Bribing Pension Fund Managers?

The first two payments were made in paper bags. The last installment came in a shoebox. The handoffs all came at a Sacramento hotel near the Capitol.

In a stunning admission covering years of corruption, the former chief executive of CalPERS said Friday he accepted $200,000 in cash, along with a series of other bribes, from a Lake Tahoe businessman who was attempting to influence billions of dollars in pension fund investment decisions.

Fred Buenrostro, who ran the nation’s largest public pension fund from 2002 to 2008, pleaded guilty in U.S. District Court to a charge of conspiracy to commit bribery and fraud. He has agreed to cooperate with federal prosecutors as they pursue charges against his longtime friend, Nevada businessman Alfred Villalobos, a former CalPERS board member.

Buenrostro, 64, said that Villalobos plied him with casino chips and a trip around the world, plus a high-paying job with his investment firm after leaving CalPERS. He also admitted working with Villalobos to create phony documents to ensure that Villalobos earned his multimillion-dollar fees representing a Wall Street private equity firm seeking CalPERS investments.

Most of those allegations had been aired publicly already. What was new Friday was the blockbuster admission that Buenrostro took $200,000 in cash from Villalobos. In his written plea agreement, Buenrostro said Villalobos paid him in three installments in 2007, “all of which was delivered directly to me in the Hyatt hotel in downtown Sacramento across from the Capitol.”

According to Buenrostro, Villalobos told him to be careful how he deposited the cash in order to avoid detection by banking authorities. “Villalobos told me to be sure to ‘shuffle’ the currency before making any deposit, as the bills were new and appeared to be in sequential order,” Buenrostro wrote.

Later, after he’d left CalPERS and the investigation into their relationship gained momentum, Buenrostro said he accepted an additional $50,000 from Villalobos, paid by check.

The former CEO’s guilty plea is the latest chapter in a corruption scandal that first surfaced in 2009 at the California Public Employees’ Retirement System. Documents showed that Villalobos, a former deputy mayor of Los Angeles, had earned $50 million helping his Wall Street clients win investments from CalPERS over several years.

“We condemn the misconduct and ethical breaches admitted today by Mr. Buenrostro,” CalPERS said in a prepared statement. “CalPERS looks forward to justice being served in this case and for the individuals involved to be held accountable for their actions.”

After years of denying any wrongdoing, Buenrostro faces up to five years in prison and a $250,000 fine when he’s sentenced Jan. 7. He remains free on bond.

“There is no question that the chickens have come home to roost for Mr. Buenrostro,” said his lawyer, William Portanova of Sacramento, after a brief court hearing. “He is starting a new chapter in his life. He is a 64-year-old man who is ready to tell all.” Buenrostro declined to comment as he left the courtroom.

His old friend Villalobos will continue to fight charges filed in the case, said Villalobos’ defense attorney Bruce Funk.

“We don’t think there’s any truthful information (Buenrostro) could give that could affect Mr. Villalobos,” Funk said after the court hearing.

The criminal trial was supposed to begin earlier this week with jury selection. Instead, it has been postponed, probably until the fall. Villalobos, 70, is in poor health and wasn’t in court Friday. He listened to the proceedings by phone.

Buenrostro, in his plea agreement, admitted taking bribes large and small. He let Villalobos host and pay for his 2004 wedding at Lake Tahoe. Villalobos took Buenrostro and a CalPERS board member on a 2006 worldwide trip. (The member isn’t identified in the plea agreement, but a state lawsuit filed in 2010 identified him as Charles Valdes, who has since left the board.)

Villalobos paid for his rooms at two Tahoe casinos, Harveys and Harrah’s. And Villalobos delivered on a promise of a $25,000-a-month job for Buenrostro after the CEO left CalPERS in 2008. The job ended two years later, about the time Villalobos and his company filed for bankruptcy.

