The Private Equity Limited Partnership Agreement Release: The Industry’s Snowden Moment

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Last week, the Wall Street Journal released an important story that chronicled how the private equity industry kingpin KKR systematically took advantage of its credulous investors via taking questionable charges through its related company KKR Capstone. That story depended critically on the Wall Street Journal obtaining the terms of the investment from a 2006 KKR limited partnership agreement so that it could ascertain whether the investors had authorized these charges. Readers may recall that the private industry heretofore has kept these contracts under lock and key, insisting zealously that they be kept in the strictest confidence possible by those who obtain access to them.

We’ve published 12 private equity limited partnership agreements (LPAs), including the KKR limited partnership agreement that key to the Wall Street Journal’s story, in a searchable format that you can view here and here. We obtained the documents through the Pennsylvania Treasury’s public e-contracts library. Until now, it appears virtually no one knew that they had been made public. And you can be sure that if anyone associated with the private equity industry had recognized what had occurred, they would have shut this window immediately.

It is hard to overstate the significance of Pennsylvania’s release of these private equity limited partnership agreements. This development will change the industry forever. Even a superficial reading of these documents shows that investors and policy-makers were naive to treat private equity general partners as deserving of the blind trust they had placed in them.

Trade Secret? What Trade Secret?

For decades, private equity (PE) firms have asserted that limited partnership agreements (LPAs), the contracts between themselves and investors, should be treated in their entirety as trade secrets, and therefore not subject to disclosure under Freedom of Information Act laws in any jurisdiction. These private equity general partners argued that the information in their contracts was so sensitive that it needed to be shielded from competitors’ eyes, otherwise their unique, critically important know-how would be appropriated and used against them. In particular, PE firms have made frequent, forceful claims that their limited partnership agreements provide valuable insight into their investment strategies. The industry took the position that these documents were as valuable to them as the formula for Coca-Cola or the schematics for Intel’s next microprocessor chip.

Now that we can look at the actual language in limited partnership agreements, we can see what any sophisticated user of legal instruments would guess: the PE firm lawyers describe the strategy in the broadest, most general terms to give the private equity fund as much latitude as possible. For example, here is the investment strategy language from the KKR 2006 Fund:

2.1 Objectives The objective and policy of the Partnership are to invest in (i) Securities of Persons formed to effect or which are the subject of management buyouts or build-ups sponsored by the General Partner or any Affiliate thereof and (ii) Securities of Persons the investment in which the General Partner reasonably expects to generate a return on investment commensurate with the returns typically achieved in previous KKR-sponsored buyouts, build-ups and growth equity investments.

Claiming this statement is a trade secret is analogous to the U.S. Navy claiming classified status for the fact that it operates ships on oceans.

Moreover, if you read the balance of section 2.1 (“Objectives”), you see that that most of the remainder of the paragraph deals with the goal of tax avoidance, with 195 words in the paragraph dedicated to this issue. When KKR claims the limited partnership agreement is a trade secret, it’s not hard to surmise that these tax games are a big part of what they are really trying to hide. But now that we can look across a series of limited partnership agreements, it’s clear that the tax strategies are highly parallel across funds. To the extent that there is anything distinctive, it’s in minor details relating to the implementation of the tax scheme, and not its objective or design.

The closer you look, the harder it is to find information in the LPAs that even approaches a bona fide trade secret. Could it be the management fee? Platinum Equity Capital Partners III says in its LPA (p. 158) that the management fee during the commitment period is equal to “0.4375% per quarter”. At the same time, in its publicly-available Form ADV Part 2 (p. 4), the firm discloses that “Platinum Equity Capital Partners III, L.P., together with its Parallel Funds, is subject to a Management Fee of up to 1.75% [annually] of committed capital…” (1.75% = 0.4375% X 4). So, apparently that’s not the trade secret either.

Key person terms are another provision of LPAs that PE firms have asserted rise to trade secret status. The idea behind a “key person” provision is that certain individuals are critical achieving the sought-after investment returns and the investors thus depend on their expertise and experience. The agreements provide that if any of these “key persons” depart or otherwise can no longer work for the private equity firm, the limited partners can stop contributing capital to a fund or even force its dissolution.

Let’s look at Milestone Partners IV, where in section 3.2(h), you can see that both John P. Shoemaker and W. Scott Warren are defined as the sole “key persons”. Are we supposed to be surprised by this? Both Shoemaker and Warren are described on the firm’s website as Milestone’s sole managing partners. So there is nothing really a secret about this either, nor is it easy to see how disclosure of Shoemaker’s and Warren’s key person designation, even if it were previously a secret, would hurt Milestone upon disclosure.

So what might be the reason for such stringent efforts to maintain secrecy? We described one reason why private equity firms are keen to keep limited partnership agreements confidential last year:

This information lockdown prevents a worst-case scenario for scamming PE firms, that a mid-level accounting employee at a portfolio company would use public documents to compare the payments made to fund investors with what was taken from the portfolio company where the accountant works. State qui tam laws, which are designed to prevent precisely this type of abuse by awarding a portion of the government’s recovery to people who uncover fraud, would provide a powerful incentive for employees at portfolio companies to rat out their PE overlords. But that’s not going to happen as long as public pension fund PE investors keep the contracts and cash flows behind the FOIA wall.

