Yesterday, we discussed how fiduciary counsels, whose stated role is to advise pension fund trustees and staff members how to meet their fiduciary duties to beneficiaries, and for public funds, taxpayers, are in fact in the business of shielding boards and fund employees from liability. We showed that by discussing not just the incentives of fiduciary counsels but also their conduct. For instance, they often thwart reformers and dissidents. A striking example was how a so-called “fiduciary auditor,” Funston Advisors, has accepted the role of undermining South Carolina Treasurer Curt Loftis. Loftis not only worked diligently to address indefensibly poor investment performance at the states’s pension fund, but has made it a leader in getting private equity funds to disclose previously hidden fees and costs. Fiduciary counsels also sidestep instructing trustees and staff to be vigilant about conflicts of interest among their advisors.
Today we will discuss how CalPERS is poorly governed, and how its repeated efforts to check its lone vigilant board member, JJ Jelincic, are proof of how the institution puts protecting its image over the interests of its beneficiaries and California taxpayers.
Why Dissent is Essential to Good Governance
In a bit of synchronicity, law professor and former bank regulator Bill Black and the Harvard Business Review have just written about the importance of dissent and robust debate among board directors. From Black’s post:
The Wall Street Journal recently published a summary of a study of “desired director traits.”
A survey of 369 supervisory directors from 12 countries by search and advisory firm Russell Reynolds Associates asked which behaviors they thought are most important to creating a board culture that drives effectiveness and company performance.
The Ideal Director’s Traits
The study found that the five most highly valued traits in a director are, in descending order:
- Willing to constructively challenge management
- Sound business judgment
- Asking the right questions
- Maintaining an independent perspective and avoiding “group think”
The first two traits are essentially the same – courage. Traits three through five are closely related to each other. The fifth has an element of courage as well, the courage to fend off “group think” and the CEO’s views and maintain an “independent perspective.”
And from the Harvard Business Review last week, True Leaders Believe Dissent Is an Obligation. A key section:
Why would executives at so many iconic organizations — Volkswagen, Wells Fargo, FIFA — tolerate behavior so egregious that it threatens the very future of their organizations? How should innovators with a fierce sense of ambition handle the criticisms and objections that inevitably come their way and make sure that confidence does not turn into bombast?
In a world hungry for great leadership, these are just a few of the questions that too many leaders seem incapable of answering. I don’t pretend to have easy answers myself. But I do know that the best leaders I’ve studied — executives and entrepreneurs who have created enduring economic value based on sound human values — recognize and embrace the “obligation to dissent.” Put simply, you can’t be an effective leader in business, politics, or society unless you encourage those around you to speak their minds, to bring attention to hypocrisy and misbehavior, and to be as direct and strong-willed in their evaluations of you as you are in your strategies and plans for them.
Needless to say, vigilance is even more important for public pension funds than private companies. It isn’t just that public pension fund trustees and staff members are fiduciaries. Public pensions are also even more subject to corruption, due to fund managers being wealthy enough to be regular political donors and thus willing and able to try to use donations or other forms of back-scratching to steer pension fund dollars to them when they would otherwise not be chosen. Finally, shareholders of public companies should be diversified and can sell their stakes when they become unhappy with management. Public pension beneficiaries and the taxpayers that backstop them are left holding the bag when fund officials fall down on the job.
Yet as we discussed at length yesterday, fiduciary counsels, and that includes ones briefing CalPERS, have actively opposed the sort of courage and dissent widely recognized as central to good oversight, through a perverse reading of trustee responsibilities branded as “co-fiduciary duty.”
