Castle Hall continues to complete an ever increasing volume of due diligence across the private equity industry - and it's an interesting journey as we encounter diligence issues across both large and small PE managers.
Three recent enforcement actions have caught our eye, which raise topics which should be considered by investors as they conduct diligence on private equity funds. We'll look at each in a short series of Risk Without Reward posts.
The first is the case of Riordan, Lewis & Hayden ("RLH"), a private equity firm based in Los Angeles that reported regulatory assets under management of $1.3 billion as of their latest ADV filed in April 2018.
RLH purchased a portfolio company, "Diabetic Care LX" (which conducted business as "Patient Care America"). Per Justice Department documents (see complaint here) this company allegedly:
"presented, false or fraudulent claims for compounded drugs to TRICARE, the federal health care program for active duty military personnel, retirees, and their families. As part of the scheme, Defendants paid kickbacks to “marketers” to target military members and their families for prescriptions for compounded pain creams, scar creams, and vitamins, regardless of need. While these products were supposed to be compounded specifically for individual patients’ needs, the formulations were in reality manipulated by the Defendants and marketers to ensure the highest possible reimbursement from TRICARE. The marketers paid telemedicine doctors who prescribed the creams and vitamins but never physically examined the patients. The marketers also colluded with the Defendants to pay many patients’ copayments to induce them to accept the compounded drugs. The Defendants and marketers then split the profits, and the scheme generated millions of dollars for them in a matter of months."
Point 1 is that allegedly defrauding TRICARE - the federal health care program for active duty military personnel, retirees and their families - sounds like a particularly bad idea.
Point 2 is directly related to diligence: amongst those indicted were not only the CEO and President for Operations of Patient Care America ("PCA") - but RLA, the PE firm which owned Patient Care as a portfolio company. Per the Justice Department, "At all relevant times, RLH managed and controlled PCA on behalf of the private equity fund through two RLH partners, Michel Glouchevitch and Kenneth Hubbs, who served as officers and/or directors of PCA and of a holding company with an ownership interest in PCA."
In this instance, therefore, the asset manager is facing a lawsuit as a result of events at a portfolio company. We do not have any direct knowledge of RLH or this specific investment: however, in general terms, various questions arise:
Traditional operational due diligence has "stopped" at the PE asset manager, with no additional work conducted on the underlying portfolio companies. In discussions with several large investors, however, we are seeing an increase in appetite to "look through" the manager / GP / fund to the assets which are actually owned by the investor.
The phrase "reputational due diligence" comes to mind - do investors actually know what each portfolio company does? As an investor, how can we be sure that there are no companies within our overall portfolios which are potentially engaged in inappropriate activity?
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