If California Treasurer John Chiang is any indicator, elected officials are finally noticing that public pension fund staff seem more worried about ruffling the feathers of private equity kingpins than acting in the best interest of fund beneficiaries.
For those new to our coverage of this story: in early June, we broke the story that CalPERS Admits It Has No Idea What it is Paying in Private Equity Carry Fees. These fees are the biggest that CalPERS pays. The story got traction after it was taken up in June and early July by Pensions & Investments (the lead story in their June 15 print issue), the New York Times’ Dealbook, Dan Primack at Fortune (who depicted CalPERS as lying or suffering from a “massive breakdown in financial controls”) and then the Sacramento Bee.
Twice, after the second Dan Primack story and again after the SacBee article ran, we urged readers to call and write California State Treasurer John Chiang, who sits on the CalPERS board, and tell him to get to the bottom not just of the carry fee mess, but also the even more troubling issues it raises about governance.
Shortly after those posts ran, the Financial Times joined the fray, reporting that Chiang claimed he was on the case:
“This issue is of great concern to me,” said Mr Chiang, who is a known reformer and also sits on Calpers’ administration board. “This will have my close attention until it is solved.”
Um, it’s nice for Chiang to take interest well after Dan Primack of Fortune reported on July 1 that after he’d boxed the giant pension fund’s ears, CAlPERS had sent letters to all of its general partners and demanded that they provide carry fees for all funds since the inception of the funds by July 13. The Financial Times story ran on July 12. It’s virtually certain that the authors of the Financial Times story, Chris Flood and Chris Newlands, spoke to Chiang well after CalPERS was already gathering the data.
In Venezuela, they call what Chiang is doing “getting in front of a mob and calling it a parade.”
We pointed out that Chiang also sat on the board of the second biggest California public pension fund, CalSTRS, which also happens to be the second biggest public pension fund investor in the US in private equity. Yet curiously, after having expressed his grave concerns about CalPERS, he said nary a word about CalSTRS, even though we pointed out that if anything, CalSTRS’ posture on collecting carry fee data was even more lame than CalPERS’ had been (CalPERS agreed it would be good to have it but tried pretending no one got it, even though they’d had an outside consultant getting this exact information as recently as 2011; CalSTRS said they didn’t see it as worth getting at all). We urged readers who had not already contacted Chiang about CalPERS not only to call or write him about CalPERS but to be sure to ask why he was giving CalSTRS a free pass.
In a striking coincidence, after that post ran, the Financial Times decided to have a second chat with Chiang, this time about CalSTRS. Lo and behold, Chiang is suddenly on that case too:
The second-largest US public pension fund has admitted it has failed to record total payments made to its private equity managers over a period of 27 years.
The admission by Calstrs, the $191bn California-based pension fund, prompted John Chiang, the state treasurer of California, to declare he will investigate the failure, which poses serious questions as to how pension fund money is being spent.
It might be nice if the Financial Times authors gave credit where credit was due. It was the Sacramento Bee, in its July 2 article, that reported:
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.”
And now that it is in the media hot lights, CalSTRS is trying to argue that it should not be required to disclose carry fees because….drumroll…the dumb chump public can’t be trusted with the information:
Margot Wirth, director of private equity at Calstrs, said it used “rigorous checks” to ensure private equity managers took the right amount of carried interest.
Before we get any further, this is laughable. How can you perform “rigorous checks” when you have admitted you don’t get the information? What is CalSTRS using? Sunspots?
Back to the article:
Ms Wirth argued it was “wrong to conflate the fees paid to private equity managers with carried interest”.
She said: “Carried interest is a profit split between the investor and the private equity manager. The higher that carried interest is, then the better both the investor and private equity manager have performed.”
In fact, there’s a very good reason to find out the fees. Professor Ludovic Phalippou of Oxford has estimated that private equity firms extract roughly 7% per annum on average from the funds they manage. This is such an insanely high number that there’s no justification for it, particularly now that private equity performance is lagging and it’s set to get only worse as private equity firms are paying top-of-cycle prices for deals done in the last couple of years. Private equity staffers like Wirth are afraid of being caught out at their failure to get to the bottom of how much private equity hoovers off at the fund and portfolio company level and their abject failure to negotiate both for better disclosure and for lower total costs.
