Category: Private Investment Funds

Is CalPERS a Sovereign Wealth Fund?

Ashby H. B. Monk wrote Is CalPERS a Sovereign Wealth Fund? (He ends up saying no.)

Sovereign Wealth Funds have come under increased scrutiny with countries concerned that an investment by a SWF could be used as a political tool and not a mere investment. The underlying concern is that many of the SWFs come from countries that at times are hostile to the United States and often lack a substantive rule of law. Ashby notes that there is some confusion as to what constitutes a sovereign wealth fund.

While all seem to agree that the China Investment Corporation and the Abu Dhabi Investment Authority are SWFs, there is a lively debate as to whether public pension funds, such as the California Public Employees Retirement System (CalPERS), are also SWFs. While CalPERS itself is adamant that it is not, others disagree. The stakes are high for a fund like CalPERS, as the SWF label could come with a high cost.

Ashby starts with several of the SWF definitions and creates this definition:

SWFs are government-owned and controlled (directly or indirectly) investment funds that have no outside liabilities or beneficiaries (beyond the government or the citizenry in abstract) and that invest their assets, either in the short or long term, according to the interests and objectives of the sponsoring government.

Based on this definition, Ashby concludes that CalPERS is not a SWF.

Ashby H. B. Monk is a Research Fellow at the Center for Retirement Research at Boston College (CRR) and the University of Oxford.

Control under FINSA and CFIUS

On November 14, 2008, the Department of the Treasury issued its final rule to implement the Foreign Investment and National Security Act of 2007, which provided guidelines for the Committee on Foreign Investment in the United States when reviewing investments by foreign persons in U.S. businesses for national security issues. The final regulations go into effect 30 days after publication in the Federal Register: Regulations Pertaining to Mergers, Acquisitions, and Takeovers by Foreign Persons. (.pdf) That means they should be in effect by the end of the year.

One issue with the law and regulations is the uncertainty of when notification is required under FINSA.

Under §800.207:

The term covered transaction means any transaction that is proposed or pending
after August 23, 1988, by or with any foreign person, which could result in control of a
U.S. business by a foreign person.

The issue then is what is meant by “control” under FINSA?

The final regulations do not offer much help:

The Final Rule maintains the long-standing approach of defining “control” in functional terms as the ability to exercise certain powers over important matters affecting an entity. Specifically, “control” is defined as the “power, direct or indirect, whether or not exercised, through the ownership of a majority or a dominant minority of the total outstanding voting interest in an entity, board representation, proxy voting, a special share, contractual arrangements, formal or informal arrangements to act in concert, or other means, to determine, direct, or decide important matters affecting an entity; in particular, but without limitation, to determine, direct, take, reach, or cause decisions regarding the [matters listed in §800.204(a)], or any other similarly important matters affecting an entity.” See §800.204(a). Two points should be emphasized concerning this definition. First, it eschews bright lines. Consistent with the existing regulations, control is not defined in terms of a specified percentage of shares or number of board seats. Although share holding and board seats are relevant to a control analysis, neither factor on its own is necessarily determinative. Instead, all relevant factors are considered together in light of their potential impact on a foreign person’s ability to determine,
direct, or decide important matters affecting an entity.

One useful carve-out is under §800.302(b) that transactions that are not covered transactions include:

A transaction that results in a foreign person holding ten percent or less of the outstanding voting interest in a U.S. business (regardless of the dollar value of the interest so acquired), but only if the transaction is solely for the purpose of passive investment. (See §800.223.)

See my prior blog posts:

Treasury Issues Final Regulations for Committee on Foreign Investment in the United States

On November 14, 2008, the Department of the Treasury issued its final rule to implement the Foreign Investment and National Security Act of 2007, which provided guidelines for the Committee on Foreign Investment in the United States when reviewing investments by foreign persons in U.S. businesses for national security issues.

The Foreign Investment and National Security Act of 2007 amended section 721 of the Defense Production Act of 1950 (50 USC §2170) authorizing the President to review merger, acquisitions and takeovers by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States to determine the effects of such transaction on the national security of the United States.

