Regular readers may recall that as as result of your letters and e-mails to CalPERS board member, State Treasurer John Chiang,* said he would sponsor legislation to require disclosure of all fees private equity firms charge to California public pension funds, including related party fees. CalPERS staff, usurping the board, quickly voiced support for the idea. As much as we were heartened by the news, we warned:
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.
While the bill is not ideal, it goes a long way towards meeting Ching’s commitment. It requires at least once a year disclosure of the fee information in a public meeting. It included carry fees and portfolio company fees, including those paid to affiliates.
The one big lapse is something we flagged in our November post when Chiang announced his intention to launch a bill:
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.
The gap here is that the bill stipulates that portfolio company fees be disclosed only if they are paid to the general partner or its affiliates. In fact, as we discussed at length in 2014, the general partners present a team that the limited partners assume are all employees of the general partner, when a significant number are “senior advisors” which are billed out as consultants on an individual basis, and the general partner claims they are not affiliates. Mark Maremont of the Wall Street Journal discussed an egregious example, of the house consulting firm KKR Capstone, which KKR astonishingly maintains is not an affiliate despite it being entirely captive to KKR, housed in KKR leased space, having its professionals listed on KKR’s website and participating in KKR’s carry pool, and having “KKR” on employee business cards. But the SEC let this one slide and apparently so did Chiang.
Chiang is seriously considering running for governor, so it remains to be seen whether he will push for the bill to pass, or try to pretend that the opposition was too great. If CalPERS and CalSTRS were both to back it, it would be hard for the legislature not to follow suit. Even though CalPERS’ staff voiced support of the concept, they could easily retreat, using the excuse that the general partners are threatening a revolt based on the actual language of the bill. Yet it seems hard to imagine that they can afford to write off the state of California, particularly since its state employees, generally speaking, get higher wages and benefits than in other areas of the US.
So it is time again for NC readers to saddle up and write Chiang and State Controller Betty Yee, who also sits on CalPERS and CalSTRS boards.
Please thank Chiang for following through on his promise, but remind him that you expect him to deliver, and you hope he’ll continue to provide the leadership necessary for CalPERS and CalSTRS to endorse the bill, and to keep pressure on the legislature.
Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
Please contact Yee and thank her for her pressuring the SEC to take more concerted action on the private equity front, and that you hope she’ll also support important private equity initiatives in California, like Ching’s bill. Ask her to press her fellow board members at CalPERS and CalSTRS to back the bill.
Ms. Betty Yee
California State Controller
P.O. Box 942850
Sacramento, California 94250-5872
And on another front, the Pew Research Center published a report last week on disclosure in state private equity funds. This is from the overview. Readers will recognize that this issues have been discussed in detail in past posts:
The California Public Employees’ Retirement System (CalPERS), the nation’s largest public retirement plan, recently raised the bar on investment fee transparency by disclosing the full amount it pays to invest in private equity, which may bring greater rewards but also greater risk and higher management costs. CalPERS, like most public retirement systems, pays performance-based fees, known as carried interest, to external investment managers as part of their compensation, but the system only began publicly disclosing these costs in November. CalPERS’ new policy of reporting carried interest and other performance fees resulted in the disclosure that external investment partners realized $700 million from profit sharing agreements in fiscal 2015.
The move highlights the widespread problem among public retirement systems of underreported manager fees and expenses, particularly those associated with alternative investments such as private equity, real estate, and hedge funds, and points to the need for greater disclosure in order to provide full transparency on investment costs. State retirement systems receive guidance on disclosing investment details from the Governmental Accounting Standards Board and the Government Finance Officers Association’s Best Practice for Public Employee Retirement System Investments. However, states interpret and implement these standards differently.
Pew did the heavy lifting of surveying the 73 biggest state funds which account for 95% of all state pension fund investments to document how disparate investment strategies and fee capture and disclosure policies are. It made some modest recommendations: to disclose performance fees and performance both gross and net of fees. But as we’ve also reported at CalPERS, even the most straightforward fee, the management fee, is not reported properly, since CalPERS bizarrely treats the portion shifted onto portfolio companies as a freebie to them even though it comes out of their monies too. It will be hard for CalPERS to maintain this fiction as the bar keeps (slowly) rising across the industry.
Again, thanks for all your support in these efforts. And keep the heat on!
* This is not an exaggeration. We’ve gotten information from insiders that NC reader pressure goaded Chiang to act.