Return to search

A simple case of fraud, or the advent of PE greenmailing?

NYPPEX CEO Laurence Allen stands accused of forging documents and misleading investors in a lawsuit that goes deep into private fund secondaries. But is he the victim?

New York attorney general Letitia James filed a lawsuit in December against an investment advisor/broker-dealer who she says forged documents, violated the terms of a PPM and LPA, made confusing and misleading amendments to the fund’s LPA that hurt investors, and strong-armed employees on an investment committee to certify investments.

Laurence Allen, CEO of broker-dealer NYPPEX, has – according to James’ 51-page complaint – been committing fraud since the financial crisis, when he ran into cashflow problems.

Allen has repeatedly denied all the charges, and asserts he is the victim of a disgruntled client who is using the AG to exact revenge. Since the lawsuit was filed, Allen has provided multiple written statements that claim his innocence, accusing an investor of engaging with the AG to motivate Allen into buying out his interest in a fund Allen manages (see ‘The defense’), and saying that the AG not only misunderstands the secondaries market, but is also politically motivated in pursuing the case against him.

The claim

James’ suit claims that NYPPEX, a platform that matches buyers and sellers of fund secondaries, ran into liquidity issues in 2008 as the financial crisis intensified, and that Allen began siphoning assets from his ACP X fund – a fund of funds launched in 2004 and dedicated to buying secondaries interests in private equity funds – into his broker-dealer NYPPEX to keep the company afloat.

Since then, James alleges, Allen has “looted” more than $13 million from ACP to keep NYPPEX going, pay affiliate expenses and enrich himself.

Though the fund was supposed to wind down by December 21, 2018, the AG says investors have not received their $17 million in contributed capital back, or their preferred return.

Allen misled investors in order to conceal the fraud, creating “sham” documents “to add legitimacy to the prohibited transactions” from ACP into NYPPEX, James’ lawsuit claims.

The lawsuit also accuses him of designating employees for an investment committee that held no meetings, took no minutes, followed no agenda and held no votes.

“Employees believed that if they did not sign the certifications they would be fired or that their compensation would be withheld”

Letitia James

New York Attorney General

Rather, James alleges, Allen created self-serving certifications, forcing the employees to sign off on them “as a condition of their employment,” even going as far as to include this as stated terms in their employment agreements.

“Employees believed that if they did not sign the certifications they would be fired or that their compensation would be withheld,” the lawsuit says.

Investor worries

No affidavits have been released publicly, but the lawsuit includes the texts of supposed investor complaints about Allen’s valuations, the lack of distributions from the fund and about amendments to the LPA that Allen proposed.

Among other major accusations is that in 2014 one LP threatened to file a mismanagement claim if Allen didn’t buy out the LP’s interest early. The investor was ultimately bought out, but James’ suit says others weren’t given the same opportunity, nor was the redemption and the source of funds used (an ACP bank account) disclosed to other investors in the fund.

Other investors were nervous, according to the lawsuit. In 2017, one wrote to Allen: “I’d like to exercise my right as an investor to understand the valuations. The fund is down to a handful of key holdings in individual companies. If the fund can explain, we value company ABC at X for these reasons then I can decide if I want an early withdrawal or not.”

That investor and one other asked to be bought out, but Allen allegedly responded: “We cannot redeem your investment as per the terms of the operating agreement of ACP X. ACP X is a private equity partnership (and not a hedge fund some of which redeem investments). Otherwise, we would have to provide the same opportunity to all LPs.”

Another investor was worried about Allen’s valuations and the lack of distributions in late 2018, the suit says. She wrote to Allen: “As you know, I am very concerned about the limited distributions coming from ACP X. I do not understand how you can claim the valuations are as high as you say yet only a small percentage of the value of the fund has been distributed to investors (not counting the investors who took a big haircut to get out (through Early Withdrawals) – which I think is outrageous that they felt the need to do that).

“I also do not understand how the majority of the Fund now consists of individual company positions rather than secondary interests in PE funds – which was supposed to be the primary investment that ACP X was making. Are the marks on these positions valid?”

Auditors get anxious

Letitia James
James: the AG alleges Allen has “looted” more than $13 million from ACP to keep NYPPEX going, pay affiliate expenses and enrich himself

The lawsuit details emailed interactions between Allen and ACP auditors, who James says repeatedly asked for third-party valuations of NYPPEX and threatened to issue a qualified audit opinion letter. In one email exchange, Allen threatened to fire the auditor over its insistence on support for his valuations, the lawsuit claims.

In 2014, Allen allegedly agreed to an independent valuation of ACP in order to mollify the auditor and get it to release its report. But in May 2016, the auditor began to worry that the independent valuations weren’t coming and reached out to Allen.

Allen allegedly “responded that the requirement was a non-starter, despite his prior agreement, and that he was reconsidering whether to continue adhering to the General Partner’s obligation in the LPA to obtain audited financials at all.”

After James’ office began its investigation and had issued a court order limiting Allen’s access to ACP funds, Allen got a third-party valuation report. But, the lawsuit claims, “the company Allen hired merely incorporated Allen’s flawed projections into a report.”

