Commitment killer

What a $40m Orange County fund commitment gone wrong tells us about the new fundraising regime for public pensions.

The Orange County Employees Retirement System, with about $8.3 billion in assets, in November had approved a $40 million commitment to EnCap Investments, an oil and gas-focused private equity firm with offices in Houston and Dallas, Texas that has been attracting strong interest from LPs in the US.

EnCap has been targeting $2.5 billion for its eighth fund and is expected to hit its hard cap of $3.5 billion, sources tell me. As of press time a final close was expected by the end of January.

Chris Witkowsky

EnCap and Orange County were hammering out final negotiations on the commitment and got snagged on some terms of the pension’s placement agent disclosure policy, which the pension adopted in June 2010.

Specifically, the firm would not agree to “remedy provisions” in the policy. These provisions would be triggered in the event of a material omission or inaccuracy in disclosures related to the placement agent policy, according to pension documents. The remedies allow the pension to fire the manager without penalty, or stop making capital contributions without any penalty. Also, the provisions would allow Orange County to recoup certain management or advisory fees paid by the pension, according to pension documents.

EnCap was “uncomfortable” with “the ongoing obligation to ensure the placement agent provides disclosure of all the requirements in the policy, because they cannot ascertain whether that disclosure is accurate or not”, Jennifer Hom, OCERS’ managing director of investments told the pension’s retirement board in a letter on 9 December.

Also, EnCap was concerned that by allowing the provision for OCERS, the firm would be forced to accept the same terms from its other limited partners, Hom said.

EnCap did not return a call for comment.

Orange County eventually chose to drop the commitment, which had been approved at an earlier meeting. The technical reason was that the pension was not going to be able to get the size of commitment it wanted: $40 million. It wouldn’t be able to make its desired $40 million commitment because it couldn’t finalise it by a certain deadline. And presumably at least part of the reason it couldn’t meet the deadline was because of the disagreement over the disclosure policy.

EnCap had told the pension to finalise the commitment by 15 December or risk losing its place in the fund, Shanta Chary, the pension’s chief investment officer, told the board in a letter.

“Alternatively, if documents are signed and returned by December 31, OCERS will be guaranteed a place in the fund but not the amount, as the fund is expected to be oversubscribed,” Chary wrote to the board.

The situation may be the first time a pension has lost the opportunity to invest with a desired manager in part because of complications arising from its placement agent policy.

The pension, like many public pensions in the US, was looking to make sure it didn’t become enmeshed in a New York-style pay-to-play scandal. Pensions across the country are creating disclosure policies that make their investment managers disclose the name of the third-party marketer and how much the placement agent is being paid.

Orange County modeled the penalties in its policy on the California Public Employees’ Retirement System’s placement agent policy, Hom said. The pension may review the policy to determine if the penalties are too stringent.

“The placement agent policy is new and has never been tested,” Hom wrote to the board. A GP’s reputation would be tarnished if an LP cancels its contract and would impact the manager’s ability to raise another fund, she said.

“A remedy provision is important to the enforcement of the board approved placement agent policy. However, a less stringent penalty might be more appropriate,” she said.

More pensions may find their policies tested, especially when confronted by GPs raising funds that are attractive to LPs. While enhanced disclosure policies are important, as was evidenced by pensions getting burned by crooked politicians masquerading as placement agents in New York, they need to be balanced so as to not scare off those GPs and risk missing out on good investment opportunities.