Private Equity Redaction Continued
Dan Primark’s very informative daily blog Term Sheet, written for Forbes, sheds a great deal of light on the private equity business. On Monday he wrote about Gretchen Morgenson’s New York Times recent column on private equity secrecy. Mr. Primark made two points that I think are worth further discussion. First, he pointed out that public pension beneficiaries do not bear the costs when private equity funds incur questionable expenses. Mr. Primark was commenting on Ms. Morgenson’s contention that municipal employees and retirees paid part of the settlement cost when Carlyle settled a class action lawsuit contending that private equity firms had colluded in acquiring public companies.
Technically, Mr. Primark is correct. The retirement payments to public pension beneficiaries aren’t dependent on the cash flows from specific investments. If investment results fall-short of the required capital, taxpayers are required to step up contributions in order to pay those benefits. However, public employees have every reason to be concerned. Most public pension plans are underfunded, and state and local governments have shown increasing reluctance to appropriately fund these plans. When investments fail to produce expected returns, or money managers saddle investment funds with inappropriate expenses, the long-term sustainability of public pensions is undermined.
I used to make Mr. Primark’s point on a regular basis. From a legal perspective, taxpayers should be much more concerned about the poor performance of pension investments, since they’re on the hook for any shortfall. However, when you examine the funding practices in states like Illinois or New Jersey, it’s rather evident that pension beneficiaries have every reason to worry about the returns from and expenses of investment portfolios. Politicians aren’t inclined to raise the revenues required to keep pensions funded. Instead, they are inclined to gamble on higher risk investments, tax-exempt borrowing, and/or accounting gimmickry in order to avoid raising taxes.
Moreover, when politicians see private equity or hedge fund managers charge excessive fees or saddle funds with inappropriate expenses, it further undermines support for public pensions. Why should taxpayers support a pension plan that is seen as a conduit for making certain money managers incredibly rich? In short, public employees and retirees suffer a loss when investments fail to perform and funds are saddled with unwarranted expenses.
Mr. Primark also asserted that much of the redaction of private equity legal documents is really the result of law firms trying to protect “their own "proprietary" LPA [limited partnership agreement] docs, rather than the PE firm trying to pull one over on someone.” I’ve never heard that argument made before, and I don’t think it holds much water. While I haven’t surveyed all the public records laws in the U.S., I’m not aware of a proprietary exemption for the law firm drafting legal documents for a state or municipal vendor. In the treasure trove of letters submitted by law firms and money managers as a result of the State Employees Association of North Carolina’s public records request in North Carolina, I’ve never seen this argument. All the exemptions are based on the vendors’ proprietary interests. Finally and most importantly, there’s nothing remotely proprietary about any of the provisions in these documents. I’m pretty confident that over the years, every significant law firm has seen the work product of just about every private equity document produced by its competitors. The only reason these materials are heavily redacted is because money managers can get away with it.