Thursday, April 1, 2010

CalPERS Battles Blackstone on Middlemen


CalPERS and Blackstone Group battle over proposed ban on contingency fees paid to intermediaries:
Legislation to ban commissions paid to intermediaries for steering California's public pension money to investment houses has spurred a lobbying war led by Wall Street's powerful Blackstone Group, allied with such major banking firms as Wells Fargo & Co.

The battle over fees for so-called placement agents is heating up as the bill gets its first hearing in the state Legislature next week.

The fight arose amid a series of federal and state investigations in California and New York into possible corruption and influence peddling at major public pension funds, including the California Public Employees' Retirement System, the nation's biggest.

The U.S. Justice Department is monitoring the other investigations, said a high-level CalPERS official, who didn't want to be identified because of the sensitive nature of the probes.

Huge commissions paid only for favorable results is a "system that invites corruption," said state Treasurer Bill Lockyer, a CalPERS board member.

Blackstone Group, which not only invests state pension money but also owns a placement agent firm, has hired a Sacramento powerhouse in government relations and lobbying to fight the legislation.

That firm, California Strategies, has a stellar list of former state officials as partners, including its latest hire -- James E. Burton, a former CalPERS chief executive.

CalPERS is on the other side, seeking to eliminate the incentives that fueled allegations last year of influence peddling at the $206-billion fund. It is pushing the key measure in the reform legislation -- a provision that would ban paying commissions to middlemen.

Winning passage would be a challenge for CalPERS despite its riches and clout in the financial world.

"This is looking more and more like it's going to be deep-pocketed financial giants against the workers, retirees and taxpayers of California," Lockyer said.

The state treasurer, state Controller John Chiang and CalPERS board President Rob Feckner are lining up bipartisan support for the bill, AB 1743.

Blackstone spokesman Peter Rose said the company had no problem with California's effort to register placement agents as lobbyists and to limit campaign contributions and gifts to pension fund officials -- all part of the reform bill. Those actions could keep "political fixers and influence peddlers" away from pension funds, he said.

"Our concern with this bill is simply the ban on contingency fees," Rose said.

Blackstone earns fees for managing $4.4 billion in investments contracted by CalPERS and the $130-billion California State Teachers' Retirement System. The firm, which manages $96 billion in assets, earns fees on capital committed to its own private equity, real estate and credit-based funds.

Blackstone's wholly owned Park Hill placement agent, based in San Francisco, has earned commissions on more than $110 billion in investments with 73 private equity, hedge, venture capital and real estate funds, according to the company's website.

Placement agents, Rose contends, play a useful role helping small and sometimes minority-owned investment funds put together sales pitches that would get the attention of investment staffs at large bureaucracies such as CalPERS.

"Most of these [investment] funds are fairly small and can't afford to pay a large monthly retainer," Rose said. Under a contingency fee system, they don't get paid unless they're successful.

But those small firms shouldn't feel compelled to hire a placement agent to get a hearing at CalPERS, said Joseph Dear, the system's chief investment officer.

The bill's sponsor, Assemblyman Edward Hernandez (D-West Covina), said he was committed to banning commission payments as part of a disclosure process that protects the pension system from improper influences.

Good-government advocacy groups are standing behind Hernandez.

"We're talking about multimillions of dollars to single individuals. That goes beyond a simple incentive to do well," said Kathay Feng, executive director of California Common Cause. "People are outraged by this contingency system that gives people outrageous bonuses."

Other major players -- Wells Fargo, Credit Suisse First Boston and the Securities Industry and Financial Markets Assn. trade group -- have raised objections to the bill in talks with the staff of the Assembly Public Employees, Retirement and Social Security Committee, which Hernandez chairs.

The industry group supports increased regulation of placement agents but opposes any changes in the way they are paid. Prohibiting commissions "amounts to a placement agent ban," said Andrew DeSouza, an association spokesman.

Placement agent activities at CalPERS, until recently, were unregulated and occurred largely out of public view. But in May, the CalPERS board, alarmed by a corruption scandal at a New York state pension fund, ordered its investment partners to report their financial relationships with placement agents.

The disclosures last fall contained a bombshell: A former CalPERS board member, Alfred J.R. Villalobos, garnered at least $70 million for getting CalPERS and CalSTRS to invest in a handful of big funds.

The disclosures of the fees and Villalobos' hiring of a former CalPERS chief executive, Fred Buenrostro, caused an embarrassed CalPERS board to hire a Washington, D.C., securities lawyer to look at possible conflicts of interests and overpayments of investment management fees.

At the same time, California Atty. Gen. Jerry Brown has issued a number of subpoenas and has been working with his New York counterpart, Andrew Cuomo. A two-year New York investigation into pension fund corruption has led to convictions of high-profile officials, fund managers and placement agents, including an investment manager and a placement agent from California.

The CalSTRS board doesn't want the bill to impede the access of female- and minority-owned investment firms to public pension fund business.

Seizing that issue, opponents of the measure contend that cutting off commissions would hurt the prospects for small investment firms in getting a piece of the investment action at big funds such as CalPERS.

Placement agents are an economic and effective marketing tool, said Deborah La Franchi, chief executive of Strategic Development Investments, a small, female-owned investment management firm in Los Angeles.

"It allows a firm to focus on portfolio management without also having to develop a marketing department as well," she said in a letter to the Securities and Exchange Commission, which is proposing a nationwide ban on the use of placement agents.

The same type of political pressure already is being felt in California, state Controller Chiang said.

"Any time you take on the financial lobby you can expect to have to climb a tall wall," he said.

Passage of the Hernandez bill is no sure thing because the measure, by law, needs support from at least two-thirds of the Legislature.

But a successful opposition campaign could backfire on the securities industry, Lockyer warned.

State and local government pension funds already have the authority to outlaw placement agent activities related to their investments.

"If we can't reform these practices," the state treasurer said, "then I'm for a ban."
I've been calling for a ban on placement agents for the longest time. For the most part, they are useless financial parasites who offer no value whatsoever to pension funds or even the funds they represent.

As for female and minority-owned investment firms, all the big public pension funds should have a dedicated ombudsman overseeing these minority programs, not that I believe they are in the best interests of pensioners.

But let's say that Blackstone makes a compelling case that they offer true value in their placement agent operations. Fine, then I would argue they should get a flat fee based on the performance those funds generate over a three year period. You don't see a dime until the pensions funds see performance.

The problem with the system right now is that's so open to corruption, fraud and abuse, that nobody stopped to think what's in the best interest of the workers and pensioners.

And good governance isn't just about passing laws or banning placement agents. Every pension fund should have a dedicated senior internal auditor who reports directly to the board of directors. Employees' code of conduct should stipulate that they have to report fraud to the senior internal auditor and whistleblowers should be protected by law.

Don't get me started on pension governance. If I told you all the shenanigans I've witnessed at public pension funds, you'd be floored. But tomorrow is Good Friday, the non-farm payrolls should finally show meaningful job gains, and the last thing I want to think about are the political snakes I had to deal with at public pension funds. May God have mercy on them.

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