CalPERS’ Fiduciary Counsel, Ashley Dunning, Lies to Board to Defend Private Equity Secrecy and Perpetuate Inadequate Supervision of Staff

A remarkable section of an official training session for CalPERS board encapsulates much of what is wrong with public pension fund governance as well as the excessive deference of public pension funds to private equity. We will discuss how Ashley Dunning, a partner at Nossaman LLP, lied to CalPERS’ board in its most recent fiduciary training in an apparent effort to defend the staff’s ability to control information flows to the board and disempower it. That is not only a chronic problem at CalPERS but widespread across public pension funds. And as this short vignette demonstrates, fiduciary counsels have become critical enablers of weak boards and staffs run amok.

Background: How Fiduciary Counsels Have Been Weaponized to Disempower Boards and Enlarge Staff’s Turf

One of the big reasons for this pathology is that fiduciary counsels nominally represent the board as their client. But this is a fiction, since at most public pension funds, the very same fiduciary counsel is also counsel to staff. This bizarre dual role establishes a pretense that the interests of the board and staff are aligned. In any supervisor/subordinate relationship, there is a conflict of interest. This conflict is even more acute in financial institutions where employees have access to funds. Why do you think, for instance, that regulators require that bank employees take at least one full week off a year? So that if they are up to no good, someone will be stepping into their shoes for long enough to detect if anything is not on the up and up. The premise that employee who handle funds can be given carte blanche is simply not accepted in the financial services industry, which is rife with checks and supervision of the “trust but verify” sort.

Aside from the problem financial firms worry about most, potential embezzlement or other misuse of funds, there are numerous soft conflicts. At an institution like CalPERS, the biggest is that internal staff members in its funds management operations aspire to better-paid jobs in the private sector. That can foster a mind set of wanting to curry favor with counterparties who have financial interests that are in many ways opposed to those of investors like CalPERS, such as in matters like fees and other investment fund terms. Insiders tell me that public pension fund employees often believe that private equity general partners would be willing to give them referrals when they were looking for a job. That is a powerful inducement for favoring their career interest over the interest of their current employer.

The role of a fiduciary counsel would be less problematic if pension fund boards and staff each had their own legal representation. While CalPERS has never had two separate fiduciary advisors with distinct roles, in the past, there was a very clear emphasis on the primacy of the fiduciary counsel’s role representing the board. .1 With the way this dual role operates at CalPERS, it is ludicrous to think that the fiduciary counsel has the board as its primary client in practice. Among other things:

The staff screens candidates for the fiduciary counsel role, interviews them and presents its scoring and de facto recommendation to the board. Staff has its finger very heavily on the dial of fiduciary counsel selection. The proof at CalPERS is that in the selection of its previous fiduciary counsel, staff withheld from the board critically important information, that its pick, Robert Klausner, which the board approved, had been involved in questionable behavior since the late 1990s that had been repeatedly reported in the media, including the New York Times and Forbes, and was currently involved in a potentially criminal scandal in Jacksonville, Florida.

Staff directs the work of the fiduciary counsel, receives its invoices, and pays its bills.

How Ashley Dunning Lied to the CalPERS’ Board

The key segment is short. The key part starts at 36:50 in the video below:

Board Member Margaret Brown: So when I look at this duty of prudence regarding terms, so are we talking about terms of the agreements we sign with general partners in private equity, because I go back to page 5 and you talk about the changing legal landscape. And we are supposed to have increased tolerance, you say for less LP friendly terms, so I assume that means worse terms. And then here, we’re supposed to have a duty of prudence regarding terms, except my understanding is the agreements are secret because they are trade secrets so we don’t get to see the terms a lot of times, that’s my understanding. So I’m just wondering how do we have our fiduciary duty regarding the terms when we don’t see them.

Ashley Dunning, Partner, Nossaman LLP : So there was a lot packed into that question. Let me see if I can address a couple of components of it. The first point is on slide 5 when I say increased tolerance for less LP friendly terms. I’m not suggesting that’s a good thing. What I’m saying it that is a reality I understand exists, particularly in certain asset classes. And I’m basing that on my partners very close to this in terms of the investment side of it, what she’s seeing.

The fiduciary duty applies to the big picture. Is this a prudent investment under all of these circumstances, one component of which is terms, the other, another component is is this a great fund for us to get into, and are we willing to sacrifice on some terms in order to be able to get into the fund? That’s the analysis.

