Despite, or maybe because, the Pennsylvania Public School Employees Retirement System is in a boatload of trouble, including falsifying returns, its executives are fighting tooth and nail against the efforts of recently-appointed trustee Katie Muth to get basic records on what the fund owns, leading her to have to sue to get information that is clearly necessary for any board member to do an adequate job. We’ve embedded her filing and the latest, interim ruling at the end of this post.
Anyone in corporate America or investment land will recognize how batshit crazy this situation is…..yet it is pervasive across public pension funds. A board member has the right to any record in the possession of the organization they oversee. And any board that is met with the sort of defiance that PennPSERS is engaging in should tell the CEO that if staff does not fall in line, they will be axed. But public pension fund boards too often give top priority to avoiding any controversy, out of fear that it will help those who want to gut or end public pension funds. The result instead is deep seated corruption and lousy returns.
Let’s first review the scandal at PennPSERS and then turn to Muth having to wage a pitched battle just to be able to do her job adequately. From a post last April:
Frankly, it’s surprising that it’s taken this long for an investigation of a public pension fund over allegations that it lied about its returns. But it’s not a surprise that it took Federal investigators, as in the FBI, to saddle up, in this case against a Pennsylvania Public School Employees’ Retirement System, aka PSERS.
Readers regularly lament how CalPERS regularly and obviously runs roughshod over the law and board members openly violate their fiduciary duty by not even pretending to oversee staff adequately and undermining anyone who dares to do so. That’s because CalPERS has the deficient governance structure that is pervasive among US public pension funds: boards captured by staff and a dearth of other local or state supervision and enforcement. So things have to get really bad, as with CalPERS former CEO Fred Buenrostro taking bribes, to get the FBI to go after misconduct. And yes, Buenrostro is now in Federal prison.
The incentives are obvious: most public pension funds base staff bonuses on investment performance. But a second, powerful motivation is that raising pension contributions to shore up pension funding is deeply unpopular. Even at CalPERS, where any increases fall on employers and not on the paychecks of beneficiaries, the giant pension fund clearly regards more realistic funding assumptions, which would mean higher employer contributions, as anathema, and so is moving slowly and reluctantly in that direction. [Clarification: The mechanism is more complicated. CalPERS sends annual contribution requirements to employers. While the employer can/does pass costs on to employees, they are also required to “bump” employee pay in “classic” CalPERS contracts. This is at risk of being rescinded in collective bargaining. The typical short-term adaptation is to cut government staffing, usually of the most junior employees].
By contrast, at PSERS, who bears the pain of shortfall is more complicated and is directly tied to the fraud allegations….
We don’t yet know how big the adjustment was but it pushed the returns just over the line [From the Inquirer]:
The target was a return of 6.36%. In December, the board endorsed a report from the plan’s experts that the fund had actually grown by 6.38% — just enough to spare teachers an increase…
The mistake, if uncaught, could have improperly spared 100,000 teachers and other employees from a hike in pension paycheck deductions, leaving taxpayers to cover more of the rising gap between the fund’s assets and future payments to working and retired public school staff…..
The Inquirer described how three of PSERS’ 15 board members voted against a staff effort to say the return numbers were fine after some sort of not fully disclosed brouhaha with an outside consultant. This section comes close to saying the majority of the board chose to lie:
In its December meeting, the board acknowledged investment profits had not met the system’s own target, but found them just barely good enough under state law to avoid an increase in teachers’ deductions.
WTF? This earlier section gives just a tad more color:
The Pennsylvania Public School Employees’ Retirement System also disclosed it is investigating an error by an unnamed outside consultant as well as the response by the consultant and its own staff once the error was discovered.
The error was incorporated into a report approved by a majority of PSERS board members in December after executive director Glen Grell, investment chief James Grossman, and chief financial officer Brian Carl assured board members it was accurate. Even with their assurances, three board members who raised questions about how it was calculated declined to approve the report.
Back to the current post. I’ve embedded both Muth’s original suit and the ruling after the initial skirmishes to have her suit dismissed because reasons. If you read the second filing, you will see the judge rejected all of the respondents’ arguments, which is unusual and suggests a certain amount of desperation in their claims. Note that two other board members filed amici briefs to separate themselves from the rest of the board, since they argued they had different interests. The judge agreed with that too.
Without seeing the exhibits to Muth’s filing, which show the scope of Muth’s initial information requests, it’s hard to know exactly what she was after. However, the filing discusses how she was drilling into some particular real estate investments, a tiny portion of the fund’s holdings (my assumption is that fight for them escalated because they relate to the FBI investigation). Her argument is that she has to understand how these (presumably bad) decisions were made so she can keep them in mind when the board is considering similar investments. However, the filing stakes out a broad claim to her right to records:
48. Pennsylvania law already recognizes the rights of corporate stakeholders, in other contexts, to inspect and view full corporate records.15 Pa. C.S. § 1508; see also In re Application by Nonprofit Corporate Trs. To Compel Inspection of Corporate Info., 157 A3d 944, 1001 (Pa. Commw. Ct. 2017). This does not mean that staff can merely parrot to the Senator what these documents contain.
