The private equity industry was abuzz last week after hearing that some of its marquee names are enmeshed in a pay-to-play scandal that could damage their firms and impugn an industry that already has a spotty PR record.
New York Attorney General Andrew Cuomo brought a slew of charges—including fraud, bribery and money laundering—against David Loglisci, the former deputy comptroller for pension investment of the $120 billion New York State Common Retirement Fund, and Hank Morris, a former adviser to former New York State Comptroller Alan Hevesi. The indictment and a parallel civil complaint from the Securities and Exchange Commission accuse the two of coercing buyout firms and hedge funds to pay millions in “finder” fees to Morris-controlled companies in exchange for commitments from New York State Common to their funds. Firms named in the indictment and SEC complaint include buyout shops The Carlyle Group, Riverstone Holdings LLC, Quadrangle Capital Partners—which recently suspended fundraising, Odyssey Investment Partners, and advisory firm Aldus Equity Partners (See accompanying chart for others).
None of the investment firms are charged in the indictment. At least for now, the SEC is targeting companies created by Morris to profit from the alleged scheme, but it calls out some of the private equity firms for being reckless in their dealings with Morris, and for not disclosing the true nature of payments to Morris to the pension’s investment advisory committee. It’s not clear whether the SEC might bring separate actions against those firms.
The SEC complaint noted that in some cases firms hired Morris-related companies as a finder even though their placement agents were already in negotiations with Loglisci when they were told they needed to “hire” Morris. The head of a New York buyout shop not named in the indictment or SEC complaint told Buyouts that because a public pension fund usually has already hired its own advisor, it should not tell a firm it must go through—and pay—another entity. “That doesn’t pass the smell test,” this fund manager said.
Though the buyout and advisory firms aren’t charged, they could potentially be held liable for aiding and abetting a scheme to defraud the pension if they did not properly disclose the payments, and for breaching their fiduciary duty to the pension, Martha Coultrap, an attorney with Sullivan & Worcester, told Buyouts. Remedies could include having to repay management fees to New York State Common and, if the funds are underperforming, they could owe the pension damages, Coultrap said. Coultrap represents institutional investors who invested in some of the funds named in the indictment and SEC complaint. The office of the New York Attorney General did not return calls asking if it plans to pursue charges against the involved firms.
The scandal highlights the opaque, complex set of relationships that exist between private equity firms, investors, the advisors to investors, and the finders who try to monetize their relationship with investors by making introductions. The head of a placement agency uninvolved in the situation said that disclosure between the private equity firm and the prospective limited partner—about who is being paid and why—is crucial when dealing with placement agents or finders. A situation like New York State Common’s, involving a placement agent-finder with no track record in private equity—but with experience as a political consultant—would raise serious concerns. “If it’s one guy, I would go ‘Wait a minute, where’s the infrastructure here? Why is this huge investor relying on some guy who has no experience?’” he said.
While the private equity firms may not have done anything illegal, there was shock and befuddlement among industry players Buyouts interviewed regarding some of the behavior detailed in the indictment and complaint.
For example, the SEC complaint—which paints the private equity firms in a much harsher light than the indictment—alleges that Carlyle Group retained a Morris company to secure a commitment to Carlyle/Riverstone Global Energy and Power Fund II LP, even though Carlyle Group had its own in-house operation that was spearheading the fund’s marketing. Loglisci allegedly induced the pension fund to commit $500 million to the fund pursuant to the arrangement. The complaint also alleges an official at Riverstone Holdings—identified by the Wall Street Journal as firm co-founder David Leuschen—invested $100,000 in a low-budget movie called “Chooch,” about a pair of cousins from Queens who get mixed up in some misadventures in Mexico, that Loglisci and his brothers produced.
“Carlyle is fully cooperating with the New York Attorney General and the SEC and is not a target of the investigation,” Carlyle Group spokesman Chris Ullman told Buyouts. A source familiar with Carlyle Group’s situation said the firm legally hired the Morris entity, Searle & Co., which was a registered broker-dealer, as a finder and made all disclosures required by law. This source declined to comment when asked how Carlyle Group found Searle & Co. Riverstone Holdings declined to comment through a spokesman.
In a similar scenario, the SEC complaint alleges that Odyssey Investment Partners agreed to pay Searle on any commitment that the firm received from the New York pension fund, even though Odyssey Investment Partners had already hired a large and well known investment bank—believed to be Credit Suisse, though the bank wasn’t named—as its placement agent. After Odyssey Investment Partners agreed to pay Searle, Loglisci allegedly arranged for a fund of funds that managed certain investments exclusively for New York State Common to commit $20 million to Odyssey Investment Partners Fund III LP. Stephen Berger, co-chairman and founder of the firm, declined to comment through a spokesman.
And, according to the SEC complaint, Loglisci and Morris allegedly recruited Aldus Equity Partners to launch a fund-of-funds through which the pension fund would invest in minority-owned and other emerging funds, even though Aldus Equity is not minority-owned and did not have an established track record for doing this. As part of the agreement, Aldus Equity allegedly agreed to pay another entity created by Morris an amount equal to 35 percent of the management fees that Aldus Equity received from the pension.
The SEC complaint also accuses Loglisci of pressuring Aldus Equity to have its fund of funds invest in a fund run by Falconhead Capital LLC after he arranged for Falconhead Capital to pay Morris in exchange for the investment. “Aldus Equity ended its relationship with Henry Morris in 2006, more than a year before the New York Attorney General commenced its investigation,” a spokesperson for Aldus Equity wrote to Buyouts. “Throughout the term of the relationship, Aldus had no knowledge that Morris was engaged in wrongdoing. Aldus fully disclosed its relationship with Morris to New York State Common, as it would with any placement agent.”
The placement agent Buyouts spoke with suggested that buyout firms may have lowered their standards in an effort to procure highly sought after funds. “The thing that nobody writes about is that fundraising is hard,” he said. “If someone joins the band that can help you, it can lessen your scruples. You want to build momentum. Everybody’s trying to achieve a goal and you get caught up in it.”