Friday, March 22, 2013

CalPERS Indictment the Tip of the Iceberg?

Peter Lattman of the New York Times reports, Former Calpers Chief Indicted Over Fraud:
As head of the country’s largest pension fund, Federico R. Buenrostro wielded vast influence in the money management world.

From 2002 to 2008, Mr. Buenrostro served as chief executive of the California Public Employees’ Retirement System, or Calpers, which allocates more than $200 billion to investment firms across the globe.

Federal prosecutors say that Mr. Buenrostro abused that position. In an indictment filed in Federal District Court in San Francisco on Monday, the United States attorney charged Mr. Buenrostro and his friend, Alfred J. Villalobos, with defrauding the private equity firm Apollo Global Management.

The corruption charges against Mr. Buenrostro and Mr. Villalobos are connected to a nationwide pay-to-play scandal that erupted several years ago. Regulators from numerous states, including California and New Mexico, have cracked down on widespread influence peddling in how their state pension funds were invested.

The scandals focused on the role of middlemen, or placement agents, who charged lucrative fees to help money managers win business from state pension funds. In some cases, placement agents proved to be unlicensed fixers who received illegal kickbacks from pension officials. A number of pension officials and middlemen have served prison time, including Alan G. Hevesi, the former head of New York’s state pension fund.

The government claims that Mr. Buenrostro and Mr. Villalobos invented a crude scheme that tricked Apollo, one of the world’s largest private equity firms, into paying Mr. Villalobos at least $14 million in fees for his help in securing an investment from Calpers.

“We are extremely pleased that law enforcement authorities are moving to hold individuals accountable for activities which violate the public trust,” Rob Feckner, the board president of Calpers, said in a statement.

A lawyer for Mr. Buenrostro, William H. Kimball, declined to comment. Mr. Villalobos, who filed for personal bankruptcy in 2010, could not be reached for comment.

In the insular world of private equity, the charges struck many executives as unusual given Apollo and Calpers deep and lucrative ties. The California fund has invested at least $3 billion with Apollo, including a 2007 transaction in which it paid $600 million for a 9 percent stake in the firm.

For years, Apollo had retained Mr. Villalobos — a former Calpers board member — as a placement agent, agreeing to pay him for his help in securing investments from state pensions. Apollo paid at least $48 million in fees to Mr. Villalobos for his help in arranging for Calpers and other pensions to invest in its firm.

But to comply with securities laws and avoid perceived conflicts of interest, Apollo asked that Mr. Villalobos disclose to Calpers that he would receive payments related to the pension fund’s investments.

Prosecutors said that Mr. Buenrostro, 64, and Mr. Villalobos, 69, worked together, and fabricated letters from Calpers that purportedly signed off on the payments from Apollo to Mr. Villalobos.

“The allegations in the indictment unsealed today by the United States Department of Justice, if true, are troubling,” Charles V. Zehren, an Apollo spokesman, said Monday. “Apollo has always followed best practices in handling its placement agent relationships, and was not aware of any misconduct engaged in by Mr. Villalobos during the time that he worked with Apollo.”

The charges come after a civil lawsuit brought last year against Mr. Buenrostro and Mr. Villalobos by the Securities and Exchange Commission. And in 2011, a Calpers internal investigation concluded that Mr. Villalobos had turned Mr. Buenrostro into “a puppet” who directed Calpers investments to his clients. The firm’s report said that Mr. Villalobos lavished bribes on Mr. Buenrostro, including trips on private jets and gambling junkets at Nevada casinos.

When Mr. Buenrostro left Calpers in 2008, he took a job working with Mr. Villalobos as a placement agent.
Reuters also reports on the alleged fraud scheme, providing these details:
The private equity company had hired Villalobos' firm, ARVCO Capital Research LLC, to provide placement agent services to secure investment business at the pension fund, formally the California Public Employee Retirement System. He and Buenrostro conspired to create fraudulent investor disclosure letters sent to Apollo, according to a statement released by the U.S. Attorney for the Northern District of California.

Apollo paid ARVCO about $14 million in fees after receiving the fraudulent letters, the statement said, adding that ARVCO transmitted the last of the letters in June 2008, a few weeks before Buenrostro retired from Calpers and was hired by Villalobos to work for ARVCO.

