CalPERS, CalSTRS, Other Investors Have Indemnified Private Equity Criminal Conduct Even Though Fiduciary Counsels Say No

We have pointed out that supposedly sophisticated investors like CalPERS sign private equity limited partnership agreements that include broad indemnifications which we’ve argued are unsuitable for any fiduciary. Thanks to the astute questioning of CalPERS board member JJ Jelincic, two major fiduciary lawyers have confirmed that view.

Jelincic focused on the most rancid part of some already-dodgy indemnification provisions: that they indemnify the fund manager, also called the general partner, against certain types of criminal conduct. Our trove of 26 limited partnership agreements is a small subset of thousands. Nevertheless, CalPERS is an investor in nine of those funds, and eight of that nine grant indemnification against criminal acts.1 We’ve already written about one, Apollo’s most recent flagship fund, Apollo VIII. While these clauses have some qualifiers, there’s reason to be skeptical about how much relief they provide in practice.

Yet both finalists in the recent CalPERS board interviews for fiduciary counsel, Nossaman, LLP and Seyfarth Shaw, said that investors like CalPERS should not give this sort of indemnification.

And that raises another troubling issue: what exactly are these fiduciary counsels doing? Either they never read their clients’ private equity limited partnership agreements or they fail to understand what they say. Neither conclusion is pretty.

As we’ll discuss below, this revelation has serious implications for all private equity investors who are fiduciaries, such as public and private pension fund staff and board members.


Indemnification is a contractual obligation by one party to an agreement to pay or reimburse another for certain fees, costs, losses, liabilities, or damages. It’s perverse to see public pension funds, which fetishize making sure all their other investment managers act as fiduciaries, allow private equity managers to slip that leash so readily and fully.

Why should passive investors give such broad protection against a general partner’s bad actions when they have no ability to oversee, much the less constrain its behavior? And on top of that, other sections of limited partnership agreements waive the general partner’s fiduciary duty. One common means of doing that is to provide that the general partner may consider interests other than that of the investors in his fund, including his own interest.

CalPERS’ Fiduciary Counsel Finalists Reject Providing Indemnification for Criminal Acts

Below is video of the board interviews of fiduciary counsel candidates. The first firm interviewed was Nossaman, LLP, with Ashely Dunning, who at the time was CalPERS’ interim fiduciary counsel, and Yulia Oral. Jelincic poses his question at 43:50 below and at this link:

Board Member JJ Jelincic: Do you think it’s appropriate to pledge trust fund assets to indemnify a vendor against allegations of criminal behavior; and if so, why; and if not, why not?

Ashley Dunning: To indemnify a vendor?

Jelincic: Yes.

Dunning: I always recommend against indemnifying vendors.

Yulia Orvol: If I can answer that from an investment perspective. Your investment contracts, whether it’s separate account, investment management agreement, or a limited partnership agreement, or side letter, whatever the nature of the contract is or the vehicle that you’re investing in, or however you hire the manager or third-party service provider, there should always be an inclusion for indemnification for criminal activity, fraud, gross negligence. And, in some cases, it’s appropriate for breach of contract.

Seyfarth Shaw’s team was Alan Cabral, Kathleen Cahill-Slaugh, and Javier Plasencia. If anything, they were more definitive than Nossaman. Jelincic pops his question at 31:10 below and at this link:

Board Member Jelincic: Do you believe it’s appropriate to pledge trust fund assets to indemnify vendors from allegations of criminal behavior; and if so, why, and, if not, why not?

Alan Cabral: My response to that would be no. It’s not appropriate. And why not? Vendors have their own insurance. Vendors are looking to do business with pension funds. I think their incentive to do business with pension funds, their own insurance, those things should be covered by the vendors. But I think – now has it happened? It has happened, but I think my position would be to avoid that to whatever extent possible.

Law professor Bill Black also weighed in:

Pension funds should never indemnify vendors against criminal liability. Officers and directors who approved such an indemnification would breach their fiduciary duty to the fund. Indeed, pension funds should not indemnify vendors for the vendors’ own negligence.

In response to CalPERS Board Member Jelincic’s questions, both candidates for the position of fiduciary duty counsel to CalPERS’ board of directors gave the same advice. The problem is that funds that these candidates advise have been indemnifying vendors – even for some crimes committed by the vendors’ staff.

