I really wanted to lay off private equity for a bit, but the news flow keeps getting in the way.
Today, the New York Times’ Andrew Ross Sorkin has a detailed story on a troubling, and apparently well-established practice among buyout firms: that of making sure that the lenders to their deals don’t have the benefit of independent legal advice. No, I am not making that up.
As we’ll discuss in due course, I suspect the reason for bank complacency is analogous to what took place with securitization: they do not think they have to care much about corner-cutting on risk because they don’t anticipate being long term holders of much, if any, of these loans. I’d love people current on how these loans are sold down to weigh in; the fact that this practice is not well known outside the industry and that Sorkin found sources to be closed-mouthed (despite also trying to maintain that this practice was no big deal) suggests that the ultimate owners of these loans may not always be aware of this dubious practice. It appears to be yet another case of the “originate and distribute” model leading to the ability of the originator (in this case the lead lender or lenders) to escape liability despite its assumed role as quality-vetter.
Sorkin’s piece is solid. Key sections:
Over the last several years, a new, insidious relationship has quietly developed between the nation’s largest private equity firms, the banks that lend them billions to fund their buyouts and the law firms that advise on these deals.
Historically, when a bank, like JPMorgan Chase, made a loan to a private equity firm planning a big acquisition, like the Blackstone Group, the bank would hire an outside law firm to scrutinize the loan and the transaction.
That made a lot of sense: Loans made to finance private equity deals are some of the riskiest because they typically involve a lot of debt…
Instead of allowing a bank to hire its own lawyers to vet a potential loan, many large private equity firms — Blackstone, Apollo Global Management, Kohlberg Kravis Roberts and Carlyle Group among them — now regularly require the banks to use a specific law firm that they designate, hence the term “designated lender counsel.” The private equity firms pay for the law firm’s services, too.
Think about it this way: It is, in effect, the equivalent of your employer giving you an employment agreement and telling you that the only lawyer who can look it over is the one the company has retained.
Bankers and their in-house lawyers privately complain that the private equity firms are assigning them law firms that have little allegiance to them and might not necessarily have their best interests at heart. But given the pressure to secure these big loan deals — which can be worth hundreds of millions of dollars in fees — few are willing to publicly criticize the practice.
As Sorkin also points out, the Fed has been sufficiently concerned about bank exposure to buyout loans that it has put constraints on them, yet has been asleep at the wheel as far as this not-so-new development is concerned.
And his uncharacteristic tone of alarm is fully warranted. While on small venture deals, the entrepreneur and funder will sometimes agree to use the same counsel, particularly when the lawyer made the match by virtue of having a relationship with both sides, heretofore it would be well-nigh unheard of for a sophisticated party to agree to use a lawyer picked and paid for by the other side. It’s stunning that the participants are trying to pretend that the lenders have adequate representation.
So why are the banks not up in arms? Here is where the piece gets disingenuous, not because Sorkin is being disingenuous per se. He’s just repeating the lines that private equity kingpins have successfully honed as to why their victims agree to go along: “They agreed to be marks”:
Indeed, when I called private equity firms — representatives from which all refused to speak on the record about this practice — they all said that if the banks were really that upset about it, the firms would have already heard complaints.
But that ignores the influence that private equity firms have over the banks, and the banks’ lack of incentive to speak up.
“The borrower has a lot of muscle, a lot of leverage,” Robert Profusek, a partner at the law firm Jones Day and one of the few lawyers who would speak on the record about this issue, said of the private equity firms. “When you’re competing for business, you’re not going to turn it down because you can’t use law firm A rather than law firm B.” (Mr. Profusek’s firm does some work as designated lender counsel.)
Let’s unpack why this “no one has complained” (or more accurately, “not enough people to matter have refused to do business with us over this issue”) excuse is rubbish. All you need to do is look at the incentives.
