Pensions & Investment Editorial Savages Trustees for Failing to Perform Fiduciary Duty Over Private Equity Fees

A seismic shift is underway.

I have never seen an editorial of a trade publication, much the less a mainstream media publication, take on its establishment in as brutal a manner as Pensions & Investments did yesterday in Shining new light on fees. Mind you, the strident tone is fully deserved, indeed necessary given the complacency, severity of capture, and fecklessness of most “alternatives investment” limited partners, particularly in private equity.

The members of this too-cozy industry are not used to being called out by fellow insiders. But the fact that P&I has taken this bold step says that a considerable minority recognizes that the retrograde position of blind loyalty to private equity lords and masters is a long term losing proposition, particularly now that it is being revealed that private equity is failing to deliver on its its promise of clearly superior returns. Once the emperor is revealed to be scantily clad, it’s well-nigh impossible to justify the lack of transparency, the one-sided agreements, the fee gouging, and the outright criminality.

Of course, the private equity firms still have a tremendous amount of power, particularly by virtue of their near-lock on top legal expertise by virtue of how much they throw around in fees. But a turn in political sentiment and media coverage is going to mean many of the standard lines that investors accepted that were just a crock, like the claim that private equity agreements are trade secrets. will increasingly have to be defended on their merits. And a lot of them simply won’t hold up to any degree of critical scrutiny.

I urge you to read the op-ed in full. You’ll see I am not overstating in depicting this article as “brutal”. Key sections:

Asset owner fiduciaries have fallen short in their oversight in identifying, understanding and disclosing investment management fees, especially in alternative investments. They have just not been up to the task.

That practice is unacceptable.

John Chiang, California state treasurer, in an Oct. 12 letter to the investment committee chairs of the California Public Employees’ Retirement System and California State Teachers’ Retirement System, urged them to work with him to draft a state law to “require private equity firms to disclose all fees charged to California pension funds” and “place fee disclosure requirements” on private equity managers.

Such a law is necessary only because trustees have failed to undertake that fiduciary duty. Any such law should have provisions to hold fiduciaries accountable for such failure.

Stop right here. Did you see what P&I is proposing? It is saying that Chiang’s proposal is too weak, and to have teeth, fiduciaries need to face real consequences…meaning real liability or fines, meaning something that presumably cannot get their directors & officers insurance to cover.

Fiduciaries ought to be liable, given the duties of loyalty and care to which they are held under the law. But that has all become theory and cheap talk. P&I is making the radical suggestion that fiduciaries be held accountable, not just in the sadly-more-common-than-they-ought-to-be cases of outright criminal behavior, like CalPERS’ former CEO Frank Buenrostro taking cash bribes in paper bags, but also for serious deficiencies in performance of their regular duties. In other words, no more “board members are a protected class” treatment.

Back to the editorial. P&I dismissed the argument of limited partner like CalPERS that private equity firms run closed clubs and they need to compete for admission:

Private equity firms have been seeking out asset owners as investors. Asset owners have the clout to demand more transparency. Pension funds, private and public, as well as foundations and endowments accounted for 57% of all investment in private equity in 2013, according to the Private Equity Growth Capital Council….

Asset owners have failed in their fiduciary duty by not reaching out to those who could identify the costs. They don’t have that excuse anymore. They must ensure disclosure includes all fees.

Asset owners have been sitting ducks. They have let the private equity managers off the hook by not demanding transparency on fees. The lack of disclosure limited the degree to which asset owners could challenge and negotiate fees….

Fiduciaries must be held to account for their lack of oversight and scrutiny of investment management fees, particularly in private equity and other alternative asset allocations. Fiduciary duty calls for maximizing return for the risk taken for the sole benefit of participants or their financing objectives. Without examining fees, including profit sharing, fiduciaries cannot evaluate the full cost of investment management, properly assess performance and risk, or make decisions on the allocation of assets.

And P&I also calls out investors for not being vigilant about getting good advice:

Fiduciaries also have failed to seek out adequate assistance, or the guidance they received from investment consultants and pension fund attorneys has been insufficient to uncover all the components of fees so they could derive the full costs.

The editorial even urges beneficiaries to demand governance reforms because they are not being well served:

At many public retirement systems, participants, active and retired, elect some of the trustees to the governance and oversight boards, while elected officials appoint other trustees. These constituencies must demand an examination of the failure to account for fees and replace trustees that failed the due diligence.

We saw yet again another example of putting fear of upsetting the delicate relationship with the privare equity industry over putting the beneficiaries needs first at CalPERS yet again on Monday. Even though the board did take the unusual step of rejecting proposal by staff, this one an indefensible plan to end the requirement that private equity investments be managed to maximize risk-adjusted returns, another section of the discussion over the same agenda item was a case study of the sort of conduct that this editorial deplored.

