April 23, 2009 / 11:57 AM / 8 years ago

NY ban on middlemen bad news for private equity

By Megan Davies - Analysis

NEW YORK (Reuters) - Private equity firms, already squeezed by the credit crisis, will find themselves under more pressure after New York State barred the use of middlemen to help them attract money from its $122 billion pension fund.

The current New York State comptroller banned placement agents, paid intermediaries and registered lobbyists on Wednesday, as a result of federal and state probes into kickback fees.

The investigations have been gathering steam since March when the state and the U.S. Securities and Exchange Commission charged two top aides to the former state comptroller with making more than $15 million in fees for helping private equity firms get a piece of the state’s pension fund.

The ban, which observers expect will be followed by other states, could have the biggest impact on small private equity funds that lack the staff and budget to conduct extensive fund-raising activities themselves.

“I think it is very likely to gather momentum,” said Michael Holland, founder of fund manager Holland & Co and a former partner at private equity firm Blackstone Group (BX.N). “I’d be very surprised if other states don’t follow that lead.”

D.C.-based Carlyle Group CYL.UL, and New York’s Quadrangle Group have been caught up in the probes, but have not been accused of wrongdoing.

Carlyle said Wednesday it would stop using placement agents when seeking investments from public pension funds in the United States.

Quadrangle, co-founded by Steven Rattner, President Barack Obama’s auto task force chief, had no comment.

Placement agents act as middlemen between pension funds looking for places to put their money and private equity funds seeking investments.

The business has been growing, according to London-based research firm Preqin. Of the private equity firms that raised funds in 2008, 54 percent used a placement agent, up from 45 percent in 2007 and 40 percent in 2006, it said.

The placement agent business is mostly made up of brand name firms such as Credit Suisse’s CSGN.VX Private Fund Group and Blackstone’s (BX.N) Park Hill Group, according to Preqin.

“Placement agents are ... professional outfits, which are very valuable to the private equity industry and provide them a number of services,” said Tim Friedman, Preqin’s head of communications.

Those in the industry say they are being unfairly tarred.

“Genuine placement agents and finders often perform a variety of specific services, such as helping to craft marketing materials and presentations to investors,” the SEC’s civil complaint against the two aides said.

“To penalize the whole industry is dramatic,” said one senior executive at a large placement agency, who requested anonymity because he was not authorized to speak to the press. “Why punish the intermediaries?”

FUNDRAISING CONUNDRUM

The big question for smaller private equity funds now is how can they raise money if they cannot use placement agents.

“If you’re not allowed to use a placement agent and you don’t have your own fund-raising staff, what do you do?” said another private equity executive who asked not to be named.

It is also a hit to an industry already struggling to attract fresh money from pension funds. Some pension and endowment funds are over-exposed to the asset class after seeing the value of their equity portfolios shrink and need more persuasion to keep investing.

Preqin’s Friedman said placement agents are especially valuable during the current financial storm when it takes funds longer to raise money.

Another executive at a private equity firm, who also declined to be named, said that the move would favor large funds with pre-existing relationships and disadvantage smaller funds.

Current New York State Comptroller Thomas DiNapoli said he did not think that the pension fund would miss out on profitable investments.

It was “more typical” for investment managers to seek him out instead of his having to hunt for them, he said.

“I think...that on the upside, not to have this...sense of compromise that we’re having right now -- that would be a huge benefit moving forward.”

Additional reporting by Joan Gralla, editing by Leslie Gevirtz

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