Sep 01, 2026
On September 1, The Capitol Forum held a conference call with Jim Woolery, Founding Partner of Woolery & Co., to discuss emerging litigation and risks in the private credit market. The full transcript, which has been modified slightly for accuracy, can be found below.
TEDDY DOWNEY: Welcome. I’m Teddy Downey, Executive Editor here at The Capitol Forum. Today, I’m pleased to be joined by my colleague, Josh Kosman, who has written a book about private equity and has followed the space for many years as a reporter.
And our featured guest is Jim Woolery, founding partner of Woolery & Company, a strategic law firm operating at the intersection of law and corporate finance. Jim previously served as a Senior Partner at Cravath, Swain & Moore, co-head of Mergers and Acquisitions at JPMorgan and co-founder of Hudson Executive Capital. Jim, thank you so much for doing this today.
JIM WOOLERY: I’m so glad to be with you.
TEDDY DOWNEY: So, you have this big lawsuit that’s sort of making waves in this community. Can you lay out what the lawsuit is about?
JIM WOOLERY: Sure, sure. And I would say it’s lawsuits. There are multiple cases involving Blue Owl, Ares, and FSK KKR. Those are the cases that we’re pursuing right now. These are publicly traded BDCs. And we should just pause for a second and just kind of describe what is a BDC? What is private credit? What are these investment vehicles? Essentially, they are private loans anywhere—they’re in the hundreds generally. So, take an average number of, say, 500 loans might be in one of these vehicles.
And the structure of these companies is that they are investment companies. So, because they are investment companies—and they acknowledge that. They say we are an investment company, and we are regulated by the Investment Company Act of 1940. We’re subject to that act.
And in that law, there is a private right of action for shareholders, or holders, to challenge the compensation of what’s called the investment advisor. So, this entity, say Blue Owl, has a board of directors. It also has what’s called an investment advisor. And the investment advisor is the entity that collects the fees, selects the loans, originates them, manages them, and, importantly, values them.
And I want to just point the listeners to the fact that these loans that are made are not publicly quoted loans. There’s not a public price. So, that’s why it’s called private credit. Because these are private loans. They’re not publicly, as I say, listed.
So, the investment advisor, they’re not trading these loans. This isn’t a trading exercise. They originate the loan, and then they manage it, oversee it. And as I say, they pick the value of what is this loan worth?
And the thing that has happened in private credit is that the compensation scheme is divorced from the shareholder experience. So, a lot of times when you have a mutual fund or a hedge fund or something, they get paid based on shareholder performance. Here, that’s not how they get paid. They get paid on what’s called gross assets, okay?
So, they don’t get paid on the NAV that it trades at. And many of these are trading at a very public, very pronounced discount. I’m going to explain why that discount is there and why it won’t go away until there is reform. But in any event, they pay themselves, and they sort of set their own fees. There’s a board of directors. And because of this kind of conflict of interest where they sort of, in effect, set their own fees, the law provides for this private right of action.
Now, what’s different here than exists in kind of every mutual fund or investment company act since the history of time is that in most of these, say, mutual funds, Apple stock is worth what Apple stock is worth. It’s quoted. And so, what the arguments are around compensation, and excessive compensation, is around the percentages that they apply to, let’s say, the Apple stock.
Here, very different, okay? We’re talking about not just the percentages and the compensation scheme, but we’re talking about the denominator. What is this loan worth, okay? And we started to investigate this about a year ago because we were confused by what was happening. And as we investigated it further, we found a compensation scheme that is unlawful. It doesn’t comply with the law.
And here’s why it doesn’t. Because the investment advisor is extracting fees, up front in many cases, for loans that are no longer good loans or they’re weaker loans. And I’ll explain that. And they pay themselves a fee, and then they also borrow money to pay the fee. And that directly transfers wealth from shareholders to the investment advisor.
And how do they do that? Well, there’s something called pay in-kind loans, which I’m sure many of your listeners are familiar with. And there are two different kinds, I would say, for this purpose of discussion, two different kinds of PIK loans. There’s a PIK loan where you’re paying me in more loan. You’re not paying me in cash. But let’s say you’re a high-growth company. I underwrite it at the beginning, and I say, you know what? This is a good loan to originate as a PIK loan. And we’ll let them pay in kind, in an IOU. They’re not paying cash.
And there’s a second kind of PIK loan. And I would call that, for this purpose, sort of bad PIK. And what is bad PIK? It’s we originally underwrote the loan. And we underwrote it for—they were going to pay us cash interest. Then they get in trouble. They come to us, and they say, we can’t pay the cash interest. We need to restructure the loan. Here is where one of the fundamental problems exists in private credit. When they go to restructure that loan, they say, you now no longer have to pay me cash. You’re going to pay me in more loans, in IOUs. Those IOUs add to gross assets, right?
