Governance after Refco

When it was revealed that the head of US broker Refco had allegedly concealed $430m of debt, one question that needed answering was whether investors in the firm should have known more about goings-on behind the scenes. Andy Thomson asks a corporate governance specialist about the lessons for private equity.

The backlash from the Refco debacle continues to be felt across financial markets, and the buyout industry is no exception. The firm, which collapsed last month after the discovery that $430 million (€369 million) of company debt had allegedly been masked by its former CEO Phillip Bennett, has no doubt already earned its place in private equity folklore.

Thomas H Lee Partners, the buyout firm that was a major shareholder in the commodity brokerage, might have hoped the storm would blow over. But there’s no sign of that happening anytime soon. Last week, it was named along with 39 other parties in a lawsuit issued by former Refco employee Gerard Sillam, who claims to have helped the firm establish its European securities arm and is claiming $800 million in back payments and $600 million in punitive damages.

Today, Thomas H Lee is reported to have issued its own lawsuit against Bennett, former Refco CEO Santo Maggio and former president Tone Grant in an effort to recover $245 million of losses it claims to have sustained as a result of the alleged cover-up.

The truth is that fraudulent management teams will for a period of time be able to pull the wool over the eyes of anyone they want to

Vincent Neate, director, KPMG & member, EVCA Corporate Governance Working Group 

As lawyers prepare to go into battle, industry professionals are debating questions about the degree of supervision that private equity firms exercise over portfolio companies. Is it the case, for example, that corporate governance procedures should be tightened to help prevent similar situations arising in future?

In Europe, such issues are being pondered by the Corporate Governance Working Group of the European Private Equity and Venture Capital Association (EVCA). In June of this year, the Working Group unveiled new corporate governance and best practice guidelines for the management of privately held companies. The guidelines provide recommendations for various areas of conduct, including those relating to the management of portfolio companies (the guidelines can be found and downloaded at

In an interview with PEO, Working Group member and KPMG director Vincent Neate has reassuring words for private equity. “My view is that the corporate governance of private equity-backed businesses is generally of a very high standard,” he says. “GPs are represented on boards, they find out what’s going on and they take a long-term view. Many of them perform good governance without even necessarily thinking that’s what they’re doing.”

However, Neate says issues at portfolio companies can sometimes “fall between the cracks” because buyout firms are not always as process-driven as other kinds of business. He says that, despite their willingness to conform to the “spirit” of corporate governance guidelines, they tend not to put as much effort as they should into ticking boxes. “We would like to see more of a corporate governance process – and so would limited partners,” he adds.

One reason for this alleged unwillingness to get too bogged down in processes might conceivably be the entrepreneurial flair that drives the industry – and which no-one, least of all LPs, would wish to dilute. Nonetheless, there is a growing sense, says Neate, that corporate governance is an important aspect of private equity firms’ ability to add value.

His view is that this message is being taken on board. He defines ‘old-fashioned’ private equity as follows: “The company is bought and the deal executive quickly moves onto to the next deal. Accounts of portfolio companies are glanced at on the way to the monthly board meeting. No doubt some very intelligent questions are asked at the meeting, but the deal executive is not getting to grips 100 percent with what is going on within the business.”

However, this approach is undergoing change in the “21st century” version of private equity which, says Neate, is more based on “trying to anticipate problems and finding ways of managing portfolios in a way that’s not as libertarian as was once the case”.

Nonetheless, in spite of the best efforts of the industry, there remains no safeguard against malpractice. Concludes Neate: “The truth is that fraudulent management teams will for a period of time be able to pull the wool over the eyes of anyone they want to. You can’t legislate against that – but you can be alert and have the best processes in place that you possibly can.”