FINSA codifies the structure, role, process and responsibilities of the Committee on Foreign Investment in the United States. Previously, CFIUS had existed only by executive order. FINSA establishes CFIUS in statute.

On April 21, 2008, the Department of the Treasury issued proposed regulations for the CFIUS . You can also get the comments on the proposed CFIUS regulations.

The final regulations go into effect 30 days after publication in the Federal Register: Regulations Pertaining to Mergers, Acquisitions, and Takeovers by Foreign Persons. (.pdf) That means they should be in effect by the end of the year.

See my blog posts:

See also:

Ruder Calls for Regulation of Hedge Funds

Former SEC Chair David Ruder testified to the House Oversight and Government Reform Committee that the SEC should be given the power to register hedge funds advisers and force them to disclose their risks. This testimony was part of the testimony of Congress Examining Hedge Funds. You can read the Testimony of David Ruder (.pdf).

Mr. Ruder states that:

New regulations are needed in order to protect hedge fund investors and in order to monitor hedge fund contributions to systemic risk. These regulatory needs can be accomplished by giving the Securities and Exchange Commission power to register and inspect hedge fund advisers, including the power to require disclosure of activities that might injure investors, power to require hedge fund advisers to disclose hedge fund risk activities, and power to monitor and assess the effectiveness of hedge fund risk management systems.

I disagree with the statement that regulation is needed to protect investors in hedge funds.  The exemptions from registration of hedge funds is for those funds and advisers with significant assets and understanding of risks.

As for the systemic risk posed by hedge funds, I remain unconvinced. Mr. Ruder refers back to the Long Term Capital Management in the late 90s.  We have not been hearing about hedge funds causing the current crisis. It appears that the investment banks and rating agencies were the parties most at fault. It also seems the lack of regulation in the derivatives markets, especially Credit Default Swaps, and poorly underwritten residential mortgages and mortgage securities were the tools that caused the most damage.

Congress Examining Hedge Funds

On Thursday November 13, 2008, The House Commitee on Oversight and Government Reform held a hearing on hedge funds and the financial market.

The following witnesses testified:

  • Professor David Ruder, Northwestern University School of Law, Former Chairman, U.S. Securities and Exchange Commission
  • Professor Andrew Lo, Director, MIT Laboratory for Financial Engineering, Massachusetts Institute of Technology, Sloan School of Management
  • Professor Joseph Bankman, Stanford University Law School
  • Houman Shadab, Senior Research Fellow, Mercatus Center, George Mason University
  • John Alfred Paulson, President, Paulson & Co., Inc.
  • George Soros, Chairman, Soros Fund Management, LLC
  • James Simons, President, Renaissance Technologies, LLC
  • Philip A. Falcone, Senior Managing Partner, Harbinger Capital Partners
  • Kenneth C. Griffin, Chief Executive Officer and President, Citadel Investment Group, LLC

Walker Guidelines

In February 2007 the British Private Equity and Venture Capital Association asked Sir David Walker to undertake an independent review of the adequacy of disclosure and transparency in private equity with a view to recommending a set of guidelines for conformity by the industry on a voluntary basis. This review culminated in November 2007 with the publication of the Guidelines for Disclosure and Transparency in Private Equity (.pdf).

The Guidelines require additional disclosure and communication by private equity firms and their portfolio companies where such portfolio companies had more than 1,000 UK employees, generate more than 50% of their revenues in the UK and either had an enterprise value of more than £500 million when acquired by one or more private equity firms or, in the case of a public to private transaction, had a market capitalisation together with premium for acquisition of control of more than £300 million.

  • The principal recommendations of the Guidelines for enhanced disclosure by portfolio companies are that:
  • The audited report and accounts should be readily accessible on the company website no more than six months after the company year end.
  • The report should identify the private equity fund or funds that own the company and provide details of the composition of the board.
  • The financial review should cover risk management objectives and policies in the light of the principal financial risks and uncertainties facing the company with links to the appropriate detail in the footnotes to the accounts.
  • The report should include a business review that substantially conforms to the provisions of Section 417 of the Companies Act 2006 including the Enhanced Business Review requirements that are ordinarily applicable only to quoted companies.