Debates over the level of disclosure in private equity have traditionally been played out between GPs and LPs, but the pressure is on from outside parties for the industry to become more transparent.
To a certain degree, the private equity industry has become a victim of its own success: as GPs go after bigger, higher profile deals, the public wants to know more about the buyers.
Regulators have historically had much to say about private equity transparency. But now public pressure is changing this hands-off inclination. Below is what investor relations professionals need to know about the issues around the world that might affect reporting.
United States: Open records, read-only PDFs
The so-called Freedom of Information Act (FOIA) is no longer as hot a topic in private equity as was the case four years ago, but it continues to be an underlying theme in general partner investor reporting (see p. 27 for issues and trends in investor reporting). An uptick in FOIA requests – usually under the guise of individual state open-records laws – has led to a corresponding rise in confidentiality agreements in limited partner agreements. Where there was once an implicit understanding that information disclosed to LPs was confidential and private, LPs are now held liable should the information they receive from GPs about the fund get out, sometimes at the cost of getting kicked out of the fund entirely.
The rise of confidentiality clauses in LP agreements has meant that some state pensions and other FOIA-exposed investors have been essentially banned from funds.
Short of kicking out certain LPs, some GPs have become more circumspect and are disclosing less information about each fund.
They are doing so legally. “What has become standard is that the fund’s partnership agreement now often gives the GP the right to withhold any information from one or more LPs if the GP deems this to be in the best interest of the fund,” says Malcolm Nicholls III, a partner at law firm Proskauer Rose in Boston. “So even though the GP might be required to disclose something under the terms of the partnership agreement, the GP now has the right to choose not to do so.”
GPs may decide to withhold more information, but they are also willing to work with LPs to get them the information they need.
“Most investors of size who want additional information from GPs find them pretty reasonable and open on a one-off basis,” says Michael Hoffman, president and partner of San Francisco-based private equity advisor Probitas Partners.
Many LPs are not letting FOIA exposure prevent them from committing to favored GPs. Some states have amended their FOIA laws so that information on investments held by state plans would not need to be disclosed. The states that have passed laws to exempt disclosure of certain types of confidential information by public entities include California, Colorado, Illinois, Maryland, Massachusetts, Minnesota, Nevada, South Carolina, Texas, Utah, Virginia and Washington.
Because of the efforts of some states to amend their open records laws, some GPs are willing to accept investors that are public entities.
One GP, who declined to be named, said that the firm has always had FOIA clients. In this instance the interests of both parties are aligned: the public pension funds would not ask the GP for detailed portfolio company data, which the firm prefers not to disclose to its LPs, either.
Investors that are particularly affected by confidentiality agreements are funds-of-funds, which have disclosure obligations to their own investors. “Often times you will see a fund-of-funds specifically asking for provisions in the partnership agreement that will allow them, notwithstanding confidentiality limitations, to pass through certain information to their investors,” says Jeffrey Tabak, a partner at law firm Weil, Gotshal & Manges in New York.
Concerns over confidentiality have changed not only what is – or isn’t – communicated to GPs, but also the medium in which the message is disseminated. Web-based reporting is becoming more popular, where security parameters can be set by the GPs. “Some GPs will only allow certain investors to view their quarterly financial reports through the GP’s website. These websites are passwordprotected but certain investors cannot download or print these
reports,” says Allen Williams, vice president of reporting at Philadelphia-based investment advisor Hamilton Lane. “This allows the GP to control the distribution of their information.”
With less information being shared in print, communication at annual meetings and on an informal basis is now all the more important.
Europe: ‘We have to be more open’
Confidentiality agreements are starting to take hold in European LPAs, but the central issue surrounding investor relations is the raging debate taking place over the transparency of the private equity industry. Politicians, heads of private equity firms, trade unions and the media have all spoken out, either for or against the industry.
While there are currently no decrees over the level of disclosure required, efforts by various bodies are underway to determine exactly how transparent the industry must become.
It is in the UK where the debates – and most constructive steps in resolving perceived conflicts – on transparency are occurring. The industry acknowledges that there are issues in transparency: Damon Buffini, head of European buyout firm Permira, in an interview on BBC Radio 4’s flagship breakfast news show in late February said that, as an industry, “We have to be more open.” (See also p. 4 for David Rubenstein on transparency).
The UK government is entering the fray, launching a study of the industry via the Treasury Select Committee. The committee will be looking into three main areas: the regulatory environment, which will incorporate the debates on transparency and excessive leverage; taxation, which will consider whether the current regime gives the industry an unfair advantage; and the economic context, which will look into the longer-term implications of private equity ownership and its link to the economic cycle.
Richard Lambert, director general of the Confederation of British Industry reportedly has voiced his support for the private equity industry’s reporting practices, noting: “The issue of transparency and disclosure is more of a matter of perception than of reality…But perceptions matter.”
Public pressure was enough to warrant a response from the private equity industry’s trade body, the British Private Equity and Venture Capital Association, in March 2007 to form a working group that will explore how the industry can become more transparent, both in the level of disclosure and method of communication. “We believe there would be real benefit to all stakeholders if a regime of more effective disclosure took hold. This is why the industry is committed to taking this review,” the BVCA and its private equity firm backers said in a statement.
Many high-profile figures have voiced their support for the industry, but these reassurances were not enough for trade union GMB over concerns of job losses. Supporters include Prime Minister Tony Blair, City Minister and a key adviser to Chancellor Gordon Brown Ed Balls, and Shadow Chancellor George Osborne; the regulatory body Financial Services Authority in a discussion paper last November also sanctioned the industry.
The BVCA’s working group intends to review the industry’s transparency and disclosure, with a view to forming a set of guidelines for its members. According to the BVCA’s website, the group will assess, first, the adequacy of existing disclosure arrangements for portfolio companies for both for investors and for the public, and second, the clarity and consistency of valuation methodology and verification and the disclosure of returns and fees to investors.
Twenty-three buyout firms are backing the initiative, including some of the biggest: 3i Group, Apax Partners, The Blackstone Group, Kohlberg Kravis Roberts and Permira. The working group, which hopes to report its findings by the fall, will be led by Sir David Walker, former chairman of Morgan Stanley.
“I think there are two separate issues here,” says Edward Smith, a partner at law firm Linklaters in London. “One is investor reporting. The much greater debate has been around companies that are previously listed, and when those companies are taken private by buyout firms, those disclosure obligations cease.”
Whatever the outcome, investor relations executives in the UK are watching closely, as their jobs may change dramatically as a result.
Asia: Stay tuned
In Asia, where government and public furor over private equity has been the most vehement in South Korea (see p. 7 for troubles foreign private equity firms have had in Korea), it has been business as usual.
Local regulatory requirements drive changes in reporting. One country which may soon require increased disclosure in private equity deals is China. Recently released guidelines from the Chinese Ministry of Commerce on antitrust filings for acquisitions of domestic companies by foreign investors require greater disclosure of the details of proposed deals, but whether the guidelines will take effect, and when, is unknown. (See p. 8 for the updated antitrust filing guidelines in China).
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