So, they take a fee in these cases. Not all people do this. Not all entities do it. But these entities do. Each one of them take an upfront fee when they convert something to PIK. It adds to gross assets. So, they take a fee. But there’s no cash because it’s pay in kind. There’s no cash being paid. So, what they do is they go out and they borrow money against the shareholders to pay themselves the fee. And the fee scheme provides that if the PIK never pays off, they don’t have to pay that fee back.
Now that is a dramatic—dramatic—asymmetry for shareholders. So, I’m getting paid upfront. Imagine if you guys got paid at The Capitol Forum based on your estimates of what’s going to happen in the future, and you got paid today, and you borrowed money against your shareholders to pay yourself back, whether or not that estimate ever plays out.
JOSH KOSMAN: And Jim, I was just going to jump in. In the suit, you allege the PIKs are also considered revenue, even though they’re not collecting money. It’s just more IOU notes.
JIM WOOLERY: That’s correct. So, it’s a sort of phantom—there’s no cash, right? But I’m paying myself a fee and I’m estimating I’m going to get fully paid out. Now, when these things started, when these entities started, in some cases they had no PIK or they had very small amounts of PIK, five percent, three percent, that kind of number. Guess what that number is today? Thirty percent. Thirty percent is IOU money. That’s a huge number.
Here’s the other problem with what they do. If they took that package of loans—Blue Owl sits right across the street from JPMorgan. If they walk across the street to Jamie Dimon and they said, “Here. We have this package of loans.” They started out cash pay and now they’re PIK loans. They would never get par for those loans. Never. And everybody knows that, okay? But they wouldn’t, right? But guess what they do? They mark it at par. Today, they’re marking those loans at par.
So, we have borrowers who can’t pay the cash interest. We’ve restructured the loan to recognize that, right? And then we’re going to try to defy financial gravity and say that notwithstanding that that’s not a cash pay loan, we’re going to hold it at par.
That is the reason, ladies and gentlemen, why the discounts to NAV, if you look at the public entities, you’re talking about 30, 40—in the case of FSK KKR, a 50 percent discount to what they say the loans are worth. Fifty percent.
TEDDY DOWNEY: Jim, before we even get to the PIK loans, there’s a lot of reporting out there that the assets, other assets, are inflated. So, do you even need to get to the PIK loans to be confident? I mean, obviously, you’re laying out this very transparent way where you can know that the assets are not priced appropriately.
And basically, because those assets are not priced appropriately, you’re getting a higher percentage based on those assets. And so, the fee that you’re taking from the investor is too high, right? If those things were mark to market, you would pay less of a fee. You’re talking about these PIK loans, but aren’t there questions about all the assets that might be underperforming that aren’t being marked down, in addition to the PIK?
JIM WOOLERY: Yeah. So, PIK is one example. It’s sort of clean, and that’s why I led with it because I think folks can understand it. The other area of focus is software loans. So, there’s something called the Global Industry Classification System or what they call GICS, right?
And that is something where I tell Blue Owl or FSK or any of these entities, tell their investors, here’s how much we have in software loans, right? And as we all know, over the last year, these software loans—last two years—the software loans have been underperforming significantly.
And what they do is they, in effect, hide their software exposure because they’ll have something that’s in healthcare. They’ll call it healthcare, but it’s healthcare software. And we demonstrate that in the complaint. We estimate that—based on our work—that they underreport anywhere from 10 to almost, in some cases, 20 percent underreporting of their overall exposure.
So, they say it’s 10, but it’s really 30. Or they say it’s 10, but it’s really 25, okay? And I’m confident that when we get to discovery that we’re going to be able to demonstrate—and we’ve already demonstrated in the complaint, in the motion, in what we put forward—we’ve been able to demonstrate on its face with the public information where they don’t classify the loans accurately.
So, you have that problem. And then you have the overall inflation, which is, remember, I’m getting paid based on what I say the loan is marked at. That’s what I’m getting paid on. So, they have an incentive to hold these things at par. And then when they go bad, they decide to write them—there’s no in-between, guys. They’re not like sort of writing these down over time. They’re either marking them at par, or when they go to nonaccrual, which the nonaccrual amounts have increased, when they move them to that, then they write it down. But they don’t sort of write it down 5 percent a quarter. It’s very much of what I would call cliff marking, where it’s either par, par, par, par, par, or we write it down. There’s nothing kind of in-between.
