Private equity faces pressure from pension funds for increased disclosure

Pension plans and other institutional investors are adopting a federal proposal that would require hedge funds and private equity funds to provide more information to investors.

University endowments, insurance funds and pension funds serving teachers and firefighters are urging the Securities and Exchange Commission to move forward with a proposed rule that would ensure private equity investors receive annual audits and quarterly statements.

The rule, which has been heavily criticized by private funds and Republicans, would also bar fund managers from passing on certain legal fees and limit the ability of funds to protect themselves from lawsuits.

Many pension plans are struggling to meet their payment obligations to their members, the result of decades of underfunding, overpromising benefits and unrealistic demands from unions. The simultaneous decline in stocks and bonds this year has only made matters worse. To compensate, many pension plans are increasingly putting their money into private market investments like hedge funds, private equity funds and private debt funds.

Private fund managers control more than $18 billion in assets from pension plans, sovereign wealth funds, endowments, insurers and family offices. They pool investors’ money and lock it away for years in private equity funds that buy and restructure companies, private debt funds that provide loans to companies, or other investment vehicles similar. They operate with far less government oversight than publicly traded companies or mutual funds.

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Support from investor groups is critical for the SEC initiative, which has been hotly pushed back by Republicans, private equity firms and hedge funds. These critics argue that the proposed disclosure requirements are unnecessary because institutional investors are large and sophisticated enough to demand all the information they need from private funds.

State and local pension systems and other government investment funds control more than $5 billion in combined assets. But they say that as capital has flowed into private markets in recent years, fierce competition over in-demand managers is leaving them at an increasingly disadvantaged.

“A frequent refrain that the [New York State Common Retirement Fund] receives in response to its request for improved fund terms that would benefit all investors is: ‘respectfully declined’,” the fund’s chief investment officer wrote in a comment letter to the SEC.

Private fund managers say the proposed rules would reduce returns for the very investors taking action. A letter from the American Investment Council, the private equity industry’s leading trade group, said the “paternalistic” plan would “limit the entrepreneurial spirit, flexibility and returns on investment that make private funds a increasingly attractive option”.

Pension funds, anxious to raise enough cash to cover the promises they have made to investors, hope that the potentially higher yields offered by hedge funds and private equity firms will help fill funding gaps and to limit how often they have to make the politically unpopular decision to raise pension contributions for state and local governments and their workers. Pension plan private equity holdings alone are about half a trillion dollars, according to data from Preqin and the Federal Reserve.

At the Ohio Public Employees Retirement System, where private equity accounts for 12.5% ​​of total assets and has outperformed the system’s broader portfolio, executive director Karen Carraher expressed support for most aspects of the SEC’s proposal. She said it would reduce the need for investors to meticulously negotiate basic private fund information and help them more easily spot self-serving behavior by private fund managers.

The chief investment officer of a major US pension plan said The Wall Street Journal it takes about six months for its accounting staff to extract and standardize information from private fund manager reports to compare and track costs.

SEC Chairman Gary Gensler told reporters last month that the proposal was about efficiency. “If I know you pay one thing for a cup of coffee and I pay the same, that transparency helps price formation in capital markets,” he said.

The Democratic-controlled commission approved the proposal by a 3-1 vote in February, signaling a strong chance that a final version will pass. The agency recently extended the proposal’s comment period until June 13 under pressure from some lawmakers and industry groups.

Pension funds make less money on their private equity investments than other types of institutional investors. The average annualized return of large public pension plans for the 20 years ended June 30, 2021 was 11.8%, according to an analysis of data from the Boston College Center for Retirement Research on the five largest plans with fiscal years from 1 July to June 30. Annualized returns for private equity funds tracked by data analytics firm Burgiss for the same period were 13.4%.

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In a survey of 100 in-house lawyers representing private equity investors, 84% said they accept unsatisfactory terms in at least some funds they invest in for fear that seeking better terms will cause their institution access to the fund manager or receive a smaller share of the fund. More than a third of the lawyers surveyed came from public pension funds.

“That’s what you hear from investors, ‘We’re nervous about losing our allocation, so we don’t want to be the squeaky wheel,'” said law school professor William Clayton. from Brigham Young University, which led the study. survey at a conference in October and made the data public in a comment letter.

In addition to imposing disclosure requirements, the SEC’s proposal would prohibit private fund managers from charging investors the costs of regulatory reviews, investigations or SEC settlements and fines. And it would prohibit contracts between institutional investors and private fund managers in which investors agree not to sue for certain types of negligence and breaches of fiduciary duty. Florida laws prohibit some of these contracts.

Jeremiah Williams, who represents investment managers at law firm Ropes & Gray, co-wrote a comment letter pushing back on some of the bans. He said immunity from low-level lawsuits can help managers take risks that translate to higher returns.

“It doesn’t seem particularly unfair to me that the people who have had the best performance are the ones who are able to negotiate terms that are to their advantage,” said Williams, who is also a former member of the SEC Division of Security Forces. order. management unit, said in an interview.

Another provision of the SEC rule would target private fund managers using debt instead of investor money as an initial source of funding for new ventures, a practice that can make returns seem higher than they really are. are. The rule would require managers to calculate returns over the longer period beginning with the borrowing, not just the shorter period beginning with the withdrawal of investors’ capital.

Write to Heather Gillers at [email protected] and Paul Kiernan at [email protected]

This article was published by Dow Jones Newswires, another service of the Dow Jones group