CalPERS, which has endeavored to wrap itself in the mantle of ESG virtue-signalling, now finds itself embarrassed by its connection to Leon Black, the founder and long-standing head of private equity heavyweight Apollo, who in turn is more than trivially connected to sex offender Jeffrey Epstein, whose misdeeds are now coming under renewed scrutiny.
It’s telling that image-above-substance-sensitive CalPERS is bothered by being tainted by being one of many limited partners in Apollo funds, when it chose to look past lasting institutional damage done to CalPERS when a pay-to-play scandal that had Apollo providing the overwhelming majority of the dodgy money led to the conviction of former CEO Fred Buenrostro for fraud. Yet, as the letter embedded at the end of this post shows, CalPERS’ attorney Philip Khinda of Steptoe & Johnson, who headed the whitewash investigation of the pay-to-play affair, the giant fund took a fawning posture towards Apollo in accepting a settlement proposal from Apollo that may never have been properly papered up or accounted for.1 And more important, it looks likely that CalPERS got shortchanged on the fee reductions it was promised.
But back to the current scandal, which has a Master of the Universe looking like he’s been caught with his pants down. Not only is Leon Black’s name in Epstein’s infamous black book, but Epstein was an “original trustee” of the Leon Black Family Foundation, dating from 1997. Black has attempted to disavow state filings that reported Epstein as still on the board through 2012, years after Epstein pleaded guilty in 2008 to solicitation of prostitution. Black has tried claiming that the filings were in error and Epstein left the board in 2007.
Even less credible are Black’s claims about his relationship with Epstein. Bloomberg published a story earlier this week, Jeffrey Epstein Had a Door Into Apollo: His Deep Ties With Leon Black, which depicted Black as having permitted Epstein to solicit other Apollo executives for his “personal tax strategies”. The Bloomberg piece was clearly based on inside accounts. The article also had a section on CalPERS’ hand-wringing:
“Calpers takes this issue very seriously,” Wayne Davis, a spokesman for the Sacramento-based pension, said in an email last week. “The actions our general partners take, both in professional and private contexts, impact our assessment of which firms we desire as long-term partners. We consider any issue, including reputational risk, a serious matter if it impacts a firm’s ability to be successful.”
He said Tuesday that the pension fund is “in the process of contacting Apollo to discuss this.”
All CalPERS can do is make sanctimonious noises. The idea that Black would do anything other than repeat his official story is ludicrous. One wonders who CalPERS thinks will be impressed by its efforts to have a tea and cookies chat with Black about his poor taste in friends. Dumping its stakes in Apollo funds on the secondary market would come at a very high cost, particularly given how much CalPERS would need to unload.
But for CalPERS to act like some sort of naif about Black and Apollo and cop that had every reason to think Black was an upstanding guy is laughable. Not only is chicanery the default in private equity (see numerous articles about how the industry rips off investors, as well as SEC fines and disgorgements, including by Apollo) but Apollo was at the center of the bribery scandal from which CalPERS has yet to recover.
And there would be quite a lot to discuss if Black could be persuaded to be candid. Black claims that he turned to Epstein for professional advice on taxes, philanthropy, and estate planning. Why would someone like Black turn to Epstein, who has no training and no demonstrable basis for claiming expertise, when Black and Apollo have access to the top professionals, including tax attorneys who could treat discussions as attorney-client privileged?2
However, Black sent a letter to Apollo limited partners, which quickly made its way to journalists. Black also read it out loud on the Apollo earnings call earlier this week. It didn’t seem to do much to assuage doubts. For instance, the New York Times pointed out:
Mr. Black described his relationship with Mr. Epstein as one largely limited to tax strategy, estate planning and philanthropic advice.
“I want to emphasize that Apollo has never done any business with Mr. Epstein at any point in time,” Mr. Black said in his letter, a copy of which was reviewed by The New York Times.
