Private equity not so private as fees revealed at Blackstone

BOSTON: Two of the biggest private-equity firms are disclosing fees that had largely been hidden as U.S. regulators demand increased transparency from the industry. Blackstone Group LP said it could collect as much as $20 million annually from investors and companies in its next buyout fund, for services such as health care consulting and bulk purchasing. TPG Capital put the potential charge for similar services at as much as $10 million a year for its new fund, which is currently seeking to raise as much as $10 billion.

The U.S. Securities and Exchange Commission has criticized the industry for passing on charges to clients without their knowledge, and is trying to persuade the $3.5 trillion private-equity industry to improve disclosure.

"We've entered a new day," said David Fann, chief executive officer of TorreyCove Capital Partners, which advises pension plans on private equity investments. "Most investors will request more robust disclosure surrounding fees being paid by portfolio companies to private equity funds."

Private equity firms buy companies using a combination of investor capital and debt, with the goal of selling them or taking them public for a profit. They typically charge annual management fees of 1.5 percent to 2 percent of committed funds and keep 20 percent of profits from investments. Buyout firms also charge the businesses for buying, selling and monitoring them, though firms have increasingly passed on these expenses to investors in the funds by reducing the management fee.

The fees questioned by regulators are for services provided by consultants, known as operating partners, who are paid by private equity firms for their expertise on various aspects of running a business including recruitment, procurement of goods and pricing strategy.

In a May speech, Andrew Bowden, head of the SEC's inspections office, said he was concerned about improper fees and the allocation of expenses to investors that should be paid by the firms. He said more than half of the private equity firms examined to that point were either breaking the law or had "material weaknesses" in controls.

One of the most common deficiencies found was the funds' failure to tell investors about how operating partners were compensated and how those levies weren't used to pay the management fee. Most limited partnership agreements require that fees produced by employees or affiliates of the private equity firm offset the management fee, Bowden said.

"Operating partners, however, are not usually treated as employees or affiliates of the manager, and the fees they receive rarely offset the management fees, even though in many cases the operating partners walk, talk, act and look like employees or affiliates," Bowden said.

The SEC has backed Bowden's tough talk with enforcement actions. In October, the agency fined Clean Energy Capital and its founder Scott Brittenham for misallocating funds and changing distribution calculations without adequate disclosure. Clean Energy didn't admit or deny the SEC's findings in the settlement.

"We're happy to get this behind us," said Aegis Frumento, a partner at Stern Tannenbaum & Bell LLP in New York, who represents Brittenham and the firm.

In September, the SEC fined Lincolnshire Management $2.3 million for sharing expenses between portfolio companies in a way that benefited one fund over another. Lincolnshire, a New York-based private-equity firm, didn't admit or deny the SEC's allegations.

Robert Pommer III, a lawyer for Lincolnshire with Kirkland & Ellis LLP in Washington, didn't reply to a voicemail or e-mail for comment.