- CalPERS PE chief requests reimbursement from TH Lee
- Accuses firm of collecting fees without disclosing in LPAs
- TH Lee aggressively defends past practices
The nation’s largest public pension fund has been engaged in a bitter dispute with Thomas H. Lee Partners over accelerated monitoring fees, Buyouts has learned.
In correspondence obtained by Buyouts, Real Desrochers, private equity chief at California Public Employees’ Retirement System, late last year accused the Boston buyout shop of collecting accelerated monitoring fees from portfolio companies without adequately disclosing the practice to investors.
He also claimed that the firm had not been sufficiently up front with limited partners about how it allocated expenses to general-partner-funded co-investment vehicles.
Several emails and one letter were exchanged by Desrochers and TH Lee executives in December and January, with the tone growing more heated over time. Spokesmen for CalPERS and TH Lee declined to comment on the matter.
A number of questions remain unanswered. Foremost, it is unclear whether the dispute has been resolved. Also unclear is whether the conflict hurt TH Lee’s recent fund-raising effort. The firm has been targeting $3 billion for Fund VII and had raised more than $2 billion as of January.
In his initial email (dated Dec. 9) to TH Lee executives, Desrochers suggested that a Securities and Exchange Commission inquiry last year alerted the $293.6 billion pension and other LP advisory committee members to the practices in TH Lee’s Fund V, which closed in 2001, and Fund VI, which closed in 2007.
The SEC declined to comment on the matter.
Request for reimbursement
Desrochers asked TH Lee to reimburse Funds V and VI investors for the accelerated monitoring fees that TH Lee kept and for the expenses he says were improperly charged to the main funds.
He asked that the firm share the findings with all TH Lee LPs and the SEC. The dollar amount of the fees in question was not disclosed.
TH Lee executives responded in a multipage letter dated Dec. 17. They wrote that the limited-partnership agreements TH Lee signed with CalPERS gave TH Lee the ability to collect accelerated monitoring fees from portfolio companies and to share those fees with investors.
A side letter signed by CalPERS on Fund VI specifically allowed for the charging of termination fees, which TH Lee execs say includes what CalPERS called accelerated monitoring fees. They argued that the LPAs do not require the GP co-investment vehicles to pay fund expenses, and they pointed out that investors get reimbursed for all fund expenses.
The letter from TH Lee stated: “[W]e complied fully with our agreements, and disclosed to CalPERS and all other LPs, in detail and for a decade before November 9 of this year, exactly how we shared termination payments and how expenses to the funds were treated.”
Desrochers responded with heated language in a Jan. 11 email. “Your position appears to us to indicate that you believe that the legal agreements allow you to self-deal in all instances except where a practice was not specifically prohibited,” he wrote.
He added that “you should not self-deal unless the practice was fully and timely disclosed and specifically agreed to in the legal agreements.”
TH Lee responded in a Jan. 14 note. Managing Director Gregory White wrote: “[W]hen you make unsupported, unjustified — and frankly, defamatory — charges of self-dealing and non-disclosure, you threaten a reputation and relationships that we have worked hard to build.”
An LP with knowledge of the situation said that TH Lee surveyed LPs in Funds V and VI in late January, asking whether the firm should hire legal counsel to determine whether it owed LPs money based on CalPERS’s findings. The LP advisory committees for both funds did not support CalPERS’s request, the LP said.
TH Lee is not alone in being accused of inadequate disclosure of practices related to fees and expenses, especially in older vintages.
The SEC has focused on ensuring that LPs get fair treatment and that GPs abide by fund documents. The agency recently brought cases against two publicly traded buyout firms involving both accelerated monitoring fees and the payment of expenses by co-investment vehicles.
Last year Blackstone Group paid $39 million to settle a case that involved improper disclosure of accelerated monitoring fees. Blackstone did not admit or deny wrongdoing. (In a related development, rival buyout shops Apollo Global Management and Carlyle Group both disclosed in regulatory filings that the SEC has asked them for more information about their past use of fee acceleration.)
Kohlberg Kravis Roberts, meanwhile, agreed to pay $30 million last year to settle various SEC charges, including that the firm did not disclose to LPs that GP-affiliated co-investment vehicles were not being charged broken-deal expenses. In settling the case, KKR neither admitted nor denied the allegations.
“Investors in certain circumstances do not have sufficient transparency into how fees and expenses are charged to portfolio companies or the funds,” Andrew Ceresney, director of the Enforcement Division at the SEC, said in a May 12 keynote address.
“Sometimes fees are not properly disclosed, conflicts are not aired, expenses are misallocated, and investors are defrauded. Private equity advisers are fiduciaries and need to fully satisfy the duties of a fiduciary in all of their actions.”
Disagreement over language
The heart of the CalPERS-TH Lee dispute comes down to interpretation of the language used in Fund V and VI LPAs and in a Fund VI side letter.
