State secret no more
When a confidentiality clause comes head-tohead against a freedom of information act, which one prevails? That is the question being posed to US public pensions and endowments, which now find themselves at the center of a debate over the public's right to access information on state investments. If the outcome favors the advocates of openness, it may change the marketing and reporting game entirely for private equity fund managers in the US and elsewhere, says David Snow.

Most private equity partnerships have terms that require LPs never to disclose to outside parties details of the fund's activities. This includes, of course, information on the fund's performance and about the underlying portfolio companies. The confidentiality clause makes most sense in a market where private transactions are conducted by groups of private investors. But when state money is involved, the confidentiality clause can be viewed as an excuse to hide financial shenanigans from the public.

At least, that's how the story was spun in The Houston Chronicle, which recently prevailed in its attempts to force a major Texas education endowment to reveal performance and other details of its private equity portfolio. At issue was the $1.7bn alternatives portfolio of the University of Texas Investment Management Co. (UTIMCO), a major public institutional investor with capital commitments to roughly 130 private equity funds. The Chronicle felt that, in light of public suspicions of old-boy, backroom deal-making in the Texas private equity scene, it was imperative that the public be allowed to see how UTIMCO's private equity funds were doing. The board of UTIMCO, for its part, pointed out that it was contractually obliged not to disclose said performance data, and that, doing so might blacklist the endowment in GP circles.

Then the politicians got involved. No less than six office-seeking public figures spoke out against UTIMCO's policy of not disclosing IRRs. In September, the UTIMCO board relented, and the pension now offers performance data to all requestors for funds managed by Baker Capital, The Blackstone Group, Doughty Hanson, KKR, Clayton Dubilier & Rice, The Carlyle Group, and Willis Stein, among others.

Politically calculated righteous indignation notwithstanding, the Chronicle's quest was aided immeasurably by the Texas Public Information Act, a law which requires state bodies to release most information to the public if requested. Every state in the US has its own freedom of information act, and the laws differ widely in how they define what can and cannot be disclosed. But most freedom of information acts are designed to shed light on public affairs, thus discouraging, or uncovering, abuses of power.

While every freedom of information act varies, most confidentiality clauses are essentially the same – LPs may not disclose IRR information to anyone, period, a principle that many GPs treat as if it were sacred. Private equity investing, its practitioners are want to argue, suffers when important data is shown to outside parties. At the very least, the argument goes, the public does not understand the long-term, illiquid nature of private equity, and are quick to assume that a fund is doomed when it shows negative returns in its early years. More seriously, taking the lid off a private equity fund can impair its managers' ability to compete – a fund that just appeared in the newspaper with a negative 10 per cent IRR might lose an auction against a fund that hasn't suffered the same indignity.

The advocates of full disclosure also have compelling arguments. What good reason is there for shielding pensioners from information on how their money is being managed? Why are they provided with details about stocks and bonds, but not about alternative investments?

The showdown in Texas appears to have been only the beginning. In Massachusetts, the state pension is caught between groups, including The Boston Globe, demanding that it release details of its private equity program, and angry GPs who are threatening to sue to stop the disclosure. Once again, the parties seeking disclosure are brandishing the state freedom of information act to support their argument. So far, the Commonwealth of Massachusetts is not in the GPs' corner. The state's Supervisor of Public Records in September ordered the Pension Reserves Investment Management Board (MassPRIM) to release performance data on its private equity funds. But according to a source familiar with the situation, MassPRIM has not yet complied with this directive. Thomas H. Lee Co. and Charles River Ventures, along with law firm Hale and Dorr, are reportedly encouraging the pension to keep return data close to the vest.

“Failure to comply may result in notification to the Office of the Attorney General for enforcement”

A lawyer who follows freedom of information cases says that, from a legal standpoint, the MassPRIM debate comes down to whether or not private equity investing can be viewed as “public policy.” According to the Massachusetts Public Records Law, a public document can be exempt from disclosure if it is deemed to be “trade secrets… provided to an agency for use in developing governmental policy and upon a promise of confidentiality.”

The lawyer says that, according to state law, communications to a public pension related to private equity funds are not exempt from disclosure: “Are the quarterly reports being submitted to MassPRIM in connection with a policy function? No. The people managing this information are providing it in connection with a commercial purpose, and therefore do not get protection under the freedom of information act.”

Massachusetts' Supervisor of Public Records, Alan Cote, said the same in a letter to MassPRIM, which reads, “The [private equity] documents cannot be said to have been submitted for use in developing governmental policy.”

CalPERS versus The Mercury News
The conflict may get nasty. Cote's letter, dated Sept. 16, concludes with: “Failure to comply with this order [to release the information] within ten days of receipt may result in notification to the Office of the Attorney General for enforcement.”

Now, the biggest kimono of all is the target of an immodest demand. Last month, San Jose, California-based The Mercury News sued the California Public Employees Retirement System (CalPERS) to unveil its enormous alternative investment portfolio. CalPERS, in fact, famously posted detailed IRR information on its Web site in December 2000, only to take the data down several months later. As one market observer put it: “The GP mafia closed in.”

The Mercury News was more explicit in its suspicions: “[A]fter the first quarter of 2001 – embarrassed at the devastating losses which shriveled its portfolios and shrunk the nest egg of thousands of its retirees – CalPERS… decided that it would no longer make those records available, in violation of the Public Records Act,” read a recent editorial.

In Texas and Massachusetts, GPs have not ventured to explain why it is so important that their returns be kept secret. Perhaps they know their objections will not fall on sympathetic ears. In the minds of the public, and of most state officials, the public's right to know trumps the GPs' right to privacy.

Portfolio data is the real issue
Some GPs have argued publicly that the important issue is not fund performance, but the performance and valuations of underlying portfolio companies. Making public details of the financial health of thousands of privately held companies – many in the vulnerable, early stages of their growth or recovering from bankruptcy – would be disastrous. For example, a young software company will find it hard to vie for new business if its potential clients know that a competitor has a stronger balance sheet.

The CPP Investment Board, a behemoth Canadian pension with billions allocated to private equity, recently enacted a policy of posting fund-level performance data on its Web site. General partners agree to have such information posted as a condition of the pension's investment. The data does not include portfoliocompany level information. In fact, neither CalPERS, UTIMCO or MassPRIM have been asked to make public data that drills down to the portfolio company level. The public just wants to see IRRs on a fundby-fund basis. And until GPs come up with a convincing argument for why their performance data is exempt from the various state freedom of information acts, the people will likely get what they want.

David Snow is the editor in chief of, a New York-based website providing news and information on the private equity industry.

For a detailed account of what prompted UTIMCO to lift the lid on its private equity portfolio, read the interview with Bob Bolt, UTIMCO's President, CEO and CIO, in Asset Class on page 15 of this issue.