Private equity and hedge funds fees placed under closer SEC scrutiny

The US Securities and Exchange Commission’s (SEC) corporate enforcement efforts continue with the latest announcement on January 19, 2022 that the transaction costs charged by private equity and hedge funds will be scrutinized. Specifically, SEC chairman, Gary Gensler, announced that the fees paid to these funds will be subject to closer scrutiny as part of a broader effort to boost efficiency, competition and transparency in the markets. In prepared remarks, Gensler stated, "[i]f we can use our authorities to bring greater transparency and competition into that market, that helps portfolio companies on the one hand, and the pensions and endowments that are investing in that space on the other. . . .Similarly, if we can drive efficiencies across other key sectors of the capital markets, that too would help issuers and investors.”

Previously, in November 2021, Gensler made similar remarks regarding private fund fees. He discussed the increasing economic impact that private equity and hedge funds have on the US economy and his perception that steep transaction costs are injuring investors. Gensler stated that, given this economic impact and the SEC’s overall efforts to increase transparency in the markets, private equity and hedge funds are "ripe for a closer look." Gensler’s November 2021 comments suggested that the Commission will review management fees, performance fees and for many private equity funds, portfolio company fees, as well as the aggregate amount of fees. Gensler noted the traditional norm of “2 and 20,” i.e., a 2% annual management fee and 20% performance fee, and indicated that in light of market entrants and conditions, the level of fees could be lower. We previously published this article concerning the SEC’s focus on private equity firms.

In light of these pronouncements and a likely industry-wide sweep, private equity and hedge funds should review their disclosure of fees. This review should include an analysis of policies regarding fee disclosures to ensure that they are clear, as well as a review of expense and allocation disclosures. In the event of an industry-wide SEC sweep, such proactive diligence is likely to pay its own dividends and will save firms from being in a defensive position.

Special thanks to Emma Yeremou-Ngah for her assistance in the preparation of this content.