Le Show; 2014-06-29

And eight and six minutes, you ready for this from Mark. This is Global Radio in London, England, which the show originates in four,

minutes from Mark. And eight and six minutes, you ready for this from Mark. You

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From deep inside your radio from London home of Ping Pong in the rain. Yes, adding to our culture's storehouse of London clichés was walking here through Soho Square, lovely Soho Square, but it was raining and two sets of people. Not one, two. Playing Ping Pong in the rain helps the spin, doesn't it? Ladies and gentlemen, why did Judges hate freedom?

The US government deprived 13 people on its no-fly list of their constitutional right to travel and gave them no adequate way to challenge their placement on the list. That's what a federal judge said this week in the nation's first ruling finding the no-fly list and its procedures for redress, unconstitutional, judge Anna Brown. Her decision says the procedures lack a meaningful mechanism for people to challenge their placement on the list, including why they're there in the first place. And a military judge this week ruled the CIA has to release information on the location of the black prisons and the details on the enhanced techniques applied to a prisoner who was later transferred to Guantanamo. Why do these judges hate freedom? And now, news of our friend, the Adam. Clean, safe, too cheap to meet. Safe, too cheap to meet.

Safe, too cheap to meet. Safe, too cheap to meet. Andy Adam is in the spa this week. I don't know what he's having done. Can you both talk, Senator? Steve Louise can return home in the hardest hit areas around FUC by 2021. Welcome home. After decontamination works, sufficiently reduces radiation levels there. That's according to the Japanese government's estimates. The cabinet office is working team. Estimates cleanup efforts and natural decontamination effects. Mother Nature, cleaning up for us. We'll cut annual radiation doses by 54 to 76% in the difficult to return zones around the plant. Members were presented to local leaders at a meeting near FUC in FUC. The government intends to use the latest estimates to reassure evacuees so it can lift evacuation orders as early as possible. But one of the local officials raised doubts about those estimates. They're too optimistic, he said. I want the central government to release more accurate estimates for the nearer future.

And he wants a pony. A glowing pony, deadline Albuquerque officials investigating a mysterious radiation leak from the government's underground nuclear waste dump. In South Eastern New Mexico, it turned to focus to Los Alamos. The National Laboratory, the Department of Energy's team, has been at the lab for about three weeks, according to a state official. A canister shipped from Los Alamos to the weight, waste isolation pilot plant, the whip. Burst in the mine, on February 14th, contaminating 22 workers and shuttering the nation's only permanent repository, for the waste we've got from building nuclear bombs for a few decades. Visuals are also monitoring whether hundreds of other barrels from Los Alamos that are currently stored at the nuclear waste dump and a facility in West Texas are at risk of bursting. Investigation is one of just nine underway. The state is investigating the accident too. Initial probes into the leak and an underground truck fire six days earlier identified a host of management and safety shortcomings.

Questions about oversight by the lab have been raised. The waste was packed with cat litter to absorb moisture and teams of scientists are trying to determine whether a switch from inorganic to organic cat litter is to blame for helping to fuel a chemical reaction. Or whether the cats to blame, you know those cats, they're so ornery. Data line Oslo Sweden this week proposed a sharp rise in fees that nuclear power producers have to pay the country's nuclear decommissioning fund, saying previous cost estimates were too low. Sweden has three nuclear power plants with 10 reactors in operation, generating slightly less than half of the country's electricity needs. The oldest ones are expected to be shut at the beginning of the next decade. The Swedish radiation safety authority says it is proposed raising fees for decommissioning by 73%. Just off, just off a hair there. They line water for Connecticut. Federal regulators began an inspection of Connecticut's nuclear power plant this week.

More than a week after a power failure forced both units to shut down and water was found to be slightly radioactive. The NRC announced its examining the response by the Milestone power station. Why do you think they call it Milestone? To the outage that lasted about six hours in late May. Inspectors will examine drainage from the reactor's cooling system and why equipment known as a rupture disk opened to relieve pressure. I'd be asking why do you have something called a rupture disk. The health of workers was not affected, said the NRC. Milestone supplies half of all power in Connecticut. That's a good idea, Connecticut. And Salem Unit 2 nuclear plant in Delaware continued to sit out an ordinarily lucrative run of hot weather last week because its owner worked to recover from dozens of critical bulk failures in four key reactor coolant pumps. Those bolt failures can drive you nuts. I'm glad Addy wasn't here to hear that clean, cheap, safe to two everything to meet our friend, the autumn.

Ladies, gentlemen, the test of the missile defense system last week was successful. The bad news is that increases the likelihood for a $1 billion edition of 14 missiles to Ford Greeley in Alaska. Even though the missile defense agency hopes to start flight tests four years from now of a newer better kill vehicle that would replace those it plans to buy those that we're going to spend a billion dollars on. Question of whether it's worth spending 75 million per missile on a kill vehicle that the Pentagon says should be replaced by 2020. That's just another question about this whole system. The current plan before Congress is to spend 99 million in the next fiscal year to start designing the replacement, which would be more reliable, more available and easier to maintain test produce an upgrade. According to the missile defense agency.

