On September 14, 2016, California passed Assembly Bill Number 2833 to require managers of any private equity fund, venture fund, hedge fund, or absolute return fund (Private Fund) to provide additional disclosures for investments by California state and local public pension plans (Cal Plans). The bill amends California’s existing Private Fund disclosure rules to require that fee and expense information not historically included in agreements with Cal Plans or otherwise made publicly available must be publicly disclosed on an annual basis.
Existing Basic Disclosures
For investments by Cal Plans, the California Public Records Act (CPRA) currently requires Cal Plans that invest in Private Funds to provide, upon request, basic disclosures (Basic Disclosures) with the following information:
- The name, address, and vintage year of each Private Fund
- The dollar amount of the commitment made to each Private Fund by the Cal Plan since inception
- The dollar amount of cash contributions made by the Cal Plan to each Private Fund since inception
- The dollar amount, on a fiscal yearend basis, of cash distributions received by the Cal Plan from each Private Fund
- The dollar amount, on a fiscal yearend basis, of cash distributions received by the Cal Plan plus remaining value of partnership assets attributable to the Cal Plan’s investment in each Private Fund
- The net internal rate of return of each Private Fund since inception
- The investment multiple of each Private Fund since inception
- The dollar amount of the total management fees and costs paid on an annual fiscal yearend basis, by the Cal Plan to each Private Fund
- The dollar amount of cash profit received by Cal Plans from each Private Fund on a fiscal year-end basis
Historically, Private Fund fee and expense information was considered a trade secret proprietary to the fund manager and wasn’t required to be provided under the CPRA. The bill would force Cal Funds to require that Private Funds in which they invest make public disclosures of certain fee and expense information.
Under the bill, Private Fund that manage investments for Cal Plans must make additional disclosures (Additional Disclosures) with the following information:
- The fees and expenses that the Cal Plan pays directly to the Private Fund, the Private Fund’s manager, or related parties.
- The Private Fund’s pro rata share of fees and expenses not included in paragraph (1) of the Additional Disclosures paid from the Private Fund, the Private Fund’s manager, or related parties. The Cal Plan may independently calculate the fees and expenses based on information contractually required to be provided by the Private Fund to the Cal Plan. If the Cal Plan independently calculates the pro rata fee and expense information, the Private Fund will not be required to provide the information.
- The Private Fund’s pro rata share of carried interest distributed to the fund manager or related parties. The bill defines carried interest as “any share of profits from a Private Fund distributed to a fund manager, general partner, or related parties, including allocations of Private Fund profits received by a fund manager in consideration of having waived fees that it might otherwise have been entitled to receive.”
- The Cal Plan’s pro rata share of aggregate fees and expenses paid by all of the portfolio companies held within the Private Fund, the Private Fund’s manager, or related parties.
- The Basic Disclosures required to be provided under the CPRA.
What Fund Managers Need to Know
The bill requires disclosure of fees and expenses that any Cal Plan “pays directly to the Private Fund, the fund manager, or related parties.” Related parties include “any consulting, legal, or other service provider regularly engaged by portfolio companies of a Private Fund, account, or fund managed by a related person and that also provides advice or services to any related person or relevant entity.” This means that attorneys’ fees, fees paid to consultants and the fund manager’s travel and entertainment expenses may now be publicly available. However, the bill doesn’t define the terms “regularly engaged,” “fees” or “expenses.” It is unclear what constitutes “regular” engagement and whether fees and expenses will include discounts, incentives or other forms of compensation. For private equity and venture capital fund managers, the bill doesn’t require disclosure of the operating results of portfolio companies. For hedge fund managers running equity or equity-linked funds, the bill doesn’t require disclosure of investments (but many positions are already publicly reported on SEC Form 13F).
Manner of Disclosure
The bill requires Cal Plans to disclose the Basic Disclosures and Additional Disclosures at least once annually in a report presented at a meeting open to the public. The report must include the gross and net rate of return of each Private Fund, since inception, in which the Cal Plan participates. The Cal Plan may report the gross and net rate of return and fee sharing information based on its own calculations or based on calculations provided by the Private Fund. The bill does not require the investment management agreement, limited partnership agreement or related documentation to be publicly disclosed.
The bill applies to all new contracts that Cal Plans enter into on or after January 1, 2017, as well as all existing contracts pursuant to which Cal Plans make a new capital commitment on or after January 1, 2017. For legacy contracts for which a Cal Plan will not make a new capital commitment after January 1, 2017, the bill would only require the Cal Plan to undertake “reasonable efforts” to obtain the Additional Disclosures. The bill does not define reasonable efforts.
What Happens in Sacramento Doesn’t Stay in Sacramento
California is the first state to pass legislation mandating additional disclosures regarding fees and expenses for investments by public pension plans. Given the size and importance of California’s pension system, including the role that California Public Employees’ Retirement System (CalPERS), California State Teachers’ Retirement System (CalSTRS) and the University of California Retirement Plan often play in setting standards for other state plans, we can expect other states to follow. Other states may consider whether to require that alternative investment managers use the reporting template created by Institutional Limited Partners Association or some other another standard form to disclose fees and expenses. However, alternative investments don’t conform to “one-size-fits-all” boxes and additional disclosures may not be in either party’s best interests. Mandatory disclosures may limit a public pension plan’s choice of alternative investments, and may increase political pressure on pension plans to invest in low-cost alternatives, or to forego externally-managed investments entirely. This could be problematic for smaller public pension plans with less negotiating power and fewer assets under management, as they may find themselves limited in their choice of asset managers. Alternatively, larger public pension plans could pay higher fees because they could effectively lose the ability to enter into favorable side fee arrangements when making substantial commitments. Fund managers may fear that customized fee arrangements would end up being publicly disclosed, thereby leading other investors to request similar treatment, which would put further downward pressure on a manager’s fees. The Additional Disclosures may be helpful for Cal Plans to make informed investment decisions, and for improved public transparency, but overly broad disclosure templates could have the unintended consequences of limiting investment options or the ability to negotiate bespoke fee arrangements. The political push for greater transparency of fees and expenses paid to alternative investment managers may provide for greater public accountability, but it does not necessarily translate to providing pension plans with negotiating leverage or a wider selection of available investments.