When one says, “We don’t get to see the terms,” we CalPERS see the terms. Those are negotiated, you have delegated some of that authority to your trusted staff, and that is fundamental to that relationship, that those terms be negotiated in a way that your staff can say to you, “We believe these terms are prudent. And here’s why.” And if there are reasons why the document itself is not to be shared more broadly, those may be to protect the value of your investment as well ’cause you won’t get into a particular fund if those terms were specifically provided to the full board.

Notice the position that Dunning is taking: that is it kosher for the staff to withhold fund documents from the board, even though the board is in a fiduciary role and is ultimately responsible for any decision. 2

Dunning falsely pretended she had actual knowledge based on the reading of a partner that she presented as being on the investment side. That amounts to hearsay and is also from a party who has a commercial conflict, since anyone working on limited partnership agreements, even if they are nominally representing investors, are reluctant to upset the private equity apple cart, since representing the general partners or their portfolio companies is vastly more lucrative. The sorry fact is that it is well nigh impossible for someone like CalPERS to get truly independent advice from someone seasoned in the private equity space.

The problem of a business conflict is even more acute at a San Francisco law firm like Nossaman, where any firm with a corporate law practice will have private equity portfolio companies as a large amount of its practice and will be seeking to cultivate good relationships with private equity general partners to get even more business with them. Serving CalPERS is pocket change compared to the private-equity related opportunities.

More troublingly, Dunning presented the utterly bogus idea that some funds would insist as a condition of investing in the fund that the board of the institution considering an investment commitment not be allowed to see the offering or contract documents.

No competent investor would allow that. The most sought after investors, such as prestigious endowments like Yale, as well as heavyweight fund of funds like JP Morgan, would never tolerate such a requirement and therefore it never happens. At a large number of very important investors, the boards are integrally involved in making decisions on private equity investments. Moreover, unlike CalPERS, many institutional investors have professional investors on their boards who would never accept not being allowed to see the key documents describing an investment. Generally, investors have “most favored nation” clauses which would entitle them all to the same privileges, so it’s not even feasible to say, “Your board can see the documents but that other board can’t.” Either Dunning fabricated this idea on the fly to get herself out of a corner or she parroting false information given to her by staff.

Moreover, Dunning also sells the urban legend that there is such a thing as being able to pick a “great fund” ex ante. There are such things as “hot funds” that investors think will perform well. However, even with private equity academics being overwhelmingly captured by the industry due to the fact that they can earn vastly more in consulting fees from them than they can from their day jobs, recent studies have demolished the myth that private equity investors can pick funds that will outperform. In fact, the approach that did work back in the 1990s, of trying to pick the “top quartile” funds that did well on their most recent fund, produces results worse than just using a dartboard. Top quartile funds are slightly more likely to underperform on their next fund than a random pick.

Dunning provides additional misinformation with the notion that CalPERS staff negotiates private equity terms. As CalPERS’ own staff ‘fessed up in its 2015 private equity workshop, limited partners like CalPERS do not negotiate private equity terms in any meaningful sense. For instance, fees are set by the general partner and at most vary by the amount of fund commitment. Limited partners have little say over vast swathes of critical language, such as indemnification, the de facto waiver of fiduciary duty, and clawbacks. To the extent there are negotiations, they focus on a few terms, like “key man” provisions, which almost never comes into play. This ritual keeps private equity staffers employed and perpetuates the myth that these documents are negotiated, as opposed to almost entirely “take it or leave it.”

It is also noteworthy that when board member Brown focused on it, Dunning didn’t retreat from her statement that investors were seeing less favorable terms. The financial press has repeatedly pointed out that this is the result of investor desperation for returns as a result of many years of super low interest rates. Most articles also describe the market as frothy and the tight terms being a cyclical phenomenon. It is curious, to say the least, to see a nominal advocate for the board not present a more balanced picture.

Finally, Dunning also subtly reinforces the notion that the board has to be utterly passive if it “trusts” staff. This is nonsense. No one who is competent delegates authority fully; that sort of thing occurs only in with impaired or extremely unsophisticated principals, the cliched widows and orphans. Dunning’s position is even more reckless for an institution which has a former CEO now in Federal prison for literally taking cash in a paper bag from a private equity placement agent.

