More than a dozen private equity firms have revised their regulatory filings amid pressure from federal securities regulators, publicly disclosing for the first time some fees and expenses charged to public pension funds and other investing clients.
The new disclosures—made in unusual midyear revisions to documents required to be filed annually by investment advisers—cover an array of buyout-firm practices that the Securities and Exchange Commission has scrutinised over the past six months. Among those revising their disclosures are large publicly traded investment shops such as Apollo Global Management and KKR.
The disclosures reflect a cat-and-mouse game now playing out between regulators and the buyout-firm industry. The SEC, which gained new power to regulate the industry under the Dodd-Frank financial-overhaul law in 2010, took the unusual step earlier this year of publicly accusing the industry of having widespread problems.
In a May speech, Andrew Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, said the agency had scrutinised more than 150 firms and found legal violations or other issues at more than half, including hidden fees, poor disclosures and improper shifting of expenses onto unsuspecting fund investors.
The added disclosures in many cases respond to SEC concerns, lawyers for buyout firms said, and aim to head off unwanted attention from the agency. An Apollo spokesman declined to comment; KKR had no immediate comment.
“Everyone is doing it in response to the regulatory climate and the statements that have been coming out of the SEC,” said Marco Masotti, a lawyer at Paul, Weiss, Rifkind, Wharton & Garrison who represents buyout firms, adding that he was making general observations and not speaking about his clients. Various fee and expense practices are now being “made crystal clear” to “avoid any misunderstanding or ambiguity.”
In a recent interview, Bowden said the agency has noticed the host of new disclosures since the May speech. But he said an amendment to a buyout firm’s investment-adviser form “alone is unlikely to be viewed by us as a sufficient cure for a past material omission in a limited partnership agreement or offering materials.”
If a firm has been levying unjustified fees or expenses, Bowden said, it also needs to either refund money to investors or explicitly seek investor consent for past practices.
Recently, some buyout firms have held meetings with their fund investors, including pension funds, to ensure there weren’t any misunderstandings. Many took the added step of updating their regulatory filings, lawyers say, while others have deferred doing so, concerned about attracting SEC scrutiny to past practices.
The Wall Street Journal found more than 15 private equity firms that made significant changes to investment brochures filed with the SEC since Bowden’s speech. The investment brochures—known as “Part 2A of Form ADV”—generally are updated annually, but must be amended at other times to reflect any material changes.
Apollo, Sun Capital Partners Inc. and Thoma Bravo, for instance, all recently have disclosed for the first time that they charge large fees for services they don’t render, according to the filings. The payouts often come in the form of “monitoring-fee accelerations.”
Representatives for Thoma Bravo and Sun Capital declined to comment.
Monitoring fees are paid by companies to buyout-firm owners through a contract for a set number of years, often a decade or longer. But if a private equity firm sells or takes a company public before the contract’s expiration, the company often owes a lump sum to make up for years of consulting work the buyout firm will never perform.
Apollo’s disclosure also noted that if a company can’t afford such a payment, the private equity firm could initiate a “capital call,” or demand for cash, on its fund investors to cover the fee. Apollo has never taken that step and isn’t likely to, despite detailing the option in its brochure, said a person familiar with the firm.
Bowden singled out monitoring-fee accelerations in his May speech as a little-known practice that can generate eight-figure fees for private equity firms, often with no disclosure or disclosure he described as “too little, too late.”
In their revised disclosures, many firms are making clearer the allocation of costs associated with “operating partners.” These individuals often are hired by private equity firms to provide expertise in turning around or running portfolio companies.
Buyout firms often have touted these executives as integral to their success and have featured them alongside firm employees in marketing materials.
But Bowden in his speech noted buyout firms in many cases have failed to make clear that operating partners aren’t employees on the firm payroll, but independent consultants for whom investors are footing the bill.
In its revised ADV, Advent International Corp. inserted a new section to address this issue. Operating partners are “not employees of Advent or its affiliates but rather consultants,” the new disclosure reads, adding their salaries and other fees are borne indirectly by investors. An Advent spokesman declined to comment.
Other new ADV disclosures relate to which fees are—and aren’t—being shared by buyout firms with their fund investors, who under contract are entitled to as much as 80% to 100% of various fees that the private equity firms charge the portfolio companies they buy on behalf of those investors.
In one little-known practice, some firms don’t share fees they receive for introducing their portfolio companies to “group-purchasing” programs that provide discounts on office supplies and other goods.
KKR, which previously disclosed that it doesn’t share group-purchasing fees, in late October beefed up its disclosures to add that it gets “rebates” from the arrangements and that KKR itself also can take advantage of the group-purchasing discounts.