The banks that are the lead lenders, meaning the ones who historically did due diligence on the deals, which included hiring counsel to review and negotiate terms, are not significant ultimate owners. I’m not current on industry norms, and in over-the-counter markets like leveraged loans, it’s hard to get good data (you have problems of definition of the universe as well as getting private parties to supply data). If readers know of any good academic studies or recent articles on who are the end investors in leveraged loans, please pipe up in comments. Nevertheless, the major investor types include:
¶. Collateralized loan obligations
¶ Private equity credit funds
¶ Other banks, presumably foreign
¶ Retail leveraged loan funds
¶ Junk bond funds (in a major disclosure fail, the fine print of these funds typically allow for considerable investment in loans, which are not very or not at all liquid, when investors have the impression that the fund assets are securities)
¶ Hedge funds
¶ Direct lending funds. This appears to overlap with what some might call “private equity credit funds” so you can already see the difficulty of parsing data as bankers sell old wine in new bottles
And of course, another problem with this list is it mixes product types with investors. CLOs are often bought by credit funds, but they can also be purchased by hedge funds, and I would expect foreign banks to be a target market too.
But you get the general idea. In most cases, the lead lender(s) is not likely to wind up holding much, if any, of the loan.
Even when banks do wind up eating their own cooking, the incentives of staff conflict with the incentives of the institution. Even though regulators have pressured banks to have staff get more of their compensation tied to long-term results, that has happened more in what regulators see as the high-flying areas: trading and investment banking. While top leveraged lenders, like the recently deceased Jimmy Lee at JP Morgan, are big honchos, in most banks, they sit on the traditional lending side. Thus there is reason to doubt how much they are subject to the investment banking regime of having comp deferred or take the form of, say, restricted stock.
In other words, these loans pay big up-front fees. The lending side of banks find these tempting even though they ought to know better. Those fees bolster quarterly earnings and department/division revenues in a big way. That means that some of those revenues will wind up in bonus pay packages too.
Now you might say, “But what about the end investors? Surely they do their own due diligence?”
In short, no, or not much. This gets back to a myth we have been trying to debunk, that of the “sophisticated investor”. CalPERS is a sophisticated investor. It has invested in private equity credit funds. The terms of those funds are as one-sided as private equity deals are generally. CalPERS is along for the ride that the general partner has put it on. As we’ve discussed at length, these investors have very limited oversight once they’ve committed to a fund. So they do no due diligence whatsoever on the loans these funds make. Their “due diligence” is limited to that of the fund manager.
And even when the lenders actually are banks or end investors like insurers participating in a loan syndication, there is ample evidence that due diligence is sorely wanting. For instance, a contact said that in the mid 2000s, leveraged lenders in London distributed offering documents via a web-based tool. It was an open secret that the information was often downloaded long after many of the stuffees, um, investors, has signed up. In other words, it is all too common in this market that stuffees take down loan participations without doing much (or any) analysis.
Sorkin ends on this note:
Of course, the choice of which law firm will represent a bank on a big private deal will not lead to the next financial crisis. But if regulators care about reducing risk and eliminating conflicts in the markets, this practice might be a good one to examine.
While this is technically accurate, this fact set points to a more troubling conclusion: the fact that lenders are accepting this indefensible arrangement is a sign of a lack of due diligence. Worse, the general partners have strong incentives to do everything they can to weaken already lax due diligence even further, since it leads to underpriced credit risk, which in turn lets them do deals on more attractive terms. In case you missed it, the last crisis resulted from underpriced credit. So while this legal representation issue is not a systemic risk issue per se, it is a symptom of practices that combined do increase systemic risk. And by minimizing them individually, the private equity industry hopes to blind investors, regulators, and the broader public to this pathology.
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Translation of lawyer-gobble and bank terms: GIMME!
There was a brokerage firm in Denver once upon a time called Blinder-Robinson – it was known as “Blind Em and Rob Em” – accepted industry practices have moved up the food chain
Kinda like that law firm in the Marx Bros. movie – Dewey, Cheatem, and Howe.
Actually that was a W. C.Fields movie. But good point!
And I only knew it from Car Talk….
In the tax world, this kind of practice is all too common. Many tax shelters involve multiple parties that are all in on the game, and often they are sold to the “client” with all the key players already in place, including the lawyers.