There are two possible explanations for this contradiction. Either both candidates failed to ensure that their clients did not breach their fiduciary duties by indemnifying the vendors even from criminal acts or they do not actually advise their clients not to indemnify vendors. In either event the candidates for fiduciary counsel for CalPERS have failed to ensure that their existing clients meet their fiduciary duties.

How Bad Are These Criminal Indemnifications?

We can make some inferences about criminal indemnifications from the nine private equity funds in which CalPERS has invested where we have the limited partnership agreements. Despite this being a tiny subset of the universe of deals done, five funds contain problematic criminal indemnification language: Apollo VIII, Blackstone V and VI, Carlyle V, and Oak Hill III. Three others, KKR 2006 and New Mountain II and III, also have criminal indemnification provisions that are only slightly more restrained, and we question how much difference that restraint makes in practice. The fact that the largest eight of nine funds under review, including four of the biggest private equity fund managers, have language of this sort suggests that the practice is widespread.2

Perversely, CalPERS has higher permissible exposure limits for Apollo, Blackstone and Carlyle, fund managers with the most aggressive criminal indemnification language (on page 6, Appendix 3, see note B-2).

The criminal indemnification in Apollo’s agreement is so troubling that we called it out in a 2016 post. It is also easier to parse than the others. From section 6.7 on page 62:

To the fullest extent permitted by applicable law, the Partnership shall indemnify each Indemnified Person against all losses, claims, damages or liabilities, whether or not matured or unmatured or whether or not asserted or brought due to contractual or other restrictions (including legal or other expenses reasonably incurred in investigating or defending against any such loss, claim, damage or liability)…In addition, indemnification shall be permitted with respect to a criminal Proceeding only if the Indemnified Person did not have reasonable cause to believe that its conduct was unlawful.

In other words, the new “dog ate my homework” is “I didn’t understand what my lawyer told me.”

But in reality, criminal allegations are unlikely to get far enough to trigger the intent question because savvy lawyers know how hard it is to prove. The plaintiff may nevertheless have leverage because digging into criminal allegations will expose a lot of the defendant’s dirty laundry. So these cases are almost without exception settled. And the way the Apollo section reads, investors like CalPERS are on the hook for defending against criminal claims.

This issue isn’t theoretical. As we discussed earlier, it appeared likely that this section would be invoked in the Caesars bankruptcy, in which Apollo and TPG were sued in bankruptcy court for fraudulent conveyance, which is legalese for continuing to loot a company after it is clear that it will go belly up. As former bankruptcy practitioner Ed Walker pointed out:

Note that the General Partner is in a position to settle the case…and that will mean no issue of intent will arise, and the damages become subject to indemnification, or at least a lawsuit will be required by a group of investors who have already proven themselves mostly incompetent and who will have already lost a bunch of money.

In a private equity fund, this kind of transfer is anticipated. The whole point is to screw the acquired company for the benefit of the managers and perhaps a few dollars to the investors. This creates a risk of bankruptcy for the acquired company, and the risk that the transfers from the acquired company to the private equity fund will be deemed to be fraudulent conveyances under the Bankruptcy Code. There are many cases where creditors have accused the managers of fraudulent conveyances, and many have been won by the creditors either in full or by settlement. This is a known risk, and one that the managers of the private equity fund should be required to avoid. They aren’t getting paid to destroy acquired companies, but to operate them at a profit.p and they should not expose themselves to losing litigation. Destructive transfers primarily benefit the managers, not the investors. Therefore the investors should not indemnify the managers, and in fact should not bear any of the costs or expenses of defense or investigation. with regard to any claim of a fraudulent conveyance.

Even though the relevant text for Blackstone, Carlyle, and Oak Hill is denser, the carveout is substantively the same: “had no reasonable basis to believe” or “had no reasonable cause to believe”.

Let’s look at how this might work out in practice. A hypothetical example of a criminal act where Apollo would be entitled to indemnification:

An Apollo partner makes an inspection visit to a portfolio company facility in California. While there, he encounters a 15 year-old girl who is present because she is a customer of the facility. The Apollo partner and the girl have consensual sex and are caught in the act. The partner is charged pursuant to California Penal Code 261.5(d), the state’s statutory rape law. The prosecutor, as the law permits, decides to pursue misdemeanor, rather than felony, statutory rape charges against the partner. The partner argues that the girl told him that she was 18 and most people would agree that she looks to be at least 18. However, the prosecutor points out to the judge that California’s statutory rape law is based on “strict liability,” meaning it only matters what the victim’s age actually is, not what the party having sex with the victim believed it to be. The partner is therefore convicted.

