The Securities and Exchange Commission under Chair Gary Gensler has been exploring transparency issues and other problems in the private equity industry and considering whether additional policy interventions are needed. One motivating factor is that public pension plans are the largest investors in this $5 trillion industry.
Context is important here. This is not the first time that more aggressive policy interventions have been considered to address perceived problems in private equity. As discussed in my 2020 paper, Public Investors, Private Funds, and State Law, a wave of state legislatures passed, or seriously considered passing, laws to mandate better transparency from private equity managers in the mid-2010s. Responding to controversial SEC examination findings, state policymakers were concerned that managers were providing insufficient disclosure of the fees that they were charging state and local pension plans, which collectively are some of the largest investors in private equity funds. The most notable response came from California, which passed detailed legislation in 2016 dictating the specific fee disclosures that managers must provide to California pension plans.
This effort to protect public pensions through state law was messy, for a number of reasons. Most fundamentally, states didn’t have direct authority over private equity managers, which meant that they could not force managers to comply with laws requiring stronger disclosure. This was compounded by the fact that most states have a wide range of public plans of differing sizes, and discriminatory treatment of those plans through the use of side letters is quite common in private equity. As a result, any single disclosure standard was likely to have a different impact on different public plans within the same state. Smaller plans with little bargaining power could be frozen out by managers that didn’t want to provide the required disclosures, other plans could retain access but be forced to give up offsetting benefits in their side letters with managers, while the largest plans could generally avoid negative effects altogether. Another factor that made it difficult for state legislatures to police private equity terms was the cyclicality of the private equity fundraising market. Because shifts in market-wide bargaining power dynamics are common, a law that is appropriately calibrated to reflect the bargaining power of a state’s public plans in one year is likely to be off-balance in another year, further complicating the dynamic described above.
Likely for many of these reasons, state and local pension plans across the country resisted efforts to enact state-level fee transparency legislation in the mid-2010s. In California, state plans lobbied for dilutive changes before the state’s 2016 law was passed. Public plans helped to kill another prominent bill that had been introduced in Illinois and challenged bills in many other states. While there have been improvements, the state-based fee transparency movement largely failed to have the industry-wide transformative impact that many people hoped for.
Why does this matter for the SEC? Because most of the challenges discussed above don’t apply – or are much less acute – at the federal level than the state or local level. Accordingly, if the SEC finds that transparency issues and other problems in the industry are serious and persistent enough to warrant greater intervention, experience has shown that federal policymakers are probably in a better position to enact that policy than are state policymakers. State and local pension plans have collectively become massive investors in private equity, but state-based efforts to oversee private equity have been problematic.
 In this respect, California fee transparency laws have proven to be far less influential than, for example, the California emissions regulations and consumer protection laws that have famously become industry-wide standards over the years.
This post comes to us from Professor William W. Clayton at Brigham Young University’s J. Reuben Clark Law School. It is based on his paper, “Public Investors, Private Funds, and State Law,” available here.