In 2005, Buenrostro said he watched Villalobos give casino chips to certain CalPERS board members and to Buenrostro’s wife. At the time, CalPERS was considering awarding a pharmacy contract to a health care company.

Buenrostro didn’t identify the company, and said the board members are no longer at CalPERS. In 2011, CalPERS fired a New Jersey drug-distributor, Medco Health Solutions, after it was revealed that Medco had paid Villalobos about $4 million to help win a contract to supply pharmaceuticals to CalPERS members. The firm, which was later sold, paid a $2.7 million fine to settle a state investigation but didn’t admit any wrongdoing.

In addition, Buenrostro said he worked with Villalobos to “cover up the evidence of our corrupt relationship by concealing and destroying records.” In 2010, after he invoked his Fifth Amendment right against self-incrimination during questioning by Securities and Exchange Commission investigators, Buenrostro said, he received a $50,000 check from Villalobos.

Buenrostro said the $50,000 was supposedly a loan, but Villalobos told him he probably wouldn’t have to repay it.

If Buenrostro had gone to trial and been convicted on all charges, he was facing up to 40 years in prison. The conspiracy charge to which he admitted carries a five-year maximum penalty. So far the prosecutors haven’t made any sentencing recommendation, but agreed to ask for a reduced sentence based on Buenrostro’s “truthful cooperation,” said his lawyer Portanova. U.S. District Judge Charles Breyer will sentence him.

The original indictment was fairly narrow. It focused mainly on a series of letters Buenrostro said he created on CalPERS stationery at Villalobos’ behest.

Villalobos’ most important client, Apollo Global Management, had demanded disclosure letters in which the pension fund said it realized that Villalobos would earn fees from Apollo if the firm got CalPERS investments. When he couldn’t get a CalPERS investment officer to sign a disclosure letter, Villalobos turned to Buenrostro, who put together the letters on the pension fund’s stationery, according to the plea agreement.

Buenrostro said no one at CalPERS saw the letters, which Villalobos then mailed to Apollo. The firm got $3 billion of CalPERS’ money in 2007 and 2008, and Villalobos earned fees of $14 million. Apollo has said it wasn’t aware of any wrongdoing.

An investigative report commissioned by CalPERS said it was unlikely that Villalobos and Buenrostro were able to steer investment dollars to Villalobos’ clients. But the report, by Washington, D.C., securities attorney Philip Khinda, said Villalobos’ clients probably charged CalPERS millions of dollars in extra investment-management fees to compensate for the money they paid Villalobos.

The guilty plea marked the latest chapter in the downfall of Buenrostro, a longtime state employee and former deputy director of the state Department of Personnel Administration who became CalPERS CEO in 2002.

Because of his guilty plea to a felony, Buenrostro could have to forfeit a portion of his CalPERS pension, said fund spokesman Brad Pacheco. The amount is to be determined, he said.
Former head of U.S. pension fund pleads guilty to bribery, fraud:
The former head of the nation’s largest pension fund admitted Friday that he took bribes, including hundreds of thousands of dollars stuffed in paper bags and a shoe box, and helped an associate collect millions in a fraudulent investment scheme.

Fred Buenrostro Jr. pleaded guilty in San Francisco federal court to fraud and bribery charges stemming from his time as chief executive of the California Public Employees’ Retirement System from 2002 to 2008.

In his plea agreement, Buenrostro said that in exchange for his help Alfred Villalobos, a former CalPERS board member, took him on a trip around the world, gave him casino chips and paid for his wedding in Lake Tahoe, California.

Villalobos denied the allegations through his attorney Friday.

Buenrostro’s guilty plea arises from a years-long investigation into the role of money-management firm middlemen, called placement agents, in helping clients win investment business from a California pension system that controls $300 billion.

CalPERS said the investigation has prompted it to take “aggressive steps to implement policies and reforms that strengthen accountability and ensure full transparency.”

Buenrostro said in his plea that he started taking bribes in 2005 to use his influence with CalPERS to make investment decisions to help Villalobos’ clients. He also said he gave Villalobos, a CalPERS board member in the mid-90s, access to confidential investment information.