Even worse, as far as investors doing their job is concerned, it is the general partner who decides whether or not to charge legal and settlement expenses back to the fund. Many general partners provide little to no detail of the expenses they charge back to the fund; even ones that do are pretty much guaranteed not to itemize their legal expenditures. So unless they found out about the case and asked the general partner whether they’d been charged for the costs, they’ve be almost certain to be in the dark if they were charged for the defense of a case like this.

Moreover, even if the investors did find out they’d paid for a criminal defense and they objected, their only recourse would be to sue. Given how cowed limited partners are, how likely to you think that is to happen? And that’s before you get to the fact that the cost of the litigation would eat up any recovery.

How Often Have CalPERS and Other Public Pension Funds Given Criminal Indemnifications?

The short answer is we don’t know given the success of the private equity industry in wrapping its activities in a shroud of secrecy. However, even in our small set of examples, we can easily find other prominent investors who have agreed to these indefensible terms, apparently without getting the advice of their fiduciary counsel.

We looked at which of Nossaman’s other public pension fund practice clients are investors in the five funds with the most problematic indemnification language. Since we only had a “Representative Clients” list from which to work, this tally is probably incomplete:

Apollo VIII

Colorado Public Employees’ Retirement Association
Los Angeles City Employees’ Retirement System
Los Angeles Fire and Police Pension System
San Francisco Employees’ Retirement System
State Teachers’ Retirement System of Ohio

Blackstone V

Los Angeles Fire and Police Pension System
San Francisco Employees’ Retirement System
State Teachers’ Retirement System of Ohio

Blackstone VI

Colorado Public Employees’ Retirement Association
Los Angeles City Employees’ Retirement System
Los Angeles County Employees’ Retirement Association
Los Angeles Fire and Police Pension System
Massachusetts Pension Reserves Investment Management Board
San Diego County Employees Retirement System
San Francisco Employees’ Retirement System
State Teachers’ Retirement System of Ohio

Carlyle V

Los Angeles City Employees’ Retirement System
Los Angeles County Employees’ Retirement Association
State Teachers’ Retirement System of Ohio

Oak Hill III

Employees’ Retirement System of the State of Hawaii
Los Angeles Fire and Police Pension System
San Francisco Employees’ Retirement System

We have other limited partnership agreements for funds in which CalPERS has invested which also contain criminal indemnification language. However, the language is a bit more restrained but there is an open question as to how it would operate in practice. KKR 2006 excludes indemnification for “Malfeasance,” a defined term. That definition includes all criminal acts. Similarly, both New Mountain II and III, exclude indemnification for criminal acts that “have a material negative impact on the fund.” But even though that might appear to limit investors’ exposure, as we describe above, these cases are almost without exception settled, and thus never reach the concluding point of being a criminal act. That would appear to allow, consistent with Jelincic’s line of questioning, for the firms to be indemnified for criminal allegations, since the cost of defense would be charged to the fund (and that’s before you get to the fact that many general partners are less than fully transparent about the expenses they deduct from fund distributions, so the limited partners may not be able to see if the general partners have interpreted these clauses in an overly aggressive manner.

Why Are Fiduciary Counsels the Dogs That Don’t Bark?

This example reveals that public pensions fund use of fiduciary counsels is mere compliance theater, designed to create a liability shield for pension fund staff and boards. Either these lawyers have not been asked to review limited partnership agreements, they did review them but did so in only a cursory manner, missing many of their troubling terms or they saw but did not object forcefully to the indefensibly broad indemnification language. Which is more probable?

Our guess is that the fiduciary counsels are enabling a “Don’t ask, don’t’ tell” culture. Pension fund staffs have bought into the belief that they need private equity to meet targeted returns, and are loath to make demands. The general partners have cultivated the urban legend that if limited partners are difficult, they won’t be allowed into future funds. Thus even though private equity is far and away the riskiest public pension fund investment, it appears that fiduciary counsels have been kept from giving them legal scrutiny. Law professor Bill Black shares that view:

Any practice of funds indemnifying vendors cannot simply be a failure of fiduciary counsel. The officers running the fund have to be the initial source of the breach of fiduciary duty to the fund. The fund’s officers must be willing to waste fund assets in reimbursing the vendors’ officers for liability imposed on them due to their misconduct. CalPERS has been beset for many years by senior officials who have breached their fiduciary duties in order to benefit vendors at the fund’s expense. CalPERS needs outstanding directors and fiduciary counsel with a track record of success to root out this corrupt culture. Board Member Jelincic has done CalPERS’ pensioners a great service through his research on actual indemnification clauses and his questions to the fiduciary counsel candidates.

