If you’re Blackstone or KKR, are you on balance pleased or not pleased that Bain Capital’s favorite son is running for president? On the one hand, millions more people now think that they know what “private equity” is – and that they don’t like it – than did a year ago, and that loosely coagulated hostility has led to attempts to ban carried interest and dividend recaps and management fee conversions and the Cayman Islands. On the other hand, when a lawsuit accuses the entire private equity industry of antitrust violations and rampant corruption, now you get headlines like “Equity Firms Like Bain Are Depicted as Colluding,” and so I guess KKR employees can tell the folks back home “we are not an equity firm like Bain.” If Bain is a metonymy for Everything Bad in your industry, you can’t help but look good by comparison. Goldman Sachs once played this role for another industry, or still does, but at least Goldman is genuinely evil;1 boring Bostonian Bain is a weird choice to be the poster boy for badness. Did you know that Cerberus – an “equity firm like Bain” – is named after an actual hell hound?2

Anyway! Today’s unflattering depiction of Bain & ilk comes from a long-running class action lawsuit accusing those firms of price-fixing on a series of club LBOs in the go-go five-years-agos; the theory is that every private equity firm was in a conspiracy not to bid up each other’s deals, and to split the profits. The court recently released a heavily redacted complaint in that case that claims to draw on PE firms’ internal emails basically saying “let’s collude to drive down prices on all these deals.”

Presumably the redacted bits all say “let’s do lots of crimes!” but the unredacted bits tell a … pretty unsurprising story. Private equity firms wanted to buy companies cheap. They did so in part by not getting into tooth-and-nail bidding wars over any individual target, either by just not bidding for the target or by trying to club up with other bidders to split the deal. When this worked and PE Firm A got a deal cheap because PE Firm B passed on it, Firm A was like “yaaaay” and Firm B was like “you totally owe us, man,” which I feel like is in exact equipoise between “evidence of criminal antitrust collusion” and “just a bluffy/jokey thing you say when your competitor lands a deal.”

I am not an antitrust lawyer, but the complaint reads less like criminal price-fixing and more like regular old sharp negotiating. The basic dynamic in any auction is of course that the seller wants a bunch of bidders who are desperate to win, and that each bidder wants to minimize competition even at the cost of cutting in another firm on its sweet sweet deal – because getting 1/3rd of a sweet sweet deal, in an environment where there’ll always be another target, is much better than getting all of a disaster.

So you negotiate. The PE bidder negotiates for exclusivity with the target, or failing that for the right to club up with other potential buyers and/or lock up exclusive financing sources to deter other bidders. The seller, if it’s smart, shops broadly and demands confidentiality agreements that forbid clubbing and financing exclusivity. You fight over it and ultimately make a judgment about your negotiating position and what’s best for shareholders. But you don’t expect the PE firms to be nice about it. From the complaint, on PanAmSat:

KKR “won” the auction on April 20, 2004 as sole sponsor, and although the deal did not close for another four months, no other competing bids were ever made. … But less than a month later, on May 17, 2004, KKR cut the “losing” bidders, Carlyle and Providence, into the deal, allowing those firms to each invest $185 million in PanAmSat. … KKR’s co-founder George Roberts testified that KKR always intended to bring other private equity partners into the PanAmSat deal, but never told [PanAmSat's sell-side bankers] CSFB of his intention.

Why would he? That’s not criminal conspiracy; it’s just being a dick. His job is to be a dick, to extract maximum value for his investors. CSFB’s job is to stop him being a dick, to extract maximum value for PanAmSat’s shareholders. In the deals chosen by these plaintiffs to sue over, the KKRs of the world did a better job than the CSFBs.

