If you have not had the opportunity to do so yet, please read the earlier posts in our CalPERS’ Private Equity, Exposed, series:
• Executive Summary
• Senior Private Equity Officers at CalPERS Do Not Understand How They Guarantee That Private Equity General Partners Get Rich
• CalPERS Staff Demonstrates Repeatedly That They Don’t Understand How Private Equity Fees Work
• CalPERS Chief Investment Officer Defends Tax Abuse as Investor Benefit
• CalPERS, an Anatomy of Capture by Private Equity
• CalPERS’ Chief Investment Officer Invokes False “Superior Returns” Excuse to Justify Fealty to Private Equity
• CalPERS’ Senior Investment Officer Flouts Fiduciary Duty by Refusing to Answer Private Equity Questions
• How CalPERS’ Consultant, Pension Consulting Alliance, Promotes Intellectual Capture by Private Equity
All of the private equity experts that we asked to look at the video of the latest CalPERS Investment Committee meeting were appalled by the performance not only of CalPERS’ private equity staff but also its board members. As Georgetown law professor Adam Levitin said via e-mail:
It’s shocking to see how many of the CalPERS investment committee are utterly ignorant. Aren’t these people supposed to know something?
And as Andrew Silton, the former Chief Investment Advisor to the State Treasurer of North Carolina, wrote on his website:
What’s the best defense against capture? A strong staff and informed trustees. The CalPERS video strongly suggests that CalPERS is lacking on both fronts.
It is hard to overstate the vehemence of the reactions I’ve gotten to the video of the CalPERS’ last investment committee meeting. In the majority of cases, when I’ve asked for a mere quote, the respondents were so disturbed by what they saw that they wrote commentary that ran to multiple pages. For instance, Andrew Silton, who had stopped financial blogging months ago to pursue his art, felt compelled to come out of retirement to write not just one, but three posts on the Investment Committee meeting train wreck.
CalPERS’ Investment Committee bears significant blame for the poor performance of CalPERS’ staff. Most CalPERS board members seem to regard their job as cheerleading and protecting CalPERS’ senior officers, rather than acting as vigilant protectors of CalPERS’ beneficiaries. This misguided sense of priorities was evident when Investment Committee chairman Henry Jones repeatedly undermined fellow committee member JJ Jelincic’s questions. Jones acted as if Jelincic was putting the private equity team members on the spot, when competent industry professionals should have been able to field Jelincic’s questions easily. Similarly, other board members allowed staff to give misleading and incomplete answers.
But even worse than the board’s lax attitude toward oversight is its lack of expertise. The presentation that led Jelincic to pose those not-difficult questions that nevertheless put the CalPERS officer responsible for private equity, Réal Desrochers, on tilt, was an insultingly basic primer on “carry fees,” which is the 20 in the prototypical “2 and 20” private equity fee scheme. The “20” stands for a 20% profit share once a preferred return, typically 8%, has been met. Stunningly, most of the Investment Committee members seemed pleased by the slideshow and acted as if they had learned something from it.
In other words, the board is so utterly lacking in knowledge that it is incapable of providing adequate oversight, even if it were inclined to do more than governance theater. That means that staff operates with no meaningful supervision. The bumbling, evasiveness, and apparent lack of command of what should be basic material is exactly what you’d expect to see as a result of letting the inmates run the asylum.
Yet Investment Committee members display their ignorance as if it were a badge of honor. Consider this speech from the end of the session:
Vice Chairman Bill Slaton: What I’ve gleaned from this, and I’d like to just kind of make some comments at a higher level than where we’ve down in the weeds. It’s very clear to me that the terms and conditions of private equity deals vary by general partner and by vintage. There’s no set process. It’s a negotiation.
It’s also clear to me that there’s a large number of investors for GPs to choose from, that CalPERS is not the only investor out there, and so therefore, our ability to get the industry to change is something that I appreciate that we’re leading on, but we can’t control. But I think we’re making progress.
