I’m of two minds in criticizing a letter that California Controller Betty Yee, who also sits on the boards of CalPERS and CalSTRS, sent to SEC chairman Mary Jo White about private equity transparency. On the one hand, it’s good to see that Yee recognizes that private equity is rife with abuses and problematic practices, as the SEC’s head of compliance Andrew Bowden pointed out nearly two years ago. On the other hand, Yee’s first step out on this issue was so tentative as to look an awful lot like wanting to take credit for Doing Something about private equity while being unwilling to take any political risk.
Normally, I would not hesitate to make that charge, but even though Yee has a long career in public service, this is the first time she;s been in such a visible role and the first time she’s had to deal with private equity. Thus she is also likely to have conferred with staff at CalPERS and CalSTRS on any possible reform ideas. Given how deeply captured both institutions are, the odds are high that if Yee had come up with any proposals that might actually ruffle the overly-cozy relationships between the general partners and limited partners like CalPERS and CalSTRS, you can be sure that the staffs would have come up with plausible-sounding reasons to discourage any meaningful plans. So I’m going to be more charitable than I would otherwise be.
Yee’s letter is embedded at the end of this post. In the second half, Yee raises a valid issue that the SEC will find it difficult to justify not rectifying. Under the Dodd Frank Act, all but the smallest private equity firms are required to register as investment advisers. That requires among other things, filing an extensive disclosure document called a Form ADV at least once a year. Despite the obvious value in being able to track an investment adviser’s disclosures and conduct over time, the ADV database (which is actually a FINRA site, despite appearing to be an SEC site, another troubling element of how these records are handled) shows only the most recent Form ADV. Yee calls for the Form ADV database to operate at the same standard as the SEC’s EDGAR database, of allowing investors to see the full history of EDGAR filings, including filings that were later revised.
However, the first part of Yee’s letter is sorely disappointing. She calls on the SEC to require regulated private equity firms to report fees and expenses at both the fund and portfolio company level consistent with the newly-released Institutional Limited Partners’ Association template. Compliance with it is voluntary. Even though general partners participated in the development of the ILPA template, there is an obvious lack of enthusiasm on behalf of the general partners. A story on PE Hub lists 21 limited partner that have endorsed the template, as well as six major private equity consultants, such as Cambridge Associates and CEM Benchmarking.
Revealingly, no private equity general partner had endorsed the template. And they made clear they don’t intend to accommodate the single most important investor group in private equity, public pension funds, which almost without exception have a June 30 fiscal year. From the article:
The template originally called for reporting on a trailing 12-months basis, to comply with disclosure requirements for those LPs with fiscal years other than Dec. 31. However, GPs preferred year-to-date reporting, which the template reflects.
“LPs have indicated that [trailing 12-month] reporting capability would be strongly preferred,” ILPA said. “As the industry advances towards the fully electronic exchange of standardized information, the ILPA recommends that GPs and the software community begin evaluating ways to adapt current processes and systems to allow for this adjusted reporting horizon.”
It says a lot about ILPA (which we have pointed out is funded by the general partners, not the limited partners) that it promotes the general partner position that the refusal to provide fee information on a fiscal year basis is due to it being difficult. As one pension trustee translated the exchange:
GPs to LPs: “You may want data on a trailing 12 months because of your reporting requirements but we are going to give it to you on a calendar year basis. We don’t want you reporting it anyways.”
LPs to GPs: “OK, yes masters of the universe.”
So with the general partners fighting the limited partners on every issue, one might think that Yee has a point in calling on the SEC for help. But a group of 12 state treasurers plus the New York City controller have gone down the path of asking the SEC to ride in to their rescue. We explained why that was tantamount to asking the SEC to do their job:
Why the State Officials’ Letter to the SEC is a Joke
If you didn’t know better, and the tacit assumption is that the dumb chump public does in fact not know better, you might easily think a letter by state officials to SEC chairman Mary Jo White amounted to meaningful action. Here’s the overview from the Wall Street Journal; we’ve embedded a copy of the letter at the end of the post:
A group of states and cities said it intends to send a letter to the Securities and Exchange Commission late Tuesday asking for greater transparency and more frequent disclosures by private-equity funds.
Around a dozen comptrollers and treasurers from New York to California want the SEC to demand private-equity funds make disclosures of fees and expenses more frequently than they do now…
This is patently ridiculous…
These limited partners have chosen, for decades, to give private equity general partners a blank check by allowing them to use the portfolio companies purchased with the limited partners’ monies as piggy banks, with virtually no checks or oversight. Critically, the limited partners have no right to see the financial statement of the portfolio companies, nor do they get information about transactions or business arrangements between the portfolio companies and parties related to the general partner and its owners, employees, and affiliates.
Sure, the officers of these portfolio companies nominally have a duty of loyalty and care to these entities. But what do you think happens when the private equity overlords, who can fire anyone at the portfolio companies, tell its employees to engage in indefensible arrangements, like contracts that provide for handsome fee payments but do not require that any services be provided, or agree to the use accounting systems that allow the general partners to tamper with the data?
The elected officials who are asking the SEC to intervene on their behalf are all board members or trustees of pension funds that have agreed to sign remarkably one-sided agreements with private equity general partners. So why, pray tell, have they sat pat and allowed this sort of thing to go on?
Back to the current post. Although we did not indulge the idea in the older post we just cited, the SEC could in theory require more private equity disclosure, using its authority under the 1940 Investment Advisers Act. But that level of intervention would be completely inconsistent with the idea that funds like CalPERS and CalSTRS are “accredited investors,” meaning sophisticated and able, in the language of court decisions, “to fend for themselves.” Their status as accredited investors is what allows them to invest in non-SEC-registered exotica like private equity. So as we pointed out in a Bloomberg op-ed, if you are to take the logic of the earlier state officials’ and now Yee’s letter seriously, what they are really saying is that investors like CalPERS and CalSTRS aren’t capable of operating like accredited investors, and should be stripped of that designation, at least as far as investing in private equity is concerned.
And that’s before you get to the other wee problem that the SEC is not in the business of taking on powerful interests. Bowden’s tough 2014 speech about private equity misconduct was remarkably out of character for the agency, but it became far more explicable in mere months. Bowden had apparently at most hoped that his alarms would embarrass the heretofore complacent limited partners into action. Whether due to them instead circling the wagons with their victimizers, or as part of his original plan, Bowden was walking back his stern remarks less than four months later. No wonder Elizabeth Warren has called the SEC “particularly feeble”.
As we have also pointed out, state officials like California Treasurer John Chiang, as well as Yee, have a far more viable route for effecting change, if that were really their intent, which is to propose legislation, as Chiang has done. Yee’s letter, by using the ILPA template to focus on the very same issues that Chiang has already said he intends to address via path-breaking legislation, looks like an effort to try to steal his limelight or worse, sabotage his effort by falsely asserting the SEC can and should handle this matter.
Please circulate this post to friends family, and colleagues in California. Encourage them to write or call Yee. They should thank her for recognizing the importance of addressing widespread abuses and thank her for her efforts to get the SEC to make the reports that private equity investors file with the SEC available on the same basis as EDGAR data. However, also say that you are disappointed that she is turning to the SEC to suggest other private equity reforms that she could advance on her own, both by being a more tough-minded trustee at CalPERS and CalSTRS, and proposing state-level legislation.
If Yee really is serious about private equity, there are plenty of abuses that she could address via legislation. Time for her to break fresh terrain.