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.