Our efforts to learn more about the private equity industry are revealing how determined public pension funds are to hiding as much as they can, even when they don’t have a legal leg to stand on.
Readers may recall our rapidly-expanding public records dispute with America’s largest public pension fund, CalPERS, where we’ve been forced to sue for private equity returns data. At the same time, we’ve been seeking investment records from other public pension funds in California. That has included filing Public Records Act requests for real estate investment contracts with other public pension systems. So far, we’ve hit a brick wall of obstruction and brazen favoritism toward the interests of investment managers who are keen to maintain secrecy. Gee, you think they have something to hide?
We’re focusing on California because a court there recently ruled that a real estate limited partnership agreement (LPA) is a public record. That means it must be disclosed when a Public Records Act request is made.
Several years ago, the California First Amendment Coalition sued for the release of the LPA governing CalPERS’ investment in a troubled fund called Page Mill Properties II, L.P. In 2010, the San Francisco superior court ruled in favor of the document’s release. The judge rejected various claims made by CalPERS, including the argument that a real estate fund is actually a form of private equity, which would have made the LPA statutorily exempt from release. This leg of the ruling is important: the judge explicitly found that a real estate fund is not an “alternative investment” for purposes of the law because it is not a private equity fund, venture fund, hedge fund, or absolute return fund.
And there are sound reasons for that conclusion. The term “alternative investments” was coined to apply to investments in asset classes that were not ones that institutions had invested in traditionally. By contrast, real estate funds have a long history. Thus, there is good reason to believe that the legislature didn’t think they need the “nurturing” of private equity, venture capital, or “absolute return” funds.
The court also scoffed at CalPERS’ argument that the LPA document constituted a trade secret of the fund’s sponsor. Under court order, CalPERS capitulated and released the document.
We asked the Los Angeles County Employees Retirement Association (LACERA) for a copy of its real estate fund LPAs and received a blanket denial, shown below.
LACERA Public Records Act Request Response, 3/19/14
What arguments did LACERA make? We encourage you to read the letter in full; don’t be deterred by its “the lady doth protest too much” quality.
Two major assertions were the same ones that the San Francisco court had rejected in the Page Mill case, 1) that real estate funds are a form of private equity; and 2) that the LPAs are a trade secret of the investment managers. In case you are wondering, we did point out in our original request letter that the Page Mill decision precluded LACERA from relying on either of these claims, but the pension fund asserted them nevertheless.
LACERA offered one other major justification for non-disclosure, which was an invocation of the PRA catch-all exception to document release when “the the public interest served by not disclosing the record clearly outweighs the public interest served by disclosure of the record.” Now how can that strained argument be made to sound plausible in this case, when millions of retiree dollars are at stake? LACERA’s twisted reasoning exposes how it is utterly in thrall to the investment management industry.
According to LACERA, releasing the real estate contract, “risks alienating alternative fund managers and, as a result, jeopardizing its [LACERA’s] access to top-tier investments.” In other words, the fund managers might get their feelers hurt and will take it out on LACERA by not inviting them in to future deals. (Notice how LACERA tries calling them “alternative funds managers” when the court has firmly rejected that characterization on real estate deals. Even though many funds do manage both private equity and real estate funds, these are distinct business, each with their own professionals, and operate with a great deal of autonomy).
So what LACERA is arguing here is that there is an overriding public interest in avoiding any action on LACERA’s part that might displease its investment managers. Essentially, LACERA has said it will never publicly oppose its investment managers, since any strong action to do so might alienate them. That means, like CalPERS, it will defy clearly settled law and require anyone who wants to get real estate or private equity-related records to sue to gain access to them.
Even worse, LACERA is delusional about the fundamental nature of its relationships with its investment managers. They are counterparties in an extremely complex, long-lived transaction. Even in a successful deal, there is only so much money to go around, making this is a zero sum game. When it comes to how to divvy up the money, their interests are adverse. Moreover, there is substantial risk of being short-changed by the manager, since the manager controls the money.
But that’s not how LACERA sees it. Instead, its letter sets forth a charming fairy tale in which investment managers treat LACERA “as a partner within the close-knit alternative asset investment community.” You can’t make this stuff up. And the worst is that LACERA almost certainly believes this blather. That’s how badly captured they are.
The people of Los Angeles County are poorly served by a pension system that, self-admittedly, sees itself as part of a “close-knit” community with investment managers who are, by definition, trying to make as much money as possible off their backs. I bet you can hear the sheep bleating blocks away from LACERA’s offices.
