Information Rights for Limited Partners Invested in Venture Capital

Limited partners cannot make a meaningful assessment about the risks in their venture capital holdings without adequate access to information. Read what Investment Governance, Inc. Advisory Board member, Mr. Pascal Levensohn, has to say about transparency and due diligence. Click here to read Mr. Levensohn's impressive bio.

According to Mr. Pascal Levensohn, Section 17-305 (b) of the Delaware Revised Uniform Limited Partnership Act, which governs LP information rights according to DE law, specifically allows the GP to withhold from LPs “any information the GP reasonably believes to be in the nature of trade secrets or other information the disclosure of which the GP in good faith believes is not in the best interest of the Fund or could damage the Fund or its business or which the Fund is required by law or by agreement with a third party to keep confidential.” This would include the GP’s fiduciary duties and confidentiality obligations with respect to not disclosing portfolio company information without the consent of such company. The Act provides for a specific list of information that LPs are entitled to, and funds historically disclose that same information to their LPs—the top law firms in Silicon Valley model their LP agreement forms to be pretty consistent with Delaware law.

Specifically, Section 17-305 of the Act provides for the following:

(a) Each limited partner has the right, subject to such reasonable standards (including standards governing what information and documents are to be furnished, at what time and location and at whose expense) as may be set forth in the partnership agreement or otherwise established by the general partners, to obtain from the general partners from time to time upon reasonable demand for any purpose reasonably related to the limited partner’s interest as a limited partner:

(1) True and full information regarding the status of the business and financial condition of the limited partnership;

(2) Promptly after becoming available, a copy of the limited partnership’s federal, state and local income tax returns for each year;

(3) A current list of the name and last known business, residence or mailing address of each partner;

(4) A copy of any written partnership agreement and certificate of limited partnership and all amendments thereto, together with executed copies of any written powers of attorney pursuant to which the partnership agreement and any certificate and all amendments thereto have been executed;

(5) True and full information regarding the amount of cash and a description and statement of the agreed value of any other property or services contributed by each partner and which each partner has agreed to contribute in the future and the date on which each became a partner; and

(6) Other information regarding the affairs of the limited partnership as is just and reasonable.

The current state of the art for Agreements of Limited Partnership in venture capital allows the GP to override the information rights LPs have pursuant to the Delaware Revised Uniform Limited Partnership Act (the “Act”) as permitted pursuant to the Act and allows the GP to “adjust” identifying information given to the LPs in order to protect the identity of the Fund’s portfolio companies, which often is an issue in the case of Freedom of Information Act (FOIA) LPs. In addition, the partnership agreement allows the GP to restrict / withhold information from LPs if “the General Partner reasonably determines [such LP] cannot or will not adequately protect against the [improper] disclosure of confidential information, the disclosure of such information to a non-Partner likely would have a material adverse effect upon the Partnership, a Partner, or a Portfolio Company.” Other elements of the well drafted agreement do provide the LP’s with disclosure rights to their advisors, equity holders, etc. and provide remedies and protections to the GP with respect to GP withholding rights and improper LP information disclosure.

Career Risk and Action: Chicken or the Egg?

 

In a recent Virtual Town Hall about what governance means in the investment world, guest speaker Mr. Wayne Miller mentioned a relationship between career risk and fiduciary reform. Chairman Emeritus of Denali Fiduciary Management, Miller said that many people abide by the status quo, however ineffective, rather than innovate and improve their fiduciary practices. The fear is loss of one's job by taking prescription actions to better manage how monies are allocated and monitored. My response was to suggest the opposite. Why would a professional willingly adhere to bad practices when doing so could imperil his or her job and the related ability to get a bonus and/or promotion?

Which is the chicken and which is the egg? Does doing the right thing jeopardize one's climb up the career ladder or immensely help someone advance?

Click here to access the full transcript and enjoy all FiduciaryX subscriber benefits. If you think you qualify for a free 90-day trial as an institutional decision-maker, email Sales@InvestmentGovernance.com.

 

What is Investment Governance?

 

What is pension governance? More broadly, how does one characterize investment governance? Talk to a dozen institutional investors and you are likely to get a dozen different answers.

Brian Holden has an interesting take on this important query. In "Where there's a will: governance check" (Pensions Week, January 11, 2010), his suggestions include the following:

  • Go beyond regulatory mandates to include best practices
  • Balance the representation of stakeholders 
  • Add knowledgeable individuals to decision-making bodies
  • Introduce risk management principles to guide actions
  • Manage pensions with beneficiaries and shareholders in mind
  • Adopt a "dynamic and more businesslike approach"
  • Establish a governance code "to provide guidance and assessment."

A lot of this sounds eerily familiar. I've been making many of the same points for years as have others. Increasingly, dissonant voices are coming together to speak a common language of reform. This is encouraging indeed.