How realistic is that scenario? Two days ago, the New York Times’ Gretchen Morgenson quoted a high-level SEC official discussing the practices of PE firms: “In some instances, investors’ pockets are being picked.” So, it’s reasonable to suspect obscuring this “pocket picking” is a major reason why general partners insist on keeping LPAs hidden.

Tax Dodging

A cursory look shows that the KKR, TPG, and Platinum LPAs all contain management fee waiver provisions (see language relating to “Increased Capital Amount” in KKR; “Waiver Election Amount” “Waiver Contribution” and “Waiver Earnings” in Platinum; 6.02(c)-The Management Company may “elect to waive all or a portion of the Management Fee…” “for a number of quarterly periods determined by the Management Company” in TPG). We have written extensively about this tax dodge, whereby PE firms con their investors into enabling a scheme that allows private equity general partners to convert what would otherwise be ordinary income into capital gains. The PE firms purportedly “waive” their management fees in return for supposedly receiving additional carried interest compensation. This is similar to telling your boss not to give you the raise he’s offered, but to buy you Yankees season tickets with the money instead, and claiming that the transaction is tax free.

The IRS has been grumbling for some time that it’s on to this maneuver and takes a dim view of it. In April, a high-ranking official made a speech intimating that the IRS is finally clamping down. Regulations will be issued shortly that will clarify that, under existing law, fee waivers are do not achieve the claimed tax result. Somebody needs to ask the investors in the KKR, TPG, and Platinum funds how they justify cooperating with this scheme in light of the IRS’ vocal disapproval.

The LPAs also reveal potentially illegal efforts for the funds and their investors to hide arcane but important forms of income called “UBTI” (“Unrelated Business Taxable Income”) and “ECI” (“Effectively Connected Income”). The idea behind both UBTI and ECI is that tax exempt investors should not be able to hide behind their tax-free status to operate businesses that would have a competitive advantage because the profits aren’t taxed. As a result, UBTI federal tax is assessed on U.S. non-profits and ECI federal tax on foreign investors in U.S. funds to level the playing field.

One of the few ways that limited partners have pushed back against the general partners is that the limited partners have demanded and won a de facto fee reduction via the sharing of general partner transaction and monitoring fees with limited partner investors (as we’ve also discussed, the degree to which there actually were any services rendered is open to question). But for the limited partners to take their partial rebate of these fees would clearly constitute UBTI/ECI absent any special maneuvering to avoid the tax.

PE firms long ago came up with the idea of crediting these rebates against the management fees otherwise owed by investors, rather than writing checks to investors. The argument for why these management fee offset arrangement doesn’t implicate UBTI/ECI gets fairly arcane, but the key point is that the PE firms take the position with the IRS that “Hey, we’re not sending the investors checks, so it’s not UBTI/ECI.”

Now that we can scrutinize LPAs, however, we see that some do call for checks to go back to the investors. For example, on p. 158, Section 3.02(d) TPG’s limited partnership agreement says:

(d) On a cumulative basis, the Management Fee due in respect of each Limited Partner (including any additional Limited Partner) shall be reduced by an amount equal to one hundred percent (100%) of such Limited Partner’s share of Net Fee Income, if any, B-3 received by the Management Company, any Principal or any Affiliate of the Management Company, in each case in connection with such Person’s activities as a representative, or on behalf, of the Partnership. To the extent that the amount referred to in the preceding sentence exceeds the Management Fee due in respect of such Limited Partner, such excess shall be carried forward and, if not previously applied against such Management Fee, shall (notwithstanding paragraph 4.02(d) of the Partnership Agreement) <strong>be paid by the Management Company (or its Affiliate) to such Limited Partner upon liquidation of the Partnership [emphasis added].


What this complicated section provides for is that TPG will roll forward any management fee credits that can’t be applied in a given period because the management fee has already been reduced to zero. If any remain at the end of the fund life, the investors get a check. So, rather than there being the potential for payment issuance in any particular accounting period, TPG has pushed the accounting around so that any check is issued just once, at the end of the fund life. But it’s the same either way, and the key point is that the practice pretty much destroys their argument that these payments are not subject to UBTI/ECI tax. Other of the LPAs have this same feature (see, for example, Palladium at p. 100 section 4(b))

Tricky, Tricky Language

Some of the language in these documents is so sneaky that, if the investors’ lawyers didn’t flag it in the legal review process, they are arguably guilty of malpractice. And, if their lawyers did point it out, yet the investors ignored the problem, one can only ask: What were they thinking?

We’ll offer just one very disturbing example of how the PE firms use language to mislead, from the “Definitions” section of the KKR 2006 Fund LPA. A careful reading reveals that all of the following are defined terms: “KKR”, “Affiliate”, and “KKR Affiliate”. Critically, “KKR Affiliate” is much narrower than what “KKR” and “Affiliate” mean when defined separately. And KKR clearly understood that what was and wasn’t an affiliate was key to its KKR Capstone fee-hogging activity. As we noted in our analysis of the Wall Street Journal story on KKR Capstone, whether or not the SEC goes after KKR on this matter hinges on whether it accepts KKR’s tortured defense.