The expansion plan was announced in 2013 in response to some noise from North Korea, but the plan needed a successful intercept to get the go ahead. The Alaska congressional delegation extends. The countdown should be underway critics say it's wasted by more units of a kill vehicle. It's already been deemed deficient. The system has a poor record so far mainly caused by the political pressure to do something fast say critics and here we go again quote time and again the process for developing and procuring these kill vehicles has been driven by politically motivated timelines, rather than sound practical procedures and oversight, according to the union of concerned scientists. What do we, what are the, what is the union of relaxed scientists think that's what I'd like to know, but it's not just kill vehicles, a US Air Force F 35 fighter jet caught fire during takeoff Monday. It's a controversial plane. The pilot safely escaped. He was on routine training mission. It wasn't immediately clear what caused the fire, where it originated or how badly it damaged the aircraft, which cost more than 100 million.

One news reports of the aircraft was severely damaged and possibly destroyed. This is the most expensive weapons acquisition program we got. We're spending almost 400 billion dollars for a total of 2400 aircraft for the Air Force Navy and Marine Corps because they all got to have their own. Developmental problems have kept the F 35 from flying in the past last year. The entire fleet was grounded after a crack was found on an engine turbine blade. More recently test flights were stopped due to an engine valve fitting. If it ain't the bolts, it's the valve. Ladies and gentlemen, it costs a lot to keep us almost safe. And now, the apologies of the week. Former editor of the British tabloid news of the world owned by Nice Corp, Andy Kulson has been found guilty of conspiracy to hack phones. He went on after he left the newspaper to become director of communications for British Prime Minister David Cameron. He has now apologized for appointing Kulson.

I take full responsibility for employing Andy Kulson. I did so on the basis of undertaking so I was given by him about phone hacking and those turned out not to be the case. I always said that if they turned out to be wrong, I would make a full in franc apology and I do that today. I am extremely sorry I employed him. It was the wrong decision and I am clear about that. Prime Minister said, I gave someone a second chance. It turned out to be a bad decision. The BBC, another British apology has apologized after sending two test breaking news alerts in an error to BBC news app subscribers. They were sent to millions of UK subscribers on iOS devices like the one I've had stolen. Don't worry, the cops are. The BBC said it had not been hacked. We've been in the process of testing new functionality for our apps in a text. Test message was sent an error this morning. We apologize to our app users who are necessarily interrupted with the alert.

Adeline Tokyo, Takata Corporation CEO Shigahisa Takata apologized this week to shareholders about that company's growing liabilities for its role in an industry recall, industry wide auto industry wide recall of air bags. He said the company was still telling the cost of the recall. The supplier could face a $500 million charge in a net loss this year. He addressed the company's shareholders at their annual meeting. Bad bags. And John Huppenthal, the Arizona Republican official who earlier this month to confess to being a prolific and nasty anonymous commenter on local politics blogs, apologized this week for his bigoted online writings during an emotional press conference that ended with him walking out of the room in tears. I'm here today to apologize for my blog comments. There's been a lot of discussion in recent days on my blog comments. I don't combine getting beat up.

What does bother me would really bothers me is that my blog comments were hurtful. I'm here today to repudiate those blog comments. I'm here to renounce those blog comments. They're not what was in my mind. They don't reflect the love that is in my heart. He's Arizona's superintendent of public instruction. He wrote hundreds of comments under pseudonyms on a number of political blogs. On one of them, he criticized President Obama for quote, rewarding the lazy pigs with food stamps, air conditioning, free health care, flat screen TVs, typical of poor families. He also flirted with birthism compared to how planned parenthood founder Margaret Sanger to Edolf Hitler and urged people to stomp out Spanish language television stations and newspapers in the good old USA. The apologies to the weak ladies, gentlemen. It is a copyrighted feature of this broadcast.

This is the show and I don't know if you're like me or if you just plain like me, the letters PE said in that order, probably bring up dark memories of one period in high school unlike all the others where you had to strip. But it's taken on perhaps even a darker meeting in the current context of our increasingly financialized world. And when financial subjects come up, I turn to my friend Eve Smith, a proprietor and chief correspondent chief author of the blog, Naked Capitalism, who has been doing some fascinating reporting on the private equity business and its ways. Eve, welcome back. Harry, thanks so much. Great to be here.

You have been trying to find out what the contracts are between private equity firms and some of their major investors who have just happened to be public employee pension funds. Why don't we start by you explaining to us what a private equity firm is and how it differs from a hedge fund? Sure. They have similar compensation structures. So both of people who run hedge funds and private equity funds make tons of money. So that that much they have in common and they both are lumped under the category of more exotic, high return investment strategies called alternative investments. And the reason that public pension funds and other pension funds have been so interested in these riskier investments is that many of them have been underfunded either just by design or by having overly optimistic return assumptions. So there's been more and more investment in this type of category. Hedge funds invest in liquid securities or they invest in derivatives. So that at any point in time they can shut down their business in fairly short order. Investors can get in and out. They usually have restrictions on redemptions. Investors being able to sell their investments that are three months. But still if you're in a hedge fund, you can get your money out in some reasonable period of time.

