Wednesday, September 3, 2014

When Public Pensions Plans Duck

When Public Pensions Plans Duck

Andrew Ross Sorkin’s article in Dealbook yesterday raised interesting questions about the relative silence of the big public pension plans in regard to the increasingly common practice of corporate inversions.  In corporate inversions, U.S. companies acquire foreign entities in order to reduce or avoid U.S. corporate taxation.[1]  While pension plans like CalPERS are usually very vocal when it comes to matters of corporate governance, they seem inclined to take a narrow view when it comes tax inversions.  Based on Mr. Sorkin’s conversations with a couple of big pensions, when it comes to corporate inversions the focus seems to be on a pension’s duty to maximize the profits on and returns of its investments.  When pension plans want to don their corporate governance hats, they often adopt a broader and longer-term view of their fiduciary responsibility.  Whether it’s environmental matters, labor issues, or local economic development, many public pension plans seem willing to adopt more expansive standards when it suits their purpose.

I am very familiar with this sliding standard of prudence.  During my time with the North Carolina pension we often used the tighter standard of care to deflect governance issues that posed a potential conflict.  It was far easier to say that we couldn’t support a particular initiative because it would violate our duty to seek the best possible returns for our investors than to explain why we didn’t want to take on a local business interest.  On those occasions when there was a matter that might crimp short-term profits in exchange for a longer-term or broader benefit, we’d adopt a more expansive view of our responsibilities.

In recent days, we’ve seen another example of the big pension plans ducking a controversial issue.  In this case, it’s not their fiduciary standard that is at issue.  Instead the final settlement of the “club deal” class action lawsuit illustrates some of the deep conflicts imbedded in large-scale public pensions.  I wrote about this about a year and a half ago (see, “Club Deal Law Suit Narrowed [March 15, 2013]). 

Last week Carlyle Group was the last private equity to settle, having been accused of conspiring to depress the purchase price of a series of buyout deals.  According to the lawsuit, the PE firms agreed among themselves to limit the competition and bidding on the buyouts of Freescale Semiconductor, HCA, Kindermorgen and host of other deals.  As I wrote in my original post, the complaint read like a press release rather a legal document.

The plaintiffs were a series of individual investors and the Detroit Police & Fire Retirement System with only $3 billion in assets.  Without admitting or denying any of the allegations Bain Capital, Blackstone Group, Carlyle Group, Goldman Sachs, Kohlberg Kravis Roberts & Co., Silver Lake and TPG Capital will pay roughly $600 million before lawyers fees.  The plaintiffs were seeking $36 billion and the case was slated for trial in November.  It’s no surprise that the PE settled.  There’s only one big winner in this case; the law firm representing plaintiffs.  Presumably they’ll get a sizable fraction of the settlement.

The plaintiffs who brought this case demonstrate the conflict borne by large pension plans.  Undoubtedly, there were plenty of pension plans that suffered greater alleged damages than Detroit Police & Fire, since most big pension plans had positions in the host of public stocks that were the subject of the suit.  However, the big pension plans also had a massive conflict of interest.  Almost every one of them had and still has two or more relationships with the defendants.   For example, CalPERS has significant PE firms with Blackstone, Carlyle, Silverlake, and TPG, while Detroit Police & Fire doesn’t appear to have a relationship with any of the PE firms.   

Under normal circumstance, a pension plan would want to achieve the highest possible price for its shares in the sale of a company.  However, when one of its PE funds was the buyer, an artificially lower price was in the pension’s interest.  As a result, the big pensions had to sit out this litigation.

In a way, it’s too bad that this litigation was settled.  While I don’t think the plaintiffs would have prevailed, the trial would have provided a great deal of insight into the business practices of private equity.  While, the rising cost of the litigation and the remote possibility of losing certainly factored into the defendants’ decision to settle, I’ll bet the private equity industry didn’t want to air their dirty laundry.


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