Private Equity Shills Resort to Ludicrous Arguments to Try to Deflect “Carry Fee” Reporting Scandal

The scandal over CalPERS’ and CalSTRS’ failure to track private equity “carry fees” has the industry worried enough that it is offering up ludicrous rationalizations.

Perversely, the fact that private equity mouthpieces have escalated so quickly to strained arguments, particularly over a new, nothingburger threat, is a good sign. It shows both how threatened private equity firms are by the prospect of having their economics exposed, and how utterly incapable they are of making any sort of credible case for their long-standing secrecy practices.

By way of background, we broke the story on CalPERS’ failure to monitor its “carry fees” in early June. A mere month later, CalPERS was in full retreat. It was contacting all of its private equity managers to have them give the giant pension fund all the historical data on the “carry fees” CalPERS had paid on funds the general partners managed.

As an aside, “carry fees” are the largest fees that private equity limited partners like CalPERS pay across their private equity programs, unless they have the misfortune to invest only in really dodgy funds. In the prototypical fee schedule of “2 and 20,” 2% is the annual management fee (which typically scales down later in a fund’s life) and 20% is the participation in profits, usually after beating an 8% hurdle rate.

We’re also starting to put “carry fees” in quotes, since the term is a misnomer. It implies, incorrectly, that private equity firms have a “carried interest”. This term is also widely misdefined in layperson investor guides, a sign of the effectiveness of private equity propaganda efforts.

A true “carried interest” occurs when an investor allows another party to borrow from them in order to acquire a stake in the venture. Borrowing to obtain your participation means that the party with a true “carried interest” is at risk of loss. They eventually have to repay the lender the full amount borrowed, irrespective of whether the investment works out. If the borrower is the promoter, as the private equity funds are, a true “carried interest” exposes him to loss and thus aligns his incentives with those of his funders.

By contrast, the upside fees that private equity and hedgies extract from investors are a profit participation, or what the IRS calls a “profits interest”. This profits interest is yet another example of how private equity general partners structure their relationship with limited partners to be “heads I win, tails you lose” arrangements.

As we described in our last post on the running “carry fee” disclosure battle, a group of state Treasurers, all of whom are public pension trustees or board members, wrote a letter to SEC Chairman Mary Jo White asking her to Do Something to improve private equity fee and expense disclosure. Remember, even the formidable Elizabeth Warren, who has been thumping Mary Jo White regularly via press stories, long and carefully documented letters, and grilling in Senate testimony, can barely get her to budge. Do you seriously think a lone letter by state Treasurers is going to move her to act?

We discussed at some length why this letter was an a clumsy effort to shift responsibility for these Treasurers’ failure to do their jobs onto the new kid on the block, the SEC:

The SEC does not have the authority to order more frequent fee and expense disclosures. The information that the investors receive now is what they have obtained in their negotiations at the time they invest

These limited partners have chosen, for decades, to give private equity general partners a blank check by allowing them to use the portfolio companies purchased with the limited partners’ monies as piggy banks, with virtually no checks or oversight. Critically, the limited partners have no right to see the financial statement of the portfolio companies, nor do they get information about transactions or business arrangements between the portfolio companies and parties related to the general partner and its owners, employees, and affiliates….

The elected officials who are asking the SEC to intervene on their behalf are all board members or trustees of pension funds that have agreed to sign remarkably one-sided agreements with private equity general partners. So why, pray tell, have they sat pat and allowed this sort of thing to go on?

Yet the private equity funds seem so desperate to combat any discussion of greater disclosure, even blatantly self-serving efforts by elected officials that are destined to go nowhere, that they now feel compelled to trot out new arguments against more transparency via favored mouthpieces. The arguments made are so intellectually bankrupt that they demonstrate that the private equity industry has no valid defenses for its secrecy regime.

Yesterday, Private Equity Manager (PEM) published an editorial on the “carry fee” contretemps titled, “Split the debate in half”. It’s available online only to subscribers but a private equity investor sent me the full text. Amusingly, the article fails to mention that the “carry fee” disclosure brouhaha was kicked off by CalPERS board member JJ Jelincic asking whether CalPERS tracked “carry fees” in a public board session and getting the “dog ate my homework” excuse that not only didn’t CalPERS do that, but it couldn’t. That falsehood kicked off an avalanche of bad press and a rapid volte face by CalPERS.

But you hear nary a word of that from PEM; readers are inaccurately told that the pressure for disclosure resulted from industry bodies revising their reporting templates.

