On September 14, 2016, the State of California enacted new legislation (AB-2833, the Act) which substantially increases the amount of information that must be obtained and disclosed by California public investment funds (CPIFs) with regard to their investments in private investment funds (specifically, venture capital, private equity, hedge and absolute return funds) (Private Funds). The Act represents a significant development in the evolving relationship between California public entities and the Private Funds in which they invest.
Traditionally, Private Funds consider most information regarding their governing agreements, investment activities, investment performance, and compensation to sponsors/managers (General Partners) to be confidential and proprietary. Most Private Fund governing agreements impose strict obligations upon Private Fund investors (Limited Partners) to maintain the confidentiality of such information.
Many public entities are subject to "freedom of information" laws that require public disclosure of certain information relating to their activities. In California, the primary governing law has been the Public Records Act (PRA), which requires disclosure of certain written information prepared, owned, used or retained by a public entity.
Because the PRA required disclosure only of written information prepared, owned, used or retained by a public entity, it effectively allowed CPIFs and the General Partners of Private Funds to carefully craft governing agreements under which particularly sensitive information would be withheld from CPIFs, and thereby protected from public disclosure. The Act appears to have been specifically designed to disrupt such arrangements and thereby expand the scope of public disclosure.
Key Provisions of the Act
The Act does not directly impose any obligations upon Private Funds or their General Partners. Instead, it obligates CPIFs to obtain certain information (the Required Information) relating to their Private Fund investments, and to publicly disclose such information at least annually.
For purposes of the Act, "CPIF" is defined somewhat more narrowly than under the PRA. Specifically, the Act applies to any public pension or retirement system, including any pension or retirement system of the University of California.
For each Private Fund, the Required Information includes:
- The Private Fund's name, address and vintage year
- The dollar amount of the CPIF's capital commitment
- The dollar amount of the CPIF's cash capital contributions
- The dollar amount of cash distributions received by the CPIF
- The combined dollar amount of: (i) cash distributions received by the CPIF, plus (ii) the value of the CPIF's share of remaining Private Fund assets
- The Private Fund's net and gross internal rates of return since inception
- The Private Fund's investment multiple since inception
- The dollar amount of cash profit received by the CPIF from the Private Fund
- The fees and expenses paid by the CPIF to the Private Fund, the General Partner or its related parties, either directly or indirectly through the Private Fund
- The CPIF's share of any carried interest distributions made by the Private Fund to the General Partner or its related parties
- The CPIF's share of any fees and expenses paid by portfolio companies of the Private Fund to the General Partner or its related parties
Significantly, except as noted in item 11, the Required Information does not include valuation, performance or similar information relating to specific portfolio companies, nor does it include copies of Private Fund governing agreements or information regarding other Limited Partners.
The Act will apply with respect to each Private Fund to which a CPIF makes an initial or increased capital commitment on or after January 1, 2017.
Additionally, with regard to each pre-existing investment by a CPIF into a Private Fund, the Act requires the CPIF to "undertake reasonable efforts" to obtain (and then disclose) the Required Information.
Because CPIFs will be legally required to obtain the Required Information, General Partners must anticipate that CPIFs will insist upon a right to receive such information when negotiating the terms of their investments into Private Funds.
The obligation that CPIFs undertake "reasonable efforts" to obtain the Required Information in respect of pre-existing investments may have far-reaching consequences. General Partners should expect to receive demands for information they may have been withholding from CPIFs under prior agreements/understandings that may or may not be legally enforceable. It is not yet known whether CPIFs or the courts will interpret the "reasonable efforts" obligation to include lawsuits or similarly aggressive actions.
CPIFs likely will be subject to scrutiny regarding their compliance with the Act. Over the last 15 years, a variety of parties (including public employee unions and the press) have sued California public entities to enforce disclosure obligations arising under the PRA. It seems reasonable to anticipate that those parties will be equally interested in obtaining information under the Act.
It is unclear whether other States will adopt similar legislation. Based solely upon pre-existing disclosure obligations under the PRA, a significant number of highly regarded General Partners have declined to accept investments from California public entities. If that number rises in response to the Act, other States may be disinclined to follow California's lead.