By contrast, private equity funds by the wealth of America, private equity funds invest in companies and they are much more powerful than is commonly realized. The total assets under management, which is how much investors have given them to run collectively is about $3.5 trillion. That compares with the US stock markets total value of around $21 trillion. But if you want to put it on a more apples to apples basis, when private equity firms by companies, they use much more debt than companies that are listed on the stock markets normally use. These are about twice as much. So to put it on a more apples to apples basis, you can think if you sort of normalize for the debt level, say, gee, their money really goes twice as far. So if you were to say that if you were to amp their, put them on a more apples to apples basis and say it's more like $7 trillion if you want to put it on the same basis as the market cap.

I mean, this is very crude. We're just trying to get a crude sense. $7 trillion versus $21 trillion. That means that they own somewhere between, but some of that's foreign funds. You can say that they own roughly 20% of the meaningful sized corporate wealth in America, the medium sized and bigger companies in America. And yet ordinary people have no idea how powerful they are. For instance, the biggest private equity player, Blackstone Group, the companies that it owns employ over 700,000 people, KCR, another one of the biggest funds over 600,000. That's more than the post office employees. It puts them in easily, I haven't seen the recent numbers, but the numbers is of 2007 put them in the five top employers in the United States. A couple of questions is one of the incentives for pension funds to go into investing in private equity, these alternative investment vehicles. The fact that thanks to the federal reserve, normal interest rates have been pushed down for so many years that it's hard to get any return on your money in normal investing.

Well, that's been a big impetus for both hedge funds and private equity, and that also helped them in the last boom they had, they had a real boom in the early 2000s up to the crisis. Again, because we had not, they're not as low as the interest rates now, but we had a period where interest rates were very low relative to inflation. And again, investors were, as they call it, reaching for yield. The interesting thing this time around is in the post crisis area, even though interest rates have been very low, private equity hasn't been returning anywhere as near as well as it used to because they've been whacked with the aftermath of the crisis. Normally, they make their money by selling companies. They bought a lot of companies right before the crisis at very high prices. And the post crisis area hasn't been so favorable for them selling companies quickly at good returns. So even if they sell a company for a number that they like a year or two later than they wanted to, that actually reduces their returns quite significantly.

So investors have been disappointed with private equity returns, and their fundraising hasn't been as strong as you would expect given how low the interest rate environment is. The flip side is that they've piled very aggressively into new strategies, and those have been very successful in terms of fundraising. Some of the funds, and again, the blackstone that I mentioned before has been the biggest, have been very aggressive entrance into buying single family homes at distressed prices, and then renting them out to people. So that's somewhat compensated for the fact that they're not them, for the fact that they're not doing as well fundraising wise or performance wise in their traditional business. So the traditional business is what I guess those of us who are paying attention while back would connect with Michael Milken and his ilk or his ilk and the buying of companies stripping them down, i.e. making them more efficient, i.e. firing a lot of people, and loading them down with debt and then selling them at a profit, right? You mentioned debt. The debt is carried by the company they buy, not by the fund. Is that right?

That is absolutely correct. That's right, and that's one of the things that's interesting about the structure, is the way that the, it really is a heads-eye windtails you lose kind of deal for the folks who manage the funds. Even when they drive companies into bankruptcy, which they do twice as often as normal companies go into bankruptcy, they still make money. So that's one of the sort of pernicious aspects of the strategy, and you're correct that it became its real heyday was in the 1980s when it was called leveraged byouts, and one of the reasons it was so successful back then. I mean, and their returns were much harder than they are now, was that there were a lot of companies in America that were basically, you know, quasi conglomerates, they had diversified way too much. And the market assigned a discount to them because they were overly diversified, plus some of them were just, you know, we're run a little bit fat. In those days, it was that, you know, almost all the companies had sort of imperial corporate headquarters. This was the Gulf and Western syndrome.

Exactly. They didn't have to do much in those days in the way of, quote, financial engineering, to get big returns if you bought these companies and broke them up and sold the parts. And you stripped out some cost, and then they might do a few other things like if they had a lot of corporate real estate, they might sell the real estate, and then lease it back. A few fairly simple measures would produce a tremendous amount in returns. Now what's happened is that these strategies have become more diverse. There are some companies, the bulk of the money is in the biggest companies, the large and very, and mega deal tier, and they still use the traditional reliance on financial engineering, cost cutting, a lot of leverage to earn their returns. There is a tier of companies, smaller deals, where the deal size is less than 350 million, where even though it may still involve some cost cutting, they don't lever the companies up as much. And it's typically a size of company that would invest for more professional management and might have some expansion opportunities that the current owners don't have the money to exploit. But the industry then likes to wrap itself in the virtue of the smaller ones.

Oh, we really add jobs and oh, we really build companies. They'll cherry pick these examples from the smaller end of the industry to wrap themselves in the mantle of virtue that really, if you look at the sort of aggregate statistics of the industry, really give you a misleading picture of where the bulk of the activity and the bulk of the dollars are. Just translating for folks like me leverage and lever refers to debt using a lot of debt using a lot of debt. And the thing the most people focus on initially is that it increases the risk the company will be driven into the ground. There are a whole lot of other nasty effects that it has. If you're carrying a lot of debt and paying a lot of interest and having to worry about paying down debt that puts more pressure on needing to cut head count, it makes it harder to reinvest in the growth of the business. And in a lot of companies it leads, they've increasingly been buying companies of any sort and using a lot of debt on companies where it's really not an appropriate strategy because the company doesn't have very consistent income. Where you can get away with putting on a lot of debt is if a company is a very steady earner.

One of the areas that leveraged by companies have been purchasing more companies has been retail and restaurants. And those companies for instance traditionally owned their real estate because if they own their real estate that enabled them to ride out business cycles and just the variability over the year. Most retailers make all their money in the fourth quarter with run up to Christmas and Christmas sales. With these companies what they have done is sell the real estate to another company which they also own. And so they profit and then they lease it back at a very high price. And then the company and there have been cases where the companies have gone bankrupt because they couldn't afford to carry enough inventory to keep customers happy. And they engage in these kind of reckless strategies again with great frequency because as long as not too many of the companies they buy go bankrupt they can tolerate a certain level of bankruptcy and make their returns. And as I said on an individual deal basis they will still profit because they take out all kinds of other fees even if they don't get one of the fees they get as a success fee.

But even if they don't get a success fee they also pay themselves fees for all the transactions that they do. So for example if they do a sale lease back they will literally charge a fee to the company for the sale lease back transaction. To the company they bought. To the company they bought when they actually hired an investment banker to do the deal they will charge a second fee for babysitting the investment banker. Can you name a couple of the better known corporate names that are currently being operated by private equity firms? Olive Garden, Red Lobster, TXU which is a company now they call it they've changed the name I'm blanking what the name is but TXU is one of the biggest bankruptcies ever and that's and that's a private equity owned firm. Hertz, Hertz was a famous case where the Clayton Doe Belier bought the company and then levered it up and paid themselves an enormous dividend and then the company got in quite a lot of trouble. You know Mervins which was driven into bankruptcy was another private equity deal.

We're going to get to the pension funds because this is I think the most newsworthy part but previously you've been reporting the and you mentioned it earlier. The degree to which a lot of these private equity firms have been in some way fueling the so-called housing recovery because as houses foreclosed houses came on the market and there might not have been any individual buyers they were being snapped up and suddenly these private equity firms were large scale rental housing owners. Right and this is this is really a very untested strategy. I mean on the one hand you can say that that maybe they played that they played a very helpful role because basically there was a point where Fannie and Freddie the two big government sponsored enterprises which also happened to have a lot of foreclosure inventory foreclosed homes that they owned said that they were thinking about launching a bulk sales program that they were just going to sell a lot of homes at once. Well as one of my investor buddy says whenever the government is selling I want to be buying there's a perception that the government tends to unload things at an overly cheap price. The mere fact that Fannie and Freddie announced a bulk sales program suddenly led investors to rush into the market and they actually wound up doing very few bulk sales because there was so much investor appetite.

So the investors focused on basically the sun belt states because they're the homes also don't require as much maintenance as in states where there's where your roof can leak and it means something. That's right. They also happened to overlap to a significant degree with where there was a lot of distressed inventory so they've been very active in in Florida, in Atlanta, Phoenix, Las Vegas, you know a lot of California cities. So that's where the bulk of the buying is taking place and in those very distressed markets. There was a lot of appreciation and that actually drove for at least at the start of the housing recovery that really drove the perception that housing was getting better. One of my buddies Josh Rosner who does quite a lot of analytical work in the housing space actually decomposed the recovery numbers for 2012 and found that that the recovery in housing in that year. Was entirely in investor owned homes. If you looked at homes actually sold by normal people, you know owners as opposed to banks and bought by other owners, the appreciation was only 1% that year was all in the investor properties.

Now the recovery then became more self-sustaining, you know in in 2013, but the real impetus that sort of got the car out of the ditch was the private equity guys rushing in bottom fishing went bad. Bottom fishing went basically fanny and Freddy sort of set the signal that that they were putting a floor into the market. And if you talk to anybody who's actually owned single family homes and rented them, they just think this idea of owning them in bulk is crazy because it's historically been a very high touch business that if you've got a tenant in a home and something goes wrong if there's a leak. You don't want the tenant fixing it, you want to get there and fix that leak and it's that's very hard to do when you've got houses that are spread out. I mean even though they've tried investing in a concentrated manner, you know they'll buy 200 homes in Atlanta, they won't buy 200 homes scattered across six states.

