Guest Post: Public Pension Shakedown?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

The WSJ reports on the public pension shakedown:

President Obama’s auto fix-it man, Steven Rattner, is in the news as one of the Wall Street financiers hit up for big money as part of New York state’s unfolding pension-kickback scandal. The White House says he’s done nothing wrong, and there’s no public evidence that he broke any laws.

But Mr. Rattner’s high profile is nonetheless useful in drawing attention to the real story here, which is the growing evidence of corruption by officials who use their power over public pension funds to shake down private companies. This is the same political class that has been blaming banks for “greed” in the financial crisis. The pension fund scandal exposes the myth of the superior virtue of the public and nonprofit worlds. Greed is universal. And the opportunity for corruption is enormous when political discretion is tied to vast sums of public money.

New York Attorney General Andrew Cuomo and the Securities and Exchange Commission allege that investment firms paid politically connected “placement agents” in return for a piece of New York’s $122 billion pension fund. The AG has indicted three politicos for kickbacks, but the media have focused on the private firms that hired some of these political agents. Thus the attention on Mr. Rattner, who as co-founder of the Quadrangle investment firm met with a consultant about paying a finder’s fee for pension cash.

The motive and knowledge of these private investors need to be explored, but the main culprits are the public officials and their agents. Former New York Comptroller Alan Hevesi resigned in 2006 after pleading guilty to unrelated charges of defrauding the government. But his office served as exclusive manager for the pension fund that is one of the world’s biggest institutional investors. What the New York scam is laying bare is the extent to which officials allegedly leveraged those taxpayer dollars to enrich themselves and increase their political power.

For the record, it isn’t illegal for investment firms to hire “placement agents.” Hedge funds and private equity firms have long outsourced their marketing to companies whose job it is to reach out to potential investors and arrange roadshows. These placement agents are typically paid a percentage of the money raised.

[Note: For the record, it should be illegal as it opens the door to bribes and abuses!]

In New York, however, the agents were also major political players. Hank Morris is a noted Democratic strategist and was a top adviser and chief fundraiser for Mr. Hevesi; Mr. Cuomo has indicted him for money laundering and bribery. Former Liberal Party boss Raymond Harding had aided in Mr. Hevesi’s election. When men like these come knocking on investment-house doors, the message is pay to play.

Mr. Morris and associates are alleged to have made $30 million selling access to the fund. Mr. Harding helped to clear a state Assembly seat for Mr. Hevesi’s son, and was allegedly rewarded by being allowed to pocket $800,000 as a pension placement agent. The indictment says Mr. Morris was aided by former deputy comptroller David Loglisci, who made clear to investment firms that they should hire Mr. Morris and who signed off on the subsequent pension fund investments. (All three men deny the charges. Mr. Hevesi, who hasn’t been charged in this case, also denies any wrongdoing.)

In Mr. Rattner’s case, SEC documents say he met with the brother of Mr. Loglisci to discuss acquiring the DVD rights to “Chooch,” a low-budget movie that Mr. Loglisci and his brothers were producing. Quadrangle, through an affiliate called GT Brands, agreed to acquire the rights for about $89,000. Several weeks later, Mr. Loglisci told Mr. Rattner that Quadrangle would be getting a $100 million investment from the pension fund. Quadrangle then paid $1.1 million in finders fees, most of which went to Mr. Morris. Now that Mr. Rattner holds sway over the U.S. auto industry, we hope his judgment about cars is better than his taste in cinema.

This scandal is only one example of how political actors leverage pension-fund cash for personal gain. The most routine and pervasive practice is the way officials like Mr. Hevesi tap hedge funds and private equity firms for campaign contributions. The Wall Street crowd knows that to refuse to pony up would limit their access to pension money.

It has also become routine for politicians to inject their pension funds into partisan debates that have nothing to do with the sound management of retiree money. Mr. Hevesi once used a pension-fund investment to threaten Sinclair Broadcasting into taking off the air a documentary critical of Senator John Kerry. Calpers, the California public pension fund, tried to bludgeon Safeway into capitulating to a striking union. The then-chairman of Calpers was executive director of the same food worker union that was striking. Safeway held firm.

