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Thu, Mar 28, 2002 - Page 19 News List

How to make a truckload of money without doing anything

Private equity funds are lucrative and have lots of potential for abuse. The funds remain private, disclose little information and remain largely free of scrutiny

By Matthew Lynn  /  BLOOMBERG , LONDON

Occasionally you might wonder where your next few million may be coming from. How is the yacht going to get paid for? What about the alimony? How will you ever afford a house in the Boltons, the Hamptons, or any other kind of 'tons? Relax. Put on a Dido CD, swing your feet up on the desk, and read on: This column is about to explain how you can make free money for the rest of your life with no effort whatsoever.

It's called the private equity business. Right now, it looks like the best thing going.

Two recent court actions have shone some light on this often neglected corner of the financial universe. In one, a New York-based hedge fund called Millennium Partners LP is suing a venture capital fund called meVC Inc. In another, Forstmann Little & Co, the buyout fund run by Wall Street veteran Theodore Forstmann, is being sued by the Connecticut state pension plan.

Both illustrate why private equity is such a lucrative industry, in ways that its champions would rather not talk about.

They help to explain why for many of the smartest people in the financial markets, it has been the hottest ticket around for the last few years.

A battle between a hedge fund and a private equity fund looks like the kind of spat in which it would be foolish to take sides. Like piranhas complaining that sharks are giving flesh-eating fish a bad name, there is probably right and wrong on both sides. All the same, the statement put out by Millennium is an education in the sharper side of corporate finance.

The story goes like this. MeVC runs a fund called the meVC Draper Fisher Jurvetson Fund 1, in which Millennium has been one of the major investors. So far so good. The trouble started when Millennium looked at what was happening to its money and didn't like what it saw. In its lawsuit, Millennium alleges "excessive, unreasonable and unearned fees have been received by meVC Advisers." Excessive, unreasonable and unearned? It is hard to say which of those adjectives sound sweeter to anyone interested in making lots of money for doing nothing. How do we get our fingers into that honey pot exactly? Like this, according to the writ. The stated objective of the fund was to make venture capital investments in information technology companies. But, through the 2001 fiscal year, over 60 percent of the money remained in cash. In spite of that, meVC carried on collecting fees on all the money sitting in the fund.

Not just that. Millennium goes on to allege that even though Securities & Exchange Commission approvals to make follow-on investments in other Draper Fisher funds weren't forthcoming, meVC made no downward adjustment in its 2.5 percent advisory fee or its 20 percent incentive fee.

Nor, it further alleges, did it make sufficient mark-downs in the net asset value of the fund, even as the value of those investments it did make tumbled in value (by January this year, those investments had lost 54 percent of their value). The result of not marking down the net asset values was "inflated advisory fees." "The advisers took in excess of US$12 million in fees," said Robert Knapp, the managing director of Millennium in a statement accompanying the action, "essentially making shareholders pay them to `manage' money sitting in money-market assets." Now, no one would question that opening a bank account can be a tricky business. There are forms to be filled in, boxes to be ticked, and statements to be checked. Nor would anyone question that meVC did an excellent job of opening the account.

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