Disclosure Threatens Portfolio Companies –

Any venture fund manager who thought that underlying assets were off limits had now better think twice before taking money from a Texas LP.

In October, Texas Attorney General Greg Abbott became the first attorney general in the nation to publicly support the public disclosure of underlying asset information, so long as the company has indirectly received capital from publicly funded Texas institutions.

For example, private companies that raise money from Austin Ventures or Blackstone Group would be subject to Freedom of Information Act (FOIA) requests for revenue projections, because the firms count the University of Texas Investment Management Co. (UTIMCO) as a limited partner.

As a result of Abbott’s stance, private attorneys nationwide are advising venture capital and private equity firms with public LPs to take proactive steps. One law firm sent a letter to clients in early October that called on fund managers to reexamine the types of information that must be sent to limited partners, and instructed fund managers with Texas LPs to pay particular attention to “the level of truly confidential information being provided.”

The letter also said that certain clients have considered whether to ask public LPs to sell their stakes on the secondary market and whether to ban such LPs from future funds.

One attorney acknowledges that there is not yet a decent test case proving that VC firms or their portfolio companies would be substantively harmed by the public disclosure of confidential information. Of course, the attorney adds, none of his clients are interested in serving as a guinea pig.

Free Legal Advice

A private equity attorney who has followed the disclosure issue closely says that he is coming across more and more VC clients who are reconsidering whether they will take money from public LPs. It’s especially vexing for investment firms that accept public LP money from multiple states, because disclosure laws are becoming slightly different in each state, the attorney says.

“The result is that a number of firms are raising less money [in new funds] than they did in their last funds,” he adds. “They are asking themselves why they need the headaches. That is a genuine concern for public LPs.”

Indeed, some brand-name funds have not shown any hesitation in excluding public LPs. Last year, Sequoia Capital kicked out two public LPs from its eleventh fund due to disclosure concerns: the University of Michigan and the University of California. This past February, Charles River Ventures (CRV) held a final close on its 12th fund without any public institutional investors. Past public backers who didn’t get into the $250 million fund include the City of Lowell, Mass., the Rhode Island State Treasury, and the Massachusetts Pension Reserve Investment Management Board (MassPRIM). CRV became the first known venture firm to exclude public LPs when raising a new fund. (Sequoia had let in UM and UC before kicking them out.) Then Woodside Fund, which closed on its fifth fund in March, did not accept any public pension money in its $146 million fund. Woodside also cited disclosure concerns.

However, in Texas, Abbott dismissed concerns from critics who claim that the disclosure fears would lead to Texas LPs getting shut out of funds. In a speech before the Freedom of Information Foundation of Texas on Oct. 1, Abbott said he was protecting Texas citizens who support the pension funds.

“The people of Texas-whose retirement savings and pensions are directly affected by these investment decisions-deserve no less than to have the light shine on the investment of these dollars,” Abbott said. “There is no proof that secrecy will ensure good investments, but it is true that secrecy can conceal bad investments.”

Abbott’s speech was referring to pending litigation brought against the Texas AG by the Texas Growth Fund. The Teacher Retirement System of Texas (TRST)-a limited partner with Texas Growth Fund-also joined the suit, which basically revolves around this issue of underlying asset disclosure.

It began last year when a reporter for the Austin Chronicle was writing a story about Texas Growth Fund investments in defense contractor Veridian Inc. and was reviewing information from TRST. But when some of the LP’s investment data was withheld, the newspaper filed additional FOIA requests. The attorney general ruled that information about individual companies in the portfolios of PE funds should be made public. Following that ruling this summer, Texas Growth Fund filed suit, arguing that releasing the information “is a threat of actual or potential harm to the marketplace interests of TGF.”

Ever since the private equity disclosure battle began in late 2002, some venture capitalists have warned that the industry was teetering on the edge of a slippery slope. Critics said that the public dissemination of top-line fund-level performance information would eventually embolden someone to call for the release of underlying asset information, like portfolio company valuations, revenue streams and other potential trade secrets.

Joe Aragona, general partner at Austin Ventures, says the Texas lawsuit is a defining moment in the local venture marketplace. UTIMCO and TRST are both LPs in Austin Ventures.

“You’d be hard pressed to find a GP or an LP who says that the release of portfolio company information would cause no harm,” says Aragona, who’s also chairman-elect of the National Venture Capital Association. “There’s no question certain information should be kept private, and there has to be an understanding between GPs and LPs that there is a required level of confidentiality.”

Austin Ventures is not in fund-raising mode, as it currently is investing from its $830 million AV VIII fund. But Aragona says that if it’s ruled in Texas that more than just top-line data is not confidential, “then private equity firms nationwide, including us, will not be raising money from Texas-based LPs.”

Many states are still trying to sort out the scope of exemption from open records law as it implies to LPs and VC firms (see table, opposite page).

Certain members of the Texas investment community are pushing state legislators to pass a bill that would exempt underlying asset information from being subject to open records laws. A similar measure was recently passed in Colorado, while both Michigan and Massachusetts also have exempted top-line data (although the Massachusetts state pension system has disclosed top-line data for funds raised more than five years ago).

