Some private questions for Apollo, before it goes public

March 17, 2011, 5:33 PM UTC

Hey Leon, can we talk?

Apollo Global Management has delayed the start of its long-awaited IPO roadshow, due to market turmoil caused by the Japanese earthquake. CNBC reports that the private equity firm now plans to begin soliciting investors next Monday, with hopes of raising around $500 million by the end of March.

In other words, prospective investors have a bit more time to get their list of questions collated. Let me add one to the mix: Why did Apollo pay millions of dollars to Alfred Villalobos, the notorious “placement agent” currently under indictment in California for fraud?

Between 1992 and 1995, Villalobos served as a director with the California Public Employees Retirement System (CalPERS) — the nation’s largest pension system, with over $225 billion in assets under management. After leaving, he morphed into a placement agent, or someone who raises money for private investment funds.

Most placement agents play a valuable — and legitimate — role in the capital markets, but Villalobos appears to have been crooked. Specifically, California officials have charged him with providing gifts and promises of future employment to his former colleagues at CalPERS. In other words, kickbacks.

Among those clients was Apollo, which paid nearly $40 million to Villalobos in exchange for his helping to raise money for several different funds. Apollo also used Villalobos when CalPERS agreed to buy a 9% stake in the firm for $581 million in 2007.

To date, there has been no accusation that Apollo was involved in the fraud. In fact, a CalPERS-commissioned report released this week suggests that placement agent disclosure forms submitted by Apollo to CalPERS were doctored by a CalPERS official who also is named as a defendant in the fraud suit.

That said, there are some major question marks surrounding the relationship.

Apollo first got to know Villalobos shortly after he quit CalPERS, through his subsequent role as chief strategist for the private funds group at Donaldson, Luftkin & Jenrette. DLJ helped Apollo secure its first fund commitment from CalPERS, a $150 million slug into Apollo’s third fund. DLJ then helped secure another $150 million for Fund IV.

By the time Apollo’s fifth fund rolled around, Villalobos was working for himself. DLJ’s placement group was still active (albeit re-branded as Credit Suisse), but Apollo stuck with Villalobos. He helped Apollo secure $250 million, and then another $650 million five years later. Each time, Apollo agreed to pay Villalobos around 1% of the capital commitment. It then paid him 2.2% — or $13.2 million — as part of the stake sale, and then returned to 1% when it came time to raise $1 billion from CalPERS for Fund VII.

In most of these cases, it now appears that Villalobos employed illicit means to secure CalPERS money for Apollo. I am not saying that Apollo knew about the back-room deals, but am saying that it may have intentionally turned a blind eye. Consider:

1. It’s understandable that Apollo would use a placement agent to get initial business from CalPERS (make introductions, etc.). But why continue using that placement agent once Apollo’s foot was in the door? Couldn’t Apollo just go through normal channels at that point? This becomes particularly troubling for Fund VII, which was raised after CalPERS acquired a 9% stake in Apollo’s management company. Why on earth would Apollo need a placement agent to get money from one of its existing owners?

And I’m not the only one asking. Leon Shahinian, former senior portfolio manager for private equity, said the following in a Villalobos-related deposition: “I guess I didn’t understand why Apollo felt like they needed to hire a placement agent on something where CalPERS had explicitly indicated an interest in investing in.” Shahinian colleague Joncarlo Mark added: “Apollo was an existing manager with CalPERS and [I] felt it was unnecessary to have… Villalobos involved in representing them when we had an existing very large scale relationship with Apollo.”

2. It is true that certain firms continue to employ placement agents to secure funds from past investors. But, in most of those cases, the fees decline over time. For example, if a placement agent received 1% to secure an initial commitment, he might receive 0.5% to secure a follow-on commitment (since it’s an easier job). But Villalobos kept getting his 1% throughout (as commitment amounts rose), and actually received the equivalent of 2.2% on the 2007 ownership stake sale. In other words, Villalobos kept getting paid more as time went on, not less.

3. In the private equity world, there are two types of placement agents: Brokers and finders. Brokers typically are compensated by a percentage of the commitment they secure, while finders (i.e., folks with inside connections) usually are paid a plat referral fee to make introductions. Villalobos has been repeatedly referred to as a finder in the press, but he clearly was compensated like a broker.

Brokers are supposed to be registered with the SEC and/or FINRA, but Villalobos wasn’t registered until May 2009. His independent firm, ARVCO, got its broker papers in order about one year earlier. Apollo could have learned all of this in about five minutes, but either chose not to or didn’t care. In subsequent disclosure forms for each of its funds, Apollo checked a box saying that Villalobos “is registered with the SEC or FINRA.” Perhaps they just got clever with the verb tense, since each of these forms were submitted after May 2009 (and, apparently, never seen by anyone at CalPERS other than a Villalobos crony).

Again, I’m not claiming Apollo necessarily did anything wrong, let alone illegal. But it did do something strange, and prospective investors deserve some straight answers.