Such misuse of pension dollars is increasing, and it was inevitable that it would lead to pay-to-play schemes. New York Governor David Paterson says he wants to end his state’s practice of giving the comptroller sole control over the pension fund, and to move toward the system in which a board oversees the money. But as Calpers makes clear, any political board can also abuse its power. The real problem is the huge political temptation and leverage these public pensions create. The solution is to take these assets and the pension investment decisions away from political actors.

Reuters reports that pension kickback spreads to New Mexico:

A firm affiliated with Henry Morris, the former New York state comptroller’s top fundraiser, was involved with helping investment firms procure pension fund business in New Mexico as well as New York, a source and one of the firms said on Sunday.

Last month, Morris and David Loglisci, New York State’s pension investment chief, were charged with taking millions of dollars in kickbacks from money manager firms.

[Note: Read my post, The Mother of All Stealth Scams?]

Morris, who was associated with Connecticut-based advisory firm Searle, made over $15 million in purported placement and finder fees between January 2003 and December 2006, a U.S. Securities and Exchange Commission complaint said in March.

The scheme is alleged to have centered around the New York pension fund, but Searle was also used to procure investments in New Mexico, one firm and a source said on Sunday.

The Carlyle Group, one of the world’s biggest private equity firms, used Searle in New Mexico a couple of years ago, a spokesman for Carlyle confirmed. Carlyle has not been accused of any wrongdoing in connection with the probe.

“We used Searle to obtain an investment from the New Mexico State Investment Council and disclosed it to them at the time,” the spokesman said. He added Carlyle only used Searle to obtain investments from the New York and New Mexico investment funds.

Private equity firm Quadrangle Group also hired Searle seeking an investment from the New Mexico fund, a source close to Quadrangle said. However, although Quadrangle did receive an investment from the fund, it did not pay Searle a fee, said the source, who did not want to be identified because the matter had not been made public.

Quadrangle, which has also not been accused of any wrongdoing, was co-founded by Steven Rattner, the leader of the Obama administration’s auto task force.

The Wall Street Journal cited a spokesman for the New Mexico fund saying that Quadrangle and Carlyle used Searle & Co, to get investments from the government-run fund in New Mexico. The New Mexico fund was not immediately available for comment.

Separately, Morris or one of his associates placed or tried to place other investment firms with government-run funds in California, New Jersey, Connecticut and New York City, the Wall Street Journal reported, citing person familiar with the matter.

The first criminal charges related to the scheme were brought last month by New York state attorney general Andrew Cuomo, who accused Morris and Loglisci with taking million-dollar kickbacks. The two men, whose lawyers say they are innocent, also face civil charges from the SEC.

More than 20 investment deals made by the state’s pension fund were “tainted” by the kickbacks, Cuomo said at the time.

The FT reports that pensions watchdog sounds alert over fraud:

The Pensions Regulator has issued a stern warning on fraud, dishonesty and other efforts to avoid pension obligations, and reminded employees, trustees and pensions professionals of their legal obligation to become a whistleblower if they become suspicious of any activities.

“Employees and pension scheme members should report any concerns to trustees, whose duty it is to protect their interests. Trustees should contact us,” the regulator said.

“The whistleblowing duty overrides any other duties a reporter may have – such as confidentiality – and any such duty is not breached by making a report,” the regulator said.

While noting that “the vast majority of schemes are well run by dedicated and hard-working individuals”, the regulator said that the severe economic downturn “may accentuate the vulnerability” of schemes and members to activities that ultimately reduce retirement benefits.

The warning comes just days after the regulator published details of a previously undisclosed effort by directors of a company, who were also trustees of the scheme of a technically insolvent subsidiary, to strip out the assets of that subsidiary and buy these back in a pre-pack arrangement but without the pension scheme.

The scheme, which had a buy-out deficit of £1.4m, would have become the obligation of the Pension Protection Fund, the pensions safety net.

In an emergency proceeding in February, the regulator removed the trustees and replaced them with an independent trustee.

