Friday, October 16, 2015

Thursday, October 15, 2015

All or None Isn’t A Good System of Governance: North Carolina’s Sole Fiduciary

All or None Isn’t A Good System of Governance:  North Carolina’s Sole Fiduciary

A couple of days ago Janet Cowell decided not to run for reelection as Treasurer of North Carolina.[1] As a result we will have an open election in 2016 to select someone to act as the sole fiduciary for the state’s $90 billion public pension plan.  Although the North Carolina State Treasurer has a myriad of responsibilities, the stewardship of the pension plan probably has the greatest long-term consequences for the financial well-being of the state and the retirement security of civil servants.

The North Carolina Constitution does not specify any particular substantive qualifications for the position of State Treasurer (it only provides that the Attorney General has to be a lawyer[2]).  Thus, the voters, state employees, teachers, and first responders are about to engage in a risky proposition.  They’ve got to hope that the next Treasurer has financial experience, reasonable judgment, and an honorable character.  Moreover, they’ve got to trust that the next Treasurer will keep political influence to a minimum.

Unfortunately, the election process does not lend itself to selecting a candidate based on the requirements of the job.  The next Treasurer will be largely determined by the party affiliation of the next President and Governor of North Carolina.  The particular qualifications of the Republican and Democratic contenders will hardly matter.  Even if a candidate were eminently qualified, it would be next to impossible to properly inform the voters in the cacophony that is a general election.

No one would retain a money manager for her personal accounts or retirement savings via an election process.   No one would invest in a mutual fund if the portfolio manager were selected by the vote of the general public.  And yet anyone who pays the filing fee can run for State Treasurer and the job of investing $90 billion.

Fortunately, North Carolina has had three good treasurers in the last fifty years.  Harlan Boyles, Richard Moore, and Janet Cowell have been reasonable stewards of the pension plan and kept political influence to a tolerable level.  A quick aside: anyone who thinks that there isn’t some level of politics involved in the investment decisions of pension assets is terribly naïve.  North Carolinians can only hope that their string of luck continues.

Well over a year ago, Treasurer Cowell appointed a commission to look at this very question and propose alternatives to the sole fiduciary model.[3] Regrettably Treasurer Cowell never took up any of the commission’s proposals either to enhance the role of the existing advisory committee or create a board of trustees to share control over pension investments. 

Investment boards are far from perfect.  As I’ve described in recent posts, the boards at CalPERS and CalSTRS don’t seem up to the task of overseeing their pensions’ private equity exposure.  Moreover, there are all too many instances when public pension boards have endorsed strategies or hired managers based on faulty information or political influence.  Nonetheless, I have come to the view that it is riskier to empower a single elected official rather than appoint a board to oversee billions in pension assets and dole out hundreds of millions of dollars in management fees.  On a board there’s some chance that a dissident or two will speak up when investment policy steers off course.  For example, at CalPERS  J.J. Jelencic has single-handedly forced the nation’s largest public pension to examine the true costs of its private equity program.  And California State Treasurer John Chiang, an ex-officio member of CalPERS and CalSTRS, has introduced a proposal to force the pension plans to make better disclosure  (My friends at Naked Capitalism have done an excellent analysis of Treasurer Chiang’s proposal, as well as its short-comings[4]).

When Treasurer Cowell leaves office in early 2017, North Carolina will undergo a complete turnover of the decision-making process.  In all likelihood, the new treasurer will hire a new CIO and replace one or more of the professionals overseeing a particular asset class.  These changes will drain the pension plan of its institutional memory and disrupt one or more long-term investment programs.  A board better preserves institutional memory and continuity because trustees tend to depart and join one at a time.

I’ve been a critic of Treasurer Cowell’s big commitment to alternative investments and her program to direct investment into North Carolina.  The Treasurer is far from alone in pushing the pension plan in this direction.  Almost every large public pension plan is drinking the alternative investment Kool Aid being served up by hedge fund and private equity managers, and many plans are trying to steer investments into their home states.  While I disagree with these policies, I continue to believe that North Carolinians were well-served by Treasurer Cowell.

