Inside the GP: Cost Sharing

At the PEI Private Fund Compliance Forum in New York in May, there was a sharp collective intake of breath when Drew Bowden delivered his now notorious speech, “Spreading Sunshine in Private Equity”. His revelation that the SEC had found “violations of law or material weaknesses in controls” at half of the 150 funds recently examined by his team was quite an eye-opener.

As PEI has reported in the months since, Bowden’s intervention has already had an effect on how GPs communicate with investors around fund expenses. But it’s still not clear exactly what the SEC’s position is. Which allocations are considered safe, and which are unjustifiable in any circumstances? Are you now wondering whether your firm should be picking up the tab after dinner with a portfolio company executive? Suddenly, compliance teams are worried that their current practice is out of whack with best practice.

With that in mind, PEI’s sister title pfm decided to try and provide some better context. In partnership with Pepper Hamilton and PEF Services, we asked over 100 CFOs and other industry professionals to tell us about their current fee and expense policies. Our objective? To provide GPs with a benchmark that allows them to compare their procedures with others – and, if they’re too far removed from standard practice, change their approach before the regulator starts sniffing around.

PICKING UP THE TAB

Perhaps the main conclusion from the findings was (as expected) that there’s still no industry-wide standard in terms of how GPs allocate costs between the management firm, investors and portfolio companies.

Investors like to argue that things like SEC registration, tickets for industry conferences and even certain costs that come with vetting deal opportunities (before it’s clear which fund would make the investment) should be a firm expense, a cost of doing business – so the money should come out of the management fee.

GPs, on the other hand, have tended to argue the opposite, and attempted to pass on most of these costs to the fund. But the heightened regulatory scrutiny – not to mention the slight swing in the power pendulum towards LPs post-crisis – has rather weakened their hand.