As a young pup in the early 1990s, I experienced this first hand. My firm was retained by a multinational communications company to review a structured financing strategy being peddled by a money center bank. The bank was none too pleased that the company had decided to retain us – they pushed very hard for the company to retain another firm that “had experience” representing borrowers using the strategy. They only relented because the company refused to do the deal without retaining its own counsel, and the size of the deal was such that the bank couldn’t refuse.
My how times have changed. Now the borrowers are forcing the banks to use their chosen counsel. What goes around comes around, I guess.
Just to clarify: this is even worse than the practices you saw. The private equity firms in question (pretty much all of the big boys and one wonders how many of the net tier) aren’t simply requiring the use of friendly counsel. They are paying for them. Among other differences, I’d suspect the counsel hired by the PE firm to work for the lender would be quite open kimono about his putative client’s position.
Just a thought: How does the borrower paying for the lender’s legal counsel affect things like attorney-client privilege? If you’re paying the bills, aren’t you the client, and therefore entitled to the confidentiality? And doesn’t the borrower being the client preclude the lender from access to documents and testimony in the event of future litigation? I can imagine a case where a down-stream buyer brings suit to get information about the original deal, only to be told that the lender can’t supply what should be their own documents and testimony because the original borrower has asserted attorney-client privilege.
Yes, I wondered about that too when I was drafting my reply above….but a quick reply from a law prof says no, the bank is still the client and the normal attorney-client privilege almost certainly applies.
Borrowers have always paid for lender counsel. That is nothing new, as Sorkin says in his column.
As your other comment evidences, you like making stuff up.
I’ve been working with LBOs from virtually the very inception of the business (the early 1980s) and among other things, ran an M&A department for a bank that was a major syndicate lender. I can assure you that the lead lender paid for its own counsel.
Moreover, you either have a problem with reading comprehension or are deliberately misrepresenting the Sorkin article. He makes crystal clear that this is a relatively recent development (it’s almost certainly a function of too many investors needing yield being willing to buy junk loans, which gave the PE firms new buyer power that they were happy to exploit) and that some firms, like Clayton & Dublier, do NOT control the choice of or pay for lenders’ counsel. The C&D data point alone shows your comment is false.
Finally, knowing how Sorkin works (his stories are always to do a favor for someone in his network, even when the story goes against the interest of other people in his network), this story was planted, most likely by JP Morgan. JP Morgan or whoever complained to Sorkin would have nothing to complain about if this were a long-established practice.
Yves,
To put this into terms that I might better understand, if this were a securitized MBS pool/bond, are you saying that, by analogy, an Angelo Mozilo would have his own legal team review the terms of the SEC filings regarding any particular Trust–the Forward Looking Prospectus, etc.–and any prospective party of interest in said Trust/bond is given sort of a “take-it-or-leave-it” sort of proposition?
What if that which is in the “fine print” isn’t even legal? (I.g. It is in violation of a UCC Provision, or some State Statute, or maybe even violates Dodd Frank, etc.) Who would be there to catch such a possible violation?
Does this fall into the same category as the IBG-YBG type of greed-induced lack of risk management that we saw in the run-up to the 2008 Lehman-lead run to the fire exit? (In other words, Lehman lawyers were able to at least voice their concerns at the time that they were uncomfortable with the exposure that the company was taking on–but because there was so much money to be made upfront–the Lehman lawyers’ concerns (obviously) went mostly unheeded.)
The situation you describe above sounds as if even that measure of due diligence on the part of the lender is being made “unavailable” to the lender. Do I understand that correctly?
Also, I was wondering if such an arrangement is thought to be giving to the lenders some sort of excuse for not doing due diligence, perhaps? (“Well–we never would have given a stamp of approval to this particular deal–but we had no say in the matter.”) Akin to “plausible deniability?”
Maybe it is designed precisely to do just that–to reduce the exposure borne by the lenders by giving them an “out” to what we would consider the upholding of standard due diligence?
Perhaps it is thought that lenders having legal departments weighing in on transactions is an actual exposure in itself?
