Private Equity Fee Disclosure Law Signed By Jerry Brown

Jerry Brown on Thursday signed a law requiring California’s public pension funds to disclose fees and carried interest paid to alternative asset managers.

The new law appears to make very few people happy on any side.

As we’ve written previously, advocates of disclosure say the law doesn’t go far enough and was gutted in backroom meetings. Meanwhile, some public pension officials have publicly worried the law would make it difficult to do business with asset managers.

From ai-cio:

The new law, which affects commitments to private equity, venture capital, hedge funds, and absolute return funds, will apply to investments made on or after January 1, 2017.

“California taxpayers and pension beneficiaries will now get to go behind the curtain to view the previously hidden fees and charges paid to Wall Street firms,” said State Treasurer John Chiang, who sponsored the bill.

Public pensions based in California—including the California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS)—will be required to “undertake reasonable efforts” to obtain and disclose fee information, as well as the gross and net rate of return of alternative investment vehicles, at least once annually at a meeting open to the public.

As for the watering down of the original bill, Naked Capitalism’s Yves Smith writes:

AB 2833 has gaping holes that will allow general partners to structure related party payments to escape reporting. The bill, which you can read here, has a very long and complicated definition of what constitutes a related party. It is inferior to shorter and more comprehensive definitions in earlier drafts.

[…]

AB 2833’s definition of “portfolio company” allows payment to be routed through other entities. The definition of “portfolio company” is more obviously deficient than that of “related party” and again allows the bill to be circumvented:

“Portfolio companies” means individual portfolio investments made by the alternative investment vehicle.

Huh? What does “individual portfolio investments” mean? This language does not map onto legal entities or contractual relationships. But by saying “individual,” that would appear to set up the argument that the portfolio company is only “individual” meaning the senior-most legal entity that owns fund assets. But private equity funds seldom invest directly in a portfolio company. For tax and other reasons, there are often “blocker” legal vehicles and other legal entities that sit between the private equity fund and the investee business. It thus appears that general partners could launder the former portfolio company fees through legal vehicles that sit above the portfolio company. For instance, Portfolio Company contracts with Intermediate Co. which has a mirror contract with the general partner or a related party.

Reporting is at far too high a level of abstraction to allow for verification or cross-checks. Another major flaw in the bill is that it fails to report fees quarterly, as the unhappy 13 major trustees had called for, and is nowhere near granular enough to allow them to map the fees back to either portfolio company activities or limited partnership agreements. It simply calls for an aggregate of fees and costs, reported on a pro-rata basis for the fund and also by the portfolio companies.

Bear in mind that the previous version of the bill required that all related party transactions be reported. The current version calls only for providing each CA public fund with its pro rata share of those fees.