Two cases in US courts highlight aspects of private equity which some practitioners perhaps feel had better stay hidden. One is a case launched by parties including the Managed Funds Association (MFA), the National Association of Private Fund Managers (NAPFM), the National Venture Capital Association (NVCA), the American Investment Council (AIC), the Alternative Investment Management Association (AIMA) and the Loan Syndications & Trading Association (LSTA) in the Court of Appeals for the Fifth Circuit, which alleges that the US Securities and Exchange Commission (SEC) has “overstepped its statutory authority” by introducing its recent package of regulations of private funds. The other, in a Delaware court case reported by the Wall Street Journal and others, is that Apollo Global Management, Carlyle Group and other funds paid themselves up to a billion dollars in fees for tax deals that essentially enriched fund heads at the expense of shareholders.
The cases, originally launched against Apollo and Carlyle in 2021 on behalf of Pittsburgh’s municipal pensions plan and others, concern so-called tax-receivable agreements (TRAs), designed to give founders and early investors in corporate restructurings lucrative tax assets. In these cases, the tax assets never materialised, yet the private equity firms still paid moneys to the connected insiders anyway. In August, a related lawsuit against internet hosting company GoDaddy and its private equity backers KKR and others, ruled that GoDaddy’s private equity-appointed board had egregiously approved a plan to pay US$850 million to its founder, KKR and other investors to buy out a TRA obligation valued at $175 million.
The ruling in the GoDaddy case has direct bearing on the cases concerning Apollo and Carlyle. In the case of Carlyle, the suit alleges that some $344 million cash was paid to fund insiders. As for Apollo, the relevant suit alleges that Apollo founders Leon Black, Josh Harris and Marc Rowan, arranged for a $570 million payment to be made to themselves and other insiders - just as Black was about to leave his firm due to controversy over his connections to Jeffrey Epstein.
Exactly how much chance the fund industry’s lawsuit has is open to question. The SEC has declared that it will vigorously contest the suit. Democratic Senator Elizabeth Warren, US labour unions, and many other interest groups and watchdogs have declared support for the new regulations. Some might take the view that the lawsuit itself specifically shows how needed the new rules are, and how much the private funds industry needs reining in.
The cases concerning TRAs, meanwhile, obviously have their own arcane regulatory determinants. Yet as reported in the WSJ, they resulted in multi-million dollar direct payments to Black, Harris, and Rowan, and in Carlyle’s case, William Conway Jr., Daniel D’Aniello and David Rubenstein. These kinds of payments for services to investee companies are exactly what the SEC rules were intended to open up to greater scrutiny. And you have to wonder, as the suit against the SEC proceeds, just how overweening the private funds industry’s sense of entitlement is.