And in real life, the way this works, they say they source this from third parties. They get ranges, okay? So, accountants and other people they talk to give the appearance of compliance that aren’t substantive compliance. They come in and say, here’s this loan, it’s worth 60 to 90. And 90, let’s say, is par. And every time, these folks are saying you know what?, We’re picking 90. So, they’re holding loans at par that aren’t at par. And if they were, it wouldn’t be a discount of 50 percent to the NAV. If they believe these loans are par, why don’t they just buy out the shareholders? They can buy them out at NAV, right? They’re not doing that because there’s no support for that. There’s no bid for that.
So, that is the fundamental problem. And until the industry reforms, until people can have confidence that they’re getting what they’re paying for in terms of properly valued and serviced loans, again, this is the service they provide. And any reasonable board would not pay an investment advisor for, in effect, mis-marking loans. They wouldn’t do it. And that’s why it fails the law.
TEDDY DOWNEY: I’m so curious. Because, I mean, look, we investigate the same stuff. And the lack of transparency is really difficult to get around. It’s really difficult to understand what’s going on with these loans. What’s in this portfolio? How are they performing? I’m curious.
Obviously, I’m eagerly looking forward to discovery here so I can get a little transparency. But you have customers who are clients. Do they have any mechanism? Obviously, the lawsuit is one. But do they have any way of getting some level of transparency? Do they not really have any rights to go in and see and do their own analysis of what’s performing or not performing?
JIM WOOLERY: Well, it’s challenging. This is a follow-the-money case. And the reason that we are in the public BDCs is because we have a little more to work with there in terms of information. But it’s not good information. It’s very opaque.
And so, we’ve done analysis loan by loan. And we’ve been able to do that. It’s taken hours and hours and hours and hours of work. And so, it’s difficult for normal retail investors to be able to do that. And they don’t disclose the effective rate of the fee. If you look in our complaints, we show that once you take out the fees, these things are earning less than T-bills often.
So, it’s not a good proposition right now the way it’s structured. And it’s very difficult for shareholders. Are there other ways to do it? Yes, you could lobby the SEC. You could lobby Congress, try to get better rules in the application. But essentially, this lawsuit is the remedy. This is what Congress provided. They said, shareholders, you can bring a private right of action and ask for your money back on the compensation if it is so egregious as to not be appropriate for a reasonable board. And so, that’s what we’re doing.
TEDDY DOWNEY: And how big are the stakes here? What are the potential damages? I mean, this is obviously not the entire private credit industry. If you can answer in the small slice that you’re suing, and then maybe talk about the bigger picture.
JIM WOOLERY: Well, I think it’s a small and a big slice. I think that’s what needs to happen –
So, number one, there needs to be a refund. And it’s going to be, in many cases, in the hundreds of millions of dollars. But there needs to be a refund of the inappropriate excessive fees under the act. So, we’re going to get a refund for the shareholders, number one.
And number two, we’re going to press for a renegotiation of these agreements. The agreements are done annually. What’s amazing here is that the boards at Blue Owl and the boards at FSK KKR, and the boards at Ares, in the last year, when all the red lights were flashing, there was no secret that there was a big problem in private credit. There was no secret that there was these discounts in that. They just rubber stamped the agreements, didn’t even touch them. Didn’t change a word. That’s not going to fly. That’s not going to work.
But what the problem they have is, if they adjust all this in the public ones, it has implications for the private ones too. So, this is another problem of private credit. It’s that they run five, six, ten entities. And then some of them are public, some of them are private. If I mark down on the public side because I got these huge discounts in that, now what is the implication of that for the other loans? Because the portfolios are now—there’s like almost 50 percent overlap in a lot of these portfolios between these entities.
And, of course, we all saw what happened in the fall with Blue Owl. This was the big tell for us. They had two entities, one private, one public. The public one was obviously trading a discount. I think 20 percent, roughly, to the NAV. They went to try to merge the two entities, and there was a revolt on the private side. They said we’re not going to accept this 20 percent NAV discount. So, they had to call it off.
Now, the number of times that some big merger like that’s been called off by somebody like Blue Owl who controls both entities, you can sort of count those on one hand. So, that tells you that the market does not believe or support what’s happening in private credit on these values. And until they reform, there’s not going to be – there’s no money coming into the space. The money’s flowing out.
So, they’re going to have to make an adjustment here, and that’s the real implication for everybody on the phone and investors and so on is there’s going to be an adjustment in private credit. There needs to be reform. We need fee reform. We need these agreements to be reformed. We need the sponsors of these entities to get paid when shareholders get paid. If shareholders do well, they do well.
You have a situation right now where you have all-time high fees, historically high. Fees are up 50 percent over the last five years. NAV is down 20 percent, 30 percent, 50 percent. How does that happen? How is it possible that you can take the most fees you’ve ever taken in history, and you have the worst performance you’ve ever had? That’s not arm’s length. That’s not kosher.