The term “Affiliate” has the meaning that readers of corporate agreements would expect and refers to both entities and individuals. A “KKR Affiliate” refers only to entities controlled directly or indirectly by KKR.

This distinction matters a great deal. Section 6.3.1(b) appears to provide the fund investors with the critical protection they need against various forms of fee skimming that both KKR entities and their executives might otherwise be free to pursue with the fund’s money or the money of portfolio companies:

The General Partner, KKR and the KKR Affiliates will not engage in any transaction with the Partnership or any Portfolio Company or subsidiary thereof unless the terms of the transaction are on an arm’s-length basis and no less favorable to the Partnership or such Portfolio Company than would be obtained in a transaction with an unaffiliated party…

What is clearly intended here is for investors to read the term “KKR Affiliates” as synonymous with “Affliates” of “KKR”. But that’s not what it means. If it did mean “Affiliates” of “KKR”, the restriction would prevent KKR executives from having side businesses that they could force the fund or the portfolio companies to hire for purported “services”. This is not a hypothetical situation. We documented that Tony James, the COO at Blackstone, has just such a business that is active in industries in which Blackstone owns portfolio companies. The investors no doubt believe they got a restriction on related party activities, but Blackstone’s agreements almost certainly contain similar language which permits this sort of abuse.

The Snowden/NSA Analogy

For decades, the NSA kept its domestic spying activities under wraps, claiming that it served as a wise and responsible steward of the powers with which it had been entrusted. Similarly, the private equity industry has insisted for decades that none of the usual SEC and FOIA transparency requirements should apply to its activities, but that the general partners should be trusted to comply with the law and treat investors fairly.

Snowden’s documents revealed that much of the NSA’s domestic spying is arguably illegal, and that a primary objective of the secrecy surrounding it was to shield the NSA from accountability and oversight, since that would curb the scope of the agency’s actions. The private equity industry now finds itself in much the same situation, albeit in this case, there’s no Snowden-like insider who chose to break institutional rules and give confidential information to journalists. Here, a public pension fund had simply made them public and it took a surprisingly long amount of time for anyone to notice.

Nevertheless the uncomfortable analogy to the NSA’s fetish with secrecy remains. Here the exposure of key documents reveals the private equity industry’s claims that the general partners obey the law are false. Instead, critical elements of their scams and violations of public interest depend on their being hidden from view.

The document release also reveals what dupes the investors have been. The SEC has already reached that conclusion, stating in a recent speech that investors have done a poor job of negotiating agreements so that they protect their interests and have done little if any monitoring once they’ve committed to a particular fund. As we’ll chronicle over the next few days, anyone who reads these agreements against the disclosures that investors are now required to make to the SEC and the public in their annual Form ADV can readily find numerous abuses, which range from bad-faith dealing to potentially criminal conduct. And remember, investors have far more detailed information, and also can ask the general partners questions if they detect practices that look sus.

But rather than live up to their fiduciary duties, pension funds that have invested in private equity funds haven’t merely sat pat as they were fleeced; even worse, they’ve been staunch defenders of the private equity industry’s special pleadings.

The private equity industry’s obsession was never about competing effectively. It was a self-serving ploy to shield the documents from scrutiny, since third parties might ferret out how private equity firms increase their already substantial profits at the expense of compliant, clueless investors. And as we’ll discuss in more depth, quite a few general partners have been both relentless and shameless in how they’ve gone about it.

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  1. psychohistorian

    Kudos to Yves for casting some light on the tools of those that claim to be doing Gawd’s work.

    Cancerous parasites of a species, it reads to me.

  2. Chris Tobe

    This is an important article for pushing disclosure. It is interesting that it suggests that the lawyers for entities did not do a good job reviewing the documents. With the Kentucky Retirement Systems I believe they purposely did not review the documents, and refused to even show them to Trustees like myself to avoid any questions.

  3. Paul Niemi

    Elsewhere in links, we have Larry Summers on Picketty, arguing that the only really overpaid CEOs, responsible for most contemporary excess income disparities as observed, are associated with private equity firms. This is interesting stuff.

    1. cnchal

      Here is the link to Summers’s article.

      I have learned some astonishing things reading NC and one of the most astonishing was Larry talking about altruism as a rare good that should only be spent on family. As if being nice and kind to people was something that had to be mined out of the ground and processed into niceness and kindness and bought at a store. My astonishment stems from the fact no one called him on that. Larry must have no friends, because a friend would say ” hey, Larry, stop saying that. It makes you sound like an idiot”. Larry can open his own doors from now on.

      From Larry’s article, a nice three paragraph set that inadvertently reveals the root of our problems.

      There is plenty to criticize in existing corporate-governance arrangements and their lack of resistance to executive self-dealing. There are certainly abuses. I think, however, that those like Piketty who dismiss the idea that productivity has anything to do with compensation should be given a little pause by the choices made in firms where a single hard-nosed owner is in control. The executives who make the most money are not for most part the ones running public companies who can pack their boards with friends. Rather, they are the executives chosen by private equity firms to run the companies they control. This is not in any way to ethically justify inordinate compensation—only to raise a question about the economic forces that generate it.

