San Francisco is a global center of finance, so it's no coincidence that a major class action lawsuit filed against some of the world's biggest private equity groups is targeting firms headquartered in the Bay Area. While the case is a long way from being decided, it has already peeled back the curtains on the otherwise secretive world of private equity, publicizing some embarrassing communications that reveal potentially illegal activities by some of the world's wealthiest men.
The lawsuit, Dahl v. Bain Capital, alleges that the largest U.S. private equity groups conspired over the span of about four years to allocate the market for leveraged buyouts of major publicly traded corporations by partnering through clubs, or else agreeing not to engage in costly bidding wars against one another. Using these cartel tactics, buyout shops were able to drive down prices on the publicly traded stock they need to purchase in order to take targeted companies private. This boosted profits when the companies were later sold. Lawyers representing the Plaintiffs in the suit —including individual shareholders, and institutional investors such as pension funds— say this cheated them of millions, possibly even billions in value.
Add this up as just another means by which private equity firms have been accused of harming the economy and siphoning off wealth in order to mint their elite ranks of partners as millionaires and billionaires. Other practices of the industry that have received scrutiny in recent years include tax arbitrage, tax evasion, offshore accounting, looting companies through bankruptcy, dividend recapitalization, and asset sales, squeezing value out of companies by laying off workers, busting unions, and outsourcing jobs, among many other legal strategies. Dahl v. Bain targets a strategy that is illegal: forming trusts to undermine competition in markets.
The Bay Area private equity firms named as conspirators in Dahl v. Bain include TPG which has its operations office in San Francisco, and Silver Lake Technology Management which is headquartered in Menlo Park, with offices in Cupertino and San Francisco.
San Francisco buyout firm Hellman & Friedman is named as a co-conspirator in the lawsuit.
Kohlberg Kravis and Roberts, known as KKR, has offices in Menlo Park, and KKR co-founder George Roberts resides in Atherton and is well-known in elite social circles in San Francisco.
Other private equity firms named as conspirators in the case have Bay Area outposts, including Bain Capital which operates a Palo Alto office, and the Blackstone Group which leases San Francisco office space in the 101 California building.
TPG is arguably at the center of the conspiracy, making San Francisco very much a center of action. Originally called the Texas Pacific Group, because the firm split its offices between Fort Worth, Texas, and San Francisco, TPG is the biggest private equity firm in the world with $50 billion in assets under management. To put that in perspective, Bain Capital, the Boston-headquartered buyout shop that has received a lot of attention over the last year because of Mitt Romney's past-role there, only has about $21 billion under management. A lot of TPG's money comes from extremely wealth individuals, including the firm's founders and partners. Much more of it is committed by a few large pension funds that over the last decade sought seemingly magical double digit returns on investments that TPG has been able to produce. The California Public Employee Retirement System, CalPERS, is possibly TPG's single largest source of capital.
TPG is accused of working directly with all of the major private equity groups named in the lawsuit on 10 of the 23 buyouts investigated, more than any other firm. These include the purchase of SunGard, a software company, Neiman Marcus Stores, the Spanish language Univision media company, casino operator Harrah's, and TXU, a texas utility company, among others.
The SunGard buyout is illustrative of the collusion and bid rigging TPG and others are accused of. In SunGard the early leader to take the company private was a club led by Menlo Park's Silver Lake Technology Management that included KKR and Bain. TPG apparently made some noises about possibly forming a competing consortium of private equity firms to contest Silver Lake's bid. Silver Lake's partners were shocked, calling this “classless behavior” because it was out of step with the understanding the big private equity groups had forged in recent years. This understanding was referred to variously as “club rules,” “professional courtesy,” or perhaps most preciously as “club etiquette” - the big firms courteously agreed not to compete with one another because there were plenty of deals to be made, and competition would only eat into profits.
One of TPG's co-founders, David Bonderman, was apparently ready to instigate a full-blown bidding war between the firms. According to documents and communications referenced in the lawsuit, TPG's other co-founder, James Coulter, suppressed the competitive instinct. Coulter cautioned a subordinate at TPG that the odds were against TPG, and another private equity group, Blackstone, in forming a competing club for SunGard. In an e-mail to his staff, Coulter explained that, “being overly aggressive here will make further enemies at [Silver Lake] and Bain while perhaps benefitting noone [sic] but the Sungard shareholders.”
