The following story by David Sirota at PandoDaily is simply excellent. It zeros in on the secretive and rapidly expanding relationship between private equity firms and the public pensions that invest in them. It shows a crony capitalist love affair greased by lobbyist influence peddlers known as “placement agents,” as well as non-public agreements between PE firms and public pensions chock full of conflicts of interest, extremely high fees and underperformance. Unbelievably, in many instances the trustees of the public pensions are not allowed to know what funds the “fund of funds” invest in. This makes due diligence impossible, and in one particularly egregious example it led the Kentucky Retirement Systems to unknowingly invest in SAC Capital despite the fact it was under SEC investigation at the time.
Furthermore, with the Wall Street Journal reporting back in 2011 that $37 of every $100 dollars invested in Blackstone’s investment pool coming from state and local pension plans, it appears that taxpayers are once again being fleeced by the financial oligarch class. Additionally, it appears to answer a recent question I posed in my piece: Is the Credit Bubble Popping? Carlyle Group Warns on Frothiness and Junk Bond Deals Get Pulled. After reading about a growing pool of insane “dividend deals” and payment-in-kind” notes being issued, I wondered who in their right mind was buying these deals. Well, based on the complete lack of competence and due diligence happening at public pension funds, I think we have solved part of the mystery.
The chief villain in this article will be no stranger to readers of this site. It is Blackstone, the private equity giant who I have criticized many times on these pages for buying up homes all across America in “all cash” deals, making homes unaffordable to average American peasants. Of course, Blackstone is just one of many, but given its size and influence, highlighting its practices is probably quite representative.
Here are some excerpts from the article. Read it and weep:
When you think of the term “public pension fund,” you probably imagine hyper-cautious investment strategies kept in check by no-nonsense fiduciary laws.
But you probably shouldn’t.
An increasing number of those pension funds are being stealthily diverted into high-fee, high-risk “alternative investments” that deliver spectacular rewards for the Wall Street firms paid to manage them – but not such great returns for pensioners and taxpayers.
And yet… despite the fact that they deal with the expenditure of taxpayer money, the agreements between public pension systems and alternative investment firms are almost entirely secret.
Thanks to confidential documents exclusively obtained by Pando, we can now see some of the language and fee structures in the agreements between the “alternative investment” industry and major public pension funds. Taken together, the documents raise serious questions about whether the government employees, trustees and politicians overseeing major public pension funds are shirking their fiduciary responsibilities under the law when they are cementing “alternative” investment deals.
The documents, which were involved in a recent SEC inquiry into the $14.5 billion Kentucky Retirement Systems (KRS), were handed to us by SEC whistleblower Chris Tobe, an investment consultant and former trustee of the KRS. Tobe has also written a book — “Kentucky Fried Pensions” — about the scandalous state of the Kentucky public pensions system.
The documents provided by Tobe (embedded below) specifically detail Kentucky’s dealings with Blackstone – a giant Wall Street investment firm which has deployed a platoon of registered lobbyists in Kentucky and whose employees are major financial backers of Kentucky U.S. Sen. Mitch McConnell (R).
The Blackstone-related documents, though, don’t just tell a story about public pensions in Kentucky. The firm, which just reported record earnings, does business with states and localities across the country. The Wall Street Journal reports that “about $37 of every $100 of Blackstone’s $111 billion investment pool comes from state and local pension plans.”
In other documents, public pension money is exempted from some of the most basic protections usually guaranteed under federal law. Other contract language appears to license Blackstone to engage in financial conflicts of interests that could harm investors.
Despite the documents involving government agencies, and taxpayer money, they are all marked confidential. The public is not allowed to see them.
One of those documents given to Pando by Tobe is a confidential memo to KRS investment committee members from August 2011. In the memo, KRS staff outlines their desire to invest roughly $400 million in Blackstone’s Alternative Asset Management Fund (BAAM), which is a so-called “fund of hedge funds.”
As documented on page seven of that memo, Blackstone was guaranteed whopping fees of 50 basis points plus 10 percent of any overall profits on retirees’ money. In addition, the memo estimates 1.62 percent management fees and 19.78% incentive fees to be paid on top of the Blackstone fees to the underlying (and undisclosed) individual hedge fund managers in the “fund of funds.”
