Whistleblower Points To Private Equity Transaction Fees

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According to Crains, a senior private-equity insider filed a whistleblower complaint with the SEC earlier this year. In the complaint he alleges that private equity firms are breaking federal securities law through the fact they are acting as unlicensed brokers when they collect transaction fees. The whistleblower’s name has not been released because the complaint hasn’t been made public by the SEC yet.

Private equity profits and preferential treatment

Private equity firms are among the most profitable businesses on Wall Street. Private equity firms such as KKR & Co. L.P. (NYSE:KKR), TPG Capital and Goldman Sachs Group Inc (NYSE:GS) manage more than $3.3 trillion dollars for pension funds, institutions and individuals. Private equity funds also receive favorable tax treatment.

There have also been recent allegations of impropriety and collusion among private equity funds. A shareholder lawsuit claiming some firms colluded to depress the prices of acquired firms has been cleared to go to trial. The quite substantial fees charged by private equity firms are also being questioned in some quarters. Private equity firms typically charge fees of around 2% of assets under management as well as 20% of investment gains, then throw in transaction and other administrative fees.

Transaction fees represent significant percentage of private equity profits

According to Crains, private equity firms have raked in more than $2 billion in transaction fees over the last decade; fees that basically represent bonuses for undertaking their usual business of buying, turning around and selling companies. This $2 billion in extra fees adds up to a significant percentage of revenues for private equity firms.

Violation of securities laws

According to the whistleblower’s attorney, Jordan Thomas, who put together the whistle-blower program at the SEC and is currently a partner at Labaton Sucharow, these “fees” are clearly against the law. “This is one of the most black-and-white examples of a securities violation that I can recall,” he said. “The widespread, systematic and flagrant nature of these violations is likely to be deeply troubling to the new, more aggressive SEC under Chairman Mary Jo White’s leadership.”

But even if the SEC did decide to take on private equity transaction fees, it would be difficult to really put an end to the practice. As Gregory Brown, a professor of finance at the University of North Carolina’s Kenan-Flagler Business School, points out, “Transaction fees, the subject of the whistle-blower’s complaint, would be difficult for the government to regulate, as the fees are set by sophisticated parties on both sides of the negotiating table.” Furthermore, according to Brown, even if transaction fees came to an end, private-equity firms would almost certainly find other ways to charge clients similar amounts.

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