Here are the key sections:

Conflating carried interest reporting with that of general fees and expenses only muddies the transparency debate….a coalition of state officials are now urging the SEC to mandate standardized fee disclosures by force.

I have to interrupt. You gotta love the hyperventilating “by force”. Back to the article:

But allow us to unpack what’s happening here from a more technical standpoint with respect to reporting (which is of higher interest to the finance and administrative team).

To begin, consider this: what does it mean exactly to report carried interest? It’s a question few are asking, despite most agreeing with criticisms that CalPERS dropped the ball after admitting it didn’t know how much carry it pays its managers.

But here’s the thing: it’s not CalPERS that is paying the carry. Carried interest is a profit allocation made after fund divestments, collected by the GP after hitting a pre-negotiated performance benchmark. Is the expectation that CalPERS knows how many dollars it sacrificed for agreeing a 20 percent profit share with the general partner based on their ownership percentage of the fund? Or how much carry in total the GP receives? Or something else? In the end, what does knowing that number provide CalPERS after the partnership agreement is signed?

This is insult to any reader’s intelligence. PEM is trying to say, with a straight face, that a fee deducted from profits is not a fee.

A profit share by design is contingent compensation. The absurd PEM statement that “…it’s not CalPERS that is paying the carry,” is logically equivalent to, “It isn’t Oracle that is paying a commission to its salesmen,” or “It isn’t the plaintiffs in a class action suit that are paying contingency fees to the attorneys that represent them.” PEM is trying to persuade its audience that because private equity investors have signed agreements that allow general partners to “collect” a profit share, that the investors have not paid it.

Private equity investors are acutely aware of the fact that “carry fees” are taken out of the profits (to the extent there are profits) earned on monies they provide. It’s their money and their risk. Private equity funds typically have only a 3% equity interest in the funds they manage, and much of that is not even a hard dollar investment. Part often comes about via a tax gimmick that the IRS has finally decided to stamp out, that of the management fee waiver. So some of what little investment the general partners make was not to have skin in the game but to lower taxes.

PEM then tries taking the absurd position that a fiduciary like CalPERS can’t possibly have a bona fide reason for knowing what “carry fees” are charged. At a minimum, CalPERS needs the data to make sure it isn’t being ripped off. Given that the SEC has warned investors that pilfering is rampant in private equity, limited partners have good reason to find out the amounts that are being deducted from their distributions. Our understanding is that some funds do disclose this amount when they remit payments, but as CalPERS’ and later CalSTRS’ flat-footedness attests, the practice seems to be far from common.

But at least as important, as Georgetown law professor Adam Levitin pointed out when CalSTRS officials tried claiming that “carry fees” weren’t worth tracking, is that fiduciaries should know what their full investment costs are:

CalSTRS argument is like saying that the only cost of a credit card that matters is the annual fee, not the interest rate or other fees. Smaller management fees could be offset by larger carry costs. It’s total cost that matters.

Recall that Oxford professor Ludovic Phalippou has estimated that the total amount of private equity fees that the general partners extract is 7%. That’s an indefensibly high number, hence the fierce efforts of the industry to avoid and downplay disclosure. As anyone who has read John Bogle knows, even small amount of additional investment costs eat into returns over time, most of all for long-horizon investments like retirement portfolios.

Assuming Phalippou is correct, and there’s no reason to think he isn’t, private equity limited partners should be demanding that overall charges be lowered by at least 2%. And the place to start would be ending clearly abusive portfolio-level charges like monitoring fees (which Phalippou calls “fees for doing nothing”) and transaction fees (which are unjustifiable double charging, since virtually all private equity general partners hire third parties to execute transactions and arrange financings).

But what justification do we get from PEM?

Let’s also remember that carry is not a simple accounting number. It can be accrued, earned, paid or even locked in escrow to secure future clawback obligations. These nuances will need to be considered if we are to speak of carried interest reporting in a meaningful way.

Gee, so general partners make “carry fees” hard to compute and understand? Even better to get more disclosure, particularly since limited partners and their hired guns are asleep at the wheel as far as the impact of many of the finer details is concerned. As we wrote:

As we’ve noted previously, if you look at the reports prepared by industry consultants, they are embarrassingly superficial in how they review fees. Oxford professor Ludovic Phalippou explained in a 2009 paper that this sort of simple-minded comparison is misleading. For instance, supposedly standard terms like a 20% upside fee subject to an 8% hurdle rate, using a representative set of fund cash flows, could lead to success fees being as low as $7.5 million or as high as $19 million depending on the definition of key terms.