Most important, he wrote, “I was completely unaware of, and am deeply troubled by, the conduct that is now the subject of the federal criminal charges brought against Mr. Epstein.”
But so far, Mr. Black has not discussed a company that he and his four children — as well as Mr. Epstein — invested in three years after Mr. Epstein pleaded guilty to a charge of soliciting prostitution from a minor in Florida. Mr. Epstein’s financial advisory firm took a roughly 6 percent equity stake in Environmental Solutions Worldwide in 2011. Two of Mr. Black’s sons serve on the board of the company, which makes emission control products, according to the company website.
Similarly, from Dan Primack at Axios:
Leon Black yesterday spoke publicly for the first time about his relationship with Jeffrey Epstein, in response to a question from JPMorgan analyst Ken Worthington.
He mostly just read, verbatim, the letter sent last week to Apollo employees (which is quite similar to a letter Apollo sent yesterday to its limited partners).
But he also said:
“There has been a virtual tsunami in the press on the subject. It’s seems to be the gift that never stops giving. For the press, it’s salacious. It involves elements of of politics of me too, of rich and powerful people and and my guess is it will continue for a while.”
I can’t speak for other media, but my interest in this story isn’t because it’s salacious or because Leon Black is rich. It’s because he continues to refuse to answer a central question about judgement — why he donated $10 million years after Epstein plead guilty — and Black’s judgement is a big part of what Apollo sells its shareholders and limited partners and portfolio companies. So, yeah, this will continue for a while.
Back to CalPERS. Let’s look at the key section of the deal that Black offered to CalPERS to make up for a pay-to-play fee that was so ginormous that it looked like a bribe, and some of that money did go to CalPERS CEO Fred Buenrostro in cash in paper bags.3
We’ll charitably assume this flimsy commitment was firmed up and properly commemorated.
Notice how this section twice refers to funds managed “solely for CalPERS”. That means a dedicated fund, not a “co-mingled” fund, meaning the common form of private equity fund. These dedicated funds are called “separately managed accounts”.
If you look at the list of CalPERS’ current Apollo investments, you’ll see only one that looks like a separately managed account, the 2007 “Apollo Special Opportunities Managed Account.”
In theory, there might have been other separately managed accounts in 2010 that were liquidated since then, but the fact that Apollo hasn’t wound up 1998 and 2001 funds makes that seem unlikely.
The Apollo proposal says it agrees to reduce its “management and other fees on funds it manages solely for CalPERS by $125 million.” It also has verbiage about a new fund that appears never to have been consummates, since its “vintage year” would have been 2010 or later, and we see no fund like that (Apollo VIII in 2013 is a “flagship fund” with lots of investors).
But what are “fees on funds”? Aside from management fees, it’s hard to think of any. This clearly means (well, clearly if you’ve gotten down the curve a little bit on private equity sharp practices) means fees paid at the private equity fund level, not at the portfolio company level. Note also that fund expenses, like the cost of preparing books and records, are expenses, not fees, and aren’t eligible either
The Apollo VIII limited partnership agreement (and any CalPERS agreement is likely to closely parallel it) draws a clear distinction between portfolio company level fees (which are defined as “special fees” and the management and unspecified fund-level fees.
Similarly, the so-called “carry fee” is not a fee as defined in the limited partnership agreement. Pages 37 through 39 set forth “Portfolio Investment Distribution,” known in the trade the “waterfall.” And the 20% cut of the gains that goes to the general partner is repeatedly called a distribution, not a fee.
So CalPERS had $800 million of committed capital that was eligible to have its management fee waived until the $125 million was exhausted. Recall that management fees usually step down after the fifth year and are usually based on the amount of capital then deployed, and not the committed amount.
Some simplifying assumptions:
1. CalPERS was already a full three years into its 2007 fund by the time its fee reduction agreement with Apollo was effective. So it would have only two years of fee reductions at the full management fee rate
2. Due to the size of the commitment, the management fee was 1.75% (this if anything is conservative)
3. It effectively dropped to half that after the investment period of five years, meaning after the two years left at full rate on this fund.