Yet Dunning acts as if the board, which is supposed to be in the ultimate “buck stops here” role, must kow-tow to staff if it has delegated a duty to them as opposed to do what bosses do with subordinates, monitor how they are doing on an ongoing basis, and that is more than just an annual review.

This incident is yet another manifestation of the culture of casual lying at CalPERS. The time is long overdue that it stop. It enables poor decisions, inadequate risk controls, and in this instance, undue deference to private equity firms when academic studies have shown that investors can attain similar and even higher net returns through public market investment strategies. A $300 billion pot of money with inadequate supervision is a prescription for disaster. CalPERS’ flagging performance bears that risk out. But there appear to be way too many people who profit from poor governance for that to change any time soon.


1 We say only “less problematic” because private equity firms are the single largest customer for law firms in the US. It is very difficult to find truly independent representation because law firms have such powerful economic incentives not to cross swords with them.

2 It is unfortunate that new board member Margaret Brown repeated the private equity industry myth that private equity fund documents have anything in them that even remotely approaches trade secret status, a notion we have debunked repeatedly based on having published and examined many limited partnership agreements and having spoken to insiders who have read other agreements and confirmed that there is nothing particularly distinctive about any they have seen. However, Dunning didn’t pick up on that as the basis of her argument.

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  1. The Rev Kev

    “Dunning…presented the utterly bogus idea that some funds would insist as a condition of investing in the fund that the board not be allowed to see the documents. ”

    Wait, wouldn’t the board be held legally responsible for any legal problems that cropped up in investing in a fund that may prove not to be kosher? Delegation, like she talks about in the video, does mean giving over some responsibility but there is still an over-watch component function left in place. How could this blow up for the board? Well..

    What if the fund invested in had documents showing that they also had investments in mobs like Al-Quada Investments, the North Korean Rocketry Fund, the Colombian Chemical Importation Fund Facility, etc. This is not so far a stretch. Remember how several years ago it was found that Wachovia Bank had laundered hundreds of millions of dollars for Mexican drug lords along with American Express Bank International and Western Union? Is this how it happened for them?

    People that agree to this sort of deal should be given blank pieces of paper with a request to put the date and their signature at the bottom of it.

    1. Richard Matta

      I have represented public and private plans for 30 years and have NEVER heard it suggested that a plan’s board should not review fund documents. I would immediately advise the board that they should not invest. End of story.

      1. Yves Smith Post author

        Look at Ashley Dunning’s video above. The evidence speaks for itself and yet you act as if nothing of the kind ever happens? How can I take anything else you have to say on this topic seriously?

        Board member Brown makes clear that the norm at CalPERS for the board to be denied access to fund terms, which is even more restrictive than not being allowed to see fund documents. Dunning not only does not take issue with that practice, she offers a factually-challenged defense.

        Dunning is fiduciary counsel to many public pension funds and is a highly regarded lawyer. Her example alone calls your assertion into question.

        CalPERS’ immediate predecessor in that role, Robert Klausner, who similarly has many public pension fund clients all over the US and something of a reputation, also supported CalPERS’ staff in forbidding staff members from reviewing fund documents, and only under duress was one allowed to see specific documents, on a single deal that was already done, in a room with staff present where he was only allowed to take “limited notes” and was specifically told they were not to be on fund terms and conditions. He said that since that was all those documents contained, what exactly was he allowed to do?

        As you surely must know, limited partnership agreements are so complex that it takes even securities lawyers who have never seen that sort of agreement two full days to go over them. The idea that someone could even begin to make what could be called a review under these constraints is absurd.

        1. Richard Matta

          One statement by one individual regarding one retirement fund – even if it is CALPERS – isn’t evidence of a systemic problem. Yes, if fund managers or staff members deny board members the opportunity to review fund terms, that is a clear fiduciary problem. On the other hand, with scores or even hundreds of investments being made, many with hundreds of pages of documents, not every board member is likely to have the time – or the expertise – to review and approve all negotiated terms. Fiduciary law allows board members prudently to delegate their responsibilities to those with more expertise, provided that they exercise appropriate diligence. Most boards are briefed on key business terms, usually on legal and operational due diligence items only when they materially deviate from the norm. Some of our clients have us prepare summaries of all key terms – and any issues we have with them – before making investments. And more than once they have refused to make investments based on our presentations.

