naked capitalism

It is long overdue, but big institutional investors are finally rebelling against the outsized fees charged by large private equity firms. Since the moneybags are an understated lot, their protest, so far, looks rather tame. But by the standards of this clubby world, this is still a serious move.

Originally, when funds were smaller, the typical 2% annual fee was meant to cover overheads (including staff salaries), with the performance fees (typically 20% of the upside, with no benchmarking against inflation or prevailing interest rates) meant to constitute the meaty reward. But for a $5 billion fund, the annual fees are $100 million, meaning the top dogs have a very handsome living just for showing up in the morning. That’s before the fact that they also charge transaction fees (only a portion of which is plowed back into the fund) and sometimes “consulting” fees to portfolio companies.And the outsized comp for PE firms and hedge funds serves to justify high pay levels for Wall Street firms (the threat being that the “talent” will decamp for these greener pastures if they don’t get their way).

Although investors have been unhappy about fees for some time, this salvo shows a new level of seriousness. Predictably, however, the Wall Street Journal spins the story in favor of the industry, starting with the headline, “Investor Principles Rankle Buyout Shops“:

Having played nice for years, private-equity firms and their investors—pension funds, endowments and foundations—are exchanging punches over the terms and fees paid to buyout shops… the Institutional Limited Partners Association, calls for big changes in the hidebound ways of private equity. The principles, which call for suggested caps on fees, increased disclosure, and greater investor oversight, have rankled some buyout executives. Some have complained that the investors are illegally conspiring against them. ILPA denies it.

The investor group has outsize influence, with 215 members controlling more than $1 trillion in private-equity assets. The principles are a rare show of strength among limited partners, who have historically caved to demands of private-equity firms. Though the terms aren’t binding, ILPA hopes the “wish list” of fund terms will level the playing field…

at least three large private-equity firms have retained outside counsel to examine potential antitrust issues. A spokeswoman for law firm Boies, Schiller & Flexner LLP said that a large private-equity client has hired it to examine the issue.

Yves here. David Boies is America’s top anti trust litigator (first the never-ending IBM suit, then acting for the Department of Justice on the Microsoft), but this is ridiculous. The big PE firms engage in what amounts to cartel pricing, and they are going to hire a fancy attorney to rough up their biggest meal tickets? Yet another example of industry sociopathy in action. Back to the article, which spills more ink dignifying this idea than it deserves before noting:

Kathy Jeramaz-Larson, executive director of the Toronto-based ILPA, says the organization’s lawyers have vetted the principles and there are no antitrust issues. She points out that there aren’t any specific terms in any of the documentation…

One of the more contentious issues relates to fees. The principles state that management fees “should cover normal operating costs for the firm and its principals and should not be excessive.”

Also, the principles suggest that all additional fees charged—such as so-called deal fees that firms pay themselves for completing a transaction—should accrue solely to the investors rather than split between the investors and the private-equity firm…

“The firms shouldn’t use management fees as profit centers,” Ms. Jeramaz-Larson said. “We want them to make their money off of the carry,” a reference to the 20% of a fund’s profits that private-equity firms normally charge.

Some changes already are afoot. For instance, Blackstone Group LP has cut it fees on a new fund planning to invest in infrastructure deals, reducing the carried interest—the percentage of profits paid out to the firm—to 10% from 15%. Goldman Sachs Group Inc. made a similar move with its latest infrastructure fund, reducing the so-called carry from 20% to 10%.

Buyout executives acknowledge that there even if there are legal problems with ILPA members’ conduct, there is likely to be little sympathy for the plight of private-equity firms.

“Even if there was an antitrust problem from a legal perspective,” said one senior private-equity executive at a large firm, “I don’t see the Justice Department coming to the rescue of Henry Kravis and Stephen Schwarzman.”