A few weeks ago, Gretchen Morgenson of the New York Times wrote on how state-level bills to increase private equity disclosure, including California Treasurer John Chiang’s AB 2833, were being blocked or considerably weakened.
Apparently Chiang was not pleased at getting less than glowing press. His letter to the New York Times editor ran last weekend under the header, A Look Behind the Curtain:
In “Keeping Private Equity Shrouded in Shadows” (Fair Game, July 3), Gretchen Morgenson contends that the private equity fee disclosure legislation I am sponsoring in the California Legislature has been “watered down.”
Should Assembly Bill 2833 become law, it would impose the most robust transparency requirements in the nation on private equity firms. For the first time, California public pension funds will be allowed behind the curtain to view previously hidden fees and charges that are paid to general partners and related parties.
Ms. Morgenson cites the concern of a former Calpers board member that my measure presents “less than a full picture” because it discloses only the related-party costs allocated to California public pension funds. I am open to sponsoring future legislation requiring broader disclosure of related-party transactions affecting private sector or non-California investors.
However, today, I am more concerned that our pension fund members and taxpayers are given a full picture of their share of total investment costs. A.B. 2833 does that. This type of disclosure is crucial given that every dollar paid in fees is one less dollar available for promised benefits.
It’s difficult to know what to make of this.
Who is the audience? The New York Times is not all that popular in California. Most readers consume the online version, where letters to the editor are hard to find. In searches, the Morgenson article will be prominent, while this missive will be comparatively obscure. Perhaps the motivation was that in the event that members of the public or the legislature cite the Morgenson article, Chiang can point to his letter as a retort.
But more important, did Chiang even recognize that, even taking his letter at face value, all he was doing was whinging about the Morgenaon article rather than actually making a cogent argument about it?
The opening paragraph repeats Morgenson’s observation that the bill was “watered down” and never once disputes that. Even worse, Chiang makes an admission against interest, confirming an unnamed critic’s (private equity expert Michael Flaherman’s) claim that the bill is flawed by saying he is open to sponsoring a future bill that would provide for fuller disclosure. Why wait till then and not fix this measure?
In addition, the letter is misleading in claiming that AB 2833 would let public pension funds “view previously hidden fees and charges”. At best, it would allow them to “view some previously hidden fees and charges. We described three flaws in bill at length:
AB 2833 has gaping holes that will allow general partners to structure related party payments to escape reporting
AB 2833’s definition of “portfolio company” allows payment to be routed through other entities
Reporting is at far too high a level of abstraction to allow for verification or cross-checks
So Chiang’s defense boils down to “This bill is better than nothing”. But is even that weak claim true? For the reasons listed above, it’s very likely that it will represent no meaningful change. That’s before you get to the fact that, in the June CalPERS Investment Committee meeting, as we wrote today, the board voted for an amendment, which if passed, would weaken the bill even further. Yet if AB 2833 is enacted, it will allow both general partners and limited partners to claim they’ve made meaningful steps, and thus allow them to resist better legislation as unnecessary until it’s become clear this bill has failed, which will take at least a few years.
The real tell that AB 2833 is no threat to private equity, as an effective bill would be, is the lack of opposition. Nary a vote has been cast against it. It would be one thing if Chiang and the bill’s author Ken Cooley had stuck with the original strong version, had forced opponents into the open, and made them show their faces and present their arguments. The more the fatuous defenses of private equity secrecy are on public view, the harder they are to support. And if Chiang lost, he could point to a hard-fought battle and demonstrate how powerful the private equity industry is, which is in and of itself a cause for concern.
But whether due to lack of commitment, habit, or not understanding their opposition, Chiang and Cooley decided to handle as as much as possible behind closed doors, a game the private equity industry was sure to win. Once again, secrecy remains private equity’s best friend.
Thank you for the continued coverage of the PE industry – as an LP it is valuable insight, pls keep it up.
You might find this study interesting: “Pension Fund Asset Allocation and Liability Discount Rates”
abstract: This paper studies the regulatory incentives of U.S. public pension funds to increase
risk-taking arising from their unique regulation linking their liability discount rates
to the expected return on assets, which enables them to report a better funding
position by investing more in risky assets. Comparing public and private pension
funds in the U.S., Canada, and Europe, U.S. public funds seem susceptible to these
incentives. More mature U.S. public funds as well as funds with more political and
participant-elected board members take more risk and use higher discount rates. The
increased risk-taking of U.S. public plans is negatively related to their performance.
Thanks! Just linked to an Economist write-up of it in Links, but need to read it myself.
this and the other PE article reveal the bait and switch that has become regular in lawmaking, protect the bullies. The cynic in me, which is unsurprisingly the greater half, expects there must be some quid pro quo, but it would be worse if it’s just a starry eyed view of the money and executive panache
What you said!
Agree. Hard to say which is worse: starry-eyed or on the take.
Hi, sorry to be a relative ignoramus/naïf but can you spell out plainly the exact incentives for these trustees to act so badly? From direct/offshore payments of money, to implicit/explicit promises of future cushy employment, to simple peer pressure: what is it? They are obviously shameless shills, so I do not see how it is productive criticism to heap further shame on them. Why not go directly after the incentives that are driving this bad behavior?
One issue you’ve overlooked is the idea of intellectual capture, something that is a lot less obvious than the much more visible flat-out corruption. NC has been talking about it for a while but I’d like a full-on article about it (probably from Lambert).
There is a decent chance that these people legitimately believe they are doing the right and good thing, and that they are being attacked for being helpful. This is due to flat-out ignorance (willful or not) on their part, so they’re not innocent – just foolish.
