How Cal. PERS Was Taken By Private Equity Firm Silver Lake and Tried to Hide That (A Tale of Two Spreadsheets)In January 2. Cal. PERS made what would seem to be a no- lose investment: the purchase of a 9. John MacIntosh writes that despite continued high pay, hedge fund managers risk losing business from pension funds and other investors disappointed with the returns.Silver Lake Technology Management, which serves as the fund manager, or colloquially, the general partner, for various Silver Lake private equity funds. In her early years as a star analyst, Sallie Krawchek observed, “It’s better to work for a Wall Street firm than invest in one.” That same logic would seem to apply for Cal.
PERS’ participating side- by- side with the firm’s founders in the management company: they would reap rewards akin to those of owner/operators rather than those of ordinary investors. Yet from the end of its fiscal year 2. Cal. PERS showed a nearly 5. Topic Author Replies Freshness +254: Acing the investment banking analyst interview <em>Mod Note (Andy): Throwback Thursday - this was originally posted 9/27/13</em> Been a while since I posted so I thought I’d write in. A former lawyer at the Securities and Exchange Commission is raising funds on Kickstarter to investigate Calpers to determine how much it pays in private equity fees. Silver Lake in its Annual Investment Reports in the absence of any big decline in assets under management or other bad news. By contrast, publicly traded private equity firms KKR and Blackstone showed declines only half as large in their unit prices over the same period. In March 2. 01. 5, Silver Lake stated in an SEC filing that Cal. PERS owned only 0. Silver Lake stated could be in the next few months. What happened? Industry rumors, including from insiders, suggest that Cal. PERS took a loss well over $1. Data first supplied by Cal. PERS to us showed an $8. After we told Cal. PERS that it was required to show more of the history of its investment, Cal. PERS provided a second set of records that was radically at odds with the first disclosure. These records showed the giant pension fund, remarkably, just breaking even, which is still poor result. As we’ll explain in detail later, this second, less damaging data story is inconsistent with other disclosures Ca. LPERS had made about Silver Lake, its established practice for how it reports investments, and documents about the transaction obtained from independent parties. In other words, other information as well as Cal. PERS’ own records and established practices strongly suggest that Cal. PERS suffered a significant loss on this investment. Cal. PERS’ poor performance results directly from its failure to insist on protections widely recognized as necessary for minority investors. An individual knowledgable about the initial Silver Lake investment stated that it did not include a customary anti- dilution provision. Silver Lake did indeed dilute Cal. PERS as it restructured the ownership of the management company. Cal. PERS’ embarrassing result is due to the fact it listened to the two most dangerous words in investing: “Trust us.” Just as troubling: Cal. PERS appears to be trying to cover up its loss. One might normally wonder whether the inconsistencies in documents that Cal. PERS provided in response to our Public Records Act requests were the result of incompetence in record- keeping, since the differences between the spreadsheet that depicts Cal. PERS breaking even and other reports made by Cal. PERS show numerous eight figure discrepancies. But Cal. PERS’ short explanation of its “tah dah” spreadsheet is that it found and attributed “contingent” investments to the Silver Lake parent investment. Put it another way: Cal. PERS could have been so eager to muddy the waters regarding Silver Lake that it was willing to create the impression that its private equity information systems are so deficient that they routinely have $1. If Cal. PERS maintain that this is the case, which is what the public would have to believe in accepting the story in its second spreadsheet, that should send alarms ringing among beneficiaries, legislators, trustees, and California taxpayers and lead to demands for an investigation of Cal. PERS’ reporting and controls. Co- investments are the right to invest side by side with the general partner of the fund in a fund investment, in addition to investing through the fund. These opportunities are offered only at the discretion of the fund manager. While they allow investors like Cal. PERS to save management and carry fees (with the tradeoff of bearing the full brunt of portfolio company fees), these investments take place completely outside the public’s view. Thus private equity investments are becoming even more opaque as the SEC has raised red flags about private equity practices and returns to public pensions funds have overwhelmingly fallen short of their own benchmarks. Finally, this incident reaffirms a pattern we’ve documented again and again with public pension funds. While they can be and typically are very competent investors in traded securities, they are no match for private equity firms. And rather than steer clear of private equity, they instead compound the error by putting their trust in general partners who view them as just another meal ticket. As UK- based private equity researcher Peter Morris said by e- mail,The significance of this story goes way beyond Silver Lake, private equity and Cal. PERS. Finance academics and regulators alike make it a core article of faith that big investors like Cal. PERS are . The sorry saga of Cal. PERS and private equity helps to show that both academics and regulators need to change the way they think about these big investors. Background: Cal. PERS’ Naive Approach to Taking Stakes in General Partners. In publicly traded stocks, Cal. PERS’ ambitions served it well. In the 1. 