Of course in a truly free market system private investors would in fact act “overly aggressive” and compete against one another, without worries over their friendship status, for deals such as the SunGard buyout. The owners of SunGard, the shareholders, and the entire securities market, would benefit from this healthy competition as private equity firms would be forced to zero in on the true value of a company. That's not what happened in SunGard. Citing internal e-mails and other evidence, the Plaintiff's lawyers in Dahl v. Bain conclude: “Silver Lake, despite being peeved with TPG's “classless behavior” agreed to bring it into the consortium. As a result, on March 2, 2005, after negotiations between Jamie Greene of KKR, Steve Paglicua of Bain and Glenn Hutchins of Silver Lake, and Bonderman and Coulter of TPG and Tony James of Blackstone, Silver Lake, KKR and Bain agreed to fold TPG and Blackstone into the growing consortium.”
This single buyout brought five of the biggest private equity groups together to purchase a company that any one of them could have swallowed on their own. The only purpose for forming this club, allege the Plaintiff's lawyers, was to avoid costly competition and drive the purchase price down.
In another moment of tension between TPG and their friends in the industry, TPG's Coulter chastened a Goldman Sachs employee for the investment bank's perceived lack of reciprocity in cutting TPG into lucrative deals, as per the etiquette of the club. TPG's Jim Coulter emailed Richard Friedman, a partner at Goldman Sachs' private equity arm to tell him: “Over the past half year we have reached out strongly to GS as a partner. I believe you would not be participating as a full partner in Alltel, TXU, Biomet or PRG,” said Coulter, referring to numerous club deals where both firms teamed up with other conspirators in LBOs, “had not we, at TPG, opened our deal flow to you ... During this period we received no reciprocal calls of equal quality from GS.”
Coulter, an east coast native who attended Stanford's business school, runs TPG's San Francisco office, an operation of several dozen employees ensconced 33rd floor of the 345 California building, the third tallest in the city. Coulter's personal fortune is estimated at $1.2 billion by Forbes. He resides in a mansion in San Francisco's Presidio Heights neighborhood and rubs elbows with the city's top politicians and business titans. Unlike many private equity billionaires, Coulter and his co-founding partner at TPG, David Bonderman, are liberals who pour millions into mostly Democratic Party campaigns and liberal causes.
Keeping track of the dealmaking chits within the alleged cartel appears to have frequently caused problems as the otherwise cutthroat business executives tried to hold their alliance together. Glenn Hutchins, a co-founder of Silver Lake, had to remind one of Blackstone's billionaires Tony James of favors owed at one point: “[y]ou are one of the very few firms in the Sun[G]ard consortium who hasn't found an opportunity to invite us into something that we weren't otherwise engaged with. We invited you into Sun[G]ard and have a reasonable expectation of your reciprocating.”
The web of favors owed throughout the cartel became so complex that “Defendants, like Goldman Sachs, Bain, KKR and Silver Lake maintained detailed 'scorecards' that listed the deals they worked on, who else was involved in those deals, and the resulting favors that they owed others and that others owed them,” according to the deposition of Richard Friedman of Goldman Sachs.
“The SunGard buyout bolstered Silver Lake's relationship with the firms it had invited into the deal,” claim the Plaintiff's lawyers in Dahl v. Bain. “As a result of SunGard, George Roberts (KKR co-founder) spoke to Jim Davidson (Silver Lake co-founder), expressing his 'hope there was something [KKR] was working on that they could invite [Silver Lake] to join.' Davidson 'said basically the same thing back to him,'“ according to depositions of Silver Lake executives.
Silver Lake's Davidson works out of the firm's Menlo Park headquarters and has a lengthy career in technology investment. Davidson and his partner Glenn Hutchins apparently named their firm after the Silver Lake Lodge in Deer Valley Utah, an exclusive retreat that is a favorite venue for business and pleasure among powerful deal makers and the Republican Party. (A Romney fund-raiser and strategy meeting that included Karl Rove and James Baker, among others, was apparently held there over the Summer.) Silver Lake's Davidson also reportedly owns a stake in the Golden State Warriors basketball team along with other private equity and technology executives, while his co-founder Hutchins owns part of the Celtics along with Steve Pagliuca of Bain Capital. Cozy ties such as these between private equity managers is alleged in the Dahl v. Bain suit to have facilitated the conspiracy; Davidson and Hutchins are not rival businessmen to private equity managers at firms like Bain Capital and Oak Investment Partners, they share lucrative investments in basketball franchises, and even pool their money in investment funds.