      The rise of incomes of the top 1 percent also reflects the extraordinary levels of compensation in the financial sector. While anyone looking at the substantial resources invested in trading faster by nanoseconds has to worry about the over-financialization of the economy, much of the income earned in finance does reflect some form of pay for performance; investment managers are, for example, compensated with a share of the returns they generate.

      And there is the basic truth that technology and globalization give greater scope to those with extraordinary entrepreneurial ability, luck, or managerial skill. Think about the contrast between George Eastman, who pioneered fundamental innovations in photography, and Steve Jobs. Jobs had an immediate global market, and the immediate capacity to implement his innovations at very low cost, so he was able to capture a far larger share of their value than Eastman. Correspondingly, while Eastman’s innovations and their dissemination through the Eastman Kodak Co. provided a foundation for a prosperous middle class in Rochester for generations, no comparable impact has been created by Jobs’s innovations.

      I note that Job’s innovations are manufactured in a building in China with anti suicide nets surrounding it. Brought to us by extraordinary entrepreneurial ability, luck or managerial skill.

      1. Paul Niemi

        It is the coincidence which is suggestive. First, Summers feels at liberty to, in essence, expose private equity firms as outliers, at least outside of norms in executive pay. That’s odd or noteworthy, because he seems to always have an agenda behind anything he says, he being conceited enough to know that what he says will be repeated by others on down the intellectual pecking order. Then Yves finds examples of private equity partnership agreements, inadvertently published perhaps, sensational of course. When dissimilar sources seem to converge, it gets from me the question of “What’s next?” I think private equity firms have been getting away with highway robbery, and it wouldn’t surprise me if a critical mass of public opinion has evolved that knows about it and is willing to shut the door on it finally.

        1. farang

          There’s no suggestion….I mean, it wouldn’t be possible….no one could plan….you don’t think lowering interests rates to zero while government Regulators non-regulate and government Enforcement agencies policing the financial world “looked the other way,” while corporate personnel transfers into positions of agency heads and managers insured the preceeding occurred, was planned and advantage was taken of hundreds of billions in pension funds seeking a decent return or facing financial collapse, do ya?

          And then wrote the “details” of their scam into “that which cannot be questioned.” Naw, nobody outside prison or insane asylum walls are THAT devious, are they?

          I’ve heard questioning just ONE event in the past in Germany can land you in PRISON. Just asking questions. Oddly enough, a certain segment of our society is overwhelmingly present in both scenarios….

          And, well, to top it off, now a video emerges of Charles Schumer, US NY Senator, talking about how we must modify Free Speech in the US, that a Right “isn’t really a Right”…..yep. Free Speech? Freedom of Press? Not on all subjects, you see: HE will let you know if you can talk about something. He might HATE having to tell you HIS private business….Hate Speech, don’t ya know? Be careful!!!!

          “Better watch what you say, watch what you do!!” Ari Fleishman.

          Schumer, with his fake professor schtick. He’s a Gangster. Trying to cover his tracks.

          The guy that facilitated Obama meeting with and receiving….. what was it? $30 million in Wall Street banker and hedge fund contributions in 2007? No, I don’t see tracks being hastily covered…no no. Holder can’t find ANY criminal activity on Wall Street? Can he find his hand to reach around to look for his ass?

          Move along, nothing to see here….No, THAT would be a conspiracy, and we all know they are just whackos without a clue.

          Funny thing…all these billionaires we are creating here in America: where are the products they are providing we all are rushing out to purchase? Where is the HUGE demand for their services? The blockbuster movies we are lining up to watch?

          Exactly HOW are they making BILLIONS???? I mean a BILLION, HONESTLY EARNED, is like for CURING CANCER. FOR NEW SPACE PROPULSION TECHNOLOGY. For a car that goes 20,000 miles on ten gallons of gas.

          Not for “shaking paper back and forth.” Luckily, I am not in Germany (or the very real future of America on present course), and am still FREE TO ILLUSTRATE THE PAST vs THE PRESENT. Causes and Effects. Label as you will…but who was/is trying to hide what, from whom?

          Fairness? Customer Service? Integrity? Level-dealing? Long term investment?
          Call me “old-fashioned” but it has VANISHED BY PLAN. That plan went into effect on 9/11/01. ALL THE ROT STEMS FROM THAT. Oddly enough, sadly enough, same players.

          Only the looting is ongoing. Real economic advancment has halted, America is in full economic regression. War and Imperialism now the ONLY driving “foreign policy.” BY PLAN. When there are no more Ukraines to foment anarchy in, to steal tons of their gold and place, well, you know who in power……the Music Stops.

          They will only have ONE POTENTIAL VICTIM LEFT TO SUBJUGATE.

          2500 armored personnel carriers being FORWARD POSITIONED in all US states. US government agencies ordering MILLIONS of rounds of ammo. Department of Agricuture ordering body armor. Angry Cows, much?

          Remember when you could chuckle and label us CRAZY for POINTING OUT THE OBVIOUS? How soon before this blog goes….*dark*?

