CalSTRS Board Chairman Harry Keiley, in Op-Ed Rejected by Financial Times, Gave Inconsistent and Inaccurate Information in Carry Fee Scandal

The staff and board members of California public pension fund CalSTRS continue to embarrass themselves in their efforts to justify their indefensible position on private equity carry fees.

Readers may recall that the biggest public pension fund, CalPERS, had a put-foot-in-mouth-and-chew incident when it said it didn’t track the profits interest more commonly called “carry fees,” which is one of the biggest charges it incurs on its private equity investments. CalPERS added to the damage by falsely claiming that no investors could get that information. After we broke that story and a host of experts and media outlets criticized CalPERS over the lapse and the misrepresentation, CalPERS reversed itself. It asked its general partners for all the carry fee data for the entire history of all of its funds, and obtained it all in a mere two weeks, with only one exception out of the nearly 900 funds in which it has invested.

So what has the second biggest public pension fund, CalSTRS, done? Like CalPERS, it has admitted that it does not track carry fees. But in a remarkable contrast, CalSTRS is attempting to justify inaction by misleading beneficiaries as to how much information it really has and saying that it’s thinking really hard about what (if anything) to do.

The dishonesty of the CalSTRS position is evident in its e-mails with the Financial Times after the pink paper reported that CalSTRS, like CalPERS, did not track carry fees, and California Treasurer John Chiang, who sits on both the CalPERS and CalSTRS boards, said he would press CalSTRS to look into the matter. I became aware of the contretemps when an FT reporter called me to thank me for my work. I asked him how CalSTRS was taking his story. He said they weren’t happy with it and they’d offered CalSTRS the opportunity to publish an op-ed, which was running early the following week. When I failed to see any such article, I contacted the reporter, who said his editor had rejected the article. I then lodged a Public Records Act request (California-speak for FOIA) for the op-ed and all e-mails between CalSTRS and the Financial Times from the date the Financial Times ran the article on CalSTRS’ carry fee tracking.

It’s important to remember that CalSTRS had said, flatly, that it does not know what it pays in carry fees. From the Sacramento Bee on July 2:

Ricardo Duran, a spokesman for the California State Teachers’ Retirement System, said CalSTRS can estimate the fees “within a couple of percentage points” but doesn’t report the figure.

“It’s not a number that we track,” Duran said. “It’s not that important to us as a measure of performance.”

Memo to CalSTRS: if you are estimating, you don’t know for sure.*

AFter the Financial Times ran its CalSTRS story, Ricardo Duran, CalSTRS’ head of communications, sent a clearly-annoyed e-mail to the Financial Times’ Chris Flood. Duran tried objecting that the so-called carry fee was not a fee because….drumroll..it was not paid directly by CalSTRS to general partners:

The following paragraph talks about [California Treasurer and CalSTRS board member] Mr. Chiang’s demand of CalPERS about how much has been “paid in carried interest.” Carried interest is not a payment but a profit split. I believe [head of private equity] Margot [Wirth] mentioned that distinction as well.

The language throughout the piece conflated carried interest with management/manager fees. That’s fine if that’s the way you want to characterize it. I only ask if you write about CalSTRS and carried interest again, you specifically mention this and attribute it to me or Margot.

So get a load of this: CalSTRS demanding that if the FT ever dare report on CalSTRS’ carry fee reporting again, that it include the staff’s pet position that a carry fee is not a fee, even when that contradicts statements by board members who oversee CalSTRS. Since when do mere employees a California agency have the right to undercut on-the-record statements of top California government officials?

And that’s before you get to the fact that this “carry fee is not a fee” position is bogus. As Eileen Appelbaum, the co-author of Private Equity at Work, wrote:

The email exchange in which CalSTERS argues with the Financial Times over the question of when is a fee not a fee has a certain Alice in Wonderland quality. The CalSTRS representative insists that a fee is not a fee if it takes the form of profit sharing. But profit sharing is clearly a performance fee – a fee paid to the PE investment manager based on the performance of the PE fund.