In theory, the board is the fiduciary counsel’s primary client. Yet Ashley Dunning, the winning candidate, made clear who she really reports to. At she stated (see 36:24 in the first embedded video, or at this link):

In a healthy environment, typically I would interact through the general counsel and the CEO, and as needed, the board president and chair of each committee.

As an attorney and CalPERS beneficiary translated: “In other words, ‘I will be working for Matt Jacobs.'”

And it also appears that CalPERS’ staff has been ducking Jelincic’s questions about indemnification for some time. In the Investment Committee meeting in April 2016, JJ Jelincic asked about the Caesars’ bankruptcy and whether CalPERS had indemnified Apollo (see starting at 17:40 here). Chief Investment Officer says he won’t answer Jelincic “in this forum” presumably because the content of limited partnership agreements is allegedly a state secret Jelincic points out that another Apollo limited partnership agreement is public, and that it does indemnify against criminal conduct, and asks if Apollo VI, the fund that invested in Caesars, has the same language. Eliopoulos demurs, twice saying he hasn’t reviewed that section (at 19:05 and 19:30).

Bear in mind that Eliopoulos is an attorney. This question is not above his pay grade.

Board member Richard Costigan, who is also a lawyer, follows up and asks for the board to be briefed in closed session (meaning in private) on private equity indemnification, particularly with respect to litigation, “sooner rather than later”.

The fact that Jelincic had to ask fiduciary counsel candidates about the very same issue in public suggests that this board briefing never took place.

The reason CalPERS’ staff can get away with this sort of insubordination, as well as the casual lying that we’ve repeatedly documented, is that the board has chosen repeatedly to cede power to staff. The board drew all the wrong lessons from the CalPERS’ pay to play scandal, which was due to a former board member bribing a current CEO. The most severe governance breakdown was at the staff level, yet the perverse outcome was for the board to tolerate a power grab under newly elevated CEO Anne Stausboll, who had been Chief Operating Investment Officer at at the time.

CalPERS’ board foolishly gave up its ability to ride herd on staff by reducing its number of direct reports from four to one, the CEO. Before, the chief investment officer, general counsel, and chief actuary also reported to the board. Do you think the CIO Eliopoulos and the general counsel Matt Jacobs would brush off board requests, and in Jacobs’ case, lie to them so often, if they were able to fire them?

The board still has the capacity to change the power dynamic by calling out staff when they try to deflect questions or blow off board requests. The fiduciary counsel interviews showed the board can perform at a much higher level than it routinely does. The questions were well thought out and direct. In particular, Richard Costigan, in the interview of Seyfarth Shaw, refused to let Alan Cabral try twice to duck the simple question, “Do you believe in the California rule?” More of that and the board would be vastly more effective and held in higher regard by CalPERS members.

1 While CalPERS may have side letters excluding it from this liability, it seems unlikely given the only known instances are investors where indenmification is limited is by statute, such as in Florida, where the total dollar amount that Florida government investors may agree to indemnify is capped under state law.

2 The remaining fund, Essex Woodlands Health Ventures Fund VII, provides for exculpation, but not indemnification, of criminal conduct.

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  1. Tom Stone

    The Fiduciary Counsels who are PK with indemnifying funds for criminal acts might also be willing participants in a corrupt system. CAlifornia is a ome partystate and it is to my knowledge as corrupt as Cook County Illinois.

    1. Yves Smith Post author

      California regularly scores in corruption surveys as one of the least corrupt states in the US. Public Integrity scores California as second least corrupt, but even then, its grade was C-. However, the state does score badly on number of public officials that have been convicted. CalPERS has contributed to that result! But this isn’t adjusted for size of population, so it seems badly flawed. It should official convictions per capita. And of all parties. FiveThirtyEight didn’t bother making the obvious adjustment to the measurement.

      And it’s inaccurate to single out California public pension funds as operating any differently that other pension funds, public or private.

