We reported yesterday that CalPERS, the giant California public pension fund, is scrambling to collect information from private equity firms It’s not hard to suspect that the reason that CalPERS was on self-imposed forced march was that it got wind of the fact that the Sacramento Bee was working on a story about its failure to gather carry fees and include it in its metrics. The one thing that CalPERS fears is the California legislature. The Sacramento Bee carries more weight with them than any other media source, including national papers like the New York Times and the Wall Street Journal.
So while it was encouraging to see the SacBee publish the story, CalPERS tries to get handle on management fees, it’s also frustrating to see how much they dumbed down the reporting. The paper calls the fees at issue “management fees” when the “management fee” is the prototypical 2% in the “2 and 20” formula. The “carry fee” is the 20, for 20% of profits, usually over a hurdle rate of 8%. So it fails to convey even the basics correctly that CalPERS is missing the biggest type of fees it pays (as much as $900 million in the last year, which the article does point out). It does mention “base” fees, which are presumably management fees, of $441 million, but isn’t clued in enough to recognize that that figure is understated too. As board member JJ Jelincic has pointed out, CalPERS tracks only the fees it pays to private equity firms directly, when those direct fees are reduced by being shifted on the portfolio companies (see this post for more detail). Unlike the carry fees, it’s trivial for CalPERS to compute and record the management fees it pays directly and indirectly, since they are set forth in its investment agreements.
The story also gives undue prominence to Edward Siedle, who is in the process of attempting to raise money to “audit” CalPERS. The information needed to get to the bottom of what is going on with private equity fees and costs is at the portfolio company level, that is the companies owned by the private equity funds and effectively controlled by the private equity managers (the “general partners”). Investors like CalPERS don’t have access to this information, and worse, outsiders can’t get to much of the informational crumbs that limited partners like CalPERS are allowed to have because that’s shielded from the public by being exempted from FOIA in every state either by statutes that the PE firms got passed or by favorable attorney opinion. So it is hard to fathom what Siedle can do that would make any difference, particularly in light of the fact that Jelincic has already been exposed some important CalPERS dirty linen.
The article refers to the ruckus made by “financial bloggers”. I can see Naked Capitalism being relegated to the status of A Blog That Must Not Be Named, but what about Dan Primack at MSM outlet Fortune? He’s the one who blew the story open and described in gory detail why CalPERS’ defenses were lame.
The SacBee also may have been artfully misdirected by CalPERS. Recall that it’s big excuse was that it’s supposed inability to get carry fees was an industry problem. Primack found that limited partners were stunned that CalPERS would make that claim. Yet the SacBee picks it up and provides some corroborating evidence:
But many institutional investors, not just CalPERS, don’t know or don’t disclose how much they pay in performance fees to their private equity managers.
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.”
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 as test of reader critical thinking skills, consider the close of the story:
Leaders of the private equity industry wouldn’t comment directly on CalPERS, but said big institutional investors understand the fees they’re paying.
“Limited partners such as CalPERS are among the most sophisticated investors in the world,” said James Maloney, spokesman for the Private Equity Growth Capital Council, a Washington trade organization. “They understand the investments they’re making, including detailed fund terms. They go through their agreements line by line.”
Do you see what’s wrong here? The Private Equity Growth Capital Council is a lobbying group for the private equity general partners. No one in it has ever sat in on a CalPERS review and negotiation to say that they review the agreements “line by line,” much the less even carefully. These agreements are so complex that much of the review is relegated to outside counsel. Yet as we’ve discussed repeatedly, limited partners like CalPERS can’t get adequate representation because any law firm worth its salt wants to be working (or in most cases is already working for) the general partners. They don’t want to break a much bigger actual or potential rice bowl by negotiating all that hard.
But more important, the contracts themselves have nothing to do with the issue at hand. While CalPERS was not getting the carry fee information broken out, but that it could be derived with a good degree of accuracy without too much work and could also be requested from the general partners.
But even though this article is far less forceful than the underlying facts warrant, CalPERS is highly sensitive to what it regards as unfavorable press, most of all from the SacBee. So this is a step in the right direction.
And even better, it will give even more credibility to letters and e-mails from CalPERS beneficiaries and California residents about the sorry state of CalPERS’ corporate governance and financial reporting. As we urged yesterday:
I hope all readers in California, particularly those who are current or future CalPERS beneficiaries, will call or better yet write their state legislator about the financial reporting and governance failings at CalPERS. You can find the contact information for state senators and assemblymen here. Be sure to send a carbon copy to the Treasurer John Chiang, who also sits on the CalPERS board:
Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
Or call his office at (916) 653-2995.
In addition, if you belong to a union, contact your representative and encourage him or her to bring these lapses to the legislature. And finally, e-mail Jon Ortiz, who publishes the at firstname.lastname@example.org. Please let us know what responses you get in the comments section of this post.
