SEC Again Signals Increased Scrutiny Regarding Private Equity Fees

In a recent speech, a Securities and Exchange Commission official followed recent comments made a month earlier from one of its directors and again called out the private equity industry for insufficient transparency in reporting its fees to investors.

Igor Rozenblit, co-head of the recently formed SEC private funds unit, signaled again that fee disclosure will continue to be a hot button issue for examiners in their assessment of private equity firm policies and procedures, reinforcing similar comments made last month by Drew Bowden, director of the SEC’s Office of Compliance Inspections and Examinations (OCIE). Bowden had indicated that of the more than 100 private equity firms whose fee and expense procedures had recently been examined by his office, more than half had deficiencies involving violations of law and/or internal control policies.

Private equity firms typically generate fees in two ways: by charging their limited partners with a management fee at the fund level, and by charging their portfolio companies with various management and advisory fees. Fees charged at the portfolio company level are also indirectly borne by investors in the private equity fund, though most funds provide their investors with at least some of the benefit of these portfolio company-level fees through a fund management fee offset mechanic. Bowden indicated that the deficiencies identified by the OCIE involved both fund management fees and fees charged at the portfolio company level.

The number of firms in the private equity industry under the direct purview of the SEC has increased dramatically in recent years following the implementation of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, which generally requires PE firms with more than $150 million in assets to register with the regulator and submit to presence examinations. With the growth of the industry and the expansion of the investor pool to more high net worth and retail-type investors, adequate disclosure has become an issue of focus for regulators in an effort to ensure that investors fully understand the terms of their investment. We will continue to monitor these developments and their impact on the private equity industry.