99. 0s, it acted as a leader in corporate governance reforms and backed its commitment up by operating as an activist investor. That strategy proved effective, not only burnishing Cal. PERS’ reputation but also improving its returns. Cal. PERS, as the largest single investor in private equity as of the early 2. For instance, one rationale for Cal. PERS to participate at the management company level could have been to earn a much higher return, or alternatively, to have a less risky investment, since most of the income at large private equity firms comes mainly from fees which are not at risk of market performance. However, Cal. PERS sought only modestly better results than from investing in private equity funds themselves. It also had no exit strategy other than assuming that its chosen firms would do a public offering or be acquired by a larger financial institution. By contrast, private equity funds have typically cashed out their investors out by year ten, and the general partners have incentives to realize profits and return at least some proceeds relatively early in the fund’s life. Another potential benefit of Cal. PERS’ investing in general partners would have been to increase their expertise, so that they could move in the direction that Ontario Teachers has, of doing more private equity investing in- house. However, Mc. Kinsey ruled that out in a study for Cal. PERS in the early 2. In addition, Cal. PERS didn’t ask for the sort of measure that Japanese investors who want skill transfer routinely get, such as having a set number of “trainees” work side by side with firm professionals. Finally, Cal. PERS did not obtain any voting rights. It was prohibited by law. Andrew Silton, North Carolina’s former Chief Investment Officer, in a 2. A bad idea: when pension plans own a piece of a money manager, set forth why he opposed this type of investment, using the State of Florida’s pension fund investment in Providence Equity Partners as his example: These are the kinds of investments that create conflicts of interest and undermine confidence in pension plans. However, the playing field is hardly level. The Silver Lake Investment. In 2. 00. 6, Cal. PERS had approached a short list of private equity firms that it viewed as attractive and said it would be interested in acquiring a stake in the fund management entity. Cal. PERS had bought a 5% stake in Carlyle in early 2. In 2. 00. 7, in three transactions, Cal. PERS, the Abu Dhabi Investment Authority, and other investors had together purchased a 2. Apollo. 4. According to a source familiar with the Silver Lake transaction, in late 2. Silver Lake contacted Cal. PERS to take them up on their offer. The Cal. PERS staff apparently did not consider the issue of adverse selection; for example, that Silver Lake approached Cal. PERS at that time because it foresaw that it might face liquidity issues. Cal. PERS did examine the proposed valuation in light of the developing financial crisis but in the end accepted Silver Lake’s assessment. Cal. PERS also objected to the lack of an anti- dilution provision in the proposed agreement. But Silver Lake partners Jim Davidson and Glenn Hutchins pressed Cal. PERS hard to agree to omit that provision, arguing that their interests were aligned. On January 3, 2. 00. Cal. PERS purchased 9. Silver Lake Technology Management for $2. As of June 3. 0, 2. Cal. PERS reported that the market value of its stake in Silver Lake was just shy of $3. A year later, even though the price of KKR’s and Blackstone’s units declined by 2. Cal. PERS reported a market price for its Silver Lake position of $1. Later in 2. 01. 2, Cal. PERS decided to restructure its interest in Silver Lake. Cal. PERS was to be diluted pari passu with the founders, so as they withdrew, Cal. PERS’ interest would be diluted massively. Silver Lake had proposed a full repurchase at a large haircut to the original $2. Dan Primack of Fortune, using data from Cal. PERS’ Annual Investment Report, noticed that Cal. PERS ownership had fallen by approximately 3. Silver Lake. 6. In its March 3. Form ADV filing,Silver Lake Technology Management, LLC wrote: Cal. PERS previously owned 9. Silver Lake Technology Management and is also an investor in certain Funds. The Adviser and Cal. PERS have an agreement pursuant to which, by a future date, the Adviser has the right to purchase Cal. PERS. As a result, the Adviser expects to acquire Cal. PERS. Cal. PERS’ First Story: They Lost Money In early 2. Cal. PERS’ loss in its Silver Lake investment, we submitted a detailed Public Records Act request for financial information about the Silver Lake investment. This is what we got back. New IRS Revenue Ruling 2. Use of Hedge Fund Stock Options . Q& A- 2(b) of IRS Notice 2. June 2. 3, 2. 01. Earle, Benefits Law Journal, Vol. Performance fees should be based on long- term performance, and mechanisms such as delayed realizations and clawbacks can better align long- term interests of managers and investors..
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