Conflicting interests in the money management business

The NY Times has an interesting article today about conflicts of interest between private equity firms and their investors.

The specific conflict addressed relates to payments to outside vendors like law firms: In a nutshell, many private equity firms pay two different rates: A high one, when they’re paying with investor money and a low one, when they’re paying with their own money.

The business of managing other peoples’ money is fraught with potential conflicts of interest. For example: You get a legal bill for an attorney’s work in organizing a new entity. Some of the cost relates to reviewing the PPM and the rest to hammering out the operating agreement.

The PPM expense is pretty clearly marketing, which the manager ought to pay. And yet there is, of course, the temptation to lump it all together as part of the cost of organizing the entity and bill it to the fund (eg pay with investor money), since it’s very unlikely anyone will ever check.

But we don’t do that, because we regard each of our investor relationships as a precious asset to our business. If something is on the margin, we err on the side of eating costs, rather than doing something that even hints at putting our interest ahead of those of our partners’.

What bothers me so much about the article is that I like to think about Blackstone and the other big PE shops as models for what we could become if everything breaks right. It’s just crazy that these guys, who have reached the absolute pinnacle of the money management business, have such poor judgement about how to treat investors.