It’s clear this is a largely unregulated industry that we’re trying now… that the United States is trying to do a better job regulating. And I’m glad that CalPERS is a participant in that.
I read in the press terms like, you know, hide and cheat and steal. I think those are inappropriate terms. I think we have an industry that probably needs more regulation, but I — what I want us to focus on is to make sure that we are gleaning as much data as we can, and that we see the progress that’s attained, and we start to see the reports.
I have faith in this group in front of us that you’re negotiating on behalf of CalPERS, as well as it can be done. So I’m not trying to…. and I don’t think we should spend a lot more time trying to find where there’s an error or a problem. I think you all are on to this, that you’re working hard at it, and I think that there’s value in us better understanding what the range of possibilities are. So bring scenarios back to us and how it works, like you did here, is instructive for us. But I don’t think it’s productive for us to spend a lot of time trying to play gotcha.
As Rosemary Batt, co-author of the landmark book Private Equity at Work, said:
I was completely appalled to listen to Bill Slaton as apologist for the staff. It reminded me of the Public Relations Director of Wal-Mart in the documentary, “Is Wal-Mart Good for America?” The notion that the GPs can choose whom they want to, putting CalPERS in a defensive posture, is absurd.
Let’s go through Slaton’s remarks in detail.
Slaton starts out by obliquely criticizing Jelincic’s efforts to get answers to what are simple questions by as being “down in the weeds.” He then parrots the diversion that Réal Desrochers relied on earlier in the meeting, that he couldn’t answer a question from Jelincic because everything was deal-specific. As Oxford professor Ludovic Phalippou said about that exchange, “The PE team line of defence is incredibly amateuristic. I would fail my private equity students if they wrote such a thing in their exam.”
Slaton continues with a claim straight out of the Private Equity Growth Council, the private equity industry’s chief lobbyist, and presumably also invoked by CalPERS’ staff, that private equity agreements are negotiated. Again, as Professor Phalippou, who has read 300 private equity agreements stressed, they are in fact “take it or leave it” agreements. As a former private equity partner said: “General partners have done a masterful job of dividing and conquering the limited partners on the negotiation process.”
Slaton then moves on to another bit of general partner propaganda that he, and apparently CalPERS’ staff, have swallowed, namely, that CalPERS has to compete to get general partners’ attention, and not vice versa. As Eileen Appelbaum, co-author of Private Equity at Work, wrote:
I find these responses, which I am sure are sincere, simply incredible. Public pension funds make the single largest contribution to PE fundraising of any type of investor. Data provided by PitchBook show that public pension funds contributed between 15% and 25% of all funds raised by private equity in the years from 2000 to 2012. In 2013 public pension funds contributed 24.5% of all funds raised by private equity; and in 2014, 21.5%. One might reasonably expect pension funds to demand respect and deference from PE firms when the latter come, hat in hand, seeking capital for their private equity funds. Certainly CalPERS, which makes large investments in private equity year after year and whose lead is followed by many other pension funds should be sought after by GPs, not told by GPs — as is apparently the case — not to make demands because there are many investors for GPs to choose from.
Slaton then notches his defense of private equity up a register and objects to the usage of words like “hide and cheat and steal” when applied to private equity. Perhaps he needs to read the press more extensively or acquaint himself with a dictionary.
Private equity investors were upset when they leaned about fees like “termination of monitoring fees” of tens, sometimes hundreds of millions of dollars, via Gretchen Morgenson of the New York Times, particularly when they realized those fees were not shared with them in management fee offsets. They were similarly stunned to learn from Mark Maremont of the Wall Street Journal that KKR’s captive consulting firm, KKR Capstone, was treated by KKR as being an independent contractor. That means KKR charged hundreds of millions of dollars of dollars for KKR Capstone services, when investors had assumed that was already covered by the management fee.
If someone is taking a lot of money out of your investment and hasn’t told you about it, pray tell how is that not hiding?
