Why Isn’t This Extortion?

On Monday, Manhattan federal judge Jed Rakoff rejected a proposed $33 million settlement between the SEC and Bank of America, over the issue of whether BoA had lied to shareholders about bonuses paid to Merrill Lynch employees. Near the end of his ruling, Rakoff wrote:

Oscar Wilde once famously said that a cynic is someone “who knows the price of everything and the value of nothing.” Oscar Wilde, Lady Windermere’s Fan (1892). The proposed Consent Judgment in this case suggests a rather cynical relationship between the parties: the S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the Bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators. And all this is done at the expense, not only of the shareholders, but also of the truth.

This characterization also could be applied to the New York pay-to-play investigation, with the state attorney general’s office subbing for the SEC.

For the uninitiated, former New York pension fund official David Loglisci and “placement agent” Hank Morris were indicted earlier this year for allegedly conspiring to take money from private equity firms in exchange for fund commitments from NYCRF (i.e., kickbacks). There since have been a small handful of other indictments, including of two other alleged fixers and a politically-connected fund-of-funds manager.

What there have not been, however, are indictments against the private equity firms that paid Morris to help secure commitments from the New York Common Retirement Fund. Instead, there have been a steady series of “agreements” whereby the firms “repay” a certain amount of money and sign codes of conduct (which basically say the firms won’t use placement agents to solicit fund capital from public pensions).

In exchange, the firms are excused from any future prosecution under New York’s vague and expansive Martin Act. None of the agreements include an admission of wrongdoing, nor does AG Andrew Cuomo allege that the firms did anything illegal.

This “repent for nothing” strategy was in full effect yesterday, when Cuomo announced agreements with four more firms: Access Capital Partners, Falconhead Capital, HM Capital Partners and Levine Leichtman Capital Partners. The firms “repaid” a total of $4.66 million, signed codes of conducts and got to put this mess behind them. Two of the firms had direct relationships with Morris (HM and Falconhead), while Access and Levine Leichtman hired other fixers who basically sub-contracted Morris (without the firms’ knowledge, according to Cuomo).

To be clear, I believe that many of the firms signing agreements with Cuomo knew what was happening. Not the specific mechanics (i.e., the kickback scheme), but that someone like Morris did more than simply present a compelling case to pension fund staffers. So, yes, a lot of them are crooked.

But Cuomo is also exhibiting bad behavior. He pulls these firms into a room, and effectively says: “If we choose to prosecute, we’d have a very strong case. But we might be willing to reach an agreement that could be in both of our best interests. You wouldn’t be prosecuted, and we wouldn’t spend the time and money prosecuting you.”

It’s all hypothetical, but the message is clear: Settle or else.

Private equity firms simply cannot afford to be charged with this sort of crime. Not only would the legal fees likely become larger than the “repayments,” but it would be virtually impossible to secure new fund commitments while under indictment. Even if a firm were to ultimately prevail in court, it would still have a lingering stain on its reputation.

So the firms settle, choosing the path of least resistance. Both the guilty and the innocent. We, of course, can’t distinguish between the two, because Cuomo has intentionally shielded us from the truth.

To put it in language Cuomo might understand: I’m not saying you’re an extortionist. I’m just saying, what if I said you were?