Major LP explains to Senators why private equity needs more transparency

Information asymmetry is growing as more administrative costs are being shifted away from the management fee and directly charged to LPs as expenses.

The state treasurer of Illinois, which has one of the busiest private equity programs in the country, explained during a Senate hearing why the industry needs stricter transparency requirements.

“In my own experience, the lack of transparency surrounding private equity investments,
specifically related to fee arrangements and the calculation of the internal rate of return creates significant challenges for institutional investors like my office and our state retirement plans,” Michael Frerichs said in prepared testimony.

“Private equity firms use different terms, different methodologies around calculating asset values, and different metrics to report on their performance, with some breaking out fees and expenses to investors while others make fee and expense information much harder to identify. This makes evaluation cumbersome and makes direct comparisons between funds nearly impossible.”

Frerichs was one of several speakers during a hearing in front of the Senate Committee on Banking, Housing and Urban Development Wednesday. The hearing, led by Senator Elizabeth Warren (D-Massachusetts), served as a platform for Warren to re-introduce her private equity regulatory bill called the Stop Wall Street Looting Act.

Fee and expense transparency is clearly in regulators’ crosshairs. SEC Chairman Gary Gensler said during separate Congressional hearings the commission is exploring potential stricter rules governing disclosure of fees, expenses and potential conflicts of interest. The SEC can create stricter rules outside of the legislative process.

Representative Ayanna Pressley (D-Massachusetts) urged Gensler during a hearing earlier this month in front of the House Committee on Financial Services to enact stricter regulations on the industry.

“While banks are subject to certain SEC reporting requirements on their private assets, private equity firms do not have to provide that same level of transparency and are not subject to that same regulatory scrutiny, and they benefit from that,” Pressley said.

The industry is facing scrutiny by Congress, both through potential tighter restrictions on how performance fees quality for capital gains tax treatment (which is lower than that of regular income), and Warren’s bill.

LP support

Many LPs support stricter standards for fee and expense disclosure, Buyouts previously reported. Large LP institutions generally are able to use their ability to make large commitments to push for easy and consistent access to financial information. Smaller LP organizations, however, have to negotiate for access to such information, potentially giving up other important fund terms.

This information asymmetry is growing as more administrative costs are being shifted away from the management fee and directly charged to LPs as expenses, according to a recent survey on fund terms by Institutional Limited Partners Association. And as more costs shift directly to LPs, organizational expenses overall are increasing, the survey found.

“The management fee used to be used to keep the lights on … we’re seeing more of those expenses shifted outside the management fee, which [makes] the fee look like another income stream for the manager, rather than just being used to fund operations, as opposed to the manager relying on carried interest to drive their revenue and profit,” Chris Hayes, ILPA’s senior policy counsel, told Buyouts in a previous interview.


At the hearing, Senator John Kennedy (R-Louisiana) badgered Frerichs with a question, that, from outside the industry, makes a lot of sense. Kennedy asked if Frerichs, as a fiduciary, ever invested in a fund with terms he did not understand.

Frerichs said no, after some back and forth, to which Kennedy responded that the federal government should not have to get involved in a contract between an accredited investor and an investment firm. The idea was, LPs can simply walk away if they are not getting the information they want.

But that’s not exactly what Frerichs and others mean when they advocate for stricter disclosure requirements. The need for better and more consistent information goes well beyond the initial headline fees agreed to in the LPA. It has more to do with the gray area of fund expenses, and the changing calculations that impact performance fees.

“Clear and standardized fee and expense disclosures, similar to the template established by the Institutional Limited Partners Association, would allow institutional investors to streamline their analysis and will drive better decision making,” Frerichs said.

“These basic reforms would also reduce the compliance burden and cost, not only on limited partners … but also on general partners being asked to report against a range of varying templates from investors. Investors would also be able to accurately understand and account for general partner fees, fee offsets, and fund expenses in order to verify what they are being charged against what was agreed upon in investment contracts,” he said.

Illinois plans to do more with private equity, which has proven to be a boon for the state’s pension system. “I firmly believe that private equity can help unlock economic opportunity in ways that grow our communities, expand the circle of possibility, and provide excellent, long-term returns for investors like the Illinois Treasury,” Frerichs said.