Admittedly, most CalPERS board members have been working hard at imitating potted plants. The rare exceptions that attempt to perform their constitutionally-mandated jobs as fiduciaries, like JJ Jelincic and now Margaret Brown, are subjected to CalPERS-orchestrated attacks in the press and petty hazing.
However, in a brazen power grab, the staff is about to have the board sign away its remaining power, even though the board members cannot escape their legal responsibilities by saying, “Oh, those CalPERS people did it. How was I supposed to know?” Yet the board is about to go officially into head in the sand mode despite the fact that it is becoming even more clear that leaving the staff on auto-pilot leads to abuse.
Tony Butka of LA CityWatch has a good piece out on this power grab: COVID-19 or the CalPERS Board – Which is Worse?. We’ll turn to it later in the post.
The latest example is the fiasco of Chief Investment Officer Ben Meng failing to tell the board about his decision to exit two tail risk investments just as they were about to turn spectacularly profitable.
These hedges were intended to reduce the damage of a market downdraft, to the tune of over $1 billion in missed gains. The only reason CalPERS didn’t suffer from even more egg on its face was the manager of the smaller exposure begged CalPERS to delay the wind-down, with the result that CalPERS had a bit of unintended protection through the end of March.
On top of that, Nassim Nicholas Taleb alleges that Meng flagrantly misrepresented the cost and benefits of what Meng claimed were superior and lower cost alternatives to the abandoned hedges. Taleb does not dispute that the two approaches, long dated Treasuries and factor-weighted equity investing, blunted CalPERS losses by $11 billion this year. But Taleb called out Meng for fibbing about the cost, which was sacrificing roughly $30 billion in investment profits last year. That leaves CalPERS net $19 billion worse off than if Meng had left things alone.
In combination with the $1 billion in sacrificed tail risk profits, should we start calling Meng CalPERS’ $20 billion wrong way man?
The issue here isn’t simply that Meng made poor investment calls. Even storied investors make mistakes. It is that Meng looks to have exceeded his authority by firing the tail risk managers without informing the board or even CalPERS’ consultant, Wilshire Associates. He then lied about it to the board, beneficiaries, and California taxpayers when asked a direct question at the March board meeting. Meng then went further in the “cover up is worse than the crime” territory via claiming his supposedly better risk mitigation strategy made even more than the lost in the hedge fiasco. Taleb exposed that as false by showing that all in, it was a big turkey. Taleb is in a position to know that pretty well because CalPERS’ asset allocation major domo left just this month for Universa, the fund with which Taleb is affiliated, so Taleb has a good idea of how CalPERS was implementing its strategies.
So CalPERS has its top investment official defying normal requirements and sound investment practice by ignoring the advice of CalPERS’ expert, Wilshire, and ditching the hedges.1 And this defective decision process blew up with surprising speed. What other risk bombs might be about to go off?
Yet with CalPERS having even more visible management problems than ever, and at the worst possible time, when the world economy is falling off a cliff and recovery could be many years away, the board is about to go into hands off the wheels mode.
We’ll go over the details shortly, but the votes on the board’s abdication are set to take place first in the Investment Committee on Monday, April 20, and then before the full board on Wednesday. You can see how Marcie Frost orchestrated this coup. First she persuaded the board to meet fewer times a year, pushing it further out of the picture. Then she got them to agree to shrink the Investment Committee, knowing that the only board member who is vigilant and reasonably clued in, would be excluded, since the other board members are allergic to asking staff questions. Can’t harsh their mellow!
As Butka put it:
….faced with relatively low return on investments, the institution, has adopted a siege mentality, with the key executive staff manipulating a compliant Board to hide the real inner workings of CalPERS. As well as its problems and failures…
[It] raises questions as to whether the CalPERS Board members are simply toadies to the staff, instead of doing their fiduciary duty to the beneficiaries and taxpayers who fund the institution.
The Staff’s Plan to Get the Board to Resign
So let’s now look at the CalPERS board’s death warrant.
As regular readers know, the CalPERS board has been abandoning any pretense that it supervises staff. It has been handing over more and more power to the staff in the form of increasing its “delegated authority,” as in how much the staff can spend on investments without getting board approval. Committee chairmen also regularly tolerate staff insubordination by not calling staff out when they fail to report back on certain matters.
As JJ Jelinic summed it up,
Only Private Equity and Real Estate have staff delegation limits in their policy.
Other than that there are no limits on staff. However, staff cannot just overturn Board decisions on asset allocation and risk levels. At least until April when the Board will withdraw its limited control.
As Jelincic alludes, the board does have some remaining points of intervention, such as investment manager selection. That has proven to be extremely important. Remember that CalPERS was planning to hand over its entire private equity program to BlackRock, even though that would clearly increase costs with no reason to expect improved performance. The need to discuss this and other parts of the ever shape-shifting “private equity new business model” to the board provided enough transparency for the idea to become bogged down under the weight of its internal conflicts.
We’ve embedded the key document at the end of this post. This section shows how the Board is giving up virtually all investment supervision and setting itself up simply to hear staff pleasantries and vote in favor of them:
In all seriousness, what is there left for the board to do? It is no longer “conducting” asset allocation but merely waving through what staff wants to do. It no longer have any say over strategies within asset classes. Recall that CalPERS made a costly mistake a few years back in deciding to considerably reduce the number of private equity fund managers and concentrate on fewer and bigger managers. The board won’t have any ability to review or challenge changes like these.
Similarly, giving up the authority to “Oversee selection process and performance of investment partners, managers and consultants” makes clear the Investment Committee is just a big charade.