          Diane Feinstein has a list of REAL JOURNALISTS to offer us AFTER she amends the 1st amendment….are you on that list, naked capitalism???

            1. Doug Terpstra

              Why don’t you please clarify your own implicit charge of Anti-semitism in the above? Really, your charge is bizarre.

              1. dmg

                I imagine monday1929’s charge of anti-semitism is based on a number of memes present in farang’s comment: the paragraph beginning “I’ve heard questioning just ONE event in the past in Germany….”, plus farang’s focus on Summers, Fleischmann, Schumer, Feinstein (I am surprised Bloomberg didn’t make the list), his affinity for phrases like “Oddly enough, a certain segment of our society is overwhelmingly present in both scenarios….” , and “Oddly enough, sadly enough, same players” and “..steal tons of their gold and place, well, you know who in power.”

  4. RepubAnon

    It sounds as though the trade secret being protected was how much money was being extracted from the limited partners. It’s a secret which gave the general partner a competitive advantage, and thus meets the definition of a trade secret. (The definition of trade secret doesn’t require the thing being kept secret to be ethical, or legal…)

    1. scraping_by

      Yes, but is it an advantage over other PE firms, the limited partners, or the IRS? Dunno the legal definition, but that would seem to matter.

  5. TheCatSaid

    This is absolutely brilliant work.
    Thanks for making this info available and for the examples in your post of what to look for. It helps remove some of the mystery, making both the information and implications of these documents more accessible and approachable.
    It’s great each document is available on two servers in different countries. Download is in progress . . .

  6. MRW

    BRAVO, Yves! And thank you for the vivid analogies used to explain arcane concepts, or to put the concept in context.

  7. John Mc

    Well out. This chapter in the history of Private Equity warrants its own volume in the annals of Agnotology (study of ignorance). Someone send this to Robert Proctor and Londa Schiebinger. Yves, I know you have said you are never going to write another book, but this dissection of what is happening in PE and regulatory agencies is so important. Thanks for your work.

  8. 4D

    Great work as usual Yves.

    If you are able to tell, I’m interested to know how you actually came across the agreements?

    1. Jim Haygood

      It would be interesting to know whether this was an accidental oversight by the state of Pa. (in which case the documents will be quietly taken down), or the result of a disclosure policy which supersedes the confidentiality provisions of the limited partnership agreements.

      If the latter, it is potentially a model for other states (such as California) as well.

      Hidden treasures buried in the interwebz … Chercher et gagner!

      1. Yves Smith Post author

        They were still up at the end of the day today. Perhaps the powers that be decided that taking them down would only result in more media discussion, which is presumably the last thing they want.

        1. Chris Tobe

          The Democratic Treasurer a former PE guy is in a battle with the Republican Governor’s people on the board. There are 2 powers to be in conflict.

  9. reason

    “These private equity general partners argued that the information in their contracts was so sensitive that it needed to be shielded from competitors’ eyes, otherwise their unique, critically important know-how would be appropriated and used against them. In particular, PE firms have made frequent, forceful claims that their limited partnership agreements provide valuable insight into their investment strategies. The industry took the position that these documents were as valuable to them as the formula for Coca-Cola or the schematics for Intel’s next microprocessor chip. ”

    Sorry, I don’t quite understand why a free society (particularly one that believes in competitive markets) should support the idea of “trade secrets” in the first place. Where we think that it necessary to support innovation we have patents, which PUBLISH and protect an idea. Where not, we believe in general in an open society. The only exception could be work in progress (the INTEL example) not yet ready to be patented or copyrighted. And if agreements are enforceable in public courts shouldn’t they HAVE to be published?

    1. abynormal

      its not reasonable so lets follow the money:
      Suspicious Deaths of Bankers Are Now Classified as “Trade Secrets” by Federal Regulator
      snip – “The OCC responded politely by letter dated April 18, after first calling a few days earlier to inform us that we would be getting nothing under the sunshine law request. (On Wall Street, sunshine routinely means dark curtain.) The OCC letter advised that documents relevant to our request were being withheld on the basis that they are “privileged or contains trade secrets, or commercial or financial information, furnished in confidence, that relates to the business, personal, or financial affairs of any person,” or relate to “a record contained in or related to an examination.””

      lets follow the money:
      Four of Wall Street’s largest banks hold a total of $68.1 billion in BOLI assets. Using Michael Myers’ approximate 10 to 1 ratio, that would mean that over time, just these four banks could potentially collect upwards of $681 billion in tax free income from life insurance proceeds on their current and former workers. (Death benefits are received tax free as is the buildup in cash value in the policies.) The breakdown in BOLI assets is as follows as of December 31, 2013:

      Bank of America $22.7 billion

      Wells Fargo 18.7 billion

      JPMorgan Chase 17.9 billion

      Citigroup 8.8 billion

      In addition to specifics on the BOLI assets, the consolidated financial statements also showed what each bank was reporting as “Earnings on/increase in value of cash surrender value of life insurance” as of December 31, 2013. Those amounts are as follows:

      Bank of America $625 million

      Wells Fargo 566 million

      JPMorgan Chase 686 million

      1. abynormal

        what i meant to type is ‘let’s follow *Some* money. somehow Citigroup got left off the bottom of the list…Citigroup 0 (zero)

        Sunshine Law from investopiedia:
        In some cases, an event or document that would normally be accessible through sunshine laws is closed to public access (such as a legally protected matter currently under investigation), but sunshine laws are supposed to minimize these exceptions. Sunshine laws also differentiate entities that are subject to the laws from those that are not. For example, any entity with the authority to create binding laws would be subject to the law, but an advisory committee that lacked such authority might not be subject to sunshine laws, even if it dealt with matters related to government.