          I’m not suggesting that you are right or wrong about Dunning or Klausner, I have no knowledge of those circumstances. But you are wrong in suggesting that this is normal practice.

          1. Yves Smith Post author

            Based on your behavior here, it appears it is habit for you to distort what other parties are saying to protect your meal ticket.

            You first claimed board members were never denied the opportunity to review investment agreements, denying the unambiguous evidence in the post. And contrary to your misrepresentation, this is not “one statement by one person.” This is a standard practice at CalPERS that both Dunning and before her, Klausner defended, and is confirmed by the fact that even a board member who persisted was allowed only highly restricted access to the documents from a single transaction that had closed years before! CalPERS does not allow board members to see fund investment documents on pending private equity transactions, period.

            The issue is denial of access to documents by staff to board members who want to see them. Your argument about some board members not wanting to review them is irrelevant.

            And contrary to your claim, CalPERS is not the only place where this occurs. It is also a long-standing practice at Kentucky Retirement Systems, which you ought to know because former board member Chris Tobe has made an issue of that. So your strident statement earlier that this sort of thing never happens is false.

            Having been caught out, you then attempt to smear me by asserting I said this sort of thing was common. I never said anything approaching that. The post clearly states the opposite:

            More troublingly, Dunning presented the utterly bogus idea that some funds would insist as a condition of investing in the fund that the board of the institution considering an investment commitment not be allowed to see the offering or contract documents.

            No competent investor would allow that. The most sought after investors, such as prestigious endowments like Yale, as well as heavyweight fund of funds like JP Morgan, would never tolerate such a requirement and therefore it never happens. At a large number of very important investors, the boards are integrally involved in making decisions on private equity investments. Moreover, unlike CalPERS, many institutional investors have professional investors on their boards who would never accept not being allowed to see the key documents describing an investment.

            Your persistent efforts to discredit me strongly suggests you and your partner regard well warranted criticism of fiduciary counsels as a personal threat. This reminds me of a scene from the science fiction classic Dune:

            “My son displays a general garment and you claim it’s cut to your fit?” Jessica asked. “What a fascinating revelation.”

  2. Lambert Strether

    Brown asks a good question:

    So I’m just wondering how do we have our fiduciary duty regarding the terms when we don’t see them.

    I sure hate that trendy “BOOM!” locution on the Twitter, but BOOM!

    1. Jim Haygood

      ’cause you won’t get into a particular fund if those terms were specifically provided to the full board

      Calpers — partying like 1720:

      “A company for carrying on an undertaking of great advantage, but nobody to know what it is.” — proposed South Sea Bubble IPO

      This way to the egress! :-)

  3. Paul P

    Don’t the big pension funds meet and develop a common position on charges and fees? With all the money they have to invest, they would be able to dictate the terms–one would think.

    Where are the unions? Their members should be storming the Board en masse.

    Every book on how to invest explains you can’t pick which fund manager is going to have a good year. Paying an attorney to educate the Board and then having that attorney telling an obvious falsehood …

    Until those getting ripped off make a stink, the charade will continue.

    1. Yves Smith Post author

      Believe it or not, the pension funds believe that if they were to work together, it would be an anti-trust violation. On top of that, most public pension funds have so bought into the private equity pitch that their returns are terrific, so don’t think about all those fees and abuses (which in many cases are flat out embezzlement, as in taking money to which they are not entitled) that they are unwilling to rock the boat. This misguided loyalty has not wavered despite heads of top PE funds saying for nearly two years that returns in the future will be lower, investors not getting returns high enough to justify the risk over the last ten years, and having options they refuse to explore (taking more PE in house, public market replication).

      I don’t understand why the unions don’t understand that by investing in private equity, they are paying for the rope being used to hang them. Private equity funds seek to break unions and slash the benefits for the ones they can’t kill, which makes it much harder for public pensions funds to defend their existence. They also work hard to reduce headcount, which hurts municipal and state tax bases and again hurts public sector unions. Many top private equity players are big Republican donors and hostile to unions.