Not Binding … Yet

Abbott declined repeated interview requests from VCJ, but spokeswoman Angela Hale said that his reference to the pending litigation could be extrapolated into a broader view of underlying asset disclosure. When asked if Abbott supports the public disclosure of portfolio company valuations and revenue streams, she said “yes.”

Hale also said that Abbott has not changed his position on the matter, because he had never been asked to rule on related issues in the past. “He only issues opinions when he is asked to,” she explained. Abbott’s actual record, however, is a bit murkier. In an earlier opinion also related to a FOIA request of TRST, Abbott’s Assistant AG, Cindy Nettles, wrote, “If the system funds were required to release information about their portfolio companies, those funds might be denied the opportunity to invest in prospective portfolio companies or forced to agree to less favorable investment terms to compensate the portfolio companies for the risk that their information will be released.”

Nettles further wrote, “that competitors of the portfolio companies could use the information at issue to compete with the portfolio companies and thereby harm the system’s investment. …We conclude that the system and TGF have shown that release of the information at issue will bring about a specific harm to the system’s and TGF’s marketplace interests.”

VCJ emailed a request to the Texas AG’s office for clarification on this earlier opinion, but spokeswoman Hale did not respond.

Abbott’s opinion on underlying asset disclosure is not yet binding in Texas. Even if a judge rules against Texas Growth Fund and TRST on the pending litigation, future FOIA requests may also find themselves in a courtroom until a ruling is issued broadly enough to be considered precedent setting. In fact, the Austin American-Statesman and Institutional Investor News have already followed the Chronicle’s lead and requested similar info.

History Lesson

This is not the first time the disclosure issue has rocked the Lone Star State. In 2002, UTIMCO published the investment results of its private equity funds to end its dispute with a Texas newspaper that requested the information. But that disclosure has created more controversy among funds about the future confidentiality of their proprietary information when they accept public institutions as investors.

Shortly after UTIMCO published its data, the San Jose Mercury News sued the California Public Employees’ Retirement System seeking disclosure of information relating to its private equity investments, and now various states are dealing with the issue through legislation.

For his part, Abbott seems to believe that Texas institutions will be just fine without disclosure-wary firms. In his recent speech, he said, “Money management organizations around the globe would be glad to manage [Texas’] money.”

It might not take long before that theory is put to the test.

Disclosure Policies From Around the Country


In September, the California First Amendment Coalition filed suit in San Francisco Superior Court, requesting that the California Public Employees’ Retirement System (CalPERS) “release all reports showing the amount of fees paid to venture capital and hedge funds, identifying amounts paid to individual funds.” CalPERS only discloses aggregate management and advisory fee expenditures and argues that public disclosure of management fee terms could cause it to be evicted from existing partnerships and to be shut out from future partnerships. This is a similar defense to what CalPERS argued in 2002, when a judge ruled that only underlying asset data, not top-line performance data, qualifies for trade secret protection. CalPERS settled that case out of court and began publishing its performance data online.


In April, Gov. Bill Owens signed a bill that prevents the release of underlying asset data (such as trade secrets and financial reports of VC firm portfolio companies). What remains for public consumption in Colorado is the amount of capital an investor, such as the Colorado Public Employees’ Retirement System, commits to a fund, the distributions it has received and internal rates of return of the various funds it has invested in.


Last year, the senate considered an amendment to its open-records law that would have protected certain data from being disclosed from the Florida State Board of Administration’s alternative investment program. It was similar to what was passed in Colorado. It was never voted on.


Legislators have proposed a bill – which is similar to legislation passed by Colorado – that would make a private equity fund’s performance numbers available for public consumption, but would not subject details about the fund’s underlying assets to Freedom of Information Act requests. The bill failed to pass before the state’s General Assembly went on hiatus for the summer, but it has a chance

of getting passed during a special legislative veto session that begins in November. Illinois lawmakers tried to pass a similar bill last year, but Gov. Rod Blagojevich refused to sign it.


Late last month, Massachusetts State Treasurer Timothy Cahill released internal rates of return for more than 100 private equity partnerships that the state pension plan invested in from 1986 to 1998. This was the first time that the Massachusetts Pension Reserve Investment Management Board (MassPRIM) has released individual performance figures for its investments. Cahill had resisted disclosing the returns because firms have threatened to shut out MassPRIM and other public pensions from their funds for violating the tradition of secrecy in the business. Cahill filed legislation earlier this summer to try to keep the investment details private. But Gov. Mitt Romney vetoed Cahill’s measure even though he is a former venture capitalist whose many business colleagues and political supporters favor privacy in venture capital.


In the spring, Gov. Jennifer Granholm signed into law an amendment to the state’s open records laws to prevent public institutions from disclosing certain private equity investment returns. The legislation extends an open-records exemption that already existed for state pension funds. The move comes more than a year after The University of Michigan released market values and internal rates of return (IRRs) for each of its 122 limited partnerships with venture capital and buyout firms. The University of Michigan last year was then booted out of a new Sequoia Capital fund, and asked to sell off existing stakes in earlier Sequoia funds.


Earlier this year, the state exempted from open-record law investment related information that is provided to the state under a promise of confidentiality. The statute says that the exemption doesn’t apply to the identity of an investment held, the amount invested and its present value.

Compiled by Alastair Goldfisher

Email: daniel.primack@thomson.com

Email: alastair.goldfisher@thomson.com