More Railroading of CalPERS Board: General Counsel Withholds That Fiduciary Counsel Candidate Is Leading Case That Undermines CalPERS and CalSTRS

It looks like CalPERS’ general counsel Matt Jacobs is yet again giving the mushroom treatment to the board: keep them in the dark and feed them shit.

In this case, Jacobs has failed to brief the board on a serious potential conflict of interest of one of the two candidates for fiduciary counsel, the most important advisor to the board. The position that became vacant when the prior counsel, the tainted Robert Klausner, was pushed out for his many dubious practices.

As we will describe in greater detail below, the lawyer, Ashley Dunning of Nossaaman, LLP, is representing Marin County on what so far looks be a landmark case, in which a California appellate court has reversed over 60 years of precedent. This ruling threatens the pensions of all California public employees, including members of CalPERS and CalSTRS. The case is set to go to the Supreme Court and a number of groups have objected fiercely to the court’s legal reasoning. CalSTRS’ general counsel Brian Bartow weighed in against the decision promptly after the ruling was issued, in October 2016.

At the end of this post, we’ve attached two of many amicus curiae letters, including the one from CalSTRS, to show that informed parties see the decision as a threat to the benefits even of major California pension funds.

As one retired state attorney wrote:

Jacobs is trying to make monkeys out of the employee-elected members of the CalPERS Board. That is a level of disloyalty to the Board that would get him fired — if the Board were actually his client. He reveals himself to be working against their interests.

Moreover, after being hand-picked by Jacobs, Dunning is currently advising the board as interim fiduciary counsel. Jacobs has not only failed to tell the board of the conflict of interest but as a result has also failed to get the board to provide a written waiver. Nor is it clear whether Jacobs waived the conflict of interest on behalf of CalPERS.

Mind you, this isn’t just a political problem. This is a State Bar rule violation. This case is so important that the CalPERS agenda shows that Jacobs has briefed the board about it in closed session at least three times. CalPERS may want to file an amicus brief or even attempt to intervene in the case at some point. At a minimum, the board should expect that it may want to receive future briefings on the case. As a former state prosecutor said by e-mail:

The problem here is the lack of disclosure. If I were a Board member, a late and forced disclosure of the potential client conflict wouldn’t cut it, because the circumstances are strongly suggestive that the conflict was hidden with the intent to deceive.

Jacobs, if he’s asked to address the issue, will no doubt hand-wave and try to claim that he knew about the conflict. But Rule 3-310 requires that the client be advised in writing and provide written consent. Note that this section uses the word “shall,” which is mandatory. It’s not clear that this took place with CalPERS and more importantly, it does not appear to have taken place with the board, which is supposed to be Dunning’s main client.

Let us be clear about the underlying issue: Jacobs is routinely cutting corners and overstepping his authority in dealing with the board and the public. This is the exact opposite of the behavior that is sought after in a general counsel.

Jacobs’ bad habits interact destructively with the misguided decision by CalPERS’ board to stop having the general counsel report directly to the board. The board compound that error by delegating the hiring of fiduciary counsel to the legal office.

While Dunning has a potential conflict of interest which per State Bar rules must be disclosed and waived, her case is symptomatic of a bigger problem. The Board has an actual conflict with staff, since the board has a constitutional duty to oversee staff, who are currently critically under-performing. The Board should have independent legal counsel who isn’t advising them that their duty is to cover for screw-ups by staff. You can see the degree to which the staff has succeeded in indoctrinating the board of the exact opposite, that they should avoid “embarrassing the System” when that is tantamount to hiding lapses or outright abuses.

To her credit, as far as I can tell, Dunning never endorsed this topsy-turvy view of board duties. But because Jacobs acts as the “legal services gatekeeper” when he implies that undermining public confidence in staff is somehow a violation of fiduciary duty, he cloaks his own advice in the false mantle of having consulted with fiduciary counsel.

