Los Angeles Times: Treasurer Chiang’s Private Equity “Transparency” Bill Fails to Deliver (Updated: LAT Misrepresents Credentials of PE Booster)

Posted on by

The Los Angeles Times weighed in on how the Calfornia private equity fee transparency legislation sponsored by Treasurer John Chiang, who sits on the boards of CalPERS and CalSTRS, has had one of its initial supporters, himself a former head of CalPERS Investment Committee, go into opposition against the bill. We wrote earlier about how Michael Flaherman, who has also been a private equity executive and now is a visiting scholar at UC Berkeley, who not only backed the bill but actually provided some of its original language, is campaigning actively against the bill, AB 2833.

As much as it is gratifying to see the Los Angeles Times take up the controversy, it is also frustrating to see it miss or mischaracterize some of the underlying issues. The reason legislation like this is so important is that the SEC described the private equity industry as engaging in widespread abuses, including what amounted to embezzlement, in a landmark 2014 speech. Note that we had written about private equity abuses the year before. In addition, the agency made clear that investors like CalPERS and CalSTRS enabled these violations by entering into agreements that did a poor job of protecting their interests.

Shortly after the SEC revelations, major stories in the New York Times and Wall Street Journal described a wide range of misconduct in detail, implicating major firms like KKR, Blackstone, Apollo, Carlyle, and TPG. The SEC has entered into settlements with some of these players and has said more enforcement actions are coming. This is weak tea compared to the scale of the grifting, but at least one can no longer deny that there is gambling in Casablanca.

Yet the Los Angles Times does not make clear that the most important motive for transparency legislation it to expose all the ways that the private equity firms are hoovering cash from the companies they control. That will reduce the amount of misconduct, and also reveal the true cost of investing in private equity. Professor Ludovic Phalippou of Oxford has estimated it at a staggering 7% per annum of funds invested; CalPERS confirmed that it viewed this estimate as reasonable by including it in a private equity workshop last year.

Bear in mind that there is no excuse for fiduciaries like CalPERS and CalSTRS to have only a dim idea of the fee and expense drag of investing in private equity. Fiduciaries are obligated to consider the reasonableness of fees and costs when evaluating an investment strategy.

So the Los Angeles Times unwittingly does Chiang and his fellow complacent CalPERS and CalSTRS board members a favor (save CalPERS’ JJ Jelnicic, the only board member who has kept after these issues). The story attributes Chiang’s initiative as the result of an embarrassing episode at CalPERS last year. We broke the story that Chief Operating Investment Officer Wylie Tollette said CalPERS had no idea what it was paying in carry fees, and further compounded the damage by falsely claiming that no one got the information. That incident was one of several in which CalPERS’ staff was caught out not understanding the basics of how private equity fees work.

So while the Los Angeles Times is narrowly correct in that Chiang was trying to position himself as being on the right side of an escalating controversy, it misses the what is really at stake: the regularity with which private equity firms either outright violate their own agreements, the fact that those contracts also have “gotcha” provisions that investors appear not to understand, and the degree to which limited partners like CalPERS and CalSTRS are captured by private equity. These investors are not only afraid to rock the boat; they regularly side with private equity to the detriment of their beneficiaries and California taxpayers.

Nevertheless, the article does make clear that AB 2833, which was supposed to sail through the California legislature and give Chiang a talking point in his gubernatorial bid, has become controversial:

A bill that would require more disclosure from private equity firms that manage money for California’s public pension plans has been weakened, prompting a former state investment official and early backer of the legislation to pull his support…

Michael Flaherman, a former board member of the California Public Employees’ Retirement System who had promoted the legislation, argues that the change has gutted the bill.

“The private equity industry clearly intends to fool the Legislature and the public with the most recent amendments to AB 2833,” Flaherman, who has also worked for private equity firms, wrote in a letter sent to legislators last week…

The original bill would have required firms to report the total fees paid by the companies within a particular private equity fund. Now the bill only requires the firms to report the share of fees proportional to a California public pension’s investment in a particular fund.

Flaherman said that’s a crucial change. Because of the way that private equity deals are often structured, it would make it impossible to know how much companies are really paying.

