Henry Kravis, Co-CEO of KKR
By Stephen Gandel
May 29, 2014

FORTUNE — Private equity firms may soon have to open up about the fees they charge.

The Securities and Exchange Commission is looking into whether these firms — which manage funds that buy and sell companies on behalf of wealthy individuals, pension funds, and others — are giving investors a fair share of the money that their investments generate.

“In some instances, investors’ pockets are being picked,” Andrew Bowden, the SEC’s director of compliance inspections and examination, said in a recent speech.

Last week, KKR & Co. had to walk back statements the firm and its founder Henry Kravis had made about similarly named consulting firm KKR Capstone. In the past, KKR and Kravis had called Capstone an affiliate of the giant private equity firm. They now say it is not and never has been. If Capstone were an affiliate, it would have to share the fees it generates from KKR companies with KKR’s investors, something it has not done.

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On Monday, financial blog Naked Capitalism published a dozen partnership agreements between private equity firms and their investors that showed that, at times, particularly in KKR’s case, there was no clear difference between the fees that PE firms shared with their investors and the ones they got to keep for themselves. The documents, though, dated back to 2006, and they could have been revised since then. KKR said they had.

At issue are the fees that private equity firms regularly charge companies that they control for services like management advice or financial restructuring. PE firms collect those fees on top of the money they are already getting to manage the investments in their funds. The PE firms justify those fees by saying they are providing a service that such companies would have to pay to receive from an outside investment bank or consulting firm. That didn’t sit well with some investors. So, a few years ago, private equity firms agreed to split the consulting fees they collect from their portfolio companies with their investors.

The question now is whether those fees are being split fairly.

If PE investors are getting shortchanged, they may have not noticed because these fees are relatively small compared to the overall profits PE firms generate for their investors, or the total fees the firms collect. But such service fees are growing.

In the first quarter alone, KKR (KKR) collected $129 million in monitoring or transaction fees from its portfolio companies. That was up from $49 million in the first quarter of 2013.

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Still, that’s considerably smaller than the $300 million in fees the firm charged its investors overall, and just a fraction of the $2 billion in investment gains generated by KKR in the first quarter, 80% of which it hands over to investors. What’s more, KKR seems to have been more generous, not less, recently in how it splits those service fees. Of the total $129 million, KKR handed over $80 million, keeping just $49 million, or nearly 38%. A year ago, KKR retained 55% of the consulting fees it collected.

Advising and monitoring fees appear to be rising rapidly at Blackstone as well. Though it’s not exactly clear from its public documents how much the firm collects. In one place in its first quarter filing with the SEC, Blackstone (BX) says the firm collected $43 million in fees from “transaction and monitoring fees” from its private equity business. There is no figure for advisory services. And that $43 million is just how much Blackstone kept. The firm doesn’t disclose the total amount in fees it collected or how much it handed over to investors.

But in another place in the same filing, Blackstone says that its net earnings from affiliates for providing “management and advisory fees” was $74 million in the first quarter of the year. Both figures had nearly doubled from a year ago. A spokesperson from Blackstone did not return a request for comment.

Rival PE firm Apollo (APO) said it earned $116 million in advisory and transaction fees from its affiliates. Just $38 million of those fees related to its private equity business. The rest came from its funds that buy and sell debt. Still, the private equity fees were up from $25 million the year before.

This is, of course, just what the firms are reporting in their financial filings. They could be collecting fees from portfolio companies from technically unaffiliated firms. That wouldn’t show up in the filings. KKR Capstone, for instance, is not mentioned in KKR’s latest quarterly filing.

And just because the fees are growing doesn’t mean these firms are ripping off their investors. What’s more, at least for the big publicly traded private equity firms, less money for investors means more money for shareholders. And visa versa. So, you might ask, why does the SEC care?

At a time when private equity firms are earning billions for their investors, few are likely to complain about a couple extra million dollars in fees. So this may all seem like small potatoes, for now. Perhaps the SEC is waving a warning flag to make sure it stays that way.


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