A new story on private equity secrecy by Mark Maremont at the Wall Street Journal started out with a bombshell, that of private equity industry kingpin KKR muscling a public pension fund to deny information requests about KKR’s practices:
KKR & Co. warned Iowa’s public pension fund against complying with a public-records request for information about fees it paid the buyout firm, saying that doing so risked it being barred from future private-equity investments.
In an Oct. 28 letter to the Iowa Public Employees’ Retirement System, KKR General Counsel David Sorkin said the data was confidential and exempt from disclosure under Iowa’s open-records law. Releasing it could cause “competitive harm” to KKR, the letter said, and could prompt private-equity fund managers to bar entree to future deals and “jeopardize [the pension fund’s] access to attractive investment opportunities.”
The article also demonstrated, as we’ve pointed out earlier, than many investors are so cowed that they don’t need to be on the receiving end of overt threats:
Once public pension funds start releasing detailed information in response to public-records requests, “that’s the moment we’re done,” said Linda Calnan, interim chief investment officer of the Houston Firefighters’ Relief and Retirement Fund. “These are sensitive documents that managers don’t want out there.”
This risk, that private equity funds might exclude public pension funds that the general partners deemed to be insufficiently zealous in defending their information lockdown, has long been the excuse served up public pension funds for going along with these secrecy demands. As we demonstrated in May, the notion that the information that the funds are keeping hidden rises to the level of being a trade secret or causing competitive harm is ludicrous. We based that conclusion on a review of a dozen limited partnership agreements, the documents that the industry is most desperate to keep under lock and key.
But the only known instance of that sort of redlining actually taking place, as the Journal notes, took place in 2003 after CalPERS said it would start publishing limited data on financial returns as a result of a settlement of a Public Records Act (California-speak for FOIA) lawsuit. As we wrote in April:
Two venture capital firms, Sequoia and Kleiner Perkins, had a hissy fit and refused to let funds that would disclose their return data invest in them. Now this is of course terribly dramatic and has given some grist to the public pension funds’ paranoia that they’d be shut out of investments if they get too uppity. But the fact is that public pension funds overall aren’t big venture capital investors. And people in the industry argue that there was a obvious self-serving motive for Sequoia to hide its returns. Sequoia has launched a number of foreign funds, and many are believed not to have performed well. Why would you invest in Sequoia’s, say, third India fund if you could see that funds one and two were dogs?
So why has industry leader KKR stooped to issue an explicit, thuggish threat? Why are they so threatened as to cudgel an Iowa pension fund into cooperating with KKR and heavily redacting the response? Just as with the Sequoia and Kleiner Perkins case, it’s naked, and not at all defensible self interest.
Law firm Ropes & Gray, which counts Bain Capital among its clients, issued what amounted to an alarm to its private equity and “alternative investment” clients over an increase in inquiries to public pension funds about the very subject that the SEC had warned about in May, about fee and expense abuses, as well as other serious compliance failures. It’s a not-well-kept-secret that many investors were correctly upset about the SEC’s warnings, and some lodged written inquires with general partners as to what specifically was going on. We’ve embedded an unredacted example of one such letter at end of this post. It was the same one that CalPERS board member JJ Jelincic used to question investment consultants last month because the letter ‘fessed up to an abusive practice called evergreen fees.
Journalists like Maremont and interested members of the public have written public pension funds to obtain the general partners’ responses to these questionnaires. And this is a matter of public interest, since shortfalls in private equity funds, even minor grifting, is ultimately stealing from beneficiaries, and if the pension fund is underfunded, from taxpayers. Yet notice how Ropes & Gray depicts questions about what are ultimately taxpayer exposures as pesky and unwarranted intrusions:
We have recently observed a surge in freedom-of-information (“FOIA”) requests made by media outlets to state pension funds and other state-government-affiliated investment entities. Although the requests have so far concentrated on information related to private equity sponsors, they have also sought information about investments with other alternative investment fund sponsors. The requests tend to focus on information about advisers’ treatment of fees and expenses, issues raised as areas of SEC interest in a speech by an SEC official earlier this year. The requests may also ask for information concerning recent SEC examinations of fund managers. Many state-level FOIA laws exempt confidential business information, including private equity or other alternative investment fund information in particular, from disclosure. Nonetheless, record-keepers at state investment entities may reflexively assume that all information requested should be disclosed. But a prompt response, supported by the applicable state law, can help ensure that confidential information that is exempt from FOIA disclosure is in fact not released.