JOSH KOSMAN: So, Jim, how do you square this with, you know, 401Ks very soon are going to be open to invest in private equity firms, funds, as well as private credit funds? This is sort of the unsophisticated money that private equity and private credit firms, who are one and the same in some cases, have wanted badly. Meanwhile, these reforms are needed. How do you square all that?
JIM WOOLERY: Well, I think if you want to just kind of move a second to kind of private equity writ large, there are significant issues around bringing public investors into the vehicles where maybe the compliance and the valuation and so on isn’t really up to snuff. And I think that private equity definitely wants to access public money, but they’re going to have to live with public accounting standards as well.
So, we’re not going to be in a world where we have this private accounting where everything’s arranged, and I kind of say what it is. I kind of make up what it is a little bit. And it doesn’t really square with what public values are. And I think right now in private equity, there’s something like $4 trillion in unsold companies. There’s $1.5 trillion that have been held for more than five years.
So, there’s a reckoning out there. I mean, this is an extreme example in private credit. It’s the most extreme version I’ve ever seen in terms of conflicts and fees. Never seen anything to this degree in my career. So, I think this is the canary in the coal mine, but I think it’s a wider issue. Here, the reason they’re liable is because they’re taking incredible fees at the expense of shareholders, and the shareholders at the same time are losing money.
So, that’s a fairly egregious scenario. The market doesn’t buy their valuations at all. And yet, that’s the service they provide. So, again, they’re not trading these loans. All they’re doing is originating them and then valuing them. The valuing is the principal service. It’s 90 percent of the service.
And I’ll tell you something else, guys. If the investment advisor had to bet their compensation on the NAV, you wouldn’t see this kind of discount.
TEDDY DOWNEY: We’ve got a listener question here. Can you discuss the one-year damages limitation on these suits under the ICA? I think that’s kind of relevant to what we’ve been discussing.
JIM WOOLERY: Yeah. So, the Investment Company Act provides for a one-year look back. So, you can’t go back sort of four or five years. The SEC could do that, but not under the private right of action. It’s a 12-month look back.
And so, we’re focused in these cases on the prior 12 months from when we commenced this lawsuit, and these lawsuits some of which began in April. And what we’re looking at is, in effect, the last investment advisory agreement that was approved. So, we aren’t going for five years of fees. We’re going for one year of fees. That’s correct. It’s still hundreds of millions of dollars, believe it or not, in each case.
And we are very much looking to reform and renegotiate these agreements on behalf of shareholders. That’s our whole point. Because it’s structural misappropriation by these entities of shareholder money. It’s being misappropriated. It’s being taken. It’s being taken inappropriately and under false pretenses.
TEDDY DOWNEY: What are the credit funds saying in their defense? What’s their excuse here?
JIM WOOLERY: Well, it’s interesting. Because when you go to the Investment Company Act, it’s not such an easy standard. There’s a case called Gartenberg. All the lawyers want to talk about Gartenberg, Gartenberg. And they say it’s a really high standard. And here’s what the standard is. It’s that the fees are so excessive and disproportionate to the services rendered that no board would agree to them. They are not the result of arm’s length bargaining. That’s the standard. And it’s pretty high.
But they’re not even willing to engage on that standard right now. What Blue Owl has argued—which I think is extremely reflective of both the problems at Blue Owl and the lack of accountability in the space—is what they’ve tried to argue is, oh, Mr. Woolery is suing under 36(b). He’s suing for compensation. But, Your Honor, this isn’t really a 36(b) case. This is a valuation case. And because it’s a valuation case, only the SEC can bring it. Even though that’s not in 36(b) and even though the principal service that they provide is valuation, one of the principal services they get paid for is valuation. Again, they’re not trading these loans. They’re originating them and then valuing them.
People can argue stuff. I mean, it feels a little bit like what I wish the law was by Ropes and Gray because that’s not the law. In 36(b), it doesn’t say the SEC has to come first and then you can get your money back. It says if your compensation is excessive, you can get your money back.
And here, what we’re going to be able to show is no reasonable board would pay compensation for an inflated mark. Why would they do that? Where does that happen on Wall Street? As aggressive as Wall Street is, find me a fee structure anywhere where shareholders lose 50 percent and our fees are up 50 percent. It doesn’t exist.
And the reason it doesn’t exist is because it shouldn’t exist. And the reason that private credit is going to have a reckoning—and it’s going to start here—is because they chose these structures. They put them in place. They made the investment decision to increase the PIK and hide the software loans and sort of kind of run the fee game. That was their choice. They made the choice to borrow money against shareholder returns to pay themselves the fees, which directly transfers wealth out of the shareholder’s hands.
