This week was released the Obama cabinet’s plan to overhaul the American the financial regulation system. Unfortunately, private equity is not explicitly mentioned and is wraped with hedge funds for the paragraphs dealing with alternative investments. Even if hedge funds managers are protesting, some private equity players have heavily sigh and almost celebrated these measures.
Of course, it is large/mega buy-out fund managers which are the happiest. Not only there is no governmental finger pointed at them, but they just have to register as financial advisers with the SEC. If there is a wonder why, we have to remember that the Geithner’s plan involves a « public-private partnership» where TARP assets were supposed to be acquired by (hint, hint) private equity funds. Those who can buy such things are the mega and large BO fund managers who raised distressed debt funds (the same who lighted the LBO debt craze).
Unfortunately, this could have been an occasion to really set some more than needed measures. One of them is the obligation to use the services of a fund administrator. This did not prevent to have scandals, but at least, a third party is certifying that cash flows are correctly reported.
The second would be to impose a minimum of corporate governance to private equity funds and funds of funds. Among these measures, the obligation to give the names and contact details of the representants of each LP to all limited partners, so that they can directly address some concerns without the imprimatur of the general partners.
That would be a start.
The next step would be to ask the managing directors of general partners to disclose their personal wealth (including direct relatives) before each fund raising. The idea is that to align interests, general partners have to put their own money at stake. Most of them limit their commitment to 1% of the fund, but their personal wealth can make this commitment ridiculously low.
Another step would be a gradual vesting of the carried interest, with no carried for a profit below 6% and 1.2x (net) for example. Then the proportion of carried interest would grow with the marginal increase of profits. In that respect, we have to go beyond the IRR to include investment multiples in every performance evaluation.
On the long term, it is necessary to force general partners to disclose the net performance of each fund that they have managed. That does not harm their business and would put some pressure on the management fees and carried interest level. An additional element would be to require that their due diligence material is audited just like any financial statement.
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