After NC, Media Coverage of CalPERS and CalSTRS Private Equity Fee Lapses, California Treasurer John Chiang Calls for Legislation

We’ve been devoting a significant effort to covering how the giant public pension fund CalPERS, like all investors in private equity, has no idea of the total cost of investing in private equity.

As we’ve discussed at length, CalPERS and its Sacramento sister CalSTRS do not know what they pay in the way of the profits interest widely called “carry fees,” one of the biggest charges taken from their investments. Neither of the California giants properly tracks management fees, the annual 2% of the prototypical “2 and 20” fee structure. Their systems capture only the portion they pay in hard dollars, and not the part that is shifted onto portfolio companies, as well as other fees and costs loaded on to them. And bear in mind that while not all of these charges can be obtained under the secrecy regime that private equity general partners have succeeded in creating, some funds, such as the South Carolina pension system, do a vastly better of getting this information than the far better staffed and more powerful CalPERS and CalSTRS do.

The winds seem to be changing. In an important step, California State Treasurer John Chiang, who sits on the CalPERS and CalSTRS boards and had expressed concern about the CalPERS fee lapses, is moving to get more disclosure. This is a major shift for Chiang, who despite at least having made the right noises had also, with a group of other overseers of public pension funds, asked the SEC to ride to his rescue. As we pointed out, these public pension officials have the power as a group to press for more transparency on their own, rather than rely on the compromised and overburdened SEC.

We want to thank readers who wrote letters and made calls to Chiang and California Controller Betty Yee, who also sits on the CalPERS and CalSTRS boards. Insiders tell us that these messages played a significant role in Chiang’s change in stance.

From Reuters:

California’s state treasurer, John Chiang, on Monday called for state legislation requiring private equity firms to disclose all fees charged to California public pension funds.

In a letter to the country’s two largest public pension funds, Chiang said the California Public Employees’ Retirement System and the California State Teachers’ Retirement System, along with other limited partners, “pay excessive fees to private equity firms and do not have sufficient visibility into the nature and amount of those fees.”

Chiang urged that all California public pension funds, as well as the University of California Retirement System, work with his office to develop legislation to place fee disclosure requirements on private equity firms.

We’ve embedded Chiang’s letter below. While this is indeed progress, it’s also important to recognize that Chiang’s (and CalPERS’ and CalSTRS’) incentives are to do the bare minimum to make the problem of private equity transparency go away.

But even with this caveat, Chaing does deserve praise for laying out what looks to be a demand for disclosure of all fees, as well as related party transactions. The inclusion of related related party transactions is critically important, since they have been one of the biggest sources of chicanery. For instance, professionals have been presented as part of the private equity “team” for marketing purposes, then being billed to the funds as independent consultants. That makes these consultants expenses to the investors, when the investors assumed those individuals were employees, and hence on the general partner’s dime. Needless to say, this provision needs to be drafted to include transactions with the portfolio companies, and not just at the fund level.

But if you read Chiang’s letter carefully, you’ll see, despite the forceful tone, as well as his call to have California public pension funds act in a unified manner, there is an uncomfortable amount of wiggle room to allow for far less disclosure than a layperson would expect to come out of this initiative. Again from Reuters:

Ludovic Phalippou, finance professor at Oxford University’s Saïd Business School, praised Chiang’s efforts, but said pension funds need to disclose past fees paid and the total fees charged by each fund as well.

“This is actually the most important and difficult task,” said Phalippou.

Here is the key section from the letter:

Screen shot 2015-10-13 at 5.20.55 AM

The idea that “not impairing current agreements” means that the new requirements would have to apply only to future contracts is deferring far more than necessary to the general partners. First, as we indicated, other investors obtain vastly more information about fees and costs than CalPERS and CalSTRS do now simply by virtue of being diligent.