And as an expert who has been writing about private equity fees for decades said:

Private equity general partners put up around 1% of the money in a fund once you back out management fee waivers. They get 20% of the profits. The part over and above their pro-rata share is clearly a fee. As we lawyers like to say, res ipsa loquitur.

But the best part is Duran’s wounded claim that the FT “conflated” interest with management fees, as if that were inaccurate. This is from the very first limited partnership agreement I looked at from our document trove, KKR’s 2006 fund:

The Partnership will not invest in investment funds sponsored by, and as to which a management fee or carried interest is payable to, any Person….

Gee, KKR says in its own agreement that carried interest is indeed “paid” just like management fees!

But this is all a warm-up to the op-ed that the chairman of CalSTRS’ board, Harry Keiley, submitted to the Financial Times. It’s troubling to see a board chairman defend staff’s delaying tactics after another board member has demanded answers.

Other public pension fund trustees thought the odds were high that the article was either originally drafted by staff or had staff input. If staff did indeed provide text that Keiley assented to have run under his name, that has the effect of committing him to their position, even if he was privately not fully aligned with them.**

Moreover, it is peculiar to have a defense of CalSTRS’ position on carry fees come from someone who is almost certain never to have seen a private equity fund’s financial statements or reviewed the language in limited partnership agreements that describe the distribution “waterfall,” as opposed to the officers who are responsible and who presumably have expertise.

The full text of Keiley’s submission is at the end of this post. Here are the telling parts (emphasis ours):

We at CalSTRS are in favor of more, rather than less, transparency and disclosure as our history and current checks and balances show. We agree that it’s important for the public to know the estimated amount of carried interest investment managers are earning, tracked as net profits, which a majority of public pension plans report. Almost all private equity partnerships split profits, with the investor (e.g. CalSTRS) taking at least 80 percent and, at most, 20 percent taken by investment managers. Typically, a partnership must earn a minimum of 8 percent return for its limited partners (e.g. investors) before an investment manager earns any carried interest. Also, there are several large, publicly-owned private equity investment managers that report their earnings to delineate their carried interest income. I am confident that the CalSTRS board will continue to examine the issue of reporting carried interest in the context of its overall private equity disclosure practices to ensure we are taking all necessary steps to have full awareness and understanding of both fee and profit structures.

The boldfaced section is simply wrong. At best, it’s a laughably inept effort to mislead the audiences CalSTRS is most concerned about: its beneficiaries and California legislators. Net profits to investors like CalSTRS are after carry fees have been taken by the general partner. Tracking net profits tells you absolutely nothing about carry fees. And Keiley effectively admits that in the next paragraph:

Within our private equity program, we have always reported our returns net of all costs and fees.

From Eileen Appelbaum via e-mail (emphasis original):

What strikes me in the CalSTRS op-ed and their correspondence with the Financial Times is the complete lack of consistency in what CalSTRS’ board is saying. Mr. Keiley, Board Chair of CalSTRS, says that the pension fund agrees that it is important for the public to know what the pension fund pays to its investment fund managers. He finishes that sentence, however, by saying that CalSTRS fulfills that obligation by tracking and reporting net profits. I don’t know what subject Mr. Keiley teaches, but is it possible that he doesn’t understand that this is the crux of the matter? Tracking net profits is not the same as tracking all fees, expenses and carried interest the pension fund pays to private equity managers.

After trumpeting CalSTRS commitment to transparency, Mr. Keiley goes on to baldly contradict himself by asserting: “Within our private equity program, we have always reported our returns net of all costs and fees.” If Mr. Keiley is to be believed, the problem is not that private equity firms don’t provide information on the amount of carried interest they collect; indeed, he asserts that they “keep investors [like CalSTERS] fully informed as to the carried interest shared with their investment managers.” Astoundingly, one is left to draw the conclusion that CalSTRS has that information but chooses not to share it with California’s taxpayers and teachers.

