Readers may find it hard to grasp how successful the private equity industry has been in brainwashing investors, particularly large public pension funds. Investors who ought to have clout by virtue of their individual and collective bargaining power instead cower at the mere suggestion of taking steps that might inconvenience the private equity funds in which they invest.
A recent example comes via the Reuters publication peHub, which discusses their latest information request rebuff. Remember that public pension funds are government agencies, and every state has a version of the Freedom of Information Act. Yet public pension funds routinely turn down requests seeking private equity fund data.
Here are the key details from the Reuters recap of the latest sorry incident. The New York State Teachers’ Retirement System provides only overall data on its private equity returns. The public and its retirees have no idea what particular funds it invests in, much the less how they are doing. By contrast, even though we are in the process of prying more information out of CalPERS, the recalcitrant California giant public pension system, it is a model of transparency compared to New York State Teachers’ Retirement System (it should be noted, however, that CalPERS’ relative openness is the result of a hard-fought court battle by the Sacramento Bee over a decade ago, rather than the result of CalPERS being more public-spirited).
After being nudged via an open records act request, the New York pension fund did disgorge a bit more aggregate data, and provided some basic return information by type of investment, for instance, breaking out IRRs and investment returns since inception for US buyout, US special situation, international funds, and venture capital. The pension fund also disclosed how much it had invested in each strategy at year end 2012 and as of September 30, 2013.
But where the New York teachers’ fund chose to draw the line on disclosure is revealing, and not in a good way. Key details from the Reuters account. Note that even though this article use the word “appeal,” so far the process is internal to the fund. Reuters hasn’t filed a suit.
Buyouts asked for IRRs and investment multiples for each partnership, along with management fees. The pension fund responded that those numbers were off limits. It cited a provision of the state’s open-records act that lets it deny requests of information that “would if disclosed impair present or imminent contract awards” and “are trade secrets …”
In our appeal of that decision, we pointed out that sister state pension funds such as the Teachers’ Retirement System of the City of New York have been disclosing such details about their funds “with no apparent ill effects” on the general partners.
But Kevin Schaefer, the records appeals officer for the pension fund….denied our appeal. He went through six factors used to determine whether information is a trade secret immune from disclosure. The first, he wrote, is “the extent to which the information is known outside the business.”
Buyouts possesses similar information—IRRs and investment multiples, for example—for several funds that are backed by New York State Teachers’ because they are also backed by New York City Teachers’; among them are The Blackstone Group’s fourth and fifth funds. Schaefer did not view our argument through the same lens. The information made public by New York City Teachers’, he wrote, “is specific” to that pension fund and not New York State Teachers’.
Dear readers, I hope you caught this. That argument is laughable on its face. Schaefer is trying to claim that return information that has already been made public is a trade secret. And these returns aren’t investor specific (other investments might be, but not this type). The returns that CalPERS publishes for the funds it is in are seen throughout the industry as official reports on how those funds are doing. Particular investors might have slightly differing commitment dates, but the all get the same capital call notices and distributions.
Back to Reuters:
The second factor was similar to the first, while the third of six factors, Schaefer wrote, is “the extent of measures taken by a business to guard the secrecy of the information.” Buyouts possesses detailed fund information on hundreds of limited partnerships disclosed by sponsors via their pension backers around the country.
But again, Schaefer did not see it this way. “General partners of funds,” he wrote, “take measures to ensure the confidentiality of their investment strategy and fund level performance by providing it only to investors and customarily under confidentiality obligations.” At press time a spokesperson for New York State Teachers’ added in an email that ”the NYS and NYC are separate and distinct organizations which, among other differences, include separately negotiated investment agreements with potentially unique rights, obligations and liabilities—including those governing confidentiality requirements and the protection of trade secrets.”
So basically the negative marks on three of the six tests this fund uses are remarkable stretches. Back to Reuters’ private equity battle:
Buyouts hasn’t decided whether to continue the battle. It should be obvious by now that no harm results from disclosing fund return data, which has been available from pension funds like the California Public Employees’ Retirement System for years following lawsuits early last decade by the San Jose Mercury News…
Is it wise to hide from New York State Teachers’ Retirement System pensioners—including both my parents—how individual money managers are performing, and how much they’re charging?
Don’t underestimate the significance of the “no harm results” remark. That is the rationale these government investors use for blowing off press and other inquiries, that these huge investors might be denied access to the precious “top tier” funds if they do anything that might cross their private equity lords and masters. We’ve already debunked this argument: first, that the idea that investors like the New York Teachers’ Retirement System could out-compete its peers to get into the top quartile funds flies in the face of widely accepted investment logic. And in what should put a stake in the heart of that argument, McKinsey has recently found that those supposedly special top tier funds no longer persist in the top tier. There’s no way ex ante to determine who they are.
This is in keeping with the behavior we chronicled at the Los Angeles pension fund LACERA. As we wrote:
According to LACERA, releasing the real estate contract, “risks alienating alternative fund managers and, as a result, jeopardizing its [LACERA's] access to top-tier investments.” In other words, the fund managers might get their feelers hurt and will take it out on LACERA by not inviting them in to future deals..
So what LACERA is arguing here is that there is an overriding public interest in avoiding any action on LACERA’s part that might displease its investment managers. Essentially, LACERA has said it will never publicly oppose its investment managers, since any strong action to do so might alienate them. That means, like CalPERS, it will defy clearly settled law and require anyone who wants to get real estate or private equity-related records to sue to gain access to them.
And these investors cling to the belief that they need to be subservient to private equity funds, even as evidence mounts that they are being ripped off. From SEC Chairman Mary Jo White’s testimony yesterday before the House Financial Services Committee:
In addition, since the effective date of the Dodd-Frank Act, approximately 1,800 advisers to hedge funds and private equity funds have registered with the SEC for the first time… Some of the common deficiencies from the examinations of these advisers that the staff has identified included: misallocating fees and expenses; charging improper fees to portfolio companies or the funds they manage; disclosing fee monitoring inadequately; and using bogus service providers to charge false fees in order to kick back part of the fee to the adviser.
Both the description of the abuses and an earlier leak by the SEC about the high level of fee abuses it is finding at private equity funds suggest strongly that these scams are primarily, if not entirely, at private equity firms, and they are not mere mistakes. Yet public pension funds continue to stick their heads in the sand and pretend that the private equity industry has their best interests at heart. They are about to get a rude and embarrassing awakening.