According to a tentative court ruling, the world at large may soon have access to internal rates of return (IRRs) for the 250 private equity funds committed to by the California Public Employees’ Retirement System (CalPERS). On the flip side, it appears unlikely that general partners will be forced to explain how those IRRs were derived. In other words, people can see the sausage, but not all of the stuff inside like portfolio company valuations, fund investment strategies or accounting methodologies.
This finding comes from Judge James Robertson of the San Francisco Superior Court, who last month heard preliminary arguments in a case brought against CalPERS by the San Jose Mercury News. The newspaper had argued in an October pleading that CalPERS, which is the nation’s largest public pension fund, should be compelled by the California Public Records Act to release fund-by-fund performance data from within its $20 billion private equity portfolio. Once in court, attorneys representing the plaintiff also expressed a desire to see underlying asset data from CalPERS’ general partners, such as portfolio company valuations from the funds in which CalPERS invests.
CalPERS’ primary line of defense was that IRRs constituted a trade secret, but Judge Robertson disagreed and said that such data should be available for public consumption (this is a tentative ruling which the judge can later overturn). Rather than slamming the door completely, however, the judge said that CalPERS’ GPs who disagree with his tentative finding have until Dec. 9 to file a declaration with the court explaining why fund IRRs should be considered trade secrets. If the Mercury News contests the declarations, a referee will be assigned to the case and make a recommendation to Judge Robertson prior to a Jan. 30 hearing.
“He’s given an opportunity for general partners to argue their case,” said Pat Macht, head of public affairs for CalPERS. “He’s trying to get the contestability down to who is actually asserting the trade secret protection.”
As for underlying asset data, including the identity and value of every company in a fund’s portfolio, Judge Robertson said that it is all competitive information protected as a trade secret. The only exemption would be if a GP released this information without confidentiality attached. If the GP did, indeed, keep the information secret, then the GP must submit a letter certifying such continued confidentiality to the court. The Mercury News has the right to challenge those letters, at which point a referee would be brought in, make a recommendation and Judge Robertson would rule at the Jan. 30 hearing.
“The judge is being very careful on this,” said David Godkin, a partner at Testa, Hurwitz & Thibeault LLP, a law firm that represents the National Venture Capital Association. “He could have ruled that everything was or wasn’t a trade secret.”
One attorney representing a number of CalPERS’ GPs said that some of his clients were adamant about not having their IRR information released. “Most of them are more concerned about portfolio company information being published, but some will, most likely, file these IRRs as trade secret declarations.”
It is not yet clear what arguments such firms will make, but there are some definite options. First, a GP may argue that the IRR is the result of trade secret-protected accounting methodology and, as such, inextricably linked. Likewise, a GP could say that the IRR essentially is the aggregate of private company valuations, which are also trade secret protected.
“Trade secret is generally something that someone takes extra care to protect,” said a venture capital industry attorney. “Since most funds market and form partnership agreements on new funds with nondisclosure agreements (NDAs) attached, I don’t see why trade secret wouldn’t apply.”
Karl Olsen, a lawyer representing the Mercury News, countered that recent open disclosure agreements by institutional investors like The University of Texas Investment Management Co. (UTIMCO) make sure secrecy is a moot point. “The horse is out of the barn [on IRRs],” he argued. “Even if [GPs] want to keep them secret, the court has to weigh the balancing test of public interest.”
The issue of the public interest balancing test is an important one, because it is at the heart of both sides’ case – the newspaper arguing the public’s right to know and the pension fund arguing that nondisclosure will ultimately help generate higher returns for pensioners by keeping CalPERS in top-tier funds. Perhaps more importantly, the balancing act argument is CalPERS’ second and final line of defense if it ultimately loses in a final ruling on any contested IRR disclosures. Judge Robertson declined to hear most of the balancing act arguments in the initial hearing, but may take them up during the Jan. 30 hearing.
Opening Trade Secrets
In an interesting bit of irony to all this, CalPERS followed up its court appearance by revealing that it once published partial valuation information on approximately 850 California-based private companies in which it had invested. The information appeared in both a printed brochure and on the pension system’s Web site, according to court papers (available at www.buyouts-newsletter.com).
The released data did not include complete portfolio company valuations. Instead, CalPERS listed the company name, its industry, what partnership it had invested in the company through (if indirect) and the market value of CalPERS’ particular investment. What CalPERS did not reveal was its ownership stake in each company, so overall valuations could not be determined, just mark-ups or write-downs.
“This came from a one-time special report on California holdings and we have not continued giving out this type of information,” said CalPERS’ Macht. “Regardless of what’s been given out in the past, the court will give us direction so that in the future we’ll know once and for all if this is trade secret or not.”
In related news, Buyouts has discovered that some old fund performance data from 1997, 1999 and 2000 is still floating around cyberspace courtesy of CalPERS. The information does not include IRRs, but does discuss cash-in/cash-out disbursements.