One of the benefits of seeing the battle over private equity transparency legislation in California play out is that it makes clear who is carrying water for the industry. Today’s example is CalPERS board member Bill Slaton. As we’ll show, Slaton sided with staff and the private equity industry to seek another amendment to the bill, AB 2833. His amendment strengthens CalPERS and the private equity industry’s hand in more easily circumventing legislation that the industry could already evade.
At CalPERS’ June board meeting, staff gave an update on AB 2833. Recall that this legislation was sponsored by Treasurer John Chiang, who sits on the boards of the giant public pension funds CalPERS and CalSTRS. Last fall, Chiang promised a bill that would achieve wide-ranging disclosure, including, critically, of related party transactions, which the media and SEC have identified as a major area of abuse.
The initial version of the bill largely filled its stated aims. However, amendments, including ones sought by CalPERS, gutted the bill. We identified three major shortcomings. Based on one defect alone, former CalPERS board member and private equity executive turned reformer Michael Flaherman, who provided some of the language in the original version, has switched from being a supporter to an opponent.
In its briefing, CalPERS’ lobbyist mentioned that it had not gotten one amendment that it had sought, which was to have the bill have what amounts to a “fiduciary out,” that California public pension funds can ignore the bill if it conflicts with their fiduciary duties. A discerning reader might wonder, how could a bill intended to have pension funds know the true cost of investing in private equity possibly interfere with that? In fact, a large body of case law has found that fiduciaries are required to weigh the costs of an investment, as well as its returns and risk. That means that fiduciaries investing in private equity have universally breached their fiduciary duty by not knowing all the fees and costs. AB 2833, as originally drafted, would have enabled them to remedy that long-standing failing.
So how is what seems like an apple pie and motherhood statement in fact a huge gimmie to the private equity industry? The sleight of hand hinges on buying into the belief that private equity is an essential investment for public pension funds, and that if the private equity funds are made to disclose their various fees (which has also reveled what amounts to embezzlement, as the SEC has pointed out), some might refuse to let CalPERS invest with them.
We’ll put aside the obvious question, “Why should you be willing to make a long-term investment with someone who refused to make a full accounting of what they’ve done with your money?”
The idea that private equity funds might refuse to deal with investors if forced to make more disclosures is a carefully cultivated urban legend. It rests on a widely misrepresented response when CalPERS, as a result of a 2002 settlement with the San Jose Mercury News, started publishing quarterly return data for all the private equity funds in its portfolio. Two fund managers, Sequoia and Kleiner Perkins, huffily said they’d never do business with anyone that published their returns.
Why is that less meaningful than it sounds? It was only public pension funds that might be required to emulate CalPERS’ move. Sequoia and Kleiner Perkins are venture capitalists. While that technically makes them private equity funds, the fact is even the large venture capital funds are too small for a large majority of public pension funds to invest in them. It’s also an open secret in the industry that the reason for Sequoia wanting to hide its results was that it had India and China funds that had done badly and didn’t want that exposed.
Industry stalwarts might nevertheless contend, “But Sequoia is a top performer! If you did want to invest in Sequoia, you’d have suffered.” That is also inaccurate. It is true that Sequoia’s flagship fund is widely cited as regularly delivering impressive results. However, investors in Sequoia’s flagship fund are required to invest in other Sequoia funds that do not perform as well. The blended return is underwhelming.
With that background, let’t turn to the board meeting. As you can see on the recording of the session, starting at 8:55. CalPERS lobbyist Mary Anne Ashley provides an update on the bill, and said that all of CalPERS’ requested amendments had gotten the bill, except “reference to fiduciary duties and responsibilities.” Since this is cryptic, we must turn to Buyouts Magazine, in a paywalled article by Sam Sutton for details:
….additional disclosure “could result in some managers choosing to forgo California public pension plan partnerships and instead accept commitments from other investors without the same requirements,” CalSTRS staff wrote in an April 12 memo. CalPERS staff noted a similar concern in a May memo.
Chiang’s designee, Grant Boyken, addresses this concern at 11:25:
Grant Boyken, Deputy Treasurer: So right now I think we’ve satisfied all of the, all of the concerns, except the fiduciary language, which, in our view and the Treasurer’s view the fiduciary language stems from the plenary authority and the sole fiduciary responsibility that is authorized under the Constitution, and no statute changes that. So if we leave it out, the Constitutional authority of the system still stays.
Translation: The Treasurer believes this amendment was unnecessary because CalPERS has the authority under the California constitution to give its fiduciary duty priority over the bill if need be.
