Even Matt Levine Feels Compelled to Say Sorta Bad Things About Apollo’s Conduct in $52.8 Million SEC Settlement

If Andrew Ross Sorkin had the self awareness to realize that pretty much everyone with an operating brain cell sees him as a stenographer for Wall Street, he would want to grow up to be Matt Levine. Levine is an extremely clever and engaging writer who has the considerable advantage of being an attorney with expertise in derivatives. Thus when he adopts his usual posture of “Oh, I’ve looked at the details [and he really does] and there’s nothing to see here,” he can paper over any cracks in his argument with far greater success than Sorkin and his ilk.

Mind you, as much as I abhor Levine’s default posture of minimizing financial services industry misconduct as business as usual among consenting adults, what makes him so dangerous is that he’s so damned good at it. He’s enormously entertaining and has the rare ability to give apt yet accurate 50,000 foot overviews of complex transactions, and regularly provides footnotes to satisfy the geeks.

So it’s noteworthy that Levine’s article earlier this week on SEC’s biggest private equity settlement to date, in which Apollo agreed to pay $52.8 million, including $12.5 million in fines, had an atypically critical undertone for a Levine piece. Is it because everyone knows that Apollo’s Leon Black makes Mike Milken look like a choirboy, and being too dismissive of Apollo’s wrongdoing would undermine Levine’s posture of being oh so knowing? Or is it that Levine has come to recognize that the sort of grifting that the private equity industry has engaged in so gross (for instance, how it taking unauthorized fees any different than stealing?), that he can only go so far in prettying it up?

Having said that, the SEC order (embedded at the end of this post) is, as usual, weak tea. The agency cites three types of misconduct: charging so-called accelerated monitoring fees, which was responsible for the overwhelming majority of the charges paid by Apollo, issuing fund financial statements that misrepresented a loans made by Apollo funds for the purpose of deferring capital gains taxes by Apollo principals, and roughly $200,000 of personal expenses charged to funds by an Apollo partner who was eventually fired, allegedly over these expenses.*

Before we get to what the SEC dinged Apollo over, what’s striking is what the SEC chose to let Apollo get away with. As Gretchen Morgenson pointed out earlier this year, Apollo admitted in its Form ADV filing to having negotiated discounts for legal services while it charges investors a premium rate. This is particularly cheeky when you understand that the reason that Apollo can get hefty discounts is that the volume of legal work generated in the course of buying and companies on behalf of investors, as well as the related tax fancy footwork, is ginormous and dwarfs the legal work for Apollo proper. The very same abuse was part of a $39 million Blackstone settlement in late 2015. So this is yet another example of the SEC pattern of engaging in token enforcement actions, singling one firm out for an abuse, ostensibly to tell the others to shape up. But why should other investors who’ve lost money to which they were entitled be shortchanged by the SEC’s complacency? Moreover, the SEC’s open posture of very selective enforcement, combined with “cost of doing business” fines, is almost an invitation for firms to keep cheating.

As followers of private equity chicanery know, monitoring fees are already plenty dodgy. As we’ve discussed, they are foisted on companies that the general partners control, and they get the fees whether the general partner gets out of bed or not. That raises the issue that these are really disguised dividends, paid preferentially to the general partner, and should not be deductible to the portfolio companies. But tax issues are outside the SEC’s purviews. The SEC has made its enforcement actions about disclosure, and what the agency is targeting with accelerated monitoring fees is investors weren’t told that the portfolio companies would be charged large lump sum fees, “accelerating” the monitoring fees that were due to be paid over the remaining life of the monitoring agreements.

With that as background, let’s look at how far Levine goes in trying to dress up the SEC order. His headline is a classic by virtue of failing to mention that Apollo paid a big settlement by the SEC’s lame standards:
Apollo Paid Itself Some Fees and Gave Itself Some Loans. Translation: Apollo engaged in some normal-sounding activity. Aiee.

Levine then starts out with the small-potatoes abuse of the partner expenses, but does ding the SEC for having been unduly protective of Apollo for not having described exactly what the expense abuses were about, when it normally makes a point of maximizing the embarrassment by presenting them in detail. As he writes:

It’s almost like there are two genres of SEC enforcement action: The funny ones against two-bit Ponzi schemers, and the Very Serious ones against big firms.

