It’s troubling that some stinging charges against the very biggest names in private equity are getting only passing attention in the financial media.
The New York Times last week managed to get some court filings unsealed last week in a class action lawsuit, Dahl v. Bain Capital Partners. This revelation came after the parties tried to satisfy the NY’s motion with a heavily redacted filing, which the judge nixed. This short post by yours truly in the New Republic gives an overview; due to space constraints, I had to stay pretty high level:
One of the salutary side effects of the Mitt Romney presidential bid is that it has shed light on one of the most secretive yet influential parts of the financial services industry: the major buyout firms. Thanks to motions filed by the New York Times, a federal judge in Boston released court filings this week that had previously been under seal in a class action, anti-trust lawsuit — Dahl v. Bain Capital Partners — against the eleven biggest and most blue-chip names in the private-equity industry, including Blackstone, Carlyle, Goldman, and TPG. The plaintiffs contend that they lost billions as shareholders in companies that were sold at lower prices than they would have otherwise fetched in the 2003 to 2007 period due to buyer collusion through a system they called “club deals.”
No wonder the defendants had been keen to keep the case under wraps. The 221-page complaint goes through 27 transactions, and with each, presents not only persuasive economic analysis, but more important, damning e-mails showing how the heads of each of the firms were involved in submitting sham bids, sharing information about their offers, working with management of the target companies to restrict the sales process, enforcing elaborate systems of quid pro quos (for instance, not submitting a bid with the expectation of being cut in on that deal or future deals), and other forms of market manipulation. The messages make clear that the intent was to reduce competition and buy the companies on the cheap. For instance, on the sale of Toys R’ Us,
KKR representatives admitted that KKR decided to partner with Bain and Vornado due in part to its “desire to effectively eliminate a competitor from the auction process.”…. Richard Friedman, head of merchant banking and PIA at Goldman Sachs, acknowledged in an email the belief that “the competing bidders ha[d] colluded and ganged up.”
It’s obvious that reducing the number of bidders and containing the competition among them would lower prices. I ran a mergers and acquisitions department in the 1980s, shortly after auctions became the preferred way for selling companies. The rule of thumb was that getting an additional bidder increased the sales price by 10 percent. The complaint includes economic analyses that show that these mega funds got better prices on average on these deals than on the ones where they duked it out.
Now after ordinary consumers have been on the wrong end of bank bailouts, foreclosure fraud, credit card tricks and traps, and debt collectors from hell, this scheme might seem like a fight between different types of investors and hence of limited real world import. That view could not be more wrong. Private equity firms concentrate enormous financial power in comparatively few hands. Their $2 trillion of assets under management, which they augment with a typical $3 of borrowed money for every $1 of their investors’ money that they put down, translates into $8 trillion of buying power. Compare that to the roughly $16 trillion value of the U.S. stock markets at year end 2011. More people in the U.S. work for companies owned by PE funds than belong to unions. More than half the corporate debt in the U.S. is rated junk, and the high leverage used by PE firms in their deals is far and away the biggest culprit. It’s a virtual certainty you are supporting the private equity industry. Public pension funds, whose monies come from state and local tax dollars, are one of the biggest investors in LBO funds, particularly the mega funds like KKR and Blackstone.
LBO firms fetishize secrecy and use their power to maintain it. Given that governments, both public pension funds and sovereign wealth funds, are important investors in these vehicles, their contracts with these firms are of public interest. Yet PE firm threats to turn away government investors in states where their agreements might be exposed through state Freedom of Information Act requests have led to extreme measures such as the passage of state laws to keep executed private equity from being classified as public records, unlike every other contract for goods and services. This double standard pervades the funds’ dealings with their investors. For instance, the extensive communications among private equity firms presented in Dahl v. Bain look to a layperson like clear-cut anti-trust violations. Yet the PE firms try to cow their investors by claiming that communicating with each other could violate anti-trust laws!