It is alarming to see the board ceding “Oversee investment office risk assessment and control environment.” As we’ve described, CalPERS already has a defective risk management structure, with risk control reporting to the Chief Investment Officer rather than the General Counsel or the CEO. This is the same bad approach that led to the JP Morgan London Whale fiasco. At least risk control now has what organizational management types like to call a dotted line relationship to the board, a limited window in. That is set to go.
And in keeping with the wrong-headedness of this exercise, the next section, on page 3 of the embed below, strikes out all of the requirements from the California Constitution. The CalPERS board in theory cannot abandon these obligations, but putting them next to the board’s clear abandonment of its role evidently makes the contradiction too obvious:
And don’t kid yourself that the board can also delegate its duties to staff. Those responsibilities are always and ever the board’s. Per Article 16 sec. 17(a) of the California Constitution (emphasis ours):
The retirement board of a public pension or retirement system shall have the sole and exclusive fiduciary responsibility over the assets of the public pension or retirement system.
As former prosecutor, now prominent retiree David in Santa Cruz warned:
This means that when the members eventually see their contributions increased and the beneficiaries eventually have their benefits cut, and are looking for someone to sue, it is the individual board members who will be sued personally. Then Jones will also discover that the E&O “self-insurance” that the CalPERS CAFR reveals is not reserved — as required by both state and common law — provides as much coverage as the Emperor’s New Clothes.
It’s always a bad idea for a fiduciary to involve him or herself in a cover-up. It’s doubtful that a future governor or legislature tasked with bailing-out the fund will be much interested in bailing-out the current board from personal bankruptcy when they so blatantly ignore their duty to hold managers accountable.
CalPERS Elected Board Members Thumb Noses at Public by Taking Time Off Via Shedding Duties While Lying to Employers and the Public
The fact that the Investment Committee, far and away the most important and time-consuming activity of the board, is meeting less often, dumped some members and is about to dump pretty much everything it once did, begs the question as to why board members (for the ones that are current government employees) are being compensated in the form of undeserved paid vacations at CalPERS’ expense.
Six of the 13 board members are elected by beneficiaries. One seat is for a retiree. Of the rest, at least three and potentially all five of the rest are held by active employees.
These employees get “release time” from their employers to (supposedly) work on the board (it’s formally called employer reimbursement). The theory is that the board member works for CalPERS X% of the time and CalPERS reimburses them for that.
In a show of utter disrespect to the public, the requests for release time authorization are also scheduled for the board meetings next week. Yet most board members are asking for the same or increased “release time” despite the fact that they are clearly doing vastly less than they used to. Specifically:
All are vastly in excess of actual board meeting time. The “release time” presupposes that board members are carefully reviewing all the materials the staff sends prior to board meetings. From the caliber of discussions, it is evident never happens save for the board members that staff treats as dissidents and has successfully gotten the rest of the board to treat as pariahs). At Butka noted:
Just go look at the video recording of any meeting and look for any questioning of staff by Board members on anything. Good luck finding any fiduciary oversight. More like a bunch of crash test dummies.
In addition, the ability of the board to do anything between board meetings is severely circumscribed by the Bagley-Keene Open Meeting Act, which is designed to bar deliberations outside of formal meetings with stipulated notices and disclosures.
On top of that, the reality is for any desk job, it is hard for employers to make use of the remaining <30% or less time (recall that ~10% is vacation, so the remaining work time is <20% of total man days/year). So in many cases, employers don’t ask the CalPERS board member to take on meaningful work the balance of their time (this was clearly the case for long-standing board member Priya Mathur).
So it is no accident that Rob Feckner asks for far more release time than anyone else (95%). He is a glazier, meaning he fixes broken windows. That’s one of the few things an employer could readily arrange to be done on an ad hoc basis for a few days total every month.
Notice that staff provides cover for these ludicrous number in the form of “baselines” that are out of date by showing 12 months of board meetings when the board went to 10 several years ago and has now cut that further.
The matter of release time may seem trivial compared to the utter abdication of duty. But it’s the sort of thing that sticks in the craw of the beneficiaries who vote for candidates for these seats, and even more so to employers, who resent how increases in CalPERS contributions were breaking their budgets even before the coronavirus came also to crush their revenues.
There is a tiny silver lining to the coronacrisis. CalPERS will, for the first time, read e-mailed public comments into the record during the board meeting. They to be limited to roughly three minutes of speaking time.
Please, if you are a CalPERS beneficiary or a California resident, give CalPERS a piece of your mind! State that you firmly oppose the reduction of board investment oversight as a rejection of its fiduciary duty.
The more voices speak out, the better the odds of beating back these abuses. We have the rare luck of the wind of deserved bad press at our backs. From CalPERS:
Individuals present at the CalPERS auditorium may provide public comment on agenda items at the time each item is heard. Members of the public may also submit written public comments by email to email@example.com. Written public comments should note the meeting and agenda item the comments relate to and shall be read into the record at the time the corresponding agenda item is heard. All public comments shall be subject to CalPERS Pusblic Comment Regulation (Cal. Code Regs. tit. 2, § 552.1.)
Be sure to check the board vote on April 20, because you have two shots at defeating these changes. Even if they are approved at the Investment Committee on April 20, they still need to be approved by the full board on April 22. So you may need to submit a second round of critical comments and perhaps enlist even more friends and colleagues to join you.
Give them a piece of your mind! And please circulate this post widely and ask everyone you know to do the same!
1 It may seem I am making overmuch of this point, but the key to avoiding liability as a board or executive is acting in accordance with expert advice, and papering your files very well as to why if you choose to ignore it. Meng is violating bedrock practices in blowing off Wilshire’s recommendation.
As we can see from the his talk in this post, Meng did not have independent expert advice that diverged with Wilshire’s view based on looking at the performance of the two funds and how they managed their hedges. Instead, all he could muster were two articles, neither specific to these managers, and one not rising to the level of being academic work.00 CalPERS Board Suicide Pact