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The one question all private equity investors should ask

“When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time.”

That’s what SEC official Andrew Bowden said more than a month ago, at a private equity industry conference.

Since then, investor relations staffers at private equity firms report being deluged with calls and email from their limited partners, fielding all sorts of questions about fees and expenses that may not have been enumerated in their original investment contracts. Particularly for funds raised before the financial crisis, when terms were a lot less LP-friendly than they are today.

“Our LPs have become very suspicious, almost overnight,” says one investor relations executive at an East Coast buyout firm. “I really wish the SEC would just sue the firms it thinks are in violation — or announce that they aren’t suing anyone —  because it’s hurting all of our reputations and taking up an extraordinary amount of time.”

So let me try to simplify this for everyone, while the SEC continues to get its enforcement house in order. If limited partners have concerns, they should ask exactly one question:

Please provide a list of all payments in excess of $10,000 which the firm or any individual or organization associated with the firm (e.g., operating partners) has received from its portfolio companies or from limited partners since the fund was formed.

At its core, this is what every limited partner really is asking about. And even though it sounds daunting, any private equity firm with decent accounting controls should be able to compile such a thing fairly easily (if it can’t, then there might be a second question to ask). Moreover, in the long run, it would save IR pros from those countless iterative calls.

Limited partners could then try to reconcile this list with their own inbound payments and fee rebates, to see if their general partners are inappropriately enriching themselves. Or not.

It’s a simple-sounding question, and there certainly is a chance that deceitful general partners would fudge the numbers. Plus, in most cases, such reporting is not contractually required. But sharing such data could help begin to repair what currently is a fractured trust between partners, whether justified or not.

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