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UC Announces Challenge To Fund Disclosure Ruling

Friday August 15, 2003

The University of California plans to appeal a court ruling it claims could shut UC out of some of the most lucrative investment opportunities on the market. 

At issue is the July 24 ruling by Alameda County Superior Court Judge James Richman who held that the university must disclose the “internal rate of return” (IRR) for its investments with various venture capital firms.  

UC claims that IRRs, used to determine the value of investments, are trade secrets and that the disclosure requirement could scare off the venture capital firms which sink millions of dollars into start-up companies, hoping to reap big payoffs if the up-and-comers succeed. 

“If [a venture capital firm] is presented with the opportunity of taking $10 million from a private institution that will keep the IRR secret and a public institution that is compelled by the courts to make it public, the [firm] will choose the private institution,” said UC spokesperson Trey Davis. 

The university, whose portfolio is valued at $53.3 billion as of June, claimed in court papers that forced disclosure could cost the university “billions of dollars in returns.” Any losses would impact funds for research and academic programs and the university’s $35.2 billion retirement fund, which serves over 170,000 employees. 

But representatives of the Coalition of University Employees (CUE) and the San Jose Mercury News, which joined UC Berkeley professor emeritus Charles Schwartz in bringing the action, said IRR disclosures by other public entities have not provoked retribution from venture capital firms.  

They also argued that the benefits of informing the public about UC’s investment decisions far outweigh any perceived risk of financial losses. Without a transparent process, they say, the powerful UC Board of Regents—many of them business leaders appointed by the governor—could direct public funds into poorly-conceived investments with their cronies in the financial world. 

“We’re afraid that they will just give the money to their friends,” said Mary Higgins, who serves on the executive board of CUE, which represents 18,000 clerical employees throughout the UC system. “There should be full disclosure.” 

In his 20-page ruling, Richman agreed with the plaintiffs. 

“The Court concludes that the public’s interest in [the release] of the IRRs clearly outweighs any public interest in keeping them secret,” he wrote. 

Part of Richman’s ruling rested on the finding that a host of public institutions—from the California State Teachers’ Retirement System to the University of Illinois to the University of Michigan—have made IRRs public without any ill effects. 

“None of [UC’s] ‘the sky will fall’ concern has manifested,” Richman wrote. 

The judge said he found “particularly persuasive” evidence that top venture capital firm Sequoia Capital had accepted a new $8 million investment from the University of Michigan after the school publicly released IRR information. 

But one day after Richman’s ruling, the University of Michigan received a letter rejecting the $8 million bid and asking the school to withdraw all its existing investments from the Menlo Park-based Sequoia. 

UC has filed a motion asking Richman to reconsider in light of the Michigan incident and of a decision by Portola Valley’s Three Arch Partners two days later to reject a UC investment in its new fund. 

“This ‘particularly persuasive’ evidence now supports the University, not the Petitioners,” the motion reads. 

But Mercury News attorney Judy Alexander said the Sequoia and Three Arch arguments don’t hold water.  

“Neither of them have much bearing on our case,” she said. 

Sequoia has stated publicly that it asked the University of Michigan to divest because of wide-ranging public information requests from the public and the press that cover much more than simple IRR disclosure, Alexander noted. 

The lawyer added that Sequoia, which also handles UC investments, has not asked UC to divest, despite the Richman ruling. 

Furthermore, Alexander said, Three Arch has said publicly that it rejected UC because it had too many investors bidding to get involved in its new fund, not because of disclosure concerns. 

“We didn’t have enough room,” Wilfred Jaeger, a founding partner at Three Arch, told the Bloomberg News service last week. 

But Jaeger said disclosure could make a difference in selecting future investors. 

“If that’s the distinguishing feature between investors, we probably would take that into account,” he said. 

If, as expected, Richman denies the motion for reconsideration at an Aug. 28 hearing, UC has indicated that it will take the case to the First District Court of Appeal in San Francisco. UC’s filing is due Sept.. 8. 

At stake is $646 million invested in the “private equity” market with venture capital firms. UC’s private equity investments have gained an average of 32 percent per year over the last five years, surpassing a benchmark of 8.4 percent, according to the UC treasurer’s annual report. 

But CUE’s Higgins said she still has concerns about the management of an overall endowment that fell 10.7 percent last year—more than any of the other ten largest U.S. university endowments, save for the Massachusetts Institute of Technology—before rising again this year. 

That concern was at the heart of the request Richman also granted to order the university to release records from a pair of Fall 2000 closed Regents’ meetings that resulted in the firing of UC’s internal equity investment staff and transfer of fund management to several outside firms. 

Richman ruled that while the law allows the Regents to remain in closed session when discussing specific investments, it does not shield general discussions of investment strategy. 

The university disputes Richman’s finding. 

“The meetings under contention relate to investment matters, so it’s perfectly appropriate for those sessions to be closed,” said UC spokesperson Davis. 

Alexander, the Mercury News attorney, said Richman’s ruling on the closed meetings covers new legal ground and could persuade the First District Court, which is not obliged to hear UC’s appeal, to take up the case.