That’s a problem, he said, because the fees, which can add up to millions of dollars, can be a big burden for the companies paying them – potentially cutting into their profitability or ability to grow – and therefore harmful to investors.

Mind you, this isn’t the only serious failing of the bill. We’ve described others: that general partners can structure related party payments to escape reporting and that the definition of “portfolio company” allows payment to be routed through other entities. Taken together, these shortcomings mean the bill is fatally flawed.

Notice the misleading defense that Chiang’s office gives for this Potemkin measure:

Deputy Treasurer Grant Boyken said a complete accounting of fees – the kind that the bill originally called for – is an admirable goal but that getting the share of fees paid by pension funds is Chiang’s main concern.

“Our immediate goal is to look at what California pension funds are paying,” Boyken said. “The language we have now does that. The bigger story with private equity is not how much we’re paying, but are we paying too much? We can’t have that conversation until we know how much we are paying.”

You can see how much of a backtrack this is when you go back to Chiang’s announcement last fall. He deemed the more detailed Institutional Limited Partners Association fee template (then in an advanced draft state) to be insufficient.

And the Los Angeles Times finds a dubious “expert” to provide the obligatory limited partner and industry PR:

CalSTRS in particular had raised concerns that if the bill became law it could endanger those returns because some private equity firms might choose not to work with California pension funds, preferring instead to take money from investors who don’t have such strict disclosure requirements.

Timothy Spangler, a UCLA law professor who has worked with private equity firms and investors, said that’s a legitimate concern.

“If you’re producing 30% returns year in, year out, you have a lot of people who want to invest in your funds,” he said.

Spangler, a law professor and not a finance expert, shows he is not competent to discuss private equity returns. Just a few of the many reasons his flip statement is incorrect. Private equity funds do not deliver returns remotely as high as he says, much the less with machine-lke regularity. First, it’s been well documented that there has not been “persistence” in top private equity returns in this century. In fact, the most recent studies have found that a top-tier firm is slightly less likely to deliver top-tier performance in its next fund than by merely investing randomly! Second, these returns need to be adjusted for the idiosyncratic risks of investing in private equity. When all those risks are included, private equity not only does not outperform, but it underperforms. Third, private equity executives have warned that private equity returns are going to fall, and stock market valuations of the public equity fund managers that are private say that they expect the decline to be significant.

Spangler also makes the intellectually dishonest argument that the SEC should ride into the rescue and impose transparency regulations. As we pointed out in a Bloomberg op-ed last year:

One can only conclude that the state and local officials are trying to shift responsibility to the SEC for their own failure to perform their fiduciary duties. This is clearly cynical, because there’s not much the SEC can do. The agency is already struggling to get private equity managers to improve the very general annual disclosures that regulations currently require. Often masterpieces of obfuscation, the documents describe the types of fees received, but not the amount. More detailed disclosure would require a radical rewrite of existing rules.

Private equity executives would argue that they give investors plenty of opportunity to do due diligence and that the investors all have their own lawyers who signed off on these deals. What is seldom acknowledged is the public funds’ outside counsel often invest in private equity funds, sometimes on a preferred basis relative to their clients, and typically earn far more working for private equity portfolio companies than advising public funds. Moreover, private equity firms are big political contributors: They have been barred from contributing to state treasurer elections, but they still spread vast sums around state legislatures.

The most realistic solution lies with the SEC — but it won’t be what the state officials have in mind. If public pension funds persist in feigning helplessness, the agency should consider rescinding their accredited status. This designation allows large and sophisticated investors to operate with minimal oversight. It requires that they be competent to review legal agreements and negotiate terms, including disclosure and audit rights, when the SEC has not reviewed the offering documents for accuracy and completeness. Without it, the pension funds would not be able to invest in private equity unless the latter submitted to the higher cost and disclosure of registering their offerings with the SEC.

Losing accredited status would be a huge embarrassment. As such, it could serve as a wake-up call, forcing complacent and captured public pension fund trustees and staff to just say no to private equity shenanigans.

