers — a practice that can result in institutional investors paying significantly different fees, or having different levels of liquidity.
“This can create an uneven playing field among [investors] based upon those negotiated terms,” Gensler said. “Research in this area suggests that similar pension plans consistently pay different private equity fees. The range of fees can be large.”
Private equity managers are obliged to observe a fiduciary duty to their clients. But Gensler noted that the top executives at private equity firms often secure waivers or modifications to some of these duties.
“Make no mistake. Contract provisions purporting to waive the adviser’s federal fiduciary duty are inconsistent with [the law],” he said.
Igor Rozenblit, founder of the Iron Road Partners consultancy and a former senior SEC regulator, said that Gensler’s agenda had “the potential to change the business of private equity forever”.
“It remains to be seen if all of these rules will be proposed and ultimately implemented but this is the most expansive private equity agenda since Dodd-Frank,” he added. “There is also significant potential for unintended and unforeseen consequences. Only time will tell the true impact.”