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Thanks to a recent research paper by the Social Science Network (SSRN) we now have a glimpse into the controversial, often self-serving, and mostly undisclosed fees, that private equity managers pay themselves.

Thanks to a recent research paper by the Social Science Network (SSRN) we now have a glimpse into the controversial, often self-serving, and mostly undisclosed fees, that private equity managers pay themselves.

The paper’s authors, Ludovic Phalippou, associate professor of finance, Oxford University Saïd business school, Christian Rauch, also from Saïd business school, and Marc Umber, Frankfurt school of finance and management reviewed more than 25,000 SEC fillings between 1995 and 2015. The documents covered 1,044 General Partner (GP) investments in 592 leveraged buy-out (LBOs) transactions, whose total enterprise value (TEV), including add-on acquisitions, comes to $1.1tn.  (Source: Alpha Journal, Jan 6, 2016)

The fees were mostly classified as  “administrative fees” charged by the partners to the companies they controlled. Often, with General Partners sitting on the boards of the companies, the fees were opaque at best. Under the Global Fiduciary Standard of Excellence (Practice S-1.4, Criteria1.4.1), such transactions would be considered clear conflicts of interest for the fees were voted upon and paid by the controlling entity without clear communication to, or regard for, the other stakeholders. “Lining one’s pocket at the expense of another” might be another name for such activity.

So what does this mean for trustees and board members? It means that you need to dig more deeply in such transactions if you decide to invest in the private equity market. Depending on the size of your portfolio and the sophistication of your Investment Committee, it may make sense to forego the general partner route and look for SEC registered mutual funds that mimic the strategy of the GP portfolios. Talk to your financial advisor or consultant about what might be available. The benefits of the mutual funds over the Limited Partnership Funds include significant cost savings, transparency and stronger SEC oversight.