San Francisco buyout firm Hellman & Friedman is said to have participated in several of the illegal club deals, including the 2003 LBO of the electrical utility Texas Genco by a team led by TPG and KKR. Once again TPG's dealmakers played key roles in negotiating the alleged conspiracy. David Bonderman of TPG is said to have urged Blackstone, a potential competitor, to join the TPG, KKR, and Hellman & Friedman club, instead of making a rival bid. Internal Blackstone documents state forthrightly that the firm's partners believed it was “better for everyone to join forces and have a much higher chance of winning the deal and not drive the price up,” and that the private equity firms did so out of “the mutual desire to improve the competitive dynamics.”
“Improving the competitive dynamics” here seems to have meant undermining actual competition so as to drive down share prices of publicly traded companies in anticipation of a takeover. Some of the internal documents obtained by the Plaintiff's lawyers relating to the Texas Genco deal are quite revealing. One documents, a Goldman Sachs presentation titled “Anatomy of a Perfect Deal: TexasGenco,” apparently “pokes fun at the shareholders” and quotes a Hellman & Freeman partner who supposedly joked with the other private equity club members that, “by the time anyone figures out the financials, we'll be working on the IPO.”
Hellman & Friedman is easily San Francisco's most well-known private equity firm due to the status of its late founder Warren Hellman as “Mr. San Francisco,” an informal title bestowed on him by the San Francisco Chronicle. The great-grandson of Isaias Hellman, founder of Wells Fargo Bank, Warren Hellman was deeply involved in San Francisco politics, from funding a city employee pension rollback in 2011, to floating the ballot initiative that led to the construction of a parking garage under Golden Gate Park. Hellman & Friedman spawned several private equity firms and hedge funds in the 1990s and 2000s as former staff left to create their own investment companies, many of which remain headquartered in San Francisco.
In his deposition George Roberts of KKR seemed to acknowledge that at the height of the buyout boom in the mid-2000s all the big private equity groups had ceased competing with one another in favor of the benefits of collusion: “why would you go give business to somebody that— your direct competitor? You give business to somebody that is going to help you, not hurt you.”
Forbes estimates Robert's net worth at $3.7 billion. Roberts and his co-founders at KKR were among the first to devise the leveraged buyout strategy in the late 1970s. KKR partook in the first LBO boom of the late-1980s and sealed the marquee deal of that era, the purchase of RJR Nabisco in 1988. Roberts has a law degree from UC Hastings, and is a trustee of the San Francisco Symphony. His home is an enormous mansion set among multi-million dollar residences in the ultra-exclusive city of Atherton. Roberts runs his non-profit organization, the Roberts Enterprise Development Fund, like just another business venture. According to the San Francisco-based foundation's web site, REDF is a “venture philanthropy organization” that provides “equity-like grants and business assistance to a portfolio of nonprofits in California.”
In his court deposition, George Roberts said that he contacted TPG's James Coulter sometime in the mid-2000s so as to “have a lunch, and see what other opportunities are out there that we could work together.” TPG and KKR ended up partnering on four of the twenty-three buyouts examined in Dahl v. Bain, including the second biggest LBO in history, the purchase of TXU by TPG, KKR, Goldman Sachs.
Whether the private equity firms conspired or not to depress the purchase price, they've still lost several billion on TXU because of dropping prices for natural gas, a key factor in their bet on the company. There's evidence though that some investors were brought into the TXU deal just to further strengthen the cartel of big private equity firms and a handful of investment banks. Roberts said in his deposition that KKR and TPG invited Goldman Sachs into the TXU deal just to give the bank's private equity arm an investment opportunity. That the opportunity turned sour is ironic, but Goldman reportedly tried to repay KKR for getting in on the TXU deal by inviting KKR to join a club that was bidding for Foschini, a South African retailer.
In a correspondence with Blackstone's Tony James about teaming up for club deals, James wrote to KKR's Roberts a frank note about the need to suppress competition. “We would much rather work with you guys than against you,” said James. “Together we can be unstoppable but in opposition we can cost each other a lot of money.” Roberts responded with a one-line e-mail: “agreed.”