Wednesday, April 30, 2014

We Care About Sports

We Care About Sports

When a jealous eighty-year old NBA owner gets caught using racially offensive language America wants to know.  At around two o’clock yesterday afternoon, every television in the gym was airing Commissioner Silver’s press conference to announcement the banishment of Donald Sterling from the Los Angeles Clippers and the NBA.    The Commissioner did the right thing in meting out severe penalties.  However, you have to wonder why it took so long for the NBA to take action against Mr. Sterling.  His business practices, attitude toward minorities, and poor record as an owner warranted this action long ago.



The NBA didn’t take action because Mr. Sterling’s words were highly inappropriate.  Rather, they responded because the players were prepared to take concerted action.  They acted forcefully because the league’s advertising sponsors were withdrawing.  They banned the Clipper’s owner because the fan base seemed to care about this issue.  In other words, the NBA’s action wasn’t about a racial statement.  The league acted because their reputation was at risk.

By the way, Mr. Sterling isn’t going to be hurt by the NBA’s action.  In due course, his ownership interest will be sold to a private equity or hedge fund titan, and he’ll walk away with hundred of millions of dollars in profits.  I’m sure he’ll be able to take his young girl friends to a variety of non-NBA venues.

Meanwhile the other owners and players ought to think carefully about what has just happened.  I’m sure that there are many owners and players who would not want some of their comments about minorities, women, or gays leaked to the media.  Since Mr. Sterling’s punishment was banishment, a player or another owner may one day face the same fate, or the league will wind up looking hypocritical.

In the past several years, we’ve seen the leaders of many of our financial institutions engage in all sorts of questionable business practices.  However, we haven’t dealt with them as decisively as the NBA dealt with Mr. Sterling.  In fact, many of these executives have kept their positions.  Very few senior managers have been banished from the industry.  While we’d prefer to blame regulators or politicians, it really is our own fault. 


We’ve followed every twist and turn in the Sterling saga over the past few days, because we care about sports.  Our television networks pre-empted their soap operas for Commissioner’s Silver’s press conference, and The New York Times carried the story on the front page.  In other words, the public cared enough to force decisive action. When it comes to financial malfeasance, we simply don’t care enough to force meaningful change.  I suppose we’re happy as long as the games continue to be played in the NBA and on Wall Street.

Tuesday, April 29, 2014

Thinking Big Because We Have To

Thinking Big Because We Have To

In the United States, we’re having a heated debate about the appropriate roles of the federal and state governments.  While many Americans and even their political leaders agree on the country’s basic problems, they are deadlocked when it comes to solutions because they can’t agree on whether the states or Washington should have primary jurisdiction over the issue.   We even debate whether a rancher should have to compensate the government for grazing his cattle on federal (our) land. In my view, the two biggest issues facing us make the debate over American federalism look trivial.


In Thomas Piketty’s new book, “Capital in the 21st Century”, he lays out the consequences of gross income inequality and the global nature of the problem.  Mr. Piketty proposes a global tax on wealth (rather than income) in order to slow the accumulation of wealth and power by a tiny elite.  Many critics see Mr. Piketty’s solution as impractical and wrong-headed.   In the US, we’ve spent the last decade fostering wealth accumulation by virtually eliminating the estate tax on wealthy people and larding our tax code with loopholes, so it’s no surprise that Mr. Piketty’s proposal has been met with derision.  Mr. Piketty’s specific proposal is actually beside the point.  The key is to understand that gross wealth disparity is a worldwide problem.  If an economist’s view isn’t convincing to you, I suggest you consult Pope Francis, who is making the same argument.

In a tiny example of this phenomena and the inability of any one government to control the accumulation of wealth, Pfizer is proposing a merger with Astra Zeneca.   Why?  Pfizer would like to escape US corporate taxation by renouncing its corporate citizenship.  I’m sure Pfizer’s executives will continue to want the full protection of the US government when it comes to their safety, their ability to conduct business anywhere in the world, and their right to spend unlimited amounts of money influencing our political process.  They just don’t want to pay for it.  America alone can’t arrest this phenomena; it’s going to take a global approach.