Second, although it would be out of keeping with the supine posture that limited partners have heretofore taken, they have a great deal of leverage that they could exploit. For example, there has been plenty of media coverage with substantial evidence of private equity abuses, from group purchasing company kickbacks to undisclosed fees to the “independent contractor” sham above. And the SEC’s approach appears to be to ding particular firms only of a subset of the abuses in which they’ve been engaged, meaning there is plenty of bad conduct they’ve chosen to ignore. If California wanted to play hardball, getting Attorney General Kamala Harris to say she was thinking about picking up where the SEC left off would likely lead to the industry being far more willing to cooperate in making disclosures beyond those mandated in current limited partnership agreements. The general partners have been so egregious in their misconduct as to make them vulnerable if anyone were to make an issue of their compliance with their own agreements. I’m not saying this is likely to occur, but the underlying fact set is so bad that Chiang and the state have far more cards that they can play than his letter would lead you to believe.

So since your efforts have proven to be so productive, I hope those of you in California will continue to circulate these posts to friends and colleagues in the state, and will continue to send letters and make calls to Chiang as well as Controller Betty Yee.

Here are Chiang and Yee’s contact information:

Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
(916) 653-2995

Ms. Betty Yee
California State Controller
P.O. Box 942850
Sacramento, California 94250-5872
(916) 445-2636

Please tell Betty Yee that you’ve seen John Chiang step forward to demand more private equity transparency and you expect her as a fellow fiduciary and state official to join him.

For Chiang, thank him for his proposal, but tell him you expect him to get more disclosure not just on future investments, but on current ones. Remind him that small funds are already doing far more that CalPERS and CalSTRS are in getting fee information, and that big public pension funds and state official have powerful bully pulpits, and they should use them to demand more disclosure now, particularly on related party transactions. The industry has no excuse save that they don’t want the magnitude of their grifting exposed. The fact that they will not be able to point to any tangible harm save to their inflated reputations can and should be used against them.

And thanks for your efforts!

John Chiang Letter to CalPERS and CalSTRS Oct 2015

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  1. timbers

    This is incredible. Imagine if this could be done to influence bad actions by public officials in other areas (write letters, unfavorable media coverage) when say for exmaple our leaders say WMD in Iraq we must invade, or we must bomb Syria, Russia is an aggressor or fill-in-the-blank.

  2. Sluggeux

    Typical California political theater, if you ask me. More Kayfabe.

    First, why do we need legislation defining what CalPERS staff and others already have a fiduciary duty to track and disclose to their oversight board, members, and annuitants?

    Second, this legislation will become a limiting factor on disclosures. If the legislation only requires disclosure of fees charged to investors, what about the giant underwater iceberg of fees extracted from portfolio companies that is the real problem here? It’s those “related party transactions” that are going to have to be carefully defined if this legislation is going to have any teeth — and the term-limits brain-drain in the halls of the capitol in Sacramento is more likely to result in more loopholes than solid rules.

    Third, as the Obama/Holder/Breuer/White crowd proved, rules are meaningless without enforcement. Back to the same oversight boards who are failing already — with Mr. Chaing himself sitting on the dais the whole time with a microphone and a fiduciary duty. Good luck with that…

    1. Yves Smith Post author

      I actually beg to differ, since I know from insiders that Chiang is not liking the heat he is under now. And I neglected to mention that this isn’t just the media. Recall that the teachers’ union is now calling for full transparency for all fees and costs. And the union spokesman who made that pitch is savvy and has been involved in the investment world a long, time, so he won’t be fooled.

      Now having said that, the GPs will try to push in precisely the direction you suggest. But if you read the letter, the related party transactions would get at the portfolio company charges. And I know how that came about, and trust me, Chiang is going to find it hard to get cute with that. Letting that one get on his wish list pretty much ties his hands re getting at portfolio company charges. Once you start pulling on that string, it’s hard to (sensibly) limit that to fund level charges. By including that, he’s made it very hard to pull off the sort of finesse you suggest, if that was his intent (given what we’ve seen of the sophistication of CalPERS’ staff and the way the pension fund consultants do everything in their power to fend off inquisitiveness, it is not at all clear that Chiang understands the structure of the fees. Look at how frighteningly basis that carry fee presentation was. If you Google on “carry fees” and “private equity” just about any overview you get is way more sophisticated).

