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During period of growing regulatory and investor scrutiny of private equity managers, Leonard Green & Partners is marketing its latest buyout fund, Green Equity Investors VII, with a target of approximately $7.5 billion.1

have recently pressed private equity managers for greater disclosure, particularly on fees, to ensure alignment of interests.

Fee practices employed by Leonard Green on some investments appear similar to those that have recently been scrutinized by the SEC.

that it may charge portfolio companies accelerated monitoring and other fees that have been criticized by regulators and investors, and in certain cases have resulted in cease-and-desist proceedings and large payments to settle charges.

Administration (FAA) show that currently Leonard Green owns three private jets2 for an 3

Leonard Green is facing a competitive environment as some institutional investors are whittling down their number of PE relationships and Preqin reported a record 2,348 private equity funds were in market at the start of the 4th quarter in 2015.4

Key Questions:

• Why did Leonard Green & Partners wait until 2015 to disclose the collection ofaccelerated monitoring fees when it had engaged in the practice at least as far back as2010?

• When does Leonard Green choose to use accelerated monitoring fees? For whichinvestments are accelerated fees appropriate?

December 2015

A Report by UNITE HERE

Michael Pineschi

mpineschi@unitehere.org

916.390.0261

Do Leonard Green & Partners fee practices run against industry trends?Leonard Green’s 2015 Form ADV details practices such as accelerated monitoring fees, private class travel and fees for deal sourcing that other firms are moving away from

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• How has Leonard Green disclosed which fees will offset limited partner managementfees and those which do not? Will Leonard Green itemize fees, expenses andreimbursements for LPs going forward?

• Why does Leonard Green & Partners have three private jets for an investment staff of40? How does Leonard Green disclose payment for costs associated with its privatejets?

• Leonard Green frequently uses co-investment vehicles, which don’t share in expenseswith comingled funds. How will such arrangements change going forward?

Can Leonard Green adapt to the changing landscape?

Leonard Green & Partners is a mid-size private equity firm that has raised around $15 billion in capital.5 Leonard Green typically targets deals between $500 million and $2 billion. Its acquisitions have tended toward the higher end of this range and often focus on retail company investments.6

In May 2014, Andrew Bowden, then-Director of the SEC’s Office of Compliance Inspections and Examinations, gave what became known as the “Sunshine” speech in which he called for greater transparency in how private equity managers report to limited partners, particularly on fees.7 The event marked an increase in regulatory scrutiny on the private equity industry and detailed a number of concerns. Since, the SEC has issued charges, serious fines, and reached s ettlements with asset managers such as Kohlberg Kravis Roberts, and the Blackstone Group.

In addition to regulatory scrutiny on private equity firms, a number of limited partners have pushed for fuller disclosure by private equity managers. In July 2015 around a dozen public pension officials from New York to California wrote a letter to the SEC demanding private-equity funds disclose fees and expenses more frequently and clearly.8 The sentiment was echoed by the Institutional Limited Partners Association, which in October 2015 released a draft template for fee disclosure including itemized expenses, fees charged to portfolio companies and carried interest charged to LPs.9

A review of Leonard Green’s recent Form ADV brochures shows that the manager disclosed practices such as the use of accelerated monitoring fees for the first time this year. Will Leonard Green and Partners continue this and other criticized practices going forward?

Accelerated monitoring fees

Leonard Green’s 2015 ADV brochure added a paragraph not present in its previous brochure stating that Leonard Green may receive accelerated monitoring fees.10 (CC: Flikr User FEDEX)

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Accelerated monitoring fees have been at the center of ongoing debate and regulatory investigation in the private equity industry, most recently in the SEC’s $39 million settlement with Blackstone Group,11 where the SEC alleged that Blackstone had failed to adequately disclose to limited partners the practice of accelerating monitoring fees applying to several years after its exit from a portfolio company.12