  4. Rich

    How does the following excerpt add to the discussion when the statement warrants the same criticism Dunning deserves?
    “No competent investor would allow that. The most sought after investors, such as prestigious endowments like Yale, as well as heavyweight fund of funds like JP Morgan, would never tolerate such a requirement and therefore it never happens.”
    Actors like Mike Silva and Timmy Geithner with their historical performance at the NY Fed would appear to have birthed the likes of Dunning and her behavior. Government as the omnipresent teacher so-to-speak. It’s not like we’re working on 30+ years of historical abuse of private/public pension programs since the inception of the PBGC.
    I guess I’d suggest sprinting in the other direction when the terms “competent”, “most sought after”, “prestigious”, “Yale”, “heavyweight”, “JP Morgan”, “never tolerate”, and “never happens” are strung together in consecutive sentences.

    1. Yves Smith Post author

      We are talking about competence as investors. If you were up to speed in this area, you would know that Yale has had stellar investment returns for many years. To pooh pooh that demonstrates that you don’t know this terrain at all.

      And it appears not to have occurred to you that general partners do want certain marquee investors in their funds, and Yale and JP Morgan are among them. CalPERS when it was seen as a highly competent investor (back in the 1990s) would also have been on that sort of list.

      It also appears not to occur to you that Geithner was hired at Warburg Pincus not to run money but for his value as a door opener, meaning in raising money.

      Better trolls, please.

  5. diptherio

    Occam’s Razor would seem to indicate, at least to me, that a large portion of the staff and board at CalPERS are involved in outright corruption. They know perfectly well what they’re doing and that they’re spouting a bunch of nonsense, but they think they’re going to be able to get away with it, or they’re too scared to stop. Maybe I’m wrong and it really is just that CalPERS is filled to bursting with incompetents, but that seems…unlikely.

    It’s obvious, to me anyway, that the rot at CalPERS extended far beyond Mr. Buenrostro, and was not excised from the organization with his removal. Watching the body language of the staff in the videos of meetings has me convinced that the staff knows full well they’re involved in a whole lot of shadiness. This video is a case in point.

    And this whole attitude, and way of talking about PE, as if it’s all just waaaay over everybody’s widdle heads, is just so insulting. They talk about GPs and those super-special funds in tones of awe. The implication seems to be that PE is so complex and so lucrative that none of us mere mortals could ever understand it and shouldn’t even try to but just be glad we’re being allowed to hand our money over…or California state employees’ money, whatever. And these are supposedly serious professionals who occupy positions of social status and power. Gee, I wonder why our country is so messed up?

    And last but not lease, right on Margaret! Not wasting anytime on calling out the absurdity, I see. Nice work!

    1. Tom Stone

      Don’t worry, Attorney General Becerra will be all over this as soon as he’s done dealing with more important matters!

    2. RUKidding

      I agree with you, diptherio. From Yves excellent reporting on CalPers – great work!! – it’s always seemed to me that there has to be a level complicitness amongst the CalPers Board members making these decisions. I’m certainly NOT in a position to figure out most of this stuff, but it just seems to me that these Board members are getting some sort of kick back or something to continue induling these skeevy practices.

      Also agree: go Margaret!! Keep up the good work. Hope you can make a difference.

  6. diptherio

    Think I may have caught a typo:

    For instance, fees are set by the limited partner and at most vary by the amount of fund commitment.

    Shouldn’t that be “general partner” instead of “limited partner”?

  7. RUKidding

    Thanks, Yves. Excellent investigative journalism, as always. Very heartened to see Margaret Brown standing her ground and asking the difficult questions.

    Keep it up. Much appreciated, as a current CalPers investor and future annuitant.

  8. Paul Harvey 0swald

    This passage piqued my curiosity:

    To the extent there are negotiations, they focus on a few terms, like “key man” provisions, which almost never comes into play. This ritual keeps private equity staffers employed and perpetuates the myth that these documents are negotiated, as opposed to almost entirely “take it or leave it.”

    Um, then what does the CalPERS staff potentially need BlackRock’s help with, again?

    There is a gap in the logic. I’m in flyover country, so I don’t have a dog in this fight – just enjoying the show. Thanks, Yves, for staying on this. Time to refill the popcorn bowl.

    1. Richard Matta

      We have numerous provisions that we seek to negotiate for every private investment deal. Many of them we insist on even if we’ve never had them kick in – like exit strategies. Key man provisions are low on the legal list – but sometimes high on the staff’s list because they consider quality of management to be important. And yes, they DO come into play.

      1. Yves Smith Post author

        Straw manning, which is violation of our written site Policies. I said “almost never”.