The sleight of hand here, which we’ve discussed longer-form, that merely asserting that something is confidential does not exempt it from disclosure. In fact, if you look at the examples from selected states that Ropes & Gray cites in its missive, states have tended to shield certain specific types of private equity information from disclosure, including limited partnership agreements and detailed fund performance information, but generally restrict other disclosures not on the basis of mere confidentiality but on trade secrecy or similar competitive harm, meaning the private equity firm’s competitors might learn something about the fund’s secret sauce if they obtained that information.
Please look at the first letter at the end of this post and tell me what if anything in it is so valuable that competitors might seek to copy it. Contrast that with a second letter from a Florida pension fund, from KKR that the Journal obtained and see how much is blacked out.
The fact is that the various FOIAs focused on getting at SEC abuses aren’t about protecting valuable industry intelligence, to the extent there really is any in any of their documents; it’s simply to hide their dirty laundry. The Wall Street Journal story reports how in Washington, Florida, and North Carolina, public pension fund officials have been acceding to private equity fund “concerns” and using strategies ranging from foot-dragging to woefully incomplete disclosure to outright denial to stymie inquiries.
The interesting thing about KKR’s exposure is that its defensiveness is likely due to how much scrutiny it is getting from the SEC. Maremont earlier exposed how KKR’s captive consulting firm KKR Capstone appeared to be charging undisclosed, hence impermissible fees to KKR funds. KKR has attempted to defend the practice by arguing that KKR Capstone isn’t an affiliate. We debunked that argument here.
Even though we have criticized the SEC for its apparent inaction on the private equity front, in terms of following through with Wells notices after describing widespread private equity industry malfeasance, we have been told that the agency is in the process of building some major cases against private equity firms. Given how many times KKR’s name has come up in Wall Street Journal, New York Times, and Financial Times stories on dubious private equity industry practices, one has to imagine that KKR would be a likely target for any action that the SEC would consider to be “major”.
This is an area where readers can make a difference. The one thing public pension funds, even one like CalPERS, are afraid of is their state legislature. Call or e-mail your state representatives. If you have the time and energy, also write to the editor of your local paper and the producers of your local television station. Tell them you’ve read in the New York Times and the Wall Street Journal (and if you are in California, the Sacramento Bee) about public pension funds refusing to provide information to members of the public about fees as well as widespread abuses that the SEC discussed at length in a speech this year. Tell them that the SEC has made it clear that private equity can’t be treated on a “trust me” basis any more. The time has come for more pressure on public pension funds to weight the public interest more strongly in dealing with these inquiries, and if needed, new legislation to force more accountability from private equity funds and their government investors.
Welsh Carson Response to Illinois
I’m confused. I thought free markets were the best of all possible worlds and famous free marketeers say markets are best because transparent, full information mean that all market players adjust to produce the best possible outcomes for everyone. I also just looked at the NY Times map of election results — and see that, whether red or blue, Congress is safely in the hands of neoliberal free marketeers of both parties.
So why are public pension fund officials dragging their feet on getting and sharing the information?
Aren’t our markets free?
Shhh! The watchword is
Free for me,
Not for thee.
Debunking the free market myth would take several volumes (see Marx), but from where I sit the big issue here is not whether party A agrees to pay party B the established price and party B provides the agreed-upon goods or services, it is that in many transactions and especially in financial transactions it is very likely that party B knows something about his goods and services that party A doesn’t. And what you don’t know can hurt you. This is the crux of the matter. It certainly may be that KKR and other PE firms do hinky things that would be outside of their contractual authority, but I suspect that such fees as evergreen fees are either disclosed (in fine print of course) or hidden in the investment itself (a subsidiary vehicle). In fact, this inequality in information is a root of the wealth inequality problem. Looters and inside traders make money – lots and lots of money – keeping us just a tad ignorant. That is why forensic accountants are so damned dangerous. They read the fine print. They know the law. They could potentially review contract and transaction information and find where the general partners violated the contract, or the law. I’ll add one more ingredient to this pot – embarrassment. Note, the Illinois Board of Investment should have known the answers to the questions it raises before investing with KKR. Thus, if long after an investment contract is signed a FOIA request results in the exposure of excessive fees, it would be the Board that would be the most embarrassed. Unless the fees were blatantly illegal, or undisclosed in the contract, KKR could argue that its fee structure was disclosed and the board decided to invest anyway. Hence, it doesn’t surprise me much that CalPers and others are damned slow to release these PE agreements. Nobody wants others to know that they were bamboozled.
