Sacramento Bee Takes Up Our Fight Against Private Equity Firms’ Secrecy

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On Monday, the Sacramento Bee published an editorial that took up many of the issues that we’ve raised in recent months about private equity firms’ fee abuses and the extraordinary shroud of secrecy that the industry has thrown over most of its activities. This article is a confirmation of the importance of our ongoing Public Records Act efforts with CalPERS to obtain more information about its private equity investments (while we lost a case on one request, CalPERS still maintains it will fulfill that request, and we have others where CalPERS’ response is very problematic that we will discuss in upcoming posts).

Here is the critical part of the SacBee editorial titled Secrecy helps private equity line pockets at expense of public:

In a speech to private equity industry members in May, Andrew J. Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, said that he’s been seeing troubling trends in the public equity industry. One is vague language in contracts. “This has created an enormous gray area, allowing advisers to charge fees and pass along expenses that are not reasonably contemplated by investors.” Furthermore, he said agreements don’t give investors “sufficient information rights to adequately monitor their investments.”

We wouldn’t necessarily care about private well-heeled investors getting fleeced by financial firms. It’s their money to lose. But investors include public endowments and pension funds such as CalPERS. And if CalPERS is getting soaked, so is the public.

It’s virtually impossible to tell if that’s the case, however, since the agreements that public pension funds have with private equity firms are exempt from California’s Public Records Act. CalPERS does disclose the assets it has in private equity, their value and the rate of return, but not the fees paid, which could be in the millions. If these documents were public, then analysts and financial watchdogs would be able to keep track of schemes that cost the funds and their beneficiaries.

The reasoning behind the disclosure waiver was to protect investment strategies. But they seem to have done a better job of protecting the ability of public equity firms to line their pockets with the public’s money. This is an issue ripe for legislation.

This editorial is significant, particularly for citing CalPERS, which does provide more investment information than most other public pension funds, as an example of inadequate disclosure. The editorial board has thrown down the gauntlet that the private equity firm secrecy regime is damaging to the public and needs to be cut back in a major way.

The Sacramento Bee has great clout with the California legislature, and the one thing CalPERS and other public pension funds are afraid of is the legislature. While this editorial isn’t quite like the cavalry riding over the hill, it’s tantamount to hearing its horns coming straight in our direction.

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  1. Fraud Guy- Also

    If I squint just right, I think I can see the cavalry in the distance.

    Between this editorial and the North Carolina legislation that you wrote about, I see the makings of a trend.

  2. Dan

    Congratulations! Great work on helping focus attention on one (of many) financial frauds that we all pay for.

  3. Fool

    If I was a GP managing CalPERS’ money (or a PR rep thereof) I would be very happy to read this article. Any potential wrongdoing — or, put differently, whatever it is I wanted CalPERS not to disclose at a humble blogger’s request — has been reduced to fee discrepancies and my alleviated tax burden, none of which is news to your average PBS viewer.

    1. Yves Smith Post author

      You are uninformed as to the level of fee abuses going on in the private equity industry. I suggest you read the Drew Bowden speech, in which he said that more than half the industry was guilty of serious violations of securities laws, primarily stealing from investors.

      This was news to the industry and has caused widespread consternation among private equity limited partners, as was reported in a front page story in the Financial Times. It most assuredly is big news, and if industry professionals are shocked, there is no way “your average PBS viewer” has a clue.

      Your handle “Fool” is apt.

      1. Fool


        The comment above was not my view, but my reading into the purported subtext of the SacBee’s editorial. Apologies for not being a good writer.

        The Private Equity industry — since its inception as the Leveraged Buyout industry — exists to make the GP’s rich, in particular, by way of draining from the capital structure of a target company every last drop of profit. You don’t go into private equity for any other purpose than to be rich; you also probably don’t care much for liberal conceptions of collective justice and fairness, which is why you don’t care about shifting your tax burden onto pensioners nor the livelihood of the target companies’ employees; you also probably view a 9-figure annual income as something that can be rightfully earned, but I digress….

        Be that as it may, for these reasons it would seem that “fee abuses going on in the private equity industry” is a redundancy in terms — if not, as I mentioned, “reductive” in the sense that fee abuse seems more symptomatic and indicative of the larger issues than it is *the issue* itself. Case in point: Executive Life Insurance Company. Garamendi’s seizure and subsequent resell was a “fee abuse” (or whatever, its ugly cousin the kickback), but needless to say the larger crime, among others, was the policyholders who got royally screwed.

        I hope the editorial board at the Bee chooses to make available the relevant archives as reported by its own Dan Walters.

        p.s. Private equity’s inequities have in fact been available to PBS viewers (it’s no wonder Romney wanted to take it through the chop-shop!):

        1. Yves Smith Post author

          In private equity, the fee abuses are pure skimming and not symptomatic of larger abuses. PE does engage in a great deal of dubious conduct, such as very aggressive tax strategies, flagrant broker/dealer abuses, and common use of financial engineering and often damaging levels of cost cutting, which hurt not workers but also the companies themselves. Some private equity firms also engage in pay to play. But these are all separate distinct from the fee grifting. This stealing isn’t a symptom of something worse. It’s stealing.

          However, this flagrant an abuse, particularly when the investors are fiduciaries, has woken many limited partners up. They were naive enough to believe the private equity firms had their best interests at heart. This new-found recognition that private equity general partners should not be trusted has the potential for the limited parters to (finally) start questioning other articles of faith, like their belief that PE alway delivers superior returns, when it hasn’t over the last decade and in general is highly cyclical and showing a long term secular decline. Political heat from influential publication (and the SacBee is influential in California) will also put pressure on limited partners like CalPERS to stop placing their misguided loyalty to private equity firms ahead of their responsibilities to beneficiaries and the public at large.

