Opinion: Do “ethical” pension funds have a private equity problem?


The managers of public pension plans today like to boast of their “ethical” investment policies, for example in terms of the environment or “Diversity, equity and inclusion”.

During this time they pour billions of dollars in secret private equity funds looking for extra profit.

Now, more evidence that some of these private equity managers are in turn using this money unethically.

“Private shareholding leads to a 147% increase in the percentage of … financial advisers committing professional misconduct” in the companies they take over, report researchers Albert Sheen, Youchang Wu and Yuwen Yuan from the Lundquist College of Business at the University of Oregon. And the number of misconduct incidents per advisor increases 200% after a private equity buyout, they add. “The increase in misconduct is greatest in companies with higher post-buyback growth in assets under management per advisor and is concentrated in companies whose clients include retail clients.”

Repeat: After private equity takes over a financial advisory firm, the number of misconduct incidents per broker is usually triplets.

The research is based on a study of 540,000 individual financial advisers at more than 14,000 companies registered with the Securities and Exchange Commission between 2000 and 2020, including 275 companies that were bought out by private equity funds. Researchers looked at customer complaints and disciplinary actions disclosed by the SEC.

Private equity is the Hottest major asset class for large pension funds and other institutional investors, precisely because private equity managers have been so successful in extracting additional profits from the companies they buy.

Private equity funds are the most likely to buy financial advisory firms with good ethical records – those with few customer complaints or regulatory penalties – and then send the ruthless figure of Alec Baldwin of “Glengarry Glen Ross” to Increase Sales.

“While the misconduct rate for acquired businesses is only about 40% of the industry average before the takeover, it becomes comparable to the industry average after the takeover,” the researchers found. Private equity managers “pick targets with untapped ‘margin of misconduct’ and exploit the opportunity to make a profit, perhaps to the detriment of clients,” they write. “While PE targets consulting firms with sharper-than-average balance sheets, the severity of misconduct in these firms converges to the industry average post-acquisition. “

In the parlance of the most ruthless investors, any business that has very few customer complaints and ethical penalties “leaves money on the table.” By “weighing” misconduct against the industry average, new owners can “sweat assets,” “generate alpha” and “capture untapped economic potential,” while shifting responsibility away from the business. ethics on government regulators and “the market”, that is, customers.

But customers are in a better position to protect themselves when a product is simple and depends on customer loyalty. Someone who tries to make money by selling, for example, hammers that collapse quickly, will soon go bankrupt. In contrast, note the Lundquist researchers, “Financial advice is an opaque and complicated product for many that is purchased infrequently, and therefore perhaps there is an opportunity to take advantage of customers… Increasing company profits Charging additional fees or placing clients in excessively expensive financial products can outweigh the costs of occasional breaches and the associated penalties.

The latest study adds to growing evidence that private equity managers engage in unethical business practices when they find an opportunity. Studies published last year found that increasing private equity in nursing homes leads to lower standards, higher costs and no more deaths. Other research has shown that private equity takeovers can be bad for things like themployee morale and quality of life, and worse results for clients.

Organizations representing the private equity industry did not immediately respond to requests for comment.

The results should come as no surprise. People who run private equity partnerships are given huge, unbalanced incentives to ruthlessly cut profits at all costs: most of their pay comes from a share of the extra profits.

During that time, they were also rewarded by Congress – both sides – with lavish tax breaks on that salary, relief inaccessible to the middle class. Through the so-called “deferred interest loophole,” a private equity partner can earn $ 10 million or even $ 100 million in a year, pay almost no federal tax back then, and years or so. even decades later, paying only discounted “capital gains”. tax rates.

Compare and compare that with other high earners, such as doctors, lawyers, and business owners, who pay up to 37% federal tax. Not to mention the hospital nurse or the busser who pays 15 cents in tax on the first dollar they earn.

But given the huge benefits that private equity managers offer the rest of us, who can say they don’t deserve it?


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