United States: New California Law Requires Additional Public Disclosure By Private Funds

Last Updated: October 25 2016
Article by Barry A. Brust

On Sept. 14, 2016, the State of California enacted new legislation that requires additional public disclosure by the funds of any California public pension or retirement system, including the University of California (Public Investment Funds), with respect to their investments in private equity funds, venture funds, hedge funds or absolute return funds (Alternative Investment Vehicles). The law, AB-2833 (the Act), is designed to "increase the transparency of fees paid by public investment funds to alternative investment vehicles" since "public investment funds pay significant fees to alternative investment vehicles and do not have sufficient information regarding the character and amounts of those fees." Because the Act affects the portfolios of such large pensions as CalPERS and CalSTRS, among others, the implications of the Act, including any possible backlash by fund managers and sponsors, may be far-reaching.

More specifically, the Act adds a new Section to 7514.76 of the California Government Code, which obligates every Public Investment Fund to disclose, at least annually, the following information with respect to each Alternative Investment Vehicle in which it invests:

1. The fees and expenses that the Public Investment Fund pays directly to the Alternative Investment Vehicle, the fund manager or any "related parties," which are defined to include all of the following:

(a) Any "related person," that is, any current or former employee, manager or partner of any related entity that is involved in the investment activities or ascertaining and valuation functions of the relevant entity or any of their respective family members.

(b) Any "operational person," that is, any operational partner, senior advisor, or other consultant or employee whose primary activity for a relevant entity is to provide operational or back-office support to any portfolio company of any Alternative Investment Vehicle, account or fund managed by a related person.

(c) Any entity more than 10 percent of which is held, directly or indirectly, by a related person or operational person, regardless of whether the related person or operational person participates in the carried interest received by the general partner or special limited partner.

(d)  Any consulting, legal or other service provider regularly engaged by portfolio companies of an Alternative Investment Vehicle, account or fund managed by a related person and that also provides advice or services to any related person or relevant entity.

2. The Public Investment Fund's pro rata share of fees and expenses not included in Paragraph 1 that are paid from the Alternative Investment Vehicle to the fund manager or related parties. However, if the Public Investment Fund independently calculates this information, then the Alternative Investment Vehicle will not be required to provide it.

3. The Public Investment Fund's pro rata share of carried interest distributed to the fund manager or related parties.

4. The Public Investment Fund's pro rata share of aggregate fees and expenses paid by all portfolio companies held within the Alternative Investment Vehicle to the fund manager or related parties.

5. Any additional information described in Section 6254.26(b) of the California Government Code, which includes:

(a) The name, address and vintage year of each Alternative Investment Vehicle.

(b) The dollar amounts of the commitment and the cash contributions made to each Alternative Investment Vehicle.

(c) The dollar amount, on a fiscal year-end basis, of cash distributions received by the Public Investment Fund from each Alternative Investment Vehicle.

(d) The net internal rate of return and the investment multiple of each Alternative Investment Vehicle since inception.

(e) The dollar amounts of the total management fees and costs paid on an annual fiscal year-end basis by the Public Investment fund to each Alternative Investment Vehicle.

(f) The dollar amount of cash profit received by each Alternative Investment Vehicle on a fiscal year-end basis.

Each Public Investment Fund must disclose all of the above information at least once annually in a report presented at a meeting open to the public. Such report must also include the gross and net rate of return, since inception, of each Alternative Investment Vehicle in which the Public Investment Fund participates.

The new legislation applies to all new contracts that a Public Investment Fund enters into on or after Jan. 1, 2017, and to all existing contracts pursuant to which a Public Investment Fund makes a new capital commitment on or after Jan. 1, 2017. Furthermore, each Public Investment Fund is required to take "all reasonable efforts" to comply with the reporting requirements of the Act for all other existing contracts with Alternative Investment Vehicles as to which no new capital is to be committed. The Act, however, does not explain what the term "all reasonable efforts" encompasses. Query whether a written request would be sufficient, or whether a Public Investment Fund must take even more steps.

The Act's goal of increased transparency is consistent with trends in the private fund industry, including the Private Equity Principles of the Institutional Limited Partners Association (ILPA). Among other things, ILPA has advocated for more disclosure to investors by fund GPs, especially with respect to management and other fees. However, the Act would take the additional step of making such disclosure publicly available, which fund managers, who often put a premium on confidentiality, may try to resist by avoiding investments from California's Public Investment Funds.

The consequences of the Act must therefore be closely monitored. In particular, it will be instructive to see whether other states follow California's lead. It will also be important for Alternative Investment Vehicles and Public Investment Funds to determine the extent of "all reasonable efforts" and whether fund managers comply when Public Investment Funds, pursuant to the Act, seek disclosure when they are no longer making additional capital commitments to their existing investments.

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.

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