      For instance, Apollo VIII had close to 80 investors. Pension funds all over the US have fiduciary counsels and invest in private equity funds. Here is the list of pension investors in Apollo VIII, all of whom are fiduciaries:

      1199SEIU National Benefit Fund
      Aegon Companies Pension Plan
      American Electric Power System Retirement Plan
      American Federation of Musicians and Employers’ Pension Plan
      Anne Arundel County Retirement and Pension System
      Arizona State Retirement System
      British Columbia Investment Management Corporation
      California Public Employees’ Retirement System (CalPERS)
      Colorado Public Employees’ Retirement Association
      CPP Investment Board
      Directors Guild of America – Producer Pension and Health Plans
      Dominion Resources Pension Fund
      Dow Chemical Company Pension Fund
      DTE Energy Company Master VEBA Trust
      Eli Lilly & Company Pension Plan
      Emerson Electric Company Retirement Master Trust
      Essex County Council Pension Fund
      Fort Worth Employees’ Retirement Fund
      General Electric Pension Trust
      Houston Police Officers’ Pension System
      Kaiser Permanente Pension Plan
      Kansas Public Employees’ Retirement System
      Laborers’ International Union of North America Staff & Affiliates Pension Fund
      Los Angeles City Employees’ Retirement System
      Los Angeles Fire and Police Pension System
      Los Angeles Water & Power Employees’ Retirement Plan
      Louisiana State Employees’ Retirement System
      Maryland State Retirement and Pension System
      Masco Corporation Retirement Master Trust
      National Elevator Industry Pension Plan
      National Grid Pension Plan
      New Mexico Educational Retirement Board
      New York City Board of Education Retirement System
      New York City Employees’ Retirement System
      New York City Fire Department Pension Fund
      New York City Police Pension Fund
      New York State Common Retirement Fund
      NextEra Energy Employee Pension Plan
      Oklahoma Law Enforcement Retirement System
      Oklahoma Police Pension and Retirement System
      Pennsylvania Public School Employees’ Retirement System
      Public Employee Retirement System of Idaho
      Retirement Plan of Carilion Clinic
      San Antonio Fire and Police Pension Fund
      San Francisco Employees’ Retirement System
      Santa Barbara County Employees’ Retirement System
      Shell Retirement Fund (US)
      South Yorkshire Pensions Authority
      State of Connecticut Retirement Plans and Trust Funds
      State of Wisconsin Investment Board
      State Teachers’ Retirement System of Ohio
      Teacher Retirement System of Texas
      Teachers’ Retirement System of Louisiana
      Teachers’ Retirement System of the City of New York
      Teachers’ Retirement System of the State of Illinois
      Textron Pension Fund
      United Food & Commercial Workers International Union – Industry Pension Fund
      United Launch Alliance Master Pension Trust
      Virginia Retirement System

  2. Sluggeaux

    Excellent piece! These pension boards were designed to oversee funds making “safe” investments in stocks and bonds. The sort of opaque, risky, investments that they’ve had to seek in order to make historic return targets are simply a license to steal — literally, as you’ve shown repeatedly. The legal advice that these boards are getting, that so long as they consult and follow “experts” they’ve met their fiduciary obligations, is nothing but a circular firing squad.

    1. flora

      +1. Thanks to NC for continued reporting. Are board members indemnified for misfeasance? (rhetorical question.)

  3. RUKidding

    Thanks, as always, for your detailed investigation and reporting on the ongoing travesty with CalPERs. I agree with you comments, above, Yves, that CA is definitely NOT akin to Cook County, IL. It is better than that, but clearly there is always room for improvement.

    Keep the heat on CalPers. It has wrought some good, but as always, I look at the CalPers Board members and think: Cui bono? What kind of payola are they getting? A question that needs to be asked over and over.

    I am a current contributer to CalPers and will eventually be a CalPers annuitant. I want to see MY money invested wisely. All CA citizens deserve that as well.

  4. Scrooge McDuck

    First, my sincerest admiration to Mr. Jelincic for continuing to ask intelligent questions despite facing incredible resistance and antagonism from his staff and fellow board members. I’m not sure that I’d have his stamina were I in his shoes. Second, Yves reporting continues to shine light into some of the darkest corners of our economy/society… great work! You would think that the SEC enforcement actions against some PE firms, and hundreds more PE firms that the SEC will not pursue due to lack of staff and political will, would have been enough to put LPs on high alert, but nothing. Many LPs remain as clueless as ever. I imagine that some even go to bed feeling like they finally understand PE shenanigans and they’ve finally rained in all the sleaze bags… poor fools.

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