Beware of Buyout Bullies?

Mark Maremont and Mike Spector of the Wall Street Journal report, Buyout Firms Push to Keep Information Under Wraps:
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.”

Iowa soon after released a document with numerous redactions requested by KKR, in a “Transparency Report” that details certain fees and expenses from a 2006 KKR fund in which Iowa invested $70 million. The pension fund received requests for documents from The Wall Street Journal and others.

A KKR spokeswoman said confidential treatment enhances the firm’s ability to share extensive amounts of information with its investors.

Buyout firms, facing scrutiny from regulators on fees and expenses, are trying to keep details of those matters and many others from becoming public through freedom-of-information-law requests being made by journalists, unions, private citizens and others. They have been advising public pension funds to keep secret details about fees, interactions with regulators and other investment data.

There has been a flurry of open-records requests after the Securities and Exchange Commission this year raised concerns about fee and expense practices at buyout firms. The requests often seek details on fees and SEC regulatory examinations.

Financial firms and other corporations often closely guard what they deem to be secret strategies with competitive implications. In this case, private-equity firms are sometimes threatening to punish investors who don’t heed warnings about keeping documents they deem confidential out of public view.

Public pension funds collectively are the largest investors in private equity, with more than $500 billion committed world-wide, accounting for roughly 28% of the total cash outside investors give these investment firms, according to data provider Preqin.

Government employees, retired teachers, firefighters, police officers and taxpayers all have money at stake in these pension plans, and have an interest in how the plans are run and the fees they incur.

The pension funds, under pressure to seek sizable returns amid funding shortfalls, often want to avoid antagonizing buyout fund managers. Meanwhile, private-equity firms aren’t shy about suggesting that access to their funds, which can garner big returns, is a privilege that can be taken away.

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.”

In the Iowa case, the pension fund’s general counsel, Gregg Schochenmaier, said KKR’s confidentiality request was “an appropriate assertion of their rights” under Iowa public-records law.

There are varying federal and state open-records laws designed to allow citizens access to documents, emails, meeting minutes and other records related to how government agencies and employees conduct work.

Buyout firms contend it is crucial to keep much information secret for competitive reasons. Disclosing certain data “could undermine a fund’s ability to invest and generate high returns for its limited partners,” said Steve Judge, chief executive of the Private Equity Growth Capital Council, an industry advocacy group.

Private-equity firms enjoy special protection under some state open-records laws, exempting much of their information from disclosure. Some of the exceptions were enacted a decade ago, after a 2003 incident in which venture-firm Sequoia Capital booted the University of Michigan from its fund after the school provided performance data to a newspaper. A Sequoia spokesman declined to comment.

Other skirmishes have arisen this year in various states. A North Carolina public-employees union this year battled the state treasurer over open-records requests, which sought information about alternative-investment fees as part of a union investigation into alleged pay-to-play activities. Citing a broad “trade secrets” exemption for records designated confidential by state contractors, the treasurer produced some records that were heavily or completely redacted.

“It’s all cloak-and-dagger and very hidden with the fees,” said Anne Marie Bellamy, a 60-year-old retired community-college administrator and union activist in Holden Beach, N.C., who receives state pension benefits. “We have a right to know where our money is. I’m planning on that money.”

A spokesman for North Carolina’s treasurer said it provided many unredacted documents to the union, but was obligated under state law to protect certain information. The treasurer’s office avoids making them public amid concerns that investment firms and other companies would stop doing business with the state, he said.

In June, citing concern about the SEC private-equity scrutiny, the Washington State Investment Board sent a questionnaire to 38 of its private-equity managers, asking about fees and expenses and the results of any SEC examinations.

In response to an open-records request from the Journal, the Washington pension fund asked its private-equity managers whether they were opposed to releasing the records under state law. The fund said it received overwhelming expressions of concern about confidentiality from the firms and needed time to review which records would be redacted.

In Florida, a special exception to the state’s expansive Sunshine Law, enacted in 2006, allows alternative-investment firms to designate documents as proprietary and exempt from disclosure.

The Florida pension fund this year also emailed private-equity managers asking about fees and SEC exam findings. In response to a Sunshine Law request from the Journal, the fund provided some heavily redacted responses. A three-page response from KKR was almost entirely redacted.