I am so concerned that the rule of law just doesn’t seem to matter when a lot of money is at stake or when very wealthy parties are involved and, indeed, are so wealthy that they just don’t have to concern themselves with pesky laws, statutes, standards of practice, etc.
Increasingly (and personally terrifying to me) I feel that laws are just becoming things that are solely constructed for the “little people” to follow for the purpose of keeping we “little people” in line and in fear of those who own and yield the power….
Pearl, I believe your fear is clear-eyed & fully justified…
You’ve got to hand it to the private equity industry for its creativity in developing new ways to tilt the playing field.
On a sad but related note, today it was announced that one of the few remaining regional, and regionally owned (the family is from Brainerd, MN, IIRC), big-box retailers, Mills Fleet Farm, is selling out to KKR.
http://www.startribune.com/mills-fleet-farm-to-be-sold-to-investment-giant-kkr/364191451/
Sorkin quotes with a straight face some cheesy anonymous finance person as saying that there’s reputation risk for doing a bad job. Snicker. There is no clarification on the nature of the risk, for obvious reasons.
“making sure that the lenders to their deals don’t have the benefit of independent legal advice. No, I am not making that up. ”
Jaw. Dropping.
Where is the due diligence? Where the fiduciary duty? Where the hell are the bank regulators?
oh. right…
“[The] Fed …has been asleep at the wheel as far as this not-so-new development is concerned. ”
Thank you for your continued reporting on PE.
This arrangement gives PE a particularly insidious double benefit:
Not only do they get huge loans (FDIC insured?) on their terms with no real due diligence from the banks,
PE can use a loan from a name brand bank as an imprimatur, or ‘seal of approval’, to convince the limited partners that the purchase made with the loan is sound. ‘See, the bank thinks it’s a sound business purchase or they wouldn’t have loaned us the money.’ ( Brings to mind all the AAA+ ratings the ratings agencies gave subprime dreck 10 years ago.)
Glad to Sorkin’s reporting.
The global monetary system was designed by bankers for bankers and they get a cut at every step in the process of money creation.
They are given the privilege of creating money out of thin air (fractional reserve banking), which they can then lend out and charge interest on.
There is only one task they have to carry out and that is to lend the money prudently to people that can pay them back plus the interest.
Could it be any easier, with no manufacturing, supply and distribution chains to worry about?
What are bankers like at prudent lending?
“What is wrong with lending more money into the Chinese stock market?” Chinese banker recently
“What is wrong with lending more money into real estate?” Chinese banker last year
“What is wrong with lending more money to Greece?” European banker pre-2010
“What is wrong with a NINA (no income no asset) mortgage?” US banker pre-2008
“What is wrong with lending more money into real estate?” US banker pre-2008
“What is wrong with lending more money into real estate?” Irish banker pre-2008
“What is wrong with lending more money into real estate?” Spanish banker pre-2008
“What is wrong with lending more money into real estate?” Japanese banker pre-1989
“What is wrong with lending more money into real estate?” UK banker pre-1989
“What is wrong with lending more money into the US stock market?” US banker pre-1929
Globally incompetent at the only job they have to do.
Shouldn’t we be asking why bankers are so useless rather than bailing them out?
Banker’s have a look at the Shanghai Composite stock market over the last five years, you see that big spike that topped out in June, that is called a “bubble”.
If you lend money into bubbles you can inflate the asset prices for a while, but sooner or later reality is going to catch up with you and those loans will go sour, the imaginary wealth you have created will evaporate just as quickly.
I know you are suckers for “the new paradigm” and don’t seem to have learnt a thing since Tulip Mania in 1600s Holland.
“The new paradigm” is just nonsense for gullible fools like you, keep an eye on the fundamentals, this is reality.
Please pass this to the FED who just can’t spot bubbles.
P.S. The fundamental in housing markets is size of mortgage to income (please retain for future reference).
. . .and they get a cut at every step in the process of money creation.
After the money is created, they get a cut at every step in the process of money transaction.
When a bank births a dollar, when does it die?
I really wanted to lay off private equity for a bit, but the news flow keeps getting in the way.