The statement also said the two men made false statements to authorities investigating the disclosure letters, adding that the grand jury charged Buenrostro with making a false statement and obstruction of justice.

Buenrostro's lawyer and representatives for Villalobos could not be reach for comment.

Apollo and Calpers have cooperated with long-running federal and state probes of placement agent activity at the pension fund, and the investigations spurred it to increase its oversight of placement agents.

"We are extremely pleased that law enforcement authorities are moving to hold individuals accountable for activities which violate the public trust," Rob Feckner, president of the Calpers board, said in a statement.

Apollo said the allegations in the indictment are "troubling" if true.

"Apollo has always followed best practices in handling its placement agent relationships, and was not aware of any misconduct engaged in by Mr. Villalobos during the time that he worked with Apollo," the company said in a statement.
And in an op-ed editorial, CalPERs sees corruption charges at last, Merced Sun Star reports:
Neither man has entered a plea, but lawyers for both told The Sacramento Bee that their clients were not guilty.

Still, the forged documents provide a smoking gun -- strong evidence of a conspiracy that is simple and easy to prove in a court of law. Were the documents forged? Were they sent through the mail? Did one of the defendants lie to prosecutors about them?
But it's the conduct underlying those documents that goes to the heart of the corruption that has engulfed the highest levels of leadership at the state's $248 billion pension fund. Civil suit allegations filed earlier by the state and the federal governments against Villalobos and Buenrostro previously disclosed lavish round-the- world trips taken by Buenrostro and former CalPERS board member Chuck Valdes that Villalobos paid for.

Villalobos allegedly paid for Buenrostro's 2004 wedding at his Lake Tahoe mansion, treated him to stays at casinos in Lake Tahoe and China and even financed a Lake Tahoe condo.

Buenrostro and Villalobos are entitled to a presumption of innocence. But if they are convicted -- and the evidence against them appears very strong -- it shows dangerous rot at the very top levels of the state pension fund.
If true, the allegations are very "troubling" because they involve the highest office of the largest and best known public pension fund in the United States.

Chris Tobe of Stable Value Consultants wrote an article for Marketwatch, Feds indict public pension placement agent:
A placement agent for The California Public Employees’ Retirement System (Calpers) was indicted Monday for conspiracy to create and transmit fraudulent documents and committing mail fraud and wire fraud.

This long expensive Federal investigation possibly could have been avoided if the U.S. Securities and Exchange Commission (SEC) had not bowed under to Wall Street pressure and dropped its proposed national ban on placement agents in 2009.

The Wall Street lobby is so strong that placement agents still run rampant, cutting backroom deals in state capitols and city halls all over the country. While placement agents claim to widen options to plans, in reality these middlemen serve no useful purpose as most public plans have independent consultants.

New York was the only state to completely ban placement agents and according to The Wall Street Journal they have gone a long way in cleaning up their plan. The WSJ story reported that New York Comptroller Thomas DiNapoli recently completed a review of the ban and confirmed the in-house feeling that banning placement agents didn't close out many investment options.

"The reality is so much of what went wrong under the prior administration had so much to do with that relationship," DiNapoli said. "My feeling was the only way to be sure that kind of corrosive relationship won't happen again is to not do business with placement agents. I think the findings confirmed we have not suffered because of that."

The SEC in May 2009 proposed the outright banning of placement agents, which in New York, California, New Mexico and Kentucky, were the conduit for corruption in those states’ public pensions. However, the Private Equity industry was able to kill this SEC proposal, I believe by getting the Obama administration to pressure the SEC to water down this ban.

Blackstone's billionaire founder, Stephen Schwarzman, personally sent a letter to the SEC opposing a placement agent ban. In California, a state placement agent ban was proposed but opposition led by Private-equity firm Blackstone and their captive placement agent Park Hill were able to water down the bill to mere registration spending millions on lobbying. In Kentucky a ban was proposed in 2011 but like California, came back as watered down registration in 2012.

Dodd-Frank ushered in a new SEC whistleblower program, and a placement agent paid by a private-equity firm for the New York State Pension was an early catch.

A recent Fortune column lamented that Steve Rattner's reputation, “has been rehabilitated, just two years after settling with federal and state authorities over allegedly participating in a kickback scheme to get public pension fund investments for his private-equity firm."

