CalPERS’ Private Equity “Fire, Aim, Ready”: Railroading Board by Screening Candidates Before Scheme Approved; Seeking to be Victimized Again by Silver Lake Partners

On Wednesday, John Gittelsohn of Bloomberg wrote that CalPERS acknowledged that it has been in ongoing discussions with two former partners from the tech-focused private equity firm Silver Lake. Each is a candidate to run one of CalPERS two new private equity schemes, even though the board hasn’t agreed to commit the needed funds. In no functioning organization do you start recruiting before an initiative has been approved, but this speaks again to poor governance and lack of professionalism at CalPERS.

Dan Primack, the influential private equity columnist now at Axios, took a swipe at this CalPERS news Thursday morning. Primack pointed to the fact, as we have, that Silver Lake already took CalPERS for a big, costly ride and that the histories of the two Silver Lake executives don’t look compelling. As we’ll discuss, the picture is even worse than Primack indicates.

A refresher: the centerpiece of CalPERS’ “highly questionable plans,” as Primack put it, is creating two new large fims, each of which would invest roughly $10 billion of CalPERS monies. One would focus on “core economy,” whatever that means, and hold investments for a very long time, which is a prescription for valuation fraud and which, CalPERS now admits, is expected to generate lower returns than traditional, shorter holding periods. The other would invest in yet another fad, “late stage venture capital,” with focuses on life sciences and clean energy.

CalPERS has admitted these vehicles won’t be accountable to CalPERS; CalPERS won’t even appoint its toothless advisory board. CalPERS has also ‘fessed up that these funds may, which means will, raise money from other investors. At that point, CalPERS will have succeeded in re-creating the traditional private equity fund structure that it originally set out to escape with the initiative, only at much greater risk by making super-large commitments to start-ups with no track record and by making concentrated investments.

CalPERS’ “Fire, Aim, Ready” is a too-obvious effort to muscle the board. CalPERS staff is operating in an astonishingly high-handed and incompetent manner. The only rationale for trying to recruit candidates before staff has finalized the private equity scheme and the board has approved it is to strong-arm the board, by trying to argue that these great picks won’t wait much longer. It also serves to condition board to see the venture as a given by getting them to focus on implementation issues and divert their attention and energy from fundamental “Why are we doing this at all?” questions.

CalPERS’ staff is simply trying to get these schemes across the finish line rather than making sure they get done well. The way to get the most candidates for any sort of hiring process is to be public about the opportunity and invite proposals. This is particularly true if the role is attractive and the best candidates are currently employed. In this instance, there was definitely no public solicitation.

CalPERS almost certainly approached only the personal contacts of its executives and key advisers, particularly the uber-conflicted Silicon Valley lawyer Larry Sonsini, who has an extensive paper trail of business dealings with Silver Lake. The fact that CalPERS has kept its private equity staff frozen out of this process means this effort has to have been superficial since the CalPERS PE staff possesses most of the organization’s connections to the industry.

When CalPERS has repeatedly emphasized the importance of attracting “talent,” why would it so flagrantly undermine that objective via a severely constrained search process? The only plausible answer, as former board member JJ Jelincic intimated in his What’s the Payoff? article, is that staff is pushing this scheme so hard to advance their personal aims, as opposed to those of beneficiaries.

CalPERS yet again wants to enrich its victimizers. CalPERS acts like the battered girlfriend who keeps going back to the tattooed bikers who beat her.1 Remember that CalPERS took a highly embarrassing and visible hit via investing at BlackRock’s instigation in the Stuyvesant Town deal, in which the giant pension fund lost over $500 million. Moreover, that investment was made by senior management, over the objection of the apartment portfolio manager.

Yet despite BlackRock doing squat to make that up to CalPERS, CalPERS was falling all over itself to hand a large chunk of its private equity business to BlackRock, via a “what could they be thinking” fund of funds scheme which was guaranteed to increase costs and lower returns.

As we described in an earlier post, Silver Lake managed to do BlackRock one better, delivering big losses to CalPERS on what should have been a sure-fire deal. BlackRock’s StuyTown deal, like any real estate investment, could always lose money. By contrast, CalPERS took a stake not in a Silver Lake fund or deal but a 9.9% interest in the firm itself. Investing in an established private equity general partner ought to be as close as you can get to a guaranteed win: only vanishingly small odds of loss with handsome potential upside. Recall that, as Eileen Appelbaum and Rosemary Batt pointed out in their landmark book Private Equity at Work, over 60% of the income that private equity firms earn is from fees that the firm collects regardless of how it performs, like management and monitoring fees.

