LP Notes –

After a two-year battle, Pennsylvania State Auditor Robert Casey Jr. won the legal right to audit the two largest state pensions in Pennsylvania.

In October, a Pennsylvania court ruled that Casey can conduct a special performance audit on the State Employees Retirement System (SERS) and the Public School Employees Retirement System (PSERS). In a 6-1 ruling, the Commonwealth Court of Pennsylvania ordered the funds to provide necessary documents and cooperate with Casey’s audit.

Neither PSERS nor SERS commented on the court order.

It is unclear how the ruling might affect other pensions nationwide, since other states have varying divisions of powers between auditors, treasurers and other officials.

A spokesman with the National Conference on Public Employee Retirement Systems in Washington, D.C., says he knows of no other state officials who wish to audit a state pension.

The legal battle over Casey’s right to audit the state retirement funds began two years ago when it was revealed that the retirement systems used 150 outside consultants and investment advisors. The tally for those services added up to more than $250 million. Meanwhile, the two pension funds have had to scramble for cash infusions totaling $200 million this year to pay pensioners. The funds, combined, have lost about $20 billion over the last two years.

In a prepared release, Casey said, “Taxpayers certainly have the right to know how these funds spend … and how they select the firms that help manage $73 billion in public employees’ retirement assets.”

The overseers of the funds, State Treasurer Barbara Hafer-who is chair of PSERS and sits on the SERS board-and SERS chairman Nick Maiale have maintained that the auditor general lacks the authority to conduct special audits. They have pointed out that the use of outside investment advisors is practiced among other states and that many state pension funds have suffered similar losses in recent years.

They also have suggested Casey used the audit request to pursue political objectives. Hafer (a Republican) will soon end her term as state treasurer, due to term limits. Casey (a Democrat) had been campaigning during the last several months to become State Treasurer of Pennsylvania. He was voted to the post in the Nov. 2 election, which occurred a couple weeks after the Commonwealth Court granted the state auditor the right to audit SERS and PSERS.

Casey’s term as auditor general expires in January. He says he would like to at least make some progress on the audit before leaving office. Now that he’s elected state treasurer, he will sit on both pension boards.

Jack Wagner a Democrat – won the state auditor general’s post in the election. During the campaign, he said he supported the special audit, as did his Republican opponent, Joe Peters.

Casey had recently been winning the battle of public opinion. Last year, the Pennsylvania Association of School Retirees announced its support of the special performance audit. Also, the Pennsylvania legislature passed a resolution by a vote of 187-12 calling on the pension funds to cooperate with the special performance audit request by Casey.

The state resolution also called on the sides to reach an agreement on the costs of the performance audits that would provide for the auditor general’s office to be reimbursed up to the amount that the pensions had initially planned to spend on their own audit.

The cost of the audit was one of the reasons cited by pension officials resisting Casey’s proposed audit.

PSERS manages approximately $50 billion and invests in Adams Street Partners, Spectrum Equity Investors, TA Associates, Madison Dearborn Partners and Landmark Partners.

SERS manages approximately $25 billion and its portfolio includes Apax Partners, New Enterprise Associates, Summit Partners and HarbourVest Partners.

-Matthew Sheahan

SEC Regulates Hedge Funds

The Securities & Exchange Commission voted in October to regulate hedge funds, as anticipated, but the impact on venture capital, is minimal. At least for now.

“A carveout was made in the language of the rule to exempt institutional investors. Most venture capital funds are not covered by the regulation,” says Marco Masotti, a partner in the law firm of Paul Weiss Rifkind Wharton & Garrison in Manhattan. He adds that state pension funds and other institutional investors are specifically protected in the rule, should they be forced to redeem investments in a VC fund in under two years due a statutory requirement.

The final rule-which has yet to be published by the SEC-will take effect in February 2006. “We’re going to read the publication of the rule very carefully,” says Masotti, “to see what final tweaks and changes may be made before final publication.” His law firm helped clients file comments against the rule.

Chairman William Donaldson led the SEC to a 3 to 2 vote to regulate hedge funds, as predicted by many industry observers, ignoring the recommendation from the National Venture Capital Association.

Jennifer Dowling, vice president for federal policy at the NVCA, says that the association was “pleased with the carve-out in the rule,” which makes a distinction between hedge and venture funds related to redemptions.

“While we haven’t seen the final language, I am convinced that our concerns relating to the possible inclusion of VCs under the rule if they liquidate their investments in under two years is addressed,” Dowling says.

While some see the rule as a step toward eventual regulation of venture funds, David Goldstein, a partner at White & Case in Manhattan says, “The rule doesn’t have a lot of bearing on other forms of private equity.”

Goldstein adds that the SEC is unlikely to move further in the direction of regulating private equity based on the regulation of hedge funds.

“The impact on other forms of alternate investments is marginal,” says Goldstein, who represented clients for whom his firm filed comments against the rule.

Commissioner Paul Atkins said that the only real distinction between hedges and venture capital-left unregulated by the rule-was the timing of redemption. Making a distinction along the lines of a two-year rule does not capture the distinction between such funds, he said.

Joining Atkins in his dissent, Commissioner Cynthia Glassman said in the open hearing that the regulation is “a disappointment, rushed through requisite procedures and largely seen as a fait accompli even before Tuesday’s vote.”

Glassman said that passage of the rule would have the effect of opening VC to an ever-wider group, thus having the opposite impact of the intention of those voting in its favor. “It is the wrong solution to an undetermined problem,” said Glassman, who added that she was “troubled by the minimization of the concerns expressed by those opposing the regulation.”

The New Jersey State Investment Council and the Ohio Public Employees Retirement Fund both supported Donaldson’s recommendations, lending credibility to his assertion that public pensions, representing millions of retirees, are increasingly involved with and becoming dependent upon private equity asset class investments.

The rule, an audio webcast of the hearing and published versions of testimony are available on the SEC website at www.sec.gov.

Jerry Borrell