But it would have been nice if Levine had also called out the SEC for that sort of behavior in more consequential part of order. Levine makes crystal clear that monitoring fees are an exercise in extraction (emphasis his):

The basic idea is that private-equity firms charge their portfolio companies a “monitoring fee” for … monitoring them? It seems silly to insist on a reason. They charge the monitoring fee to get more money. They could charge portfolio companies a Fee For Being Nice Guys, and the portfolio companies would cheerfully pay up. The way private-equity firms work is that they buy portfolio companies with money provided by their limited partners (pensions and other big institutional investors), and then run those companies on behalf of the limited partners. So the private-equity firms are the (effective) owners and managers of their portfolio companies. They can send a portfolio company a bill, and then send themselves back some money. The guy sending the bill is also the one paying it, but with the limited partners’ money. You can monitor, or you can not monitor, but either way you charge a monitoring fee, because the emphasis in “monitoring fee” is solidly on the word “fee,” not the word “monitoring.”…

This all sounds like a racket, and it is a racket, but to be fair it is a well-known racket of private-equity investing, which is that the private-equity firms keep dreaming up amusing fees to charge to their investors and portfolio companies, and the investors keep discovering those fees, and each time they chuckle appreciatively and say “I tip my hat to you, Apollo, really well played old chap, charging those monitoring fees for not monitoring.”

Now let’s get real. If Matt Levine had ever bothered watching a CalPERS Investment Committee meeting, and had seen, say, the Chief Operating Investment Officer deny that CalPERS could find out what it was paying in carry fees, or the head of private equity, Real Desrochers, not understand that the effect of management fee offsets is not to reduce the management fee, but to shift some of it onto the portfolio companies, he’s have a much harder time treating the hopelessly outmatched limited partners as amused by the way they’ve been fleeced by the general partners. He’s telling his readers the falsehood that the power dynamics are balanced, that the general partners and limited partners are engaged a type of sport. In fact, the limited partners are much more akin to someone in denial that they are in a bad co-dependent relationship, or an abused spouse who doesn’t want a divorce because she’s afraid she’ll never live as well as she does now.

But he then does concede the point that the limited partners are unhappy…having just told his readers that if they were savvy like him, they’d be impressed rather than resentful. This is a rhetorical device that Levine has mastered, of first treating bad actions as not a big deal, or proof of the overwhelming cleverness of the perp, as opposed to chicanery or an abuse, and then saying “some people think there is an issue” while even then gliding over it. The reader is thus set up to side with him, the obviously much smarter person, who based on his allegedly superior understanding, can’t fathom what the fuss is about. Here’s the next bit:

Actually the limited partners don’t much like this sort of thing, which is why, for instance, Apollo rebates most of its monitoring fees back to the limited partners by reducing the management fees it charges them, though usually not by the full amount of the monitoring fees. (So if Apollo charges a portfolio company $100 in monitoring fees, it will reduce the management fees it charges the investors who own that company by, say, $65. )

Now having cleverly conceded that the monitoring fees are not defensible but the clueless limited partners have unwittingly allowed the general partners to effectively double charge them in all sorts of ways, Levine hand-waves about the acceleration: how is this so bad? Well, gee, as the SEC points out, this goes beyond anything the limited partners were told about in advance, and it reduces what the investors get when the company was sold. So how is that not stealing?

So Levine, taking the position that the accelerated monitoring fees are no biggie, lets the SEC off the hook for this priceless part in the order:

However, in some instances, Apollo accelerated monitoring fees beyond the period of time during which it held an investment in the publicly traded portfolio company. In other instances, Apollo provided services for periods longer than the period for which it received accelerated monitoring fee payments.

So the SEC apparently believes the monitoring fees are something other than grifting that the limited partners were dopey enough to authorize sometime in the distant history of private equity limited partnership agreements, and the general partners, having established that as a norm, are giving it up only by inches, via allowing the to be offset against management fees. We’ve discussed some length why that is an unsatisfactory remedy, versus the more obvious solution of having told the general partners to cut it out entirely.

And here is where Levine is making stuff up:

And then their only recourse was to complain about it. Which honestly isn’t nothing, as recourses go? This was a repeated game: The limited partners are big institutional investors, and Apollo kept raising new funds. And as the limited partners find silly new fees, they seem to be pretty successful at squashing them, or at pushing the private-equity firms to credit those fees against their management fees, reducing the overall cost to the limited partners. The SEC’s accelerated-monitoring-fee cases are basically just an acceleration of this process: The limited partners would eventually have cracked down on accelerated-monitoring-fee thing, but the SEC can shut it down faster and more completely.

No, Matt, there is absolutely no basis for believing the limited partners ever would have found out about these fees. They were unearthed by relentlessly comparing disclosures in limited partnership agreements and the other offering documents to the disclosures made in the IPOs of portfolio companies. Private equity investors never never never read those documents. It does not take place at the deeply staffed limited partners like CalPERS and CalSTRS (the general partners do a great job of keeping limited partners running around to various meetings they host, which the limited partners treat as real work, as opposed to going carefully over the information available to them). The only instance I have ever heard of a private equity investor even looking at portfolio company IPOs is one in Norway….and she didn’t catch this abuse.