So, these are choices that have been made. They’re not the right ones. They have to be adjusted. And that’s why we’re bringing these cases.
TEDDY DOWNEY: Usually in these credit markets, you have other entities that are quasi regulatory. You’ve got accounting firms that sign off on valuations. You’ve got credit rating agencies that sign off on quality of packaged loans. You’ve got the SEC, as you mentioned, overseeing both those agencies or at least overseeing the rating agencies. And then you’re saying they’re also supposed to be looking at these funds themselves. What’s going on from an accountability standpoint with all of these typical checks that you would have in these types of markets?
JIM WOOLERY: Well, I think everybody is on their front feet. I mean, I think Jay Clayton gave a speech in June. He almost quoted, it felt like, directly from our complaint. He talked about taking fees for inflated values. He said that was a no-no. He said he had appointed a task force for that. Of course, the SEC has a role to play. And I think all of that is happening or is underway. Although, I’m not in control of that.
But when it comes to the accounting firms, look, we go through this every 20 or 30 years on Wall Street. And they do bear a great deal of responsibility because they’re kind of in on the game. They’re getting paid a lot of money, and they come in and they provide these wide ranges. And again, if I have 500 loans and I have a range of 50 to 100—100 being par— on every one of those loans, and then I pick 100, right, every time, that’s not—the accountants are not signing off on that. The investment advisor is the one doing that. They’re inputting to it. And I think these wide ranges are part of the problem, right? It’s like pick a number between anywhere 50 to 100. I mean, that’s not real background support.
And so, I think we’re going to have another, I don’t think—it’s not going to be the financial crisis type reckoning, but we are going to—and private credit’s an important asset class, but it needs reform. And we need to have sort of fair value. And we need to have reasonable compensation in here. Because otherwise, you’re just destroying the asset class.
TEDDY DOWNEY: We’ve got another question here. Assuming these suits only cover public BDC shareholders, why haven’t Ares, KKR and Blue Owl’s private BDC holders sued yet under these claims?
JIM WOOLERY: Well, I think that the private holders have claims. I would not be surprised to see those claims brought. As I said, there’s a lot of legwork involved. These complaints are 80, 90 pages. If you look at our complaints, they’re riddled with facts. These are not generic complaints. We don’t take on routine matters. And we don’t typically—we’re not always on the plaintiff’s side. But we can follow the math. And we follow the money. And we found the problem.
TEDDY DOWNEY: And you were mentioning earlier, in these private funds, you have far less access to that information, right? With the public ones, you at least have more information to go off of.
JIM WOOLERY: Yeah, that’s right. And also, in the public ones, you can see the discounts, the math, that it’s trading, right? So, there’s a public proxy for what people think of the value. And in the private ones, less so, but what they’re doing there is they’re just gating people. They’re holding them hostage.
TEDDY DOWNEY: Yeah, so I mean, I guess I was going to jump in, Jim, and ask, could you see an impact if you’re successful? And, I mean, BDCs are public. People can trade in and out of the stocks. But do you see in the 80 percent of private credit funds that are privately held—and many of which gates are up. So, investors can’t get out. Could you see that changing? Do you think your suits could have an impact on that? And if you do think so, how much of a rush could we see for the exits?
JIM WOOLERY: Well, I do think it’s going to have an impact. Because I think that these cases are industry—I mean, they’re specific to these entities who are kind of the worst actors in many cases, but they have implications across the whole system.
So, if I agree at Blue Owl, if I say, Jim, I agree with you. We shouldn’t be paid up front on this PIK and we shouldn’t borrow money for that. We agree. I don’t know how they’re going to be able to do that in the public ones and then maintain a position in the private ones where they continue to do it. So, I do think there’s impact across.
I also think there’s going to be claims in the private ones. I think those claims will be—I think they may be a little bit harder, but we certainly are able to do the work. We’ve proven that. So, I think those claims will likely be brought if in fact the agreements are not reformed.
TEDDY DOWNEY: It certainly seems like if you get past the motion to dismiss, if you get to the discovery, you’ll be able to, I mean, other lawsuits, other plaintiffs, will be able to see more, hey, I have even more transparency and put together cases. So, it strikes me the more transparency, the more likelihood you’ll have follow-on cases here.
JIM WOOLERY: Yes. I mean, this is definitely an area that needs sunlight. And as you get more sunlight, then you start to see kind of where the problems really are. And the math, you can’t kind of get around the math. Shareholders are losing money. These guys are paying themselves up 50 percent. It’s just shocking to be honest. And this is the reason Congress put in the statute is for exactly this kind of situation.