Remember, as we stressed with CalPERS, California taxpayers are ultimately on the hook for public pension fund shortfalls. CalSTRS’ double-speak about transparency and its tracking of carry fees reveals that staff and a complaint board are more worried about keeping relations with limited partners friction-free rather than putting the interests of their beneficiaries, Calfornia schoolteachers, first.

I encourage you to send this post to people you know in California, particularly public school teachers. Urge them to e-mail Keiley to give him feedback on the terrible arguments he presented. Tell him that CalSTRS has no excuse for dragging its feet on obtaining carry fee data given that CalPERS has done just that. It would also help to tell him that it does not reflect well on him or the board to mislead the public, as he intended to do had the Financial Times not saved him from himself.

Given the e-mail address, I am highly confident that this contact information (p. 11) is indeed Keiley’s. I request that you NOT call him unless he fails to respond to an e-mail after two attempts.

Harry Keiley
Board Chair, CalSTRS
Mobile Phone: (310) 428 3624
Email: hkcalstrs@aol.com

Thomas Jefferson said, “When government fears the people, there is liberty.” There’s clearly no fear at CalSTRS. I hope you instill some.

____

* Many private equity funds actually do disclose their carry fee payments in their quarterly distribution notices, so in those cases, CalSTRS would have good data. But CalSTRS uses the same private equity management system that CalPERS does, State Street’s Private Edge. Private Edge does not have a field for recording carry fees. One of CalPERS’ excuses for not capturing carry fees was that it didn’t have a system for doing so, as if it would be too difficult to keep it in a speaadsheet in Excel.

** There is a considerable body of research that shows that people become persuaded of a point of view they advocate, irrespective of whether they originally believed it or not. For instance, trial lawyers who represent clients they strongly suspect are guilty come to believe they may be or even are innocent as they develop arguments supporting a “not guilty’ plea.

______

By Harry M. Keiley,

Mr. Keiley is the chair of the Teachers’ Retirement Board, the governing body of the California State Teachers’ Retirement System. Mr. Keiley is a high school teacher with the Santa Monica-Malibu Unified School District, and was elected to the Teachers’ Retirement Board in 2007.

With assets of $191.4 billion and nearly 880,000 members, the California State Teachers’ Retirement System (CalSTRS) is the largest public pension plan in the world dedicated solely to serving educators.

In addition to being one of the largest public pension plans, CalSTRS has one of the most comprehensive private equity programs globally. Begun in 1988, the current market value of our private equity portfolio is $19.3 billion. Since inception, our private equity program has generated over $21.8 billion in profits for the benefit of our members.CalSTRS’ highest returning asset class, private equity has returned on average 12.3 percent per year over the last ten years – well above the plan’s overall ten-year average of 6.8 percent and that of broad-based stock indices which averaged approximately 8.2 percent. Given its healthy performance over the past decade, the private equity program has also played an important role in the total CalSTRS portfolio by contributing excess returns above our long-term earnings assumption of 7.5 percent, thereby having a positive impact on the system’s overall funding.

We at CalSTRS are in favor of more, rather than less, transparency and disclosure as our history and current checks and balances show. We agree that it’s important for the public to know the estimated amount of carried interest investment managers are earning, tracked as net profits, which a majority of public pension plans report. Almost all private equity partnerships split profits, with the investor (e.g. CalSTRS) taking at least 80 percent and, at most, 20 percent taken by investment managers. Typically, a partnership must earn a minimum of 8 percent return for its limited partners (e.g. investors) before an investment manager earns any carried interest. Also, there are several large, publicly-owned private equity investment managers that report their earnings to delineate their carried interest income. I am confident that the CalSTRS board will continue to examine the issue of reporting carried interest in the context of its overall private equity disclosure practices to ensure we are taking all necessary steps to have full awareness and understanding of both fee and profit structures.