        1. skippy

          Insuring the biggest population die off [boomers+]… “because markets”.

          skippy… surely all that money will go to saving the orb… or maybe the Atlantians used BOLI to fund their next great civilization… rinse and repeat.

  10. Malmo

    I’d bet the farm that more than a few pension administrators get their palms greased handsomely (kickbacks) with these PE dealings. How could anyone in good faith sign off on this shit otherwise?

    1. cnchal

      I agree 100%. In this day and age anyone gambling with other peoples money that isn’t a greedy corrupt a$$hole is just not in the game.

      Yves shining her bright light on this dark fetid swamp of finance will make some of them slither off to their yachts for punishment.

    2. Doug Terpstra

      That’s the key question. Is what passes for incompetence or legal malpractice/negligence a cover for criminal collusion including bribery WRT fee-gouging? Are pension fiduciaries bribed to overlook the fee-skimming. I can understand mutually-beneficial collusion for tax-evasion, reaming taxpayers (I’m sure Eric Corporate-Coat-Holder will prosecute that), but why would a minimally competent fiduciary not challenge the self-dealing affiliate gouging or other embezzlement unless his/her “incompetence” (malfeasance) were adequately compensated?

    3. tiebie66

      Agreed. That’s why I found this sentence telling, and I hope someone does ask. “Somebody needs to ask the investors in the KKR, TPG, and Platinum funds how they justify cooperating with this scheme in light of the IRS’ vocal disapproval.”

  11. jpe

    UBIT typically isn’t a concern because exempt orgs often invest through a C corp, which eliminates the UBIT issue.

    1. lawyer

      You are blowing smoke.

      While it is common for non-profits to have their investments in particular deals of a fund channeled through C corp or other so-called “blocker” entities, Yves is spot-on in saying that there is a UBIT problem with management fee offsets if investors can get a check for all unapplied offsets. That’s because it’s rare for non-profits to sign a subscription document in anything but their own 501(c)3 name. That’s the entity that matters here, because it’s the entity that pays management fees, receives fee offsets, and ultimately gets a check for unapplied offsets.

      I don’t do PE every day, but I been around these deals enough to know that there is definitely a UBTI problem here.

      1. jpe

        The check would just be an increase in the dividend from the blocker which, of course, is exempt from UBTI.

        1. Yves Smith Post author

          I suggest you re-read the plain language of the text. First, payments to the LPs are called “distributions” not dividends. Second, the excerpted language states that the payment is paid the the Limited Partner, which as lawyer confirms, does create a UBTI problem.

          1. jpe

            I’m a lawyer, work in UNHW tax, and have worked extensively with charities and foundations.

            Somewhat oddly, this entity is a 1065 filing partnership. The breakup fees etal are charged to the partners and then, to the extent they exceed management fees, are refunded during the windup of the partnership. A refund of a fee not due is not UBIT. If it were a fee charged to someone else it probably would be, but the payment is of excess fees paid to the management company, which fees are only paid to the management company in the normal course. See 3.04 on 158, noting that the termination and break up fees may only be paid to the management company.

            1. Yves Smith Post author

              The discussion of UBTI in this post was reviewed by a well-recognized tax authority. And your own language reveals your position is internally inconsistent:

              “to the extent they exceed management fees, are refunded during the windup of the partnership”

              If it exceeds the fees that were due and owing, it is not “a refund of a fee not due”. It is clearly an additional payment.

              1. jpe

                Reread the LP agreement. They’re charged a management fee *and* break-up & transaction fees. Both of those fees show up on line 13K, misc deduction, and if the management fees get entirely set off then the break-up & transaction fees ultimately get refunded. The partnership agreement is crystal clear that the partners are charged those fees, so if they are repaid them it is a refund.

                1. Yves Smith Post author

                  Nope. You need to read the document more carefully.

                  The rebated fees are monitoring fees and transaction fees which are paid by the portfolio companies, and not by the fund. They were never charged as fund expenses. The fees that are being offset against the management fee were never fund expenses that were or would have been paid by the fund investors.

                  You are really trying quite hard to muddy the waters here, aren’t you? In fact, your insistent remarks are instead serving to prove, as one expert who saw your comments said to me privately, the degree to which tax attorneys don’t understand these documents.

                  1. psychohistorian

                    Yves, those tax attorney are paid not to “understand those documents”.

                    It is the attorneys tat are all going to clamor loudly that they hadn’t a clue that derivatives could be so dangerous when the next crash occurs.

    2. washunate

      When I read exchanges like this, I can’t help but think about how silly it is to have tax-exempt organizations and different kinds of individual income at all. We could abandon about 99.99% of the tax code if we just taxed all income the same.