PEM continues:

The ultimate goal, of course, is more transparency – an objective we here at pfm have thrown our weight behind in the past. But carry is not as significant a number for purposes of discovering industry abuses as is travel expenses, broken deal fees and accelerated monitoring fees, to name a few areas where regulators have unearthed questionable practices.

So in other words, now that the industry has been caught out ripping off limited partners, that is now turned around and treated as the only valid reason for investors wanting more disclosure. The notion that limited partners have a duty to understand total costs is brushed aside. You can’t negotiate effectively when you are in the dark. Private equity is particularly opaque, with unduly complex agreements that contain “squeeze the balloon” features (if you try squeezing on fees in one place, it often has the effect of the general partners getting partial offsets elsewhere). They are quite clearly designed to stymie limited partner efforts to understand total costs and take measures to contain them.

The one bit of good news is that with CalPERS having done the right thing by changing its practices quickly when caught out means that the rest of the industry will follow. The long-standing pattern in private equity is that when CalPERS moves, whether voluntarily or not, to increase disclosures, the general partners have lost the war. It’s thus instructive to see how hard they are fighting a rearguard battle. That shows they know they have a lot to lose.

Print Friendly, PDF & Email


  1. Gerard Pierce

    This might be an overly-simplified question, but how much of the attraction of private equity comes from the ability of the general partner to manage it’s investments in ways that are largely unethical and would be embarrassing for the, say, pension fund trustees if those practices were attributed to those trustees.

    If the trustees know that their investment returns are based on financial rape and pillage, it would explain why they are not too worried about how much comes off the top before they get their share of the loot.

    Or is that too cynical?

    1. Yves Smith Post author

      Even though it is generally wise to be deeply skeptical of private equity, yes, this is too cynical. Some Canadian pension funds have brought their private equity investing in house. They would not be able to do that if a significant motivation were to have plausible deniability over Bad Stuff done with their money. But one can correctly point out that it’s nuts for public pension funds to be investing in PE when PE has been in the vanguard of union-busting.

      One feature of PE that we’ve haven’t written about because everyone knows it’s true but it’s hard to prove in a rigorous manner is one of the appeals of PE is that they fudge their valuations when equity markets are really bad. Funds like CalPERS are supposed to report all their investments on what amounts to a “mark to market” basis. So when their stock portfolios go down, like in 2008, they really look bad.

      When equity markets are in the dumps, PE funds are not selling companies and merger and acquisition activity generally is non-existent, save maybe some bankruptcy-related acquisitions. So the PE firms are not burdened by having ready comparables. Of course, by any logical standard, if the stock market has collapsed, the value of PE investments have to be really down too. But they don’t show quarterly valuations that are in any way in line with what a realistic valuation at those times might be. In the crisis, PE valuations were so obviously ridiculous that I recall seeing articles about it at the time, although I’ve been unable to find them again.

      But for investors like CalPERS, those artificially high valuations are a feature, not a bug. The misreporting makes it look as if PE is some sort of magic low risk strategy, as opposed to the numbers are garbage when markets are in the tank. That reduces the heat on CalPERS and its ilk.

      1. Steve H.

        – this is too cynical.

        Thank Hyperbola, it’s an s-curve! There is a limit after all.

        1. Steve H.

          I’m sorry, I just got so excited. The truth is, the nuance of understanding that you give with the Canadian pension fund, which provides evidence over conjecture, is extraordinary. These are the trimtabs, the quick nudges towards a very clear view of how the world is working, that help keep me from skewing wildly toward my own biases. They provide, as it were, a glint in the kindling.

      2. Sluggeaux

        Thanks for this excellent clarification. Fluctuating asset values has been a HUGE problem for pension managers, and for CalPERS in particular. During the Tech Bubble of the late 1990’s, the employer fund through which I participate in CalPERS was calculated to be “super-funded” with assets in excess of 120% of liabilities. This led to a “contribution holiday” for the public entity that employs me and a benefits increase for the employee-savers, neither of which looked like such a good idea when “market cycles” went off the cliff in 2001 and again in 2008. These “market cycles” have been a beautiful “that’s just the way it is” excuse for sharp operators to loot savings. CalPERS staff finally got a clue about “smoothing” contributions, but the accounting tricks described above just aren’t a sound way to accomplish this.

  2. TheCatSaid

    Great post. Each one in this series adds much to my understanding. I can apply what I learn to other kinds of contracts and related oversight deficiencies.

    Pensioners and people paying into pension plans are a large group that could exercise a lot of power for constructive change if they were to become more aware as a group.

