Private equity giant Apollo has been in damage control mode ever since the New York Times broke the story in October that the firm’s co founder and CEO Leon Black had paid at least $50 million and perhaps as much as $75 million in fees to convicted serial child rapist Jeffrey Epstein, long after Epstein had become a pariah. Some public pension funds, the first being the Pennsylvania Teachers Retirement System, said they would not be making new commitments to Apollo had ‘splained itself; we understand other funds gave similar messages to Apollo privately. In other words, Apollo had to offer a plausible rationale for Black had been up to or get him out of the picture.
Apollo then launched the usual whitewash, um, internal investigation, even though Black was apparently not convinced of its necessity. The firm announced the findings and its actions on Monday. Even though the intent of these exercises is to put the matter to bed, anyone with an operating brain cell will not be satisfied. The fact that the monies Black paid to Epstein were more than twice as large as the previous high estimate is eye-catching: according to the New York Times, $158 million in fees, plus $30 million in loans, only $10 million of which had been repaid.2
The denouement, that Black is leaving his CEO post sometime before his birthday in July, but will remain chairman, reportedly came after what the Grey Lady depicted as a “brief power struggle over the weekend.” Black will also donate $200 million from his family’s funds to women’s programs.
The shock value of the magnitude of the payments to Black may succeed in diverting press and investor eyes from the real scandal here: what was Black paying for? And was Apollo implicated? Bear with me, because the supposedly reassuring excerpts from the report by Dechert actually suggest that Apollo was involved too.
Recall that the time frame of the fee payments is from shortly after Epstein was convicted, in 2008, through 2016, when Black and Epstein fell out over a fee dispute; Black’s last payment was to Epstein in 2017.1
This is how Dechert attemptsed to justify the transfers from Black to Epstein. From the Wall Street Journal:
Mr. Black “believed, and witnesses generally agreed, that Epstein provided advice that conferred more than $1 billion and as much as $2 billion or more” in tax savings, the report states.
It also supports Mr. Black’s contention that he paid Epstein a fee he believed was roughly equivalent to 5% of the value that the late financier generated on an after-tax basis.
We’ll deal with the second howler first, that someone like Black would pay for mere advice on a percentage of results basis. As Black knows well, the people who get rich to very rich attach themselves to capital and get paid a percentage for performance, such as brokerage or asset management fees. Black, who buys legal services from the very best firms in the US in bulk, would know he could hire the very best tax lawyers in the US for a fraction of what he paid Epstein. He could even have financed a firm with the very best minds in the industry for this kind of dough. And in earlier accounts, Black also asserted that all of Epstein’s advice was vetted by independent experts.
So it seems reasonable to think that Black was not paying just for advice but some kind of execution too, as in moving funds and engaging in sham transactions to recharacterize the economic substance or apparent ownership of funds.
So it’s hard to see Dechert with a straight face parroting Black’s defense that he was paying 5% of the economic value of what is presented as mere tax advice as if that were a reasonable compensation arrangement.3
But let’s go back to the first eyepopper: tax savings of $1 billion to over $2 billion.
Let’s be charitable and use Black’s maximum applicable tax rate: a marginal tax rate of about 50% for Federal, New York state and New York city income taxes. That means the amount of Leon Black personal income subject to Epstein’s wizardry, again charitably assuming he managed to find a way to bring Black’s taxes from 50% to zero, would be double the savings, or $2 to $4 billion.
Mere tax deferral isn’t worth much in a near zero interest rate environment, so we’ll rule out those sort of approaches.
And if you assume merely that Epstein managed to turn what would have been ordinary income/short term capital gains into long-term capital gains, again that does not seem to be so insanely rarified that other tax structuring gurus more savory than Epstein wouldn’t be able to come up with similar magic at much lower fees and reputational risk. And that level of tax savings would amount to less than half than if Epstein found some sneaky way to make the taxes disappear entirely.4 So that means you would need to assume an even greater amount of Black personal pre-tax income was subjected to Epstein’s tax legerdemain, on the order now of $4 billion to $8 billion, over eight years.