Similarly, how is it not cheating when KKR shifted nearly $20 million of broken deal expenses onto limited partners, when they should have been borne by co-investors that included KKR affiliates? The SEC deemed KKR’s conduct to be abusive enough to warrant $10 million in fines.
In other words, Slaton professes to support the effort to get tougher on the industry, as long as no one actually describes its bad conduct in simple, plain English terms. Perhaps he is concerned that the great unwashed public will wise up as to how general partners have fleeced limited partners like CalPERS for years, and the limited partners and overseers like him have done perilously little to prevent it .
Slaton then says, with a straight face, that the private equity team at CalPERS is doing a great job of negotiating, when he has no basis for his opinion. Andrew Silton, who has been the chief investment officer of a substantial private equity portfolio, begs to differ:
Like any large investor, CalPERS must systematically attack every sort of fee and vigorously negotiate deal terms. These are the only two techniques that can give a large institution marginally better performance and control over its private equity program. Clearly, the current team at CalPERS has failed to do both.
Slaton wraps up by saying he has no intention of doing his job as a board member: “I don’t think we should spend a lot more time trying to find where there’s an error or a problem.” Slaton finishes by plainly stating that he regards the work of supervision and governing as “gotcha” and sees it as beneath him. I trust Governor Jerry Brown is paying attention and finds someone else to install in Slaton’s slot.
We see similar undue protectiveness of staff in Henry Jones’ closing remarks. He used the fact that CalPERS has yet to complete its new private equity IT reporting system, PEARS, to justify the inability (and often, refusal) of staff to answer Jelincic’s questions, when Jelincic made clear that virtually all of them did not depend on data.
Chairman Henry Jones: Okay. I think it’s also important to realize that earlier in the day, Mr. Eliopoulos did indicate an update on the private equity project, the PEARS project, where he indicated that he has collected about 94 percent of the data that’s necessary to maybe answer a whole host of questions that we’ve been asking, and that he plans to come back to the Committee to present that information to us.
And so I think it’s important that we know. And matter of fact, he also stated in his comments this morning, that they actually went live and parallel on this particular project that they’re working. So it’s getting there.
And I know that we all are interested in understanding some of the complexities of private equity investment. But I think we need to be patient too to make sure that we get all of the information and get the accurate information, because I think there’s been too many misquotes, too much misinformation that’s been in the public.
And as you know, when information is provided to the press, and many times they go with what they were told, and many times it’s not accurate information coming from our Investment Office. So I would encourage us all to be a little patient, and certainly answer JJ’s questions when the data is available, or if he has specific requests that he can provide that request to you and — so that it can be responded to.
Jones’ repeated incantation, “We need to be patient” is mind-boggling. CalPERS has been investing in private equity for 25 years. Staff has, or ought to have, the sort of basic, general information that Jelincic has requested at hand.
And notice Jones tried to depict the press as being inaccurate. That’s simply bogus. I challenge Jones to cite a substantive point in which the media has provided faulty information about CalPERS in the recent fee controversy. The proof is that CalPERS does not appear to have asked for, and more importantly, has not gotten, a single retraction.
By contrast, as we’ve seen in the last two Investment Committee meetings, CalPERS’ staff has repeatedly told the board things that are flat out wrong or so heavily spun in favor of private equity general partners as to be incorrect. So how, pray tell, can Jones defend staff as the gold standard of accuracy?
Jones is effectively telling his fellow board members to regard the staff as the only valid source of information. And if board members don’t consult and cultivate independent channels for news and intelligence, they are guaranteed never to challenge staff. That assures that the board will continue to do a poor job of oversight.
CalPERS’ reaction to having its private equity failings exposed has not been to correct these problems, but to attack the people who’ve unearthed them and defend parties who should be held to account. And its board reinforces this pathological response. Sadly, this behavior is guaranteed to produce more self-inflicted wounds and diminish CalPERS as an institution.
We will wrap up this series next week.