Pay-to-play weighing on LPs minds

Private equity fundraising is all about track record, which in its broadest sense can refer to a firm’s entire history. When it comes to the pay-to-play scandals that shook several US pensions in recent years, there are probably elements of those histories that some firms would just as soon forget. 

The pay-to-play debacles that arose in New York and New Mexico are being considered as limited partners plan commitments to firms implicated in the scandals that are back in the market fundraising.

According to one LP, fund managers linked to the scandals who have otherwise stellar reputations should not be overly concerned if their name came up during investigations into pension official or placement agent misconduct. However, that does not mean the scandals aren’t being discussed during LP meetings. 

A recent example is The New Mexico State Investment Council’s $75 million re-up to Ares Management’s fourth corporate opportunities fund. The commitment should have been a straightforward investment proposal; New Mexico has a long-standing relationship with the firm and Ares’ previous funds had been classified as top-quartile by advisor LP Capital Advisors.  

Before the SIC approved the commitment however, general counsel Evan Land first gave a presentation explaining Ares’ role in New York and New Mexico’s pay-to-play scandals. 

In the minutes from a 24 January meeting, Land is paraphrased as saying: “Given the backdrop of some cloudy allegations that exist with respect to prior practices, the SIC has taken a very hard look at Ares.” 

In 2009, then-New York Attorney General Andrew Cuomo settled with several prominent private equity firms and placement agents after it was revealed that kickbacks, bribes and other untoward influences contributed to the investment decisions made by the New York State Common Retirement Fund. 

While the state’s prosecution efforts were limited to individuals directly involved, several firms – including prominent players like The Carlyle Group, The Quadrangle Group and Riverstone Holdings – were forced into financial settlements with the state of New York. Others, like Ares, were asked to sign onto a code of conduct that prohibits the use of third parties in securing public pension deals. 

Ares’ hiring of Wetherly Capital Group as a placement agent made them an unknowing participant in the scandal after Wetherly paid $250,000 to Hank Morris, then a political consultant to former New York Comptroller Alan Hevesi. Hevesi later directed the NYSCRF to make a $50 million commitment to Ares in 2003, according to the minutes and a press release from the New York State Attorney General.  
Hevesi was sentenced to one to four years in prison last year after pleading guilty to felony corruption. In a settlement with Cuomo, Wetherly agreed to return $1 million associated with NYSCRF investments to New York and exit the placement agent business. 

New Mexico and Ares did not respond to requests for comment at press time. 

New Mexico has reason to be particularly vigilant in its due diligence of fund managers. The state natural resources endowment was hit with its own scandal when Saul Meyer, founder of its private equity advisor Aldus Equity, pleaded guilty to securities fraud in New York. 

In his plea hearing, Saul Meyer said he had “ensured that Aldus recommended certain proposed investments that were pushed on my by politically connected individuals in New Mexico. … I did this knowing that these politically connected individuals or their associates stood to benefit financially or politically from the investments and that the investments were not necessarily in the best economic interest of New Mexico.”

Among the funds Aldus advised the SIC to invest in was Ares Credit Opportunity Fund III. 

“It is not fair to tar Ares with the same brush just because Aldus recommended them – other funds Aldus recommended have performed well,” Land is noted to have said in the minutes. That point was reinforced by Fund III’s performance, which has generated a 39 percent gross internal rate of return as of 31 December. 

However, Ares’ involvement with several players in the pay-to-play scandals highlighted the importance of thoroughly vetting investment opportunities presented to the SIC, Land said.