No, the SEC is of the view that the evergreen fees were not disclosed and hence not permissible. The SEC has clearly stated that they found violations of law as well as serious compliance failures in over 50% of the funds they examined so far. They’ve also made clear privately that they firms guilty of abuses are all across the size spectrum and include the biggest names in the industry.
Limited partner do NOT have the right to have access to the books and records of the portfolio companies, which is where the impermissible fees and expenses are charged. So your forensic accountant idea is off base. If you can’t get at the info, you can’t do any meaningful investigation.
I fail to understand why you are defending what amounts to embezzlement. Just because its PE firms who’ve been celebrated in books and magazines, rather than low-life mortgage servicers, that makes it OK?
It was my intent to identify motivations for the limited partners to accept the blackmail of the GPs, not to assign fault to the LPs. Most folks would be anxious to scream “thief” and seek to get authorities involved if they knew they were ripped off. The fact that pension funds seem to be playing along with the “trade secrets” argument to avoid fulfilling FOIA requests makes me wonder why. From your explanation it appears that they simply did not and do not know because the fees are from portfolio companies to the GPs and wholly hidden from the LPs. I simply did not get that. Evergreen fees are fees portfolio companies remit to the GPs, and the LPs would be wholly in the dark. That has got to be illegal if not disclosed – it clearly affects the return on investment. Sorry Yves, I have no intent at all of defending fraud. The question is – why are LPs willing to play along with the trade secrets argument?
Yeah, I suppose that people finding out that you screw your clients over as a normal part of business might make it difficult for you to compete…because who the #@$% would hire you?!? So yeah, “competitive harm.” As for jeopardizing access to attractive investment opportunities, that may be the case, but if it’s balanced out by losing access to crappy investment opportunities as well–and there’s no a priori of knowing which is which–then it’s probably a wash.
Seems like their might be an opening here for a transparent PE firm to take some business away from bullies like KKR…unless, of course, the dirty secret of PE is that it’s only profitable for the GPs because of their shenanigans…
The Carson letter started out with boilerplate language. The old “we do the best for you” to keep America strong etc. etc. I’ve learnt over the years to mentally redact everything after as a matter of course. If it starts out with B.S., it usually follows through with B.S. As you point out, the sheer brazenness of KKR’s behaviour is almost the whole story. I believe the Pecora Comission showed how to bring things into a more equitable balance. It’s a shame we don’t have a Webber Commission, unless we consider NC to be a “Free Market” version.
Please look at the Welsh, Carson letter again, in connection with the CalPERS board video which we discussed at length last week: http://www.nakedcapitalism.com/2014/10/private-equity-consultants-flounder-question-abusive-evergreen-fees-calpers-board-meeting.html. The letter admits to a bad practice that Illinois asked about, namely, charging evergreen fees. That letter was provided to anyone that asked, unredacted. By contrast, what is close to the entirety of the KKR letter is redacted. Neither conclusion is attractive: either that those two pages in full discuss questionable practices that KKR wants kept hidden, or that Illinois has been intimidated into an overly KKR-friendly approach to secrecy.
Gretchen Morgenson analyzed a Carlyle limited partnership agreement that she got via FOIA that came back heavily redacted versus a full copy with no redactions. She discussed how much of the material didn’t warrant being hidden: http://www.nakedcapitalism.com/2014/10/gretchen-morgenson-damage-private-equity-secrecy-mention-calpers-suit.html
I confused the two missives, my apologies. I did not make the CalPERS Board meeting connection. I am going back over all this now.
The mind set of “Maximum Obfuscation” appears to be a common trait of big organizations in general. The Funds treat information in a similar fashion to Governments. Hide what can be damaging, and when you succeed at that, hide just about anything else you want for fun. The KKR letter can be considered as an example of a ‘blanket redaction.’ Something like being ‘collateral damage’ on a battlefield.
