CalPERS Debunks Private Equity: Executive Summary

CalPERS’ last board meeting included a private equity workshop that featured a series of panels, led almost entirely by outside experts, the most notable of whom was Harvard Business School professor Josh Lerner. The staff’s intent was clearly not merely to educate the board about this type of investment, but far more importantly for CalPERS, to achieve two other goals: first, to persuade members of the media, beneficiaries, and important constituencies like members of the state legislature that private equity was a necessary component of CalPERS’ investment strategy; second, to demonstrate to the world that CalPERS understands private equity’s complexities and is therefore competent to participate in it.

Despite the veneer of success in achieving these aims, with the participants touting the supposed advantages of private equity, a detached reading of the evidence and arguments presented in fact leads to the exact opposite conclusion.

CalPERS’ experts put a wrapper of positive claims about private equity around evidence that actually made a compelling case against it. Apparently, the assumption was that the board and other key audiences were so credulous that they would not notice glaring inconsistencies. Even CalPERS’ star witness, Professor Lerner, gave a talk that was rife with internal contradictions and at best provided only half-hearted support.

On top of that, to the extent the panelists presented compelling-looking data in defense of private equity, the information was often cherry-picked, so incomplete as to be erroneous, deliberately manipulated, or outright false. And it goes without saying that CalPERS could not even make this failed defense on its own; it had to muster a posse of hired guns and allies (although it must be said that the one generally good presentation was by an in-house attorney, Marte Castanos, on the terms in the legal agreements and their implications for limited partners). The errors are so extensive and wide-ranging that we will be able to discuss only the most glaring ones over our seven upcoming posts in this series.

The overarching message of the workshop was that CalPERS has to invest in private equity to meet its overall return target and it is therefore necessary for CalPERS to accept a host of bad features, such as lack of transparency, unjustifiably high fees, one-sided agreements, and outright corruption. CalPERS appeared to adopt a classic poor earnings quarter strategy: tell the board all the ugly news about private equity so staff could then depict it as old hat.

However, both legs of this approach failed. As we will demonstrate over our series of posts, the returns information, which is the linchpin of the “There is no alternative to private equity” message, was rife with sleight of hand, including misleading comparisons, demonstrably invalid assumptions, and an admitted preference for substituting flattering but inaccurate accounting measures for underlying economic realities. Similarly, as we will show, CalPERS and its experts repeatedly underplayed the pitfalls of private equity, depicting problems such as weak governance, the effective renunciation of fiduciary duty by general partners, and widespread cheating, as inconsequential.

This workshop revealed:

¶ CalPERS’ inability to make an intellectually honest defense of private equity, despite a considerable expenditure of time and involvement of industry experts, suggests that no intellectually honest defense exists.

¶ Rather than having this workshop serve as a first step in a process of examining the real issues inherent in private equity investing and the options CalPERS has to address them, it was clearly meant to justify the status quo investment strategy, and suggested that the best CalPERS could hope for was slow, incremental change. In fact, as we will discuss, CalPERS has considerable leverage, but is unwilling to consider using it due to the depth of its intellectual capture and poor incentives at the staff level.

¶ CalPERS is running on brand fumes, at least as far as private equity is concerned. Its reputation for greater acumen is demonstrably false, despite the fact that it is much more heavily staffed than the overwhelming majority of private equity investors. The frequency and severity of errors in the presentations call into question the honesty and competence of CalPERS’ advisors, and in turn, CalPERS itself, since the staff chose them, worked with them to develop the presentations, and is ultimately responsible for their accuracy and completeness. This also raises Diogenes-like questions as to whether any honest advisors can be found in private equity.

¶ The diminution of CalPERS as an institution is the direct result of CEO Anne Stausboll’s strategy of aggrandizing her power by persuading the board to cede authority to her. The board asked remarkably few questions, despite the considerable amount of unfavorable information presented. By contrast, during the in the public comments section, an MBA student asked more incisive questions than the board did.

You see the direct consequences of Stausboll’s reign in our related posts today: that CalPERS treats it as routine to violate California transparency statues. This was demonstrated vividly, as we will discuss in depth, in how CalPERS knowingly violated the Bageley-Keene Open Meetings Act, which describes which matters must be handled in open board sessions, and trampled on the rights of the public to comment at this workshop, in order to silence skeptical experts in attendance at the meeting, individuals including Rosemary Batt, recognized academic expert on private equity, and Michael Flaherman, a former CalPERS Investment Committee chairman and former private equity executive who is now a visiting scholar at UC Berkeley.