The 64-year-old former executive said he forged letters allowing firms connected with Villalobos to collect a $14 million commissions on $3 billion pension fund investments. He said he started writing bogus investor disclosure letters after CalPERS legal and investment officials declined to authorize them.

Further, Buenrostro said after he left CalPERS and went to work for Villalobos that he accepted $50,000 to lie to federal investigators in 2010 about their relationship.

Buenrostro faces five years in prison and a $250,000 fine when he is sentenced in January. In exchange for a lesser sentence, Buenrostro has agreed to co-operate with the continuing investigation of Villalobos, said Buenrostro lawyer William Portonova. “He got tired of lying,” Portonova said. “He’s ready to tell the truth.”

Villalobos has pleaded not guilty to fraud charges and other related counts. His attorney, Bruce Funk, said his client denies the claims contained in Buenrostro’s plea agreement. “If he’s truthful, there is nothing he can say that will hurt Mr. Villalobos,” Funk said.

Buenrostro and Villalobos, 70, also face two government lawsuits.

The state attorney general sued in 2010, saying Buenrostro and Villalobos, along with other former pension board and staff members, participated in kickback scheme.

At that time, the attorney general obtained a court order freezing assets of Villalobos and his company in an attempt to recover more than $40 million in commissions. Villalobos filed for bankruptcy later in 2010. His assets included 20 bank accounts, two Bentleys, two BMWs, a Hummer, art worth more than $2.7 million and 14 properties in California, Nevada and Hawaii. None of Buenrostro’s assets were seized.

State attorney general spokesman Nick Pacilio said a trial is scheduled for Sept. 8 in San Francisco Superior Court.

The Securities and Exchange Commission has also filed a lawsuit in 2012, which is still pending.

In a related sanction, the state’s campaign watchdog, the Fair Political Practices Commission, fined other executives and investment managers in 2011 for failing to report gifts that included food, wine and baseball and Rose Bowl tickets.
And Andrew S. Ross of the San Francisco Gate reports, Former CalPERS CEO Fred Buenrostro pleads guilty:
The California Public Employees' Retirement System CEO who oversaw the multimillion-dollar pay-for-play scandal that rocked the nation's largest public employee pension fund, pleaded guilty to conspiracy to commit bribery and fraud in federal court in San Francisco on Friday. And he agreed to "tell all" about his chief cohort's role in the affair.

As part of the plea, Fred Buenrostro, 64, who led CalPERS from 2002 to 2008, admitted to numerous offenses, including receiving cash, casino chips and other goodies from former CalPERS board member Alfred Villalobos, who has also been charged.

"He is starting a new chapter in his life. He is a 64-year-old man who is ready to tell all," said Buenrostro's attorney, William Portanova. Meaning there's more to come about the scheme, which began in 2005, to steer CalPERS investments to certain private-equity firms, who paid Villalobos up to $50 million for his services as a CalPERS "placement agent."

Villalobos, 70, a former deputy mayor of Los Angeles, has pleaded not guilty and is due to stand trial on a date to be set. "We don't think there's any truthful information (Buenrostro) could give that could affect Mr. Villalobos," said his attorney, Bruce Funk.

"We condemn the misconduct and ethical breaches admitted today by Mr. Buenrostro," the 1.6 million-member pension fund said. "CalPERS looks forward to justice being served in this case and for the individuals involved to be held accountable for their actions."

The alleged actions, according to state and federal court documents, an independent 18-month investigation by Washington attorney Philip Khinda, and admissions by Buenrostro on Friday, included:

-- Paper bags and a shoe box containing $200,000 from Villalobos to Buenrostro in exchange for confidential information and the latter's influence in directing CalPERS investments to Villalobos' clients.

-- Forging CalPERS documents.

-- A $50,000 loan from Villalobos in return for Buenrostro's refusal to testify before the Securities and Exchange Commission about the affair.

