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In Defense of Placement Agents: “We Aren’t Unlike Bankers Doing IPOs”

Today New York State Comptroller DiNapoli announced a ban on the involvement of placement agents in any investment by the New York State Common Retirement Fund. That’s on the heels of Carlyle Group, and possibly other firms, completely dropping its use of the service.

Clearly, these actions make life more difficult for the numerous professionals who make a living placing funds. To get a placement agent’s perspective, I spoke with Russell P. Pennoyer, president of Benedetto, Gartland & Company. His firm, based in New York, is one of the earliest placement boutiques, founded in 1988. He discussed what value placement agents bring to funds in the market, and what should be done to make the process less prone to corruption.

Is the placement agent business really just a matter of selling connections? What value do you bring to clients?

The vast majority of people in this business are like any other investment banker helping a client access the capital markets. The GPs, who are extremely skilled in the types of investing they do, don’t really know how to do all of the work that goes into raising a fund. They don’t necessarily know how to describe what they do. They don’t necessarily know what an investor needs to see to make an informed decision, or what kind of background information they want.

Particularly if it’s a first-time fund, they have no idea what structure they should propose to investors. There’s a lot of complexity to starting out in this business. It’s like an investment banker helping a high tech company do an IPO. The smaller emerging managers need this service or they’ll have no hope of raising a fund. It’s a process that needs to be managed. We help them define their niche, develop their story, define their track record and really position themselves as an institutional investment vehicle.

And with people that are established, they raise new money every three years or so. They very largest funds have in-house people that do this, but for others, they are still looking for new investors. For example, in the late 90’s we saw funds with strong track records whose investor base was entirely insurance companies and Japanese banks. Their LPs were wiped out, so they had to start from scratch raising their next fund.

There’s enormous turnover on the LP side, so they need to reacquaint themselves with who is in the market. Also, it’s a big marketplace and the logistics of getting your story out there to the 300 or 400 investors who all are busy is daunting.

We can make the process much smoother for both parties. For the institution, they know the information quality will be of a certain level and the follow-up will be there with a placement agent. We are in a constant dialogue with investors. We know who is out there, and what certain investors are looking for. That’s what most of us do. There are unfortunately some who sell connections, whether it is a relative or a political connection. I’ve been in this business for 20 years and it’s frustrating to compete against this, frankly.  So I applaud efforts to make it an even playing field.

What controls need to be put in place to prevent the fundraising process from becoming corrupted in the future?

The simplest improvement would be to ban payment of fees to people who are not registered broker deals, who are examined and regulated by the SEC. They have consequences and a compliance responsibility within the firm. That would not have changed anything in the case of New York, since Searle was a registered broker dealer, but I believe there are others out there where it’s less clear.

More importantly, disclosure. All fees paid should be publicly disclosed, particularly where states are involved. That would at least allow someone to raise questions.

If it’s all out there publicly, it shines a light on it. I believe Justice Brandeis said “Sunlight is the best disinfectant.” Better disclosure and putting the onus on the GPs would solve a lot of this. There’s no reason, particularly where public money is involved, that information on fees paid shouldn’t be out there. That leads you to see things that just look a little odd.

There’s also the issue of political contributions. The State of Connecticut asks general partners to file statement on political contributions. Having a complete ban on contributions would help.

But a total ban on intermediaries will ultimately be harmful for the State of New York. It means the universe of opportunities to consider will be reduced.

What you think of the idea put forth by an article in this morning’s Washington Post, which suggested pension funds should hold an auction for a public pension fund investment?

Sounds nice on paper but how do you do that? These are subjective decisions and no two funds are the same in terms of strategy. I don’t think that would really be effective.

What about the idea that they should use a more scientific method, like past performance?

It’s tricky. In terms of decision making, there are a lot of different ways of cutting past performance. What do you look at? IRR? Return multiple? Consistency of record? Someone might have a fabulous record, but it was one deal and the rest of them are dogs. With some strategies, by the time you really know the record, it is not relevant. Does that really tell you anything about the fund they did now? And maybe the most recent fund is still investing and who knows how it will do. Not an easy solution like that. That’s why the use of consultants helps. States have consultants who do a lot of due diligence that provides more subjective analysis and brings real expertise to bear.

Read Dan’s thoughts on the news here. Read the rest of our coverage of this scandal here.

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