And remember, these are Level 3 assets. So, these guys know that they’re in an area where there’s no quoted market. They are the last—they are the goalie for the shareholders. They’re the last line of defense. And they have done the opposite. Rather than writing the loans to their fair value and not sort of taking the fees they shouldn’t be taking, they’ve done the opposite. And that’s just not going to stand. It’s not going to survive. And it just won’t.
I mean, you can’t find structures like this on Wall Street anywhere. I mean, any hedge fund, any mutual fund, there’s nobody that gets paid the way these people get paid up front, borrowing money from shareholders to pay themselves.
TEDDY DOWNEY: Instead of paying for performance, you’re paying for underperformance.
JIM WOOLERY: Yeah, yeah.
TEDDY DOWNEY: Kind of an unusual twist there. So, one thing I’m curious about, if you look at the news, if you read The Capitol Forum, you’re seeing a lot of investigative reporting around the different types of lies related to these assets on the books of these private credit firms.
You’ve already gone through a number of ways. In the case of the Mark Walter situation, you’ve got lies about affiliated entities. And so, how do you look at all the different types of revelations in investigative reporting that is coming out around the different types of lies? Like you’re looking at some very specific types of misleading the investors around what the valuation is, what the assets are really worth. You’ve got this affiliated entity stuff.
We did a conference call recently with some academics who have looked at how structurally, when you have private credit and then you have an insurer, that’s also under the PE parent that is buying up a lot of these assets, that the whole incentive structure is to extract fees out of those assets. And then if the insurance company goes belly up, that’s not the responsibility of the parent company, the PE firm. That’s actually a public resolution where that is paid for by taxpayers ultimately and by policyholders.
How do you think about just the incentives throughout the system to lie, and the investigative reporting recently around things like Mark Walter, when you have other types of lies going on?
JIM WOOLERY: Well, I think the investigative reporting is getting a lot better. And, for example, there was a very good Substack yesterday by a man named Mr. Swedroe, who’s frankly been a supporter of private credit, but did an analysis that validated our claims and laid it out for everybody to see.
But I think the reporters are kind of figuring it out. Again, it is a follow the money exercise. I would say that. But you put your finger on something I think that’s going to be a bigger issue going forward. And that is most—a lot of these folks have complexes of these entities. They have an insurance entity. They have a public BDC. They have a private BDC. And then the amount of kind of related party activity—if you want to call it that – that is, again, not arm’s length, I think is going to be a big story over the next year or so as people kind of unpack that stuff. And Mark Walter, that’s one example. But it’s a systemic kind of affiliated related party issue. And look what Blue Owl tried to do again.
Mr. Ostrover didn’t say I’m going to take my children’s money and buy out the public NAV in the public BDC at Blue Owl. He didn’t do that. But what he did was he said, let me go get the private one. It’s at NAV because I say it is. And I’ll take the public one. That’s at a 20 percent discount and I’ll just smash them together. That’s how I’ll do it just to keep the music playing. And again, that didn’t work. But that’s a huge related party transaction.
And I think that all the folks involved here—investors, regulators and so on—are going to have to really hone in on this. Because there’s a lot of risk here and a lot of, I think, really inappropriate activity by people that should know better, that are highly sophisticated.
That’s the other thing. I mean, these are entities—they should know better. They can’t—you cannot just whistle past a 50 percent discount to your NAV that goes on for months and months. And then tell everybody it’s no big deal. And keep collecting fees. That dog doesn’t hunt.
TEDDY DOWNEY: We’ve got another interesting listener question here. What is a plausible reason that a bad PIK loan could still reasonably be valued at par?
JIM WOOLERY: Well, when you say a bad PIK loan, you could have a PIK loan that is not originally PIK. But the company comes to you and maybe they have the ability to pay, but they want to use the money for something else that could make more money for the credit, right? And so, you could have a situation – although, I think it’s extremely rare, where something that was originally – remember, I underwrote something originally of cash pay. This is stuff that started as cash pay. And then it moved to, I’ll pay you in an IOU, okay?
So, that right there is not a great fact pattern. But there could be a situation where there’s a one out of 500 where maybe it is a good situation because they need to invest in AI or something like that, and somehow that’s going to be better for shareholders.
But the point is what is the problem with adjusting that loan and saying, you know what? That’s not par. We’re going to market it 10 percent down. Why don’t they do what they do at J.P. Morgan? Just because they call themselves private credit, they can somehow like hold everything apart when it’s a PIK?
I mean, the fundamental point is, if you have a basket of PIK loans that started cash pay, you cannot sell those for par. You can go back 100 years and demonstrate that. So, I’m not saying there couldn’t be an example, but it is not what’s happening here, and we’ve demonstrated that in our complaint.
JOSH KOSMAN: Jim, is there any legal ramification for these BDCs—assuming they don’t—not having a risk committee like a bank who’s actually analyzing the loans?