          Thus the fee issue has the potential to get limited partners to reduce their allocations to private equity, which would reduce the other damage it does.

          1. Fool

            I mean, yeah, fee skimming is stealing. So are a lot of things we take for granted within everyday market dynamics. People will tolerate a culture of grift or at least look the other way so long as their bottom line isn’t negatively affected. Fee skimming? What investor cares so long as her returns are above market? Industry in decline? >3 trillion in AUM is more than enough to feed the LP’s. Like you, I anticipate CalPERS finally showing just how it’s done…

              1. Fool

                Correct me if I’m mistaken: investors (LP’s) are “intellectually captured” by their PE overlords, and you hope that by illuminating the many operating practices done in bad faith by the latter (e.g. fee abuse), investors will be disincentivized from committing further capital to their buyout funds. Basic market dynamics.

                The paradox, however, in this effort to educate “intellectually captured” investors is that it presupposes that they are clueless market participants in the first place. How can a typical/average investor be expected to have the intellectual confidence to say “no” when IR from KKR/Blackstone/TPG comes calling, much less dismiss a study conducted by, say, a professor at Booth[1]; this very same investor who for the past 20 years hasn’t had the brains to grasp that his returns as an LP are being both shortchanged and below market AND all while the GP’s have been gorging themselves on 8-9 figure returns annually? Financial professionals are generally speaking creatures of simple tastes — viz. “respectable” amounts/expressions of material wealth — and if the returns in PE funds do not satisfy them then they’ll simply be satisfied elsewhere. As before, basic market dynamics.

                Needless to say we’re on the same team here. I’m just skeptical that appealing to an average investors’ intellectual rationality — in logical terms, as you effectively do — is a winning strategy. Put in analogous terms: if money talks, how loud can one effectively communicate an appeal to logic and fairness against a >$TN mouthpiece? The recent investment decisions by CalPERS and Harvard suggests a promising direction in this regard. Having said that, it can’t be a coincidence that both have suffered serious institutional embarrassment relating to their investments in PE. What is no less significant to me than their strategic shift from investing in PE funds is that they would want you or me *to know* that they were undergoing a strategic shift from investing in PE funds. In other words: how much of this was an independent investment decision vs. a PR decision? I would think that identifying these distinct degrees of influence (if not, perhaps, among others) is essential in influencing investors to similarly reconsider the capital they invest in PE.

                [1] From page 1 of Googling “private equity returns”:
                [2] Case in point, the existence of these news stories:

  4. Lambert Strether

    I’m at a loss to understand the lack of commentary on posts like this. Let me see if a metaphor will help:

    The Nazgul ride into The Shire.

    They “take private” the brewery, the mill, and all the pubs, and after they’ve stripped them of everything of value, loaded them with debts to the Dark Tower, and paid themselves huge sums of hobbit gold, they sell it all back to the hobbits who are willing to outsource everything to Mordor and slap on Hobbit branding.

    And how did the Nazgul get the money to start with, you ask? Well, long ago, Mayor Will Whitefoot was unwise enough to invest the Shire’s pension funds with the Bank of Mordor, that’s how.

    That seems like it, to me. PE is pillaging your country while being funded by you. The villainy here is hard to see, however, because the black robes of the Nazgul hide a lot, they’re invisible and in fact only held together corporeally magic rings, and so on. (The harrowing screams at night and the giant flying reptiles should give a clue, but people have lives to lead, and anyhow, it’s not that bad.)

    Thing is, it’s possible to kill the Nazgul, as Eowyn and Merry discover together. And the sort of transparency that e.g. Naked Capitalism is trying to impose on these evil dudes is the Westnernesse sword with which Merry pierced the King of Angmar’s cloak…

    Others better versed in finance than I am can rework this so the analogy works better, but this really is a huge battle with great consequences for many of you personallly, if you worked at the Shire’s brewery, or mill, or in a pub, or if your pension was looted by these creeps.

    NOTE I suppose a Game of Thrones analogy is possible to, but GoT is much more about moral ambiguity. There’ aren’t a lot of shades of grey in the PE story.

    1. impermanence

      “I’m at a loss to understand the lack of commentary on posts like this.”

      Because Americans understand that theft has always been what this [and all other] countries are about.

      Note the posts that do get a lot of attention, pure philosophical speculation and fantasy.

      Nobody wants to deal with the truth [as it is too damn simple], and, as well, people will have to acknowledge their complicity.

  5. Ben Johannson

    In a speech to private equity industry members in May, Andrew J. Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, said that he’s been seeing troubling trends in the public equity industry. One is vague language in contracts. “This has created an enormous gray area, allowing advisers to charge fees and pass along expenses that are not reasonably contemplated by investors.” Furthermore, he said agreements don’t give investors “sufficient information rights to adequately monitor their investments.”

    We’ve made our entire society so dumb, passive and complacent that even our wealthy elites fail to insist on what is necessary to protect themselves from being fleeced. When we talk about how foolish people are not to mobilize in their own interests, we should remember it isn’t just the working woman who is mentally out to lunch.

  6. Flying Kiwi

    “I’m at a loss to understand the lack of commentary on posts like this.”

    Possibly because a sizeable proportion of your readership is not American, so it’s not their problem.

    “First they screwed the Americans, and I did not speak out because I wasn’t an American…”

    (Apologies to Martin Niemoller)

    1. Yves Smith Post author

      My readership is 2/3 American. And private equity funds have been large players for over a decade in the UK, Europe, and emerging markets. Theyve done enough damage to European countries that the EU roused itself to regulate them and attempt to put limits on how much debt they use. Sovereign wealth funds are significant investors. As you suggest, the idea that this is a US only issue is naive.

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