When it comes to maintaining adequate levels of capital in big global banks, we once again see the limits of national and state bank regulators.  While bank regulators set tougher global standards in a set of regulations called Basel III, the big banks are racing around the planet to get government regulators to water down those standards.  After Bank of America’s announcement that it has miscalculated its capital levels by about $4 billion, I would prefer if we built in a good margin of safety in the global banking system.  However, it won’t happen if we don’t take a global approach.

Recently the United Nations issued its latest report on global warming.  The report paints a grim picture of the consequences of our failure to act on reducing carbon emissions.  It’s clear from reading the report that meaningful solutions will require a level of global cooperation that heretofore has been impossible.  While the earth slowly heats up, here in North Carolina we can’t even come to an agreement on whether the federal EPA or State DENR should have primary responsibility for regulating the coal ash that is polluting our rivers.  However, our biggest environmental threats will require us to take a global approach.  We’re going to have to do better than issuing press releases on the last day of global warming summits.


I’m not a fan of big government.  I’d love to live in a world in which all our problems could be solved by our city councils and state legislatures.  However, our biggest problems are even bigger than our federal government.  We’ve let wealth accumulate at dangerous levels in a small group of corporations and individuals.  We’ve let carbon dioxide reach dangerous levels.  We’d better start thinking and acting big, instead of small, if we’re going to address these problems.

Monday, April 28, 2014

The Great Omission

The Great Omission

People are the most important component of any investment organization.  Policies, procedures, contracts, and fee schedules have their place in any forensic investigation, but it’s human beings that really matter.  People make the investment decisions and conduct due diligence.   They also waste their time filling out forms to comply with public records requests.  Benchmark Financial’s 147-page report, North Carolina Pension’s Secretive Alternative Investment Gamble: A Sole Fiduciary’s Failed “Experiment” doesn’t contain any analysis of the staffing levels, compensation plans, or professional challenges facing the Investment Division of the State Department of Treasurer.  An institutional investor cannot prudently make an investment without evaluating the folks making the investment decisions, managing the risk, and running the business.  A forensic analysis of an institutional investor can’t reach any valid conclusions without considering the investment professionals who manage the investment program.



Benchmark’s report pays a fair amount of attention to the State Treasurer and references the uncomfortable interface between the Treasurer’s official responsibilities and politics.  Mr. Siedle’s references to campaign contributions reminds me of a famous line in the movie Casablanca, “I’m shocked, shocked to find that gambling is going on here!”  Politics is a part of any investment process whether we like it or not, just as gambling was a regular activity in Rick’s cafe.  I’ve written extensively about the role of politics and influence in public pension plans as well as in endowments and foundations.  Moreover, campaign contributions are only are only a small part of political influence.  Politics play a role in highway construction contracts, purchasing school textbooks, and investing a pension plan.  Rather than merely expressing shock, we need to find ways to limit its influence. The report has little constructive to say on the subject.

While the State Treasurer makes the final investment decision for the State’s pension plans, the professional staff does an enormous amount of work screening and monitoring the pension’s assets, risks, and managers.  Although Treasurers Cowell and Moore have made enormous strides in increasing the size of the staff and levels of compensation, the State continues to face challenges in retaining professionals and filling positions.  Frankly, money isn’t the only problem.  In the last several of years, the Treasurer has enacted more and more policies and regulations that take investment staff away from exercising professional judgment.   While some level of paperwork is needed, in my view it has become excessive.  Today, the staff can’t accept a cup of coffee from anyone without running afoul of ethics rules.  Does anyone really think that a state employee can be bought for a cup of coffee?    Does anyone think these kinds of restrictions foster trust and professionalism?

As Benchmark’s report correctly asserts, there’s a great deal at stake as the pension invests more of its assets in alternative investments.  Regulations, check lists, and computer systems alone will not suffice.  Referrals to the SEC won’t improve the prospects of the state’s pension.   A proper analysis of the state pension’s investment program would have covered staffing.  If Mr. Siedle had spent just a little bit of time focusing on the professionals, he would have discovered a group of people who work very hard to do the right thing.  Moreover, as a consultant for the state employees association, he should have been advocating measures to allow more functions and money to be managed internally.  If SEANC were really interested in saving money, they’d support their fellow employees who work in the Investment Division.  Instead, they’ve made massive public records requests and then issued a report that tells current professionals that they aren’t valued or trusted.   Rather than contributing to a serious discussion on the issues facing the State’s pension plan as it increases its allocation to alternative investments, Benchmark’s report has done a great deal of damage.


