Thursday, May 15, 2014

SEC: 50% of Private Equity Firms Steal from their Clients

Andrew Bowden, the Director of Compliance Inspections and Examinations recently gave a speech entitled, "Spreading Sunshine on Private Equity."  If you click on the link and read the transcript from Bowden's speech, you would have to wonder why anyone would ever give their money to a private equity fund ever again.  Bowden's speech should be required reading for all pension fund managers.  What follows is a quote from Bowden's speech:

"When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time.  This is a remarkable statistic."
The SEC has found in their audits of private equity firms that more than 50% of them:

  1.  over charge their clients for fees, and 
  2.  improperly reimburse themselves for their expenses from the companies they acquire.  

Both maneuvers essentially mean they take money that is rightfully their clients money.  In other words, they are thieves.

Another astonishing quote from Bowden's speech:
"The private equity model is very different [from publicly traded stock portfolios].  A private equity adviser typically uses client funds to obtain a controlling interest in a non-publicly traded company.  With this control and the relative paucity of disclosure required of privately held companies, a private equity adviser is faced with temptations and conflicts with which most other advisers do not contend.  For example, the private equity adviser can instruct a portfolio company it controls to hire the adviser, or an affiliate, or a preferred third party, to provide certain services and to set the terms of the engagement, including the price to be paid for the services ... or to instruct the company to pay certain of the adviser’s bills or to reimburse the adviser for certain expenses incurred in managing its investment in the company ... or to instruct the company to add to its payroll all of the adviser’s employees who manage the investment." 
Let me summarize that paragraph.  Bowden is saying that private equity managers use their client's money to buy businesses. Once they control the business, they proceed to rob it.  What an incredible business model!  Use someone else's money to buy businesses so that you can rape and pillage the business for your own benefit.

Lastly, Borden points out that Bruce Karpati of the SEC's Enforcement Division has found that many private equity funds lie to their clients about the valuation of their investments.  This also boosts fees which is another way to steal from their clients.
"Last year at this conference, Bruce Karpati, then of the SEC’s Enforcement Division, addressed this debate, noting the importance of valuations in fund marketing.  Academic studies have supported this thesis, showing that some advisers inflate valuations during periods of fundraising...A common valuation issue we have seen is advisers using a valuation methodology that is different from the one that has been disclosed to investors....."
One would have to wonder how any pension fund manager could possible ponder investing in private equity funds without inherently violating their fiduciary duty to their pensioners?