      Put it another way, even if his intent was to have this be theater, Chiang has just created a big opening to take a lot more ground.

      1. Blue Meme

        And let’s not forget: there is one simple and socially beneficial way Chiang and the other CalPERS/CalSTRS fiduciaries can turn off the spotlight and improve portfolio performance — drop PE entirely.

      2. Sluggeaux

        Sorry, but you can see that it’s Kayfabe when the last sentence of Chiang’s first paragraph depends on the canard that PE “outperforms” both projections and other asset classes. NC proved long ago that this claim of “superior performance” is a bare-faced falsehood.

        John Chiang is the Treasurer of the State of California. He can demand that the State Attorney General seek declaratory relief voiding the non-disclosure clauses that everybody is hiding the unconscionable PE fees behind as violative of public policy. However, the AG is even more cravenly ambitious for higher office than Mr. Chiang, so this is not happening.

        NC’s reporting on CalPERS and CalSTRS fiduciary violations has been nothing short of astounding, but in parsing Mr. Chiang’s letter, I’m reminded that the best Kayfabe relies on the credulous (if unwitting) participation of members of the audience and representatives of the media.

        1. Yves Smith Post author

          You are looking at the longer-term objective of creating a lot more well warranted skepticism re private equity. Even though the CalPERS and CalSTRS results clearly show PE is not earning enough to justify investing in it, guess what? The PE consultants still keep endorsing 10%+ allocations to the strategy.

          Being a fiduciary under ERISA (which public pension funds follow even though they are not subject to it) means if you hire experts and you do what they tell you to do, you’ve meet your fiduciary duty. And NC is in very small minority in calling out PE underperformance, even though all we are doing is describing what the investors’ own performance data actually says. It’s going to take time to turn around the widespread misperceptions on this, and the efforts of the GPs and their allies (the consultants) to keep the big $ committed to PE, and we’ve only started.

          So yes, please write Chiang and hammer on the outperformance canard too. But believe me, getting him to take on PE on fees is an important bt of progress. The LPs heretofore have kidded themselves that the GPs are their”partners” and therefore can be trusted.

    2. RUKidding

      Could be Kayfabe, but otoh if no one does anything, then for sure nothing will change. At least there’s been some light shed on this egregious issue, and there’s a slight chance that some improvements might occur. I’m as cynical as the next person, but I’m willing to write letters to Chiang and Yee.

  3. flora

    This is very good news. Thank you, Yves, for great reporting. Thank you, all who have written letters. A change in direction at CalPERS will have a ripple effect across all states’ pension investing environments.

    1. JTMcPhee

      Re “ripple effect,” is that likely? These rackets involve smart and smarmy bankster types building up cozy personal relationships with the “fiduciaries” and the staffs that are supposed to be protecting the interests of the mope pension expecters who pay over, mostly involuntarily, a significant chunk of their wages to these enormous, and thus irresistibly seductive to the parasite set, piles of what is mostly Real Money. Forced savings, supposedly to fund one’s old age and decline into debility. All the tools and behavioral tics that allow the construction of these scams are in place, well lubricated and well understood by the players. Especially the part about the inability of the general populace to concentrate on an issue over a period of days, let alone decades — the latter being the time frame that’s required.

      While each of these scams have common characteristics and elements, each of them is sui generis with the particular state or local polity, and do the fiduciaries get together and discuss how they are conniving at or incompetently playing into the corruption? No accountability, no consequences, all the incentives are straight down the moral hazard path…