Let’s go one step further. It is highly unlikely that much of the income was from Apollo, the public company, or the Apollo fund level. Any of the income reported in a 10-K is going to be hard to play with much. And Black and his fellow partners would already have America’s best and brightest tax minds doing their best to assure that as much of the money they get from Apollo, save their salaries, is subject to long-term capital gains treatment.
So where did the at least $250 million a year, and perhaps over $1 billion a year that Black was using Epstein to come from? Probably from Apollo portfolio companies.
If that’s correct, and we are highly confident that this is correct at least in part if not substantially, Apollo limited partners should be mighty unhappy. We have examples of this sort of thing happening again and again (see the example of KKR Capstone here and a Blackstone affiliate here). Despite the SEC evangelizing about this problem of hidden grifting at investor expense for a bit in 2014 and 2015, nothing fundamental has changed about private equity disclosure about how much in fees and costs they are extracting from portfolio companies, and accordingly, no reason to think that those charges have moderated. If anything, they could have gotten worse given that even more investors are desperately throwing money at private equity.
So if at least some of the Black monies that Epstein was shielding from the tax man came from Apollo portfolio companies, something must have been done to change their character from a tax perspective: designating a new payee, sending the monies to a different account and/or changing the claimed purpose of the fee or expense. The latter would have required changes in invoicing or even the legal agreements with the portfolio companies.
The larger point is that nothing like that could have happened without the knowledge and participation of at least some manager or executives at Apollo portfolio companies, as well as the bean-counters at Apollo and the Apollo employees sitting on the pertinent portfolio company boards.
1 It’s reasonable to assume that Black stopped or cut way back on his use of Epstein as of the fee row, in 2016; the 2017 payment was likely a settlement.
2 Oddly the Wall Street Journal is reporting only $148 million in fees and no loans, but the Times also has detail on the internal jousting and thus seems to have the better grasp of facts.
3The earlier Times account also had details that showed that Black had made an effort to conceal these payments, which again calls into question “Oh, these were just fees for legitimate services.” For instance:
Some of the payments from Mr. Black are described in an internal report by Deutsche Bank, which served as Mr. Epstein’s primary banker from 2013 into 2019…
Portions of the report reviewed by The Times describe a payment of $22.5 million in 2017 by a company called BV70 LLC, which the bank said owned Mr. Black’s yacht, to Plan D, the company that managed Mr. Epstein’s Gulfstream jet. When an employee in Deutsche Bank’s anti-financial-crime division inquired about the payment, she was told by another bank employee that it was a fee for consulting services provided by Southern Trust Company, one of the dozens of entities Mr. Epstein operated in the Virgin Islands. There was no explanation for why the payment went to Plan D.
The Deutsche Bank report also shows that BV70 made a $10 million donation in 2015 to a charitable foundation started by Mr. Epstein, Gratitude America, which made several million dollars in grants while Mr. Epstein was casting himself as a philanthropist. BV70 also planned to make another payment of $10 million to Mr. Epstein for advisory work, according to the report, although it was unclear if that payment was ever made.
And in 2014, Mr. Epstein received several million dollars in fees from Narrows Holdings, a company that Mr. Black — the chairman of the Museum of Modern Art — has used to purchase much of his billion-dollar art collection, according to two of the people with knowledge of the transactions. The details of the services Mr. Epstein provided in exchange for those fees are also unclear.
Note we do not buy the notion that Black was buying sexual services. He could have set up his own brothels in Thailand and Eastern Europe and flown there himself for less money and less risk. From what we have heard, no one in private equity things so either, and they have active imaginations. They are convinced that the size of payments alone is prima facie evidence that Black was paying for tax avoidance. And they note that Epstein’s Caribbean island was a very close boat ride to the tax haven, the British Virgin Islands.
4 This result is not utterly unprecedented. Recall that Apple had a tax deal with Ireland that achieved the result that a decent chuck of Apple income was attributable to no tax domicile and therefore not taxable.