But Silver Lake got CalPERS to remove a critical investor protection, an anti-dilution provision, from the draft contract. No competent investor should have agreed to that. And Silver Lake then massively diluted CalPERS, effectively stealing the money CalPERS had invested. Nice work if you can get it.

One of the two candidates mentioned in the Bloomberg article, David Roux, was a co-founder of Silver Lake and a longtime member of the firm’s senior management. So neither CalPERS nor he can pretend he had nothing to do with screwing CalPERS this loss.

These candidates aren’t such hot picks. CalPERS cooperated with the Bloomberg story, to the extent of having a senior staffer sit for an interview. CalPERS must have thought showcasing these supposedly hot-shot names would improve the not-very-good image of its private equity plans. As Primack’s hot take shows, that was a bad assumption. A fancy brand is no guarantee of fitness to task.

One prospect, as mentioned, is David Roux, a co-founder and recent CEO of Silver Lake who is now a “senior director.” Bizarrely, CalPERS is considering him to head the “core economy” buy and hold-too-long strategy, even though Roux’s entire professional career has been in and around tech. The consideration of Roux makes a mockery of CalPERS’ claim that it wants “deep expertise” in these roles. At best, it’s like taking a formerly great basketball player and trying to turn him into a golf pro. It means that Roux’s reflexes and his Rolodex are largely irrelevant to what CalPERS wants him to do.2

But even that assumes that Roux has kept his contacts active. Despite keeping a formal role with Silver Lake, it’s not clear what if anything Roux is doing for the firm. Roux lives in Virginia, when Silver Lake’s only East Coast office is in New York. It’s not uncommon for private equity firm founders to stay in the saddle well past normal retirement age; KKR’s Henry Kravis is 74; David Bonderman of TPG is 76; Steve Schwarzman of Blackstone is 71. Roux is a comparatively youthful 61. His distance from the firm suggests he doesn’t have the passion for deal-making that other successful firm founders had, raising questions as to his motives and view of his role with the CalPERS vehicle.

The red flags with the other Silver Lake candidate, Adam Grosser, are even more apparent. Roux is at least has unquestioned expertise, even if he is being asked to operate outside that realm. Adam Grosser is now a former partner of Silver Lake because Silver Lake is exiting the strategy with which Grosser was involved, that of “Kraftwerk,” which the website describes as “providing growth capital to technology and tech-enabled businesses driving efficiency across the operations, energy, and resources industries.”

To put it bluntly, Silver Lake would not be jettisoning this approach if it had been a success. And Silver Lake apparently didn’t think enough of Grosser to deploy him elsewhere in the firm. Note that Grosser came to Silver Lake in 2011 from Foundation Capital, where he had also been a partner. Partners in private equity firms seldom leave other than to start their own firms. Grosser’s exit from Foundation suggests either his deals didn’t do well or he had serious disputes with his former partners. The question of why Grosser left Foundation and what his track record was there bears investigating, particularly in light of presumed weak results at Silver Lake.

Are these really CalPERS deals or Larry Sonsini’s deals? As we indicated, it’s hard to fathom how CalPERS can possibly come out ahead by investing in risky new funds in a massive way. CalPERS claim that it needs these vehicles to invest “at scale” are barmy, since even bigger private investors aren’t going this route. Indeed, CalPERS is responsible for any difficulties it is having in private equity investing, first by having reduced its number of private equity managers, which its private equity consultant Meketa deemed to have been a bad idea. As noted above, CalPERS has also had no head of private equity for months, and the very real possibility that CalPERS would cut the size of its private equity staff would hurt morale and lead the best employees to leave. Thus CalPERS whinging about how hard it is to put all that money to work sounds an awful lot like a kid who has shot his parents asking for sympathy for being an orphan.