Despite its shortcomings, the Los Angeles Times article does hit the most important issues: that Chiang’s bill fails to achieve its original promise, and that big investors like CalPERS and CalSTRS are doing an poor job of oversight through their longstanding failure to understand the economics of investing in private equity. The more heat on these issues, the better.

Update July 9, 9:45 PM: A law professor who has written extensively on private equity sent this message:

Spangler is actually not a law professor at UCLA. Maybe he has taught as an adjunct, but he’s just a practitioner with PE clients.

If you check the UCLA law school’s website, it has only only dead links to some courses Spangler taught (presumably as an adjunct). More important, Spangler is not listed on the UCLA law faculty profile page. So why didn’t the Los Angeles Times do basic fact checking?

Another reader e-mailed later:

Spangler’s UCLA connection is on behalf of federal felon Michael Milkin and his brother Lowell as an adjunct of their funded program at UCLA Law and as a lecturer at the brand-new UCI law program, probably also funded by the Milkens. He recently got hired at Dechert LLP ad a PE guy. Some “law professor…” He’s just another PE shill.

Print Friendly, PDF & Email

14 comments

  1. cnchal

    “If you’re producing 30% returns year in, year out, you have a lot of people who want to invest in your funds scams,” he said.

    Logic isn’t what it used to be.

    Deputy Treasurer Grant Boyken said a complete accounting of fees – the kind that the bill originally called for – is an admirable goal but that getting the share of fees paid by pension funds is Chiang’s main concern.

    “Our immediate goal is to look at what California pension funds are paying,” Boyken said. “The language we have now does that. The bigger story with private equity is not how much we’re paying, but are we paying too much? We can’t have that conversation until we know how much we are paying.”

    That’s the bigger story?

    The pension fund managers have demonstrated total ineptitude when it comes to dealing with pirate equity. The pirates can come up with any number for anything and even with contradicting evidence have to take what the pirates tell them.

    Why are the pension funds not doing their own audits of the portfolio companies? Not allowed to according to the contract. Why would they sign a contract like that? Ineptitude.

    Ultimately, for pension funds it is self defeating to throw your lot in with the pirates.

    The pirates use your money to asset strip viable companies and either drive them into bankruptcy or load them up with huge debt and put lipstick on them and resell to the chump public.

    These mangled companies eventually pay zero taxes, which leaves a bigger tax burden for the remaining private sector, and eventually a reduced flow of taxes to fund the public sector’s salary and pensions.

    The pirates and the banksters together in one gigantic scam after another, with a big assist from NIRP and ZIRP, the enforcement monsters from the Fed.

    1. shinola

      “Why would they sign a contract like that? Ineptitude.”

      You are much too kind.

      Is it ineptitude to what your handlers (the PE “fixers”) instruct you to do?

  2. tegnost

    Nice wrap up cnchal
    “The pirates and the banksters together in one gigantic scam after another, with a big assist from NIRP and ZIRP, the enforcement monsters from the Fed.”
    Gotta love that free market…
    Thanks for keeping the light on yves, AB 2833, more sound and fury signifying nothing

  3. Hugh E

    Wow that UCLA guy just like calpers board and cio seem to have drank the kool-aid

    Lets look at the past performance of PE when investors felt “there was no other choice” and had to allocate while pinching their noses but given the long lives of these funds that will be the next board/cios problem

  4. sd

    Does anyone know, who changed the language from the original bill? Whose fingerprints are on those changes? Names please.

  5. flora

    Glad the LATimes is on the case. It brings the story to a wider audience. However, as you say:

    “Yet the Los Angles Times does not make clear that the most important motive for transparency legislation it to expose all the ways that the private equity firms are hoovering cash from the companies they control. That will reduce the amount of misconduct, and also reveal the true cost of investing in private equity. Professor Ludovic Phalippou of Oxford has estimated it at a staggering 7% per annum of funds invested; CalPERS confirmed that it viewed this estimate as reasonable by including it in a private equity workshop last year.”

    Politicians generally aren’t known for leading on anything except protecting the status quo. Looks like it’s going to take some time to turn around the S.S.CalPERS from its current PE direction. Thanks for your unrelenting reporting on this very important PE and pensions issue.

