Millions Squandered on Middlemen?
Florida's public pension has invested about $2 billion in two dozen private funds since December.
Rather than approach the pension's staff directly, half the funds used middlemen to get in the door. They paid these well-connected placement agents millions of dollars for making introductions and setting up meetings. Average finder's fee: about $1.5 million.
Florida's money managers at the State Board of Administration say using placement agents is routine and no cause for concern. But after such intermediaries were found to be at the heart of kickback scandals at public pensions in New York and California, those states have taken tougher stands.
New York's state pension has banned the use of placement agents. California has put limits on their pay and plans to post their compensation on the state pension's website.
And just last week, in the wake of problems at public pension funds, the Securities and Exchange Commission started requiring registration of placement agents.
Ashbel C. Williams Jr., the SBA's executive director, boasted that Florida's rules are even stricter. He told his agency's investment advisory council last week: "Our policy goes beyond the SEC's. We require disclosure of the compensation they've been paid."
There's just one catch: Williams' definition of disclosure does not extend to Florida's pensioners or taxpayers. His agency gets to know what the middlemen are paid. But the public — told that pension investments are made on merit, not on who you know — cannot find out how much money changed hands before a deal went down.
The reason? The SBA won't release the information if investment funds want to keep it secret. And they all do.
For example, Florida recently invested $100 million of pension fund money with GSO Capital Partners. The company said disclosing what it paid a placement agent would "harm our business efforts."
Baloney, says Christopher Tobe, a veteran financial adviser and trustee of the Kentucky Retirement Fund. Tobe is among the growing number of experts who say funds that use third-parties, rather than going directly to a pension plan, are perpetuating an unnecessary and poorly regulated system that's proved vulnerable to abuse.
"It's blatant corruption," he said. "There's really no reason for placement agents unless you want to get money to somebody through the back door."
For a few months last spring, the SBA didn't give fund managers the option of exempting placement agent pay from public records requests. In seven deals where their fees were disclosed, placement agents received a total of about $12 million, about 1.5 percent of Florida's total investment of $825 million.
The lowest reported commission was $250,000 paid by Energy Capital Partners, a private equity firm, to Park Hill Group for "scheduling meetings." Florida invested $100 million with Energy Capital Partners.
P2 Capital Partners, meanwhile, got the same result — a $100 million commitment from Florida — but paid its placement agent, C.P. Eaton, $3.65 million. Eaton's duties? "Establish LP (limited partner) relationships."
Knight Vinke signed a $250 million deal with Florida and paid its placement agent, XT Capital Partners, up to $1.25 million for services it described as "strictly ministerial."
Why did some funds feel the need to pay a third party to run interference with the state, while the rest landed approximately the same total investment without the extra cost?
"Maybe they weren't as attractive a fund," said Tobe, the Kentucky pension trustee. "They had to have some extra juice."
Girard Miller, a former member of the Governmental Accounting Standards Board and veteran fund manager, points out that pensions like Florida already pay millions of dollars to independent consultants to screen potential investments.
"So why on earth is it necessary for legitimate and competent investment advisers to a pension fund to hire a mercenary?" Miller asked in a column last year in Governing magazine.
Florida typically pays a fund 1 to 2 percent to manage its investment, so a $100 million deal could mean as much as $2 million to the fund manager. The placement agent's commission generally is taken from the management fee.
Williams, the SBA's executive director, said the fact that fund managers pay placement agents mean they cost the public nothing.
But Susan Lerner, the head of Common Cause New York, said taxpayers end up footing the bill. "The funds that use these intermediaries negotiate a somewhat higher management fee so that nothing comes out of their profit margin," she said.
"Those fees just get passed through. The public is paying for it."
Miller, who has been involved in both selling and buying funds, called placement agents "a deadweight cost on the investment industry."
"Having sat on both sides of the table at final presentations for 25 years,'' he wrote, "I can tell you that there is really no value added to the analytical process from marketers that cannot be delivered by the key players."
Tobe recently blew the whistle on Kentucky's fund when he learned it paid placement agents $15 million in fees since 2004 after years of denying it used these intermediaries. In response to his complaints, the SEC opened an informal inquiry into the Kentucky system last month.
Tobe and Miller suggest that if placement agents are used, their fees should be capped at about $200,000. "That still rewards a skilled marketer for presenting the advantages of an investment product to a large fund," Miller wrote.
In New York, the deputy comptroller and several placement agents and fund managers pleaded guilty to running a pay-to-play scheme at the public pension. The pension has recouped more than $120 million from parties accused of wrongdoing.
In California, a former CalPERS board member turned placement agent is accused of taking more than $50 million from funds in return for steering business to the pension. CalPERS now encourages funds to submit their proposals online.
"There's no reason for them to pay someone to call us or to set up a meeting," CalPERS chief investment officer Joseph Dear said in June. "Our door is open."
After reading this excellent article, two things struck me. First, I'm wasting my time blogging. With all my connections to senior officers at public pension funds, I should be investing in spiffy suits, nice shirts and ties, setting myself up in easy lane peddling funds to them. I will charge a small nominal fee for "arranging meetings". I am, of course, being sarcastic. I'd rather stick a fork in my eye than peddle funds to LPs.
The second thing that struck me in this article were the excellent comments by Tobe and Miller. As I've repeatedly stated, the overwhelming majority of middlemen are utterly useless. They're just financial parasites looking to skim off the management fee. Sure the funds love them, especially if the LPs sign over big fat multi-million dollar cheques, but the bottom line is that excessive fees paid to middlemen opens the door to serious abuse.
I always tried to avoid middlemen. Most of them are just slick marketers who try to get you to invest in funds using lame sale pitches. I prefer meeting the managers, asking the tough questions. I remember middlemen calling me saying "I can get you capacity in so and so's fund". My eyes would roll and I'd politely tell them that I'm not interested. If I was interested, I'd tell them to send over the senior fund managers.
Finally, I agree with Tobe and Miller. At a minimum, fees paid to middlemen should be capped and publicly reported in the annual report (same for all fees paid to external consultants). However, if you ask me, middlemen should be eliminated altogether. Period.
If US pension funds paid their staff properly, recruiting qualified people, they wouldn't need any middlemen whatsoever. Funds would send their documents directly to the staff who are trained to properly screen them before conducting a thorough due diligence. This is all common sense, and it amazes me that in this day and age, underfunded pension funds continue to squander millions on useless middlemen.