        You are also tag-teaming with Mr. Lanoff below, who for the benefit of other readers, is your partner at Groom Law Group, which is another violation of our Policies. You are rapidly accumulating troll points and are on a path to being blacklisted on this site. We blacklist based on behavior, not content, which is why you should read our Policies before commenting again.

        Please give me specific examples, naming particular funds, when management fee payments have been suspended or lowered or limited partners have been able to force a reorganization as the result of a key man event. There was some concern they would come into play at Alchemy Partners in 2009 but that appears not to have occurred. I am highly confident that the number of actual cases you will be able to cite will confirm my statement.

        Finally, your “seek to negotiate” is rich. I am very familiar with how very little the GPs allow the LPs to negotiate, starting with sending them black lined copies (if they are previous investors in funds with the same fund manager) showing them the language that has changed since the last deal. The GP’s position is that the LPs accepted all of the language last time, that that isn’t going to be reopened since they accepted it before. To pretend that the limited partners engage in meaningful negotiation of the limited partnership agreement is a misrepresentation. You know better and implying otherwise further undermines your credibility.

        1. Richard Matta

          Ian and I have not coordinated or even discussed our comments. I was unaware that he had even commented before I posted my first comment. No offense to Ian, but he isn’t much of a computer user, so I was surprised when I woke up this morning to see a note from him mentioning it..

          I suggested that we negotiate terms even if WE have never seen them kick in. For example, many “non-plan assets fund” managers say they will use commercially reasonable efforts to comply with ERISA if they ever cross the 25% threshold. They always insist it will never happen, and we always insist that “commercially reasonable” is not reasonable – they either WILL fully comply or they will immediately allow our client to withdraw. I’ve never represented a plan that had to trigger the provision – but I have on two separate occasions represented managers who were forced to comply with ERISA.

          Sorry, I can’t violate client confidences by providing specific examples, but we see key man provisions triggered once or twice a year. Sometimes nothing happens after staff review – and usually this is a staff decision – but in my experience they do advise the board of their conclusions.

          1. Yves Smith Post author

            First, this is yet more bad faith argumentation and more violations of our written site Policies. You are again straw manning what I said.

            Your stating that you seek to negotiate selected language like a “commercially reasonable” standard or not does not come close to disproving what I stated, that the limited partnership agreements are almost entirely “take it or leave it” contracts.

            You may not be aware of the fact that we’ve published the full text of limited partnership agreements of many of the biggest GPs, such as Blackstone, Carlyle, KKR, and TPG. It is obvious to anyone who reads them that they are extraordinarily one-sided agreements, so the proof that they are largely not negotiated is in the pudding. CalPERS legal department, in a 2015 workshop, similarly described how little it was able to negotiate. The lawyer to one of the two richest men in the US, who has a heavyweight securities law background and has negotiated many merger agreements, said after reading his first LPA: “People actually sign these?”

            Second, as to the key man language, I told you what the standard was as to whether the language was used by the LPs to protect their rights: “when management fee payments have been suspended or lowered or limited partners have been able to force a reorganization as the result of a key man event.” That would be a public event. Instead, you chose to apply a vastly lower standard and use that to give a answer that could not be verified. Aside from the case I mentioned, the only other example I am aware that comes close to satisfying my criteria is when Leonard Green died in 2005. Even then, although my understanding is that there was some GP and LP arguing, the LPs did not use their powers. My assessment of “almost never” thus still stands.

            As to Paul’s original question, the only reason I can fathom for CalPERS wanting to outsource PE is to accommodate the incompetence of its CIO, Ted Eliopoulos. He does not have an investment background yet is still collecting CIO pay when he has handed off all investment responsibilities and has turned it into purely an administrative role. Eliopoulos just lost his chief operating investment officer Wylie Tollette and is probably feeling even more out of his depth. CalPERS also hates transparency and has been repeatedly embarrassed about its staff either being unable to answer basic questions about PE or telling lame lies to try to blow board members off. So giving PE to an outsourcer means no more disclosure.

  9. Ian Lanoff

    What is your basis for making broad negative comments about public plan fiduciary counsels.I have been one for several plans since the early 80’s and don’t accept the characterization contained in this article.I don’t disagree that staff oftentimes does their best to interfere with the relationship between counsel and the board but in my experience board members don’t allow that to happen.