An example of this practice is evident with IMS Health Holdings, acquired by Leonard Green (10.7%)13, TPG (62.2%)14, and the Canada Pension Plan Investment Board (CPPIB, 26.1%)15 in 2010.16 At the time, IMS entered into a 10-year management services agreement with the sponsors that specified that the “Managers will provide management services to us until December 31, 2020, with evergreen one-year extensions thereafter,” with an annual management fee of $7.5 million.17

Four years later, when IMS Health went public in March 2014, IMS paid “a one-time fee in an amount equal to $72 million” In conjunction with the company’s IPO.18

The termination fee was equal to at least 10 future years of monitoring discounted to present value, even though there were only 6 years left in the agreement.19 The company also paid an additional $2 million in 2014 in monitoring fees subsequent to the IPO.20

In IMS Health’s 2014 operating income dropped significantly compared to 2013; half of the decline was attributed to accelerated monitoring fees.21 IMS Health’s 2014 10-K explains:

Operating income was $208 million in 2014, a decline of $146 million, or 41.3%, compared to 2013. This decrease was due to $72 million related to the termination of the management services agreement with affiliates of the Sponsors, $30 million of non-executive Phantom SARs compensation expense and other increases in operating expenses discussed above, partially offset by the revenue growth.22

J Crew, another Leonard Green and TPG partnership, was taken private in 2011. Accelerated monitoring fees were built into the management services agreement;23 “This Agreement will continue in full force and effect until December 31, 2021; provided that this Agreement shall be automatically extended each December 31 for an additional year”. Upon termination of the

The termination fee was equal to at least 10 future years of monitoring discounted to present value, even though there were only 6 years left in the agreement.

“Upon the occurrence of certain events (e.g., public offering or change in control), LGP or its affiliated entities may in the future receive (and has in the past received) from a portfolio company an acceleration payment of unpaid monitoring fees payable under the management services agreement with the portfolio company.”

—Leonard Green. ADV Brochure. Form 2A. March 31, 2015. P. 5

“In certain instances, LGP is reimbursed by a portfolio company for expenses incurred by LGP in connection with its performance of the above referenced

or private class travel and meals and such expense reimbursements are not subject to the reduction arrangements described above.”

—Leonard Green. ADV Brochure. Form 2A. March 31, 2015. P. 5

contract, J Crew would pay Leonard Green et al, “Advisory Fees that would have been payable with

prior to such termination.”24

practice.25 In November 2014, Blackstone publicly announced it would no longer use accelerated monitoring fees.26 TPG, a private equity manager and deal partner of Leonard Green reportedly said that it would “return its share of any accelerated monitoring fees by cutting management fees.”27

When the SEC settled with Blackstone in October, Andrew J. Ceresney, Director of Enforcement Division at the SEC said lack of disclosure “will not be tolerated, regardless of the size of your

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• Why did Leonard Green & Partners wait until 2015 to disclose the collection ofaccelerated monitoring fees in its Form ADV when it had engaged in the practice atleast as far back as 2010 and 2011? 29

• Does Leonard Green intend to continue using accelerated monitoring fees in currentand future investments for GEI VII? How will it disclose them to LPs?

Disclosure around private class travel

Leonard Green updated disclosures in its 2015 ADV, adding detail related to reimbursements by portfolio companies, including private class travel.

Leonard Green’s 2014 ADV said31:

“LGP may also be reimbursed for certain expenses, such as travel expenses incurred in connection with a portfolio company, by portfolio companies.”

For 2015, the ADV added detail about types of expenses that are not subject to LP fee rebates to limited partners.

CC: D Ramey Logan.30

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Recent filings with the Federal Aviation Administration show that currently Leonard Green owns three private jets,32 each with a capacity to seat around 20 people, for an investment staff of around 40.33

Leonard Green’s private jets, listed with tail numbers are: N750LG (Bombardier Challenger 600), N850LG (Gulfstream G-IV), and N950LG (Gulfstream G-IV).34

According to the Wall Street Journal’s Jet Tracker tool, a conservative estimated cost for maintaining those private jets after purchase is around $1.5 to 2 million a year, and $5,000 per hour for flights.35 From January 1, 2007 through 2011, the most recent years for which data is available, Leonard Green’s private jets logged over 500 flights.36

In addition, former managing partner Peter Nolan has a private jet registered with his family office, Nolan Capital, tail number N991NB (Gulfstream G-IV).37 Nolan vacated his position at Leonard Green in 2014, and is now acting as a senior advisor for Leonard Green and presumably doing work with Nolan Capital.38 It is unclear if Nolan Capital’s jet is used for work related to Leonard Green business.

