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?

North Carolina Retirement Systems Investment Expenses Are Out of Control

     Below is a summary of investment expenses incurred by North Carolina Retirement System's (NCRS) pension fund managed by our publicly elected Treasurer. The data are taken from the last annual Government Operations Report from June 30, 2012 provided by North Carolina's Department of State Treasurer.  

     I've calculated an Expense Ratio for each asset class provided in the "Gov Ops report" in much the same way a mutual fund would calculate an Expense Ratio.  I've also included long-term 10-year return information for each asset class where available as printed in the March 31, 2013 NCRS Quarterly Investment Update. 

  

     I'd like to point out that the State Legislature is currently mulling over Senate Bill 558 which would give the North Carolina State Treasure authority to invest up to 40% of the NCRS pension fund into Alternative Investments by primarily taking money out of the internally managed bond portfolio.  As can be seen in the table above, every dollar moved from the internally managed bond portfolio to Alternative Investments will incur expenses that are 178 times more expensive as the Internally Managed Bond portfolio.  That isn't a misprint.  Yes, the Alternative Investments portfolio expenses are 178 times MORE expensive than the Internally Managed Bond portfolio.   

Finance Clippings: Private Equity Fees

Another great post from Dr. Richard Warr at NC State.

Finance Clippings: Private Equity Fees: There's been much talk about Private Equity recently. Yesterday, an article in the FT (behind paywall) talked about the fee structure u...