How CalPERS Renounced Good Governance
CalPERS made an even worse transgression than Wells Fargo and has drawn precisely the wrong lessons from that experience. Its 2009 pay to play scandal, which resulted in the imprisonment of its former CEO and the resignation of three board members, sorely dented its reputation and produced disfunction responses. Even worse, CalPERS’ status as the largest public pension fund means it serves as a model for other public pension funds, so its poor choices can have greater repercussions .1
Contrary to the widely held view that good board members are vigilant and will stand up to executives, CalPERS’ board has repeatedly ceded authority to staff, to the degree that board members tolerate, indeed foster staff insubordination. Board members regularly state the gobsmacking notion that they should refrain from burdening staff and not ask for information. Proper oversight of CalPERS’ operations is the board’s paramount duty. It would a career-limiting event in business setting for an employee to tell his boss it was too much work to prepare a report, yet CalPERS’ board members actively promote this backwards view of who is in charge.
Needless to say, unjustifiable board deference to staff is at the root of other symptoms of diseased governance at CalPERS that we have documented, including a culture of casual lying to the board, routine violations of state transparency laws, prioritizing maintaining friction-free relationships with the private equity industry over meeting the clear obligation as fiduciaries to understand the true cost of investing in the strategy.
This devolution is no accident. CalPERS once had healthy, which mean not infrequent, friction between its board and staff. And this cannot be attributed to CalPERS being a high-profile California public pension fund. If you watch the board videos of CalPERS Sacramento sister CalSTRS, the contrast is dramatic: CalSTRS routinely has give and take among board members and between them and staff. Board members also grill experts and do not hesitate to express skepticism.
By contrast. CalPERS’ board has repeatedly ceded control to staff. I’m not sure of the dates of these decisions, but some of them occurred in the wake of the pay-to-play scandal and were clearly orchestrated by the new CEO Anne Stausboll, to take power at the expense of the board. Here are some examples:
Reducing the number of board direct reports from four to one. The board formerly supervised the CEO, the Chief Investment Officer, the Chief Actuary, and the General Counsel. It now oversees only the CEO. This means the board cannot flex its muscle save by threatening to fire the CEO, which is a radical intervention. More subtly, this means that senior staff members see themselves as beholden only to the CEO, and not to the board as well.
Delegating the hiring of outside fund managers to staff. This is very unusual among public pension funds. Sadly, it has also led to the board becoming visibly less able. It has been embarrassing to see how often board members in Investment Committee meetings ask questions or make comments that reveal a lack of basic understanding. If the board was regularly involved in manager selection, its members would be forced to up their game. The resulting erosion of competence makes it difficult for many board members even to execute their now-limited duties on the Investment Committee properly, as witnessed by the fact that they often seemed lost when JJ Jelincic was asking staff not very hard questions.
Allowing staff to divide and conquer the board through extensive and illegal pre-board meeting briefings. CalPERS as a California government agency is required under the Bagley-Keene Open Meeting Act to conduct all but certain well-defined types of board discussions and procedures in public. The state attorney general has stated the Bagley-Keene expressly prohibits using various mechanisms to “develop a collective concurrence as to action to be taken,” including a “hub and spoke” in which a point person communicates with a quorum of board members individually. As we discussed at length in 2015, a board member revealed that staff engages in extensive pre-meeting briefings with board members one-on-one. Not only does this undermine statutory requirements that the public receive the information the board does in making decisions, but it cripples the board as a decision-making body. As we wrote then:
The board has been conditioned to give preference to dealing with staff, each in isolation, rather than working together as a body to develop a common view by extracting and clarifying information from staff and having that information also subjected to examination and correction by the public. The pre-meeting briefings also serve to cement board members’ view of a matter, making it much harder for members of the public to influence the board in open sessions, no matter how erroneous or self-serving the staff’s position is.
Stausboll also appears to have learned a bad lesson from being a protege of former state Treasurer Phil Angelides and union politics: that of giving top priority to loyalty. As CEO, she had the disconcerting habit of lavishly praising staff members for merely doing their jobs. Most CalPERS board ape her, spending far too much time on “atta boys,” which sends the wrong message about their discernment and authority.