Levine similarly chooses to praise Apollo for its cleverness in the lending issue that the SEC was unhappy about…and utterly fails to tell his readers that they had to issue false fund financial statements for the con to pass muster with IRS. How can you possibly dismiss phony fund records? And pray tell, why isn’t the auditor being dinged for this too? Here is Levine’s brush-off (emphasis his):

The SEC is again concerned that this is a failure of disclosure, but I am more interested in it as a triumph of imagination. Apollo’s managers got paid in part with carried interest, a share in the appreciation of their portfolio companies. Carried interest is — notoriously — taxed at favorable rates, compared to other forms of compensation. But why pay yourself your carried interest, and incur a 15 percent tax rate, when you can instead lend yourself your carried interest, and put off paying taxes for five years? You get the money now, and can spend it now, but you don’t have to pay taxes until later. Of course the downside is that you have to pay interest on the loan, but that isn’t really so bad because you pay the interest to yourself. It’s such a nice little trade that I’m surprised that Apollo got in trouble for inadequately disclosing it. It almost seems like they should have bragged about it.

Contrast this with the SEC’s order:

Despite the terms of the loan agreement and the disclosures in the Lending Funds’ financial statements showing that the interest income was accruing, the Lending Funds’ financial statements did not disclose that the accrued interest on the loan would be allocated solely to the capital account of Advisors VI. AM VI’s failure to disclose that the accrued interest would be allocated solely to the capital account of Advisors VI rendered the disclosures in the Lending Funds’ financial statements concerning the interest materially misleading.

So this is what happens to “talent” in America. Levine is open about his lack of a moral compass. All that matters is the deftness of the con and whether the victims are alert enough to make a fuss. It appears that Levine has failed to take into account Mark Blyth’s warning: “The Hamptons is not a defensible position.”

* As much as giving the most minor offense pride of place is another one of Levine’s rhetorical devices, he’s right that there is something off about the incident. The New York Post ferreted out that the partner who was ousted was one Ali Rashid, apparently for flying his girlfriend around on a private jet at investor expense. While this is not kosher, the misuse of private jets is so endemic in the industry that one has to assume that this was a convenient way to drum Rashid out of the firm and minimize the severance cost. People who’ve tracked the tail numbers of jets owned by PE firms, where it is virtually certain that all of the costs are somehow borne by investors, show jets converging on the Super Bowl playoffs and flights to the Hamptons and the Caribbean and other weekend or holiday destinations at times that are clearly not for client meetings. As someone in private equity said via e-mail: “Come on, which PE guy is not spending LP money to fly around girlfriends, lovers, wives, family, prostitutes, etc.”

Apollo August 23 SEC Settlement

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  1. DorothyT

    California has a long history of protecting Leon Black and Apollo. Here’s a complaint that was filed by the CA A.G.’s office in 2002 when a whistleblower informed on wrongdoing regarding Apollo’s major role in acquiring the largest junk bond portfolio in the world for a song. It makes for interesting reading regarding the beginning of when Apollo embedded its talons in CA politics and finance. The Dept. of Insurance successfully opposed this complaint as paid for by the estate of 360,000 insurance policyholders who would have recovered much of their billions of dollars of loss to their policy values and benefits. Oh, and always overlooked, are the employees of the 400 companies whose bonds made up this portfolio who lost their jobs when manic M & A transactions ensued. But that’s another story that rivals NAFTA in its impact on job loss (not to mention shareholder losses).

    What the CA A.G. ‘neglected’ to add to this complaint was proof that the insurance company, Executive Life of CA (ELIC), seized by that ambitious insurance commissioner (now Congressman John Garamendi) wasn’t insolvent. Even the Nat’l Assn. of Insurance Commissioners (NAIC) agreed that the biggest threat to ELIC would be improvident regulatory action. And that proved true.

    This is not ancient history: the litigation in the ELIC matter commenced in 1991 and concluded in August 2015. The insurance commissioner, in getting the A.G.’s complaint dismissed then granted immunity to Leon Black and Apollo, the most important defendants.

    Apollo and Black then turned to CalPERS as ready customers for their newly acquired assets. The insurance commissioner ran for governor but lost in the primary. He subsequently ran for Congress where he presently serves.

    1. Yves Smith Post author

      Thanks for this. There is also the fact that it was Apollo and close-to-Apollo funds that gave the roughly $58 million in pay to play fees that led to the indictment and imprisonment of former CalPERS CEO Fred Buenrostro and the indictment and suicide of former board member Al Villalobos. Leon Black can get a meeting with CalPERS any time he wants to. The question of what he expected to get for those fees has been kept under wraps. And as we wrote, the restitution agreement with Apollo was rubbish:


      1. DorothyT

        Thank you for your courageous work, Yves. “Fearless” is a term ‘on the nose’ for the work you do, the issues you expose. Readers should be cognizant that there can be personal risk involved.