Yesterday marks the official launch of FiduciaryX.com. Click to read "Investment Governance, Inc. Announces the Launch of FiduciaryX.com." We will be announcing all sorts of events and speakers in the coming weeks and months. On February 16, 2010 from 11:00 AM to Noon EST, we are holding a FiduciaryX Virtual Town Hall on the topic of investment governance. Email CustomerCare@InvestmentGovernance.com if you are not yet a subscriber but would like to participate in this exciting online event. We hope you will join us.

Investment Governance, Inc. Announces the Launch of Best Practices Portal

Investment Governance, Inc. today announced the official launch of FiduciaryXSM – a new research, education, data and social network portal for institutional investors and their service providers. Over two years in the making, this exciting online resource enables 24/7 access to investment best practices insights from experts and peers.

Designed by and for buy side professionals who control over $25 trillion in global assets on behalf of pensions, endowments, foundations, sovereign wealth funds, mutual funds, 529 college plans and family offices, www.FiduciaryX.com offers executives a cost-effective way to improve decision-making, ask questions, search documents, exchange ideas and potentially mitigate personal and professional liability. Subscribers enjoy access to the FiduciaryX Virtual Reference Desk, Knowledgebase and Service Provider Ranking System, industry leader blogs, discussion forums, online town halls, documents archive and much more.

Be part of an ongoing conversation or carry out a quick search about topics such as reviewing an asset manager's performance, setting up a derivatives overlay program, choosing a new investment consultant, assessing 401(k) fees, implementing an operational audit, dealing with new performance reporting rules or purchasing fiduciary liability insurance.

“Our team of programmers, researchers, educators and experts are passionate about using technology to promote transparency, enhance governance and empower institutional investors and their attorneys, advisors, actuaries and other service providers” said Dr. Susan Mangiero, founder and CEO of Investment Governance, Inc. “It is a true honor to work with those individuals and organizations that continue to enthusiastically support our mission of codifying best practices and enabling stewards to gain clarity about the elements that comprise procedural prudence. The paradigm is undeniably shifting towards greater fiduciary responsibilities and disclosures for buyers and sellers of products and services alike. We believe that the launch of FiduciaryX provides a golden opportunity to showcase superb ideas and recognize industry leaders whose diligence reflects a high standard of care on behalf of underlying beneficiaries such as retirees.”

To learn more about FiduciaryX, visit http://www.fiduciaryx.com/video_tour, call (203) 929-0011 or email Press@InvestmentGovernance.com.

Qualified investment decision-makers who are willing to provide a few hours of their time over the next several months are invited to become part of the FiduciaryX User Group. In exchange, these individuals will receive a courtesy one-year subscription to www.FiduciaryX.com. Email CustomerCare@InvestmentGovernance.com for more information.

About Investment Governance, Inc.

Investment Governance, Inc. (formerly known as Pension Governance, Incorporated) is an independent research, analysis and training company. Our corporate mission is to empower institutional investors and their service providers with information and data that allows for improved decision-making with the fiduciary perspective in mind. Our services include consulting, conferences, communities, data analysis, training and benchmarking technology. Visit www.InvestmentGovernance.com, www.FiduciaryX.com and www.PensionRiskMatters.com for more information.

Benchmarking the Investment Industry

 

In my September 11, 2008 testimony before the ERISA Advisory Council, I described two buckets of organizations - those which deserve a gold star and those who don't. I went on to explain that the size of the "everybody else" bucket might be very large but that current reporting requirements make it nearly impossible to know about red flags in advance. This is cold comfort for shareholders and taxpayers who would prefer to know about financial runaway trains beforehand.

Unfortunately, those who attempt to provide more sunlight about their activities are not always rewarded. In a recent conversation with the CEO of a major asset management firm, I was told that this firm had provided detailed information about its fee structure to institutional clients. Instead of being rewarded, and because there are wide variations with report to how asset managers present performance data, sunlight led to storm clouds. Endowments, foundations and pensions responded by asking why the fees were so high. The reality was that the costs were in fact lower than those of comparable traders but, since competitors were not providing more than basic feedback, their costs were interpreted as lower and therefore "better." It's no surprise that the executive with whom I spoke expressed frustration. Here they were trying to do what they thought was the right thing and come clean with a detailed decomposition of what they charged. Instead of a reward, they were kicked in the proverbial shins.

In "Type-A-Plus Students Chafe at Grade Deflation" (January 29, 2010), New York Times reporter Lisa W. Foderaro describes a similar phenomena in the university sector. Where Princeton sought to minimize grade inflation by limiting the number of A's, top quality students found it harder to compete for jobs when graduates from other schools flashed their scores. Never mind that Princeton arguably tried to impart higher integrity data.