• How has Leonard Green disclosed which fees do not offset limited partnermanagement fees? What changes will Leonard Green make going forward?

• How are reimbursements for lodging, private flights, meals and others reported to LPsand how are fee offsets for those disclosed?

Co-Investments

In June 2015, KKR paid $29 million to settle charges with the SEC that it had charged limited partners for deals it pursued but did not consummate, but it did not charge co-investors these fees, including pools of employee capital.39 The SEC said that KKR failed to disclose to limited partners that co-investors were not charged these fees, but still benefitted from KKR’s sourcing of private equity transactions.40

Leonard Green’s 2015 ADV disclosed: “Co-Investment Vehicles do not pay any management fees and any performance-based fees received by affiliates of LGP with respect to the main Funds”.41 The form also states that co-investment vehicles “are typically not formed or capitalized until close to the time a transaction is actually consummated. Therefore, Co-Investment Vehicles have not historically shared in expenses related to proposed transactions that were not consummated. Generally, the applicable limited partnership agreements provide for the allocation of expenses amongst the Funds, on a proportionate basis. ”42

However, Leonard Green often uses side-investments and forms them before any investments are made. For example, in November 2015, Leonard Green registered a side vehicle for its new fund,

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Green Equity Investors VII - GEI Side VII.43 It is unclear if side-vehicles such as the GEI Side co-investments share in costs of main fund due diligence and other costs.

The “GEI Side V” vehicle was used alongside GEI V for investments in IMS Health, J-Crew, and The Container Store.44 Leonard Green used “GEI Side VI” as a co-investment vehicle alongside GEI VI to purchase LifeTime Fitness with TPG in 2015.45

Recent Investments with co-investment vehicles46:

• How are fee arrangements with co-investment vehicles disclosed to investors? How willsuch arrangements change going forward?

• At what point do side-investments begin to share expenses on a proportionate basis?

(Endnotes)1 “Leonard Green targets $7.5 bln for Fund VII”. PE HUB Network. November 7, 2015. https://www.pehub.com/

buyouts/leonard-green-targets-7-5-bln-for-fund-vii/ 2 FOIA with the FAA. Aircraft Registration Renewal Applications Reveal LGP ownership of three jets. N750LG,

N850LG, and N950LG. Also, N991NB belonging to Nolan Capital, with Peter Nolan. 3 Leonard Green website. Firm Professionals. Accessed online November 2015. http://www.leonardgreen.com/

FirmProfessionals.html 4 Preqin Quarterly Private Equity Update, Q3 2015 5 Leonard Green Website. Accessed November 30, 2015. http://www.leonardgreen.com/index.html 6 “12 Retailers In Leonard Green’s Portfolio”. The Street. June 29, 2011. http://www.thestreet.com/

story/11157023/1/12-retailers-in-leonard-greens-portfolio.html 7 SEC, Spreading Sunshine in Private Equity, May 6, 20148 “States, Cities to Ask SEC to Beef Up Disclosures for Private-Equity Firms”. Wall Street Journal. July 21, 2015.

http://www.wsj.com/articles/states-cities-to-ask-sec-to-beef-up-disclosures-for-private-equity-firms-1437522627 9 “Buyouts Snapshot: ILPA template details private equity fees, costs and carry”. The PE Hub Network. October 16,

2015. https://www.pehub.com/2015/10/buyouts-snapshot-ilpa-template-details-private-equity-fees-costs-and-carry/

10 Leonard Green. ADV Brochure. Form 2A. March 31, 2015. P. 5. http://www.adviserinfo.sec.gov/Iapd/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=306371

