United States: California's New Fee Disclosure Law For Public Pension Plans Investing In Alternative Investment Vehicles

On September 14, 2016, California Governor Jerry Brown signed into law a bill intended to provide transparency with respect to fees and expenses paid by California public pension or retirement systems ("PPPs") to private equity funds, venture funds, hedge funds and absolute return funds (each, a "Fund") in which they invest. This alert seeks to answer some of the key questions regarding the new law (the "Fee Disclosure Law") that we believe will be of particular interest to our clients.

EFFECTIVE DATE

  • When does the Fee Disclosure Law go into effect? January 1, 2017. Specifically, the Fee Disclosure Law applies to all new contracts, including subscription agreements, between a PPP and a Fund entered into on or after January 1, 2017, and to all existing contracts pursuant to which a PPP makes a new capital commitment on or after January 1, 2017. A PPP will also be required to "undertake reasonable efforts" to obtain the information required by the Fee Disclosure Law for any existing contract with a Fund for which the PPP has not made a new capital commitment on or after January 1, 2017.

DISCLOSURE REQUIREMENTS

  • What information will be disclosed? A Fund must provide its PPP investors the following information regarding fees: (i) the fees that the PPP pays directly to the Fund, the fund manager or related parties; (ii) the PPP's pro rata share of the fees that are paid from the Fund to the fund manager or related parties; (iii) the PPP's pro rata share of the carried interest paid to the fund manager or related parties; (iv) the PPP's pro rata share of the aggregate fees and expenses paid by all of the portfolio companies held by the Fund to the fund manager or related parties; and (v) the information already required to be disclosed under California Public Records Act ("CPRA"). A PPP will also be required to disclose the gross and net rate of return of each Fund, since inception, in which the PPP participates.
    • What are "related parties"?  In defining "related parties," drafters closely tracked the expansive language in ILPA's Fee Reporting Template, which attempts to capture all fees that are directly or indirectly borne by PPPs and, ultimately, paid to the manager, its staff or owners or certain service providers thereof. For example, of note to private equity fund managers, the definition picks up consulting, legal and other service providers regularly engaged by Fund portfolio companies that also provide advice or services to the manager or its affiliates. Also of importance to clients, given ongoing SEC scrutiny of this issue, is the inclusion of "operational persons" in the definition. This includes any operational partner, senior advisor or other consultant or employee whose primary activity for a manager, its affiliates and certain other entities managed by current or former related persons is to provide operational or back office support to any portfolio company of any Fund or account managed by a related person. "Related person" means any current or former employee, manager or partner of any related entity (a term that is not defined, and appears to have been transcribed incorrectly from the ILPA definition) that is involved in the investment activities or accounting and valuation functions of the manager, its affiliates, certain other entities managed by current or former related persons or any of their respective family members. The Fee Disclosure Law does not set forth a de minimis threshold triggering the obligation to disclose fees with respect to related parties, a fact that further increases the burden of the new law.
    • Raw dollars, not percentages: The Fee Disclosure Law calls for the disclosure of raw dollars, not percentage figures related to fees and expenses in connection with a PPP's investment. This conforms with the approach under CPRA, which calls for dollar amounts of items such as the PPP's commitment, contributions, distributions received and remaining value of the Fund's assets attributable to the PPP. Although it may be possible to piece together information disclosed under the Fee Disclosure Law and other information in the public domain to get a rough estimate of the percentage interest of a particular PPP, given the varying fee structures that a manager may apply to different investors and the proliferation of parallel funds, it would be difficult to deduce aggregate fees and carried interest received by a manager.
    • Portfolio company-level information disclosed: The Fee Disclosure Law requires disclosure with respect to a PPP's pro rata share of aggregate fees and expenses paid by all portfolio companies held by the Fund to the fund manager or related parties. Although some sponsors already track portfolio company-level information, this will likely be an additional burden for many sponsors.
    • PPP's pro rata share of fees paid to Fund manager by portfolio companies, not total fees: Initial drafts of the law required disclosure of total fees paid to the Fund manager by Fund portfolio companies. This was revised to require only disclosure of the PPP's pro rata share of fees paid by the Fund investment vehicle through which the PPP invests. Arguably, providing just the PPP's pro rata share of these fees achieves the Fee Disclosure Law's goal of transparency on fees paid by a PPP. However, if, on the other hand, reduced profitability of the portfolio company as a whole is seen as a "cost" to investors, disclosing the entire amount would have provided greater insight into the impact of fees on PPPs. Where a Fund uses multiple investment vehicles to buy a portfolio company, the aggregate amount of fees borne by the portfolio company cannot be ascertained when only the PPP's pro rata share of a given vehicle is disclosed.
  • How often and what form will reporting take? PPPs must require each Fund in which they invest to make the relevant disclosures at least annually. PPPs are then required to present a report on the information at least once annually at a meeting open to the public. There is no prescribed date by which the annual Fund or PPP reports must be made. It will be interesting to see whether the PPPs make the reports available on their websites, or whether the public will have to make individual requests to receive a copy.
  • Is there a prescribed reporting form? Initial drafts of the legislation required information to be on a form prescribed by the PPP. However, the final bill allows a PPP to comply with the rule by independently calculating certain fee and expense information from other information contractually required to be provided by the Fund. This was likely a modification made after CalPERS called for greater leeway on calculating data that Funds are required to report. CalPERS' request was practical – the resulting modification allows greater flexibility when negotiating reporting items with a Fund manager, which will presumably increase a manager's appetite to engage with a California PPP.
  • Are clawback provisions covered? Although the Fee Disclosure Law does require disclosure of carried interest paid by a PPP, it does not require disclosure on clawback provisions. Since clawback provisions impact the amount, timing and means of the return of excess carry to the PPP, disclosing these terms, together with a hypothetical clawback analysis assuming liquidation of the Fund at the time of the report, would have given extra depth to the carried interest information.