But still even if you think of 200 homes in Atlanta, they're still going to be pretty spread out and it's just a very inefficient management process and they've tried to convince themselves that they can do it efficiently. Which leads to the question if they're concentrated purchasing of homes at the bottom had an upward effect on prices. What happens when they decide to take their profits and sell, which they probably won't do in a gradual manner, they'll probably say, okay we're out, what happens to home prices then? Well they had an exit strategy originally that would have not had that effect and they're looking at other strategies which won't have that effect if they can pull them off. The original thought that these guys had was that if you basically had a thousand homes, you could sell them as an operating business. Instead of selling them as onesies and twosies back into the market to new investors or structuring it so that the renter would buy the house, that's another way of exiting.

They would set up a company and the company would own the real estate and be an operating company managing these rental properties so that they would continue as rentals just as owned by as but sold into the market. So they never enter the conventional housing market, the company that manages these rental houses gets sold but the houses themselves don't enter the houses then are not the houses are basically or need to stay as rentals. Now there were a few deals done that way but then when the Fed started talking about raising interest rates basically that window closed or only three or four deals done. Now the exit strategy that the industry is talking about and has implemented a little bit is rental securitizations and I'm not very keen about this at all. The first deals were done with great fanfare and they got off very well in part because again back to your point about interest rates being so low investors are so desperate for yield and they offered enough yield on these deals that they looked attractive. But you've got the risk much more than with an operating company that first these deals haven't reached what they call stabilized cash flow.

You really need to have owned the houses two to three years to really see you know how often the tenants leave and how much damage there is when they leave and how long it takes to release them release releases and find a new tenant. And they just don't have any history on this one rating agency actually refused to rate these deals because they said there's not enough history. I think it was S&P in any event so you know there's a great deal of uncertainty about whether the numbers on these deals are going to pan out and in fact the first deal that blackstone did and get it was blackstone. Three months later the rentals on their property had dropped 7.6 percent which was a sign that they'd basically you know manage to get a bunch of people and shove this deal out the door when you know the rents were rolling over and whoopsies some didn't you know rent up back up again. So there's a real questions as to whether that exit strategy is going to work and you know assuming the Fed ever raises interest rates the Fed's body language on this is hard to read. Again these deals are going to demand proportionately more yield and it's going to be an interesting question as to whether they can exit at the prices they want to get out at.

Alright so that's their business model and how they're doing at it. Now the investors who are putting their money into private equity firms most notably you've been trying to find out the details via California's version of the Freedom of Information Act. The details of the contract between private equity firms and the California Public Employee Retirement System fund. Right. The famed CalPERS. CalPERS is the second largest public pension fund. The amount of money they have under management is bigger than all but the 34 biggest economies in the world is about $270 billion. They're perceived to be one of the most innovative and best run pension funds and they've been a long standing and very large investor in private equity. They are now the biggest investor in private equity of all the public pension funds and the public pension funds collectively are the biggest single type of investor in private equity.

They amount for about 25% of the industry's total funding equity funding. There's a delicious just sort of on a word nerd basis irony in public pension funds being the largest investors now in private equity. Private equity yes it's true so in any of the point the point is that you know all of these public pension funds are subject to their state's version of Freedom of Information Act which in theory means all their records should be available. So you would think gee I can you know write these public pension funds and find out what kind of deal they have with investors. Well in fact in every state the private equity industry has gotten their contracts exempt from disclosure either via literally getting special legislation passed to exempt the contracts from disclosure or by getting favorable state attorney general opinion. Classifying the deals is trade secrets. Now I just went through a round of trying to get CalPERS to close some more documents because in the California version of FOIA which is called the Public Records Act they actually define alternative investments fairly narrowly and for instance there was a court decision that specifically said that real estate funds weren't private equity funds.

I mean they couldn't like claim the real estate fund fell under this private equity exemption that real estate was a very well established strategy and there you know there was nothing nothing alternative about it. Nothing high techie about it right so I recently put in a request for information where I asked for a among the deals I asked for was one was that was from an activist equity investor and one was merely the confidentiality language of three real estate funds. And they rejected the one for the activist public equity fund and of the of the three real estate funds the only one they provided was on on the specific court case that was one against CalPERS on the one fund where they were specifically required to discourage the documents and yet the opinions that all real estate funds were subject to disclosure not just the one that they were forced to give up in this particular court case. So CalPERS is just being very high handed about this but this is typical of what you see in the industry.

I mean there have been other FOIA efforts that we've made and there were some of the rejection letters are almost comical in that CalPERS doesn't explain itself. There was another one that we published you know they just send these kind of imperial letters out. There was one from another public pension fund in California, Lasera, where they wrote this very long explanation of how the reason they didn't give it was that the public interest of keeping it private outweighs the public interest of exposing to the public. And they basically said they basically said our loyalty to these I mean they said it more eloquently but amount to our loyalty to these general partners is more important than the public knowing. I mean they're very they were actually quite unabashed about saying that the general partners are the people who run the private equity fund right so what and what it boils down to is that again and it's back to why. I keep going back to the issue of the returns I know that may sound very. I'm interesting to most readers most listeners that they're more interested in sort of what these guys do and how they operate but the reason is that these investors are are convinced that private equity delivers returns that they have to have and the threat.