Among LACERA’s many preposterous statements, one is really special. LACERA’s letter acknowledged that the non-disclosure is allowed only “if the allowance of the privilege [of non-disclosure] will not tend to conceal fraud or otherwise work injustice.” As we have discussed, investment limited partnership agreements frequently are used to implement “management fee waivers” that leading tax experts view as illegal, essentially a fraud upon the U.S. Treasury. This is one of the main reasons why giving out LPAs “risks alienating alternative fund managers,” to use LACERA’s own words, since it would be tantamount to blowing the whistle on their tax fraud. Instead of acting as the whistleblower, LACERA has made the decision to assist with the cover-up.
We’re going to get to the bottom of this, and it won’t be pretty.
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The DB sector has been moving into alternative investments for a few reasons:
– they want to lower volatility and valuations based on appraisals help this.
– the only way they can meet their obligations and optimistic assumptions is by going into investments which can be marked-to-make believe for up to a decade.
-they understand that the best place to be (with current yields at 2.5%-3.5%) is in investment pools that will participate in the privatization of public assets because these tend to be sold off at ridiculously low prices and often benefit from regulated pricing.
Ironically, the majority wants to protect our currently flawed pension system which is contributing to the gutting of the middle class.
I am for one single pension plan for all, private and public workers.
Might I suggest that all readers living in Cali give a call to this LACERA office and give them what-for. A couple hundred angry phone calls might be enough to the but fear of gawd (or rather, of Yves) into ’em.
The letter’s signatory, John Harrington, actually invites contact in the last paragraph.
564-6000 x4342, or via email at jharrington@lacera.com
I am going to call him and encourage others to do so also, or at least email him.
That would be terrific, thanks! Tony too!
There is this report out today at Alternet that is in line with your efforts.
the link: http://www.alternet.org/economy/new-report-reveals-how-wall-street-impoverishes-los-angeles?paging=off¤t_page=1#bookmark
This is a seriously small world. As it happens, I am also the beneficiary of a small pension from LACERA, and actually live in Los Angeles. I can feel the urge building to write them a letter :-).
It won’t be pretty, but it will be amusing. The phrase “Judas Goat” comes to mind, somehow.
This letters reads as half snow-job, half alternative reality, and is not atypical of the usual corporate responses when under pressure. (Do the people who write these things take classes in how to generate these?) The most bizzare part was
The bizzare part appears to be the premise. We are talking about a massive pension fund with a barrel of money to invest. My understanding was that it is the fund managers who must compete for this money, but the letter seems to imply that the fund must compete for the fund managers.
So LACERA live in bizzaro world, or have there been yet more changes the the law (that great tool Neo-Liberals assure us cannot be used to shape society), in order to reshape the social/working structures of pension funds so that the funds have to compete for fund managers. What kind of way is this to run pension schemes? I suppose it’s all so easy when it involves someone else’s money.
Most of the PE funds are based on generating quick capital gains. A large percentage are not based on growing the economy but on zero-sum games.
So pension plans try to look for PE funds that will not screw them… so there are all kinds of tricks that these funds use to look appealing.
There is a special dance between the two.
LACERA sounds like a high school freshman explaining why she must stay with her abusive sophomore jock boyfriend.
And I think the fine sensibilities at NC still underestimate the power of envelopes full of cash.
‘the letter seems to imply that the fund must compete for the fund managers.’
David Swensen, in his book Pioneering Portfolio Management, points out that only the top quartile of private equity funds (and he means private equity, not real estate deals) are worth investing in. Getting into these top-drawer funds may be a bit like getting into Harvard, with far more applicants than admissions. But this makes it inevitable that many public pension funds will get stuck with lower-tier, underperforming PE partnerships.
In the case of real estate partnerships, what is the high-value secret that must be protected? Plenty of REITs are public companies, whose holdings are well known and a matter of public record. What might be sensitive in the offering documents of private real estate partnerships are the investment objectives: for instance, acquiring ‘prime office space in Sacramento.’ The partnerships worry about front-running.
Still, at all times, dozens of public and private buyers are searching for prime office space with a decent cap rate. Could anyone actually profit from this info, when plenty of other buyers already are scouring the territory to make acquisitions? Probably not.
Here’s David Swensen on ‘agency issues’: ‘Nearly every aspect of fund management suffers from decisions made in the self-interest of the decision-makers, not in the best interest of the fund.’ And you can take that to the bank!
The problem is (and there’s a study that shows this, but I need to track it down) that over 80% of the funds can define a universe in such a way as to look like they are top quartile. So this approach is useless in practice.
Here in Canada, many large DB pension plans are currently working on their asset allocation, looking to increase their weight in infra and other alternative investments.
