In the midst of his 2014 campaign for the role of Rhode Island General Treasurer, former Trillium Asset Management Vice President Seth Magaziner proposed that the state’s $8.1 billion pension bolster its bargaining power by forming a coalition of state retirement systems to collectively negotiate lower fees.
Less than a year into his first term, Magaziner has yet to deliver on that proposal. But Rhode Island’s treasurer was instrumental in assembling a separate coalition of elected officials and pension leaders to petition the SEC for greater transparency and standardized reporting from private equity fund managers.
In a July 21 letter to SEC Chair Mary Jo White, the treasurers criticized the private equity industry’s methodology for disclosing certain monitoring fees, portfolio company expenses and carried interest payments. While private equity has outperformed other asset classes, “greater private equity fee disclosure standards are in the public interest,” the treasurers wrote.
“It would be great if the SEC would take the lead on that [standardized reporting] but, if they don’t, I would hope that this furthers public discussion on how we can bring transparency to the private equity world,” Magaziner told Buyouts. “It’s not like we’re asking anyone to disclose anything to the public that would impede their ability to do what they do…It’s basic information about fees and expenses.”
While GPs typically report to LPs the fees and expenses they charge to funds and portfolio companies, the frequency with which they do so varies, according to the letter. Furthermore, the lack of a standardized reporting taxes limited resources, as staff members have to spend weeks breaking down the data they collect from the GPs, Magaziner said.
More specifically, the treasurers said that it is difficult to segregate the fees, expenses and carry GPs disclose in their quarterly or annual reports. The situation is comparable to what it would be like if restaurants took what you owed out of your next paycheck, rather than handing you an itemized bill at the end of a meal. You know what you paid in sum, but it would be difficult to assess the cost of each item, or to tell if you were billed correctly, Magaziner said.
Even though Rhode Island has not encountered any sort of impropriety within its own portfolio, “it should be on the GPs to explain to the LPs in an understandable way what the fees and expenses are,” said Magaziner. “The way that information is reported for us, it’s very cumbersome.”
“We would like to see some baseline standards within private equity funds,” said Oregon Treasurer Ted Wheeler, who also signed the letter. “It makes it very difficult to fulfill our duties to our beneficiaries.”
The SEC declined to comment.
CalPERS and CalSTRS don’t track carry
The difficulty that pensions have accounting for fees, expenses and carry became evident in recent months after the California Public Employees’ Retirement System and California State Teachers’ Retirement System disclosed they had not tracked the amount of carried interest collected by their private equity fund managers.
Long considered among the industry’s most savvy LPs, CalPERS and CalSTRS were roundly criticized—often by members of their own boards— for failing to analyze information that was likely made available by its fund managers, according to Buyouts sources and other media reports.
California State Treasurer John Chiang, a CalSTRS and CalPERS board member who also signed the letter to the SEC, told The Financial Times the disclosures merited investigation into how pension fund money was being spent, laying bare how the relationships between public pension boards and private equity investment staff can fray.
Chiang’s office did not respond to requests for comment for this article.
“When there’s headlines about the largest public pensions in the country not being able to respond to FOIA (Freedom of Information Act) requests about carried interest, that’s embarrassing,” said TorreyCove Capital Management President and Chief Executive Officer David Fann, speaking on a panel at a Pension Bridge conference last month in Chicago. “All of you are going to get FOIAs on carried interest, because the press loves that stuff.”
While speaking on the same panel, only hours before Buyouts broke the news about the treasurers’ letter to the SEC, New York City Retirement System private equity chief Alex Doñé said he expected public pensions to react to stories about fees, expenses and regulatory scrutiny “in a very public way.”
There is a “progressive element in our constituency and our boards where—if they read about less transparency, less alignment of interest—there will be less conviction on investing in this asset class,” he said.
Who tracks what?
Given the uncertainty around fees and expenses at CalPERS and CalSTRS, it is not surprising that the pensions overseen by the letter’s signatories vary in their ability to capture the costs of their respective programs.
According to Wheeler, staff managing the state’s $14.6 billion private equity portfolio can track the amount of carried interest accrued by its managers. Meanwhile, in Washington, DC, the retirement board does not have a comprehensive understanding of how much carried interest its GPs collect, but is currently working toward a more complete analysis, Treasurer Jeffrey Barnette said in an email.
Missouri Treasurer Clint Zweifel estimates the staff at the Missouri State Employees’ Retirement System can monitor “70 to 80 percent” of private equity’s costs, but still has a hard time following the expenses GPs bill to their portfolio companies.
“Every pension fund is doing this slightly differently, so when we’re comparing different costs at different funds. We’re comparing apples to oranges,” Zweifel told Buyouts. “If the inputs there aren’t the same, it’s not really a fair comparison.”
What about ILPA?
Of course, this is not the first time LPs banded together to call for standardization of reporting and transparency. In 2011, the Institutional Limited Partners Association released a standardized reporting template for capital calls and distributions.
Those templates, and ILPA’s best practices for quarterly reporting, require GPs to break out fees and expenses into their individual components so LPs can account for what they’ve paid in management fees, broken deal fees, advisory/director fees and monitoring fees.
It is not clear how many investors regularly use the template, however. During a July 21 panel at Pension Bridge’s Chicago conference, Hamilton Lane Managing Director Tara Blackburn said she knew of only one LP client that used ILPA’s capital call template.
Furthermore, even if LPs use the ILPA templates for their own accounting, they don’t account for some of the thornier issues around how fees can be charged back to the fund, Magaziner said.
For example, firms could “spin off a portion of your staff, call them an independent consulting firm, then bill the LP separately from the management fee,” he said. “It’s something that the current standards wouldn’t reveal.”
In a statement, ILPA Director Matthew DeMatteis said the organization agrees that more needs to be done in regards to transparency. He said that ILPA is working with its members on “several mission-critical efforts aimed at encouraging adoption of more uniform practices around fee/expense reporting, and compliance disclosures.”
Sidebar: Engaging with staff
The degree to which the members of Seth Magaziner’s coalition—most of whom are elected officials—consulted with their respective investment staffs prior to joining the coalition ranged from “extensively” to “not at all.”
Staff members overseeing private equity allocations at the South Carolina Retirement System Investment Commission did not have any input in Treasurer Curtis Loftis’ decision to sign on, spokesman Scott Lindenberg told Buyouts in an email.
“They are generally not friendly to the Treasurer’s initiatives until public opinion on the issue is settled,” he said. “The Treasurer is usually ahead ‘of the curve’ and staff tends to come around at some point, but generally not until the dust settles.”
Meanwhile, Magaziner said he collaborated closely with his investment staff on the letter’s tone and contents. In the District of Columbia, Treasurer Jeffrey Barnette said he consulted with staff at Washington, DC’s $6.5 billion retirement system before he signed.
“They feel it’s important to get as much transparency they can when it comes to fees and transactions,” Barnette said. “The ultimate goal is to make sure that those who are investing in the PE programs are getting the information they need to get, and if there’s a way to expand it, they’ll push for that.”