The US Securities and Exchange Commission has been very clear that private equity firms’ track records will be scrutinised under the new regulatory regime imposed by the Dodd-Frank Act. While the possibility of increased government oversight may cause consternation for some private equity firms, there may be a silver lining.
“Putting ‘regulatory’ and ‘positive impact’ in the same sentence is difficult, but this could be the impetus for the standardisation of reporting of IRRs around fundraising,” Pricewaterhouse Coopers partner Tim Hartnett said at a Debevoise & Plimpton and Private Capital Research Institute panel Wednesday.
The variety of methods used to calculate fund returns has led to a proliferation of firms that market themselves as top-quartile performers. Limited partners have a tough time distinguishing true top-earners from more dubious claims of high rates of return – particularly as firms market new funds. While establishing standardised reporting would be difficult to implement, it could also lead to a greater level of clarity, according to the panel.
The process by which this could occur is considerably less clear. Dodd-Frank and Europe’s Alternative Investment Fund Manager Directive provide little guidance as to how firms should go about reporting track records, Debevoise & Plimpton partner Michael Harrell said.
“When you dig down though, neither the reporting in the US … nor the reports under the AIFMD actually tell you how to report performance,” he said. The new regulations are even less clear on how firms should weigh the performance of their portfolio companies, he added.
The SEC’s focus on how private equity firms market and calculate their track record was highlighted at the Dow Jones Private Equity Analyst Outlook conference last month. The agency formed a team to examine alternative investments, including private equity, in 2010.
“We’re cognizant of the fact that … GPs have some discretion on how they value the portfolio, but valuation is still subject to the fiduciary duties the GP owes the fund,” said Chad Alan Earnst, Assistant Regional Director with the Asset Management Unit in the SEC’s Division of Enforcement. “This market is tough to raise capital and we expect to see even more valuation issues.”