the glamorous image Private Funds promote

The publication of a document form the American Securities and Exchange Commission into the activities of private equity and hedge funds (private funds)  came two days before the DWP called for evidence on the AE charge cap.

You can read the document entitled “Observations from Examinations of Investment Advisers Managing Private Funds” here

The document is a catalog of unsavory practices committed by the managers/advisers of private equity and hedge funds. It should be submitted to the DWP as evidence that the public needs protection from parts of the fund industry.

Writing on the document in the FT, Chris Flood provides a precis of the document, highlighting each area where the SEC finds abuse of the fiduciary duties of these advisers to their customers.

The US markets regulator has rebuked private equity and hedge fund managers for overcharging investors and secretly favouring their high-paying clients over other customers in clear contravention of existing regulations.

The criticisms by the Securities and Exchange Commission will intensify debate over whether investors are being treated fairly by the handful of super-wealthy Wall Street barons who have accumulated multibillion-dollar fortunes by running opaque private equity strategies and hedge funds.

Private equity in  workplace pensions

There has been pressure on Government to allow private equity and hedge funds to play a part in the management of the workplace pension default funds. If they were to , then the practices identified by the SEC must stop and the excess- costs that the advisers to these funds incur, will need to be properly disclosed and managed within the cap.

The SEC refer to their report as a “Risk Alert”  , it discusses three general areas of deficiencies identified in examinations of private fund advisers:

(A) conflicts of interest, (B) fees and expenses, and (C) the abuse of insider information known as material non-public information (“MNPI”).

Conflicts of interest

1. Conflicts related to allocations of investments; causing certain investors to pay more for investments or not to receive their fair share of such investments.
2. Conflicts related to multiple clients investing in the same portfolio company; clients were found to own debt and equity in the same company, without knowing it.
3. Conflicts related to financial relationships between investors or clients and the adviser
4. Conflicts related to preferential liquidity rights where side deals were done for preferred investors
5. Conflicts related to private fund adviser interests in recommended investments; some advisers were found to have stock options or investment fees in the companies within a fund
6. Conflicts related to coinvestments; where co-investors got rights not disclosed to ordinary investors in the fund
7. Conflicts related to service providers.; abuses relating to kickbacks
8. Conflicts related to fund restructurings; where advisers profited from non-disclosure to investors of their options
9. Conflicts related to cross-transactions; where assets were bought and sold to the benefit of advisers and without proper disclosure to fund holders

Fees and Expenses

There is a similar list of abuses for the

1. Allocation of fees and expenses; certain costs were mis -allocated causing certain investors to overpay and others to underpay
2. Fees charged to clients that weren’t listed in the investment agreement
3. Fees that broke agreed limits
4. Advisers not following their own expenses policies at cost the the fund
5. Misleading investors over the costs of “operating partners” within invested companies
6. Over-valuing holdings to increase advisor “carry” fees
7. Abuse of Monitoring / board / deal fees and fee offsets, typically through non or partial disclosure

MNPI / Code of Ethics

Another area of concerns highlighted by the SEC was the misuse of MNPI. The regulator noted failures by private fund managers to address the risks posed by their employees interacting with corporate executives or other insiders at publicly traded companies that would have access to sensitive information.

It noted that some private fund advisers failed to establish or enforce code of ethics provisions designed to prevent the misuse of MNPI. These lapses allowed some staff to deal in securities on so-called “restricted lists” which were supposed to be off-limits for personal account transactions.

The complex structures of private funds make abuse easy

This is why private equity is so lucrative to advisers

Although the world of private funds seems grown up and glamorous, they carry with them risks , identified by the SEC, that would undoubtedly be present if private funds found their way into the defaults of workplace pensions.

Private equity seems to prey upon the weakness of buyers and as the OFT and lately the FCA have observed, there are few weaker buyers than those of workplace pensions.

Whether we define buyers as platform managers, trustees , employers or ordinary savers. there are lucrative pickings within UK DC for the unscrupulous private fund manager/adviser.

It is particularly dangerous to admit private funds into workplace pensions where the cap does not include transaction costs and other hidden fees.

This is why workplace pensions are so vulnerable to private equity

The advisers to private funds are articulate, insistent and without scruples. Currently they are presenting themselves as holding keys to more stable returns, higher returns,  greater impact and social purpose, even ESG.

But so long as these funds are private, they are opaque and we savers are vulnerable. Many of the workplace pension defaults are now of a size that they loom in the sites of private fund marketing teams. The insistent , articulate arguments of the private funds will be hear louder as the funds continue to grow. The insistence will be all the greater as the opportunities to sell into DB pensions diminish.

It is understandable when your default fund becomes a billion pound enterprise for a workplace pension fund to start looking at the glamorous grown up world of private funds, but they should resist. It is our money and if we can’t see what is happening to it, platform managers and trustees have even greater fiduciary responsibility.

If it came to it and I had to back a private fund adviser against the CIO of a workplace pension manager, I’d back the private fund adviser to win most times.

So please, let’s not go there.

the obscurity is part of the glamour