Private equity: harnessing secrecy to fleece investors and taxpayers

The widely-read U.S. financial blog Naked Capitalism is running a fascinating post about the private equity industry, which involves the release of a number of apparently sensitive documents. The article notes:

“For decades, private equity (PE) firms have asserted that limited partnership agreements (LPAs), the contracts between themselves and investors, should be treated in their entirety as trade secrets, and therefore not subject to disclosure under Freedom of Information Act laws in any jurisdiction. These private equity general partners argued that the information in their contracts was so sensitive that it needed to be shielded from competitors’ eyes, otherwise their unique, critically important know-how would be appropriated and used against them.”

That is of course a generic argument used by corporations far beyond the Private Equity industry. Of course the beauty (for them) of such an argument is that the argument can’t be properly tested, because the stuff is secret.

The document leaks reveal just how much nonsense the arguments are. They begin by pasting a paragraph on the objectives of one particular fund held by the private equity giant KKR, which is so bland as to lead Naked Capitalism to conclude:

“Claiming this statement is a trade secret is analogous to the U.S. Navy claiming classified status for the fact that it operates ships on oceans.”

And they go on:

“Moreover, if you read the balance of section 2.1 (“Objectives”), you see that that most of the remainder of the paragraph deals with the goal of tax avoidance, with 195 words in the paragraph dedicated to this issue. When KKR claims the limited partnership agreement is a trade secret, it’s not hard to surmise that these tax games are a big part of what they are really trying to hide. But now that we can look across a series of limited partnership agreements, it’s clear that the tax strategies are highly parallel across funds. To the extent that there is anything distinctive, it’s in minor details relating to the implementation of the tax scheme, and not its objective or design.

The closer you look, the harder it is to find information in the LPAs that even approaches a bona fide trade secret.”

Boilerplate tax abuses, covered over by secrecy.

But it’s not only about tax. The dumb fool investors in these private equity firms – and that may perhaps include your pension fund manager – are being abused too. The New York Times recently quoted a U.S. official as saying “in some cases, investors’ pockets are being picked.”  (Read more about the generalised folly of investing in private equity (or hedge funds) here.)

There’s also the devious language: secrecy’s slippery cousin.

“Some of the language in these documents is so sneaky that, if the investors’ lawyers didn’t flag it in the legal review process, they are arguably guilty of malpractice. And, if their lawyers did point it out, yet the investors ignored the problem, one can only ask: What were they thinking?”

And there’s more.

“The exposure of key documents reveals the private equity industry’s claims that the general partners obey the law are false. Instead, critical elements of their scams and violations of public interest depend on their being hidden from view. The document release also reveals what dupes the investors have been.
. . .

The private equity industry’s obsession was never about competing effectively. It was a self-serving ploy to shield the documents from scrutiny, since third parties might ferret out how private equity firms increase their already substantial profits at the expense of complaint, clueless investors.”

Abusing investors and abusing taxpayers: these two practices tend to go together, like peas in a pod. The principal goal of Private Equity firms is rarely value creation but instead wealth extraction: harvesting budding companies that aren’t doing a good enough job of fleecing taxpayers, investors, creditors, employees, pensionholders and others – then tightening the screws to extract what they can, leveraging up their cashflow to juice up the returns.

Of course, there are cases when private equity firms also seek to inject business nouse into badly managed companies, but as this article describes, it’s not necessarily any more profitable to do so when you may be able to make a quicker buck by just buying, squeezing, flipping and then discarding the husk, moving onto the next target.

Anyway, Naked Capitalism is running a series on this, and the documents are available on their site, for those who take an interest in this sort of thing.