Keeping a lid on sensitive information is more difficult than ever these days. Our very own editor-at-large, Dan Primack, recently obtained confidential documents released to investors at the May annual meeting of
The explosion of interest in private equity since the beginning of the LBO boom in 2004, coupled with the ever-more instant means of dissemination available on the Internet, has created a climate that’s led to increasing amounts of previously unseen data seeing the light of day. Of particular concern is information about the performance of individual portfolio companies, which general partners regularly share with LPs, but are loathe to see leak out for competitive reasons. So what can general partners do to make sure the proprietary information they provide to limited partners doesn’t get wider distribution?
John Beals, a partner at Nixon Peabody LLP, said issues of confidentiality are usually addressed in side letters with individual LPs during partnership formation. These letters take into account the specific disclosure requirements of the investor, such as requirements under state Freedom of Information Acts (FOIA), which apply to public pension funds.
Tight-lipped as they are, most GPs are willing to provide some performance data that they understand could end up in the public domain. The usual circumstances involve an LP that is a fund of funds which needs to satisfy reporting obligations to its own investors. In these instances, the GP will provide aggregate fund-level performance data, meaning the numbers will relate to the entire fund, but never individual portfolio companies. “There’s not a GP out there that will allow disclosure on a portfolio company,” Beals told Buyouts. “That information is always locked up.”
As for dealing with FOIA requests, the GP will likely establish the requirements on the LP’s part within the side letter, as well as some options of its own, Beals said. As with so many other details of the partnership agreement, these requirements are ripe for negotiation. Typical clauses include the LP having to inform the GP of the information request, that the LP make what the GP considers a “reasonable” effort to prevent the disclosure, and even the right for the GP to stop providing certain kinds of information to the LP if the GP determines the disclosure goes too far. Indeed, a recent survey of GPs by Buyouts found that one in six withholds certain information from investors governed by FOIA laws.
Some firms decide the risk isn’t worth the reward. Elizabeth Shea Fries, a partner with Goodwin Procter LLP, said there are a number of sponsors that won’t accept money from LPs that are subject to FOIA.
In the spirit of satisfying the desire for greater transparency while at the same time preserving the need to maintain the confidentiality of sensitive information, LPs and GPs will in some cases establish alternate means by which the information may be provided to a particular LP in order to make public disclosure of such information less likely, according to Beals. Options can include steps like the GP setting up a password-protected Web site that doesn’t allow data to be downloaded or printed. They may also opt for in-person meetings, allowing the LP to come into the office and discuss specifics in an environment the GP can control. Without take-home materials, of course.
What about situations where the buyout firm feels the LP is treating sensitive information far too casually? The remedies available to a GP are pretty standard. In the near-term, a warning can be issued and information flow stopped. From there, a GP will mull its legal options. Beals said some default provisions will include a violation of confidentiality or the equivalent, but he believes only a minority of funds include such a clause. If the clause catches on, however, it would open up economic remedies to the GP, such as forfeiture of the LP’s stake in the partnership. Down the road, there’s the old-fashioned remedy of uninviting a particularly gossipy LP from the party by keeping that investor from re-upping with a subsequent fund.
Safeguarding data is poised to become an even bigger issue for buyout firms as the government moves toward increased regulation of the private equity industry. For example, if GPs are eventually required to register as investment advisers, or if the authorities step up their scrutiny of fair value accounting of portfolio investments, more information is likely to flow to the media. And that could create a climate where LPs become even less sensitive to the demands of GPs for confidentiality.