    1. Yves Smith Post author

      Mr. Lanoff,

      Thanks for giving me the opportunity to address this point long form, which I did not do so as not to make the post overly long. I have been writing about public pension funds for nearly six years, and previously started up and ran the M&A department for the second biggest bank in the world, and have had private equity firms, several Forbes 400 members, and hedge funds as clients.

      I have discussed all these issues in previous posts with substantial documentation, so none of the observations below should be controversial. Please see this post for an overview: How Experts Enable Corruption: The Role of Conflicted Lawyers at CalPERS and Other Public Pension Funds

      I must tell you that your self-assessment is unduly rosy if any of the pension plans you represent invest in private equity. The ongoing breaches of fiduciary duty there alone call into question the job fiduciary counsels are doing.

      1. One of the bedrock requirements of a fiduciary is to evaluate the costs of an investment against the potential benefits. This is not being done on a widespread basis in private equity. The industry benchmarker, CEM Consulting, issued a major report in 2014 stating that over half the expenses in private equity were not being captured, and the few funds that were diligent about trying to obtain better cost data were still not able to do a complete job. If anything, the CEM report understated how bad the situation is since many fees and expenses charged to portfolio companies are hidden (ie, CEM has no way of knowing what it does not know) plus the CEM report didn’t include the fact that many public pension funds do not capture the carry fees they pay (CalPERS didn’t until it was the object of unfavorable press in 2016).

      2. Private equity valuations are not accurate. Pension funds have shockingly allowed a practice in private equity that they tolerate no where else: that of the funds making their own valuation of their illiquid assets (the portfolio companies) rather than having a third party valuation. The conventional argument is that it would cost too much to do that. But how can you justify investing as a fiduciary in an illiquid. long-term investment on a “trust me” basis as a fiduciary? It is telling that there has never been any call for reasonable investor protections, like periodic or random independent audits.

      This practice is even more troubling in light of the fact that there is considerable evidence that private equity firms do in fact overstate the value of their portfolio companies. Academic studies have found that the do so around the time they are raising new funds, about 4 years after their most recent fund. This happens early enough in the life of the fund so as to distort the overall IRRs and give an industry-wide picture that the returns are higher than they really are.

      Similarly, it is also well known and widely acknowledged by CIOs that private equity firms also considerably overstate the value of their assets during bad equity markets. In any other field of investing, this would be considered to be a fraud and investors would shun that type of iinvestment. Yet CIOs have spoken openly about “fake” valuations and perversely regard them as a plus because it masks how badly their fund is doing in bad equity markets!

      The fact that to my knowledge no fiduciary counsel has said a peep about a widely known abuse speaks volumes about the caliber of the job they are doing. If you can cite any examples to the contrary, I would report on it.

      3. Private equity limited partnership agreements contain indemnification and/or conflict of interest language that amounts to a de facto or even explicit waiver of fiduciary duty. Yet overwhelmingly, public pension fund staffs and fiduciary counsels fail even to acknowledge how this practice is deeply problematic and may constitute a breach of fiduciary duty. In private equity, the public pension fund is a limited partner and has no control over how the funds managed by the private equity general partner are deployed. The combination of investment discretion, inability to exit the funds (save by selling in the secondary market at a discount) and the refusal of the fund manager to act as a fiduciary should be unacceptable for any party that has a fiduciary duty.

      4. The SEC has fined many of the largest, supposedly best run private equity fund manager for abuses that in any other line of work would be called embezzlement, as in taking monies to which they were not entitled. The SEC singled out particular funds for particular sanctions but that most of these bad practices are widespread, in that the funds have acknowledged them in their form ADV filings with the SEC. Note that confessing to an abuse or even saying that the fund manager is ceasing the practice does not constitute a remedy. Yet FOIAs have found that virtually no public pension funds have even asked private equity fund manager about these abuses, let alone tell them to cut it our and/or make restitution.

      5. In 2015, thirteen trustees of some of the biggest public pension funds in the US, a group of state Treasures plus the New York City Comptroller, wrote the SEC that they needed the agency’s help to get more information about private equity fees and their help in curbing abuses. That is a de facto admission that they are unable to do an adequate job of evaluating and negotiating private equity investments and managing the ongoing relationship, that they cannot operate properly as accredited investors and need the sort of help the SEC provides on behalf of retail investors. But the SEC did not and would never respond to their plea. If the biggest public pension funds have admitted that they are unable to perform critical elements of their duty due to being outmatched by private equity firms, it seems very unlikely that any investors you represent are doing a better job.

