Systematic Redaction: Private Equity Hiding from Public Scrutiny
Gretchen Morgenson’s column in The New York Times on Sunday captures the unholy alliance between public pension plans and private equity when it comes to adequate disclosure of their relationships. “Behind Private Equity’s Curtain” shows how private equity firms have grabbed hold of the trade secret and proprietary exemptions to state public records laws in order to hide the financial arrangements between their firms and public pensions. It’s a very convenient arrangement. Public officials and pension trustees can claim that they’d love to disclose more information, but that state law and the claims of private equity firms tie their hands. And as Ms. Morgenson reports, pension officials express fears that they won’t have access to top-flight private equity funds if they demand greater transparency.
As I’ve said before, there is very little in money management that is a trade secret or proprietary. There’s no reason why any terms or conditions of a private equity fund can’t be revealed, except one. If money managers laid out all details, they’d have to admit that there is little if any special sauce in their product offerings, and that they’re peddling a commodity in fancy packaging. Moreover, as Ms. Morgenson details, partnership agreements are filled with provisions that are highly favorable to the general partner and adverse to the limited partners.
The private equity industry claims that their arrangements are fully negotiated with “sophisticated” investors. Public funds, of course, wouldn’t want to contradict this statement because it would make them appear to be naïve. The truth is that the negotiations are conducted on a very uneven playing field. PE firms are adept at cultivating a lead investor who is given slightly more favorable terms (e.g., a lower fee, preferential access to co-investment) in exchange for setting the basic terms of the fund. While subsequent investors can extract small concessions and amendments, the basic terms (especially the details) are set in private equity’s favor.
Moreover, there are levels of sophistication. Billionaires and millionaires are arrayed on one side of the table represented by the finest securities attorneys. The pension staffs and their lawyers sitting on the other side of the table are completely outgunned. It’s no small wonder that Ms. Morgenson unearthed all sorts of tidbits that are highly favorable to private equity. It’s also rather obvious why so many private equity firms insist on redacting vast amounts of partnership agreements and other fund documents when The New York Times files public records requests. The industry has negotiated decidedly one-sided agreements. Revealing that information would indeed harm their businesses. However, it isn’t because the information is proprietary or confidential. Rather, disclosing the information would let the public pensioners and the taxpayers in on a little secret. They are investing in funds that are systematically skewed to place risk and expense on them and away from the general partner.