IOSCO Publishes Final Report on Private Equity Conflicts of Interest

In May 2008, IOSCO published a report identifying potential risks emerging from the private equity industry and outlining how IOSCO intended to address these risks. One of the key risks identified by this report was the potential for material conflicts of interest to exist among the parties involved in private equity sponsored transactions. In light of this the report recommended that further work should be carried out to fully identify those conflicts of interest risks which are particular to private equity and to explore the extent to which these risks are subject to adequate methods of mitigation. This report provides a summary and the conclusions of the recommended follow-up work on conflicts of interest in private equity.

The scope of this report is limited to the risks posed to fund investors or the efficient functioning of financial markets from conflicts of interest which may exist within a private equity firm or within a private equity fund, particularly the potential conflicts of interest that may be faced by the manager of a private equity fund. It generally does not address potential conflicts of interest which are not particular to private equity business, any apparent conflict related to business tensions, or those conflicts which are not within the typical mandate of securities regulators, for example any issues arising from obligations owed by the director appointed by a fund to a portfolio company. However it is, of course, possible that some of the conflicts and risks identified may be present in other industry sectors.

The report sets out the conflict of interest risks encountered through the life cycle of a typical private equity fund which is managed by a multi-fund, multi-strategy firm, as identified by an IOSCO working group formed of industry participants and members of the regulatory community. Potential and common methods for mitigating these potential conflicts of interest are set out alongside the respective risks. Mitigation typically takes the form of alignment of interest through incentive structures, disclosure and legal agreements.

Finally, based on the mitigating measures identified by the working group, this report outlines a set of principles for the management of conflicts of interest in private equity. These principles are intended to be readily applicable to all private equity firms regardless of where they are organised or operating, their chosen investment strategy(ies), fund structure or other investment business activities. However, IOSCO recognises that private equity firms vary considerably in their size, structure and complexity, and this may impact on the applicability of one or more of these principles to a specific firm’s business.