Is the message that transparency is window dressing and that no one really wants to have the low down on "true" outcomes? Alternatively, should we conclude that heightened disclosure rules are inevitable but it is incumbent upon providers of information to educate their recipients, i.e. make sure that underlying assumptions are clearly explained? If that does not occur, might well-intended parties (those who provide more detail than necessary) be impugned instead of rewarded for their forthrightness? 

Editor's Note: Click to read "Testimony by Dr. Susan Mangiero to ERISA Advisory Council Working Group on Hard to Value Assets," September 11, 2008. (Note that Pension Governance, LLC is now part of Investment Governance, Inc.)

Investment Ethics: How to Make Money and Win Clients

The following text is from an article I recently wrote for Mann on the Street (December 2009). As always, I welcome comments from readers. I am an avid believer in the notion that doing good means doing well. Click for the pdf version of "Investment Ethics: How to Make Money and Win Clients" by Dr. Susan Mangiero, CFA, FRM.

According to Plato, “Good people do not need laws to tell them to act responsibly, while bad people will find a way around the laws.” Given the current spate of financial scandals, the words of this ancient philosopher hit close to home. Rule-makers around the world are adding staff, beefing up mandates and otherwise looking to stabilize markets after an unprecedented rollercoaster ride for individual and institutional investors alike. Wall Street is girding itself for a tough regulatory climate, especially in areas such as compensation and proprietary risk-taking. The unfortunate fallout, as with any statute, is the blurring of lines between good and bad players. Companies lose the flexibility to reward prudent process and are challenged to lure new clients on the basis of transparency. After all, if everyone is forced to abide, how do buy side executives separate the wheat from the chaff?

The good news for ethicists is that integrity matters. As stated in its 2009 Midyear Special Report about trust, Edelman Public Relations reports that “profitability and performance falls behind employee well-being, transparent and honest business practices.” In “Building Customer Value and Profitability With Business Ethics, researchers Robert C. McMurrian and Erika Matulich support the notion that good behavior adds “value for customers” and results in “increased profitability and performance for the firm.” Contrast that with the results of a February 2009 Marist poll sponsored by the Knights of Columbus which assigns a “grade of D or F in ethical matters to the financial and investment industry.”

While grossly unfair to indict an entire collection of professionals, it is surprising that Wall Street executives have been relatively silent on the topic of moral leadership. Statistics document the almost $3 trillion allocated to “socially responsible” money managers yet there is almost nothing known about what the sell side spends on investment governance.

The truth is straightforward. Bad apples spoil the pie for everyone. It is folly to ignore the negative externalities due to misdeeds of industry peers. The costs are too high. Lost clients, fiduciary litigation, new law compliance and missed opportunities are only a few components of the rogue’s price tag, handed off to increasingly impatient shareholders, investors and taxpayers. Even if one is inclined to skimp for whatever reason, it is not smart business. With new fiduciary regulations looming over the horizon, service providers who take the time to learn more about institutional investor pain points could have a big advantage in terms of client acquisition and retention.

Institutional investors do not get a free pass. They absolutely must dig deep or risk being sued themselves, see their name in headlines, lose their job  and/or incur the wrath of unhappy beneficiaries.

The encouraging news is that there are lots of ways to improve due diligence. Far from exhaustive, the following list includes some suggested action steps:

  • Ask to meet with the individual who is responsible for creating a standard of investment best practices for the back office, senior traders and sales team members, respectively
  • Inquire whether bonuses are tied to risk-adjusted performance that considers both qualitative and quantitative measures
  • Identify whether a service provider has been sued and whether they were found culpable
  • Query whether the compliance officer, if one exists, is tasked to develop investment best practices that go beyond the technical adherence to a particular statute
  • Request examples as to how a service provider expended resources in implementing best practice standards even when not required to do so by law
  • Ask if best practices are applied equally across business units in different countries, if applicable
  • Discuss how the service provider controls for conflicts of interest
  • Require information about the service provider's fiduciary liability insurance policy (cost, scope, whether terms have ever been rescinded, etc)
  • Gain a better understanding of the mechanism by which a vendor acquires new clients.

Unless Lady Luck is a close friend, scant attention paid to investment ethics is an invitation to trouble. Who wants to find themselves in a courtroom, explaining bad acts or incomplete oversight?

On a positive note, conversations with buy side executives about conflicts of interest, compensation and risk management offer an opportunity to spin transparency into gold. It is better that industry participants climb the same train than be forced to bear the brunt of a “one size fits all” solution from legislators with little or no experience in capital markets. Ideally, a sufficiently large number of leaders coalesce to enforce higher standards on behalf of the millions of pension, endowment, foundation and mutual fund beneficiaries. They count on stewards and investment service providers alike  to be there in more ways than one.

Author Mark Twain's lament that "physical courage should be so common in the world, and moral courage so rare" is hollow if rational self interest combines with even a wee bit of idealism.