Company Main Fund Side Vehicles Other Side Vehicles PetCo GEI IV Rover Coinvest I, II, III, IV and VDel Taco GEI IV SAG Brands CoinvestIMS Health GEI V GEI Side V Iceberg Coinvest The Container Store GEI V GEI Side V TCS CoinvestJ Crew GEI V GEI Side V LGP Chino CoinvestKate Spade GEI VI GEI Side VIShake Shack GEI VI GEI Side VI LGP Malted Coinvest

LifeTime Fitness GEI VI GEI Side VI LTF Coinvest LP, LGP Associates VI-A, B

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11 “SEC Charges KKR With Misallocating Broken Deal Expenses: Private Equity Advisers to Pay Nearly $39 Million Settlement”. Press Release. SEC Website. October 7, 2015.

12 “Blackstone Group settles with SEC on accelerating monitoring fees and disclosure”. Pensions and Investments Online. October 7, 2015. http://www.pionline.com/article/20151007/ONLINE/151009883/blackstone-group-settles-with-sec-on-accelerating-monitoring-fees-and-disclosure

IMS Health Holdings, INC. Form S-1/A. Filed March 24, 2014. P. 151. https://www.sec.gov/Archives/edgar/data/1595262/000119312514111498/d628679ds1a.htm

13 IMS Health Holdings, INC. Form S-1/A. Filed March 24, 2014. P. 151. https://www.sec.gov/Archives/edgar/data/1595262/000119312514111498/d628679ds1a.htm

14 IMS Health Holdings, INC. Form S-1/A. Filed March 24, 2014. P. 151. https://www.sec.gov/Archives/edgar/data/1595262/000119312514111498/d628679ds1a.htm

15 IMS Health Holdings, INC. Form S-1/A. Filed March 24, 2014. P. 151. https://www.sec.gov/Archives/edgar/data/1595262/000119312514111498/d628679ds1a.htm

16 “TPG Capital and Leonard Green & Partners to Acquire J.Crew Group, Inc. for $43.50 Per Share in Cash”. PR Newswire. November 23, 2010. http://www.prnewswire.com/news-releases/tpg-capital-and-leonard-green--partners-to-acquire-jcrew-group-inc-for-4350-per-share-in-cash-110139124.html

17 IMS Health Holdings Form S-1/A. Filed March 24, 2014. P. 148 18 IMS Health Holdings Form S-1/A. Filed March 24, 2014. P. 148 19 IMS Health Holdings 10-Q. Filed March 15, 2015. P. 17. http://ir.imshealth.com/sec-filings/sec-filings-details/

default.aspx?FilingId=10987507 20 IMS Health Holdings 10-K. Filed February 13, 2015. P. 92 http://ir.imshealth.com/sec-filings/sec-filings-details/

default.aspx?FilingId=10482692 21 IMS Health Holdings 10-K. Filed February 13, 2015. P. 37 http://ir.imshealth.com/sec-filings/sec-filings-details/

default.aspx?FilingId=10482692 22 IMS Health Holdings 10-K. Filed February 13, 2015. P. 37. http://ir.imshealth.com/sec-filings/sec-filings-details/

default.aspx?FilingId=10482692 23 J Crew Group, INC. Form S-4. Filed June 2011. Exhibit 10.14. P. 4. http://www.sec.gov/Archives/edgar/

data/1051251/000119312511170909/dex1014.htm24 J Crew Group, INC. Form S-4. Filed June 2011. Exhibit 10.14. P. 4. http://www.sec.gov/Archives/edgar/

data/1051251/000119312511170909/dex1014.htm25 “Blackstone to Curb Controversial Fee Practice”. Wall Street Journal. October 7, 2014. http://www.wsj.com/articles/

blackstone-to-curb-controversial-fee-practice-1412714245 26 “Blackstone to Curb Controversial Fee Practice”. Wall Street Journal. October 7, 2014. http://www.wsj.com/articles/

blackstone-to-curb-controversial-fee-practice-141271424527 “Blackstone to Curb Controversial Fee Practice”. Wall Street Journal. October 7, 2014. http://www.wsj.com/articles/

blackstone-to-curb-controversial-fee-practice-1412714245 28 “Blackstone Group settles with SEC on accelerating monitoring fees and disclosure”. Pensions and Investments

