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Gary Gensler is a former Goldman Sachs partner who was widely regarded as a reformer during his tenure as Chairman of the Commodity Futures Trading Commission. Although the secondary regulators are disadvantaged in accomplishing most of the work, he seems to have adopted a slow and cautious approach. Designed to combat the abuse of private equity. We will soon turn to the seemingly friendly speech that Gensler just gave at the Institutional Limited Partners Association.

Gensler stated that he has instructed SEC staff to investigate what we have described for years of abuse by private equity centers: investors know nothing about the total fees they pay because private equity fund managers directly exclude various fees. Portfolio companies in the fund. They will not even pretend that these fees are for the services provided. A favorite example is monitoring expenses. We first released the video “Money for nothing” by Oxford professor Ludovic Phalippou in 2016. Phalippou reviewed the so-called oversight agreements that portfolio companies must sign with their new private equity giants. The whole video is worth watching, the key part starts at 8:00:

The following is Phalippou’s translation of the service agreement:

I may do some work from time to time
I do some work as long as I like it. Subjective translation: I will not do anything.
I’ll get it [in this case] No matter how much I decide to work, at least 30 million dollars a year. Subjective translation: I don’t do anything, and earn 30 million US dollars per year for this.
If I decide to do something, I will charge you extra
When I go out (or not out), I can stop charging, but if I do, I will get all the money I should have received from then to 2018.

Please note that even in 2016, private equity firms engaging in corruption and various other misconducts are not news. The shocking thing in the past and now is that, like investors, money has not stopped it.

In May 2014, Andrew Bowden, the SEC’s head of enforcement, gave a speech that seemed to imply that the SEC intends to truly use its new powers under Dodd Frank to supervise private equity firms as an investment advisor. Bowden explained that a preliminary review by the US Securities and Exchange Commission found that more than half of the companies under review had serious abuses of power, including what is known as theft in other industries. Privately, the agency stated that, unlike other areas, abuse of power is more frequent among the largest participants.

This simultaneous release was driven by a wave of news disclosures: Gretchen Morgenson of the New York Times and Mark Maremont of the Wall Street Journal conducted in-depth exposures. Your humble blogger also has some digging.

As we reported at the time, this manifestation of determination was quickly withdrawn. Yes, the US Securities and Exchange Commission has done a good job with large companies, and it is usually a typical abuse of a large company you have heard of. But the agency is clearly in a “one-and-for-all” mode. Bowden acted as if he really believed that these alpha predators were caught because they made honest mistakes, and now they know more, they will fly correctly, and investors will supervise them.

Less than a year after Bowden delivered his famous speech, he participated in a panel at the Stanford University Private Equity Conference.He not only pleases the industry, but also He even said he told his son that he should work in this industry, Leading the audience to provide him with work. As reader JohnnyGL said, “It’s like we’re watching the revolving door really spin in front of us.” Three weeks after we released that video, Bowden resigned.

Increasing work by Eileen Appelbaum and Rosemary Batt, as well as benchmarking expert CEM, continues to prove that there is a lot of abuse. Investors still don’t know the cost and The cost in terms of expenditure. Since almost all private equity investors are fiduciaries, this should prevent them from investing funds in private equity. One of the duties of the trustee is to evaluate the reasonableness of expenses and their impact on returns. You cannot evaluate the black box. Even so, Professor Phalippou still put forward a rough estimate, that is, the total cost of private equity is 7% of fees and expenses per year. CalPERS confirmed this level at the 2015 Private Equity Conference sponsored by CalPERS.

Since it takes a long time to open the package here, investors continue to show advanced cases of Stockholm syndrome. For example, it is shocking that in 2015, a panel of 13 major government trustees asked the SEC to intervene, effectively asking the agency to protect them like retail investors. As we wrote at the time:

There is nothing like an elected official writing to a weak institution and asking it to go beyond its power to cover up the fact that they are unwilling to do their job…

In this sad case where state and city officials are in charge of three things, the only good news is that it shows that they feel the need to be seen as an abuse of private equity.

Believe me, I will keep many chapters for you in this regrettable history.

So why is Gensler’s speech an unexpected and truly hopeful sign?

The first is that Gensler has a good track record as a faceless reformer. As a former partner of Goldman Sachs, he is already very rich, and the point is that unlike many people who do well in the financial sector, Gensler is also enough. He seems to be particularly cherished from Goldman Sachs in the age of partnership (back to the Stone Age, when Wall Street was only on the edge of crime): an emotionally mature, intelligent, hardworking, and inconspicuous person in their private lives. In my time, compared with the dull and stubborn people who made a lot of money for the company and were content to be respected in the company, people who were divorced and drove a luxury car were less likely to become partners and train to do well anytime soon. Good kid, or at least not messed up.