If they give up these documents is that the private equity funds won't let them into their deals anymore and they can't possibly risk ruffling the industry and not having access to these you know deals that they have to be in that's what's driving their behavior. So it's like the the velvet rope and the big dormant standing outside of a really crappy club but you really want to get it anyway. So yeah and and in fact the irony of this is that some of the most sophisticated again Calpers and Harvard have both actually come out and that Harvard has said it actually said it explicitly Calpers is saying in their behavior but Calpers is basically said that private equities underperformed their stock market returns over the last you know decade and Harvard's considered to have access to the best deals and be very sophisticated and Calpers is cutting its allocation to private equity so so they're both saying the strategy isn't what it used to be. And yet there's still this you know desperate perception that we don't alienate the industry talk about the Pennsylvania situation.

Oh yeah so this is the irony the big excuse the industry has used is that these agreements must be kept as trade secrets now for something to reach the standard of trade secret. You're saying that if the information got out it would damage you competitively that you have some unique properties like the formula for Coca-Cola. Exactly that is something that that that that if it were to get out into competitors hands you would be at a disadvantage. Now if you worked in the investment space this sounds absurd on its face because all these guys I mean I've described their strategy in two or three sentences at the beginning. I mean it's you buy these companies and you'll ever them up and you know there's some arcane stuff in their tax strategies but they all hire guys from the same white shoe firms who all studied the same tax and right for the same tax journals. It's not like somebody's got to you you know a unique tax structure they're deploying. But nevertheless they have succeeded in persuading the investors and state legislatures and state attorney generals that there's something really you know incredibly secret and these contracts in their entirety our trade secrets.

Now just by bizarre happenstance one of the very another very large investor in in private equity which is the Pennsylvania retirement system happened to mistakenly leave about a dozen of these contracts on their website. You know they normally uploaded the unsensitive there were some unsensitive documents related to private equity investing that they uploaded and they somehow managed to upload. A dozen of these supposedly super secret contracts and I got my whole my hands on them and published them on my website and I'm still sort of writing posts about the implications but basically look at these documents. And there's nothing here that rises to the level of trade secret except maybe some of the tax language but then again it's not really I mean it may be secret in terms of private equity versus hedge funds. But even the tax provisions you see which are are very similar across you know the dozen documents you see there is nothing here that's unique or distinctive.

And yet you know I'm still getting denial letters from kelpers you know they're still maintaining this is a trade secret. And the Pennsylvania fund scamper to get those off of its website didn't they? Right within two or three days yeah they pulled them they pulled them back down. You know this has interesting echoes of something else that's going on right now which is that as firms in the oil business are increasingly trying to get rights to do fracking of wells on on private property. And the property owners or neighbors want to know what's in the fracking liquid that's going deep into the earth beneath our property and maybe bubbling up through the groundwater or something else. The contents of the fracking fluids are and I think in certain states like Texas are legislatively determined to be secrets trade secrets. And one is tempted to sort of turn around that the irritating plant that's often heard when people protest against government surveillance.

Well if you're not doing anything wrong what do you have to hide? Well frankly you know this is one of the things that you know to the fracking point there can't be any magic in what is in this fracking fluid. I mean again it's back to the guys who dreamed this stuff up all went to the same petroleum engineering schools. There aren't that many chemicals you can put in this stuff. You know the fact that you might put more of X and a little less of Y hardly makes it rises level of secrecy. And you know that it's about people being able to connect specific ailments when they get sick to the fracking fluid. If they see if you somebody can say oh we know they put you know XYZN and I've got this ailment and you know certain percentage of the people. You know exposed to that chemical will get exposed to that we'll get this ailment you know then you then you can make a very tidy case. And you know to your point about keeping things secret one of the things that's been very distressing is the few times that families have gotten large settlements for health problems related to fracking. They have been made to sign shockingly onerous confidentiality agreements even binding seven year old eight year old children for their entire lives to maintain secrecy.

Now how adults can bind their children to secrecy I'm actually not even sure that holds up in court but those are the agreements that these type of agreements these families have signed. But going back to the private equity industry yeah you're right I mean like you know one of the issues is for instance that if these limited partnership agreements are public. Investors in portfolio companies could look at them and potentially see that there were violations in terms of what what was being done in the company they worked at and follow whistleblower claim for instance so they're good there again it's back to your point about what are they afraid of. Now you've also been poking around at the ways that private equity firms routinely and with great ingenuity structure fees that the companies they buy have to pay to the private equity firms would these contracts reveal more of that. Yeah I mean that's one of the things that again the agreements in the general publicity although the people who are driving that bus right now seem to be the securities surprisingly securities and exchange commission the SEC as a result of Dodd Frank.