In 2013, according to KRS data, BAAM earned an 11.54 percent return for the pension system. That was 20 percent below the S&P 500 that year, meaning, Tobe says, that Kentucky taxpayers would have earned $78 million more in an almost fee-less S&P index fund. Those figures are consistent with a recent study from the Maryland Public Policy Institute showing “that state pension systems that pay the most for Wall Street money management get some of the worst investment returns.”
Fees, says Tobe, are a driver of the underperformance. Using the secret memo’s figures, Tobe estimates that 33 percent of that stunning one-year underperformance - or about $25 million – was in the form of fees paid to Blackstone and the other managers in its “fund of funds.”
According to data from the investment research firm Prequin, 20 others public pension funds are also invested in BAAM. Assuming those funds invested in BAAM under roughly the same terms as Kentucky, Tobe estimates that Blackstone and underlying managers in BAAM raked in well over $200 million in fees in 2013 on just that one fund of funds.
Absent from the memo to the trustees are any details about which particular hedge funds are in the BAAM fund. In an interview with Pando, Tobe argues that was by design because, he says, Kentucky officials wanted trustees to vote on the investment without being able to do due diligence. Tobe says that meant trustees were not made aware that BAAM invested in SAC Capital – the firm whose executives recently pled guilty to insider trading charges, and who at the time of the Kentucky investment were already under SEC investigation.
Amazingly, while asking public pension trustees to invest money in the fund, the Blackstone document also says that “none of the Partnership’s investments have been identified,” meaning trustees could not even evaluate the underlying investments before they decided to invest retirees’ nest eggs.
In terms of legal protections, the document says investments made by the private equity fund could be illiquid “for a number of years.” In a section marked “absence of regulatory oversight,” the document also says investors “are not afforded the protections of the 1940 (Investment Advisers) Act.” It also says that in the event of litigation brought against the managers of the fund, those costs “would be payable from the assets” of the investors.
Another section declares that “Blackstone may have conflicting loyalties” between the different funds it operates, and that “actions may be taken for the Other Blackstone Funds that are adverse” to investors.
These people have zero shame.
According to former SEC investigator Ted Siedle, who served as counsel to Tobe during the SEC investigation, the conflict-of-interest section marked “Fees for Services” is particularly problematic. He says it permits private equity managers to assess fees on companies the private equity fund owns, but then not compensate the fund investors (like public pensions) for those fees. This stealth fee-inflating practice, which is attracting SEC scrutiny, has been called the “crack cocaine of the private equity industry.”
In recent months, questions have been raised about why pension funds are investing so heavily in high-fee, high-risk alternative investments. For example, a New York Times report recently noted that “a number of retirement systems that have stuck with more traditional investments in stocks and bonds have performed better” than those investing heavily in alternatives. Similarly, Bloomberg News reported that “more than half of about 400 private-equity firms that SEC staff have examined have charged unjustified fees and expenses without notifying investors” of such fees.
When Pando asked for specific comment on whether agreements between Wall Street firms and taxpayer-backed public pensions should be available to the public, Rose said: “We are going to decline to comment on this.” Likewise, the Private Equity Growth Capital Council and KRS did not respond to questions about secrecy.
That response – or lack thereof – highlights how public pension transactions with Wall Street remain shrouded in secrecy in states throughout the country. As Susan Webber has written, despite the astronomical sums of taxpayer money and retirement income at stake, “public pension funds routinely turn down requests” for such basic information in hopes of shielding the fee bonanza from scrutiny.
For example, following SEC warnings of fee abuse in private equity investments, the New York state’s Teachers’ Retirement System flatly rejected Reuters’ open-records request for information about its private equity holdings.
In Rhode Island, the financial industry is a major donor to the election campaigns of State Treasurer Gina Raimondo (D), who has used her power to move more pension money into high-fee alternative investments. Many of those investments subsequently underperformed and hurt pension earnings, all while generating big Wall Street fees. When transparency and good-government groups asked for the full details of the alternative investments in question, Raimondo refused.
When the SHTF again, probably some time next year, the private equity industry will emerge as one of the biggest villains, and rightly so.
For the full article and the embedded leaked documents, go to PandoDaily.
Additionally, I also suggest reading this article from today’s Wall Street Journal, Borrowing Cash to Buy Complex Assets Is In Vogue Again, showing how banks are increasingly offering massive leverage to hedge funds so that they will invest in risky assets the banks are no longer able to hold. Ultimately, public pension funds will turn around and invest in these hedge funds and the typical cycle of putting all the risk on the taxpayer and total muppet fleecing will have once run full circle. Incredible.
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