      Outside private equity, there are other practices that appear to be widely if not universally endorsed by fiduciary counsels that are highly questionable and appear designed to give staff more power relative to the board. One is the indefensible idea of “co fiduciary duty” which is used to shut down board members who disagree with the position the majority of the board is taking. Yet any objective reading of the underlying law shows that trustees are jointly and severally liable, and that co-trustees have an affirmative duty to prevent co-trustees from making a breach of trust or compel them to correct an ongoing breach of trust.

      In addition, as we also discussed at some length in the context of a newly-flied case against the trustees of Kentucky Retirement Systems and other parties. board members are likely to be violating their fiduciary duty if they are using return assumptions that are high in light of their actuary’s recommendation or their investment performance (the funds often use a discount rate based on what they argue is an attainable return level, which in many cases is too high in light of our now-decade long experience of super low interest rates, and that grim picture is compounded by the fact that any meaningful increase in interest rates would significantly lower the prices of financial assets, resulting in even lower funding levels). The breach of fiduciary duty here is that the use of overly optimistic return assumptions is of direct harm to beneficiaries by allowing employers to make unduly low ongoing contributions to the pension plan. As we will discuss soon, probably in a post tomorrow, CalPERS’ Ashley Dunning has effectively confirmed that this is an area of exposure…even though CalPERS has been engaging in this practice for years.

      If you are free of guilt on all these fronts, then I congratulate you. But to issue a blanket defense of your peers in the face of failings listed above quite frankly suggests willful ignorance. As Upton Sinclair noted, “It is difficult to get a man to understand something if his salary depends on his not understanding it.”

      1. Richard Matta

        You seem to be grossly misinformed as to public plans in general and ERISA plans in particular. We advise our public plan clients to follow an ERISA standard, which in fact is what most state laws require. As lawyers we are not qualified to evaluate valuations, but we do advise our clients to carefully consider things like indemnification provisions – that is one of the highest items on our legal due diligence checklists. Exit strategies are also high on the list – in fact, I am speaking on that subject at the NAPPA meeting next month.

        1. Yves Smith Post author

          You are straw manning my comment yet again, which is bad faith argumentation and suggests you cannot make a case if you dealt with what I actually said, as opposed to your distortion of it. As noted earlier, this is another instance of you having violated our written site Policies.

          In addition, despite your claims of expertise, it appears you are either not as knowledgeable as you assert about what happens in practice or are choosing to misrepresent it. All one has to do is read the limited partnership agreement of virtually any private equity fund to see that it contains sweeping indemnification provisions, as well as language regarding conflict of interest that amount to a waiver of fiduciary duty.

          At a minimum, since your firm’s clients nevertheless regularly enter into private equity agreements in which your clients are passive and have given funds on a long-term basis and yet effectively waived their own fiduciary duty by not having imposed that obligation of their fund manager, it would appear that you and your peers among fiduciary counsels have done an inadequate job of impressing the importance of obtaining adequate protection in these areas.

          As for valuation, I never suggested fiduciary counsels made valuations or that lawyers did valuations. This is absurd and a gross distortion for you to imply that.

          What I did indicate was that in every other type of investment made by third party managers, fiduciaries require as part of their fiduciary duty that the fund manager provide an independent valuation of the assets managed on behalf of the fiduciary, typically monthly. Even getting those independent valuations late is considered to be a huge red flag.

          You cannot possibly be as familiar with typical practices as you claim to be, yet not know that private equity firms, who as I have indicated above already have received a de facto waiver of fiduciary duty, are astonishingly allowed to make their own valuations. Worse, it is well known that they routinely overstate valuations at predictable times for their own commercial benefit and to the detriment of accurate measurement of fund performance and risks. So why are firms like yours averting your gaze from these dubious practices?

          Many funds have significant enough stakes in private equity that it is possible that their CAFRS are also including private equity valuations that are overstated to a sufficient degree as to render the reports misleading.

          And I trust you are aware of the fact that Kentucky Retirement Systems’ fiduciary counsel and trustees are being sued, along with other parties, over the alleged inadequacy of its fiduciary training, so this is now becoming a more closely watched issue in the past. The same suit also targets the trustees and other parties involved in the preparation of the fund’s financial reports for presenting an inaccurate picture of risks and potential future performance.


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