We’ve been devoting a significant effort to covering how the giant public pension fund CalPERS, like all investors in private equity, has no idea of the total cost of investing in private equity.
As we’ve discussed at length, CalPERS and its Sacramento sister CalSTRS do not know what they pay in the way of the profits interest widely called “carry fees,” one of the biggest charges taken from their investments. Neither of the California giants properly tracks management fees, the annual 2% of the prototypical “2 and 20” fee structure. Their systems capture only the portion they pay in hard dollars, and not the part that is shifted onto portfolio companies, as well as other fees and costs loaded on to them. And bear in mind that while not all of these charges can be obtained under the secrecy regime that private equity general partners have succeeded in creating, some funds, such as the South Carolina pension system, do a vastly better of getting this information than the far better staffed and more powerful CalPERS and CalSTRS do.
The winds seem to be changing. In an important step, California State Treasurer John Chiang, who sits on the CalPERS and CalSTRS boards and had expressed concern about the CalPERS fee lapses, is moving to get more disclosure. This is a major shift for Chiang, who despite at least having made the right noises had also, with a group of other overseers of public pension funds, asked the SEC to ride to his rescue. As we pointed out, these public pension officials have the power as a group to press for more transparency on their own, rather than rely on the compromised and overburdened SEC.
We want to thank readers who wrote letters and made calls to Chiang and California Controller Betty Yee, who also sits on the CalPERS and CalSTRS boards. Insiders tell us that these messages played a significant role in Chiang’s change in stance.
California’s state treasurer, John Chiang, on Monday called for state legislation requiring private equity firms to disclose all fees charged to California public pension funds.
In a letter to the country’s two largest public pension funds, Chiang said the California Public Employees’ Retirement System and the California State Teachers’ Retirement System, along with other limited partners, “pay excessive fees to private equity firms and do not have sufficient visibility into the nature and amount of those fees.”
Chiang urged that all California public pension funds, as well as the University of California Retirement System, work with his office to develop legislation to place fee disclosure requirements on private equity firms.
We’ve embedded Chiang’s letter below. While this is indeed progress, it’s also important to recognize that Chiang’s (and CalPERS’ and CalSTRS’) incentives are to do the bare minimum to make the problem of private equity transparency go away.
But even with this caveat, Chaing does deserve praise for laying out what looks to be a demand for disclosure of all fees, as well as related party transactions. The inclusion of related related party transactions is critically important, since they have been one of the biggest sources of chicanery. For instance, professionals have been presented as part of the private equity “team” for marketing purposes, then being billed to the funds as independent consultants. That makes these consultants expenses to the investors, when the investors assumed those individuals were employees, and hence on the general partner’s dime. Needless to say, this provision needs to be drafted to include transactions with the portfolio companies, and not just at the fund level.
But if you read Chiang’s letter carefully, you’ll see, despite the forceful tone, as well as his call to have California public pension funds act in a unified manner, there is an uncomfortable amount of wiggle room to allow for far less disclosure than a layperson would expect to come out of this initiative. Again from Reuters:
Ludovic Phalippou, finance professor at Oxford University’s Saïd Business School, praised Chiang’s efforts, but said pension funds need to disclose past fees paid and the total fees charged by each fund as well.
“This is actually the most important and difficult task,” said Phalippou.
Here is the key section from the letter:
The idea that “not impairing current agreements” means that the new requirements would have to apply only to future contracts is deferring far more than necessary to the general partners. First, as we indicated, other investors obtain vastly more information about fees and costs than CalPERS and CalSTRS do now simply by virtue of being diligent.
Second, although it would be out of keeping with the supine posture that limited partners have heretofore taken, they have a great deal of leverage that they could exploit. For example, there has been plenty of media coverage with substantial evidence of private equity abuses, from group purchasing company kickbacks to undisclosed fees to the “independent contractor” sham above. And the SEC’s approach appears to be to ding particular firms only of a subset of the abuses in which they’ve been engaged, meaning there is plenty of bad conduct they’ve chosen to ignore. If California wanted to play hardball, getting Attorney General Kamala Harris to say she was thinking about picking up where the SEC left off would likely lead to the industry being far more willing to cooperate in making disclosures beyond those mandated in current limited partnership agreements. The general partners have been so egregious in their misconduct as to make them vulnerable if anyone were to make an issue of their compliance with their own agreements. I’m not saying this is likely to occur, but the underlying fact set is so bad that Chiang and the state have far more cards that they can play than his letter would lead you to believe.
So since your efforts have proven to be so productive, I hope those of you in California will continue to circulate these posts to friends and colleagues in the state, and will continue to send letters and make calls to Chiang as well as Controller Betty Yee.
Here are Chiang and Yee’s contact information:
Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
Ms. Betty Yee
California State Controller
P.O. Box 942850
Sacramento, California 94250-5872
Please tell Betty Yee that you’ve seen John Chiang step forward to demand more private equity transparency and you expect her as a fellow fiduciary and state official to join him.
For Chiang, thank him for his proposal, but tell him you expect him to get more disclosure not just on future investments, but on current ones. Remind him that small funds are already doing far more that CalPERS and CalSTRS are in getting fee information, and that big public pension funds and state official have powerful bully pulpits, and they should use them to demand more disclosure now, particularly on related party transactions. The industry has no excuse save that they don’t want the magnitude of their grifting exposed. The fact that they will not be able to point to any tangible harm save to their inflated reputations can and should be used against them.
And thanks for your efforts!