2 x $800 million x 1.75% = $28 million
7 x $800 million x (.5 x 1.75%) = $ 49 million
Total = $77 million
So a reasonable guesstimate is that CalPERS got less than 2/3 of the face amount that CalPERS was supposed to receive from Apollo as compensation for the harm suffered by CalPERS, when CalPERS expected to get it all back in five years or so.4 And that’s before recognizing that letting Apollo and its fellow bad boys pay not a dime in cash was a ginormous concession. Black is worth nearly $7 billion. His worst take-home pay in recent year was $142 million and it’s been as high as in excess of $400 million. But CalPERS is too cowardly to demand that Apollo, which in this case would have been Apollo principals, to be personally responsible for their bad acts.
But the economics for CalPERS are even worse than the simple math suggests.
Remember those portfolio company fees we mentioned earlier? They are hidden from investors like CalPERS but really add up. Remember that the total cost of investing in private equity has been estimated at 7% a year. A bit over 60% of the total, meaning over 4% in total across the industry, are fees that don’t relate to performance, meaning not carry fees. That gives an idea how hefty those hidden charges are.
Some of those portfolio company fees are “offset” against the management fee. We say “some” because only fees that are specified in the limited partnership agreement are offset (and private equity firms have cleverly dreamed up other fees as the press and later the SEC has exposed) and those specified fees may not be fully offset (the average in recent years across all funds is 85%, but CalPERS is generally able to get higher offsets, and the level of offset also depends on how hot the private equity market is. In the most recent flagship fund, Apollo VIII, the offset is 100%).
The effect of getting rid of the management fee is that there would be no management fee against which to “offset” the portfolio company fees that would otherwise be offset against them. The effect is that Apollo could pocket all of the portfolio company fees, rather than have to reduce the amount of management fee to reflect the portfolio fee offset. That effect would reduce the economic value of the management fee reductions, 50% of all portfolio company fees (the not-specified ones that haven’t been subject to offsets and the ones that are) would seem to be a conservative estimate.
So I welcome seeing Leon Black squirm. And I wish the press were making CalPERS squirm for the right reason, for being such a dupe. But sadly, reporters and limited partners would rather play supplicant to private equity overlords, even when that amounts to becoming their victim.
1 As the post discusses and the letter below shows, Apollo was supposedly willing to provide $125 million in fee reductions. The so-called Steptoe Report touted that four funds, Apollo, Relational, Ares and CIM had “agreed” which means “offered on their terms” to provide $215 million in fee reductions. Yet of the total in pay-to-play fees, $48 million came from Apollo and another $10 million from Relational, Ares, CIM, and Aurora Capital. So we already have the head-scratcher that Apollo is on the hook for 58% of the givebacks when it supplied 83% of the dirty money.
2 The conventional view is that Epstein’s wealth came from extorting men who took advantage of the women and underaged girls he had in tow. I don’t find that credible since procuring and extortion both are crimes. Anyone Epstein tried to shake down on that basis could stare him down and tell him to try risking going public, it would be a sure-fire jail sentence for Epstein.
However, I am told that private jets get cursory to no checks when coming in from overseas if the jet owner is seen as being reputable and not coming in from a destination perceived as a risk for drug hauls. So I wonder if the real service Epstein was offering was indeed tax “planning” in the form tax evasion by transporting high-value assets to tax havens.
3 The Steptoe & Johnson report attempts to depict Apollo as a victim of the placement agent Al Villalobos. If you think Leon Black could be victimized, particularly to the tune of $48 million, I have a bridge I’d like to sell you.
4 Reading just the excerpted paragraph, it’s clear that the real intent of the fee waiver was to induce CalPERS to sign up for a new separately managed Apollo fund, which it appears never happened.