Memo: CalPERS says it adhered to accounting standards in shifting PE expenses

  • Controversy around $121 mln of PE fees, expenses left out of annual report
  • CalPERS reaffirms PE fund expenses, fund-of-fund fees are not related to investments
  • CEO Frost, auditor MGO dispute assertions made by JJ Jelincic

California Public Employees’ Retirement System reaffirmed that it followed government accounting standards when it shifted private equity-related expenses off its audited annual report, disputing assertions made by Board Member JJ Jelincic, according to memos obtained by Buyouts.

CalPERS staff and its external auditor, Macias Gini & O’Connell, said expenses for auditing and legal services, as well as management fees from underlying funds-of-funds, weren’t related to investment activity and therefore were not subject to disclosure in financial statements. The $323.9 billion retirement system was subjected to strong criticism in recent months after Buyouts and other media outlets reported CalPERS had shifted roughly $121 million of PE-related fees and expenses off its 2015-2016 financial statement.

“Our interpretation of [Governmental Accounting Standards Board rules] is that ‘investment-related costs’ includes all the costs associated with buying, holding or selling an investment in a security (e.g. stocks or bonds), other investment instruments (e.g currency forward contract) or maintaining an interest in a fund vehicle,” CalPERS CEO Marcie Frost wrote in a June 20 memo obtained by Buyouts. “Not included in ‘investment-related costs’ are the costs of running the underlying business that drive the value and return of the investment security or partnership interest.”

Frost was responding to a request from Jelincic, who had expressed concerns that CalPERS reassess might have violated GASB rules in how it reported fees and expenses in its annual report. Jelincic argued that the excluded expenses needed to be included in audited financial statements because they were “investment-related.”

CalPERS’s share of private equity fund expenses and underlying fund-of-fund fees will be included in supplemental materials to its annual report moving forward, Frost said in the memo. Chief Investment Operating Officer Wylie Tollettepreviously indicated staff would include information about those costs in private equity program updates presented to the board.

“As a trustee and a fiduciary it’s very troubling to say a vendor can take money directly out of the assets of the trust but it is not a cost,” Jelincic told Buyouts in a statement. He added that he is troubled by how CalPERS reported other PE-related information, including carried interest and portfolio company fees.

Pushing back

CalPERS’s shifted its share of the fund expenses limited partners pay for outside auditing and legal services, which private equity firms bill to their fund investors. The $121 million also included management fees charged by the underlying investment vehicles CalPERS pays through its funds-of-funds investments.

In the past, CalPERS staff characterized those costs as being borne directly by the retirement system and its fellow limited partners.

The retirement system had included those costs in its audited financial statements and budgets in previous years, having tabulated fees and expenses from each investment vehicle’s tax document. The amount presented in CalPERS’s annual report was reported as a lump sum that included expenses and each vehicle’s annual management fee.

In mid-2015, CalPERS launched a new accounting system that enabled the retirement system to break those amounts into their component parts. At that point, CalPERS staff deemed fund expenses and underlying management fees to be non-investment-related, which meant they could be excluded from the retirement system’s audited financial statements.

For its part, CalPERS staff struck back at critics of its PE program and its costs this week. On Tuesday, CIO Ted Eliopoulos said the controversy around the $25.9 billion private equity program and reporting of fees and expenses may result in CalPERS pulling back from the strategy.

In an op-ed published Wednesday, Investment Committee Chairman Henry Joneswrote that the rhetoric surrounding the CalPERS PE program is “often laced with personal attacks on CalPERS investment professionals [and] stands to impede the progress that CalPERS and many other limited partners have made to increase transparency and alignment of interests between limited partners and general partners.”

CalPERS and Jones did not specify how the controversy affected CalPERS and other LPs to negotiate transparency and other matters with PE fund managers.

CalPERS declined to comment. Jones did not respond to a request for comment.

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