This is a great illustration of where responsibility lies. The investment part of the financial industry has no actual power; they’re just vendors, like cleaning companies or auditors or copier leases or office supplies or any other procurement issue. They ask for things, like money and secrecy. The more the better.
The decisions to grant those things are made by public managers, such as those handsomely paid at pension funds.
Huh? First, people who work at public pension funds aren’t handsomely paid by investment management industry standards.
Second, private equity firms wield considerable power. They are the biggest source of revenues for the investment banking side of Wall Street, top consulting firms like McKinsey and BCG, and for white shoe law firms. Even clients with long-established law firm relationships like Harvard don’t command the loyalty of their attorneys when it comes to PE: http://www.nakedcapitalism.com/2013/07/memo-to-eliot-spitzer-if-harvards-own-pe-law-firm-is-really-more-loyal-to-bain-how-can-you-hope-to-get-good-representation.html.
The Department of Labor changes to ERISA in 1978 allowed for investments to be managed on a portfolio basis to facilitate the use of modern portfolio theory. Pension funds are run to avoid liability above all, and next to maximize returns. The use of MPT meant that investors are required to anything that is deemed to be an asset class. PE has managed to get itself treated as an asset class, hence investors MUST invest in it. That is in no small measure due to the fact that pension fund consultants, which pension funds rely for liability-avoidance reasons, have incentives to get more “strategies” treated as asset classes, particularly complex one. That justifies higher fees. And as we discussed in an earlier post, any pension fund consultant that was viewed as being too rough on PE firms would simply be denied access, or the PE firm would tell the fund that had hired them that they thought the consultant was difficult and unprofessional, which would get that consultant unhired.
Yves, I guess this is one of the fundamental questions for our system. You probably read a fair amount of hyperventilating and general complaining. But I mean this as a long-term, well thought out interest in governance. Is the problem only the top .0001%? Or is it also lower down the ladder? To say it differently, what is the justification for paying workers significantly more than the median wage if those workers don’t have any meaningful responsibility? Or are you saying that senior staff at pension funds don’t make more money than most workers?
What you’re describing, the various forms of finance and consultant blather, is what I’m critiquing. I’m not denying that’s how things work. I’m saying such a system is inherently problematic. It’s a systemic issue. Everyone cashes their checks; no one is responsible. Because the lawyer. Or the consultant. Or the PE firm. Portfolio theory made us do it.
Whoops, capital is being misallocated in our society? Whoops, corporations have bad governance? Whoops, workers are being abused? Whoops, our society is destroying the environment? Don’t talk to us, we don’t actually manage the money! It’s those other guys doing LBOs and angel investing in shady businesses and paying executives way too much and supporting criminal enterprises and all that jazz. We can’t afford not to invest in these companies.
If you are going to assign blame, you need to blame the right people.
In a con, even though the mark is culpable due to his greed (which in this case one can argue applied to individuals who invest in PE, probably 40% of industry assets comes from them) or agency problems, most people assign more blame to the con man.
Is that the standard we want to use, though? Pension managers are just hapless victims, blinded by incompetence or greed?
That sounds consistent with there being a systemic problem.
This is a systemic problem. There are widespread principal/agent problems. Tons of people, by accident or design, are not accountable. For the PE funds, it most assuredly is by design. They have gone to considerable lengths to move every element of their deal with investors, from both a money standpoint and a liability (as in responsibility) standpoint in their favor. Due in part to the investors being unable to get truly independent advice (the consultants and law firms are more loyal to the PE firms than them) they are COMPLETELY outmatched, even if they want to do the right thing.
Despite the PE firms hiring the best law firms in the US and crafting egregiously self-serving contracts, the SEC has still found they’ve violated the agreements! Doesn’t that give you a clue as to how rapacious and predatory this industry is? Sure, there are some less bad actors, but don’t kid yourself as to the general tenor of conduct. When the SEC is uncharacteristically calling out abuses in such an unvarnished manner, it makes sense to see who they are fingering, and it is mainly the general partners.
I appreciate the extended discussion on this topic and completely agree the financial actors are by and large predatory. I’m one of the more insistent on that point. I’d say most of the industry should be jailed or nationalized, and the rest taken off life support.
But I’m very uncomfortable with simply ignoring another part of the story, which is that public pension funds are supposed to be doing their own financial management. To say that highly paid staff fall victim to self-serving contracts is to identify either complicity or negligence.
