With the Eye of Sauron fixed firmly on private equity funds across the U.S. during the COVID-19 era (the industry is worth $4.1 trillion worldwide), Limited Partners (LP) are demanding more transparency.
It is a sobering fact that the Securities and Exchange Commission (SEC) filed over 100 misconduct cases against hedge funds between 2010 and 2012. While many of these cases are related to outright fraud, funds have also been held accountable for omitting or fudging information to investors about investing strategies, performance, fees, or conflicts of interest.
Unfortunately, all it takes is one bad apple within your organization to delegitimize everything you have collectively worked to build ultimately. Hausmann-Alain Banet, formerly of Lion Capital Management, defrauded several investors to pay for his mortgage, office rent, and staff salaries. Cases like this highlight the imperative need for private equity firms to audit transactions for investor fraud.
Fraud of that magnitude is an extreme case, but also consider that in 2015, Blackstone Group and KKR & Co. were fined a combined $69 million by the SEC due to improper fee disclosures.
The stakes are particularly high in the era of COVID-19. Think-tank American Compass out of Washington recently aimed private equity for engaging in “Coin-Flip Capitalism” and performing worse than public indexes. The think-tank will soon be launching a “Return Counter” to measure private equity, hedge funds, and venture capital against industry benchmarks.
Now is the time to shore up your corporate governance and ensure all your operations are above board.
Invest in Your Limited Partner Relations
Ensuring your fund is providing real value to LPs means that General Partners (GPs) need to be investing more oversight into their portfolio and investing in better reporting tools.
There is currently no standard for how funds must report fees, returns, values, and assets to their LPs, leading to confusion on the part of investors. Several major players, such as Allianz SE, support the Adopting Data Standards Initiative, which aims to standardize the reporting of fund performance.
Trust between General Partners and Limited Partners is more than just a legal requirement – it also provides dividends as well. A study by investment software company eFront reveals that funds that offer more transparency to their LPs are also the highest performing. Funds that utilized standardized templates provide 70% more info to their LPs, including the number of investment professionals and exposure to geographies and sectors, and a breakdown of both fees and portfolio companies.
During this time when the real worth of the PE model is under intense scrutiny, it’s more important than ever for funds to focus reporting non-financial metrics, says Rita-Anne O’Neill, a partner, and co-head of the global private equity group at Sullivan & Cromwell LLP:
“This demand for transparency continues to expand beyond fees and performance calculations, including co-investment opportunities, and governance within those co-investments. LPs are also increasingly focused on non-financial performance metrics such as those on environmental, social, and governance (ESG) and diversity. LPs want details beyond polices and initiatives. They want to see actual ESG performance at portfolio companies, and diversity at the investment professional and portfolio board level. Just as we are seeing with investors in public companies, PE investors recognize that companies that focus on ESG considerations can minimize risk and reduce costs over the long-term, and are aware of the increasing data that companies that prioritize diversity are starting to outperform their peers.”
Funds that want to ensure their reporting is above board (and that their portfolios are sound) would do well to bring in an independent analyst to audit their investments and processes. As new regulations come into place, you’ll want an expert in your corner who can make sure you’re staying ahead of the competition.