I don’t expect Treasurer Cowell to reverse course on alternative investments or in-state investments during the remainder of her term.  However, I hope she will become an advocate for a board of trustees to oversee the investments of our public pension.   The next State Treasurer will be the sole fiduciary of the pension’s investments.  Let’s hope the eventual winner is the last sole fiduciary.

[2] North Carolina Constitution, Article III, Section 7(7)

Thursday, October 8, 2015

Blackstone’s SEC Settlement Highlights the Failure of Institutional Investors

Blackstone’s SEC Settlement Highlights the Failure of Institutional Investors[1]

Once again I’m compelled to put down my pens and brushes to comment on a troubling development in money management. Over the past several years I’ve written repeatedly about the monitoring fees imposed by private equity on portfolio companies and the conflicts of interest authorized in limited partnership agreements.[2] Yesterday the SEC reached a settlement with Blackstone concerning its failure to properly disclose to LP the terms and conditions of its monitoring fees and its retention of outside counsel to advise both Blackstone and its PE funds.[3]  The SEC also found that Blackstone received a bigger discount than the funds on the legal fees charged by the law firm.

This settlement isn’t a victory for investors.  Rather, it points out the failure of sophisticated investors to protect their own interests.    The SEC doesn’t have substantive authority over money management firms, so it can’t do much more than pursue PE firms that fail to make proper disclosure or lack adequate policies and procedures.   Presumably the SEC will bring similar proceedings against other PE firms, but it won’t change the dynamics or nature of the industry.  There are simply too many firms, too many funds, and too few resources at the SEC.  Furthermore, a financial penalty is merely a small additional cost for doing business.   Blackstone will pay $28.9 million in disgorgements and $10 million in fines, which is a tiny price for a firm that collects billions of dollars in management, transaction, and carried interest fees.[4]   

The failure of LPs to protect their interests is highlighted in the text of the SEC’s order.    The SEC reveals that Blackstone notified all of its LPs about its legal arrangements and the disparate fee structure without receiving any complaints from the investors.  CalPERS, CalSTRS, Oregon, and Washington are major investors with Blackstone because they disclose the performance of their PE managers.  However, none of them complained about Blackstone’s legal arrangements.

As “sophisticated investors” the public pensions and other LPs ought to have been apoplectic over the legal arrangements and fee discounts.  No LP should be comfortable, let alone permit, a General Partner to use the same law firm as the firm representing the fund.  And if the legal arrangement didn’t bother the LPs, the discount afforded Blackstone, but not the funds, should have concerned them.  Investing with a private equity firm requires a high level of trust.  The GP (in this case Blackstone) has all sorts of discretion in buying and selling companies and retaining bankers, accountants, and lawyers.  When the GP cuts corners on hiring an attorney to represent the investors, it should raise concerns about the entire relationship with the GP. 

As a result of the SEC’s action, Blackstone has curtailed its monitoring fees and ended its practice of charging large termination fees when the monitoring contract is terminated prematurely.  I’m left to wonder why large, sophisticated investors tolerated these practices in the first place.    Blackstone and other GPs have been charging all sorts of unjustified fees for years.  Even if the disclosure was poor and procedures were deficient, major investors like CalPERS, CalSTRS, Oregon, and Washington knew about these practices.  Incredibly they’ve tolerated them.

Addendum:  Once again Naked Capitalism had provided the clearest and most detailed analysis of the violations committed by Blackstone.

[2] See for example,  Private Equity Tentacles: Blackstone Files to Take SeaWorld Entertainment Public, 1/5/13; Shuffling Paper to Generate Fees: The Case of Bain and Bright Horizon, 1/28/13; Quintiles Files to Go Public: The Details Matter, 2/20/13; Quintiles Update: Company Will Pay a $25 Million Termination Fee, 4/8/13.  I also wrote a column for the News and Observer,

[4] As per usual, Blackstone didn’t admit or deny any of the SEC’s findings.  Curiously, the fines were all related to the improper disclosure and procedures regarding monitoring/termination fees.  The hiring of a single firm to represent Blackstone and the funds, as well as the discount, did not appear to incur any particular fine.

Friday, October 2, 2015

Circuitous Strata

While CalSTRS scrambles to explain its private equity practices (see, Naked Capitalism on CalSTRS's Inconsistent Response , I've been painting.

The three water color paintings are based on the fourth image.