A spokesman for the Florida fund said the 2006 law shielding some records from disclosure achieves “an appropriate balance.”
The issue of disclosure of private equity fund investments has been garnering a lot of attention lately. Yves Smith (aka Susan Webber) of naked capitalism laments, Private Equity Kingpin KKR Threatens Iowa Pension Fund Over FOIA Request:
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. 
One of the comments by Peter Donohue at the end of the Wall Street Journal article caught my attention:
Oregon's public information law should be the gold standard for other states including public employee pension funds. Only documents concerning matters under deliberation, i.e. deciding whether a fund, for example, will or won't become a limited partner with a private equity firm, are excluded from disclosure - and those are excluded only until the decision is made. This hasn't prevented the Oregon Investment Council and other public pension fund fiduciaries from claiming that asking for information beyond dog-and-pony show presentations by KKR etc. twice a year may put limited partners at risk of sharing in general partners' liabilities. Claiming that limited partners' fiduciary responsibility requires accepting the 'mushroom treatment' from KKR et al. is a travesty.
Kohlberg Kravis Roberts (KKR) recently reported that its profit fell amid slowing growth in private equity. The environment for these large private equity firms is very tough and it won't get easier, which might be why they're pushing back hard against more disclosure of their operations (luckily all their candidates got elected on Tuesday).

But pushing back hard against public pension funds and others looking for more disclosure will just bring more attention to private equity's sunshine problem:
In October, New York Times reader Saqib Bhatti penned a letter questioning the ethics behind keeping private equity limited partnership agreements confidential.

“It is absurd that … huge pension funds like the California Public Employees’ Retirement System refuse to demand transparency from private equity firms for fear that the firms will stop doing business with them,” Bhatti wrote in the Oct. 20 letter to the editor. “Wall Street boycotting CalPERS would be like popcorn vendors boycotting movie theaters.”

The spirit of Bhatti’s letter is right on track, though the details need to be fleshed out. High-level private equity fund terms should be open for public consumption – there is no reason these terms need to be hidden from the beneficiaries of the pension systems that invest in the funds.

Here is a list of terms that should be open for viewing at all public systems in the United States, and these should be made public at the very least within several weeks of commitments being approved:

• name of firm and fund

• commitment amount

• fund target

• any and all fees, including carry, management, monitoring, board and transaction fees

• percentage of any fees that will be shared with the LP

• key fund executives

• general investment strategy

• fund track record

• placement agent (if any)

• political donations to local officials, and

• pros and cons outlined by investment staff

Also helpful would be a summary and rationale behind investment staff’s decision to invest in the particular fund.

To be sure, several public systems already include this information, so it is perplexing why every public system doesn’t disclose even this very rudimentary level of information.

One public LP that doesn’t provide enough timely information about its PE investments is the Colorado Public Employees’ Retirement Association. The system has a list of all the commitments it has made going back to 1982, but it only updates the current year’s activity months into the next year. This is due to state law, according to Katie Kaufmanis, public information officer with the system.

The data provided by Colorado includes internal rates of return since inception, so performance can be tracked. However, anyone looking for Colorado’s private equity activity this year, for example, is out of luck until sometime next year. And forget about information on the fees the system pays to individual funds.

The Maine Public Employees Retirement System had formerly been open on details of its commitments. For example, we learned from Maine documents that H.I.G. Bayside is in the market targeting $1 billion for its H.I.G. Bayside Loan Opportunity Fund IV. More importantly, the documents revealed some concern on the part of Maine’s investment staff about what they saw as a high level of turnover in Bayside’s managing director ranks. After we published a story about the staff’s concern, we learned yet another Bayside managing director, David Robbins, had also left the firm. Pensioners and tax payers should have access to this kind of information to understand the risks investment staff is considering while managing their money.

The routine defense of confidentiality is that revealing this kind of information would hurt firms, and, by extension, LPs and their beneficiaries, by putting GPs’ “trade secrets” out there. Steve Judge, president and chief executive officer of the Private Equity Growth Capital Council, wrote in a column for peHUB this week that making LPAs public is:
“akin to demanding that Coca-Cola publish its famous (and secret) soda recipe. Like Coke’s secret recipe, LPAs contain proprietary and commercially sensitive trade secret information that, if disclosed, could undermine a private equity fund’s ability to invest and generate high returns for its limited partners. Overnight, competitors would have access to sensitive information, like the fund’s investment strategy, investment limitations, and key personnel that competitors could use to outbid the fund on a deal or otherwise disadvantage it in competitive negotiations.”
To be clear, I don’t believe full LPAs should be made public. Detailed information about portfolio company financials should be confidential to protect from competitors.

But this is not the case for these high-level terms. Most terms in the industry are very similar and some public systems already release much of this information, making it available to the public already. Firms have had to learn and adapt to a world where this information can be widely available, depending on a fund’s LP base.

The idea that a big public system risks losing access to top-level managers by revealing this information is laughable. While top-performing GPs can pick and choose who comes into their fund, getting into those vehicles is likely not a function of how much information you make public about your private equity program. For example, the Los Angeles County Employees Retirement System, which routinely shares information about its PE investments, was not prevented from committing to Hellman & Friedman’s latest fund, which was one of the most in-demand funds this year.

Firms can threaten and cajole all they want, but in the end, if they need money to hit their targets, they’re going to take commitments even from disclosure-friendly LPs. And if a firm decides to exclude a retirement system from its fund because of that system’s level of disclosure, the system is better off moving to the next manager. There will be another great manager just around the corner less concerned with making public information about the fund.