JIM WOOLERY: I mean, it’s horrible. They have these directors. But you go look at these directors, they sit on all the entities. This goes back to the other question. A lot of these directors are on fund one, fund five. They used to be the auditor. Now they’re a director. It’s all sort of inside baseball in here.
And that’s, again, I think part of the problem. But the fact that these boards saw all this stuff flashing, not just red, but like really, really, really extreme metrics, and they saw shareholders losing their shirts, and they saw the shareholders paying all these fees, and they just rubber stamped it. And then they go into court and say, oh, we sourced—they used the word “source.” We sourced it from independent parties.
So, what that means in lawyer speak is, we went out and got these ranges. They’re wide. And then we picked the one that helped us. And it didn’t help shareholders. And this is a reckoning, guys.
Until this gets fixed, it’s not—and I would say this to all the lawyers on the phone representing the other side—your industry is not coming back into the mainstream until we get rid of this lingering problem. That is what is evidenced by the Blue Owl failed merger.
So, there’s no money coming in. How are we going to get the money coming into private credit, guys? It’s by adjusting these mechanisms, facing the music on value and fees, and doing it fairly, putting in clawbacks going forward, and reasonable mechanisms.
When we had a thing called the financial crisis—and I’m not saying this is the same. But what I am saying, one of the principal issues there was people figured out, wow. Bankers are getting paid up front on all these deals that blow up. Maybe we ought to have clawbacks. Maybe that’s a good thing, right? Maybe we ought to see what actually happens to the deal before we pay these guys.
So, that’s kind of the thing that needs to happen here. Because these guys have taken it to an extreme that is just beyond belief in terms of the conflict and the misappropriation of shareholder money in the form of fees for phantom income.
TEDDY DOWNEY: So, Jim, you represent these plaintiffs who are investors. Are they getting more worried, more sophisticated, when it comes to looking at what’s really going on in private credit? Because it strikes me that there’s this, oh, there’s risk that my loans will not perform, okay. But the far bigger risk to me is that this whole system could collapse. You’ve got these affiliated insurers that could be under more regulatory scrutiny, that if they all of a sudden, need more cash. The way that the Walter situation is playing out, all of a sudden, you start having forced sales of assets.
He’s sort of gotten lucky that he can sell the Lakers at a $2 billion markup after one year, like premium. But a lot of those assets, if you’re forced to sell, they’re going to sell far less and you can have this cascading problem. And then your investors are really in trouble because they’re thinking these are pretty safe loans, right?
JIM WOOLERY: Yeah, yeah.
TEDDY DOWNEY: What is the sophistication in the investor base? What are your thoughts there?
JIM WOOLERY: It’s just awful. Because what the shareholders don’t realize is they’re the ones holding the bag. Remember, Blue Owl already paid themselves a fee. They already took the money. And that’s whether the thing pays off in three years or not.
So, it’s kind of horrible from a shareholder perspective. And shareholders have got to fight back. And LPs have got to fight back. And that’s what’s happening here. That’s why these shareholders are bringing these claims. They’re not easy to bring. But it’s going to have to happen.
So, we’re going to go through this process. It could be quick. It could be slow. It’s up to the industry as to when they want to get to reform and get to the new market. Because right now we’re in an old hung market and this market is hung and they’re hung. And until they adjust, they’re going to be hung.
And shareholders have got to realize that. Before they buy into these things, they need to look at these discounts. They need to look at these fees. They need to understand. Because not every BDC pays themselves upfront like this by the way, as Mr. Swedroe pointed out yesterday. Many of them do not front load the fees. These guys do.
So, you need to make a distinction. As an adviser, you need to look for the quality and don’t just go by the name because it’s a big name—Blue Owl, KKR, whatnot. That’s not the way to do it. It’s really to look at what the terms are.
TEDDY DOWNEY: Obviously, Josh has written a book about this. To me, the far more sympathetic people in this equation are the people that work at these portfolio companies that are not performing and will go bankrupt, the retirees whose money is on the line either with these insurance products like annuities or otherwise getting this 401k money into it. I mean, they’re also going to be the ones holding the bag as far as I can tell. Does that create a little bit of urgency to get more attention on this, that there are citizens at risk here?
JIM WOOLERY: It’s a lot of urgency. At our firm, we feel a tremendous obligation to the clients who, frankly, again, have had their money misappropriated and inappropriately and illegally. And so, we’re going to continue to pursue this. It’s going to take some time. I think by the end of this next 12 month period, I think we will see—I’m hopeful that we will see substantial negotiated settlement reform. And then everybody can kind of move on with their life.