However, it sure looks like Friends of Larry are being positioned to do well. David Roux is a very long-standing buddy. For instance, when Sonsini was implicated in several options backdating scandals as a board member as well as the Hewlett Packard illegal wiretapping affair, it was Roux in 2006 who sang Sonsini’s praises for a full four paragraphs at the top of a Fortune article. And as we’ve pointed out, the rising tide of CalPERS funds going to Silicon Valley would raise a quite a few boats, some of which are sure to be Sonsini’s. We quoted Bill Lerach, the disbarred but still formidable one-time plaintiff’s attorney in our New York Magazine article on CalPERS. Recall that Lerach has tangled with Sonsini and is now a consultant on the pathbreaking fiduciary duty lawsuit against KKR, Blackstone, and PAAMCO over over-hyped and underperforming hedge fund investments by the Kentucky state pension system. His words bear repeating:

Are you kidding me? That guy’s not a fox in the henhouse. He’s an alpha wolf, whose law firm has been involved in more dubious financial companies and their practices and transactions in Silicon Valley than any other firm. Of course he’ll be great for his financial clients while he works inside CalPERS to direct billions of dollars to them. Will someone please call the cops?

Unfortunately, the only parties that might prevent this train wreck are the press and beneficiaries getting the attention of key politicians, first and foremost the state Controller and Treasurer, who sit on the CalPERS board, new governor Gavin Newsom, who I am told already has some insiders warning hime that he needs to get on top of the mess at CalPERS, and state legislators, particularly members of the Senate and Assembly pension committees. It’s hard to protect CalPERS from its own terrible reflexes, but the costs of not intervening are sure to be very high.

_____

1 And we don’t see the usual inducement of great sex, which again raises the question of what the inducement is.

2 Roux’s experience as senior partner at a firm could arguably be very helpful but this firm would have vastly fewer employees than Silver Lake and would thus not need as much in the way of “adults in the room” to keep everyone playing nicely together. Roux would also likely be very good in raising new money, something which is of no value to CalPERS.

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17 comments

  1. vlade

    It’s good to see that others are picking up CalPERS debacles – I just hope that some more generic outfits than BBG/WSJ etc. start picking it up. Maybe then some pols finally start paying attention to what at best is total incompetence, and worse gross corruption and knowing dereliction of fiducary duties.

    Incidentally, who would have standing to sue CalPERS on breach of fiducary duties? I understand that ultimately it would be the pensioners (and likely Cal taxpayers) who would pay out anything, but it may be better to do that now than leak billions over time.

    Just the discover process would be real fun here…

    Reply
    1. Anonymal

      I’m not confident that Gov. Newsom will do anything. He didn’t exactly do anything to stop blatant corruption and malfeasance in San Francisco. He sure is effective at enriching himself and his friends, though. Seems he may exacerbate the CalPERS issue.

      Reply
      1. Yves Smith Post author

        I agree that normally he’d not at all the sort to Do Something, but if he understands that CalPERS is likely to blow up on his watch, he may recognize that if he doesn’t get in front of this, the consequences for him will be worse.

        Reply
  2. The Rev Kev

    Well it didn’t take CalPERS long to get back into the news. What are we, day four now of the new year? I pity the new Governer – Gavin Newsom – for the ticking time bomb that Jerry Brown has left behind for him. Newsom’s Wikipedia entry indicates a lot of progressive policies with a lot of business sense as well which sounds hopeful. I hope that those insiders are really pushing the warnings about the mess at CalPERS to him. If these two dog’s breakfasts of entities are launched, sooner or later they will blow up and we are talking about $20 billion worth of people’s pensions here. Californian taxpayers will be on the hook to make up any losses incurred which will make for a lot of unhappy voters.
    If they go ahead, it will be under his watch which means that it will be his political responsibility to deal with it and accept any blame. The trouble with a financial scandal is that big ones always have a political angle and this one will be a beut. Whether we wants it or not, he will have to take ownership of it which will cause him all sorts of political damage. Someone should set up a email and letter writing campaign warning him what he will be in for if he lets those two entities go ahead. Once they are are launched, the pin would have been well and truly pulled. And at that point, Governor Gavin Newsom might remember that military saying: “When the pin is pulled, Mr. Grenade is not our friend”.

    Reply
    1. cnchal

      > . . . sooner or later they will blow up and we are talking about $20 billion worth of people’s pensions here. Californian taxpayers will be on the hook to make up any losses incurred which will make for a lot of unhappy voters. . .

      I think I read in comments yesterday that there was talk of taxing texting, so someone is thinking a step ahead.

      With Pirate Equity there are two victims, the so called investors and the companies bought on the investor’s behalf that are looted to float the pirate’s yachts, so the damage will be multiples of $20 billion and spread far beyond the California border.

      Reply
      1. Harry

        You make a fine point. Its almost as if the senior officials at Calpers anticipate the need for a potentially lucrative lifeboat that will hire them before the whole thing burns down.