Carried away with amendments?

The lawsuit also claims that after nine years, investors became concerned with the delay in distributions, and that Allen sought to comfort them with amendments that provided means for early withdrawal. In reality, says James, those amendments were written to trick investors into passing other proposals allowing him to direct additional ACP assets to himself. Allen fraudulently characterized it all as carried interest, it is alleged.

In 2014, one LP became concerned about the amendments, according to the lawsuit, asking for clarification on the clawback amendment and a section of it that omitted any reference to the 8 percent preferred return originally in the offering documents. In the end, James’ lawsuit says, Allen paid himself, other GP partners and other companies he controlled $3.4 million in carried interest.

Take the seventh

The final major claim of the lawsuit is that Allen sought to punish LPs helping James’ office in its investigation of him.

In December 2018, with the investigation under way, Allen sought to pass a seventh amendment to the LPA, threatening to extend the fund term by a year, distribute all carried interest fees and eliminate the clawback provision if investors didn’t pass it. That would have effectively amounted to a unilateral passing of the amendment’s financial terms.

In the amendment, he allegedly threatened LPs with individual liability if they participated, directly or indirectly, in any formal proceeding. The amendment also proposed to eliminate “nearly all of the General Partner’s disclosure obligations,” including audited financials. It simultaneously proposed to eliminate the entire clawback provision, the AG claims, as well as to allow him to distribute all “earned” but unpaid carried interest, without disclosing the amount.

Allen’s lawyer, Lean Borstein, had not yet reviewed all of the documents when he spoke to Private Funds CFO in December, but said of the lawsuit that his preliminary investigation suggested that New York may not have jurisdiction to sign an injunction against Allen and the other defendants, largely his affiliated companies and funds, saying it looks like only four or five LPs actually reside in NY. “That sounds like a regular civil lawsuit for those three or four people who are New Yorkers, if they do claim they were defrauded. I’m not sure from my preliminary investigation what the attorney general is doing, exactly.”

The defense

Allen believes the lawsuit against him for fraud is the result of the private market equivalent of “greenmailing.”

In an email to Private Funds CFO, Allen says: “We believe this entire matter has been caused by one LP with a personal liquidity problem who initially requested to be bought out by the GP. When we refused, he increasingly harassed us similar to a greenmailer [of] a public company, including baseless allegations, and threats to contact regulators.”

Greenmailing is the act of building up a large enough holding in a company’s shares that an investor can force a company to repurchase the stock at a premium to prevent a hostile takeover. Some states, including New York, restrict public companies from paying such a premium, and the Internal Revenue Service charges a 50 percent tax on profits made from such payments. Greenmailing was a widely pursued practice in the 1980s.

The case against Allen says he redeemed one LP in 2014 out of ACP X after the investor threatened to file a complaint of mismanagement, hired counsel and made a formal demand for books and records, specifically demanding a full list of other LPs.

Allen tells Private Funds CFO he did buy out an investor in 2014. “Through our periodic online monitoring of clients, we learned that the LP had become a control shareholder in a business in which we did not want to be associated.” The investor also had liquidity problems, he adds, and began making “baseless allegations to motivate us.” Allen says he then reached an agreement with the LP to redeem him at a percentage of his net asset value, believing “it was in the best interests of our LPs and the ACP X fund.”

Allen says the later “disgruntled” investor, who he believes is the cause of the lawsuit, “told us he has a personal liquidity problem (caused by the 2008 financial crisis with his real estate holdings),” which Allen believes was the cause of the LP’s original request to be bought out. The LP wanted “100 percent of [the] net asset value of his interest,” and that “once he learned that we elected to not buy out his interest, he commenced a series of baseless allegations against the general partner including threats to complain to regulators.”

Allen adds that the claims the LP made were false and defamatory, and other fund managers should feel threatened by what he says is an instance of “LP greenmail.”

“Greenmailing LPs are coming and it should be illegal, just like it is for public companies,” Allen writes. He believes he and his companies are not the only ones dealing with the phenomenon. “As a transfer administrator for numerous GPs, over the years [NYPPEX has] seen firsthand how some LPs that need liquidity make baseless allegations against the GP,” Allen writes. He says LPs then “threaten litigation and NYPPEX arranges a transfer of the LP interest to help the GP avoid ‘bad press.’”

LP liquidity

Allen says a “buyout settlement” with an LP is at the GP’s discretion, but that he generally permits secondary transfers of investors’ interests. “We have been proactive to provide liquidity to LPs in ACP X, through three early withdrawal opportunities for LPs seeking liquidity to partially withdraw some of their capital account balances from ACP X, but at an approximate 20 percent discount to NAV. We prematurely sold off some investments in order to raise cash to accommodate those LPs.”

As for claims that ACP X’s fund terms were extended, Allen says the 15-year-old fund illustrates a trend that “more private equity funds are extending terms, as they cannot fully exit all investments.”

“NYPPEX estimates that approximately 23 percent of all private equity funds worldwide are now 15 years of age or older as of December 31, 2018,” he writes.

Allen says he has refused to settle with the attorney general’s office, and that he has done nothing wrong.