Online. October 7, 2015. http://www.pionline.com/article/20151007/ONLINE/151009883/blackstone-group-settles-with-sec-on-accelerating-monitoring-fees-and-disclosure

29 J Crew Group, INC. Form S-4. Filed June 2011. Exhibit 10.14. P. 4. http://www.sec.gov/Archives/edgar/data/1051251/000119312511170909/dex1014.htm

30 Photo cc D Ramey Logan. https://en.wikipedia.org/wiki/Gulfstream_IV#/media/File:GULFSTREAM_g450_photo_D_Ramey_Logan.jpg

31 Leonard Green & Partners, ADV brochure, Form 2A, April 14, 2014, pg. 4.32 FOIA with the FAA. Aircraft Registration Renewal Applications Reveal LGP ownership of three jets. N750LG,

N850LG, and N950LG. Also, N991NB belonging to Nolan Capital, with Peter Nolan. 33 Leonard Green website. Firm Professionals. Accessed online November 2015. http://www.leonardgreen.com/

FirmProfessionals.html 34 Information provided by the FAA in response to a FOIA request. Aircraft Registration Renewal Applications

Reveal LGP ownership of three jets. N750LG, N850LG, and N950LG. Also, N991NB belonging to Nolan Capital.35 WSJ JetTracker data from 2007-2011. Accessed online November 2015. http://projects.wsj.com/jettracker/. 36 WSJ JetTracker. Accessed online November 2015. http://projects.wsj.com/jettracker/. 37 Information provided by the FAA in response to a FOIA request. Aircraft Registration Renewal Applications Reveal

LGP ownership of three jets. N750LG, N850LG, and N950LG. Also, N991NB belonging to Nolan Capital.38 “Managing Partner of Leonard Green to Step Down”. New York Times Dealbook. April 8, 2014. http://dealbook.

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nytimes.com/2014/04/28/managing-partner-of-leonard-green-to-step-down/?_r=0 39 “SEC Charges KKR With Misallocating Broken Deal Expenses”. Press Release. SEC Website. June 29, 2015. http://

www.sec.gov/news/pressrelease/2015-131.html40 “SEC Charges KKR With Misallocating Broken Deal Expenses”. Press Release. SEC Website. June 29, 2015. http://

www.sec.gov/news/pressrelease/2015-131.html41 Leonard Green. ADV Brochure. Form 2A. March 31, 2015. P. 4. http://www.adviserinfo.sec.gov/Iapd/Content/

Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=306371 42 Leonard Green. ADV Brochure. Form 2A. March 31, 2015. P http://www.adviserinfo.sec.gov/Iapd/Content/

Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=306371 43 State of Delaware. Department of State: Division of Corporations https://icis.corp.delaware.gov/Ecorp/

EntitySearch/NameSearch.aspx 44 According to SEC 10-K filings from the companies. 45 LifeTime Fitness, INC. Form Schedule 14A, filed April 30, 2015. P. 8. 46 SEC Regulatory Filings: PetcoHoldings S-1A filed September 24, 2015 09 24. Del Taco DEFA 14-A filed march

12, 2015. LGP Associates VI-B Form D filed June 23, 2015. LGP Associates VI-A form D filed June 23, 2015. Kate Spade & Co Form 8-K filed December 10, 2013. J Crew Group Form 10-K filed March 20, 2013. Shake Shack, Johnathan Sokoloff Form 4 Filed December 7, 2015. IMS Form 10-K filed February 13, 2015. LifeTime Fitness from DEFM 14A filed April 30, 2015. LTF Coinvest LP Form D filed June 23, 2015. LGP Associates VI-A, B Form D filed June 23, 2015.