Can a fund manager save the investors money, but still be doing the wrong thing? That’s the issue presented by the Securities and Exchange Commission’s look at group purchasing programs for private equity firms.
Buying in bulk usually results in cost savings. A private equity firm, with a collection of companies in its portfolios, should be able to save money by pooling the purchasing power of the combined companies.
That’s savings to the portfolio companies and savings to the investors in the funds. But the fund manager may be earning fees from the group purchasing program. That’s good for the fund manager and does not affect the investors.
A recent article in the Wall Street Journal highlights the SEC’s Concern: Buyout Firms’ Fees Come Under Review. A group purchasing provider charges a fee to vendors and may share a portion of the fee with the private equity firms. According to the article, Blackstone saved over $700 million for its portfolio companies over the last seven years. Blackstone between 2011 and 2013 received roughly $7 million in fees from a company that negotiates those discounts for its portfolio companies.
The first problem is one of disclosure. If the extra fee income is disclosed to investors in the funds, then the problem largely goes away. If the extra income to the fund manager is not disclosed, then there is a potential problem. But just a potential problem. The SEC needs to prove that the fee violated the Investment Advisers Act or is somehow fraudulent, deceptive or manipulative. Earning money from investors that is not disclosed is a problem. Even if it saves investors money.
The other group purchasing issue is having the portfolio companies buy products and services from each other. The bigger problem there may be companies selling across funds managed by the private equity firm. That’s moving money from fund to fund.
The second prong after disclosure (or lack thereof) is putting a control in place to ensure each company is getting the best product at the best price. If the portfolio company is forced to buy an improper product at an inflated price, that’s a problem.
Proving cost savings will make the fund manager look better in the eyes of its investors and regulators. But update the documents to disclose the extra fee income.
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