How CalPERS Staff and Fiduciary Counsels Stymie Dissent
CalPERS’ board is so weak as to verge on toadying to staff. As a result, any board member who is merely properly inquisitive is a threat to this diseased norm and must be tamped down.
As a result, board members and staff are overtly hostile to and work to undermine the one board member who takes oversight seriously, JJ Jelincic. If you’ve watched CalPERS board meetings, you will see Jelincic is no firebrand. He’s mild mannered and asks entirely sensible questions, particularly regarding fees and costs. And if you look at the videos of meetings of the far better functioning CalSTRS board, you’ll regularly see the sort of inquiries that Jelncic as routine and leading to productive discussion among board members, staff, and outside experts.
However, Jelicic’s simple queries have exposed staff incompetence and lies, such as when the head of private equity, Real Desrochers, repeatedly showed he did not understand that the effect of private equity management fee waivers was not to reduce management fees, but simply to shift some of the payment from CalPERS and other limited partners to the companies purchased with their money, or when Chief Operating Investment Office Wylie Tollette incorrectly said CalPERS could not obtain one of the biggest charges it pays, private equity carry fees. Both of these incidents were major embarrassments to CalPERS.
Jelincic has committed what CalPERS’ staff sees as a cardinal sin: threatening CalPERS’ relationship with private equity firms, since limited partners like CalPERS have internalized the industry party line that if they ruffle the general partners, they will be excluded from funds. As we’ve discussed, since the idea that limited partners can out-do each other in funds picking is a myth, and average industry performance does not produce enough in the way of performance to justify its outsized costs and risks, CalPERS would do much better to pursue minimizing fees and costs than continue to pursue the myth that it can find and get into “better” funds regularly. But a whole industry of consultants exists to dignify that delusion. And no one ever got fired for buying IBM.
Even though Jelincic is already a black sheep on the board, despite being popular among beneficiaries, CalPER’S legal staff and fiduciary counsels have made delegitimating and gagging Jelincic a project, to the point of taking indefensible positions about board member conduct that are clearly aimed only at him.
We recounted how this took place with the tainted fiduciary counsel Robert Klasner who recently resigned under a cloud: that he endorsed two bogus ideas that looked to be pet causes of CalPERS’ legal staff. One was a topsy-turvy reading of fiduciary to claim that Jelincic did not have the right to obtain information denied him by staff through the California Public Records Act. To a person, experts on trust law were appalled that a board member would be denied information by staff. The second occurred when Klausner led a board meeting that one reader described as a “hating on JJ session.” Board members the discussed on a preliminary basis sanctioning board members who spoke to the press on their own. As we discussed long form yesterday, the media is often the only route available to a board member who believes his fellow board members are at risk of breaching their duties, and trust law obligates the “nonpartiicpating” board member to take whatever corrective measures he can.
This morning, CalPERS board members will receive their annual fiduciary training. CalPERS does not appear to have hired a successor to Klausner, but the attorney making the presentation, Ashley Dunning, is presumably a top candidate.
If you look at her slideshow, you can see it taking up some of Robert Klausner’s messages, albeit in more careful packaging. Starting on numbered page 5, it discusses a “duty to consult”. Even though trustees clearly can and should confer with experts, page 8 strikes some sour notes. It tries to say that the board should not act as a rubber stamp, when that is what CalPERS’ board almost without exception does. It also effectively says that CalPERS should not overrule expert advice unless it is “informed by applicable expertise”. So the board has been put in a bind: it can’t reject expert advice based on common sense; it presumably has to find opposed expert views, when getting a second opinion in a public pension fund context is a cumbersome, time-consuming process. In addition, as we discussed at great length yesterday, this presentation, like most advice from fiduciary counsels, ignores the pervasive problem of conflicts of interest.
The presentation also gives lip service to compliance with Bagley-Keene, when we have documented numerous abuses, as well as compliance with other policies, when the board just gave its Chief Investment Officer Ted Eliopoulos a bonus that was $135,000 in excess of what was permitted under his formula.
