March 21, 2006
Private Equity, Illinois Pensioners and Sudan?
Posted by Bobby Bartlett

Many thanks to Gordon, Christine and Vic for inviting me to guest-blog at the Conglomerate. As Gordon notes, one of my primary areas of interest is venture capital/private equity--a topic that gets quite a bit of attention around here. Accordingly, I’d like to begin by addressing a recent issue that has arisen in the private equity world, curtsey of the State of Illinois.

In May 2005, the Illinois General Assembly passed (with overwhelming support) S.B. 23, a bill that requires state and local pension funds to divest themselves by July 2007 of any investments in financial institutions that do business with or in Sudan. To ensure compliance with this requirement, all Illinois pension funds investing in managed investment funds (such as private equity funds) must receive certifications from fund managers that no fund assets are invested in a “forbidden entity” (generally defined to be any agency of the Sudanese government or a company doing substantial business in Sudan). Private equity funds receiving Illinois money must also receive certifications from each portfolio company that the company does not do business in Sudan. The legislation was prompted by the ongoing genocide in the Darfur region of Sudan, which represents a tragedy of extraordinary proportions. S.B. 23 was signed into law (Public Act 94-0079) on June 27, 2005 and took effect on January 27, 2006. You can find the statute here.

Notwithstanding the admirable intentions of the Illinois legislature, the effect of this legislation on Illinois’ private equity investments has troubling implications for the state’s pensioners. As a number of sources of have noted (see e.g., here and here), many top performing private equity funds have already begun to refuse investments from Illinois pension funds rather than accept the additional burden of complying with the statutory requirements. This is not because these private equity funds invest in Sudan or because the statutory requirements are especially onerous. Rather, it is because these funds tend to be oversubscribed when they are formed and can pick and choose their investors as they see fit. As this blog has previously noted, private equity funds are already concerned with the additional disclosure burden of having public pension fund investors, and the Illinois legislation seems to be viewed by many private equity investors as simply one more reason to stay clear of “public” money.

Of course, one might argue that public pension funds have no business investing in “risky” private equity anyway, so being shut out of private equity funds is entirely appropriate. But I think the evidence is now pretty clear that private equity investments represent an important asset class in creating an efficient investment portfolio, particularly for pension funds facing significant fund out-flows in the years ahead. Moreover, there is considerable evidence that positive returns on private equity investments are closely linked with having access to the historically top-performing private equity shops. If Illinois pension funds are shut out of the top-tier private equity funds, their private equity returns will almost certainly suffer.

While I support the goal of this legislation, I fear it will have unintended consequences for the Illinois pensioners who had little say in whether they would be willing to subsidize it. More generally, it causes me to wonder whether using pension fund assets to pursue this type of social policy is consistent with the prudent investor standard that governs pension plan fiduciaries.

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