What transpires next? At 11:53:
Investment Committee Vice Chairman Bill Slaton: Um, while I appreciate the Treasurer’s comments, the fact is we have a lot of issues from time to time that come up where the legislature expresses an intent. And I think it’s important in every time that occurs that affects our ability to either, to make an investment or to decide not to make an investment, that we repeat that authority that we have in the legislation. So I would move that we, we, given the current status, and I appreciate the other issues have been taken care of, that we change our position to support, if amended, for the fiduciary language.
Note that Slaton does not deny Boyken’s point, that CalPERS has the authority in the Constitution to override the bill on fiduciary grounds if need be. Particular acts of legislation do not supercede that. Instead, effectively, he objects to the legislature having expressed a preference and he wants to stomp on that.
Why is Slaton proposing a measure that is clearly unnecessary, and per our discussion above, isn’t a plus as far as meeting CalPERS’ fiduciary duty is concerned, were it properly conceived? CalPERS is actively and knowingly violating its fiduciary duty ever time it commits to a private equity fund with the full understanding that many large charges remain hidden. By contrast, the concern that is the basis for Slaton’s amendment is purely theoretical.
To curry favor with staff. Slaton is one of the most aggressive defenders of CalPERS’ staff. But as a board member, he has no duty to staff. His responsibility is to the fund’s beneficiaries, and indirectly, to California taxpayers
To make clear that CalPERS and he are branded as staunch private equity backers. And perhaps, more specifically, to telegraph that CalPERS is all on board with ignoring the bill. Slaton’s amendment makes obvious what may not have been clear to private equity general partners thus far: all they have to do is send a note to the Chief Investment Officer of any California public pension fund, and say something along the lines of, “We’re not letting you invest in any future funds if you require us to comply with AB 2833.” The CIO sends back a missive excusing them and everyone is back to status quo ante.
Lynn Paquin, California Controller Betty Yee’s designee, seconded the motions. Ron Lind said he would vote against it. Priya Mather asked some questions, which included this one at 14:33:
Board Member Priya Mathur: And if I could just ask a question also of our general counsel about the fiduciary language question. I know that there’s been back and forth about what exactly the language would look like, and that the Treasurer’s office has drafted some language that refers to the, to Cal, to the Board’s plenary authority, and whether that is sufficient to cover the fiduciary duty question in your mind.
General Counsel Matthew Jacobs: Yes. Good afternoon. On balance, I would prefer to have the fiduciary language be explicitly in the bill. And I think Mr. Slaton makes a good point about the importance of the legislature recognizing every time that it wants to or potentially clip our wings that we’ve got something in there that acknowledges that.
Having said that, I agree with Mr. Boyken’s analysis that, in fact, since we do have an overarching constitutional duty to proceed in a fiduciarily, fiduciary, forget it.
Mathur: Fiduciarily responsible way?
Jacobs: Thank you, that that would hold sway if this ever conflicted with that constitutional duty.
See what happened here. Jacob concedes that the Treasurer’s legal analysis is correct, which means there is no need for this amendment. Yet he presses the argument that the legislature needs to be put in its place, basically just for the hell of it.
And notice there’s been no discussion whatsoever as to whether this fiduciary issue claim has any merit. Jacobs appears not to have given an iota of thought as to whether the benefits of understanding the full costs, which over time will help public pension funds curb abuse and push back against unjustifiable fees, as well as curing CalPERS ongoing breach of fiduciary duty in not know its private equity fees and costs, and whether those benefits outweigh the theoretical risk of being excluded from private equity funds by managers who feel the need to preserve their right to cheat.
The vote was 5 to 5, and chairman Henry Jones broke the tie by voting in favor of gutting the bill.
So once again, we see CalPERS’ board acceding to staff, not questioning the exaggerated claims made for private equity, and brushing aside its fiduciary duties rather than risk ruffling the feathers of the industry. Mind you, this legislation came about after Chiang, along with a group of state Treasures plus the New York state and city comptrollers, wrote the SEC seeking help in getting more disclosure of private equity fees. Apparently recognizing that the SEC is not positioned to act on behalf of supposedly sophisticated accredited investors like public pension funds, Chiang pursued forcing transparency on the state level, only to have captured public pension funds like CalPERS and CalSTRS act as the general partners’ stooges.
With such lax oversight, it should come as no surprise that the giant pension fund is exhibiting basic operational failures, such as problems with record-keeping that we’v seen first hand, and more recently, clinging to private equity as its potential savior from ZIRP and QE when it failed to deliver last year and private equity chieftans have warned that lower returns are coming. The inmates are running the asylum and getting more careless over time.