The section starting on page 67, “Further Considerations for Board Members Who Speak on CalPERS-Related Topics,” is even more troubling. This is the “Jelincic should shut up” part of the talk. Specifically:
It takes an exclusively negative perspective, that a a board member’s speech could only do harm and fails to acknowledge that speech can promote members’ interests.
Alleged harm is framed to some degree in terms of harm to CalPERS, the institution, omitting that the interests of CalPERS as an organization and the interests of members/beneficiaries] diverge in important respects (for instance, CalPERS employees want to increase their pay, which is clearly contrary to the interests of members and beneficiaries.) Some examples of this conflation in the presentation:
“As such, Board members will at all times act in the best interest of CalPERS and its members and beneficiaries…” (page 68)
“The speech reflects on CalPERS and may have negative consequences to CalPERS if not carefully and/or accurately expressed.” (page 71)
The presentation is completely silent regarding the affirmative legal obligation of board members to speak publicly and critically in situations where they believe that the board has acted or allowed others to act in breach of fiduciary duty.
The presentation takes a generally condescending and chastising tone (such as “Consider carefully the method, tone and content of your speech.”on page 71)
We were far from alone in being troubled by these sections of the presentation. Every expert we contacted was disturbed. We would normally have edited their reactions down in the interest of space, but they are articulate and in many cases, the nuances of their reasoning are important, so excerpting them would result in important observations being lost.
From Karl Olson, a First Amendment/media law expert who has twice sued CalPERS successfully over Public Records Act violations:
It is worrisome to see a presentation to CalPERS’ board depict board members speaking to the press solely in negative terms. The media has long been an important mechanism for holding public officials responsible. I would hope that the CalPERS board does not act to deter either board members or whistleblowers from dissenting or reporting concerns about the investment of public money, particularly given CalPERS’ recent pay to play scandal. Any such move would raise serious First Amendment concerns and would undermine accountability and the ability to monitor the spending of public money.
From Alex Arapoglu, a professor of finance at the University of North Carolina’s, Kenan-Flagler School of Business:
The presentation takes a negative view of having board members speak to the media, and this isn’t the first time that I’ve seen attorneys try to tell board members to speak with one voice even though their arguments don’t seem well founded. If this was such a good system, you’d never see members of Congress speaking out individually either. The reason they do is so that voters can see the views they represent and decide which they prefer. If any institution should have its members speaking with one voice, it’s the Fed, and yet you don’t see that at all. We hear a broad range opinion out of the Fed, not just the party line.
From Curt Loftis, the Treasurer of South Carolina and one of the trustees of the state’s pension plan:
Fiduciary education and audits are highly choreographed affairs with staff and the educators/auditors spending significant amounts of time together, forming relationships and managing outcomes while both parties are being paid large sums of money by the benfiicaries. Fiduciary audits have become commonplace at a time when forensic audits have become a rarity though the latter is needed far more than the former.
The duty of a fiduciary sometimes involves the need to speak directly to the beneficiaries and plan sponsors, via the press, without being filtered by staff. Pension plans as self-contained organizations, and their staff, speak to the beneficiaries regularly through press releases, interviews, newsletters, websites and “leaks” that are used to further their corporate needs and not necessarily those of the plan participants. The self-serving nature of their communication is most easily demonstrated by the chest-thumping press releases of good investment news as opposed to the executive session discussion of an investment that goes belly up.
In my case, the retirement system had no intention of illuminating the value-crushing amount of investment fees that reached a high of 1.57% of assets. In fact, most fees were netted out of the corpus of the account so that the apparent amount of fees as reported were much less than the actual total. I broke tradition and went, by speaking with the press, directly to the the plan participants and sponsors. The staff of pension system were not pleased with me and complained bitterly.
When they understood how badly they were being served, participants and sponsors demanded action from the pension staff. As a result of the attention sparked by the media coverage, the fees that had been previously netted are now properly reported and reconciled…and due to that enforced transparency and accountability the fees have dropped to approximately half of the original amounts.