It is time for consistency across the U.S. public pension system universe when it comes to private equity transparency. High-level terms should be made public in a timely fashion for everyone to understand the costs, benefits and risks of a system’s private equity program.
As I recently discussed, it's high time the SEC probes private equity fees and lifts the veil behind the industry's iron curtain. In that last comment, I shared my thoughts on what needs to be done:
Go back to read my comment on the dark side of private equity where I discussed some of these issues. I'm not against private equity but think it's high time that these guys realize who their big clients are -- public pension funds! That means they should provide full transparency on fees, clawbacks and other terms. They can do so with a sufficient lag as to not hurt their "trade secrets" but there has to be laws passed that require them to do so.

And what about the Institutional Limited Partners Association (ILPA)? This organization is made up of the leading private equity investors and it has stayed mum on all these transparency issues. If they got together and demanded more transparency, I guarantee you all the big PE funds would bend over backwards to provide them with the information they require.
Amazingly, the ILPA has yet to put out a press release on what constitutes proper disclosure in terms of private equity fund investments. I've been to a few of their meetings in my past life as senior investment analyst, and let me tell you, they don't do much at these meetings except talk about fund investments (in my opinion, it's a big networking schmooze fest and pretty much a waste of time!).

Not everyone agrees that more disclosure is a good thing. One astute private equity investor shared these thoughts with me:
Private equity is indeed supposed to be private. The onus is on the institutional investors, like Iowa, to govern their investments well. If they think keeping arrangements private is in the best interest of their members, then that is their call.
There are plenty of arguments around keeping economic arrangements private, views on how much and what way managers get paid from people who are not accountable for results is a bad actually do have to position and compete for transactions, including getting into many funds with sufficient time for adequate diligence, at least at certain points of a cycle.
It is a big and competitive world out there, and if public funds want to abandon an area in favour of endowments and high net worth family offices who do not feel the need to disclose private information, then that is the call of a specific organization. But make no mistake, PE general partners, especially successful ones, do look at the quality and effectiveness of their investor base, and favour those that are practical and productive in important ways.
It is a competitive world but endowments are turning negative on private equity and as the first article above states, public pension funds are by far the biggest investors in private equity and that trend won't change. PE firms need public pension funds (and sovereign wealth funds) to grow their assets exponentially, garnering those all-important fees, especially that management fee which they receive no matter how poorly funds perform (quite worrisome, PE funds are now eying retail investors).

It's also true that many underfunded public pension funds need to be invested with top private equity funds in order to obtain their actuarial target rate-of-return. Private equity is an important asset class and unlike hedge funds, PE funds have to first return all capital contributed by investors and clear a hurdle rate (traditionally 7-8%) in order to receive the carry (carried interest or performance fee). The tradeoff is that investors have to take on more illiquidity risk, which isn't always straightforward, especially in this environment.

Moreover, it's worth noting that private equity funds are not as sinister as naked capitalism portrays them to be and there are big benefits in private companies. Mark Wiseman, chief executive of Canada Pension Plan Investment Board, said during a conference Tuesday that in general, privately owned businesses perform better than public companies. A crucial reason for the difference is the “agency costs” of being a public company. “Agency costs” are less of an issue at a privately held business, because the business’s owner is typically also the manager. “The further you get away from sole proprietorship, the more agency costs you have,” he said.

Mark referred to computer maker Dell Inc., saying it is an example of a formerly public company that sees its agency costs “melting away” under private ownership. CPPIB is a longtime investor with Silver Lake, the firm behind the Dell buyout.

Dell just celebrated its first anniversary of a $24.9 billion going-private transaction. In a recent LinkedIn post, Founder and Chief Executive Michael Dell wrote that the company is enjoying “the kind of focus and freedom only a private company can enjoy.” Staying relevant in a fast-changing industry is tough,” Mr. Dell wrote. “The 90-day Wall Street shot clock makes it tougher.”

Below, Dell chairman & CEO Michael Dell, discusses how as a private company, he plans to outmaneuver the competition. And David Rubenstein, The Carlyle Group co-founder and co-CEO, says there's no place comparable to the United States for investing, but sees good opportunities in Europe and China (see rest of this interview here).

I agree, which is why I ONLY trade and invest in U.S. stocks, but I would tread carefully in Europe and think far too many investors are underestimating the "new" risk of deflation spreading to North America. That's why I'm not touching commodity and energy stocks, even if most are way oversold and could experience a nice relief rally after the latest rout. For example, check out moribund coal stocks that bounced hard this week following the GOP victory (be careful trading these relief rallies).

I end by reminding all of you that this is the best blog on pensions and investments. Nobody covers the breadth and depth that I cover, so please show your appreciation and contribute via PayPal at the top right-hand side. I appreciate all the great feedback but prefer to see your contributions. Thanks!