After KKR & Co. L.P. KKR , The Blackstone Group L.P. BX became the second large private equity firm to settle with the Securities and Exchange Commission ("SEC") in relation to charges over fee practices. The company agreed to shell out $39 million in fines to resolve regulatory claims for not maintaining a reasonable level of transparency in its disclosures.
According to the SEC, Blackstone Management Partners, Blackstone Management Partners III and Blackstone Management Partners IV failed to notify fund investors regarding the increased rate of monitoring fees paid by fund-owned portfolio companies before their sale or initial public offerings.
Moreover, the fund investors were not informed about the business discounts for services from an outside legal firm, which were not extended to the fund investors. In short, Blackstone was charged by the SEC for putting its own interests ahead of investors. Nearly $29 million of the settlement will be distributed to the affected fund investors.
"The payments to Blackstone essentially reduced the value of the portfolio companies prior to sale, to the detriment of the funds and their investors," the SEC said. Though Blackstone did not admit or deny the claims, the company agreed to settle the charges.
"Our clear message to the entire private-equity industry is that this is an area of great risk, and that whatever the success of the fund over time, hidden or inadequately disclosed fees will not be tolerated regardless of the size of the adviser," SEC Enforcement Director Andrew Ceresney said.
The $3.5 trillion private equity industry managed to evade the SEC for around 30 years with their opaque and complex organizational structures. The financial crisis of 2008, however, changed everything. The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in 2010, which in turn empowered the SEC against the private equity firms by making it mandatory for firms worth $150 million or more to register with the SEC.
This helped the U.S. regulator to keep a close watch on these firms. Scrutiny of more than 150 private equity firms since 2012 detected compliance shortfalls and violations of law in over half of the firms. The SEC believes that eradicating the inherent lack of transparency in disclosures by the private equity firms will help protect investors' interests.
Further, the SEC's efforts to uncover the hidden fees charged by these firms caught on with the investors as well. They started questioning the levels of disclosure regarding fees, allocation of fees and so on. This due diligence on part of both investors and SEC resulted in the forgoing of additional consulting fees by Blackstone last year.
Also, members of Private Equity Growth Capital Council including large buyout firms like Carlyle Group LP CG , Apollo Global Management, LLC APO along with Sun Capital Partners Inc. and Thoma Bravo LLC came forward and made early revisions and revealed in the filings that they charge hefty fees in the form of monitoring fee accelerations for undelivered services.
"This SEC matter arose from the absence of express disclosure in marketing documents, 10 or more years ago, about the possible acceleration of monitoring fees, a common industry practice," Blackstone spokesman Peter Rose said in a statement. "Each accelerated fee was, however, as the SEC order acknowledges, disclosed when received and our limited partner advisory committee did not exercise its right to object. Moreover, Blackstone voluntarily made changes to the applicable policies well before this inquiry was begun."
Currently, Blackstone holds a Zacks Rank #4 (Sell).
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.