The fee-reporting debate takes a detour

When the Institutional Limited Partners Association’s chief executive officer Peter Freire told an audience of fund managers at the beginning of the year that general partners should adopt the organization’s fee reporting template or regulators would get involved, he wasn’t too far from the truth.

Freire evoked the possibility that federal bodies like of the US Securities and Exchange Commission could step in and impose their own way of asking GPs to report fees and expenses uniformly to investors.

Right on cue, just a few weeks after Freire’s speech at Private Equity International’s CFOs and COOs Forum, legislators entered the debate. The California legislature introduced Assembly Bill 2833, which would require public retirement systems to ask each alternative investment vehicle in which it has commitments to make disclosures regarding fees and expenses. Systems would also have to disclose that information at least once annually at a meeting open to the public. According to the bill, the requirements would be for fund contracts entered into, amended or extended on or after January 1, 2017. The information required would include management fees, carried interest, expenses paid to the vehicle, the fund manager, or related parties, and the gross and net internal rate of return of each fund since inception.

Some would call this a positive development: a reassertion of the need for a uniform fee and expenses reporting system with private equity firms. However, it may well have unintended consequences. The main problem with AB 2833 is that it doesn’t offer a specific methodology to achieve its goal, leaving it to the discretion of each pension plan to interpret it and to come up with its own format. As a result, it could add a layer of complexity to an already complex issue.

Historically California – like New York – has reacted more dramatically to industry developments than other states (remember Pay-to-play?). Imagine if it sets a precedent and each state decides to jump into the fee reporting debate in the same way. GPs could easily be looking at 50 different ways of reporting, a nightmare for private equity firms. California pension plans, realizing this, are suggesting changes to AB 2833.

The California Public Employees’ Retirement System, which supports the efforts of ILPA and began adopting the ILPA fee reporting template in late January, also supports AB 2833 in principle. But it has suggested several modifications to minimize the negative effects that the bill could have on the pension system’s operations.

One of the other problems with AB 2833, as CalPERS sees it, is the fact that it includes in its scope funds being amended, forcing GPs to renegotiate reporting requirements in agreements that can be at least 10 years old. This could force CalPERS to abstain from amendments that are in its best interest. The pension also noted that blending the reporting of carried interest with certain management fees and expenses would be inconsistent with its reporting practices and those of most other LPs.

Overall, adopting AB 2833 as is would lead to increased costs and, says CalPERS, lower investment returns due to retirement systems being precluded from backing private equity firms that refuse to agree to the disclosures.

Several private equity funds are already excluding California pension plans due to disclosure requirements. AB 2833 would increase the number of funds with such restrictions, as noted by the Los Angeles Fire and Police Pensions, which is opposing the bill in its current form.

The California State Teachers’ Retirement System hasn’t yet made a state on the bill, which it will discuss at its June board meeting.

There’s no such thing as a perfectly drafted piece of legislation and there is still room for discussion and modification. Let’s hope that the state of California takes these concerns into account, at the very least for the benefit of retirement plan participants.