Private Equity Monitoring Fees

In recent years, the Securities and Exchange Commission (SEC) has been investigating
practices surrounding fees charged in the private equity industry. In this case involving private equity sponsor Thomas H. Lee Partners (THL), the SEC alleged that “monitoring” fees charged by THL to the companies it invests in were insufficiently disclosed to limited partners. In particular, when one of THL’s companies is sold or has an IPO, THL sometimes charges a termination fee for its monitoring agreements, and the SEC alleged that these termination fees were not covered in the discussion of monitoring fees in THL’s contracts with its limited partners. Compass Lexecon Senior Consultant Professor Robert Daines was asked to submit a white paper to the SEC discussing the economics of these fees and their disclosure. Professor Daines applied results from academic literature indicating that open-ended contract terms like those between THL and its limited partners are not instances of opportunism, but instead reflect economic efficiency that provide flexibility to the contracting partners to take mutuallybeneficial actions under different circumstances. Professor Daines showed that this is particularly so when, as is the case with THL and its limited partners, the contracting parties’ incentives are well-aligned and there are repeated interactions in which reputation is important. Professor Daines was assisted by Todd Kendall and Jonathan Polonsky in Compass Lexecon’s Chicago office. Compass Lexecon was retained by and worked with Mark Hansen and Daniel Guarnera of Kellogg, Huber, Hansen, Todd, Evans & Figel, PPLC.