Going back to colonial days, it has been illegal for payday lenders to operate in the state of New York. Same goes for neighboring New Jersey.
But public pension funds in both states are indirect owners of ACE Cash Express Inc., the nation’s second-largest payday lender. It’s not an illegal arrangement, but it sure borders on hypocritical.
Texas-based ACE was a publicly traded company until October 2006, when it was acquired for around $455 million by JLL Partners, a middle-market private equity firm that is currently in the midst of raising $1.1 billion for its seventh fund.
At the time of its original acquisition, JLL managing director Frank Rodriguez said that the deal “presents a wonderful opportunity for us to work with the company in continuing its development as a market leader in the retail financial services industry.” What Rodriguez didn’t add, however, was that the buyout was partially being bankrolled by public workers in states that found ACE’s business to be predatory.
JLL purchased the company via an investment pool called JLL Partners Fund V LP, whose limited partners included the New Jersey State Investment Council and the New York State Teachers’ Retirement System (both made $50 million commitments). Neither pension system appears to have objected to the deal, even though it would make them owners of a company that is barred from doing business in their states. Nor did they request a “carve-out,” which could have allowed them to remain investors with JLL but not exposed to ACE.
This was also the case for the state pension system in Montana, according to Montana Board of Investments executive director David Ewer. In Montana, the maximum interest rate and fees for loans is capped so low (36% APR) that ACE doesn’t have any locations in the state.
“The Division of Investments … neither directs nor approves the companies in which these funds invest,” says Joseph Perone, a spokesman for the New Jersey Treasury Department. “The Division is unaware of any allegations that JLL, or any of its portfolio companies, is involved in any illegal activity, either within the State of New Jersey or elsewhere.”
All of that may be true. But it’s also true that deep-pocketed limited partners at private equity funds do have the informal ability to affect investment decisions (including by threatening not to invest in subsequent funds). Moreover, ACE most certainly seems to have been involved in illegal activity.
Last summer, the federal Consumer Financial Protection Bureau found that “ACE used illegal debt collection tactics—including harassment and false threats of lawsuits or criminal prosecution—to pressure overdue borrowers into taking out additional loans they could not afford.” The company agreed to pay a $5 million civil penalty and $5 million in customer restitution associated with these allegations.
In its response to the CFPB settlement, ACE said that it retained an outside consultant to review a statistically significant sample of its collection calls and found that “more than 96 percent of ACE’s calls during the review period met relevant collections standards.” Or, put another way, more than 3% of its calls did not meet such standards.
Even when operating properly, ACE is involved in a pretty controversial business. Supporters of payday loans argue that they help unbanked and low-income workers pay bills that are due on Wednesday when payday isn’t until Friday.
Critics, however, contend that the fees payday lenders charge are usurious and can trap borrowers in a downward debt spiral. ACE’s payday loans, for example, have APRs ranging from 65.35% to a whopping 1,409.36%. In California, where the UC Board of Regents is an investor in JLL Partners Fund V, a $200 payday loan from ACE comes with a $35.28 fee and a 459.9% APR.
“From a business perspective, these deals can be brilliant because they are cash-flow positive, have return customers, and the government [is] always trying to catch up on regulation,” says James Zhang, a former private equity investor who is now an executive with consumer finance education website NerdWallet (which argues that there are better loan alternatives for the unbanked). “But not if you have a moral compass. Imagine teachers in low-income areas learning that they’re funding a company that profits off the backs of their students or their students’ parents.”
In this specific case, however, there’s even a question about how good an investment ACE Express will turn out to be for JLL.
The firm’s fifth fund has had a decent overall performance (11.03% net IRR through 6/30/14), but it’s highly unusual for a private equity firm to hold onto a portfolio company for what will soon be nine years. By now, the company usually would have been taken public or sold. Moreover, the CFBP recently proposed new payday lending rules that have been enthusiastically endorsed by President Obama. Such rules do not require Congressional approval (unless, of course, CFBP itself is unwound). So, ACE’s future growth may be stunted—and that uncertainty may help explain why it’s still in JLL’s portfolio.
JLL Partners did not return several requests for comment. Neither did a spokesman for the New York State Teachers’ Retirement System. Other states that have public pensions investments in JLL Partners Fund V include Colorado and Missouri (payday lending is legal in both states).
UPDATE: We spoke with JLL’s Frank Rodriguez shortly after publication (he had not yet seen the story). He stressed that one reason JLL was originally comfortable with ACE was that the company did not try to surreptitiously do business where it wasn’t allowed (there have been accusations that other payday lenders have still tried getting into such states via online platforms). When asked if he had any concerns that JLL funded the deal via public money from states that deem payday lending to be unethical, he said he would not presume to know why payday loans are illegal in certain areas.
Rodriguez adds that the firm did not inform LPs of the CFPB settlement because it “wasn’t material to the business,” and that the settlement did not constitute an admission of wrongdoing. As for why JLL still owns ACE, he said it was a combination of the 08/09 financial crisis and current regulatory uncertainty related to CFPB.
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