Pirate Carlyle lost almost half of his loot in the past year. Really rough water out there, lost a few boats on the way back to the boatyard.
See, it’s not all doom and gloom.
“When a bank births a dollar, when does it die?”
It creates the money out of nothing and when the debt is paid back it all goes back to nothing, the interest is profit.
If the debt is not paid back they then go to seize the asset the loan is based on.
This is why bubbles are so dangerous, when the bubble bursts the asset value may not cover the loan and effectively money is lost within the system as the money is not paid back, through repayments and/or selling the underlying asset.
When they start loaning out money to buy Complex Financial Instruments a world of loss awaits, when their asset value goes down to zero and the loans default – 2008 – adios 6 trillion.
Bubbles are dangerous for banks but around the world housing booms and busts are in progress.
Bankers never learn by their mistakes, like all psychopaths.
To learn from your mistakes you first have to take responsibility for them which doesn’t happen with bankers/psychopaths.
If I understand this correctly, the PE GPs are dictating terms not just to their portfolio companies and their LPs, but also to the banks providing leverage.
PE GPs have captured all the participants. Oh–and the regulators. They are also captured, as they seem to do f-all.
This makes a big joke out of industry “standards” regarding ethics, transparency, informed decision-making and “free” markets. It’s all just golden inner circles and everyone else being willing to go along in the hopes of getting some of the action or at least a few breadcrumbs from the table.
Is anybody paying attention? Does anybody care?
Thanks Yves for this spectacular series.
This seems so unbelievable. I have often wondered why anybody would lend to many of these big PE firms when it seems that the firms walk away with profit and the acquired firm ends up a shell of it’s former self and loaded up with debt. This article and commentary indicates that the loans given for PE buyouts are passed around like a hot potato. That lenders have strong incentives to just get deals done to pad their own pockets and then pass the thing along, consequences be damned.
Because your assumption of how these deals work out is an over generalized parody.
Do some deals go bad? Yes. It is extremely rare, however, for equity investors to make money on a deal where the debt loses money.
In general, the simple answer to your question is that lending to PE-backed companies is, on the whole, a profitable endeavor for holders of the loans and bonds.
That is absolutely not true. You are clearly not well informed about the magnitude of fees PE firms earn v. the token equity investment they have, which is overwhelmingly in the form of waived management fees, not hard cash. PE firms have 1% or less, typically, as their equity investment. One year of management fees is prototypically 2% of the invested amount. That’s before you get to transaction fees, monitoring fees, financing fees, etc. f you look at industry benchmarker CEM’s work, it’s not hard to infer that fees not at risk are well over 4% per annum. Eileen Applelbaum and Rosemary Batt have concluded that over 60% of PE fees are not risk of performance and have extensive data in their exhaustively resaerched, landmark book, Private Equity at Work, that contradicts your fact-free assertion.
Oxford professor Ludovic Phalippou has estimated that the total fees average at least 7% per annum. You take that 7% and multiply it by .6, you get the same over 4% figure that CEM comes in with. And CalPERS used the Phalippou 7% figure in its November private equity workshop, prior to its release of its carry fee data. They would have used the actual number if it was lower than Phalippou had estimated. And CalPERS is a valid proxy for the industry; its historical results have been used as the basis for academic papers since they are seen as a sufficiently large sample.
PE general partners make money even when portfolio companies go bankrupt, period. Better trolls, please.
I was speaking of returns to equity funds as investors. You’ve focused narrowly on GP economics. I disagree with some of your specifics – a 1% GP commitment to a fund is very low, for example, industry typical is more like 3% to 5% and some are 10% or more.
The bigger point, though, is that you’ve ignored the overarching fact that what you describe is a model that falls apart after one fund. That’s because GP’s are going to struggle to raise another fund if a fund posts poor or negative equity returns because most of the companies in it go bankrupt. That’s happened to some previously successful firms that had 1 or 2 funds perform very poorly. Hicks Muse and Forstmann Little are two prominent examples.