In addition to a commitment to transparency, CalSTRS also places utmost importance on internal control measures and prudent audit practices and, as such, our private equity program adheres to U.S. Government Accounting Standards Board (GASB) standards and General Accepted Accounting Principles (GAAP). Additionally, all cash flowing into and out of the CalSTRS private equity portfolio is accounted for and certified by annual independent audits. Within our private equity program, we have always reported our returns net of all costs and fees. In all cases, CalSTRS receives and regularly reviews independently audited financial statements of its private equity partnerships. It is important to note that, many times, details of those private equity partnerships are confidential due to the agreements signed by the various investors which are funding the limited partnership. However, as referenced above, capital investors involved in limited partnerships are provided with audited financial statements that disclose carried interest distributions made by the partnerships to the investment managers. As such, there is an established system of strong checks and balances to keep investors fully informed as to the carried interest shared with their investment managers.

CalSTRS has been, and continues to be, a leader in the private equity industry. Bringing innovation and diversity to our overall investment portfolio, the CalSTRS private equity program is a leader in transparency and disclosure, and acts as a fierce defender of investor rights when negotiating partnership agreements. CalSTRS is steadfastly committed to reviewing all of the checks and balances outlined above to see if we can improve upon our long track record of transparency and accountability in our disclosure practices. And, we will continue to apply our high standards, expectations, and drive for results to our ongoing and new investment partnerships in an effort to reach and exceed our private equity performance benchmarks.

Print Friendly
Tweet about this on TwitterDigg thisShare on Reddit0Share on StumbleUpon0Share on Facebook0Share on LinkedIn5Share on Google+0Buffer this pageEmail this to someone

20 comments

  1. flora

    Mr. Harry Keiley’s op-ed to the Financial Times is astonishing. How could he put his name to this after all NC’s and other major media reporting about PE carry fees and other fee abuses?
    Putting the kindest possible interpretation on that question I’d recommend Mr. Keiley and other board members stop outsourcing their thinking, their due diligence, and their common sense.
    Thanks very much for this post and your continued PE reporting.

  2. Eric Patton

    I’m sure Yves doesn’t want the job, but I’d pay money to watch her as the head of the SEC. And bring salt & vinegar potato chips and a 12-pack of Coke Zero, since I really don’t care for popcorn.

  3. diptherio

    Wow. Nice work, Yves; you’re really not letting up. Great use of Public Records requests!

    It would also help to tell him that it does not reflect well on him or the board to mislead the public, as he intended to do had the Financial Times not saved him from himself.

    FT will save you from yourself, but NC will make sure your foot makes it into your mouth, just as you intended…teeheehee

  4. diptherio

    I’m waiting for the “have you no shame?” moment, a la HUAC…Come on JJ, you know you want to do it…

  5. Andrew Silton

    Yves, thanks for the persistence and clarity in digging into CalSTRS private equity portfolio.

    As it weren’t bad enough, CalSTRS’s real estate portfolio is even bigger ($24 billion) than PE ($19 billion), and it suffers from the same disclosure defects. Fees and carry aren’t reported. Moreover, the portfolio’s longterm performance has been mixed at best (4.8% versus benchmark for 8.4% over 10 years).

    CalSTRS and CalPERS are supposed to institutional leaders in matters of corporate governance. It’s hard for them to be leaders when, as you’ve shown, their internal governance is lacking.

    http://meditationonmoneymanagement.blogspot.com/

  6. Ray Dio

    Yves,

    Why did the FT reject the op-ed? Why does the FT care if Keiley wants to clown/embarrass himself/CalSTRS further?

    Thanks, and great work on this stuff!

    1. Yves Smith Post author

      Thanks for asking. Saving Keiley from embarrassment was as bug, not a feature.