In addition, the stark contrast with the quick and firm response of CalSTRS’ general counsel to the Marin case raises an even bigger question: Why is Jacobs missing in action in the face of a fundamental legal threat to all CalPERS beneficiaries? He has shown no willingness to take up his most important duty, that of defending beneficiary pensions. How can he be trusted to make any recommendations in the face of that?

As former general counsel and now law professor Bill Black said via e-mail:

We have a general counsel who has already racked up a deplorable record who has apparently decided that the key to having the board fulfill its fiduciary duties to its beneficiaries is to pick a fiduciary counsel with a glaring conflict of interest.

As Benjamin Cardozo wrote in Meinhard v. Salmon,

Many forms of conduct permissible in a workaday world for those acting at arm’s length are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the marketplace. Not honesty alone but the punctilio of an honor the most sensitive is then the standard of behavior. As to this, there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the “disintegrating erosion’ of particular exceptions (Wendt v. Fischer, 243 N.Y. 439, 444). Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd.

But here we have a fiduciary counsel engaged in anti-fiduciary duty, in direct conflict with the interest that the board is duty bound to uphold. George Orwell would stand in admiration of how an expression has come to mean the opposite of its original intent.

Jacobs now has an established pattern of gaming the selection process to assure that the board will opt for his pet pick.

Apparently Jacobs does not want to call the board’s or public’s attention to the fact that his preferred candidate, Dunning, has wound up on the side of undermining public pensions. Mind you, the letters criticizing the decision describe at some length its tortured logic; I have not been able to locate and review her brief to see whether the apparently-dodgy reasoning came from her or was the court’s invention. Regardless, this means Dunning should be subject to a much more in-depth interview than the 20 minutes that Jacobs allowed for during the last fiduciary counsel interview, in 2014.

And on a more basic level, there is no justification for Jacobs withhholding such important information from the board. This is dealing in bad faith.

The board may well conclude that they prefer Dunning and that her role in the Marin case is not problematic. But this is a choice the board should make explicitly, after due deliberation, and not by being railroaded yet again by Jacobs.

How Jacobs Has Been Misleading CalPERS’ Board

We described how the last time CalPERS’ board selected its fiduciary counsel, in 2014, several board members, including its two lawyers, Richard Costigan and Dana Hollinger, objected to the fact that the board was denied information about the candidates that they had always been given in the past.

It turns out those board members had good reason to be concerned. Jacobs had failed to inform the board about the fact that the candidate the legal department scored the highest, Robert Klausner, had nearly two decades of bad press about questionable ethical conduct, including by the New York Times and Forbes, meaning a simple Google search would have unearthed it. Klausner was also embroiled in a dispute with the City of Jacksonville over allegations of his having set up an illegal, secret pension fund for the administrator of the Fire and Police pension fund and then superfunding it when the underlying city pension fund was the most underfunded in the state. So we are either to believe that Jacobs and his staff failed to do basic vetting or withheld important information to make sure his top choice was rubber stamped by the board.

Klausner resigned last year as a result of the exposure of his questionable history.

As we documented last week, Jacobs again withheld information by failing to provide the board with the fiduciary counsel RFP responses when background material is virtually without exception provided to the board at the time board meeting materials are made public, ten days prior to the actual session. There was no excuse for not giving the board documents that already existed and took no meaningful effort to pass along….again assuming Jacobs is dealing in good faith.

After we made a stink in our Friday morning post, the documents were sent to the board later in the day. That is hardly adequate time, given that most board members travel to Sacramento on Sunday and will have little time if any to read a last-minute disclosure. In other words, this is better than delivering the interviews in paper form at the board meeting, but not by much.

Jacobs has also lied to the board and flagrantly misrepresented statute to try to justify CalPERS’ failure to comply with the law. A board should be alarmed at the prospect of a general counsel that makes obvous misrepresentations that can and have been readily shown to be false. In addition, when as a general counsel of a state agency, he has a duty to uphold state law. We described one instance here; there’s another, regarding state election law, that we have yet to write up.