Friday, April 25, 2014

A Place Where Further Scrutiny Is Warranted: In-State Investing

A Place Where Further Scrutiny Is Warranted: In State Investing

Please indulge my continuing commentary on the North Carolina pension plan, since Benchmark’s report offers so many opportunities to write about pension and investment-related matters.   As I’ve said from the outset, there are valid points embedded in Benchmark’s report about the North Carolina Pension Plan.  As a child I remember reading Aesop’s fable about the boy who cried wolf.  By issuing a report before the Treasurer completed releasing documents and by filling the report with numerous errors, Benchmark’s cries of wolf completely drown out legitimate issues.

The pension plan’s relationship with Credit Suisse (now Grosvenor because of a sale) is one such relationship worthy of further study and inquiry.  Credit Suisse was retained by the State Treasurer to run an entity called “The Innovation Fund.”  The Fund was designed to make investments in North Carolina businesses and investment funds.  Unfortunately, Mr. Siedle gums up the analysis by referencing legal proceedings against Credit Suisse that are completely irrelevant to the management of the pension plan’s assets.  Moreover, he references the fact that Credit Suisse is a significant employer in North Carolina.  Again, this bit of smoke obscures the real issues.

I’ve written repeatedly about the real and potential conflicts of interest in making investments in a pension’s home state.  I’ve also described my own involvement in these difficult situations when I was Chief Investment Officer and a consultant.  Public pension trustees are always under pressure to invest in their home state.  It doesn’t much matter if the pension is run by a sole fiduciary or a board.  If trustees don’t make investments in their home state, they are accused of “shipping the money to Wall Street.”  If they make investments in the their backyard, they are accused of making politically motivated investments.

From what I can tell, the Innovation Fund is Treasurer Cowell’s attempt to put a third-party in a position of evaluating North Carolina-based investment opportunities.  Given the limiting staffing at the Investment Division, the third-party manager gives the State Treasurer additional resources needed to evaluate the flood of in-state proposals that land on her desk.  I spent an enormous amount of time as CIO trying to understand, defuse, and dispose of in-state investment proposals.  In addition, I had to try to find a few reasonable opportunities in order to fend off the criticism that the pension’s fees were being shipped to New York or Boston.  While the Innovation Fund makes sense, Mr. Siedle correctly points out that it carries a sizable price tag and a certain amount of potential baggage.

The Innovation Fund isn’t like most other investments made by the State Treasurer.  In addition to its in-state focus, the pension plan is the sole limited partner, and the State Treasurer exercises far more control over the Innovation Fund than a regular private equity fund.  For example, under the terms of the partnership agreement the State Treasurer receives memoranda about and certain veto rights over every deal.[1]  In addition the management agreement provides that the fund will reimburse the pension for expenses incurred by the Investment Division’s staff if they conduct due diligence on an in-state investment.[2]  Most private equity deals don’t offer these features to their investors.

In my view, the public ought to get a great deal of information about the Innovation Fund because it is largely an extension of the Treasurer’s internal investment operation.  In my opinion, the State Treasurer shouldn’t be able to shield information from public disclosure by placing assets in a private investment vehicle and then have the manager claim that the information is shielded from public scrutiny.

Despite the fact that the Innovation Fund doesn’t have any other investors, Grosvenor has made all sorts of claims that severely limit the amount information disclosed under SEANC’s public records request.  The language in Grosvenor’s cover letter may make perfect sense to a licensed attorney, but it doesn’t make sense to me.  For example, Grosvenor claims that its fee structure is proprietary because it enables Grosvenor to attract clients, and its disclosure would cause Grosvenor economic harm.   This contention is as unsubstantiated as many of Mr. Seidle’s claims in his report.  Grosvenor has a completely customized relationship with a single public client.  The fee structure ought to be disclosed.  Grosvenor makes similar claims concerning expense allocations, governance and termination, and the underlying investments.  While some of the co-investments or direct investments might deserve protection because the disclosure would hurt the pension plan, SEANC’s request ought to be honored.

