Friday, November 23, 2012

The Wrong Due Diligence Details

The Wrong Due Diligence Details

Before you hire a money manager, you’re supposed to do a bit of due diligence.  This is especially important when you’re responsible for a  $65 billion public pension, and you’re committing the fund to pay out well over a $100 million in annual management fees.  Oddly, auditors, legislators, and the press focus all their attention on the “nickels and dimes” that represent hotel rooms, plane tickets, and meals, and don’t spend much time scrutinizing the tens of millions of dollars that are doled out to managers.

During my stint as Chief Investment Officer in North Carolina, I didn’t spend much time worrying about the nickels and dimes.  We had a pension plan in need of a major modernization and a very tiny staff.  However, I learned the hard way that the little things matter in the world of pension politics. 

Acquisition Timetable (1999)

At some point in 2003, the Treasurer’s office received a public records request from Pat Stith, the Pulitzer Prize[1] winning investigative reporter for the Raleigh News and Observer for my travel records.  I’d been all over the country and in Europe on numerous forays to evaluate managers.   Thus, there were plenty of expense reports and travel receipts for Mr. Stith to peruse.  For a week or more, he pored through my paperwork in the Treasurer’s conference room in the Albemarle building.  This is the same building I’ve written about before that features darkened elevators, moldy ceiling, and leaky windows.

One evening Mr. Stith called me from the conference room, and said he was ready to ask me questions.  I told him I’d be right down.  For whatever reason, he insisted that we talk over the phone.  So for the next hour, he fired a series of detailed inquiries at me that went something like this:

PS: ‘You had a meeting in the afternoon in Boston.  How did you get from the manager’s office to your hotel?  There’s no receipt.  Did the manager give you a ride?’
AS: ‘No. I walked.’

PS: ‘You’re in New York a great deal.  Who puts you up in New York?  There are rarely any hotel charges or requests for meal reimbursement?’ 

AS: ‘I stay with my Mom and Dad.’

PS: ‘I see you flew to New York one morning and claimed reimbursement for breakfast.  I don’t think that’s permitted.  [We’re talking about the allowance for $6.70].’

AS:  ‘I took the 6am American flight to LaGuardia, so I think reimbursement is permitted.’

PS: ‘Do you have the flight information for that trip?’

AS: ‘Yes, we’ll dig it out of the files for you.’

PS: ‘Thanks’

PS: ‘How come there’s no reimbursement or receipt for this dinner in London?’

AS: ‘The money manager paid for it  [I knew my answer was going to take the conversation into an uncomfortable direction].’

PS: ‘The manager paid for it?  Isn’t that a conflict of interest?’

AS:  ‘You think I should pay a hundred dollars or more for dinner and not get reimbursed?’

PS: ‘Why do you need to have dinner with a manager in some fancy restaurant?’

AS:  ‘[imagine just a bit of defensiveness in my voice] Don’t you think, it’s a good idea for us to get to know the people who are going to manage the state’s money in a setting outside the office?  We might just learn something about their character, their personal lives, or their relationship with their colleagues.  This stuff might help to decide if we should invest or not.’

PS: ‘Isn’t the manager buying influence?’

AS: ‘[More than a hint of sarcasm] Do you really think I can be bought for a nice meal?’

The questions went on and on like this for trip after trip, and I figured I was destined for the front page of the Raleigh News and Observer.  Every morning for a week or two, I approached my front walk with a knot in my stomach.  Mr. Stith never ran a story about my travel receipts, and I never heard from him again.  However, my salary and Treasurer Moore’s travels graced the pages of the N&O, creating other moments of indigestion.

Shortly after my conversation with Mr. Stith, I had breakfast with several prospective real estate managers in Milan.  I was trying to determine if the State should commit $150 million to their fund.  After the Pat Stith episode I thought I’d better pay for the meal.  Moreover, I figured that coffee, juice, and a croissant wouldn’t be too expensive.  When I checked out after breakfast, the bill for the breakfast came to €35 (just under $50.00).  Fortunately, the meal allowance for an entire day had been raised to $30.50 from $27.50 for out-of-state meals, so I was only down $20.  Last I checked the state allowance has been raised to $38.50, unless you’re traveling within North Carolina.  In that case, you’ll be reimbursed for no more than $35.15.

We made the $150 million real estate investment, which generated about $1.9 million in annual management fees.  The investment turned out well, and the manager eventually earned another $3 or $4 million in carried interest on the investment.  No one should tolerate any employee charging personal expenses to his employer.  However, there’s something wrong with a system that focuses on entirely the wrong thing, when there’s so much at stake in our public pension systems.

[1] Mr. Stith won the Pulitzer Prize for Public Service in 1996 with two other reporters for their investigation of waste disposal in the North Carolina hog industry

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