After reviewing some of Jacobs’ recent actions, former general counsel, now law professor Bill Black concluded:

The general counsel is supposed to play a leadership role in rehabilitating a corporate culture like CalPERS that has lost its integrity. Jacobs has failed this test.

The Marin Case’s Potential to Undermine California Pensions

The lawsuit at issue is Marin Association of Public Employees v. Marin County Employees’ Retirement Association. California has a long-standing body of case law, dating back to a 1955 Supreme Court decision, known informally as the “California rule” that guarantees that employee benefit commitments will be honored. Any changes must confer an equivalent monetary benefit. Until the Marin ruling, the 1955 decision was repeatedly reaffirmed in a variety of settings.

However, in 2012, the state legislate passed some new pension rules to curb certain types of gaming, and the Marin case comes out of that. Defenders of the case argue that it is about pension “spiking” which ironically is the sort of activity that CalPERS’ former fiduciary counsel Robert Klaunsner engaged in on behalf of fire and police pension funds.

And there is a problem with this abuse at smaller funds. Note that there is a difference between CalPERS employees and CalPERS-contracted jurisdictions versus “1937 Act” county and city pension plans. 1937 Act jurisdictions have smaller investment pools and local boards which too often engaged in pension hanky-panky. These boards have tended to gift managers with “special compensation” that isn’t available to non-managerial employees through collective bargaining. It appears that this was what was at issue in Marin.

And that raises an additional troubling issue with having Dunning act as fiduciary counsel to CalPERS. She’s served as counsel to some of the same “’37 Act” boards that engaged in “special compensation” featherbedding. That should be a red flag. She’s sat pat while her clients engaged in what amounts to self-dealing, when the fiduciary counsel’s job is to prevent that sort of thing from happening. And now she is profiting by helping to solve a problem that her undue passivity helped create.

Back to the implications for funds like CalPERS and CalSTRS that are run (at least pre-Jacobs) with more care. I’m sure this list isn’t complete, but the parties providing amicus curiae letters include CalSTRS, SEIU, AFSCME, California Attorneys, Administrative Law Judges and Hearing Officers in State Employment (CASE), California Community College Independents and the Faculty Association of the California Community Colleges, California Professional Firefighters, and the International Federation of Professional and Technical Engineers. Law firms have also said they will file briefs on behalf of beneficiaries.

The issue is, as many of the petitions explain, that state employees took and remained in jobs with salaries well below what they could have earned in similar private-sector jobs. One of the biggest reasons for accepting lower current pay was the offset of eventual pension benefits. The letters are forceful on how radical a departure this ruling is from past decisions.

Most of the amicus letters request that the Supreme Court simply “depublish” the ruling. That means it would stand as far as the Marin case was concerned but could not be used as a precedent.

From the letter by Brian Bartow, CalSTRS’ general counsel:

To reach its conclusion, the Marin court converted a required consideration into a discretionary one, and in so doing, incorrectly interpreted and reversed over sixty years of California Supreme Court precedent. Furthermore, the decision will provide misguided precedent for a broad spectrum of future cases involving California pension and vested rights jurisprudence, and create an enormous amount of uncertainty for the courts, legislators, those charged with administering pension systems, and California’s public employees.

The dispute in Mann stems from the Legislature’s amendment to Government Code section 314611, which excluded specified items (such as payments for additional services, reimbursements, and executive bonuses) from the calculation of an employee’s “compensation eamable.” According to the Marin court, the purpose of the amendment was to curb pension “spiking,” the practice of increasing an employee’s defined benefit retirement allowance by increasing his or her final compensation, typically done by including various non-salary items.

The Court of Appeal ultimately held that the Legislature did not act impermissibly by amending
Section 31461, and the Marin County Employees’ Retirement Association’s (MCERA) implementation of the change did not amount to “an impairment of the employee’s receipt of a ‘reasonable’ pension upon retirement.” (Mann, supra, 2 Cal.App.5th at pp. 679-680.)