Moreover, CalPERS engages in institutionalized violation of open meeting laws to manipulate board members prior to board meetings, as described today in Board Member Reveals That CalPERS Engages in Systematic Violation of California Open Meeting Statutes. And later this week, we will discuss CalPERS’ plan to violate the Public Records Act in order to gag the only board member who is willing to try to supervise staff, despite the considerably hostility of the other members of the board, most notably the chairman of the board Robert Feckner and the chairman of the Investment Committee, Henry Jones.

Stausboll is also ultimately responsible for the staff recommendation to the board to engage a fiduciary counsel that one source called “a naked huckster,” with a second source, who has had personal dealings with him, concurring in this description. Among other things, this attorney, Robert Klausner, is alleged to have taken kickbacks from money managers and class action lawyers, which we report today in CalPERS Uses a Fiduciary Counsel Accused of Serious Misconduct Over More Than a Decade, Including Kickbacks, Failure to Disclose Conflicts of Interest.

By contrast, CalPERS’ rise to preeminence as an institution was the direct result of an initiative led by the board that was initially resisted by staff. As we wrote earlier this month:

And the initiative that led CalPERS to become a leader among institutional investors, its advocacy for strong corporate governance and its activist posture, came from a board member, Jesse Unruh, then the California Treasurer, demonstrating the value of an engaged and influential board. While the current California Treasurer John Chiang’s plan to propose legislation to require disclosure of all private equity fees and related party transactions would be an important step in board members reasserting their authority, the current enfeebled CalPERS board is a long way from taking on the sort of powerful, long-term campaigns for better investment practices that was once its hallmark.

It is with a heavy heart that I continue with criticism of CalPERS. For the most part, its staff is well intentioned and trying to do a good job. But the organization is deeply in denial about the corrosive effects of private equity. It was a private equity pay-to-play scandal that led to the successful criminal prosecution of the former CEO, Frank Buenrostro, and the resignation of several board members that seriously damaged CalPERS’ reputation. Even though Stausboll no doubt sees herself as having righted the ship in the wake of that disaster, in reality she has done more to secure her position that to strengthen CalPERS as an institution. Until she is willing to confront the issues of flawed returns reporting, capture, and corruption in private equity, CalPERS as an institution is still very much at risk. And that in turn works to the detriment of its beneficiaries, and ultimately, California taxpayers.

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  1. JTMcPhee

    Do you email, fax, Facebook, certified snail mail, whatever, the texts of these articles directly to each of the board members and other players on the Fraud Team? And keep and publish a record of the notifications given? Just curious, and no, this is not intended to be an assignment, just a question. Maybe the beneficiaries would be interested, in both the analysis and the distribution, too.

  2. irenic

    The CalPERS CEO is Anne Stausboll.

    I noticed this while googling her name, searching for a photo of Ms. Stausboll. I’ve always thought that newspapers, websites–all media– should always include a photo of people involved in questionable activities. An image leaves a greater impact than just a name in black and white. It’s always good to be able to recognize the kind of people who might have questionable ethics/morals. The kind of people one should keep their distance from while also keeping one hand on their wallet.

    1. Robert Frances

      A short resume is more helpful. At age 59 she’s been with CA government and Calpers much of her career. From a Bloomberg webpage:

      Ms. Stausboll received her Juris Doctor degree from the University of California, Davis School of Law and her Bachelor of Arts degree in English from Oberlin College. (No dates provided but presumably late 70’s, early 80’s.)

      Ms. Stausboll joined (re-hired by) California Public Employees’ Retirement System in September 2004 (promoted to Chief Executive in 2009) and works closely with the system’s senior investment officers to implement investment strategies for real estate, alternative investments, and public market portfolios. Previously, she was an Interim Investment Officer and has also been the firm’s Chief Operating Investment Officer.

      Before 2004, she was employed as the Chief Deputy Treasurer to California State Treasurer Phil Angelides, beginning in July 2000. As the Chief Deputy, Ms. Stausboll directed the policies, programs, and operations of the state treasurer’s office, which has more than 200 employees and a budget of more than $20 million. She also led a team on national corporate reform for the treasurer’s office…

      Prior to serving in the State Treasurer’s Office, Ms. Stausboll worked for six years in the CalPERS Legal Office, including two years as Deputy General Counsel.

