Second review finds discrepancies in fees, carried interest paid by LA County

Almost 40 percent of Los Angeles County Employees Retirement Association’s private equity managers collected more than their contractually agreed-to share of investment profits, according to an external review of the $52.5 billion public-pension system’s PE program.

Accounting firm Kreischer Miller reviewed the cash flows of 40 separate PE funds for LACERA to establish whether firms were adhering to the terms of their contracts. The review found 15 general partners that collected too much carried interest. Most of the overpayments appeared small relative to the size of the vehicle, averaging around $4,900 over the life of the fund.

Separately, the firm found three examples of firms overcharging LACERA on their annual management fees, a copy of the report provided by LACERA shows. The largest overpayment amounted to roughly $9,200 over the life of the fund.

The Kreischer Miller review also found several instances of GPs undercharging LACERA for management fees and carried interest. GP groups overseeing 13 of the audited funds collected less than their share of carried interest by roughly $7,500, on average. Twelve funds undercharged LACERA on management fees by $113,000 in aggregate.

PE firms typically take around 20 percent of their funds’ investment profits as carried interest. The rest is distributed among the funds’ investors, known as limited partners. Annual management fees typically hover around 2 percent of committed or invested capital.

Kreischer Miller forwarded its findings to LACERA’s investment division to resolve its issues with its managers.

“We would like to thank Kreischer Miller for their tremendous effort on this engagement and the GPs selected in the sample for their cooperation with this review,” LACERA Chief Audit Executive Richard Bendall wrote in a separate memo.

A second external review of LACERA’s private equity program, conducted by Pavilion Group, found the system had underreported the program’s total costs by as much as $37 million last year, Buyouts reported. In its annual report, the public pension reported PE fees and expenses totaled $52.6 million, considerably less than the almost $90 million Pavilion found.

While the underreported costs have no bearing on its PE program’s returns or valuations — LACERA reports both as net of all fees — they’re indicative of the struggle many institutions face in accounting for PE’s myriad costs.

“Given the complex nature of the fee structure in the alternative space, fee disclosures may never be straightforward and completely transparent,” LACERA staff wrote in a memo obtained through an open-records request. “It’s also important to note that fee transparency is not the ultimate goal; it is a means to better understanding the total fund in order to make better informed investment decisions.”

LACERA declined to comment.

Next steps

LACERA initiated both reviews of its private equity program in 2015 after several public pensions — including California Public Employees’ Retirement System — disclosed they hadn’t tracked some of the costs associated with the asset class. Around the same time, several major PE firms reached settlements with the SEC for failing to disclose certain fees and expenses.

LACERA has taken a number of steps to improve its understanding of PE’s costs, some of which were prompted by California’s passing of a law requiring public pensions to disclose more information about their private equity programs.

The law, Assembly Bill 2833 or AB 2833, forces California public investment funds to publish annual reports about the fees, expenses and carried interest charged by their external private equity managers. To obtain the information for that report, LACERA’s contractual side letter requires new funds to use the Institutional Limited Partners Association’s standardized template for fee and expense reporting.

LACERA is engaging with the management teams overseeing some of its older private equity holdings to request more data on fees and expenses, according to a staff memo. The retirement association also hired dedicated staff and external auditors to verify fees were paid and calculated correctly.

There has been some pushback here — one general partner declined to provide information about portfolio company fees to Kreischer Miller — but external managers representing more than 95 percent of LACERA’s private equity holdings agreed to participate in the Pavilion review.

“Although there is still room for improvement in achieving complete fee transparency in the alternative investment industry, there have been great strides made in the recent past by industry participants, including ILPA, [the] SEC, and investors like LACERA,” according to a staff memo.

Action Item: For more information about LACERA, visit www.lacera.com

The Olympic flame is seen at the Los Angeles Coliseum on the day the city was awarded the 2028 Olympic Games, Sept. 13, 2017. Photo courtesy Reuters/Lucy Nicholson

UPDATE: The story was updated to reflect LACERA declining comment.