I feel compelled to say that because too many people have entered the Manichae model and acted as if anyone who worked for (the large financial company that filled the gap) had to be contaminated. In fact, if you have not been to the kitchen or at least not close to the kitchen, it is difficult to know how the secret sauce is made.

Some members of the public may have underestimated Gensler because he still has a baby face and plays naively. Although it may be more gratifying to see Elizabeth Warren and Katie Porter shine, as single lawmakers, their best weapon is their domineering forum. In contrast, Gensler, as a supervisor with staff and the ability to collect fines and submit cases for prosecution, has greater powers. But deploying it, especially in the SEC, is tricky, because the victim of SEC enforcement may complain to members of Congress seeking to cut the SEC budget.

I admit that I have seen Gensler give a seemingly innocuous speech, but he seems to have no plot. But this speech took a very clever approach. It anchors the SEC’s requirements for private equity on the principle of impeccable. The industry can hardly disagree with Gensler’s motherhood and apple pie stance, and some very obvious and unwelcome consequences arise from this.

I strongly recommend you to read Gensler’s highly understandable full text of the speechPlease note that he made it a meeting of the Institutional Limited Partners Association. ILPA, as the industry claims, is another symptom of private equity capture.It nominally represents investors, limited partners, but The vast majority of its budget comes from private equity firms.

Gensler almost cutely asked fund managers if they knew enough about their private equity expenses, as if the question was even a bit suspicious. Then he drove the knife in:

These fees can add up to 3-4% in private equity and 2-3% per year in hedge funds…

This may not even include other fees charged by private equity funds from limited partners and portfolio companies. These may include consulting fees, consulting fees, monitoring fees, service fees, transaction fees, director fees, etc…

. Hundreds of billions of dollars in fees and expenses exist between investors and businesses.

More competition and transparency may bring greater efficiency to this important part of the capital market. This may help reduce the cost of capital for companies to raise funds. This may increase the return of pension and endowment funds behind limited partner investors. This can ultimately help workers prepare for retirement and families pay for college education.

This is why I ask the staff to consider what suggestions they can make to increase the transparency of the cost arrangement.

Then Gensler revealed that he was more involved than the “aw shucks” setting he was intoxicated with. Next, he will look for the accompanying letter.As we discussed based on an important new paper by law professor William Clayton, private equity investors Put in more effort and try to get a better deal through the attached letter It is different from the basic contract, which is the “limited partner agreement.” Investors behaved strangely as if it was okay to let all other investors bundle and cut better arrangements, because many also signed “most-favoured-nation” agreements, and they got all the special terms that any low-dollar investor would get.

But the biggest flaw is that only the largest investor can get all the benefits from all these side transactions. In addition, as Clayton pointed out, general partners can pretend to be cute instead of being completely frank with all the content provided by the accompanying letter.

Gensler did not touch on the dirty details in the conversation, but made it clear that he was not keen on the accompanying letter that caused some investors to obtain better financial transactions than others:

Each limited partner may be negotiating their own transaction.

Some of these accompanying letters are benign…However, other accompanying letters can create preferred liquidity clauses or disclosures…

Therefore, I have asked the staff to consider suggestions on how to compete fairly and enhance transparency, or whether certain incidental clauses should not be allowed.

Compared with what happened next, this is benign. Gensler does not like that investors have to rely on performance data prepared by general partners. They have no standards on how to calculate the numbers. Recall that not only this humble website, but even respected investors like Howard Marks pointed out that more and more gimmicks are making financial performance comparisons through the so-called fund-level leverage of subscription credit lines. Meaningless.

From Gensler again:

There is controversy as to whether private equity performs better than the public market after deducting expenses, or considering leverage and liquidity… The basic facts about private equity funds are not so easy to obtain-not only for the public, but even for investors themselves.

Regardless of the overall economic debate… it may be beneficial to provide investors with funding to increase the transparency of performance indicators. I have asked the staff to consider what we can do to increase this transparency.

Gensler is also dissatisfied that private equity funds require investors to waive their fiduciary responsibilities. The head of the SEC made it clear that in terms of federal fiduciary duties, this is absolutely prohibited. The small problem in history is that only the SEC has the authority to enforce these fiduciary obligations.

The general partner has become accustomed to the SEC falling asleep in this regard. The SEC can easily carry out a wide range of strikes.

Gensler also dislikes that general partners often seek and obtain exemptions from fiduciary duties at the state level. Unless a state’s trust law provisions are stricter than those at the federal level, it is difficult to see that state law exemptions will not infringe federal law’s fiduciary obligations. I hope that the SEC has some very smart people thinking about this issue.

Gensler hinted that he was only asking his employees to investigate these issues. I suspect that he will go public before he is sure enough that the agency will do something. Let us hope that he will continue his supervising school of “speaking softly”.