      1. tiebie66

        I think this every year when I complete my taxes. An enormous waste of effort, multiplied by millions, in which the sole purpose of one party is to extract taxes from the other; and the other, to avoid paying any more taxes than absolutely required. Nothing productive done, but much time and effort and expended. For this reason, I am in favor of a small but universal transaction tax, levied on every transaction or implied transaction (e.g. in-house netting). The tax is excited every time funds change from one account to another. The poor will pay very little as they are not economically very active, while the economically active will pay more. The rate should be low but fixed, no exceptions. It would eliminate these sorts of shenanigans as well as many others that are entirely speculative.

  12. Robert

    As a non-economist, the excellent coverage here on PE brought to mind the scene from the movie “Goodfellas” where the restaurant owner takes on a mafia boss as a partner; who proceeded to extract value by leveraging the joint to the hilt, leaving a hollowed out husk suitable only for bailout via an insurance claim. But I never would have gleaned the insight but for the reporting here. Outstanding.

      1. j7915

        What comes first? CIA or Mission Impossible?

        Regarding the life insurance on emplyees: there is a book by Norb Vonnegut. A pe fund generating cash flow through buying life insurance policies, until they decided to accelerate the payment due date…

        I thought it was a what if, maybe it was closer to truth than what if?

  13. Jim Haygood

    Poor Dr. Hussman must be tearing his hair out (again). Not only does the S&P 500 need less than a 5 percent gain from here to hit J-Yel’s unwritten ‘S&P 2K’ target, but also the Nasdaq 100 (after a nasty little 8% dip in April) is about to break out to fresh highs for this cycle too. This suggests a rising appetite for speculation.

    Sure, the Naz is still well short of its March 2000 Bubble I high. But with a QE tailwind, anything is possible now.

    Meanwhile, Case-Shiller reports that house prices are back to mid-2004 levels … about as high as they’ve ever been, barring the final two years of Bubble II.

    So many bubbles, so little cash. I will gladly pay you 20% of profits next Tuesday for an advance today.

    1. Malmo

      Tick upon tick ye levitating market lurches on–and a big thanks to the carry trade.

  14. Remco Marcelis

    Wow … revealing indeed … fantastic insight and explanation of an area overdue for exposing. Before we tar all VCs with the same tax-avoiding brush though, worth noting that KKR at the top of the tree as it were is able to pay for the most expensive tax/legal advice and use its past power of success to “dictate” terms to LPs.
    LPs should consider this as fair warning and reason to open their eyes to actively manage on their members behalf…

    1. Yves Smith Post author

      Please look at the list of limited partnerships on the document site proper. Only 3 of the 12 agreements come from the large general partners: KKR, Cerberus and TPG. The rest are from smaller players.

    2. TheCatSaid

      Would LPs have the option to manage directly on their own behalf? (And what happens if they discover something they don’t like–would they have the power to do anything about it other than complain?)

      In any case, wouldn’t the LP still have to pay the Management Fee to the PE?

      1. Yves Smith Post author

        Yes, some pension funds in Canada have started doing private equity in house, and they’ve gotten better results than investing in funds because (gasp) they save all the fees by not using a third party manager. But of course McKinsey, which did a recent report on the state of private equity (and gets lots of fees from private equity firms) discouraged that sort of thing because it’s hard.

  15. Lune

    Kudos Yves! You’ve done what every mainstream news source (not to mention 49 states) has said was impossible and/or illegal. If it doesn’t break any confidentiality protections, I (and lots of other readers, I bet) would love to hear the story of how you found out about this treasure trove lying in plain sight on the public web.

  16. kevinearick

    PimpCo Dam Builders: Consulting Bullworks Against Nature

    How’s that replacing a local tyrant with a global on working out for you?

    Nothing, nothing has changed about politics in 5000 years. Something for nothing behavior distills Nazis up the empire food chain. The organizer can only become the tyrant. Peer pressure behavior can only result in predation. Joining a group makes you weaker, not stronger. The choice isn’t between minimum wage and cartel unions. Choose C, your own path.

    You are born in legacy or one of the middle class event horizons, but there is no natural law requiring you to stay there, and accept its assumptions. Empires arbitrarily organize existing economies, distilling out real marriage to do so. As you can plainly see, the printers and the legislators have zero effect on economic mobility, but are entirely dependent upon it.

    DC control of Ac is all about harnessing AC, in hopes of getting something for nothing, which ‘works’ in the short term, but is catastrophic in the long term, and adding redundant resistors doesn’t help. This planet did not grow humanity to replace itself with a machine. It doesn’t take a rocket scientist to replace humans with machines, talking to each other to produce a market. Humans serving machines as a growing intermediary is as stupid as it gets.

    Efficient specialization on a one-way trip, the virus, is a path to death, for the organism, and the host, if the host is stupid enough to accept the virus as a fact of life. The virus has a place in the ecosystem, but not as the predominant character. Go over to Asia and look at the demographics for yourself. What you read in the papers and see in the movies is not reality.