In making its case to remove the trustees, the regulator cited an e-mail from one company director and trustee to another that said: “The main creditors losing out are the tax man and the pension scheme . . . if everything goes to plan we’ll buy back the assets for £150k but without the pension liability.”

Directors of the company, Rivermeade Signs, and its subsidiary, Graphex, had the opportunity to dispute the action at a hearing but did not do so – but there remains an opportunity to appeal.

In its warning, the regulator made clear that its concerns go far beyond outright fraud and dishonesty to include a range of actions designed to disentangle employers from their pension obligations or members from their benefits.

The regulator said: “Behaviours which unacceptably increase risks to members’ benefits, the PPF and all levy-paying schemes include avoidance of employer debt, inappropriate transfers for individuals from underfunded schemes that would not subsequently have the resources or adequate employer support, as well as employer-related self-investment and poor practice associated with transfer incentive exercises.”

I have already written about the need to protect whistleblowers. This is one of the most effective means of preventing and uncovering fraud and yet most policies fall short of where they should be.

Finally, CBS’ 60 Minutes talked about how retirement dreams disappear with 401(K)s. If you did not see it, click here to watch this segment.

I quote the following:

When employers began turning 401(k)s into retirement plans, the financial community was not shy about promoting them as such. The prospect of trillions of dollars in the hands of unsophisticated investors opened the door for all sorts of potential abuses.

“The fact is that the typical 401(k) investor is a financial novice. They don’t know a stock from a bond. And we give ’em a list of 20 or 30 mutual funds with really, really powerful names, you know, they sound like, ‘Gee, that’s where I want to have my money,'” Hamilton said,

“What are the, generally, the quality of the mutual funds in 401(k) plans?” Kroft asked.

“Mediocre,” Hamilton replied. “I’m being real honest with you, with half the funds on the list really dogs, what people would characterize as dogs shouldn’t be on the list to start with.”

“There clearly has been a raid on these funds by the people of Wall Street. And it’s cost the savers and the future retirees a lot of money that would otherwise be in their account, independent of the financial collapse,” Rep. George Miller [D-CA] said.

Congressman Miller is chairman of the House Committee on Education and Labor, and a staunch critic of the 401(k) industry, especially its practice of deducting more than a dozen undisclosed fees from its clients’ 401(k) accounts.

“Now you got a bunch of economic wizards jumping in and taking money out of your retirement plan, and they don’t wanna tell you how much, you can’t decipher it in simple English, and they’re not interested in disclosing it, or having any transparency about it,” Miller told Kroft.

“And most of the people that look at their 401(k)s have no idea that these fees are being taken out?” Kroft asked.

“No. Where would you find it? Where would you find these fees in this prospectus? You can look on any page you want, and when you’re all done reading it, and you will find some of the fees and the commissions here, but you won’t find them all, and I’ll bet you won’t find half of ’em,” Miller said.

There are legal fees, trustee fees, transactional fees, stewardship fees, bookkeeping fees, finder’s fees. The list goes on and on.

Miller’s committee has heard testimony that they can eat up half the income in some 401(k) plans over a 30-year span. But he has not been able to stop it.

“We tried to just put in some disclosure and transparency in these fees. And we felt the full fury of that financial lobby,” he said.

David Wray, a lobbyist for the 401(k) industry, says he favors disclosing the fees, but his partners in the financial industry don’t.

Asked if he thinks most people know these fees exist, Wray said, “I think they know that there are fees. They don’t know exactly how large they are.”

“Why do you think the financial services industry is opposed to fee transparency?” Kroft asked.

“I don’t know that they’re opposed to it. I think the issue is that…,” Wray replied.

“You don’t think they’re opposed to it?” Kroft asked. “You’re a lobbyist in Washington, right? You know they’re opposed to it. …George Miller hasn’t been able to get a bill to the floor.”

“I think they want to keep the systems as simple and not make changes. They like the way things are. And whenever you push people out of their comfort zones, you know, it’s an issue,” Wray replied.

“I mean, they’re comfortable with the situation because they’re making a ton of money or they have made a ton of money,” Kroft said.