  6. TheCatSaid

    Yves says, “the most important motive for transparency legislation it to expose all the ways that the private equity firms are hoovering cash from the companies they control. That will reduce the amount of misconduct, and also reveal the true cost of investing in private equity.”

    This transparency is also crucial to understand from the portfolio company‘s perspective. My personal experience is that young companies are encouraged to seek PE/VC funding–with little or not understanding of how damaging this is likely to be, including the effective hijacking of whatever inspired the company founders to create the enterprise in the first place, to morph portfolio companies into a cash supply for PE/VC funds (through both fees and speculation) in a way that does not serve the real economy and does not serve pensioners whose pension funds invest in PE.

    PE/VC funding are mechanisms designed to skim off massive amounts of funds to enrich the individuals who have leadership roles in PE (whether as GP, or as their legal or accounting consultants).

    Who suffers? The portfolio companies, the real economy, and pension fund beneficiaries.

    It is personal greed that drives this PE engine. Others can be seduced by this. (Indeed, various entrepreneurial training I’ve attended promoted greed as the only “true” impulse for doing anything in business.) The human race is better than this–but the existing system is actively promoting their own Heart of Darkness myth and claiming TINA.

    It’s not just the beneficiaries who get the short end of the stick, or no stick at all (and taxpayers who must rescue under-performing pension funds), but the portfolio companies and the entire should-be-productive economy.

    Apologies for this tangential digression/rant.

  7. Sluggeaux

    It’s embarrassing that CalSTRS is drinking the Kool-ade that PE is serving. I heard industry shill Harvard Prof Josh Lerner deliver a serving of the beverage to CalPERS last Fall: namely by telling their investment committee that only the very cream of PE (top 90th percentile) delivers better returns than a stock market index fund, but that if you have “relationships” you can access the “secret sauce” of the top returns. In classic confidence-man fashion, Lerner insinuated that we can all beat the odds and experience above average returns — a mathematical impossibility!

    I’m impressed that the LATimes has picked up this story. Their coverage is far more than superficial, even if they don’t show the whole iceberg that the California pension ship is going to strike when these funds reach full maturity. Still, I can’t believe that the LATimes fails to mention that the first past CEO of CalPERS just got a substantial federal prison term for taking kick-backs from a PE “placement agent” — if these funds were so good, why did they spend so much on bribes? How many more are out there, undisclosed?

  8. Anon

    I read the LATimes online everyday. Over the last few years the paper has gone through several editors and a shuffle in the workforce. There are many talented writers at LAT (I communicate with some of them). There are also lame ones. In the internet age it seems the rapid pace of publication seems to interrupt the fact check. (And credibility takes a hit.)

    As Obama and the Univ. of Chicago have shown an adjunct professor is still a “Professor”. Obviously it would be better to call adjuncts what they really are: lecturers.

    As a part of the “credentialed class”, I can say that it’s facts and clarity of presentation that makes the point, not the “title”.

      1. Anon

        Umm, my comment was to point out the current foolishness of calling adjunct professors “professors” and how even the U. of C. followed this nuttiness with “professor of Constitutional law, Barrack Obama. I’m sure the Times reporter was fooled by this charade, as well.

        As NC does so well, it pointed to the false facts (30%?) so the reader can make a better assessment of the “professors” argument.

  9. flora

    re: update on “expert”.

    just, wow. If the LATimes is going to use someone as a counter who argues from authority that someone should have more authority than roughly an adjunct lecturer to be creditable.

    Thanks for your continued reporting.

  10. Eileen Appelbaum

    On May 19, at Timothy Spangler’s invitation, I spoke to a UCLA Law School audience about the high fees, including monitoring fees, and mediocre performance of private equity. Other panelists also expressed concern about the lack of transparency about fees and/or decline in PE performance after 2005. Spangler cannot pretend not to know that high fee PE investments are not what they used to be, and pension funds counting on private equity returns to let governors and employers continue to fail to make necessary contributions will be sadly disappointed.

Comments are closed.