  3. RUKidding

    Thank you, Yves, thank you, thank you, thank you!!!!

    You have done heavy lifting in terms of your clear writing to help me and others understand how this works, esp with PE and Hedge Funds (and their clear Rip Off tactics). It is almost amusing to read the rationalizations and other tactics to try to make it seem like Carry Fees aren’t a rip off. The attitude emanating from PE is so snidely condescending – it’s all: don’t worry your pretty little head about this; we’re “taking care of it.” It’s not so amusing to realize that mega-rich, greedy .0001%ers are ever willing to rip off hard working, industrious citizens who are (haplessly) trusting that their pension funds will be managed appropriately.

    In a prior post, someone else wrote that (and I’m wildly paraphrasing here) maybe we should start calling Carry Fees a tax. While that’s completely inaccurate, given how “taxes” are viewed with horror, calling them taxes might garner some additional support for shedding light on how much the commoners are being “taxed” unfairly by the rich and well connected.

    The average citizen in the USA is no longer truly represented at almost any level of govt anymore, as most politicians have been clearly bought off to serve the sole interests of mega-corporations and the very wealthy. Kudos to you and Lambert for facilitating the effort for US workers to attempt to get some kind of fair shake from the Wall Street casino.

    Enough is enough. I do support Elizabeth Warren’s efforts, and I have called and written to her more than once to thank her for what she’s doing. Too bad Warren is pretty much the lone voice crying in the wilderness. Where, oh where are any of our other alleged “representatives” – whether in the House or the Senate or at the State level – pushing for transparency and a better deal for USA workers???

    I am writing as a CalPers contributer and future annuitant. I also write to the CalPers Board, as well as to CA State Treasurer, John Chiang. Let’s shed light on PE Carry Fees now!

  4. flora

    Thanks so much for clarifying the difference between ‘carry interest’ and ‘profits interest’, and how PE fudges them using the term ‘carry fees’ to fool investors. The PEM article portions you quote are astonishing for declaring a fee is not a cost to investors. Very creative bookkeeping, that. Please keep shining the light on PE.


    Please, educate me!

    The owner of the money agrees to put X€ in a Private Equity Fund.

    The owner of the money agrees with the terms of Private Equity Fund: investment policy, governance, 2% p.a., 20% over the hurdle rate, and so on.

    The Private Equity Fund is constantly under surveillance by the public supervision agencies, private auditors (for the fund, for the management company, for the investees).

    The managers of the Private Equity Fund work to make success companies.

    Where is the problem?

    1. Yves Smith Post author

      With all due respect, I suggest you get current on this topic. What you’ve written is dated industry propaganda.

      1. As we have written at excruciating length, supervision and governance of private equity investments are grossly deficient, to the point where the SEC found that over half the funds they examined had the general partners stealing from investors or engaging in other serious compliance abuses.

      2. The management company is not audited for the benefit of the investors in the PE fund, assuming it is audited at all. For private PE general partners, there’s no reason to have an audit. And the overwhelming majority are private. Similarly, the portfolio companies, which is where a lot of the PE grifting takes place, typically use reporting software which by design allows the PE general partner to tamper with the numbers:

      3. PE general partners do not have incentives to “make successful companies”. The bankruptcy rate is vastly higher among PE owned companies than for companies as a whole. PE firms now earn nearly 2/3 of their income from non-performance based sources like the cash they extract from the portfolio companies. That means they make money simply by churning companies. PE would have performed disastrously since 2007 had it not been a beneficiary of the Fed’s QE and ZIRP, which allowed them to refinance companies that otherwise would have gone bust (junk bond financing was made plentiful and artificially cheap) and goosed stock market valuations.

      4. Even with all the support from the Fed, PE is underperforming. CalPERS, which is widely regarded as one of the most savvy investors in PE, and also has advantaged access to funds, has not met its PE benchmarks for any of the last 10, 5, 3 and one years.

    2. vlade

      “The managers of the Private Equity Fund work to make success companies” Muahhahah. Pull the other one.
      Yes, some do. Generally in the smaller PE companies (and possibly some mid-sized). But most of them are there to make a buck (or ten) for themselves. The optimal way to do so is NOT to make their portfolio company successful.

      While one could, in theory, agree with your “you make your contract, you keep your contract” argument, I’d suggest that only people who weren’t part to contract negotiation can do so. Some of the LP contracts published call for judical questioning of fiduciary duties (as Yves wrote elsewhere, knowing costs of running your investment is a fundamental, basic, fiduciary duty. How else can you tell how your investment performs?).