Of course the plaintiffs have a perfectly plausible theory for that, which is: private equity firms are huge clients of the banks, being as they are repeat players in M&A and financing markets and let’s say not usually cost-conscious down to the penny, so the banks tend not to negotiate against them as sharply as they otherwise would. Maybe! But … where have we heard about sell-side investment banks with conflicts of interest? Here:

In February Goldman Sachs, El Paso and the El Paso CEO took a giant tongue-lashing from Delaware Chancellor Leo Strine about alleged conflicts of interest of Goldman and the El Paso CEO. Strine “reluctantly” declined to enjoin the deal [in which EP was bought out by partially-GS-owned Kinder Morgan] and basically told the parties to have at it in a damages action. This [$110mm] settlement resulted from that litigation.

See, when your company’s board agrees to be bought out by a private equity firm, and you think the price is too low, you get several chances to fix that. Chance one: vote no on the deal! Chance two: sue over conflicts of interest of your bankers and management, over a bad sales process, whatever, and try to get a cash settlement. Chance three is I guess file an antitrust suit years later about all of those buyouts.

Except maybe not. This was my favorite part of the complaint (paragraphs 579 etc.):

In a number of the club LBOs identified herein, settlements were reached in unrelated, earlier-filed state court breach of fiduciary duty actions, in which plaintiffs primarily alleged that the directors and officers of the target companies breached their fiduciary duties to the company and its shareholders by agreeing to have the company engage in a going-private transaction. …

The cases were resolved through settlement and each settlement contained releases. The releases were drafted in vague fashion, but antitrust claims and claims sounding in antitrust were absent from the release language. … The settlements purported to release the directors, officers and the private equity firms involved in the specific deals from all claims that were or could have been brought.

Ha! I am no class-action mechanic, but I’m pretty sure this says “all of our purported clients who are now suing these private equity firms over sharp dealing and conflicts of interest in these deals, previously sued these private equity firms over sharp dealing and conflicts of interest in these deals, and ultimately settled those cases by releasing these private equity firms from ‘all claims that were or could have been brought’ about those deals.”3 Obviously these lawyers want to get around that little problem, and maybe they can, but I’m not so sure they should. Sure, I could believe that private equity firms colluded to drive down prices, and that they were able to fool or co-opt bankers, boards, managements, and shareholders. But could they get their misbehavior past the watchful eyes of plaintiffs’ lawyers? That’s hard to imagine.

Equity Firms Like Bain Are Depicted as Colluding [NYT]
Redacted Fifth Amended Complaint – part 1, part 2, part 3 [via Bloomberg]

1. Kidding! Unless you’re looking to pay me $1.5 million to write mean things about Goldman, in which case, THEY ARE SUPER EVIL, AND ALSO THERE WERE SHENANIGANS, BE IN TOUCH.

2. From an actual myth!

3. Pour about a million grains of salt on words like “clients” and “sued,” but that’s how class actions work. The members of this class were – mostly, at least – members of the deal-specific classes, did not opt out of the settlement, and so are bound by the releases. I think. Not a class-action, antitrust, or any other useful kind of lawyer.

15 comments (hidden to protect delicate sensibilities)
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Comments (15)

  1. Posted by Texashedge | September 12, 2012 at 6:52 PM

    "Did you know that Cerberus – an “equity firm like Bain” – is named after an actual hell hound?"

    Typical that Matt styx in another cheesy classical allusion

  2. Posted by guest | September 12, 2012 at 7:28 PM

    it's the 2001 research-banking lawsuit frenzy all over again. that time it was banks providing favored clients with access to "hot IPOs," which by the time the suits were settled turned out to have been the worst investments in the world.

    this time it's private equity firms colluding to pay prices that we now know were *still* too high. anyone who has followed 03-07 buyouts knows they've mostly stunk. shareholders should be celebrating the fact that they got a cheap-debt-financed cash out when they did.

  3. Posted by güest | September 12, 2012 at 7:43 PM

    Dante just feel infernal when that happens?

  4. Posted by Bugs | September 12, 2012 at 7:51 PM

    He must have hades fill of footnotes for the day.