      From the e-mails:

      Fron: Chris Flood
      Sent: Thursday, August 06, 2015 9:06 AM
      To: Ricardo Duran
      Subject: Re: CalSTRS Opinion piece-follow up

      Hi, Ricardo – I should add that the editor wasn’t keen based on the idea of running the opinion piece as it stands as he felt it was too self-serving and not really a discussion about an issue or topic. which in normally what those pieces are intended for – if for example a private fund of fund manager had submitted same/similar viewpoint, then it wouldn’t run. But we do want to be fair, we have strive [sic] to be objective and that is why we thought that running a story based on the Calstrs submission is a way to get your views published, particularly as we have this three week production break comimg up.

  7. RUKidding

    Thank you, Yves. Continuing excellent work. Hope CalPERS is paying attention to this, too. Yoo Hoo, Gov Brown – are you reading this, too?

    I’ve said this before in relation to CalPERS, why is CalSTRS sticking like glue to these bogus explanations for keeping PE in the portfolio when so much has been uncovered about what a poor poor investment PE is? What do CalSTRS Board members stand to gain by continuing this fiscally imprudent relationship with PE? Cui Bono? It’s certainly not to the benefit of CalSTRS contributers and annuitants.

    Just saying. Gotta wonder.

    1. bkrasting

      Keilley says the PE investments had a real return of 12.3% PA over the last decade. That’s a great result.

      PE is not a bad place to invest, its the side deals, kick backs, asymmetrical profit sharing and flaky reporting that is the issue.

      1. Yves Smith Post author

        Bruce,

        You of all people surely understand the concept of a risk-adjusted return.

        PE has SUBSTANTIALLY underperformed its benchmarks over the last decade and for the five, three and one year period as well, as in the return it OUGHT to earn given its risk and the size of companies PE funds invest in (way smaller than S&P 500).

        And that’s before you get to the fact that the “return” figure you use is IRR, and comparing that to a stock market return (public market equivalent) is apples and oranges. The use of IRR exaggerates PE’s performance.

        And in addiition, PE fudges the marks during bear markets in stocks, leading to further exaggeration of returns.

  8. John Zelnicker

    Yves – All of your excellent work on the topic of PE investments by public pension funds has been eye-opening. A huge THANK YOU from me.

    I have finally decided to look into the Alabama Retirement Systems workings and investments. I know a bunch of teachers and state employees, as well as retirees who are my tax clients.

    The head of the AL Retirement Systems has invested a lot of the pension money in Alabama projects such as the Robert Trent Jones Golf Trail found across the state. The system also owns a trophy property in NYC. So far, this is the extent of my knowledge of the System’s investments.

    After obtaining whatever information is available, I will send it to you. Perhaps you and the NC community will find it useful as a comparison (good or bad) to the CA public pensions.

  9. Alex morfesis

    Ah yes…the little people are annoying the anointed one’s…just put thru a FOIA here in floriduh on the 250 million dollar give away…oops, I meant loss, at Stuyvesant town Peter Cooper MetLife purchase fiasco…

    1. Yves Smith Post author

      That is good news. Just be clear when you put in a FOIA that you ask for records. You can’t ask them to produce summaries, but you can ask for contracts, e-mails, spreadsheets, internal policy and procedure statements, meeting minutes, etc.

  10. Sluggeaux

    A late comment: several folks are asking cui bono — what is the up-side for these Board members to be so badly captive?

    In my experience of Sacramento, the political class there can be bought cheap. They literally just want to be able to fly up and down the state to meetings to sit on the dais in big rooms and hear their own amplified voices. All that they worry about is “hitting the numbers” for actuarial returns — they could care less if their so-called partners have contracts that let them take 20% of the profits on only 1% of the investment — and that’s after looting the “investment” by paying themselves unconscionable “management” fees for running the “investment” into the ground and laying off most of the employees.

    There’s a reason why pensions are known as “the dumb money.”

Comments are closed.