On various other occasions I have gone directly to the plan participants and they have responded warmly and demanded change. The ability to communicate directly with participants is an important tool curbing bad behavior by pensions plans, actions that almost always benefit the pension plan as an organization but harm the interest of the plan participants.
Plan fiduciaries owe the highest duty possible to the plan participants and therefore should not be overly concerned with the sensibilities of a well-paid and self-interested staff.
Fiduciary experts, like most extremely well paid pension consultants, become nervous at the thought of plan fiduciaries looking elsewhere for wisdom, especially if that wisdom comes directly from the participants. In fact, it seems the interest of staff, the pension plan origination, politicians and Wall Street are always carefully tended while the participants are often left to pay for the excesses of the previously mentioned groups.
And from Andrew Silton, formerly the chief investment officer for North Carolina:
Maybe the notion of CalPERS as a “leading institutional investor” was just a myth. However, as North Carolina’s Chief Investment Officer and before that as a money manager, I used to see CalPERS as a source of best practices and innovative investing. CalPERS was a public pension plan that encouraged vigorous and open debate. Admittedly that was some time ago. In the past decade or so CalPERS has become far more enamored of protecting its reputation and image than in serving the interests of its members or taxpayers. I’ve had numerous opportunities to document these instances on my blog, Meditations on Money Management. As an observer of its meetings and as a consumer of its store of online documents, I’ve noticed a shift in the tone emanating from CalPERS.
The materials produced for this year’s fiduciary training are a fine example of what’s gone amiss at CalPERS. A fiduciary should look out for the best interests of a pension plan, its beneficiaries, and in the case of public pension plan, the taxpayers. At various points CalPERS’s training materials try to make this point. However, when the materials attempt to flesh out how board members are supposed to act in specific situations, the training document directs them to be rather docile and subservient. Two sections of presentation are particularly troubling to me because they appear to be aimed at stifling debate, disagreement, and dissent.
In one section, board members are urged to subordinate their views to consultants and experts. While the board should be respectful of and give serious consideration to the views of its experts, they should also feel it is their fiduciary duty to probe experts and have a healthy degree of skepticism about their views. The so-called experts have produced an enormous amount of damage for pension plans, including CalPERS.
n another section of the presentation, board members are warned to temper their public comments lest those remarks damage CalPERS’s reputation. Obviously, board members shouldn’t misstate official policy. However, it is important to the well-being of a pension plan that its board members have fairly broad license to express their views.
As CIO, I served a sole-fiduciary. Obviously, a sole-fiduciary speaks with one voice, and can act more quickly than a group of trustees. Nonetheless, I believe that a public pension plan is better served by a board. Having a group of individuals with different views and perspectives may make the process a bit messier, but it creates greater safeguards for the people who matter: beneficiaries and taxpayers. However, when staff and legal experts attempt to constrain its board members, governance begins to resemble a sole-fiduciary as the individual voices are stifled.
Even though most of the fiduciary training document covers well-trod ground, the fact remains, as the experts above all stated, that it is being used as yet another staff tool to further hobble effective board supervision. With CalPERS’ seriously underfunded and under more and more critical scrutiny, the time is overdue for the board to be far more active and skeptical than it has been for many years.
But staff has done such a good job brainwashing the board and subverting normal, healthy reflexes that the only way to achieve change will be to get fresh blood in and continue to pressure the board members who are elected officials, meaning the Treasurer John Chiang and Controller, Betty Yee. Sadly, it will fall on interested members of the public and the media to do the job that the CalPERS board is so flagrantly neglecting.
1 For instance, when CalPERS decided to exit hedge fund investing at the end of 2014, it sent a shock wave through the fund management industry. By early 2016, it was clear CalPERS had made a sound call, as investors on a widespread basis were cutting back on hedge funds for charing too much while delivering too little in the way of performance.