Why CalPERS Private Equity Outsourcing Beauty Show Is Arbitrary and Capricious

Readers may recall that CalPERS is in the process of trying to implement an astonishingly risky and retrograde move that will cost its beneficiaries, and ultimately California taxpayers dearly, with no reason to expect any improvement in performance.

The giant public pension fund, contrary to a vague preview it gave at a board offsite last July, is moving rapidly to outsource a large part, and potentially all, of its private equity program. This flies in the face of what every other major investor in private equity is doing, which is to do more in house, both to reduce fees directly and over time, to gain more leverage over private equity general partners who reap a mind-numbing 7% on average per year of the funds managed.

One of the most eye-popping aspects of this outsourcing scheme has been the way staff members have been caught out in a remarkable number of underhanded moves, raising the question of how many more improprieties have yet to come to light. A partial list:

The board has learned of far too many important developments via the press rather than by having been briefed. This amounts to trying to foist a fait accompli upon them.

Two of five of the panelists presented to CalPERS’ board last July as giving independent advice were in fact interested parties.

Even though the board was supposedly being briefed only on possible business models, with a further update to take place in six months, in fact staff, without having appraised the board, was rushing ahead. A mere six weeks later, Bloomberg broke the story that CalPERS was already in negotiations with BlackRock, whose Mark Wiseman had appeared before the board in July.

CalPERS engaged another panelist falsely depicted as disinterested, Larry Sonsini, apparently to advise CalPERS on venture capital. Yet Sonsini is massively conflicted by virtue of serving every venture capital firm of note via their portfolio company investments. In addition, since when is a lawyer sought out as an expert on increasing investment returns or business strategy?

CalPERS put out a so-called “request for information” soliciting interest for its massive private equity outsourcing scheme. But CalPERS is clearly not acting to protect its own interest, which raises the question of who the fund is helping out in such a costly way and why.

– CalPERS sent out the invitations on December 21 and required responses by January 19. As anyone will business experience will tell you, no one who wants to have a competitive process launches it over the Christmas/New Year holiday. This alone is a big red flag that something isn’t right

– CalPERS allowed only a small number of firms it invited to submit responses, ruling out some qualified parties

– CalPERS threw it entirely on the outside firms to tell CalPERS what it ought to have. Would you ever allow a used car salesman to pick your car for you?

We’ll focus today on one aspect of the solicitation process that shows how dodgy it is, namely, the arbitrary choice of small number of beauty show participants. As Sam Sutton reported in Buyouts Magazine, six invited firms submitted proposals: AlpInvest Partners, BlackRock, Goldman Sachs, Hamilton Lane, HarbourVest Partners and Neuberger Berman. The very fact that this six, and only this six, were chosen to participate should already raise eyebrows.

First, two of the players, Goldman and AlpInvest, a subsidiary of Carlyle, are affiliated with major private equity general partners. While many mid sized and smaller private equity firms probably wouldn’t care, the biggest private equity firms are all on their way to being diversified money managers, such as Blackstone, KKR, and Apollo. They would likely object to participating in a fund of fund for a major institutional investor (as opposed to captive high net worth individuals) and not let the outsourced CalPERS entity participate in their funds. If anything, that problem is likely to loom even larger for BlackRock. Why should any firm in the high-fee, high-complexity end of the fund management industry give a player on the commodity end of the business a helping hand in the form of letting them see how they operate?

Second, a number of every-bit-as-well-qualified firms with significant private equity fund of funds were excluded, such as JP Morgan, Credit Suisse, Adams Street, Partners Group, and Merrill Lynch.

Third was the de fact admission by CalPERS, in response to a Public Records Act request, that they didn’t have any records showing why some firms were asked to propose and not others. That is a shocking admission in light of the big bucks at stake.

We’ve embedded the request at the end of the post.

Let’s unpack the PRA and pre-rebut some of the responses from CalPERS defenders.

We asked CalPERS to provide the records required under California’s procurement rules when a contract or proposal is put out for bidding only to a limited number of parties. The agency is required to have a file substantiating why it chose to limit the solicitation.

The PRA also had several sections stating that CalPERS needed to respond with particularity if it were to claim an exemption from disclosure.

CalPERS may argue that it is subject only to the Public Employees Retirement Law, which does not include any procurement provisions. Therefore it doesn’t have files describing why it asked some firms to participate and not others because it was not required to do so.

That is quite a stretch, since CalPERS is subject to vast swathes of California statutes in addition to the PERL, such as state personnel laws, the Bagley-Keene Open Meeting Act, and of course, the Public Records Act.

Moreover, CalPERS is a fiduciary. That means it is held to a much higher standard of care under the law than California agencies generally. It would seem to be both reckless as well as a violation of fiduciary duty to fail to comply with well established legal procedures designed to get California taxpayers the best deal for their money and prevent fraud.

Another line of argument by CalPERS might be that the request for information is for an investment decision. Pending investment decisions are allowed to be kept confidential.

However, this argument fails as well.

First, CalPERS has never presented this solicitation as a pending investment. Even though it does not fit into this category tidily, CalPERS has consistently referred to it as a “request for information” internally, to the press, and on the documents proper. The state procurement manual defines a Request for Information as

7.1.2 Request for Information (RFI)

An RFI may also be used to “survey” the marketplace to understand what goods or services may be available and to approximate the dollars that may be needed for a procurement. Buyers shall ensure RFIs are documented and retained as part of the official procurement file for any subsequent resulting solicitation

Second, when asked by the press for information about the solicitation process, CalPERS has never described it as an investment. For instance, when John Gittelson of Bloomberg asked CalPERS for information about the private equity outsourcing bidding, he received this reply, along with the two documents sent to the six candidates that we posted, on January 3, from Joe DeAnda:

Hey John – attached you will find the RFI you asked about. We are unable to give you a list of firms that were asked to respond, and since it is an active solicitation, we won’t be able to comment further about it. I can say generally, though, that this is part of our ongoing review of the private equity program, and we’ll spend a good part of 2018 continuing to explore strategic options.

Notice the way it was described? “Solicitation…part of an ongoing review…strategic options.” None of this is consistent with the idea that CalPERS is evaluating a possible transaction. It’s obvious that CalPERS is at best quite a few steps away from that process beginning, assuming it even gets off the ground.

Finally, if CalPERS had some records showing why it limited its review universe and was nevertheless relying on the idea that, regardless of the excuse it used with Bloomberg, this really was an investment underway and therefore it could withhold the records, sections (b) and (c) of the request required CalPERS to say why it was keeping the records secret. CalPERS didn’t argue that. It said it had no relevant records whatsoever.

Now if CalPERS wants to claim that I didn’t say the right magic words, and by asking for procurement type records when it doesn’t consider this a procurement type process, they are welcome to prove me wrong. I am sure CalPERS would like nothing better than to force me to make a retraction. Send me the records showing why you chose the six firms you picked for the RFI and not any others, when there were other solid candidates, and I’ll retract this post and happily write up how CalPERS went about making its decision.

I’m not holding my breath.

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  1. EoH

    “Continuing to diligently review”. At least CalPERS can point to one example where it is doing something diligently.

  2. Clyde

    As a state agency CalPERS is required to follow procurement practices for RFIs and RFPs. This idea and solicitation appears to be an experiment concocted by Dr Eliopenstein to create life from death…higher returns from lost VC chances. The natives eventually track down and kill the beast. And the Dr?


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