Is now supervising part of the private equity industry in that the private equity funds are now required to register as investment advisors and therefore the SEC oversees them as investment advisor so now the SEC actually does have access to all these contracts and the firms required to file a form every year there's a pretty extensive form that you can actually also look at online up you know which is a description of how they invest and there's a narrative portion and they have to talk about. You know the certain fees they charge and what not and plus the SEC can just go conduct exams they can actually go you know conduct they're now conducting an initial set of I think they call them presence audits and an interesting term of art in any event so they've audited about a little bit under 10% of the industry and they started talking to the investors about this and I've never read a speech like the speech that one of the SEC officials a fellow. The SEC officials a fellow named Drew Bowden made I mean just went through this litany of violations they were finding and he talked about things like bogus I mean he's with like bogus you know and that over half of the firms that they had reviewed so far either were engaged in criminal criminal

misconduct or had serious compliance violations and he also made a clue this was not the small fry this was across the side spectrum one of the examples that's come out so far was in a Wall Street journal story about one of the industry leaders called KKR when initially they were in the 80s they went as culprits and robberts but now they call themselves KKR. One of the fees that a lot of these firms charge are also consulting fees to the portfolio companies now you might say why are they why the portfolio companies paying consulting fees to these firms when the funds already get a management fee the funds already get a fee for buying and selling the and supposedly overseeing the companies why are they getting paid an additional consulting fee on top of that. Well one thing and this gets a little convoluted but the unfortunately the convolution is important understand what's going on as the performance in the industry when from spectacular in the 80s to merely pretty good in the 90s investors kind of woke up and said we're not so happy about all these fees I mean you know we understand you get a management fee for running the thing and we understand that you get a success fee but then these other fees what is this about I mean they they actually even these normally very sleepy

investors began pushing back a little bit and so for many of the funds the peculiar compromise that was reached was that the fees are then rebated back in a significant degree to all the investors so they'll charge 100 and rebate 80 back or they'll charge 100 and rebate 60 back but it's typically a number in the these days it's been pushed up over time it's typically an 80%. So these investors now think well these fees aren't so terrible because even though we're charged for them we get pretty much all of it back when they may not get quite as much as 80% back but they think they get a lot of it back. So in any event what turns out with this fund KKR is that they had they have an in-house consulting firm called capstone and they make a big deal about how important capstone is to their success they even

made it the centerpiece of an invest of a presentation that they made to their public shareholders no mind KKR has stockholders which is different than the investors in their fund so that's another convoluted piece. So they made a big presentation 2012 to their shareholders about how important capstone was and in general when these private equity funds are marketing their new funds they will they will present their quote management team which will you know which will include people who work with the portfolio companies. Well it turns out that KKR was not rebating the funds from capstone to its investors as its investors assumed because of the way it had set capstone up that capstone with their claiming capstone isn't an affiliate as defined in their agreement. And yet if you parse the language more carefully that argument doesn't seem to hold up because it may not be an affiliate in terms of how the SEC defines affiliate for reporting to public shareholders but the way they define affiliate in their contract with the investors in their funds. It sure looks like an affiliate so they're trying to use language definitions in two different contexts to wiggle out of the fact that they were taking these fees that it sure looks like they weren't entitled to and their investors certainly thought they weren't paying.

How many employees as CalPERS investing the retirement monies of do we know? I believe it's something like because these are the people who are entitled to a vote in their they have an outside board some of the members are voted on by the members about 300,000 people who vote in those elections. So I believe that's the number of their beneficiaries. So that's that's California public and it's school teachers, firemen, policemen. Actually the teachers are a separate fund that's CalSTRS so so so this is all the public employees pretty state employees except for the teacher so for example even judges but yes it's basically all California employees except for the teachers. One more question on a slightly related subject but also regarding secrecy and financial regulations since you mentioned Mr. Bowdoin's attempts to regulate and to call out the violations that he saw in the private equity industry.

Last week Wikileaks came back to life with a revelation of a draft agreement being negotiated by the United States and several other countries called TISA, TISA. Up till now this draft has been secret and you and I discussed a little while ago the secrecy surrounding the trade agreements US was attempting to negotiate with Europe and with Asia which had big provisos in them relating to how corporations could sue governments if regulations by those governments affected corporations chances to make profits. What does TISA take us from there? Well TISA is an interesting piece of this because the TISA sort of shocking that here you've got a Trans-Pacific Partnership and the Trans-Atlantic Trade and Investment Partnership that you've got these two deals which are at least are being talked about some in the media which would still to a very alarming degree reduce the ability of nation states to regulate business. There's another deal which is intended to accomplish pretty much the same aims that is even less heard about. So you basically have the two sort of freight trains moving that now people are paying a little bit of attention to and then you've got this other freight train that's you know, chugging along in the dark and really in the dark at night with no lights on.

It's a subway, it's underground, right? Right, that's true, it's that underground. Yes, maybe I'm using the wrong image. So TISA is an agreement among 50 countries including all the countries of the Eurozone as well as the US, Japan, Australia, Canada, Mexico and then you know it's got Paraguay and Panama and Perufus. I can remember all the peas in the video. But in any event TISA is focused on services and the part that that WikiLeaks got its hands on was the annex that relates to financial services but it is known that it also has sections that involve pharmaceuticals. So you can imagine there's a parallel pharmaceuticals version of this and it also includes telecommunications. That's another one of the chapters that are involved and some for some reason transport services. So there's this laundry list of services that are included but the ones we've gotten a little bit of a window what the thinking behind this is the financial services annex.

