Ever since public pension funds began investing in venture capital funds, the two groups have shared a mutually beneficial relationship highlighted by large commitments and even larger returns. Recently, however, this seemingly perfect marriage has begun showing signs of strain over the issue of fund performance transparency and the legal limits of LP nondisclosure agreements.
This developing issue came to a head when the University of Texas Investment Management Co. (UTIMCO) received a media request under the Texas Freedom of Information Act (FOIA) to disclose fund-by-fund investment return data for its entire private equity portfolio. UTIMCO initially denied the request pursuant to restrictions under each private equity fund’s respective nondisclosure requirements. With political and media pressure mounting, however, the UTIMCO board unanimously voted on Sept. 18 to make “full and fair disclosure” of its records.
The vote itself was controversial given that it conflicted with nondisclosure agreements in almost all of UTIMCO’s private equity partnerships. For these funds, UTIMCO said it would first request a waiver and, if such a waiver was not granted, UTIMCO would turn the matter over to the Texas attorney general under the state’s FOIA.
At this point, each private equity fund manager had to decide if it would weigh in on the attorney general opinion process or file suit against UTIMCO for violating nondisclosure agreements. The latter option, while perhaps viscerally appealing, may have been implausible given a general exclusion in most partnership agreements regarding the release of information at the request of a governmental agency, as well as the resulting negative perception of a litigious general partner. The better alternative for a private equity fund looking to keep its information confidential, if allowed by the statute, was to take part in the opinion process. If a private equity firm believed confidential fund performance data could be used by competitors or misconstrued by the public and prove detrimental to its operation, the process would have been well worth the effort.
Exemptions under the FOIA are generally complex, but if a venture fund can navigate its way through the statute, relief may be found. The FOIA’s general purpose is to increase public access to government records by substituting limited categories of privileged material for the broad discretionary standards that had, prior to enactment of the FOIA, allowed agencies to withhold information. The FOIA requires that governmental agencies disclose their records to any person requesting them, barring those records containing information specifically excepted by one of the statutory exemptions.
The exemptions from the rule of mandatory disclosure under most FOIA statutes include an exclusion from the release of information considered “confidential.” Generally, to invoke this type of exemption the requested information must be: (a) a “trade secret” or “commercial” or “financial” information; (b) “obtained from a person;” and/or (c) “privileged” or “confidential.”
In determining whether requested documents are confidential, the applicable test is whether disclosure is likely to either impair the government’s ability to obtain necessary information in the future or to cause substantial harm to the competitive position of the person from whom the information was obtained.
Presupposing that both the type of information and its supplier meet the above criteria for exemption, the focus should be the determination of the confidentiality of the information under the two-prong test. The first prong of the test, impairment of the government’s ability to obtain information, has been found to be satisfied when it is shown that the submitting entity would not provide such information in the future if it were subject to public disclosure. Only the government may initiate this prong, so the issue is unlikely to be raised. The second prong and threshold question for the venture fund is if the information is released, will there be substantial harm to a company’s competitive position?
In determining whether material should be disclosed under the second prong, the courts have expressly noted that a balance must be struck between the strong public interest in favor of disclosure of information and the rights of those submitting information to privacy and confidentiality. Each case will be reviewed with regard to its own set of facts and circumstances, but the courts generally have held that a party need not show “actual competitive harm” from disclosure of the information; a showing of actual competition and the likelihood of substantial competitive injury will be sufficient. The courts will examine whether there would be competitive harm if documents were to be disclosed to the general public, not whether harm would occur from disclosure to the individual requester.
Get the Balance Right
Where the submission of information has been found to be voluntary, some cases have held that the two-prong test above need not be satisfied; instead, a more lenient test has been applied: Voluntarily submitted information is to be deemed confidential if “it is of a kind that the provider would not customarily release to the public.”
With respect to a promise or agreement to keep the information confidential, as in the UTIMCO case, the courts have stated that the test for confidentiality is an objective one: “A record is not exempt from disclosure on the grounds that it had been obtained by a promise of confidentiality on the part of the governmental agency.” The burden of proof ultimately falls on the venture or buyout fund to prove that the release of information will cause actual competition and a likelihood of substantial competitive injury.
In the UTIMCO matter, before independently deciding to release the venture fund information, UTIMCO decided to request an exemption from the Texas attorney general under a specific subsection of the Texas FOIA statute, stating that release of the information will be “advantage to a competitor or bidder.”
In an August opinion, the Texas attorney general allowed UTIMCO to withhold certain confidential information regarding its investments because it would not be allowed to participate in future venture fund investments if required to disclose confidential information which would possibly put the pension fund at a competitive disadvantage.
Subsequently, a September opinion stated that UTIMCO withdrew its request to have such information kept confidential. In this opinion, the attorney general said that his office is waiting for related third-parties to submit their position that “with specific factual or evidentiary material that they will actually face competition and that substantial competitive injury would likely result from disclosure.” According to UTIMCO, none of the venture funds submitted information and all of the requested information was released on Oct. 4.
If UTIMCO’s PE fund managers seek to prevent future or additional confidential information from being released to the public pursuant to a FOIA request, then they should diligently prepare a response the Texas attorney general’s office, setting forth why such a disclosure would result in a competitive disadvantage. If this course of action proves unsuccessful, the only recourse may be to sue UTIMCO for breaching the terms of the limited partnership agreement or asking the Texas attorney general to enforce confidentiality. Litigation will run the risk of causing UTIMCO to withdraw as a partner, as well as create the possibility of losing existing and future pension fund clients.
For private equity funds that accept public money and want to keep performance data confidential under the FOIA, some precautions may be in order. As indicated above, regardless of how well drafted an agreement might be, when dealing with a government agency, the information may be subject to public disclosure.
A venture fund should include an acknowledgment in its limited partnership agreement that performance and financial data as well as other data marked confidential is acknowledged to be confidential, and that the release of such information would be detrimental to the venture fund’s competitive advantage.
In addition, a proprietary rights program should be initiated to raise the level of protection for information that should be treated as confidential, whether it’s within the organization or information distributed to third parties. A proprietary rights program includes many important facets, but at a minimum, and specifically for government data, such information should be prominently marked with a confidentiality legend containing a specific reference to the exemption from disclosure under the applicable FOIA statute or any other confidentiality procedure followed, such as confidential submission procedures followed by the Securities and Exchange Commission.
Todd Boudreau is an attorney with Greenberg Traurig LLP. He works in the Boston-based firm’s corporate, securities and information technology practices, focusing on startups and established businesses.