The Biden family legal flap and Andrew Cuomo’s investigations shed light on the era of shadow banking.

What is it about siblings and the White House? Jimmy Carter had Billy, Hillary Clinton had Hugh Rodham, and George W. had
Neil Bush. If Abel got elected president, it's a near-certainty that Cain would have skipped the fratricide and instead built a nice little business trading off his brother's name.

The family saga that's gotten the blogosphere riled up in recent days doesn't have to do with the president. It's the vice president's brother—Jim Biden—and his son, R. Hunter Biden, who've been drawing attention, thanks to a midsized, New York-based money-management firm they bought control of in 2006 called Paradigm Global Advisers.

The Paradigm adventure has been a comedy of errors for Hunter and Jim Biden. They've been sued—and, in turn, countersued—by a man who was to be their partner in the venture. They're in litigation over it with a lawyer who once represented them (who's now in prison because of an unrelated conviction). They're facing still another lawsuit from one of Paradigm's other investors. Meanwhile, they've had to fend off queries about Paradigm's slight links with indicted financier Allen Stanford and a more tenuous connection with a failed hedge fund with which Paradigm shared office space.

All of this has added up to headaches for the Bidens but to no clear improprieties. But the spotlight on Paradigm raises a fascinating question: Why did the Bidens want to run a hedge fund in the first place?

Over the past weeks a series of questions have been raised about the relationships between hedge funds and public-employee pension managers who are responsible for investing billions of dollars in retirement money. New York State Attorney General Andrew Cuomo has subpoenaed records of more than 100 money managers, looking for evidence of fees, and possibly kickbacks, that flowed between the hedge-fund managers, retirement funds, and "placement agents" who introduced them to each other.

A look at the court records around Paradigm shows that the prospect of bringing public-pension-fund money to Paradigm was a key part of the thinking behind the Bidens' hedge-fund adventure. The contracts signed between Paradigm, the Bidens, and then-partner Tony Lotito outline a strategy that would have paid Jim Biden and Tony Lotito big placement fees in return for soliciting pension-fund clients.

That plan, it's important to make very clear, was never put into action. Ultimately, Lotito and the Bidens parted ways; Paradigm did not, according to the company's lawyer, Marc LoPresti, actually end up going after pension-fund clients, and Jim Biden never took the fees that the Paradigm agreement envisioned. Nonetheless, the records surrounding the Paradigm litigation provide a window into the profits that people with connections in government and finance hope to gain from putting them together.

A little background: Paradigm came to the attention of the Bidens by way of Lotito, a financial consultant to public-employee retirement funds. The three men—Jim Biden, Hunter Biden, and Lotito—formed a partnership to purchase a controlling stake in Paradigm. Along the way, however, Lotito and the Bidens had a major falling out. The Bidens wound up buying out Lotito for $250,000 and acquiring control of Paradigm independently.

Lotito sued, contending he'd been unfairly cut out of the deal, and the Bidens countersued, arguing he'd misrepresented Paradigm's size and his own qualifications. Eventually, the sides settled. That's the short version of the Biden-Paradigm story—the long version stretches to three folders of court records. These documents reveal telling details about what the Biden-Lotito group may have hoped to get out of the hedge-fund business.

Two documents from these folders are especially relevant. One of them is an "Agreement for Services" that was to govern the relationship between Jim Biden, Tony Lotito, and Paradigm. That agreement essentially engages Lotito and Jim Biden to identify potential investors and offers them a cut of the proceeds. The investors that the agreement envisions are very, very specific. According to the document, the two men—or, in the language of the agreement, the "Biden & Lotito Group"—have specific expertise in identifying funds held by state and municipal labor unions."

A long list of the clients that Paradigm hoped to solicit is appended to the agreement. You can see that list here. (The document refers to the clients as "Taft Hartley" groups because pension-fund operations are governed by the Taft-Hartley Act.) It includes police retirement groups from around the country, as well as larger government pension plans, such as the Orange County Retirement System and the New York City Public Employees' Retirement System.

In return for bringing in these clients, Jim Biden and Tony Lotito would have received a big part of Paradigm's management fees. Paradigm generally collects, according to the agreement, an annual fee of 1 percent of the money it has under management and 10 percent of any investment returns. According to the "Agreement for Services," Biden frère and Lotito together would be entitled to fully half of any fees Paradigm got from the pension-fund clients they brought in.

A second agreement outlines a somewhat different and even more striking compensation system. That document is an "Engagement Agreement" signed by Lotito, Jim Biden, and LBB Holdings, the partnership set up by the two Bidens and Lotito to buy Paradigm. That engagement promises James Biden and Lotito a "Placement Fee" of 10 percent of any money invested by clients they brought in, to be split 65-35 between Biden frère and Lotito. In other words, if, say, one of the big pension funds on their list of potential prospects were to give Paradigm $100 million to invest, Jim Biden would get $6.5 million and Lotito would get $3.5 million.

In the investment world, a 10 percent commission for any money that someone brought in is an extraordinary number. It implies that once Paradigm roped in the pension-fund clients, the hedge fund could expect to collect management fees from them for many years ahead. While we do not know if this arrangement violates any laws, we do know that similar types of arrangements—well-connected insiders getting big upfront fees for their work in linking pension funds with money managers—are exactly the kind of "placement agent" relationship that's now under investigation in New York.

After the Bidens took control of Paradigm (Hunter Biden, the vice president's son, briefly served as chief executive in the transition from the old management), Paradigm did not in fact solicit the clients on the original list, or other public-employee pension money, says Paradigm lawyer Mark LoPresti. LoPresti says that the chance to get public-pension-fund clients was never a central part of the Bidens' reasons for getting into the hedge-fund business.

Those reasons, says LoPresti, were much the same as those of any other would-be hedge-fund managers. "They saw," according to LoPresti, "an industry that was in growth mode and would benefit from additional best practices."

Given that they didn't wind up pursuing the pension funds, it's absolutely reasonable to concede that the search for public-pension dollars was not the Bidens' only motivation. (The Bidens could not be reached for comment on this story.) It's important to draw a distinction between simply signing an agreement that would have given Jim Biden big commissions for luring in that money and actually doing it.

Why the Bidens ultimately decided not to pursue the original pension-fund strategy is not clear. LoPresti (who graciously answered other questions about the Bidens' involvement in Paradigm) didn't get back with an answer on this. It's possible that the Bidens decided it wasn't appropriate to reap these kinds of fees from public retirement funds. They could have simply seen a better business strategy in focusing on other clients. Or the downturn in the markets that started in 2007 could have made the issue moot.

The broader issue this raises, however, goes far beyond the Bidens. The hedge-fund industry collects heavy tolls for what is supposed to be (but rarely is) exceptional performance. Maybe sometimes it's worthwhile to pay those fees. But almost certainly not if half of them go to middlemen whose only contribution is taking pension-fund officials out to lunch and pocketing a finder's fee. The payment arrangements envisioned in this case were undoubtedly not unique.

That the vice president's brother would have contemplated participating in a "placement fee" arrangement that would have taken advantage of his name and connections to steer commissions to him and a partner is troubling. What may be more troubling, however, is the near-certainty that there are others out there with similar contracts and less prominent names who do collect them, profiting handsomely by combining their connections with hedge funds and their proximity to the public trough.