We pointed out why both CalPERS and CalSTRS have been so remiss:
Why is this quote from CalSTRS, an almost-as-ginormous pension fund as CalPERS, less convincing that it appears? Because the current Senior Investment Officer responsible for private equity, Réal Desrochers, recently held the same job at CalSTRS! The laxness about gathering fees at two supposedly leading institutions are the doings of Desrochers, who has a reputation in the industry for being controlling.
And how serious does Chiang seem to be?
As far as CalPERS is concerned, per Chiang’s statement in his first interview in the Financial Times, he’s defining the problem narrowly. All he cares about is that the issue is “solved. ” One would think that means getting the carry fee data, when according to CalPERS’ remarks to Dan Primack, it was on its well on its way to being solved.
Calpers has asked all its private equity managers to provide data on carried interest payments since their contracts with the pension fund started. So far, six of the managers employed by Calpers have declined to provide data for the current year.
There’s no excuse for these managers refusing to provide the data, or if there is, it would amount to another proof of dereliction of duty by CalPERS. It’s a standard provision in private equity limited partnership agreements that the limited partners have the right to see the fund’s books and records. It would be remarkably high-handed for general partners to insist that an investor have to inspect the records themselves to get the carry fee information.
Alternatively, CalPERS signed limited partnership agreements that did not give the giant fund the right to review the fund’s books and records. That would be an even worse lapse than its failure to collect carry fee data.
By contrast, we’d suggested that CalPERS’ board needed to take much bigger steps, including considering whether Chief Operating Investment Officer Wylie Tollette and Senior Investment Officer responsible for private equity, Réal Desrochers, were too captured by the private equity industry and needed to be held accountable for this failure to take their fiduciary duties seriously. As we pointed out:
When board member JJ Jelincic made his inquiries about carry fees, he was both lied to and blown off by Chief Operating Investment Officer Wylie Tollette. As we described in detail, Tollette claimed that CalPERS not having the fee information was “an industry problem” when CalPERS had an outside consultant compiling this data as recently as 2011! And Tollette tried telling Jelincic that CalPERS was in the process of getting the information when its own written documents to the CalPERS board on its software development plans showed it wouldn’t have the new systems in place for some time (until the press furor, CalPERS’ position was that it needed to have the systems in place first, as if it was oh so difficult to keep the information in a spreadsheet in the meantime).
It’s good to see the Financial Times bird-dogging this issue so intensely. We hope Naked Capitalism readers will too. Please send this article to any current or future beneficiaries of CalSTRS (as in California public school teachers) and encourage them to call or write John Chiang. And please weigh in if you are a California voter!
Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
Please thank him for taking interest in the CalPERS/CAlSTRS carry fee issue but tell him that you are concerned that he is not planning to go far enough. The fact that neither CalPERS nor CalSTRS were tracking fees shows that they are far too trusting of private equity. They are not willing to get on top of information they clearly have a right to obtain, much the less other costs and fees they are ultimately bearing at the portfolio company level that they’ve allowed the industry to keep secret. In the case of CalPERS, there is also troubling evidence of staff refusing to provide honest answers to board members, a serious governance failing. And have him ask staff at both funds for the names of any private equity firms that fail to comply with the carry fee information request and the reasons that they gave.
And while you are at it, be sure to weigh in with the California State Controller, Betty Yee, who like Chiang is an elected official and also sits on both the CalPERS and CalSTRS boards. In California, the Controller is as influential a position as Treasurer. Tell Yee you are disappointed at her silence and hope she will join Chiang in getting to the bottom of this matter (and stress that the carry fees non-reporting is a symptom of bigger problems).
Ms. Betty Yee
California State Controller
P.O. Box 942850
Sacramento, California 94250-5872
Please also let us know what response you get from Chiang’s and Yee’s offices. Thanks for your help!