It’s time to pull the veil off this industry. Public interest requires much greater transparency. Congress should call hearings and require that the heads of these private equity firms testify under oath. And any settlement in this case should be a matter of public record.
I wish there had been more space in the TNR post to provide extracts from e-mails, which are typically among either the heads of the mega buyout firms, or other managing directors. They show a clear understanding of what they were up to. These players were engaged in an effort to collude, by submitting sham bids, not bidding in the auction but being invited in as a co-investor on that deal later or getting a slice of a future deal, all clearly intended to buy the target companies at more favorable prices. You really need to skim the filing. If you thought the quotes from the Libor traders in the FSA’s letter to Barclays were damning, they pale in comparison to this (the juicy stuff starts on page 26 of the pdf, which is numbered page 22):
And the riveting quotes are only half of it. The filing also discusses, as asides, how investemnt banks would steer deals to private equity buyers (“financial buyers” in the parlance) rather than corporations (“strategic buyers”) because they’d rack up far more fees. And in case the pleased quotes from the PE overlords about the success of their efforts aren’t enough to persuade you, the filing also includes extensive deal by deal analysis.
Now admittedly, one reason for the understated media response is this is a private suit, not one by a regulator. But flip this around: where is the Department of Justice? It issued civil investigative demands to some of the firms who are defendants in this suit, including KKR, Carlyle, and Silver Lake, in October 2006. The content of these e-mails, along with the extensive and persuasive economic analysis of the transactions, raise serious question about the failure of the Department of Justice and the FTC to move forward.
This Department of Justice overview document titled “Price Fixing, Bid Rigging, and Market Allocation Schemes” is admittedly written informally, to encourage individuals to contact the Department of Justice, but it is instructive to read it against the sort of behavior presented in the Dahl v. Bain Capital Partners filing. Consider this section:
Most criminal antitrust prosecutions involve price fixing, bid rigging, or market division or allocation schemes. Each of these forms of collusion may be prosecuted criminally if they occurred, at least in part, within the past five years. Proving such a crime does not require us to show that the conspirators entered into a formal written or express agreement. Price fixing, bid rigging, and other collusive agreements can be established either by direct evidence, such as the testimony of a participant, or by circumstantial evidence, such as suspicious bid patterns, travel and expense reports, telephone records, and business diary entries.
Under the law, price-fixing and bid-rigging schemes are per se violations of the Sherman Act. This means that where such a collusive scheme has been established, it cannot be justified under the law by arguments or evidence that, for example, the agreed-upon prices were reasonable, the agreement was necessary to prevent or eliminate price cutting or ruinous competition, or the conspirators were merely trying to make sure that each got a fair share of the market.
It’s hard to read the private lawsuit and not wonder why this behavior didn’t lead to a criminal investigation by the DoJ. Might it have something to do with the importance of private equity in funding the Obama campaign? Rahm Emanuel raised lots of money from PE kingpins, and at least two of Obama’s New York City fundraisers were hosted by LBO heavyweights.
As Matt Taibbi has pointed out, bid rigging is not like what the Mafia does, it is what the Mafia does. Yet the harm here seems too remote to ordinary people, compared to, say, overpriced garbage services or municipalities blowing up thanks to toxic swaps.
If the Dahl allegations pan out, and they certainly look convincing, it provides further confirmation of the charge that these firms don’t even earn the returns they claim to (returns earned by cheating aren’t legitimate). And if their raison d’etre, that they provide better ourcomes than, say, an index of industrial firms (which we plan to address independent of the price fixing issue) is bogus, that means (ex the limited number of cases where they turn around failing companies) they are really in the business of extraction, looting, and transferring income from ordinary people to the top 0.1%. Not that many people don’t suspect that already, but there is a world of difference between instinct and proof. So no wonder the industry works so hard at secrecy, and must be delighted to have the lapdog Department of Justice by its inaction support that effort.