      Ms. Stausboll was a Member of the working group that drafted the United Nations Principles for Responsible Investment and served on its Governing Board from 2006 – 2009. She was named to a list of the 100 most influential corporate governance professionals for 2011 by The NACD Directorship 100 Hall of Fame.

      1. cnchal

        . . .NACD Directorship 100 Hall of Fame.

        Soon to be Hall of Shame.

        Lots of piranhas feasting on pension funds.

      2. Assolonius

        “Ms. Stausboll joined (re-hired by) California Public Employees’ Retirement System in September 2004 (promoted to Chief Executive in 2009) and works closely with the system’s senior investment officers to implement investment strategies for real estate, alternative investments, and public market portfolios. Previously, she was an Interim Investment Officer and has also been the firm’s Chief Operating Investment Officer.”

        Stausball implemented investment strategies? Really? who knew He was the “brains” behind calpers investing “success”. Lets let mAnn and Harry convene in a closed room for a day and see what great investment ideas they come up with

        What mAnn did do was oversee the largest destruction of capital of any entity on earth in 2008.
        What she did do was let the Mexi mafia/large lefty CA donors infiltrate the place and use it like their own piggybank.
        What she did do was twiddle her thumbs while the largest plan in the US atrophied to the point where its questionable if its a going concern.

    1. tegnost

      yes, and here I was thinking she was taking a break…, that she may do stuff like this for fun should concern her adversaries….

  3. Socal rhino

    I live in California. Sorry to read this ongoing saga, Calprs has enjoyed a pretty good reputation, obvious “opportunities for improvement” to regain that. Wonder if any of this has been picked up by the OC Register, seems like read meat for those folks. Unless private equity trumps hostility to Dems.

  4. flora

    Thanks for these posts. CalPERS has long been the lead entity for state pension funds; whatever CalPERS does is seen as sound and a green light for other pension funds. These posts are as important for other pension funds as for vested CalPERS members. Putting the best face on things, it looks like the CalPERS board has become Mr. Wickfield, and the PE staff has become Uriah Heep. It gives me no pleasure to write this.

    I see that the junk bond market isn’t doing well, and can only wonder if your reporting on PE has had an effect on junk bonds/PE debt financing.

    Thanks for your great work.

    1. Yves Smith Post author

      Thanks for the kind words, but trust me, this site is not having an effect on junk bond prices. They typically are the canary in the coal mine for the economy as a whole: they weaken at the end of cycles and predict recessions. But they also send false positives. As they liked to say about a negative yield curve before the Fed messed so heavily in bond pricing, it predicted 9 of the last 5 recessions.

  5. Robert Frances

    I understand Private Equity is a broad field, but in some corners of the business world they undertake very nasty corporate restructurings. Asset sales, significant lay-offs, out-sourcing (often overseas), plant and office closings and a host of major and minor transgressions against the existing business and employees are carried out in the name of efficiency and “bottom-line.” (In fairness, some of the target companies might fade away to nothingness without a major restructuring.) As is so well documented here at NC week after week, much of the “free cash flow” generated by the asset sales and restructurings are directed back to the PE partners. After a reasonably “clean” balance sheet and adequate cash flow are in place, the target company is sold to another company or goes public via an IPO.

    1. Jim A.

      Yes sometimes a company really needs a radical restructuring….But at this point I believe that in many cases, the PE “managers” simply use a round of restructuring and layoffs as a smoke screen to hide all financial manipulation, predatory fees, and hidden debt that is their real specialty.

  6. tegnost

    Here is a question somewhat out of left field. In discussions with the ubiquitous NW Techie I’m getting a bit of push that without PE the startups would have a harder time raising funds and thus those friends of mine whose jobs are in start ups feel that I am agitating against their interests. Is it possible that in the bay area that this mindset has traction, and is there any truth to the claim that limiting PE equals limiting opportunity, personally I think no but would like a more informed view if anyone has one.

    1. flora

      Your friends companies may be initially funded by venture capital firms (VC). Angel investors.
      That’s a different game from vulture capital buy-out firms. Both are private equity investments. Look up Venture Capital on Wikipedia. VC investors are looking to build up new firms, particularly in tech, and hopefully get them listed on the stock exchange, and profit if the company does well.