Building on this point, you’ve also ignored the impact on GP carry of having a company in a fund go bankrupt. Carry is calculated on an overall fund basis, so having a deal go bad reduces GP carry from an otherwise successful fund. Even granting your point that 60% of GP economics from a fund are not at risk, 40% of them still do. And, in terms of actual take-home dollars for the partners at a firm who are the key decision makers, it’s almost certainly more weighted toward at-risk dollars than 40%. That’s because the 60% not at risk is paying for fixed expenses like rent and the salaries of lower-level staff.
And, back to my point above, 100% of future fees are at risk of performance in the sense that a firm goes out of business unless it raises a new fund every five years or so,
In addition, nothing that you’ve said here addresses the key point of my response to Larry’s question of “why anybody would lend to many of these big PE firms?”, namely “the simple answer to your question is that lending to PE-backed companies is, on the whole, a profitable endeavor for holders of the loans and bonds.”
I actually generally agree with the point that LP’s should push back heavily against most transaction and monitoring fees in favor of a simpler model where the economics are just management fees and carry. Several funds have in fact moved more in that direction in recent years due to pressure from LP’s, especially large LP’s. Some of the really large LP’s have also supplemented fund commitments with lower fee ways to invest, like separate accounts and direct co-investments.
Just because someone disagrees with you doesn’t mean that they are a troll. You could do with a lot more civility, because name-calling just serves to discredit the notion that your arguments can stand on their own merits.
Dave,
You really need to read our posts, or study up more on PE. You don’t know this terrain anywhere near as well as you think you do.
First, you again did not read what I said carefully. I was speaking of portfolio company bankruptcy. You can have a lot of companies go bankrupt and still show a positive return for a fund, particularly if the GP engages in aggressive strategies like dividend recaps, which enable the equity investors to do OK or even profit at the expense of the lenders.
Second, you are incorrect re funds that have lost money or posted mediocre returns being unable to raise new funds. Just go look at CalPERS’ website. You can see tons of old vintage year funds which had doggy performance (the funds are being kept alive presumably because the GPs contend they’ve already written down the last asset to a realistic price, and they and the investors lose nothing by preserving the option value, by hoping to be able to get a better price) that have raised subsequent funds, even multiple funds. The reason is that fundraising for a new fund occurs 3-5 years after all the old fund was raised. and the performance in the early years of a fund is a poor predictor of ultimate performance.
Third, you are also wrong about the computation of carry. Except for so-called European style fund (which per the name are targeted to European investors), carry is computed and paid on a deal-by-deal basis. And the mechanism to settle up at the end of the fund life, the clawback, is designed to overpay the GP by the use of tax language that undermines the economics, and for other reasons, in the overwhelming majority of cases, is never paid out for other reasons even when money is owed. See here for details:
http://www.nakedcapitalism.com/2014/09/another-private-equity-scam-clawback-language-work-advertised.htm
Fourth, you have no understanding of firm economics. The GPs have made an art form of shifting firm overheads onto portfolio companies, for instance, via practices like presenting members of their “team” to investors, then charging many of them back to portfolio companies as consultants, when the LPs assumed they were employees and hence coming out of the management fee. GPs, in their community, are quite open about depicting their intent of having the management fee be pure profit. See here for details:
http://www.nakedcapitalism.com/2015/08/senior-private-equity-officers-at-calpers-do-not-understand-how-the-general-partners-make-money.html
And that’s before you get to the fact that the biggest players in PE are public companies, hence the top execs are at no personal risk, do not contribute capital personally, and thus have incentives that are not at all aligned with the LPs:
http://www.nakedcapitalism.com/2015/12/how-calpers-lies-to-itself-and-others-to-justify-investing-in-private-equity.html
Fifth, you are again wrong in saying that some firms “in recent years” have changed their posture and are charging monitoring and transaction fees, by implying this practice was heretofore pervasive. There was always a large cohort that did not charge those fees and they’ve always made a point of stressing that they don’t charge those fees in their fundraisings. Hellman & Friedman and Warburg Pincus are among the examples. I suspect that the firms you think “recently changed” were in fact firms that never charged these fees, and now the trade press has seen fit to point it out.