She is entitled to inspect them.
49.Similarly, Senator Muth has a right to inspect the Board’s records in order to fulfill her statutory duty and obligation to manage the fund for the best interest of the System employees. 24 Pa.C.S. § 8521(a, e).
50.Without full access to the Board’s records, Senator Muth is unable to perform her statutory obligations.
51.Board Counsel has failed to provide Senator Muth with valid legal support for its bald assertion that the investigations summarily halt the flow of all information to Board Members whose duty it is to protect the fund. Rather, Board Counsel wishes the Board Members to remain silent, wait for the final results of the investigation, and yet con tinue to vote and act as if the federal investigation does not exists. To act in blind obedience, particularly given the errors that precipitated this investigation, would be nothing short of reckless.
Although the respondents deployed some real howlers (latches? unclean hands?), one of the arguments they tried, which is foisted on public pension funds all over the US, is that individual board members have no rights, only the full board (or sometimes board committees) do. This is patently ridiculous because board members are jointly and severally liable.
In The Lever, Matthew Cunningham-Cook spoke to Muth, where she describes how she is also seeking broader information about the fund’s holdings and is being stonewalled. Muth is troubled both about the poor returns of opaque, complex, high fee investments like private equity and hedge funds, and also that PennPSERS may be funding socially destructive investments like outsourced hospital staffing firms engaging in predatory billing practices. Note that the interview indicates that Muth sought a full inventory of alternative investments, meaning investment level, not fund level. That would mean the portfolio companies currently in Apollo VIII, for instance, and not “Apollo VIII”. From The Lever:
But Muth says that when she asked the fund’s investment staff for more information about its high-risk investments, she was rebuffed — so in June 2021, she sued the fund for basic information about its investments.
“[I asked them to] give me a comprehensive list of all alternatives and traditionals, and find if we have private equity in ambulances and hospitals,” Muth told The Lever. “Their response was, ‘We have over 495 portfolios it would be impossible to track what’s in it.’ That’s BS… That’s why I’m suing: I don’t know what the money is spent on. I have an obligation as a fiduciary to make informed decisions.”
This response, if Muth has it even remotely right, is damning. PennPSERS as a fiduciary must know what it is investing in. It is a complete breach of its fiduciary duty to say, “Oh we invested in all this complicated stuff, don’t ask us to know what we did.”
The only possible excuse here is that some of the holdings are too dynamic (like hedge funds with active trading strategies) for snapshots in time to mean much. But there is zero excuse for not providing a full list of all of the private equity portfolio company investments….yet former CalPERS board members JJ Jelincic and Margaret Brown confirmed that the staff would never allow such a request from a board member, and among other things would assert the full Investment Committee would have to ask, which they have been trained never to do. (Note in the second embedded document below that the respondents made a similar argument, that only the Audit/Compliance could seek the information, which the judge rejected).
And speaking of Jelincic and Brown, they get a nod in The Lever story:
Terry Mutchler, a prominent transparency lawyer who Muth has retained to assist with her lawsuit, said, “It’s a very special case. You have a board member being put into position to have to file suit to obtain records to do her job. We believe this is the first time in the nation where a sitting board member on a public fund has had to take such action.”…
Muth is taking on real risks by waging this fight. Pension fund trustees who ask too many questions can run afoul of powerful interests — just ask J.J. Jelincic and Margaret Brown, former board members who tangled with staff leadership at the California Public Employees Retirement System, the largest public pension fund in the U.S….
Jelincic and Brown said that they witnessed the same type of activity that Muth is challenging in Pennsylvania. In 2020, the chief investment officer for CalPERS resigned in the wake of conflict of interest allegations that centered around private equity firm Blackstone….
“Trustees are basically spoon-fed by staff,” said Jelincic. “My experience, quite frankly, is that when a trustee questions what is going on there’s a coalition that says, ‘No, you can’t question staff. We’re here to support them. If you ask questions you can bring ill repute on the board.’”
Brown agreed. “When you ask questions about an investment in health care or whatever the subject matter is, the rest of the board members try to shut you down,” she said. “I kept reminding them: You have a fiduciary duty; a duty of oversight. You are not supposed to just take what the staff tells us.”
One issue that works against board members engaged in uphill transparency fights isn’t just the cost of legal action but the fact that judges are usually deferential to state agencies. The fact that PennSERS is presently mired in scandal and the judge has ruled decisively against the staff’s initial shots back give a reason to hope that Muth might be able to turn the anti-transparency tide.00 Muth v. PennPSERS Complaint
00 Muth v. PennPSERS Initial Ruling