In reaching its holding, however, the Court of Appeal embarks on a myopic expedition through over sixty years of firmly entrenched Supreme Court law, ultimately concluding that “There Is No Absolute Requirement That Elimination or Reduction of an Anticipated Retirement Benefit ‘Must’ Be Counterbalanced by a ‘Comparable New Benefit’ (Mann, supra, 2 Cal.App.5th at p. 697, italics in original), a result that directly contravenes the holdings of this Court and the Court
of Appeal.

From CASE, the organization for state attorneys and law judges whose pensions are managed by CalPERS (emphasis original):

These holdings not only conflict with prior decisions of this Court and other courts of appeal, but they also raise fundamental questions of law that need to be resolved by this Court.

The conflict with prior cases is acknowledged in the decision itself. At pages 23-24 of the slip opinion, the decision candidly recognizes that this Court previously stated:

With respect to active employees, we have held that any modification of vested pension rights must be reasonable, must bear a material relation to the theory and successful operation of a pension system, and, when resulting in disadvantage to employees, must be accompanied by comparable new advantages….

In addition to the conflicts, the holding of the case raises more questions than it answers. By declaring that a public employee’s only vested right is to a “reasonable pension” (slip opn. at pp. 2, 22) the opinion simply begs the question: what is reasonable? Or, to put it another way, exactly how much can the benefits in a vested pension be reduced without violating the constitutional prohibition on the impairment of contracts? The opinion seems to suggest that a reduction of 25% (from two thirds of an employee’s salary to only one half of an employee’s salary) is acceptable. (See slip opn. at pp.22-23, fn. 18.) But it set no real limit on the permissible level of reduction, other than to blithely declare that they cannot be entirely “destroyed.”…

The State of California already is at or near the bottom in terms of salary and benefits offered to starting attorneys, and this is based on comparisons only to other public sector agencies in California, to say nothing of private sector legal salaries. The decision in this case threatens to further undermine California’s ability to compete for legal talent by giving the employer the ability to retroactively reduce compensation in the form of a promised pension after the compensation was already bargained for and earned.

Now legal sophisticates would argue that conflicts of interest occur all the time with big firm advisors. While narrowly true, this is one reason boutiques have become popular, to make sure that the professional isn’t practically or intellectually tainted. And one might also argue that the tolerance of all sorts of white-collar abuses stems from tolerating too much “grey area” conduct, that this is the ultimate origin of the “rigged game” that swept Trump into office. If CalPERS does decide to join the Marin case on behalf of the employees, I hope the CalPERS beneficiaries will press the board to have any CalPERS advisors that are adverse suspended until the Supreme Court makes its decision.

Finally, alarge unanswered question is where is the CalPERS CEO, Marcie Frost, in this picture? Jacobs as her subordinate proceeds with her blessing. Not only is she allowing him to operate in a reckless manner, but she is also implicitly taking a position that is damaging to the elected members of the board and their constituents, meaning CalPERS’ beneficiaries. To get hired, Frost maintained that she was a staunch supporter of defined benefit programs. Jacobs’ conduct is making her pledge look like a bait and switch.

The fiduciary counsel interviews and vote are tomorrow, Wednesday March 15. Please circulate this post widely to anyone you know who has a California pension, most important CalPERS and CalSTRS beneficiaries. Urge them to call or e-mail the offices of State Treasurer John Chiang and State Controller Betty Yee, and demand that they put off the vote on fiduciary counsel for procedural lapses, namely the failure to adequately brief the board. Their details:

Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
(916) 653-2995
E-mail: john@sco.ca.gov

Ms. Betty Yee
California State Controller
P.O. Box 942850
Sacramento, California 94250-5872
(916) 445-2636
E-mail: b.t.yee@sco.ca.gov

Thanks again for your help!

Amicus Marin CalSTRS
Amicus Curiae Marin CASE CalPERS