        Either that or the Silver Lake guys have some fascinating photos/documents…

        Reply
  3. EoH

    Twenty billion dollars in two funds. At 1%, an unlikely small number, that’s $200 million in annual fees. The real annual cost to CalPERS would conservatively be several times of that.

    One would think that CalPERS would see the obvious reasons why it could and should more responsibly and cheaply manage such investments in-house. Instead, it seems determined to negotiate the open, shark-infested waters of PE in a leaky boat. Could it be that CalPERS expertise-challenged top management hasn’t a clue about how to invest, and worries about losing its sense of control over its own staff?

    Is CalPERS investing in a scapegoat, to explain away why it will not meet its investment objectives? Or is this corruption on a grand scale? Whatever the reason, no explanation puts CalPERS in a good light or moves it in the direction of meeting its fiduciary obligations.

    Will CalPERS next act be to create and invest in a Resurrection Fund, designed to give former financial managers, like Bernie Madoff, a new platform from which to work their magic, be they in or out of prison.

    Reply
  4. flora

    When I read Taibbi’s reporting on Goldman Sachs/1MDB my first thought was of a comparison with how CalPERS is run. As Taibbi wrote: all it takes is a corrupt official and a bank office with flexible morality to loot the public of billions of dollars. Will all NC’s and Bloomberg’s and even WSJ reporting on CalPERS it’s impossible for the CA state govt officials charged with oversight/regulation not to know what is going on at CalPERS, imo. Greed.

    Thanks for your continued reporting on CalPERS, pensions, and PE.

    Reply
  5. RUKidding

    File under FWIW:

    Yesterday I got my (I think quarterly) CalPers Perspective publication.

    In addition to an editorial from Marcie Frost entitled A Great Start to the New Year, I’m informed that none other than Queen Marcie herself will attend some of the upcoming Benefits Education Events. Oh joy. I may have to attend so that I can give her a piece of my mind.

    If so, I’ll report back. I doubt that I’ll get quoted, though, in the next issue like this fawning tribute:

    I have a very positive impression of CalPERS after attending last Friday’s conference. Meeting Marcie Frost gave me peace of mind about a secure retirement…

    As the kids used to say: OMG.

    Reply
  6. David in Santa Cruz

    CalPERS doesn’t have a Head of Private Equity and the CIO has been on the job for two days. Yet staffers with zero expertise in PE are clearly trying to strong-arm the Board into handing-over $20 Billion in assets — about 6 percent of the current fund — to cronies of their outside counsel, the sleazy fixer whose backdating and conflicted board memberships lost huge money to investors in companies such as Brocade. This looks like nothing more than a naked money-grab in the oversight vacuum that currently exists in Sacramento.

    Since Sonsini and Silver Lake currently happen to also be advising Elon Musk on exiting the Tesla Motors Ponzi/Tax Credits Arbitrage Scheme at just the moment when full-electrics from Mercedes-Benz, Porsche, VW, and Volvo are about to offer serious competition, one has to wonder if this “black-box” money-grab isn’t simply “funding secured” to leave California pensioners and taxpayers holding the bag when Tesla collapses? https://www.nytimes.com/2018/08/14/business/tesla-board-elon-musk.html

    Reply
    1. Arizona Slim

      And what do those other companies have in common? For starters, decades of automotive manufacturing experience. I have also heard good things about the build quality.

      Reply
  7. Susan the Other

    So just curious, does Nancy Pelosi’s husband have any direct or indirect connections to Silver Lake, Roux, or Sonsini? Maybe he’s a friend of Marcie. Maybe Gavin Newsom? Pelosi reportedly is a big Silicon Valley investor. And has east coast ties, like Nancy. Must be some connection somewhere to politically powerful interests for CalPERs to remain unchecked, no?

    Reply
    1. Synoia

      Yes, but the connections are all registered in the Bahamas, or Virgin Islands, or Panama or a combination of these and others.

      Pesky Raxes.

      Reply
    2. David in Santa Cruz

      Wilson Sonsini and Silver Lake Partners have been big “Third Way” Clintonite/Democrat bundlers and donors for years. Why on earth do you think that this CalPERS Direct boondoggle needs Cayman Islands levels of secrecy?

      Where do you think that Pelosi, as the leader of a party out of power in DC, found the cash that she needed to turn the Nixon/Reagan bastion of Orange County “Blue?” One has to wonder: is CalPERS a pension plan or a Democrat piggy bank?

      Follow the money…

      Reply

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