I hope readers forgive me for going a bit heavy on private equity coverage this week, but with markets complacent and Congress out of session (the House is back from recess as of today), the timing is fortuitous for pursuing this topic more intensely than usual.
We’ve had a surprising run of stories showing that the private equity industry, which heretofore has been treated with considerable deference, isn’t all its cracked up to be. Following hard on the heels of an astonishingly direct SEC speech in early May setting forth a bill of particulars of industry abuses, the Wall Street Journal published an important article by senior reporter Mark Maremont questioning industry leader KKR’s dealings with its house consulting firm KKR Capstone violated its agreements with investors. If KKR gets away with it, it will only be by virtue of an opinion letter from Linklaters, the same firm that blessed Lehman’s Repo 105 ruse.
A mere two days after that, over Memorial Day weekend, Gretchen Morgenson of the New York Times reported on fee abuses that are common, if not widespread in the private equity industry, including getting fees for services never rendered. And as most readers know, we released 12 private equity limited partnership agreements Monday evening. While our document publication is unlikely to register as significant to the broader public, it is a seismic event for the private equity industry, since it demonstrates conclusively that their claim that theses heretofore super-secret agreements be kept confidential to preserve critical trade secrets is an utter sham.
Curiously, the private equity firms do not appear to be reacting to these stories. One indicator is that the documents we revealed, which were made public by the Pennsylvania Treasury, are still up on its e-contracts website. The limited partners would clearly be in their rights to demand that they be taken down pronto. Even if these horses have left the barn and are now in the next county, failure to act promptly in this instance could send the wrong message to industry incumbents. However, Lambert pointed out that the mechanics for Pennsylvania to take the contracts down could be more cumbersome that outsiders might anticipate.
Admittedly, the clustering of breaking news around a weekend where anyone who is anyone in New York City decamps to the Hamptons may have caught the private equity general partners flatfooted. And they may also hope that the holiday timing blunts the impact of these stories, so if they lay low, this will blow over.
But while one robin does not make a spring, one reporter’s reaction indicates that the sudden exposure of new information about the private equity industry is leading to some serious reassessment.
Dan Primack is a seasoned reporter on the private equity beat, having launched the peHUB publications for Thomson Reuters before he joined Fortune in 2010. Primack now has a broader reporting ambit than before, but he still covers private equity.
One of the cliches of journalism is that reporters are only as good as their sources. Over the last decade, both business and government officials have used that to their advantage to play the access journalism game. Any reporter on a comparatively narrow beat can easily become hostage to his sources, and Primack’s recent articles on private equity gave reason to think he fell into that camp.
David Sirota at Pando has been all over a private equity pay to play scandal in New Jersey which has broader political ramifications, since it involves both Chris Christie and Massachusetts gubernatorial candidate Charlie Baker. Sirota and Primack have had some Twitter dust ups as well as running articles with diverging viewpoints (without directly acknowledging them as dueling perspectives).
For instance, Primack ran a reasonable-seeming piece on a critical element of the story, whether Charlie Baker was guilty of violating SEC and New Jersey rules on exactly what constituted pay to play. The account was useful in delineating the Federal v. state regulatory differences. However, the Primack story was also based heavily on input from Charlie Baker, and the subhead to the story seemed a tad generous: “It’s not really his fault, but now he has only himself to blame,” based in large measure on Baker’s claim that he was not an employee of the private equity firm in question, General Catalyst, but an “executive in residence”. If you read the piece, Primack was careful to delineate that it appeared Baker was not an employee, but he also stressed that he had asked Baker and General Catalyst for proof in the form of a copy of Baker’s contract with General Catalyst. Both Baker and General Catalyst refused, invoking the tired trade secret excuse (which Primack parenthetically pooh-poohed).
Sirota hit back with a piece showing that he had located 33 documents in the relevant time frame that listed Baker as an employee of the firm in question, General Catalyst. As you can see, the “was he or wasn’t he” issue will be subject to as much tortured legal wrangling as the question of whether KKR Capstone is or isn’t an affiliate.
Mind you, I’m not trying to arbitrate this dispute. And in fairness, Primack broke a straight-up-the-center piece after this exchange, that the New Jersey pension system was seeking an independent legal opinion on whether General Catalyst had broken pay-to-play rules (Primack’s earlier reading was that it probably had). But it’s not hard to surmise that Primack, if nothing else than by virtue of covering this industry for a long time, has become predisposed to its way of thinking but actually does try to get his hands on evidence.
I was gratified last night to see him take early notice of our limited partnership agreement release on Twitter and recognize it as significant. At the same time, he seemed to fall in with probable industry defenses, namely, that the language in the actual KKR documents related to KKR Capstone wasn’t a big deal, but an investor tax violation looked serious. In other words, his initial tweets suggested he regarded the documents as more of a problem for the limited partners than the general partners! I gave a bit of pushback on Twitter, but I’m not one for protracted conversations via that medium.
So I was surprised and gratified to see the next morning that Primack had given the my post and the underlying documents a serious read and had revised his views in a big way, starting with his headline: Will private equity investors keep getting their pockets picked?. Mind you, this is more significant than you might realize, since most people are attached to their existing beliefs. He provided solid summaries of our post and the Morgenson article, including her money quote from an SEC official, “In some instances, investors’ pockets are being picked.”.
My understanding is that the SEC thinks the following is happening, broadly speaking: LPs and their attorneys negotiate the LPA, and include all sorts of fee rebates. And then the LPs let their (outside?) accountants handle the incoming checks from the GP. What doesn’t apparently happen is any reconciliation between what the LP is owed from the GP (per the LPA) and what actually gets paid. Perhaps because the LPAs are written in such tortured language that the average accountant would likely give up. Thus the massive potential for pocket-picking….
It remains entirely unclear if the SEC will or won’t act on the alleged abuses that it has found (and I can almost assure you that even more of these will leak within the next few weeks). But if LPs believe they’ve been dupes, then they do have the power to collectively stand up and demand LPA amendments and/or reparations… After all, fiduciary responsibility should outweigh embarrassed ego
Primack has thrown down a guantlet: either limited partners should insist on much more stringent protections as a condition of future investment, or tell the public that they are really on board with how general partners (mis)treat them. The problem is the latter position exposes them to considerable reputation loss if (as we anticipate) more disclosures of abuses become public.
Why am I focusing on this from a media perspective? There are two reasons. One is to confirm that these revelations really are shocking. For an industry reporter like Primack to call out this behavior is confirmation that it really does look poor. But there’s a second layer, which is that heretofore in private equity, industry incumbents have controlled the news flow almost completely. The scandals and hot stories are ones that tend to involve scandals or successes at particular firms, such as the mega-bankruptcy of the company formerly known as TXU, which was a TPG/Goldman Sachs buyout, or industry jousting (who is up or down in various rankings, who succeeding in closing a major fundraising, etc.). So it’s encouraging to see someone who could potentially be an Andrew Ross Sorkin in the wings acting in an independent manner when presented with new information.
Now as we indicated, the private equity firms look to be sitting these stories out thus far. It will be interesting to see them saddle up and try to explain their way around the evidence presented so far and the ones that will be coming out soon.
The more these kingpins stick with to their current approach, that of highly technical defenses, the clearer it will become that their profit model depends less on investment performance and more on upmarket tricks and traps than they’d wanted their investors to understand.