Board member JJ Jelincic proposed a tame amendment to the policy language, that CalPERS put as a goal that general partners disclose all fees, which his language set forth in some detail, including the catchall of “economic rents”. Most of the rest of the board rushed to the defense of the private equity firms, arguing that CalPERS would be excluded. Jelincic stressed that the policy goal language only sought to get the general partners to set forth the type of fees, and did not tie staff’s hands in how they negotiated. A staff member then said the language was useless since all the general partners would do would be to provided a laundry list of every sort of fee they might conceivably charge.

Notice how the two arguments contradict each other: if Jelincic’s language could be satisfied by the general partners providing an empty paragraph, as the staffer suggested, it was harmless and the hyperventilating by the board members was off base and reveled their bad reflexes.

But the reality is more complicated. The general partner have been found guilty of charging all sorts of fees the limited partners did not know about, like “termination of monitoring fees,” and as reader TheCatSaid pointed out today, fees that are just plain grifting, like “recruiting fees”. The significance is that limited partner like CalPERS had naively assumed that all of these “hidden” fees charged to investee companies were nevertheless being rebated in large measure against the quarterly management fees. In reality, only specifically named fees were being rebated.

Thus Jelincic’s proposal of forcing all the fees to be named would then allow the limited partners to insist they all be credited against the management fee. This would close off a major loophole.

But the board and staff made a knee jerk response to reject any proposal that might upset the power dynamics with the general partners. This is precisely the sort of behavior that P&I called out as a failure to satisfy their fiduciary duties. A better response would have been to delay approval of the policy language change to study the matter further.

The article closed by criticizing Treasurer Chiang for being tardy in tabling his fee transparency proposal:

But that neglect is changing. In his letter, Mr. Chiang criticized private equity managers over their “lack of transparency and detail in how much it cost our pension systems to invest in their products.” But Mr. Chiang, ex-officio trustee of CalPERS and CalSTRS, should have raised his voice sooner and louder to draw attention to the neglect of fee disclosure. It’s better late than never.

These stern words are a badly-needed wakeup call to fund trustees over the US. Let’s hope they get the message.

Print Friendly, PDF & Email


  1. flora

    The editorial is harsh on all counts towards its establishment. Justifiably so.
    “Beware the fury of a patient man.” -John Dryden

    Thanks so much for your PE/pension fund reporting.

    1. flora

      From the editorial:
      “Asset owners have been sitting ducks. They have let the private equity managers off the hook by not demanding transparency on fees….”

      Since so many boards are captured by staff, who are captured by PE general partners interests, I hope in furture P&I will include educational articles about what pension boards should look for, what information to demand etc. The boards may think simply accepting what staff tell them is enough because they don’t know any better. (I’m being charitable.)

    2. Chauncey Gardiner

      Re: “Thanks so much for your PE/pension fund reporting.”

      Just want to echo flora’s statement. Amazing work.

  2. TheCatSaid (aka "TheCatSquid")

    What a mental image that creates! An antidote du jour for the future if anyone can find a photo of this intriguing and terrifying creature.

    But wait–maybe CalPERS executives are true CatSquids. They squirt lots of magic ink that blinds everyone around them–Board members, pension beneficiaries, financial media, state officials–while terrifying everyone simultaneously with ferocious, uber-feline snarls.

    Could this be the next blockbuster movie?

    1. Yves Smith Post author

      Oh, sorry! I have terrible name dyslexia.

      And Kevin Drum does Friday night cat blogging and Bruce Schneier does Friday night squid blogging, so I misread your name as a big inside joke. Will correct.

    1. craazyman

      there are some very strange people who post here — and not just comments, posts even! — so nothing would surprise me, not even a CatSquid

      Is Yves the Rhonda Rousey of finance journalism or what? Holy smokes, This is incredible. From laying around on the sofa thinking about it all the way to reality, like a fraud seeking missle. Wow. that is an amazing amount of work — if you really think about it. Who among us even gets their butt off the sofa to turn on the TV? don’t everybody hold up your hands at once now, hahahahahah


  3. Ishmael

    Regulatory capture by PE firms is very deep.

    I remember being at a Christmas party of one of the large PE firms and one of the future governors of the state of California was trolling around looking for contributions.

    And yes, Calpers was invested in their fund!

  4. redleg

    Reading this gives me hope that the monumental task of changing paradigms could happen without some equivalent of 1790-ish France.
    Thanks for finding and posting this.

  5. FIpmPro

    Yves, great work keep it up.

    I am completely befuddled how Calpers board can hold JJ jelncic in such disdain when hes appears to be the only one who has done his homework and is the only one who cares. Charles Valdez, an ex board member, would literally put his head down and sleep through the board meetings without any recourse whatsoever, yet an engaged and informed board member like JJ is seen as a thorn in the side of the organization? I think that speaks volumes about the organization and the entitlement the CEO and CIO think they deserve based on their personal relationships.

    Quite pathetic and revolting

Comments are closed.