But until they are willing to—and understand that these have implications for their whole complexes, right? Until they’re willing to kind of face that music, then we’re going to be here pursuing the shareholder rights. But it’s really, really a difficult time for shareholders in private credit right now. Very, very difficult time.
TEDDY DOWNEY: I want to be mindful of your time. Can I ask two more listener questions and then we’ll let you go?
JIM WOOLERY: Sure.
TEDDY DOWNEY: One question, given BDCs are mainly retail products, what can institutional investors do or look out for on their private credit fund investments for red flags besides reports that show PIK and accrual accumulation?
JIM WOOLERY: Right. So, what you need to do is you need to look at the PIK and how they get paid on it and whether they get paid upfront or not, whether there’s a clawback. Again, I guarantee you, if you had an agreement that said the investment advisor does not get paid on the PIK unless the PIK pays off, then you wouldn’t have it marked at par. You’d have a lot of these not marked at par. Because the investment advisor is aligned, why would they want to hide market? Because they’re not going to get paid.
So, these are the kind of things that need to—are going to occur. It is a difficult time for shareholders. I concede that. On the private side, again, I think those people ought to be evaluating their claims. And they ought to look and see—because if they don’t push back, they’re not going to get the kind of reform that we need. So, I would highly recommend evaluating what you’re holding and what you’ve got.
TEDDY DOWNEY: Last question here. This does not seem like a big deal. FSK has $12.7 billion of assets. Assuming 20 percent are overvalued and you mark down 20 percent, it would reduce the management fee by $10 million or .036 dollars per share.
JIM WOOLERY: I don’t follow the math. I don’t think it’s accurate at all. We’re talking about significant multimillion dollar refunds here. So, that may be small change for some on the call, but for many of these retail investors, this is real money.
TEDDY DOWNEY: Well, and that’s per year.
JIM WOOLERY: Right.
TEDDY DOWNEY: You’re only talking about one year. You said hundreds of millions of dollars for one year.
JIM WOOLERY: Yeah. And again, the agreement needs to be renegotiated. That’s the point. We’re not going to keep doing this. We’re not going to keep paying you for PIK upfront. Guess what? No. We’re going to put in a clawback. So, Ares had $750 million in fees last year. So, I don’t call this no big deal at all.
And frankly, again, it’s the structure is eating the NAV. It’s not just that they’re inflating the loans. It’s that they are paying themselves and borrowing money, taking cash out of the system when there’s no cash. Where does that money come from? It doesn’t come from Henry Kravis. It doesn’t come from Doug Ostrover. Where is that money coming from that they’re paying themselves? Because there’s no cash. That comes directly from the shareholder’s bank account. That’s where it comes from.
TEDDY DOWNEY: It seems like a big deal to me. I mean, even if it was only $10 million per fund. But I think I just want to close with that you seem optimistic that this isn’t going to be some kind of big financial crisis. But when I’m listening to what you’re saying, this is only one part of the puzzle of what they’re lying about.
You mentioned there are potentially trillions of dollars in this market. You mentioned there are problems with the SEC oversight, the accounting agency oversight. I think we discussed incentives throughout the different subsidiaries that these private equity companies have, the interconnectedness. To me, that all sounds very troubling and more like 2008 than not. I just wanted to close on why you’re optimistic that it can be resolved without having a broader crisis occur.
JIM WOOLERY: I have great faith in the Southern District of New York. I think that we are able to get to reform. I’m assuming, as I said, my base cases reform over the next 12 to 18 months. So, I think that will help box the contagion. I mean, unchecked, if this were to continue, and we just kind of continue to sort of make up asset values and pay ourselves on it, I mean, that’s not going to end well. And if it’s being done systemically, yes, there’s going to be systemic contagion.
And the Boston Fed has written on this. The PCAOB has written on it. There are several major entities that are highly respected that have raised their hand and said, we’ve got a problem here in Denmark. And so, hopefully we can contain it to this place. But I will say to you, without the right reform, we could have a much bigger crisis, yeah.
TEDDY DOWNEY: Well, Jim, this was truly an awesome conversation. I know I learned a ton. Josh, I’m sure, also enjoyed the conversation. We can’t thank you enough for doing this.
JIM WOOLERY: Happy to do it. Sorry for whatever happened in terms of getting on. And I’m really glad to be with you and your listeners. And I wish you all the best.
TEDDY DOWNEY: And just before we wrap up, if this discussion interests you, please be sure to check out “The Forum,” which is our opinion and editorial newsletter featuring perspectives on competition. We are also hosting an event on private credit. Please put in your calendars on November 12th here in D.C. And we’ve got more conference calls on the way in this vein. Probably not as good as what Jim had here for us today, but hopefully also interesting.
And thank you to everyone for joining the call today. And this concludes the call. Bye-bye.