In his emails Desrochers implies that in those documents TH Lee never disclosed its plan to collect accelerated monitoring fees. These are fees that ordinarily would be collected over time on multiyear service contracts with portfolio companies but that end up getting paid in a lump sum after the contracts are interrupted by the sale or IPO of a company.
Given the lack of disclosure, Desrochers argued that such fees should be an “asset of the fund.” He wrote in the Jan. 11 letter: “We are very disappointed that you continue to defend charging portfolio companies for work never performed and to claim that you fully and adequately disclosed this practice via a more general disclosure around monitoring fees.”
Similarly, he wrote in the Dec. 9 letter that “historical disclosure regarding the allocation of certain expenses among co-investment vehicles has been incomplete. We urge you to retroactively and prospectively share these expenses with the limited partners.”
In their December 17 letter, TH Lee executives White, Anthony J. DiNovi and Scott M. Sperling methodically laid out a case for why the language in the LPAs and the side letter let them handle accelerated monitoring fees and fund expenses as they did.
Notably, TH Lee marked this and related emails in December and January confidential. Buyouts attempted to access the emails and TH Lee letter from CalPERS through open-records requests. CalPERS rejected the request, citing various exemptions to the state open-records law. Buyouts obtained many of the documents, including the Fund VI LPA but not the side letter, through other sources who requested anonymity.
In their letter, the TH Lee executives point to a passage in their Fund V and VI LPAs that let them “receive and retain management, consulting or directors fees” — provided they share them with investors in a 60-40 ratio in Fund V and 65-35 ratio in Fund VI. They wrote that such fees were understood by all parties at the time to include fees paid for monitoring and related services.
The TH Lee executives acknowledged in their letter that the LPAs did not specifically reference accelerated monitoring fees, which they said was a relatively new term. They argued, however, that when it came to a monitoring agreement, “it does not matter whether those fees were paid on an ongoing basis or in lump sum upon termination of the agreement.”
The executives pointed out that CalPERS signed a side letter to Fund VI that specifically called for the firm to share termination fees 65-35 with LPs.
They described how investors in both Fund V and VI were kept informed about the sharing of fees, including termination fees, and how they benefited from the fees. CalPERS, like other LPs, received written notice of the exact amount and sharing upon termination of agreements with portfolio companies, the executives wrote.
The executives also took issue with Desrocher’s assertion that accelerated monitoring fees are fees paid for no work. “When agreements were terminated, it was generally not because we were no longer monitoring those investments; they were terminated because it was advantageous for the fund.”
Noteworthy is that while the Fund VI LPA fails to reference “accelerated” fee payments, TH Lee does reference them in a recent Form ADV filed March 30 with the SEC.
“Because the agreements with portfolio companies providing for such fees generally have extended terms (often 10 years or more/or subject to automatic extensions and renewal), the financial effect of such acceleration is substantial, particularly in the event such circumstances occur early in the life of the client’s investment in such portfolio company,” the Form ADV said.
As for fund expenses, TH Lee executives wrote that the LPAs put GP co-investment vehicles under no obligation to pay them.
“We as the general partner are required to invest our personal funds alongside LPs in the companies the funds acquire. As with many provisions of the LPA, this is to align interests. But the business deal struck with you and the other LPs provides that, in return for our commitment of personal funds, we do not pay fund expenses — just as LPs do not pay our expenses such as rent, salaries, and other significant costs.”
(The Fund VI LPA does not appear to address the issue of whether the GP’s co-investment vehicles have to pay fund expenses.)
Just under the surface
Jonathan Adler, a fund-formation attorney with Debevoise & Plimpton, said that TH Lee is not alone in charging accelerated monitoring fees or keeping a share of them.
Many buyout firms also have GP co-investment vehicles that don’t pay fund expenses, he said. Both practices have been around, and many LPs have been aware of them, at least in general terms.
The way LPs policed the numerous fees collected by GPs in the past has been to take a cut of the proceeds, Adler said.
What changed? The SEC has taken the view that these types of practices must be explicitly disclosed, Adler said.
And that is what CalPERS and other LPs expect from GPs today. As this situation shows, this tougher stance can cause rifts between longtime partners.
Referencing what he felt was new information to come out of the SEC inquiry, Desrochers in his Dec. 9 email wrote that “we must say that we are not satisfied with your historic disclosure regarding these practices.”
For their part, the TH Lee executives seemed slightly astonished that CalPERS would have a different interpretation of the fund contracts.
“Any suggestions that we acted against your interests are both disturbing and unsupported by the long written record we have tried to summarize in the letter,” the executives wrote. “There is nothing more important to us than our relationship with CalPERS and all our investors.”
Action Item: Andrew Ceresney’s keynote address: http://1.usa.gov/20xuDtW
Correction: A previous version of this story used an incorrect version of Thomas H. Lee Partners. The report has been updated.
Photo: Scott Sperling, co-president of TH Lee, speaks at the Reuters Private Equity and Hedge Funds Summit in New York on March 2, 2010. Reuters/Brendan McDermid