That we may have sympathy on a personal level doesn’t mean that people in positions of power aren’t responsible. And one easy way to see that is to look at their pay checks. They make a lot more money than, say, the SNAP eligibility specialist or the custodian at the local unemployment office. Never mind home healthcare aides and waitresses and housekeeping staff and all the rest of the physically and mentally taxing jobs that nonetheless pay even less than the median wage.
Hi Yves, et al-
I’m a native Iowan interested in bringing this issue up with my state gov’t representatives. Can you comment on the argument posed by Matt Levine at Bloomberg (link below) that disclosure of these fees could foreseeably cause economic loss to KKR (via service fee price undercutting by other PE firms competing for Iowa investment funds) and thus disclosure of those fees could be prevented by “Iowa Code section 97B.17(2)(e),” which allows non-disclosure “if the disclosure of such information could result in a loss to the retirement system or to the provider of the information”
Just trying to anticipate any challenges or counter-arguments here.
That is ridiculous. If that is the best Levine can come up with to defend this practice, he is pretty desperate.
The general outlines of KKR’s pricing is known, as is true for all the major PE funds. We’ve already published on KKR limited partnership agreement and I don’t see any evidence that that dented KKR’s fortunes. The damage if any would be every bit as large for Iowa’s release as for Pennsylvania’s accidental release.
What is more likely to be affected is how KKR price discriminates among various types of investors within its general price parameters. Moreover, no one is going to invest in a PE fund based on one having lower fees than KKR. They invest on expected net performance. What exposure WOULD do is create public pressure for more sensible agreements (they are appallingly lopsided in favor of the PE firms) and somewhat less fee gouging for less powerful investors (presumably smaller ones).
Moreover, a reduction in profit, even if that were to occur, is not a loss. KKR will remain obscenely profitable even if it has to concede on pricing at the margin.
Thanks Yves for your take- really appreciate it.
To be fair to Levine (without knowing whether I should be or not- I haven’t read his work before), I get sense he didn’t necessarily support the firm’s efforts to keep their fees a secret, but that there was nothing that could be done about it, as issue fell firmly within scope–and thus under protection of– Iowa law.
Regardless, will look forward to help fighting the good fight here. Thanks for supplying the ammunition.
Levine is an extremely entertaining and skilled writer. I’m envious of his ability to simplify complex issues. However, he can be relied on, virtually without exception, to make arguments that serve the financial services industry.
This issue does NOT fall firmly within the scope of the law. States with generally similar disclosure laws had investors release the same documents in full. As the WSJ article shows, the public pension funds that withheld documents or redacted them didn’t go to outside counsel for an independent view, they took the general partner objections as gospel.
If the WSJ were to go to court, they’d have high odds of winning. But that costs money and takes time. By the time they got any materials, the story would probably be dead. That means the public pension funds are effectively judge and jury on this issue. And they care much more about not annoying the general partners than with obeying the law, particularly when they know the odds of them being sued are close to zero.
This seems like just another battle line in a wider war centered on government interactions with private businesses. Shouldn’t the professionals that we hire to manage our pensions be qualified to invest the money themselves in a way that we can supervise like we would supervise any other employee? Without having our employees sub-contracting expensive help over which we have no power? And we can’t even examine the costs, as we could if they bought new office furniture? Why pay another layer of intermediaries, especially one with a built-in conflict of interest with us, the public?
But this is a war that we the public have already decisively lost on multiple fronts, such as the notorious PPPs. Once a government agency joins forces with a private corporation for any purpose, the combined entity enjoys all the coercive powers of government, plus all the immunities of private enterprise, including privacy and the right to make arbitrary decisions. Both sides gain new powers and enhanced freedom from restraint. A pair of heavyweights that should each be keeping the other honest, instead join forces to deliver a one-two punch to the public’s referee. It’s a KO for the public’s rights.
So we learn not to waste time arguing or questioning, when (as near me) a toll road appears (on land acquired with the public’s eminent domain powers) and signs don’t just specify the toll, but also say “payment charges apply”, meaning that if you stop to pay the toll to a machine, or telephone in a credit card payment (as opposed to paying online), you will be charged extra to cover the cost of collecting the toll that way. Free choice, isn’t it? What’s not to like?