The management fees ALONE make most GPs rich. The notion that they have to struggle to pay overheads is a canard. CalPERS board members, who are generally clueless on other matters, were alert enough to pick up on that at a board meeting. See here for a longer discussion:
Sixth, you are 100% wrong re your assertion on commitments. It averages well below 3% for the industry. Plenty of data on that, and the majority of amount is waived management fees, not actual cash paid by the GPs. I can cite cases where only 10% of the capital nominally contributed by the GP was in the form of his own money. The historical reason that GPs committed money was the view among tax lawyers than that the IRS rule that effectively said that a GP had to have an economic stake in the fund could be satisfied if they made a 1% contribution. Now tax attorneys have relented on that view, but the 1% has become anchored as a level LPs like to see so they can maintain their pretense that the GPs have “skin in the game”.
Seventh, lending to PE at the top of the cycle is always a money-losing exercise. There was a massive LBO debt wipeout in the early 1990s which didn’t get the press it deserved due to the even greater S&L crisis losses. Everyone in 2009 forecast that the peak of cycle loans in 2006 and 2007 would be a bust when they came due in 2012-2014 because it would be impossible to refi them. It was only by virtue of QE and ZIRP going on as long as they did that the lenders got rescued. Lending to PE companies is a boom-bust exercise, and the reason the last bust didn’t hurt investors was because taxpayers and savers are footing the bill due to financial repression. And the biggest amount of loans are put out at the worst possible time. Your cheery assertion re profitability ignores massive agency problems: that the lenders and fund manager, who are NOT the investors, are measured and paid on much shorter cycles than the success and failure of a loan, and there are no clawbacks for their comp, and that they payment of up-front fees plays very badly into bank measurement and reward systems. It’s yet another example of “I’ll Be Gone, You’ll Be Gone” inventives.
Finally, I am focused on GP economics because GPs make the decisions. The LPs are passive, and as we’ve documented at exhausting length using CalPERS as the example, are captured as well.
I am calling you a troll because you behave like one. The fact that you persisted in spouting uninformed industry talking points with no substantiation confirms my initial assessment.
We have written site policies which you clearly did not bother to read before commenting. This site is not a chat board and I do not have any tolerance for people who show up and spread disinformation, whether via greatly overestimating their knowledge or by being propagandists. It requires that I waste my very scarce time debunking your incorrect assertions. I’m not letting further comments by you through because they are almost entirely in error and hence below the standards we set for this site.
Yves, sorkin is misinformed. PEGs may suggest a lawyer but Banks always have a separate law firm for documentation. It’s required by the fed.
1. Sorkin has multiple sources, including ones on the record, and has named specific firms that are requiring it and some others that are not. This practice is happening on a large-scale basis despite your contention that the Fed would not allow it. Moreover, Dan Primack at Fortune, the top beat reporter in private equity, picked up the Sorkin piece. It would greatly enhance Primack’s cred to catch Sorkin in an error. Moreover, the Sorkin article makes both the big PE firms that insist on dictating the choice of law firm and paying the bills and the lenders look bad. You’d expect Primack’s contacts to have been all over him if the Sorkin story were wrong.
2. I contacted an expert in bank regulations and he never heard of any such regulation, although he did say, “perhaps it is an informal regulatory expectation.”
3. The banks do have a separate law firm. The bank is still technically the client. I checked with a law professor and he said even though he was not an expert on attorney-client privilege, that he was pretty sure the relationship between the law firm paid for by that PE firm and the bank client would be deemed to be privileged.
4. Even if you can cite a regulation, regulations are regularly not enforced. The Fed did not enforce the Home Owners Equity Protection Act. The New York Fed fired Camine Segarra (and the NY Fed is in charge of large bank supervision) because she found that Goldman’s conflicts of interest policy was grossly deficient. PE firms that take transaction fees are flagrantly violating broker-dealer regs by acting as unregistered broker dealers. And the few that have set up broker dealer subs are still violating the regs because they are not executing those transactions via the registered broker dealer.