Stress that CalPERS hasn’t been honest and forthcoming when asked reasonable questions about private equity, acts only when subjected to considerable pressure, and demonstrates that all it is willing to do is make the immediate problem go away. CalPERS needs to address the underlying pathology, that it is putting its fear of rocking the boat with private equity kingpins over its fiduciary duty to beneficiaries.
You might refer to the forceful Dan Primack stories at Fortune (see here and here) as well as our post yesterday. Keep the pressure on!
“A Blog That Must Not Be Named”
My family and friends refer to DC’s “Reagan National Airport” as “Voldemort National,” because WE refuse to utter the evil name “Reagan.”
Thanks for the analysis of the SacBee piece. Let’s hope they follow up with something more substantial that gets to the heart of the issue instead of dancing around the edges of it.
I’ll be sharing this with a relative who does a lot of accounting work in CA. I bet he’ll be putting the pressure on.
For these private equity posts I’m starting to see from a systems engineering perspective (no I’m not a systems engineer) where you have a complex system and there’s a leak somewhere, still not really putting it all together, though…but i’m sure the complexity is currently being used to obfuscate
The 19% funded Kentucky plan has even worse disclosure http://www.marketwatch.com/story/kentucky-pensions-stubbornly-cling-to-private-equity-2015-06-24
Continuing to enjoy your focus on this Yves.
A fund that invests in private equity is pretty much by definition not acting in the best interests of the fund’s beneficiaries.
“ So while it was encouraging to see the SacBee publish the story, …, it’s also frustrating to see how much they dumbed down the reporting. ”
It would be very interesting to see the original reporting and compare it with the edited version published by the paper.
Thanks for continued reporting on CalPERS.
For CA residents who write a letter to their state legislators include a reference to the SacBee newpaper story by including the story clipping , a web link, or at least naming the story by title.
This lets the legislator know: the issue is now prominent enough to have drawn the major local paper’s attention; the newpaper’s story has drawn your attention; and lets the SacBee know the story is important enough to its readers to deserve follow-up stories.
Be very careful what you wish for.
Vis today’s post about fraud being the Number 1 issue on the U.S. economy being addressed by institutional investors: John (Enron) Arnold, his useful idiot former-San Jose mayor Chuck Reed, and Mark Bucher’s right-wing California Policy Center are taking another run at the “dumb” money in the next election cycle via an initiative to force employees into “saving” through 401k-style schemes that are even easier to game.
These fraudsters will use the well-founded criticism of CalPERS to argue that retirement savers can “protect” themselves from the “corruption” of CalPERS by handing their money over to their tender mercies. Arnold has a long history of conning retirement savers into bankruptcy, and he got his employee Reed to “privatize” the management of San Jose’s (non-CalPERS) fund and run it into the ground. He got out of Enron a few footsteps before the FBI came knocking and his old associates ate Federal beefs.
Let’s keep the Big Picture in mind — papers like McClatchy’s Bee and the MediaNews Group (or whatever it is Gates Foundation/Alden Global Capital are calling them this week) are oligarch-owned and oligarch-friendly. Posts like this one are needed to keep them honest.
Below is a link to some excellent reporting (funded by oligarchs with a different set of interests) on San Jose’s pension “crisis” caused by Reed and his handlers. In fact, San Jose’s political class had been looting via Municipal and Redevelopment bonds for 20 years, but it all turned into Junk when Governor Jerry Brown pulled the rug out from under Redevelopment Districts. The “leaders” were trying to use the pension casino to make up the difference, but got schnooked instead. The result: in the past 48 months the police force saw a mass exodus, going from 1400 to 850 cops due to un-competitive compensation and pensions. The few cops left are all on forced-overtime, and are sure to crack (then we’ll blame the “culture” of police). Not pretty:
Operator error? Or Safari. Here’s the link (I hope): http://america.aljazeera.com/articles/2014/3/14/san-jose-pensionreform.html
While this piece is about what passes for investigative journalism these days and a call for action, when considered together with Yves piece on the growth and dominance of financial fraud (or is it mere gimmickry?) and Dr. Black’s favorite bugaboo of insider looting: control fraud – I see the current status of capitalism much as Karl Marx saw it – descending into a speculative ‘fictitious capital’ vortex, becoming more and more reminiscent of the proverbial bucket shop (hyped up on modern technology hormones) and bigger and more powerful than God. Yes, please write those letters, Californians. Not only must there be a full accounting of fees, but the current level of obfuscation requires the removal of the decision-makers.
But, to stop the vortex we need to somehow awaken those around us to a disease I see akin to american exceptionalism – the belief that capitalism has always had its fair share of fraud and associated political corruption, but “it’s the best system going”– we’re better off today in the burbs than the kings of yesteryear were in their castles. “Don’t rock the boat! You’re just envious of the rich.”