  2. diptherio

    the SEC’s open posture of very selective enforcement, combined with “cost of doing business” fines, is almost an invitation for firms to keep cheating.

    …fixed it for ya.

  3. Foppe

    Yves: “The very same abuse was part of a $39 Blackstone settlement in late 2015.”
    This sounds like very weak tea indeed, but I get the feeling that there is a unit missing.

  4. cnchal

    . . . So how is that not stealing?

    What Pirate Equity does is a glorious taking whereby the rubes deserve to lose their money.

  5. Timmy

    I recognize and share concern for the issue of selective enforcement. It is my perception that the SEC would respond that this is both a resource and a logistics issue where the volume and complexity of the issues is the primary constraint on enforcement. Perhaps I’m naive…

    In their enforcement manual, here’s how the SEC describes their prioritization of enforcement opportunities (this is the first and, presumably, the most important of nine bullets in the list of considerations):

    “Whether the matter presents an opportunity to send a particularly strong and effective
    message of deterrence, including with respect to markets, products and transactions that
    are newly developing, or that are long established but which by their nature present
    limited opportunities to detect wrongdoing and thus to deter misconduct.”

    This seems like an explicit acknowledgment that they have to be extremely selective to those investigations that have the highest impact on both those being investigated and those who are undetected committing the same violations elsewhere. This means much goes undetected and unenforced but I’m not sure I understand the alternative to this approach.

    1. Yves Smith Post author

      The problem is, as we described, that selective enforcement does not send an effective message of deterrence. As we outlined in early posts, private equity firms are in fact thumbing their noses at the SEC by listing things that the SEC has sanctioned as things they are doing, as if ex post facto disclosure solves the problem. It doesn’t because as this order indicates and the SEC has separately said in speeches to the PE community, that the disclosures need to be made before investors invest. That’s a bedrock principle and is even more important in PE.

      The other reason this “we are so powerless by having limited resources” does not wash in PE is that the agency has a nuclear weapon: virtually all firms have been engaged in unlicensed broker-dealer activity. This is trivial to document and the penalty is dollar for dollar of the fees charged. This would amount to hundreds of millions of dollars each at the biggest firms. All the SEC has to say is. “We are on firm grounds on this action. Yes, you can fight us, but if you do, we’ll go after you on broker dealer fees and we both know that’s a slam dunk win. So tell me what you want to choose here.”

  6. Scrooge McDuck

    My guess is that Leon Black threw a lot of people under the bus to get a pass on the legal fees discounts. Call it a plea bargain.

  7. Fool

    I happen to be a big Levine fan — pretty much my go-to for financial/legal news, second only to here. (He has the unique ability to make a financial derivative seem like the coolest, most interesting thing; it’s like reading Matt Stoller in which no matter how technocratic the subject I always feel smarter for having done so.) But yeah, the amoral whimsy thing Levine does can be annoying, when it’s so clear that he knows — or at least should know — better. For example,

    The improper expensing is just a small part of it, though; the main problem is that Apollo charged its portfolio companies accelerated monitoring fees without adequately disclosing to investors that it would do that. The SEC takes that very seriously, though I am a little meh on it. We talked about it last year, when the SEC fined Blackstone Group $39 million for the same thing; it is part of a broader SEC crackdown on the private-equity industry’s habit of charging whatever fees it can get away with.

    There is a word for charging fees, without disclosure, simply because you can, and that word is stealing. Just say it man!

    A part of me also sees the aesthetics in these shenanigans — I haven’t missed a single episode of Yves’ private equity crackdown — and no doubt there is something aesthetically impressive about lending to yourself from four different funds an amount equivalent to your carry so that you don’t have to pay the carried interest taxes on it until the loan expires five years later. I mean, is the carried interest tax not a generous enough loophole? How can one not be outraged by such greed?

    Anyway, as mentioned, Levine’s smart enough that rarely does one ever call him out — but Yves! — so I’m happy to read this scolding. (PS: great title too!)

    1. Yves Smith Post author

      “Amoral whimsy” is great phrasemaking. And I have to confess I am jealous of Levine’s ability to explain technical material and make it go down easy.

      1. Fool

        As someone who’s read Levine since he was at Dealbreaker, I think a lot of that ability comes from a genuine delight in the architecture of structured products or the legalese with which they’re drafted. His stuff on the Blackstone-Codere trade, the London Whale, etc., makes it seem like building derivatives is the coolest job in the world — guy really puts the “fun” in fun-ance (hehe) — which is why it’s so odd that he would quit his job actually doing so at Goldman Sachs of all places.

        Re Sorkin, unlike that neoliberal tool — who speaks of inversions in terms of patriotism, or would call a donor to Robin Hood a mensch, etc etc — Levine confers little to no moral value one way or another. But yeah, it’s a mystery where he stands on the industry morals-wise since that part always gets abstracted out.

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