Whistleblower: How P/E Firms Flagrantly Violate SEC Broker-Dealer Requirements

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Last week, Crain’s Business Daily and Fortune reported that whistleblower has provided the SEC with evidence of massive, ongoing violations of securities laws, specifically, the Securities Exchange Act of 1934, by several unnamed private equity firms.

The violations result from the long-established practice of PE firms charging “transaction fees” to investors in their funds when the PE firms, as managers of various funds, buy and sell of portfolio companies. They also levy transaction fees when portfolio companies issue debt or equity securities. Bear in mind that these fees are not in lieu of fees paid to investment bankers and brokers; they are additional charges, on top of both those third party fees and the private equity firm’s management fee, the famed “2 and 20″ (2% annual management fee, 20% of the gains, although the management fee is lower for the very large funds). And these transaction fees are typically comparable in size to the fees paid to investment bankers.

This controversial practice has been going on for decades, and it is no secret. The PE firms collectively have reaped billions of dollars through this ruse. Dozens, if not hundreds, of articles have been written about it. Typically, these stories depict these transaction fees as an abuse of both the portfolio companies and the private equity fund investors, since portfolio company revenues are diverted into the pockets of private equity managers. For instance, a account about the whistleblower published last week by the usually pro-industry CNBC, where the headline itself described transaction fees as “private equity’s ‘crack cocaine.’”

But as scandalous as this ongoing looting ought to be, the whistleblower focuses on another glaring problem with the private equity firm transaction fees: the private equity firms are not registered broker-dealers.

Anyone who has been in the securities industry will know how big a deal being a broker-dealer is. Even as a small firm consultant, I’d take care with how my engagements were defined so that there was no way they’d be considered to be securities dealing and hence oblige me to register my firm as a broker-dealer. Being a broker-dealer involves not just registering with the SEC but complying with a long list of requirements to make sure you are dealing with customers fairly, including:

Becoming a member of a self-regulatory organization (usually FINRA)
Training and licensing principals and staff
Obeying state securities laws
Being subject to SEC inspections and disciplinary actions
Complying with customer protection and commission disclosure rules, recordkeeping, financial reporting requirements, and Treasury anti-money laundering requirements

See this Davis Polk discussion for more detail.

So what is surprising isn’t that the whistleblower is making these charges, but that are about twenty years overdue. These filings are simply pointing out what should have been obvious to everyone all along: most of the PE industry stands flagrantly non-compliant with fundamental law regulating the duties of investment managers when they take “transaction-based compensation” in connection with the purchase or sale of securities on behalf of their clients.

http://www.nakedcapitalism.com/2013/...ity-firms.html

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"A Bad Man's Guide to Private Equity and Pensions"

In the US, the objections to private equity financial engineering and asset stripping generally focus on the risk of company failure and job loss. But an important part of the equation often gets second shrift: that of how private equity kingpins use bankruptcy to get rid of pensions. Eileen Appelbaum and Rosemary Batt did address it in their landmark book Private Equity at Work, but the practice still needs broader exposure.

A new paper by Elizabeth Lewis for Harvard's Safra Center for Ethics, A Bad Man's Guide to Private Equity and Pensions, helps fill this gap. I've embedded it below. From its abstract:

More recently, some private equity firms have honed Chapter 11 as an efficient financial engineering tool for insider sales - and for dumping pensions.

Based on partial data from the Pension Benefit Guaranty Corp., at least 51 companies have abandoned pension plans in bankruptcy at the behest of private equity firms since 2001.

They've dumped $1.592 billion in pension bills onto a government-backed agency that insures private defined benefit plans.

Because pension insurance doesn't cover all benefits, their actions have left some of the nearly 102,000 workers or retirees with lost benefits amounting to at least $128 million.

And they've contributed to the chronic deficits at the Pension Benefit Guaranty Corporation.

Other types of businesses, including publicly held companies, have also abandoned pension plans in bankruptcy.

But the business model and practices of some private equity firms can make pension-dumping in bankruptcy especially attractive.

The legal and regulatory environments in the US combine with those practices to add up to a form of ins utional corruption. In this working paper, I explain how Oliver Wendell Holmes' hypothetical "bad man" can use bankruptcy as a strategy to profit. So, here is a bad man's guide to ditching pensions in bankruptcy - legally.

http://www.truth-out.org/opinion/ite...y-and-pensions

[ElNono]

lol red font