The problem with accelerated monitoring fees

Thomas H Lee Partners recently had to pay out $6.5 million over the way it had charged portfolio companies with so-called accelerated monitoring fees.

What was the issue?

The fund documents for two of THL’s funds – Fund V and Fund VI – noted the firm would charge fees to portfolio companies for consulting and advisory services and that “a majority” of these fees would be shared with the funds’ limited partners by way of a management fee offset. What the documents did not contain was an explicit mention of accelerated fees – essentially the lump sum fee paid to THL to cover the remaining term of the consulting agreement when a company was exited early.

The firm did, however, refer to this in a side letter – which was either seen by, or known of, by around three-quarters of the investors. It also noted any payment of accelerated fees in regular reporting to LPs, the Securities and Exchange Commission says.

The receipt of these fees is, in the words of the SEC ruling, “at least a potential conflict of interest” between the manager and its funds, which is why the regulator won’t tolerate it without full disclosure to LPs.

This is not an outlier. Late last year TPG Capital was forced to pay $12.8 million for failure to disclose accelerated monitoring fees. In 2015 the Blackstone Group had to pay almost $39 million — of which nearly $29 million went to affected fund investors — to settle charges it failed to tell investors about accelerated monitoring fees and discounts on legal fees.

Most CFOs I speak to don’t take accelerated monitoring fees, or if they do, tell me it is only acceptable to take fees for a relatively short period of time  – up to the end of the quarter or year, for example.

Why does it matter?

The way fees and expenses are accounted for in private equity has changed dramatically. “This is the reason the expense section has exploded for firms in [limited partnership agreements]; because it is apparent that if you don’t expressly name the item you might charge in advance, then you can’t use the grey to scope in new fees and expenses in the future,” a CFO tells me. “You would need an LP amendment to address any new line item.”

Write to the author: dominic.d@peimedia.com