“Well, and their systems are set up in certain ways. You know, this is gonna be a big change,” Wray replied.

60 Minutes wanted to ask Wray, who’s been so bullish on 401(k) plans, one last question about what the future holds for people like Terry and Donna McNally and Kathleen Coleman.

“Most of the people that we’ve talked to are 50 and 60 years old and have sustained these losses say there is no way they’re ever gonna make them back. Do you agree with that?” Kroft asked.

“I think we have to be truth tellers,” Wray replied. “I think that when a person has hit this point, and we’ve had this unfortunate situation, I don’t think we can misrepresent what the possibilities are.”

“And reality is that money’s not coming back that they’ve lost,” Kroft said.

“They can’t count on it,” Wray replied. “They have to…it may. Maybe they have long, maybe if they work ten more years, it’ll come back by the…but it’s important that they not have unrealistic expectations.”

They certainly can’t count on that money coming back anytime soon. What they can can count on is the financial industry’s stranglehold to continue as they conjure up new ways to screw retail investors.

It’s disgusting and while America worries about “Al-Qaeda”, the real crime is happening right under their noses. Public pension fund shakedown? If you ask me, it’s a shakedown of the entire public of unsuspecting investors who are getting fleeced by Wall Street crooks.

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  1. A

    What fees are not disclosed in either the prospectus, fund fact sheet, or 401k annual statement? I know they may not break everything down, but I thought the amount you’re paying was fully disclosed.

  2. Brick

    I am somewhat concerned that pension funds have not learnt their lesson and the risk policies that should have been put in place have been sidelined recently. We know from Tyler Durden that while Quant trading programs have made a loss, certain other market strategies are doing well. We are led to believe value investors are the new king and mathematical trading strategies based on momentum are fading. The problem is that equities prices are rising particularly where there is technically very little value, something which quant programs do take into account. My concern is that having made big losses recently, pension funds are funding an even bigger gamble to recover some of the losses made. It could be down to foreign investors coming back into the US market but I somehow it has the finger prints of mutual and hedge funds and ultimately pension funds.

    We can also track problems with securitisation back to pension funds and their desire to appear to trade in the highest grade stock. In an effort to facilitate this the markets turned junk debt into AAA quality debt by wrapping it with almost worthless insurance. The ratings agencies, the monliners, tha banks everyone played their part, but ultimately it was the pension fund taking short cuts in assessing the quality of loans.

    Considering the burden that will now fall on companies to rack up pension contributions at this difficult time, it comes as no surprise that outright stealing, accounting anomalies and other deceitful measures will be taken to lessen the load. Ultimately the burden will fall on the employee who will have less to spend, so bailing out 401K’s might be a significant aid to the economy in the long run.

  3. sanjay

    time for liberals to learn that sometimes market based solutions are in fact in the interest of the average Joe.

    If Obama was serious about changing the foundations of the economy he would get corporations and other employers out of the business of providing health care and pensions to their employees. Let them pay the wage that they need to attract the talent that they need and allow the individual the choice to purchase what they want. The government can make life easy by offering a bare bones insurance policy and index funds. Want to do anything more exciting your on your own.

    While they are it they should also make all corporations into LLC (or equivalents). This will force corporations to pay back to its owners the profits rather than allowing them to accumulate for the CEO to squander. If the corporation needs additional funds it can always go back to its existing shareholders. Eliminating large pools of money will restore our markets to sanity- they will in fact be what people claim they are millions of people making decisions rather than the group think of a handful of over compensated parasites.

  4. redst8r

    Leo: I watched 60 Minutes demagogue the 401k issue. Granted there were and are serious problems with the funds, fees and transparency. Granted many 401k funds have dropped by 40%, 50% or more.
    Q.#1 How well have pension funds done over the same period.
    Q.#2 Why is it necessarily better to be locked into a corporate pension fund than a personally owned “pension fund”? Those are the only two choices: do it yourself or pay someone else to do it.
    Q.#3 Why didn’t these people who were so close to retirement (55+) move their funds into more protected investments such as bonds or guaranteed return funds?