      It’s kind of like a wasting disease — you get used to the level of debility, you’re aware that the tumors or parasites are eating at you or that your own body has decided to go auto-immune, and that opportunistic parallel infections and failures of organs are also going on, but hey, we all try to do the best we can with what we have left, right? And one can only focus on negative stuff for just so long, especially if it’s as complicated as “carried interest” and hidden fees in huge small-print obfuscatory phonebook-sized “agreements.” (My contracts class in law school informed me that there’s supposed to be a “meeting of the minds” for there to be a “contract:” given the imbalance of information and deviant intent of one, or all, parties, one wonders how these “agreements” are enforceable anyway, other than by supine acceptance and/or connivance by the pensioners’ putative “fiduciaries,” who because they get taken to lunch and chatted up by the guys in the sharkskin suits think they are “players,” and see the personal advantages and perks of going along to get along…)

      And in other news,, and, and of course there’s a Powerpoint,

      “It’s too big!” (But thank you for doing what you can — the roaches don’t like having the light shined in their corners, though they know it will soon enough sweep on to other spots…)

      1. flora

        When Yves started reporting on PE I didn’t think the MSM – NYTimes and Forbes and FT – would pick up the ball on this issue as well. I didn’t think the California unions would start questioning CalPERS PE investment costs. I sure didn’t think anyone on the CalPERS board would read these reports take the issue seriously enough to change, or make a nod to change, their current PE investment process and reporting requirements. This is progress. And other state pension boards do follow CalPERS lead on many things.

        1. JTMcPhee

          No intention to diminish your comment, just an observation that blood sucking parasites are persistent, and the available pesticides tend to lose effectiveness as the critters adapt… see, e.g., our friends the bedbugs,, and for the Maine-iacs, — “It’s the LAW, man!”

          And it’s clear that many pension boards do follow CalPERS on many things… including the ones reported on… One can always hope, but experience teaches that the thieves and con artists are always several steps ahead of the enforcement mechanisms, even when said mechanisms are not yet crippled by their own infestations of corruption.

  4. Kim Kaufman

    OK, I’m a little (a lot) over my head in really understanding this. However, a couple of weeks ago, I was at an event where Chiang attended. I asked him about NC’s reporting, which he’s well aware of. Unfortunately, he said, “she’s got it wrong.” :( And he asserted so do the others. Basically, he said the issue is that they “can’t disclose everything.” I think he was trying to sell me that they actually get a better deal but if they disclosed it, no one would do deals with them. Perhaps that’s why he’s excluding already done deals. I’m sorry I couldn’t do better talking with him but I was expecting to have some better informed help at the event but it was just me. :(

    1. Yves Smith Post author

      Thanks so much for buttonholing him.

      Well, that just means he needs more pressure. If he has more people go after him on PE, particularly in succession, he is going to have to go beyond facile brushoffs

      It takes time to cut through the sea of propaganda in which Chiang is swimming. And he is in denial regarding what the private equity performance data at the funds he oversees actually says. Moreover, I sincerely doubt, for instance, that he’s read academic studies on performance, or the exhaustively researched and scrupulously fair and even more damning as a result book Private Equity at Work.

      He has a finance degree. Anyone who has any finance training has been told in school multiple times that IRR is a terrible metric and makes performance look better than it is. The very fact that he and other board members allow IRR to be compared directly to stock market returns is proof in and of itself that all the returns reporting in PE is a crock. And even using that flattering metric, PE still has underperformed its benchmarks for a decade. That means investors are not being paid enough to justify the risks they are taking by investing in the strategy.

      In other words, his posture is consistent with him deferring to staff and not doing adequate oversight or engaging in independent thinking. I’m not surprised, in a way, but it is still disappointing.

  5. tegnost

    In the physical world sometimes sports metaphors are appropriate and can be applied across other manifestations of being. In this case, defense in games or contests (imagine football or boxing) the best defense is to create a well guarded stasis. In the current non sports case, as in the various sports, one needs to impel the opposition to move and thus expose weaknesses that have heretofore been stably guarded. What I think we see here is yves has gotten them to move and they have adopted a secondary defensive posture, still formidable but not the posture of their choice. Kudos to yves for this and keep after them because they certainly want to regain their previous impregnable status. Thanks Kim, for having the audacity to ask about the criticisms voiced here at NC. “She’s got it wrong” indeed.

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