Disturbingly, they are getting ready for the ppp cycle that will hit. Out debt-to-GDP has ballooned since the crisis so governments will look for ways to raise capital without putting any debt on their books. They will use pension plan assets and guarantees which will attract the banks. And that’s when ppp will hit.
I say disturbing because many public assets will probably get sold to these funds on the cheap but only a small number of Canadians get to participate in the DB funds that will be tripping over each other to get first dibs.
[Swallowed post should appear here.]
The state of Pennsylvania is having a similar debate about paying private equity managers untold, well, told, but dump truck loads, well, really, Nuclear Aircraft Carrier loads of cash in fees. And the comparison comes down to this simple question posed by a local biz writer: “Why don’t they just hire Vanguard?” Now, no one gets to profit because Vanguard is set up as mutual fund cooperative business owned by the members who place their money there, which means everyone who places their money there. And the pay structure for the people who work there will keep them from missing meals or nice vacations, but will not make them as wealthy as all of the nations in Africa combined.
The interesting thing about cooperatives, is that they are businesses run for the benefit of their members, the benefit being the business service or products offered that people want or need everyday in a modern society. The benefit is not an intangible profit, but the most efficient delivery of the goods of services. By delivering on that, their is a pecuniary benefit that can be imputed as a profit for the members, that they would not otherwise accrue if they sought similar goods or services from another source, not owned by them, but by a profit seeking alternative. You buy at cost, cut out the profit margin and keep the difference.
It would seem any profit making business could not compete with the mutual coop model in many instances. And it it seems especially true in the investment in the stock market. The following is any article and a link to this matter and what it means for Pennsylvania. The county I live in has almost 900,000 people and includes the fabled Main Line. The county commissions turned over the county workers pension fund management to Vanguard saving $10s of millions annually. So, it is not an idle threat, it is being done here.
If the state of PA followed suit, it would reap over $5 BILLION in contributions over 10 years in savings from money manager fees at private equity firms. Add to that $5 BILLION, any returns on investments and you can see that the state would realize a windfall in contributions simply by saving on these fees.
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http://articles.philly.com/2014-03-17/business/48269233_1_psers-private-equity-investments-private-equity
PSERS needed $1.4 billion from state and local property taxpayers last year, and it expects to need $2.7 billion next year, it told legislators in February in its yearly report.
That’s after paying $552 million to hundreds of private investment firms – more than half the total for private equity, private debt, hedge, venture capital, commodity, and other investments you can’t buy from a broker – to keep its assets from sliding farther below its liabilities.
Isn’t there a better way?
“Arguments have been made that private equity is just an expensive form of investing in public equities and can be replicated by passively managed public equity indexes,” PSERS concedes in an unusual one-page statement almost halfway through the 116-page report.
But actually, it really works, PSERS adds, promising to show “what the returns would have been if, instead of investing in private equity, the cash that flows into/out of private-equity investments were made into/out of a very low-cost mutual fund,” the Vanguard Total Stock Market Index, for the period December 1998 through September 2013.
That 15-year graph shows a PSERS private-equity profit line that runs higher than the Vanguard fund’s line, indicating higher profit from high-paid managers vs. cheap index-fund algorithms. Next to the chart, PSERS lists “10 Year, Net of Fee” results showing PSERS private equity returned 13.95 percent a year in those years, beating the S&P fund’s 8.38 percent.
Ergo, it concludes, “PSERS has been able to generate in excess of $5 billion in incremental value vs. the passive, low-cost approach to index investing.”
Now, forget that past returns are no guarantee of future performance. (Or that Vanguard funds have become so popular the Malvern company is now one-fifth of the mutual-fund industry.)
Consider instead that, also in the report, PSERS shows the system’s private investments, in each category, have not yet returned the billions of dollars PSERS has invested in each category, let alone net profit.
How can it claim to be beating Vanguard and the S&P? PSERS spokeswoman Evelyn Tatkovski said Tuesday staffers would be too busy for the rest of the week to talk. So I called some experts.”
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You can read what they had to say in the link.
Try MacFarlane Properties. It lost tens of billions of CALPERS money and is now busy building “low income properties” and other giant units in the San Francisco Bay Area.