    Being a financial novice requires, at a minimum KNOWING you are a novice and acting accordingly.

  5. Leo Kolivakis

    "Q.#1 How well have pension funds done over the same period."

    >>Most private and public pension funds are more diversified than 401(K) plans, investing in both public and private markets. However, diversification did not help them much as they still got clobbered in 2008. Like retail investors, many institutions are highly exposed to public equities.

    "Q.#2 Why is it necessarily better to be locked into a corporate pension fund than a personally owned "pension fund"? Those are the only two choices: do it yourself or pay someone else to do it."

    >> It isn't necessarily better to be locked into a corporate pension plan, but if it is properly run by seasoned professional money managers who undestand risk, you are better off leaving it there.

    "Q.#3 Why didn't these people who were so close to retirement (55+) move their funds into more protected investments such as bonds or guaranteed return funds?"

    >>It's called the "culture of equities" which is so ingrained in people's minds (and institutions) that they consider bonds are for losers.

    I suspect that many people strongly feel that we are on the cusp of a major bull market in stocks and a major bear market in bonds.

    They might be shocked about where we are heading over the next ten years.


  6. ashutosh kulkarni

    hi leo,
    Do you think that retirement plans should be over-regulated interms of their investment strategies by making people over 50 reduce their equity stake staggered over gradual period of time . Or allow the unpolished trader do mistakes for you.


  7. Michael Fiorillo

    The issue of the UFCW strike against Safeway is much more complicated than you suggest.

    While pension funds may in the short run prosper by holding stock in companies that profit by squeezing their workers, in the (not so) long run they will run aground.

    One of the reasons we’re facing the calamity we do is that in the name of fiduciary responsibility, pension funds have chased (what have conme to be seen as) fictitious high returns by investing in entities (private equity, LBO’s, etc.) that have extracted rather than created wealth in the economy.

    Pension funds, and public employee pension funds in particular, should be more aggressive in going after managements that seek to profit by driving down living standards. After all, wasn’t our current crisis largely casued by the fact that more and more Americans could no longer afford housing, one of life’s necessities, solely with wage income, and had to resort to ever more levels of debt?

    Pension law should be modified to insure that the funds’ investment should at a minimum “do no harm” to the broader economy.

  8. Gentlemutt

    How would this work? All tax-exempt entities, be they pension funds, municipalities, endowments, religious organizations, foundations, charities, etc, should be required to file monthly investment reports for all assets that are not publicly traded on a major exchange.

    A little sunshine would probably help disinfect the dirty business of buying business.

  9. PeeDee

    This is why I’m always a bit hesitant on the plans to consolidate private pensions into large public plans. There is a real return to scale in higher levels of professionalism, but a real negative in larger opportunities for agency costs.

    Just as in the debt rating game, the consultants end up playing along and providing cover for fees. Their slogan is “past performance does not guarantee future returns”, but in fact that is the only objective data available, and ignoring it just opens the door to chicanery.

    It is still amazing to me, as an idealistic (naive?) professional investor with 20+ years of institutional and retail experience, how corrupt the financial industry is from top to bottom. Yet there is a real social benefit to enabling both saving and borrowing, and distributing and diversifying equity risk.

  10. LeeAnne

    Self-Regulation Doesn’t Work Mark Thoma”

    Wow. and 2 and 2 makes 4. The sleeping beauty wakes up.

    Business without laws doesn’t work.

    Wall Street has always required client agreement to use arbitration to settle any dispute. And the decisions are secret.

    So no one will ever know who among the public has been cheated and how. When people on this blog have asked ‘why do people invest in this stuff?’ The answer is that the public is very effectively kept in the dark by this vast cabal. This is not justice.

    Lots of information readily available on this. Just one: genius, greatest mind in the country Posner didn’t know this?

    The people responsible for destroying the well being of people all over the world are a cabal totally united in their venality and in charge for too long.

    It is obvious by now that this is a country specializing in rule of law for you and a million ways to Sunday for skirting the law for anyone with a buck.
    This is is all so sickening.

    I have to confess I haven’t read the article. I did read Posner on Clusterstock last night and that’s enough.

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