COVERED PARTIES AND ENFORCEMENT

  • What alternative investments funds are covered? Initial drafts applied the legislation only to "private equity." This was later revised to conform to the approach of CPRA, which applies to "alternative investments." Both rules define this term as "private equity funds, venture funds, hedge funds or absolute return funds." At first blush, it would make sense for the legislation to apply to other strategies that the industry also labels as "alternative," such as energy, real estate, credit, royalty and infrastructure funds. However, the scope of the CPRA definition of "alternative investments" is still subject to debate, and further clarification is required to determine whether these types of funds are also covered by the new law. There is nothing to suggest that the Fee Disclosure Law applies to registered investment funds.
  • What PPPs are covered? The Fee Disclosure Law applies to any California public pension or retirement system. Therefore, not only will the legislation apply to state-level plans, but also to plans at the county and city levels. Notable plans that fall under the law include CalPERS, CalSTRS, retirement systems governed by the County Employees Retirement Law of 1937 (e.g., OCERs), LACERS, LACERA and the University of California Retirement System.
  • What types of compensation are covered? As noted above, the law requires disclosure of "fees" and "carried interest." The law does not define "fees" or directly address other forms of compensation paid to certain investment funds, such as incentive allocations commonly made to the general partners of hedge funds. It is unclear whether such other forms of compensation would be considered "fees" for purposes of the law.
  • How will the Fee Disclosure Law be enforced? The law is phrased in terms of the information that a PPP must require a Fund to disclose. However, it does not purport to give California courts jurisdiction over actual Funds. Accordingly, the law will achieve its mandate only through its ability to require PPPs to demand the disclosure as part of its investment in a Fund. It is not clear what penalties would be imposed on a PPP that failed to comply with the law or who could enforce violations of the statute by a PPP.

IMPLICATIONS FOR CALIFORNIA PUBLIC PENSION PLANS

  • Who bears the cost? The Fee Disclosure Law creates additional administrative burdens for plan investment staff with respect to requesting, analyzing and disclosing the information mandated by the law. PPPs will not be reimbursed by the state for the cost and expense to the plans of complying with the legislation.
  • Will the Fee Disclosure Law impact access to Funds? PPPs voiced concern from the outset that managers of over-subscribed alternative vehicles would be reluctant to admit California PPPs as investors if they were required to accept the public disclosure of information covered by the legislation. It will be interesting to see whether smaller PPPs, in particular, experience difficulty gaining access to funds as a result of the new law.
  • Will the Fee Disclosure Law impact fee negotiations? Fee negotiations, and especially special fee reductions, are sensitive topics for sponsors. CalSTRS argued that managers may not offer favorable fees to it if those lowered fees had to be disclosed to the public, including other investors. Until now, tiered MFN structures and other approaches have protected managers from disclosing the preferred fee deals given to some PPPs in light of their substantial commitments. Willingness to give fee breaks when amounts paid by the PPP will be disclosed to the public will be a new consideration with which sponsors must grapple.
  • Other than disclosing to the public, what do PPPs have to do with the information they receive? PPPs will be left to determine what to do with the fee and expense information received from Funds. The Fee Disclosure Law does not mandate any analysis or set any guidelines concerning the reasonableness of expenses disclosed. Nevertheless, it would be wise for PPPs to conduct in-depth review and analysis in connection with reporting in anticipation of political and public scrutiny over investment decisions made. Accordingly, PPPs should understand the numbers they are reporting and be able to explain them both individually and from the perspective of the holistic management of their complete investment portfolio.

IMPLICATIONS FOR SPONSORS

  • How does the Fee Disclosure Law change the game?
    • New mandates. Managers were formerly able to select among California PPPs based on their relative demands for increased fee disclosures. In addition, managers have been able to find work-arounds to FOIA laws such as CPRA by, for example, providing information to third-party consultants, who then process the information for the investor subject to FOIA concerns. These approaches will not be possible under the Fee Disclosure Law. If a manager cannot afford to ignore California PPPs as a source of capital, it should expect side letter requests addressing the legislation and be prepared to provide (and see public disclosure of) the information required by the new law. Sponsors could consider charging PPPs for the incremental costs associated with providing this information, as opposed to bearing such incremental costs themselves or charging them to the Fund.
    • Existing mandates. Even if a manager chooses not to accept subscriptions from California PPPs in the future, to the extent that a California PPP currently is an investor, that PPP is required to "undertake reasonable efforts" to obtain the information required by the Fee Disclosure Law with respect to that fund. Given the objections raised by some PPPs to the bill, it is unclear how hard they will push managers of current funds for information, especially since managers in general have no legal obligation to accommodate such requests. However, if the PPP does insist on information, and the Fund manager is not willing to provide it, a secondary sale may be the only practical solution.
  • Will other states follow California's lead? No other state currently has a similar statute. However, initiatives like the Fee Disclosure Law have appeared in other states (e.g., Illinois, Kentucky, New Jersey and Alabama), and it is likely that this trend will continue. A patchwork of increasingly detailed and different standards could further burden and complicate the reporting obligations of fund managers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions