FOIA and disclosure: media hype or genuine concern?

Where did it all begin?
To understand the roots of this current debate it is necessary to rewind a couple of years. In 2001/2002, the US bore witness to a furore over the Freedom of Information Act and the revelation in the public domain of specific private equity information. It all began when one of the largest private equity investors in the world, CalPERS, posted the performance of its private equity portfolio on its web site. For months this information went largely unnoticed and was regarded by many as a welcome move, given that the bid for greater transparency in the industry was gathering momentum.

But it would seem that the media attention that was to follow had not been anticipated. Journalists saw an opportunity to bring the issue of disclosure to the top of the agenda. Information providers with commercial interests at heart took it upon themselves to request sensitive portfolio information under the terms of the Freedom of Information Act. Public institutions in the US, including UTIMCO (the University of Texas Investment Management Company) and CalSTRS (the Californian Teachers’ Retirement System), were forced to reveal sensitive fund information, much to the chagrin of the GPs they supported. Indeed, certain pension funds’ GPs went so far as to instigate legal action against their public LPs to prevent the publication of their portfolio performance. Many of these lawsuits are still ongoing today.

…and have we now come full circle?
Just as the US debate was settling down and a greater acceptance of disclosing fund performance information was becoming evident, the blame is once again being laid at the foot of the media for stirring the issue. Since the New Year, the UK’s Freedom of Information Act 2000 became fully effective. UK FOIA grants a general right of access by allowing any person (including foreign nationals and companies) to request information from a UK ‘public authority’. Institutions that fall into this category include a broad range of state entities, such as health authorities, educational institutions, the Bank of England, local government departments and UK public pension plans.

The information currently subject to a right of access includes fund performance and portfolio company data that has been provided to public authorities investing in a private equity fund. Many GPs are generally content that top level fund performance data can be revealed to the wider audience, with most accepting that this is merely progress in the wake of their calls for a greater flow of information between fund managers and their investors. Yet concerns remain as to whether this is where the boundary lies. GPs are generally unanimous in their vote on the subject - fund performance data is just about okay in the public domain, but certainly not portfolio company information.

To counter such concerns, the Freedom of Information Act contains a number of clauses that offer some degree of protection. Of particular interest to the private equity industry is section 41, which deals with information that is provided to a public institution by a third party in confidence, and probably more importantly section 43, which deals with commercial interests. This latter clause means that information is exempt from disclosure if it is deemed to be prejudicial to the commercial interests of the company involved. It is almost guaranteed that this will be cited as the primary exemption clause over the coming months.

Media intervention
As mentioned above, the debate surrounding increased transparency in the marketplace, and the effect that Freedom of Information Acts have worldwide, has been heightened by media attention. In January 2005, requests for fund information from local authority pension funds were made by journalists and information providers, mirroring what had happened in the US. Although fully entitled to do so under the terms of the new Act, such a move has unsettled a number of industry practitioners. Geoff Petty of the Powys County Council Pension Fund sums up the general sentiment: ‘I am disappointed that the Freedom of Information Act has been used by some individuals for their own commercial gain. This is not what the Act was meant for and has the potential to cause more damage than good.’

Most limited partners concur that the possible exemptions provided for by the Act will mean that sensitive company information remains the possession of the general partner and not subject to disclosure to the wider audience. As one local authority pension fund argued: ‘If GPs and LPs were to take a step back they would see that what is really being revealed is merely top-level fund information that could actually be deduced from other sources. More detailed company information must, and will, remain behind closed doors.’ The feeling amongst such players is that there is nothing to worry about and that it is merely natural progression towards a greater need for transparency. Why, then, has the introduction of FOIA caused such a furore?

The answer lies in ‘media hype’, argues one UK-based investment consultant: ‘It all began in the US with CalPERS posting its fund performance data on its web site. But it was only when the media got hold of it and created a story out of it that it became the talking point in the industry.’ There is a feeling that the issue would never have received such attention if it weren’t for the media’s desire to forge a story out of very little. The same fund adviser suggests that the now infamous case in which Sequoia Capital ejected public limited partners from its fund in order to guarantee that information relating to its individual portfolio companies could not be released into the public domain was also subject to media hype. ‘In fact Sequoia only raised about $600m and it was unlikely that many public pension funds would have been knocking at their door. But the press made it into a story, and the result is that public pension funds now cannot invest in Sequoia’s funds.’

Such aggressive tactics displayed by the media have only served to make industry players far more cautious in disclosing information. Several local authority pension funds refused to even discuss the topic. Some have resorted to taking advice from their legal teams before broaching the subject with journalists and would not be persuaded to express their opinions lest they reveal too much or are misinterpreted. If LPs do begin to take such a stolidly conservative approach to disclosure it is doubtful that this would be a positive turn for the industry, which has been seeking to prove itself a mainstream asset class and to move towards greater transparency for some time.

Genuine concerns
Yet FOIA will also have widespread implications that have caused genuine concern amongst both general and limited partners. As has already been stated, it is unclear to what extent such concerns can be justified as it is still early days but an anxiety in the GP community prevails. Several fund managers have already taken it upon themselves to write to limited partners that could be subject to FOIA requests reminding them of confidentiality clauses in their limited partnership agreements. Caution surrounds three key concerns.

The first is that of misinterpretation. Requests for information would give a snapshot of a fund’s performance at any given moment in time. Due to the J-curve effect, this snapshot would not be a true reflection of the fund’s performance if taken within the first few years of a fund’s life. As one UK-based insurance company argues, a true picture of a fund’s performance is only possible after six to seven years, while a European funds-of-funds manager suggests it is only possible at the end of a fund’s life. And many general partners are already feeling the discomfort of potentially having to reveal their figures in years when performance is negative. There is a feeling, too, that the information that is in the public domain will only be correctly interpreted by those that understand the industry.

Also, overall fund IRRs do not account for the individual circumstances in which investments are made, such as individual terms and conditions or the timing of investment in the fundraising process. This creates the potential for individual local authority pension funds to report different IRRs for the same fund. Arguably, it means that fund performance data could be regarded as meaningless. Harking back to media hype, it could open the door for press reports on the seemingly endless numbers of poor performers in the industry leading to misguided judgments about private equity as a whole. This can only be damaging for an industry that is just beginning to re-emerge after a difficult few years.

Secondly, the private equity community is worried about where the boundary lies. Currently, the argument is that public bodies must disclose information unless exemptions are sought. At the moment, it is only top-level fund information that is subject to disclosure and individual portfolio company data is preserved under the exemptions available. But is this where it will really stop? No doubt it may well fall to the courts to decide as has been the case in the US, but this could very easily hinder an industry that is striving to grow in stature and sophistication. Indeed, the very premise on which the industry was founded, that of it being private, is in jeopardy. The inefficiencies that essentially drive the asset class could be significantly impaired and the alternative asset class would become more akin to the public markets.

General partner reticence has also come to the fore. General partners could very easily become more guarded about the amount of information that they give to their public limited partners, which would reverse the desire for increased flows of information between fund managers and their LPs. Alongside the citing of confidentiality agreements by GPs, one local authority pension fund was also told by a private equity fund in which it invests that if he could not guarantee secrecy over data provided to him it would no longer be sent and he would have to physically go to the fund manager’s offices to view the figures.

Several GPs have even now expressed a need to limit the amount of information given to its limited partners in light of requests already made under FOIA’s guidelines. At its most serious, such reticence could perhaps lead to total exclusion from private equity funds, rather like the example of Sequoia Capital. This drastic action is highly unlikely given the exemptions in place and the overarching feeling that transparency, while positive, should be limited to fund information and not portfolio company data.

What does the future hold?
With the latest conditions to the UK’s Freedom of Information Act still in their infancy, it is difficult to predict exactly how this is going to affect the private equity industry going forward. A degree of solace can be found in lessons learnt from the US experience, in which general partners have been able to limit the amount of information that they disclose to their public limited partners. Similarly, exemptions are in place in the UK that allow for the most sensitive information, namely that of individual portfolio company data, to remain behind closed doors. Private equity practitioners from both the LP and GP communities are divided on the subject.

Those in favour of greater transparency in the marketplace argue that the implementation of the Freedom of Information Act is a positive move for private equity as it increases the flow of information between fund managers and their investors. They argue that FOIA is merely a natural progression in an industry that is becoming increasingly sophisticated and therefore open to a greater degree of public scrutiny.

Others fear that the potential for the most sensitive information to be revealed will only serve to make GPs more cautious and to even clam up entirely. LPs exhibit concerns that ultimately this will lead to issues of access where they are unable to enter particular funds and are effectively blackballed. Indeed, the very nature of the private equity industry being ‘private’ is under threat as increased transparency makes for a more efficient marketplace - not a positive move for an industry that relies on inefficiencies.

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• Topics
• Regulation
• Media