I doubt many of us reading this think that way, certainly not Yves and Lambert, but in enumerable ways, its out there. Yves, I hope your “faint praise” for the Sac Bee’s reporting get’s their attention. The more this airs in the public view, the more likely we are to stop that vortex.
I still keep looking for that example that you want to put in place.
First, the system we currently have is not Capitalism it is Corporatism. We were put on the path of this during WW2. When close to 50% of the GDP is driven by the government we are about as close to a socialist state as you are going to get.
Don’t get me wrong, I think the current situation is terrible but for totally opposite reasons. However, I would be more than happy to change my mind if you can show me an example of what you believe is the idea situation. I keep asking but no one ever points it out.
Ishmael, you speak of economic systems subsumed by government (so-called socialism) with disdain. Take a moment, find the CIA’s worldbook to see how so-called socialist democracies are faring in terms of such things as infant mortality and education. Or, read the world happiness report (very worthwhile http://worldhappiness.report/).
People in so-called socialist nations are happier that the average American. Look around. So-called socialism is on the rise, particularly in South America.
I would call myself a social-democrat and recognize a spectrum of political-economic thinking, including so-called capitalism. While I believe fair markets are needed in any economy, I quite openly consider Dr. Milton Friedman’s theory of corporate responsibility only to investors, a mantra preached by so-called capitalists far and wide, to be simply evil and undemocratic. Corporations exist because the laws of the state allow their creation. In exchange for shielding principals behind the corporate banner, they are expected to further the public interest, yes, through the pursuit of profit, but the underlying myth is that such profit-seeking is the engine of general prosperity. Today, that myth is becoming laughable.
It is my opinion that the term capitalism is so deified in american culture and the term socialism so vilified that there is little discussion of each’s merits and faults. That is the kernel of my concern. I also believe that that frame induces a normalcy bias, that the vortex does not exist, that the current level of fraud and deception is normal. “Keep marching to the showers.”
I assume you would agree that financial gimmickry, fraud, etc., is harmful. Let’s encourage the suits to take it on – even at the risk of substantial upheaval in the markets and the larger economy – what comes next is not worth arguing about.
I am so not envious of the rich. As a class, they have very unhappy families, they can’t trust anyone around them, and they have very bad taste. Luke 4:5:
And leaving out the God part, because my closest approximation of the divine is the mycelial mat. Nevertheless!!
The paper calls the fees at issue “management fees” when the “management fee” is the prototypical 2% in the “2 and 20″ formula. The “carry fee” is the 20, for 20% of profits, usually over a hurdle rate of 8%.
This is the misdirection device that needs to be emphasized. The common term “fee” is being used to direct attention to the more implicitly important “management fees”, and away from the incidental-sounding “carry fees”.
So is the carry fee 20% of return, or 20% of anything above 8% of the return? This somewhat clarifies why it’s a “tricky” calculation. If the actual carry fee is not specifically broken out by the private equity managers, CalPERS may have to calculate it both ways to see if either result fits; and what if neither one does?
Clearly, the private equity managers should break out these numbers, anything less is an opportunity for obfuscation.
I’ve written some accounting software, it gets very complicated very quickly, and different people read the same formal descriptions in different ways. I’ve had clients tell me, “it doesn’t matter what the stated calculation is, use this formula”, and provided something that was significantly different from the stated calculation… “because this is how we always do it”. And this is in fact true; their clients react to deviations from conditioned expectations. As long as the client sees something that looks roughly similar to what they saw last month or year, they don’t question it. Changing a calculated result in mid stream means time and effort for both sides, and time+effort=money. So even clients have an inclination to prefer stability (or the illusion of it) over improvement (and what if it’s not an improvement? how do we know?), and and to prefer simplicity(which can mean opacity) over rigor (which almost invariably becomes complex).
That’s not how they would compute it. CalPERS gets K-1s (partnership tax filings). They know what % they own of the fund. They can back it out from that.
They don’t have any access to financial information about the portfolio companies, so they don’t know the prices at which they were bought and sold, believe it or not except when the fund bought a public company and sold it in an IPO.
“As long as the client sees something that looks roughly similar to what they saw last month or year, they don’t question it.”
And I’m sure predator studies prey behavior very, very carefully….
Are there any poor Calpers administrators? Is their net worth publishable? Is it a revolving door?
I’d be curious to know if David Swenson’s Yale Investment Corp. is this unaware/cavalier about the fees it’s paying. He’s constantly singled out as the smartest investment manager in the business. I can’t believe he’d be as complacent as CalPERS is or is pretending to be. I’m sure the LPs are prohibited from comparing term sheets so the dumb ones won’t know if the smart ones were better negotiators.
Thanks Yves for highlighting this SacBee article re CalPers & their lack of disclosure re PE fees. It’s my belief that the top crooks at CalPers know exactly how much these fees are. But bc they skim off the top & siphon tax dollars into their off-shore accounts, they suddenly are “hazy” on exactly how much the fees are. Liars!!
I will contact state reps etc after the weekend.