      Re auditors – you’re joking, right? Auditors like the guys who were happy to sign off on Sino Forest and like? Anyone who believes auditors is a bridge buyer, and when PE kicks their teeth out, they put it under a pillow hoping for at least some return.

  6. cnchal

    . . .In the prototypical fee schedule of “2 and 20,” 2% is the annual management fee (which typically scales down later in a fund’s life) and 20% is the participation in profits, usually after beating an 8% hurdle rate.

    Some investments are wildly profitable for the Pirate Equity general partner, so how do the Limited Partners know they are getting the proper share of profits when they are not allowed to audit the portfolio companies or the general partner?

    As an example, look at Pirate Equity group Carlyle and their investment in Beats headphones.

    With an estimated raw production cost of $20 including labor and shipping and an out the door retail price of $199 or more, there is a huge margin of $180 in each headphone. That margin gets split several ways but there is no doubt that Carlyle made out like pirates, and the venture was wildly profitable. Was it profitable for the limited partners? No one except Carlyle knows, and without the ability for the limited partners to examine the books and bank statements of Carlyle, the profit is whatever Carlyle says it is.

    . . .A true “carried interest” occurs when an investor allows another party to borrow from them in order to acquire a stake in the venture.

    By that definition, there is no “carried interest” whatsoever. The limited partners put their money into a black box run by the pirates, the pirates do what they want, and at the end of it all the pirates decide on the limited partners profits, with no verification allowed.

    The whole Pirate Equity business is no more than an elaborate skimming operation cloaked as financial royalty.

  7. tegnost

    To paraphrase john prine…there’s a hole in society’s arm where all the money goes…

  8. Andrew M Silton

    Check page 87 of the CalPERS CAFR ( When it comes to hedge funds and real estate (same fund structure as private equity), CalPERS reports incentive fees, and has been reporting them for years. The entire debate about the availability of the data or appropriateness of disclosing it is absurd. CalPERS has had the relevant data for PE every year since it got into the asset class decades ago. They arbitrarily decided to hide the data even though they know exactly how to calculate their share of PE carried interest, and provide the public with the very same data for HFs and RE.

    For the most part, the fiduciaries and staff of public funds have been captured by the PE industry. If they were really committed to disclosure, they would release the data instead of hiding behind a letter to the SEC.

    I would have published this comment on my own blog and newspaper column but for the fact that I’ve stopped writing in order to pursue my art.

    Andy Silton

    1. Yves Smith Post author

      Please look at that page again.

      No private equity funds are includes on the page you referenced, nor is there a total for PE. Zero. Zip. Nada. It is “absolute return managers” none of which are included in the list of CalPERS’ PE funds, equity managers, fixed income managers, and real estate managers.

      The private equity schedule of fees and costs in in the investment section, on pages 104 through 107. It not only does not include carry fees, it does not include the full management fee, only the part CalPERS paid in cash (as in it does not include the portion shifted onto portfolio companies). You will see that the names listed on this page, which is an even longer list of funds (since it includes co-investments) than on its quarterly PE performance reports (see here for latest) do not overlap at all with the names on the page you identified.

      Let us put this another way: would a CalPERS board member, who also happens to be on CalPERS’ staff, ask a question of the chief investment operations officer in the limited time board members have in public board meetings if the answer was in the CAFR? And would the chief investment operations officer say CalPERS didn’t have the data and take the position that it couldn’t get the data if it was in the CAFR? And would CalPERS allow itself to be on the wrong end of a media firestorm and be pressing all its private equity managers to provide the data if it already had it?

  9. tegnost

    What’s nagging me as i ponder this article and responses is the cynicism of it all. Yves pointed out that PE is big on union busting, yet unions allow them carte blanche on their pension investments so PE can create the “spoiled workers” reality they want while raking in piles of cash, same deal with social security, they hate social security. They look at that pile of money and say “it should be mine; because I’m better, smarter, shrewder, type A”, there’s litany of excuses why they deserve it all. To the prevalent way of thinking, it’s as if we’re supposed to know that any money put in pensions will be taken less whatever miniscule percentage goes back to the fund itself. Thus the primary purpose of a pension becomes the enrichment of the few disguised as enrichment of the many. So it seems we’ve ended up with this socialism for the fabulously wealthy while they decry food stamps (which of course are making them richer because that’s a minor example of socialism for the rich in action). The numbers in the earlier NC articles regarding CalPERS were astounding, and probably just the tip of the iceberg. More please.

Comments are closed.