“–LandSource: CalPERS paid $970 million in January 2007 for a majority stake in a Lennar Corp. development on the 15,000-acre Newhall Ranch north of Los Angeles. The project declared bankruptcy 15 months later. CalPERS severed ties with the advisor that recommended the investment, MacFarlane Partners of San Francisco.”
http://calpensions.com/2010/04/30/how-calpers-bet-big-on-real-estate-and-lost/
Part of the Axis of Weevil in the San Francisco city government which has notably had one of its up and coming darlings who became an “adviser” arrested by the FBI for conspiracy to commit murder and import guns, to and including shoulder fired missiles.
http://www.sfexaminer.com/sanfrancisco/charges-against-keith-jackson-come-as-surprise-to-some-not-others/Content?oid=2747706
“In 2008, Jackson reportedly started his own consulting group called Jackson Consultancy and was retained by Lennar Urban, a division of the national homebuilding giant Lennar Corp. that’s involved in the redevelopment of the Hunters Point shipyard and Candlestick Point.”
Oh and the State senator and candidate for Secretary of State was also arrested by the FBI. Such fun to watch an edifice of corruption crumble.
Splendid work, Yves. Wow, seven whole pages just to say, “No.” Seems kind of overkill-ish. Wonder whether they put somebody on special to write that or they had it already made up due to prior demand. I can imagine the terror that the CalPERS and LACERA folks must be feeling right now, they will surely be fighting for their lives. At least when the Madoff biz went down everyone could act astonished. Oh, I took the time to read Judge Woolard’s ruling Yves linked to, http://firstamendmentcoalition.org/wp-content/uploads/2010/09/PetWrit-Order-filed-endorsed.pdf — it was LOL funny. Excellent read, I recommend it to all. In fact, I think I shall recommend it to Mr. Harrington.
Looks like Yves California lawyer may be getting some more business. We should chip in for bragging rights.
You’re great Yves… keep going!
When I ask myself why a public agency might work to protect its counterparties, I wonder where their interests overlap. Both wish to avoid scrutiny. The pension fund, because it has almost undoubtedly made some poor investment decisions – and private equity because they profited from those bad investments through fees. This leads me to wonder a bit about the legal advice the pension fund is getting. I would guess that letter was written by counsel. When you get done flogging the relationships of pensions with private equity firms, you might turn your attention to legal counsel. I am guessing, just guessing mind you, that there conflicts of interest in the legal team advising the pension system. The cadre of law firms that specialize in finance is fairly small, so it would not be too surprising that the pension fund’s legal team has a more than passing familiarity with PE firms the pension invests with. White shoe law firms have a code of secrecy – because what you don’t know, you cannot criticize – or file a complaint against. And to defend themselves.
Great article. We see the same thing in KY, NC, SC, TX, FL, RI, NJ and many others. I think with SuperPacs, are influencing Public plans to maximize the number of high fee managers with many of these plans having 200 or 300 or more managers. This creates more potential donors for the SuperPAC;s and since everything is secret there are no consequences.
thank you yves
Yes indeed!
Thank you for your continued public service for which you don’t get paid while those that oppose you do.
+1
I love the smell of threatening litigation in the morning. So please keep us informed of your (lawyer’s?) response to this nonsensical “NO!” letter to your legitimate request.
Rubenstein’s Latest PEU Lament
After Jim Cramer rolled over on the subject of private equity Carlyle Group co-founder David Rubenstein told CNBC;s national audience of private equity’s difficulty in getting their message out:
“I wish we were better at getting our message across, so maybe we should figure out how to do that better. But in the end private equity (underwriting) (PEU) is a great industry for the United States.”
Yes, they employ many retired politicians and public servants, but how does a guy with regular public access via CNBC, Bloomberg, WaPo, WSJ, FT, get his backside handed to him, such that the public has negative perceptions of private equity? I’d venture it’s the stark hand dealt to employees within the PEU family. Word of mouth on jobs cut, retirement plans frozen or eliminated, years with no pay increases and the trauma of being flipped beats slick PEU ads and presentations.
Private equity has earned its reputation with each and every management stroke. It’s the PEU boys that get the happy ending. Everyone else, not so much.
http://peureport.blogspot.com/2014/03/rubensteins-latest-peu-lament.html
My husband and I are both LA County Retirees, and so we have more than a passing interest in how LACERA invests its funds. We were told years ago that one of our real estate holdings was the Ritz Carlton Hotel in Pasadena – a very swanky place. I don’t know if that is true today.
“the the public interest served by not disclosing the record clearly outweighs the public interest served by disclosure of the record.”
I don’t think the ‘public’ wants to know that it has been bankrupted, by trading natural resources for promises, again, and would rather accept inflation, until it explodes, but History could be wrong this time…is different…
So, RE is inflated, by screwing grandma, and leveraged to the top, while the non-person is charged what rate? And Citi still can’t get up off the mat?
Good thing WB can get positive feedback to keep up with the S&P.
Clowns.
Wonderful post Yves.
Bring the rain!