And it's really quite alarming because effectively and again I'm oversimplifying this because the language is technical and you also can't reach too hard conclusions without seeing all of the deal and we don't see all of the deal. But basically its effect is that it would lock the current status of regulations in place. It would make tougher regulation difficult and the whole direction of the agreement is a very strong call that countries are supposed to further liberalize financial services that they're supposed to basically make it easier for foreign financial institutions to get into their markets which is of course really to allow America to further colonize the rest of the world. And to basically liberalize the cross border flow of capital. They had a lot of language around payment systems for instance and payment systems are things like debit card and credit cards to sort of liberalize the rules around those. So you can see that the impact here many people say that the re-regulation we had in the wake of the crisis was insufficient and that if there were the political will and there isn't really much but that we really need to have more done on this front.

And here the rule TISA would make it impossible to go any further than this. It would just lock down and eliminate the possibility of making any regulations tougher. And there was one note that you had in your piece about TISA that just stunned me which is that in that draft at least it would remain secret until five years after it went into effect. Right. And that's even longer than the secrecy that is contemplated for the Trans-Pacific and the Corresponding Trans-Pacific Partnership and the Corresponding Trans-Lantic Trade Deal. Those only a lot for four years of secrecy. And if they got nothing to hide why do they have to be secret? No, exactly. And the interesting thing is that the only place that there has been any upset that has gotten to the mainstream media is Australia because Australia has restricts foreign ownership of its banks. I believe it's to 15%.

They have four big banks that dominate their market. And the Australians will, you know, when the text was leaked in, the Australians woke up and said, hey, this would make it impossible for us to maintain these investor restrictions. And so there was a bit of a bruhaha in their media about that. But there's been absolutely no attention in the Western media about this. And I'm surprised that at least some Congress people haven't gotten up and said, what's going on here? Because there was, there is a good bit of upset in Congress about the Trans-Pacific Partnership. There's actually a large coalition of Democrats and even some Republicans in the House that are opposed to this. And Harry Reid in the Senate won't table what they call fast-track. So the Trans-Pacific Partnership looks dead in the water at the moment in the U.S. Whereas this thing looks like it's moving forward without any opposition. And it's also just very broad in the way it defines financial services.

I mean, it literally includes kind of anything that touches financial services. So all of the, for example, the data provision around financial services included, insurance is included, consultancy, any consultancy services related to this is included. And of course, investment management. So the private equity guys we discussed earlier are included. And that actually a significant, for instance, it probably wouldn't have any impact in the U.S. But the Eurozone has imposed restrictions on private equity firms and has required them to regulate and has restricted how much leverage that they get to use and deals. Because when they went into Europe, they bankrupted a lot of companies quickly and the Europeans aren't as tolerant of that as we are. So that would, you know, and one of the requirements of TISA is that is it is that they push for harmonization, which is basically, you know, regulate to the lowest common denominator. So TISA would give the private equity industry, you know, operate the opportunity to push for the rollback or elimination of these rules on them in Europe. And do we know if there's the same provision that there was in the, in the Pacific and European agreements that if governments regulation, in their attempt to regulate hurt corporations expected or anticipated or wished for profits that the corporations could sue those governments?

No, we had, but this is just a limited annex. So that part, that part wasn't in the annex. And I would expect since this was a part that was specific to financial services industry, I would anticipate that that kind of language would probably be in some section if they have those kind of provisions that would apply across all the industries as opposed to just, you know, what we saw that related to financial services. And if Smith of nakedcapitalism.com always a pleasure. You make it comprehensible to those of us who don't follow this on a daily basis. And for that, I give you my huge gratitude. And hopefully that of the listeners. Thanks again for being with us. Well, thank you. That's very kind. We really appreciate the opportunity. And that's not all about secrecy. The American Red Cross has hired a law firm to fight a public request from pro-publica.

Arguing that information about its activities, relief activities, post, super storm standee is a, quote, trade secret. The Red Cross releases few details about how it spends money after big disasters, making it difficult to figure out whether donor dollars are well spent. Trade secrets, ladies and gentlemen. That's going to conclude this week's edition of Lesho, the program it turns next week at this same time over the same station.

A tip of Lesho should pow to the San Diego Pittsburgh Chicago and Hawaii desks. Thanks to Pam Haustead. Thanks to Jenny Lawson, the WNO New Orleans. Thanks to Adrian Budnam here at Global Radio in London. Thanks to Paul Roost and Argo Studios in New York. And Nick Rogers at 5A Studios here in London. For help with the day's broadcast. The show comes to you from Century Progress Productions and originates through the facilities of WNO New Orleans. Flagship station of the Changes Easy Radio Network. So long from the home of Ping Pong in the rain. Thank you very much.