  5. Posted by T. Martin | September 12, 2012 at 10:10 PM

    How do you think Matt Smith felt when he realized Lucifer wore a red suit, had horns, tail and a giant pitchfork…after 6 years of working for him post-internship?

  6. Posted by Instagram Engineer | September 12, 2012 at 11:12 PM

    "I am not an antitrust lawyer"

    Yea, no shit, I wish I had known that before I read your post about the Instagram / Facebook deal and maxed out all my credit cards on asian hookers that I could post pictures of myself with to Instagram that I then got fired from and had all my stock options in canceled before the deal closed.

  7. Posted by Outraged logician | September 13, 2012 at 11:06 AM

    Does what you said make sense to you?

  8. Posted by Guest | September 13, 2012 at 11:20 AM

    Where do you find these pictures?

  9. Posted by guest | September 13, 2012 at 11:23 AM

    yes. regulators and attorneys pursuing financial firms, presumably on behalf of shareholders, for practices that made shareholders better off. as an LP in one of the funds in question, i can assure you i wish i'd been a seller, not a buyer.

  10. Posted by Outraged logician | September 13, 2012 at 12:00 PM

    One non-snarky reply deserves another!

    Well, it shouldn't really matter whether the transaction turned out to be a good one or a bad one for the buyer or the seller. The question at law (I think) is whether or not these parties deliberately colluded across multiple transactions to maximize value for themselves as a group.

    Note that this is different from what Matt talks about w/r/t the other suits outstanding, which all concern misbehavior WITHIN a single transaction. It seems to me that acting as a club (whether disclosed or not) isn't all that objectionable–presumably if a single PE firm thought they would get a better deal buying the company all by themselves for a dollar more, they would. So whether they club up or go solo, the seller gets the best price.

    But agreeing to collaborate across multiple transactions–that skews the whole thing and calls the above defense of club deals into question. If I say, "You bid low for company X and don't bid on company Y or we club together on both and we all avoid the Prisoner's Dilemma yay", that's collusion.

    And there's nothing that an individual seller can do to protect himself from that except not sell. But a seller is entitled to conduct a sale process in a free market, right? If telephone companies all collude to offer you service at outrageous prices and say, "But if you don't want to pay our prices, don't have a phone!" that's objectionable, right? That's what antitrust laws are for…right? So it's not a defense to say, "Sure, we colluded. But the guy didn't have to sell."

    It might well be a successful defense to say, "Let me get this straight. We nine private equity firms are such a dominant set of possible buyers for your little refining company that our decisions about how to behave in your sale process constitute a violation of antitrust law? Really? You don't know anybody, say, IN YOUR INDUSTRY who cares about your business?"

    But I don't think any of this has anything to do with whether or not those investments turned out to be good or bad investments.

  11. Posted by Captain O'Hagan | September 13, 2012 at 4:32 PM

    I swear to God I'm going to pistol whip the next guy who says, " Shenanigans."

  12. Posted by same guest | September 13, 2012 at 5:06 PM

    all fine. but two rebuttals:

    – the suit presumes that more competition would have produced a higher price. true in some cases, but in many cases the deal simply would not have gotten done, with any buyer.

    – the theoretical arguments ignore the fact that there regulatory resources are finite, and the number of bad actors in financial services is, well, not. the time, money and manpower spent making shareholders whole on the 5 or so points of premium they may have lost could be spent preventing the next madoff, shapiro, et al, who are engaged in outright theft, not shaving a couple dollars off takeover prices.

  13. Posted by Cutty Sark, Neat | September 13, 2012 at 8:22 PM

    I think those are $1 bills (photo).

  14. Posted by Elliot Rosewater | September 14, 2012 at 6:03 PM

    What I got from today's read: Matt has $1.5MM in RSUs.

  15. Posted by this article on seo, cms | September 30, 2012 at 4:07 PM

    Really interesting to see a major player become involved in a sector that hasn’t really seen that kind of involvement.