The arrogance and self-centered nature of many money managers is amply demonstrated by the unwarranted use of confidentiality and the over reliance on the trade secret exception to the public records law.  If I were State Treasurer, I would put all sorts of pressure on Grosvenor and other managers to make disclosures and eliminate the needlessly redacted documents.  Grosvenor’s position puts the Treasurer in an unnecessarily difficult spot and has created an opportunity for Mr. Siedle to make all sorts of negative insinuations. Having been the given the privilege and reward of managing money for North Carolina’s public pension, money managers ought to err on the side of public disclosure.  Of course, if money managers behaved responsibility I wouldn’t have much to write about.

In any event, SEANC is owed far greater disclosure about the terms, conditions, performance, and fees of the Innovation Fund and the other mandates managed under the Grosvenor/Credit Suisse umbrella.




[1] See Section 4 of the Partnership Agreement at  SSR-010172
[2] See Section 7.2(f) of the Partnership Agreement SSR-010183

Thursday, April 24, 2014

The Non-Germane Accusation

The Non-Germane Accusation

Greg Polsky, a professor at my alma mater, the School of Law at the University of North Carolina, has written extensively on the business practices of private equity and their tax implications.  For example, he’s argued that the monitoring fees charged by many private equity firms are really dividends in disguise, not deductions, and should be appropriately taxed.  Professor Polsky makes a cameo appearance in Benchmark Financial’s report about the North Carolina pension system. 


As I noted yesterday, the report, North Carolina Pension’s Secretive Alternative Investment Gamble: A Sole Fiduciary’s Failed “Experiment” is so error-filled that it’s actually difficult to attack.  The report uses inflammatory language to create the appearance of massive hidden problems in the North Carolina pension system.  In the course of making all sorts of wild claims, Benchmark winds up burying a few legitimate issues that are actually worth debating and analyzing.

Yesterday I discussed Benchmark’s tactic of using scary-sounding language to create the appearance of a problem.  Today I want to discuss another tactic employed in the report: the non-germane accusation. 

Professor Polsky has written careful and thoughtful articles on the tax treatment of various aspects of private equity.  I’ve spent a bit of time talking to Professor Polsky, and his work deserves serious attention.  Moreover, he’s gotten the attention of many private equity managers and their trade association.  However, Professor Polsky’s work has nothing to do with the North Carolina pension or Treasurer Cowell.  Nonetheless, Benchmark’s report has a heading entitled “Private Equity Monitoring Fees Tax Law Violations.”  While Professor Polsky’s work may prove to be correct, the Internal Revenue Service hasn’t adopted his position.  Even if the IRS takes up Professor Polsky’s contentions, it will be years before this matter is resolved.

In an effort to conjure up an ominous accusation, Edward Siedle, the report’s author, didn’t pause long enough to consider the fact that North Carolina and its pension are in all likelihood immune from federal taxation.  The federal government doesn’t tax states.  Even if the monitoring fees become taxable dividends, public pension plans aren’t going to get a tax bill. They don’t pay taxes on a variety of sources of income that impact other investors.

Professor Polsky’s work is of interest to endowments, foundations, and taxable investors, but it is irrelevant to public pension plans, and doesn’t belong in any report making accusations about the North Carolina pension.  However, Mr. Siedle was able to come up with billions of dollars in potential tax liabilities, so the numbers made useful filler in his report.

If Mr. Siedle ever decides to properly edit his report, he might consider reading Professor Polsky’s complete law review article instead of relying on a brief Wall Street Journal article. It’s well written and worth the effort.  He might also revise the heading of this section of the report to read: “Private Equity Monitoring Fees Might One Day Be A Tax Law Violation Having No Relevance to the North Carolina Pension System.”

If Mr. Siedle wants to pursue the monitoring fee issue, he will have to find a client for whom it is germane.