Rattner rather than being shunned has become a media darling appearing on MSBC and writing a column in the New York Times. The SEC has already started to sabotage their own whistleblower program with public pensions last week by refusing to fine Illinois officials. The entire whistleblower program I fear may become another victim of Wall Street power and greed as few claims have been awarded.

Public Pensions have become a crisis in this country and ethical lapses in investment management are in many cases linked to ethical lapses in funding is creating a lethal fiduciary meltdown in many states. The SEC, if it can unchain itself from the Wall Street lobby, could greatly improve the health of public pensions nationwide with a ban on placement agents as they originally proposed in 2009.

Hopefully this criminal indictment will turn into a conviction and send the SEC, Wall Street and their placement agents a strong message.
Hopefully but I wouldn't hold my breath. Powerful people like Stephen Schwarzman are well connected to Washington's power brokers, which is why they are the big fiscal cliff deal winners.

And just to be clear, I have nothing against Stephen Schwarzman who along with Pete Peterson, one of my personal favorite investors and a man who knows the meaning of enough, co-founded Blackstone, a global private equity and alternative investment powerhouse.

Schwarzman is just looking after his firm's best interests but between you, me and the lamppost, Blackstone doesn't really need middlemen to secure lucrative deals from any public pension fund. Their reputation and performance speak for themselves.

In fact, I've long argued against millions squandered on middlemen and that we need to tighten disclosure rules, bluntly stating:
...for the most part, middlemen are financial parasites who add very little or no value to institutional clients looking to make decisions on which funds to invest with. I would simply ban them altogether. There are some exceptions, but they are few and far between. Either way, disclosure rules for middlemen should be mandatory for all public pension funds.
Finally, Dan Primack of Fortune reports, CalPERS indictment leaves key questions unanswered:
A federal grand jury this week indicted the California Public Employees' Retirement System's former CEO Fred Buenrostro, on fraud and obstruction of justice charges. Also indicted for fraud was notorious "placement agent" Alfred Villalobos, a Buenrostro pal who was regularly hired by private equity firms seeking fund commitments from CalPERS.

The fraud charges are virtually identical to what was laid out last year in an SEC civil suit, alleging that the two men forged documents related to CalPERS commitments to funds managed by Apollo Global Management (APO). And, like with those SEC charges, this is like nailing Al Capone for tax evasion.

To be sure, Buenrostro and Villalobos were an unholy alliance -- the hen-house gatekeeper and the friendly fox. But these charges don't allege that the pair improperly influenced CalPERS to invest in a fund that it otherwise would not have invested in, or that Buenrostro personally benefited from a successful Villalobos placement.

Instead, they relate Villalobos' attempts to get paid by Apollo for work he actually completed -- but for which CalPERS didn't want to acknowledge. When CalPERS staff refused to sign the verifying documents, Villalobos and Buenrostro took matters into their own hands. Kind of like creating a phony receipt for an expense report, because you lost the real one and no one at the store will create a duplicate (yes, this is far more serious, but you get the picture).

We still have no valid explanation from CalPERS as to why it didn't sign the initial disclosure letter, leading me to believe it was an attempt to establish plausible deniability of Villalobos' dealings in Sacramento. Likewise, Apollo has steadfastly refused to explain why it not only used Villalobos in the first place, but why it paid him more and more money to raise subsequent capital (the opposite of how placement agent compensation usually works).

At this point, I'm beginning to fear that neither Apollo nor CalPERS will ever be asked to answer such questions by someone with subpoena power.
You can read the unsealed indictment here. I'm not sure that anyone will ever be asked to answer tough questions as the case will likely be buried. What I can tell you is that CalPERS' new CEO, Anne Stausboll, has a stellar reputation and she has implemented first-rate governance standards to make sure nothing like this ever occurs again.

And it's not just a CalPERS problem. The Detroit Free Press reports a pension fund trustee pocketed basket of cash, trips for him and mistress. The problem is corruption and fraud are very hard to prove until it's too late. Thankfully, this isn't a rampant systemic issue but these cases show that more needs to be done to address the problem of fraud at public pension funds.

Below, CNBC's Scott Cohn discusses how prosecutors plan to file criminal charges against ex-CalPERS CEO, Federico R. Buenrostro. And the Detroit News reports some colorful details from the indictment of Detroit pension fund trustee Paul Stewart, stating the indictment reads like a Scorsese movie knock-off.