    There is absolutely nothing new about consumers herding up to extort production, and being preyed upon from behind as a result. Of course the herd is bipolar, looking backward to the past in fear, and stampeding, leaving its most vulnerable, its children, behind, in a positive feedback loop with the predators. Don’t choose A or B and expect not to be part of the human farm system, locked in spacetime.

    If you look, you will see that legacy lives on artificial variability, moving the herd from pasture to pasture, stock and bond rotation, it is feeding, and those with $500k ‘properties’ are next. The hedge fund managers are managing ‘reality’ for the bankrupt pension funds, and being paid with debt to do so, hoping to avoid being fed upon themselves. What do you suppose happens when the lion tamer runs out of food?

  17. kevinearick

    Of course Freddie, Fannie and all the other ‘bad bank’ corporations are being topped up, with digital money. Facebook, like Microsoft before it, produces nothing, for something. Because there is nothing to steal from the brats waiting in line to please it, it is growing a herd in Canada, which has delivered more morons for the purpose. That’s going to fix it.

    Of course San Francisco and Seattle have the highest rates of real estate inflation and income inequality. Of course the morons are proposing them as models for best business proliferation. The consultants / public speakers / thought leaders are scam artists, big surprise. Politicians are paid in debt to pit populations against each other.

    Even if you are a relatively effective consultant, the best you can do is push on a balloon, which will return to equilibrium the moment you leave, because you are simulating demographic balance as the output and returning it as the input. Great, you are a rockstar of rockstars, for the morons, for the moment. And M&A doesn’t change anything; all it does is grow bad banks off sheet, parking structures for the like of Detroit.

    Constantly rebuilding San Francisco isn’t any ‘smarter’ than demolishing Detroit. They exist in the same circuit. If you want to collect a lot of debt, go manage a bad bank. That’s what politicians do, park dead inventory off sheet and sell a few pieces on the side in the resulting inflation. El Erian didn’t work out at Pimco because he actually wanted to accomplish something.

    Ever watch critters that wake up late. Your day is nearly done and they assume the day is just beginning, as they get into the first line, of many lines, in the day. By the time the critters see me in the coffee shop at 9:30am, washing down with a double Caesar, my day is nearly done, and they assume that they can vote me off the island and hire many below them to replace me at less cost, to continue feeding the ponzi.

    Immigration is locked up because the global population is slowly waking up to its predicament, that the ponzi is collapsing for lack of economic mobility and they have ‘secured’ themselves against economic mobility, with inflation, baked into their habits. Don’t walk through a door with nothing but bad outcomes on the other side.

    Legacy is quite capable of withstanding deflation and is doing so, by scooping up all the real estate as the flies die. Its problem is the rapidly increasing awareness to the polarity scam. And regardless of what happens, where the war goes, legacy has no idea what to do with all that real estate, because no matter how many children you have, you are not going to put a dent into the demographic collapse, which is taking legacy with it.

  18. washunate

    Sweet. Another part of the story unravels.

    I hope naive and dupes are charitable euphemisms for corruption and incompetence…

  19. farang

    “Nevertheless the uncomfortable analogy to the NSA’s fetish with secrecy remains.”

    Mmm, me likey “incomfortable analogies.”

    The NSA and uncomfortable, well since we all KNOW they will read this, howza about:

    “The NSA is like the pimple-faced 13 year old you caught peeping into your 15 year old daughters bedroom window, with his “hand on it”, but NOW REFUSES TO LEAVE THE BUSH.”

    Great article, as always, thanks. Doubt anything will come of it, but we live in “interesting times,” so time will tell….

  20. ChrisPacific

    Every time I start to think I am too cynical, Yves opens the lid on another can of worms like this and I realize that I’m actually hopelessly naive.

    It was pretty clear that organizations rejecting FOIA requests were painting with a broad brush, but I would have liked to think that there was at least SOME basis for it beyond ‘trade secrets’ consisting of a boilerplate document that was standard in the industry and some fund manager names that had already been publicly disclosed. It sounds like they have been systematically breaking the law. We have seen plenty of evidence by now that this is standard business practice on Wall Street so I shouldn’t be surprised, but it’s still depressing to see it in action.

  21. allcoppedout

    There’s some discussion of the tax matters here –

    The paper discusses Sun Capital and the notion of whether any of the necessary ‘compensatory intent’ in these PE arrangements is present to make what’s going on tax lawful. This author concludes PE’s and associates have heavy tax liabilities. We’ve been looking because we’re trying to estimate the tax subsidy in global PE businesses. The authors suggest tax losses to the treasury in the HFC (medical) case alone was $85 million.

  22. KTB

    “I fear that the local and decentralized marketplace will be replaced by a national or even international market governed by large multinational firms that whisk their profits away to other places, degrade product quality, and stymie innovation and employment.”

    Umm….isn’t that how our capitalist system works with EVERYTHING? If you have a problem with large, national firms displacing small, local businesses, then cutting every cost imaginable to increase profits, leading to crappier and crapper products over time, then take aim at the economic system that allows that to happen. The same thing has already happened with retail (Walmart), food production (Monsanto), food processing (Kraft and others), clothing, and on and on and on. This is the completely predictable outcome of capitalism. Why in the world would you expect anything else? I swear, economists are some of the most delusional people on the planet nowadays.

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