Mirabile Dictu! A Public Pension Investor Derides Private Equity Cult of Secrecy

For some time, we’ve been hectoring the supposedly most forward-thinking and best managed public pension fund in the US for its failure to take interest in widespread evidence of private equity misconduct, as reported by the SEC, the Wall Street Journal, the New York Times, and other sources. Moreover, CalPERS has continued to side with the private equity firms whenever their practices are challenged, with the most recent, stunning example being its patently bogus claim that it could not obtain the carry fees on the funds in which it had invested.

We instead see the leadership that has been missing at CalPERS coming from an unexpected and welcome source, namely. David M. Silber, the chief investment officer of the City of Milwaukee Employes’ Retirement System. It has $4 billion under management, a pittance compared to CalPERS’ total of just under $300 billion.

An op-ed by Silber in Pensions & Investments (hat tip Don) shows that size is no bar to sophistication. The article is well-written and astute, and lays waste to the notion that private equity data and legal agreements need to be kept under lock and key. From his article:

The City of Milwaukee Employes’ Retirement System believes it is in the best interest of everyone involved in the private equity industry for private equity managers to stop claiming that fees, expenses, internal controls and subscription documents are confidential information.

It is time to acknowledge and accept that the attributes that make private equity investing attractive to asset owners like CMERS have nothing to do with these “confidential terms…

While CMERS trustees believe that private equity investments are an important part of a diversified portfolio, CMERS is troubled by the lack of transparency that private equity managers offer investors on issues including fees, internal controls and subscription documents. The stated fees on private equity vehicles are lucrative to begin with, but the unstated fees managers earn in the form of transaction, consulting, monitoring and other fees are far more concerning…

CMERS leadership is skeptical of private equity managers’ insistence that fee structures, internal controls and subscription documents, particularly limited partnership agreements and side letters, are confidential information that provides a given manager a competitive advantage. Another way of saying this is that CMERS officials have never heard a manager attribute its top-quartile returns to its fee schedule, allocation of expenses, internal controls or obfuscating legal documents. What should differentiate one private equity manager from another are qualities including, but certainly not limited to, experience, relationships, skill, resources and alignment of incentives and interests. These qualities are not easily copied and an average manager cannot obtain these qualities and become a top-tier manager just by reading a competitor’s subscription documents.

CMERS challenges the private equity industry to acknowledge that much of what is claimed to be confidential:

• does not provide a competitive advantage and

• should be made public through increased transparency with investors going forward…

Private equity managers need to understand that their industry is damaged by the lack of transparency and negative headlines. In this environment of poor transparency and negative headlines, it would be natural for investors, including CMERS, to ask questions, such as: Are there other undisclosed fees? How much are private equity managers truly compensated? How serious and prevalent are the lack of internal controls at private equity firms that the SEC observed in its examinations? Are industry incentives aligned with investors’ objectives? Do the majority of private equity firms have strong enough internal controls to minimize the risk of a single employee defrauding a firm and its investors?

The failure of private equity managers to adequately address these issues leaves a vacuum that will likely be filled by additional public scrutiny, continued frustration from the investment community, and increased attention from regulators and tax authorities.

It is hard to overstate how this point of view, which should be blindingly obvious to anyone who is operating in a fiduciary capacity, is instead treated as deviant because it runs counter to private equity industry talking points, which unduly credulous and captures investors have swallowed hook, line and sinker.

If you are in Milwaukee, I hope you’ll call Silber’s office (the main number is 414-286-3557 and they do seem to have a receptionist, so if worse comes to worst, you should be able to leave a voicemail with his assistant) and thank him for taking an important and all-too-rare pro-beneficiary stand. If you have family, friends, or colleagues who live there, please you’ll forward this post to them.

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