      Then look up Private Equity (PE) as it’s come to be understood, particularly in these posts.
      ” In a typical leveraged-buyout transaction, a private-equity firm buys majority control of an existing or mature firm. This is distinct from a venture-capital or growth-capital investment, in which the investors (typically venture-capital firms or angel investors) invest in young, growing or emerging companies, and rarely obtain majority control.” -Wikipedia

      2 very different games. Your friends in tech startups are benefiting from VC angel investors.
      That’s my layman’s 2 cents.

    2. Yves Smith Post author

      Fewer than 1% of startups get venture funding. New businesses are funded by savings, credit cards, and friends and family. Despite the hype, they are just not that important to business formation.

      An attorney of mine handled a lot of small companies with very promising technologies or brands (IT, face recognition, neutraceuticals, medical devices), fashion, cosmetics) because she had a very unusual background: undergraduate engineering degree, worked at the National Institutes of Health, where she had drafted the government’s first license of intellectual property (and 80% of her language is still in use), then the legal department of a Big Pharma co, then worked for one of the big leveraged buyout players of the 1980s, then was the general counsel of an LBO company.

      So she knows tech and knows how to negotiate deals. is 80% of the way to be a securities lawyer (the only part she does not know is doing public offerings) and knows intellectual property and the FDA rulebook (and the FDA has 4-5X as many regs as the SEC).

      She advised her clients never never never to take venture capital money. The VCs would get in and pretty much inevitably push the original enterpreneurs out. Plus they were overcontroling and nowhere near as long-term oriented in their approach to the business as the original team. She told them to find any other type of financing: borrowing, getting vendor finance, etc (and she was really creative about that too). If she lost that argument, she’d urge them to get two VCs and try to play them off against each other whenever possible. I similarly know a serial entrepreneur (three times by his late 30s) who despises VC even though they funded all of his ventures, to the degree that he’s looked seriously into funding research to show how their claims about themselves are untrue or sorely exaggerated (he’s done a ton of research himself on the academic defenses and then keeps getting distracted on the “how to go about this” part). His distaste for them was rooted in part in their lack of concern about the skills possessed by key people at the company and their willingness to fire people to make the numbers.

      If you look at the Inc 500 companies, only about 25% were venture funded, and in many cases, it was well after the company was successful, just a late round financing by prestigious players to get a higher valuation in the IPO that happened shortly thereafter.

  7. tegnost

    so VC maybe more like capitalizing on sure things that have shoestringed their way along, now pondering that along the lines presented in the 2 links on “disruptive innovation” I think i’ll go take another look there but recall something about thresholds of competition, so a VC can watch companies on the threshold of competitiveness and jump on the band wagon at IPO time, without bearing too much risk.

  8. Azmat

    disclaimer: i am a Cal graduate not an employee or beneficiary or otherwise directly affected by what Calpers does

    The Berkekey Foundation ‘invests’ mych of the endiwment etc, and may do so thtough Calpers.

    I just saw a report whrre they compare performance vs benchmarks, but they are 1-2 % below S&P500.
    They do not the ‘expense ratio’ but say that it is between 4-5%!! Again, in line with benchmarks. SURE if all in the benchmark are pulling the ‘same’ shenanigans all will be ‘in the benchmark range’.

    Attempts to get clarification have not yet yielded response.

  9. participant-observer-observed

    Congratulations again to Yves and the NC team for continued coverage of CALPERS operations, by definition in the public interest.

    Perhaps NC can publish a separate volume of all the CALPERS-related coverage, for convenience of interested parties.

    There should be a Pulitzer prize for economics/finance/banking investigative reporting awarded to NC for this work.

    How much did CALPERS fork out of CA tax-payer purses for speaking fees for the HBS Lerner et al.? What is Stausboll’s other board positions and informal relations with Wall St execs and Silicon Valley VC persons? How is she in this position with no formal education in finance or economics? She probably cannot even understand integral calculus, with just a JD degree and English undergrad!

    It would be great to see more coverage of this CALPERS gaming from a national perspective from the David Dayens and Matt Taibbis of the world, given Yves’s need to keep focused on the micro-shenanigans. How many workers pensions nationwide have historically been blown/disappeared by Wall St exploitation of financial incompetence of fund board members?

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