Lends with Benefits aptly summarizes what creditors unknowingly provided for First Brands former CEO Patrick James. A lawsuit filed in connection with the First Brands bankruptcy suggests James transferred hundreds of millions from the company to himself and used the money to purchase seven homes, seventeen cars and to fund $8 million into his son-in-law’s company. The new CEO, Charles Moore, confirmed that James ordered the cash transfers to his personal account, that the company faked invoices, double-pledged collateral for loans and doctored other invoices used to secure financing. Private credit pools provided much of the debt capital. A similar tale of fraud underpinned the losses at TriColor, where the principle color was blush, as the sub-prime lender filed for Chapter 7. Banks led their creditors list. The other recent default headline reported hundreds of millions lost by HPS Investment Partners due to receivable fraud which HPS alleges was committed by several companies controlled by Bankim Brahmbhatt. This tight grouping of credit problems led Jamie Dimon to paraphrase Spiro Agnew and proclaim, “When you see one cockroach, there are probably more.”
Roach control for the credit markets is beyond the scope of this note, but it does surface the question of the wisdom of expanding access to the private markets to include unsophisticated investors. Recent rules have been altered to let 401K plans participate in private markets. The marketing machines of the large asset managers have responded rapidly to the chum in the water. Sophisticated institutions are in a position to understand the risks they are taking in private credit and are sufficiently diversified in their holdings to absorb fraud or other default losses. As egalitarian as it sounds to offer participation to all, the SEC rules are often proposed with little thought given to the unintended consequences nor who will bear those consequences.
No limits on private market allocation by 401K holders have been proposed. At its extreme, employees could opt to put all their 401K into private markets as the media’s cartoon version of private equity is a road paved with gold and high fees. As the credit examples in the prior paragraph illustrate, sometimes these investments turn to lead. Are employees financially and emotionally prepared to take that risk and to handle a disastrous result? In that event, we could expect the political class to demand the government make the employees whole for freely-made poor choices. The government has done the same for student loans in bankrupt for profit schools, for people underwater on mortgages, via the TARP bailout, and by back-stopping broke multi-state pension funds which did not properly manage pensioners’ investments. Why create yet another financial quagmire in a category where inordinate risk-taking is the strategy? After the multiple layers of fees that will be paid for capital to travel from a retail investor to a portfolio company and back, the projected rate of return is unlikely to exceed that of an equity index fund, yet the investor has assumed ample dollops of additional risk. Retail evergreen secondary funds are already pushing up prices and lowering expected returns for secondaries as the cascade begins. Sourcing capital from 401K plans does not appear to solve any problems, as private markets are brimming with capital, with enough dry powder to cover Aspen. Opportunity Zone investments were created eight years ago as a tax dodge that was also designed to stimulate growth. So far only the dodge has triumphed. The 401K scheme bodes to be the successor to the 2008 mortgage crisis. Kudzu was first brought to the U.S. in 1876 to brighten gardens, now it is a damaging invasive species. Caveat Emptor.
I’m Rob Morris and I approve this blog.