When you look at politics from this perspective, it makes a lot more sense. Chiang and his ilk are not sociopaths, just fools. They get as far as they do because the true sociopaths see them as useful, and let them stay where they are.
Thanks. Interesting perspective and sounds logical, at least. Cynical me, I always think it’s about payola & scams – and often it is. But possibly your explanation is true in this case.
Whether in the private or public sector, a lot of people who rise positions of power and/or high level responsibility are often unsuited to the job. And then perform miserably. Not unusual.
Thanks for stating this simply and well.
The public is so used to seeing the revolving door and campaign contributions and other forms of corruption that most people assume that that is what is driving questionable behavior by officials when there can be and in this case are other drivers.
A big factor is that the way fiduciary duty is handled is via process. As in no one will ever find that you as a trustee have violated your fiduciary duty if you hire experts with the right credentials and follow their recommendation. The experts all back investing in private equity. Why?
One reason is that it’s accepted as an “asset class”. Orthodox theory says the more asset classes you invest in, the better your results over time, not because it increases your return potential but lowers your downside risk. However, it’s hard to argue that PE is an asset class. Its returns are highly correlated with those of public stocks, and would be even more so if they reported valuations accurately in bad stock markets.
A second reason is that consultants make more money the more complex an investment strategy is. How much money could they make telling CalPERS to invest in a bunch of index funds, and which ones they should manage in house versus give to outside managers?
Third is that private equity won’t give any information to outside consultants who aren’t supporters. If CalPERS were to hire a consultant that were tough, the PE funds would call and complain and get them fired: “Who are these people? They don’t know what they are doing. They are asking questions that no one else asks and wasting our very valuable time.”
Fourth is that PE has managed to corrupt the academics. Unlike every other investment strategy, where the finance professors are skeptical and regularly write critical papers, in PE they are all cheerleaders except for Ludovic Phalippou at Oxford. Phalippou has found it very hard to do analytical work since the funds won’t give him return data. The funds typically provide return data, which of course means it is subject to cherry-picking. And in until recently, he was even denied access to databases like the one at University of North Carolina, Burgiss, where you have to basically apply to get to use it.
And that’s before you get to the overt corruption with PE academics, that they make way more from consulting to PE than they do from teaching. One of my colleagues was a finance prof at Columbia for a while, in the Henry Kravis chair (which bizarrely is not tenured). Not long after he was there, he got a call from Kravis himself, telling him more or less,, “Why don’t you come and spend some time at our firm and tell us what you think?” In other words, it was a consulting gig with no specified deliverables, clearly super informal, as in easy. My colleague, who is not at all money oriented and very keen to preserve his independence, gave a flattering “no,” (“Oh, you guys are so sophisticated, I really can’t, there’s not much I could tell you.”).
So they are surrounded by loyalists. It would take energy to buck that. Staff has no incentive, particularly since they have no idea how to meet their clearly unrealistic return targets (in light of ZIRP and QE, which is not their fault). PE is their hope of salvation, even if it is pretty sure to prove to be a fantasy.
It is standard practice in the industry for head hunters to call the senior sales guys at big financial institutions (jpm, ms, gs, blackstone etc) and get input for more senior positions in pension funds. Who they give the thumbs up or down to is not unlikely to be influenced by the amount of business that has come their way. I’m not saying it’s a determing factor for LP behavior but if you are a career minded person it’s probably in the back of your head when dealing with PE and other fund managers.
Yves, thank you!! Today focused on calls to the CA Federation of Teachers and CA Nurses Association. Until they take issue with the bill in it’s current form, it will continue to pass through the process “without public comment”. Don’t know if they understand how watered down the bill has become, but will attempt to address. The Assembly and Senate members staff seem very unaware and disconnected, at this point.
Thanks so much for your calls!
Thanks for drawing this Letter to the Editor to our attention, Yves. It does seem to be poorly written and not that informative. My uneducated guess is that Chiang wrote it with Wall St/PE as his intended audience. I doubt Chiang gives a stuff if any CA tax payer reads it. Seems like a fluff job to me.
Thanks, Chiang, for taking such good care of my tax dollars and my future pension. /s (in case anyone needed this)
“… claim that the bill is flawed by saying he is open to sponsoring a future bill that would provide for fuller disclosure. Why wait till then and not fix this measure?”
Spot-on! Thanks for your continued reporting on PE and pension.
The state of PA is exploding with federal investigations, but this one is about a former state treasurer who was bribed with $700,000 by an investment banker who got the state contract for pension management.
That would explain a lot of bad decisions. That and a little thing called deregulation.
“While the businessmen have financially backed dozens of officials, no politician was the recipient of more campaign money than Hafer, elected treasurer as a Republican in 1996 and again in 2000. In all, Ireland and McElwee showered her with more than $475,000. (Her lawyer, John A. Knorr, said Hafer would have no comment for this article.)
The giving came after Pennsylvania had overhauled – and greatly loosened – the freedom that treasurers had to invest public money.
Until this 1998 change in Pennsylvania law, state treasurers since the Great Depression could put taxpayer money only into fixed-return, short-term instruments. The overhaul permitted more remunerative, if potentially more risky, choices.
With that liberalization, business boomed for Ireland, McElwee, and Valley Forge Asset, which was awarded its first treasury contract by Hafer in 2000.”
There is overt corruption in some places, and bonds now won’t begin to earn enough to meet pension needs, thanks to Bernanke, Yellen. Draghi, et al. But CalPERS and CalSTRS are pretty clean these days, and there are many other public pension funds where the abject fealty to PE is due to capture.