-- First-class airfare, hotels, meals and casino chips paid by Villalobos for Buenrostro's business trips overseas.

-- Buenrostro's 2004 wedding at Villalobos' Lake Tahoe mansion, paid for by Villalobos.

Buenrostro was, according to testimony in court documents, Villalobos' "puppet."

"It's a good day for justice, and it was time for Mr. Buenrostro to admit his wrongdoing," said Khinda.

The puppet, meanwhile, faces a possible five-year sentence and $250,000 fine at his next scheduled court appearance Jan. 7. The now-bankrupt puppet-master, if found guilty, faces up to 60 years in prison.
What can I say? More evidence of fast times in Pensionland and mind blowing kickbacks at pensions. Edward "Ted" Siedle, the pension proctologist, was right on the money last year when he wrote criminal prosecutions are needed to end public pension fraud. This is what happens when you pay monkeys who control billions at public pensions peanuts and expect them to conduct themselves in an ethical manner.

The latter point is underscored in Tim Worstall's Forbes article, CalPERS Ex-CEO Buenrostro Guilty Plea Explains Why Bankers Make So Much Money:
The ex-CEO of CalPERS, Fred Buenrostro, has just pleaded guilty to accepting doucers, cash bribes and fees for placing investment business with a specific firm. The economic point that this helps us elucidate is why bankers and fund managers make such vast incomes normally. It’s a concept called “efficiency wages”. Essentially, when stripped right down, if people are handling or responsible for a large amount of money then pay them very well. So that it’s not actually worth their trying to do anything naughty, the risk of losing that high income is greater than what they can gain by being naughty.

Here’s the actual announcement of Buenrostro’s plea:
Buenrostro is the former Chief Executive Officer (CEO) of the California Public Employee Retirement System (CalPERS). In pleading guilty, Buenrostro admitted to conspiring with Alfred J. Villalobos, founder and operator of ARVCO Capital Research LLC (ARVCO). Buenrostro acknowledged in court today that he understood that Villalobos operated ARVCO as a placement agent that solicited investments by public pension funds into private equity funds. Buenrostro also admitted that he understood that ARVCO was typically paid an agreed-upon fee based on the percentage of the total dollar amount invested by the public pension fund.
To put it simply (and do note that Villalobos has not been found guilty of anything at all as yet and is thus innocent of all charges) there’s a layer of agents, or introducers, in the fund management industry. A pension fund, say, is looking around for where to invest, various fund management firms are looking for people to invest and those who introduce one to the other will get a (small) slice of the amount invested. The accusation is that Buenrostro favoured Villalobos in such allocations and then received various parcels of cash, had his wedding paid for etc. as a result. Again, note that Buenrostro has pleaded guilty, Villalobos is innocent.

So far so grubby: but this gives us an insight into why pay is so darn high right across the fund management and financial industry. Simply because these people are handling such vast amounts of money. There’s therefore obviously a temptation to make off with some of that vast river of cash that flows through such offices.

As the excellent Falkenblog explains:
The reason we pay people a lot is because we think they are worth it. Many times they are not, but not always. A fund I know shut down one of its funds and people there basically gave away their positions before they left, making payments to the favor bank, for when they went to their new jobs. Why? They were told there would be no bonus, just exit your positions, and get your 1 month severance. A zero bonus is a horrible incentive structure for someone in charge of a portfolio, and it is not feasible to think your back office or audit group can monitor this. The portfolio managers know the best price, outsiders don’t, that’s why they get paid a lot. In the context of a moving market, and illiquid securities (such as mortgages), you don’t really know how much money you are leaving on the table, but look at the incentives at the individual level, and expect people to act in their self interest.
We can look at the amount these people are making and shout “That’s inefficient!”. But when we think about how much it can cost us if they’re not motivated to do the best they can for us then it might be more efficient to pay them those vast sums and not have them dealing inefficiently for us. Thus this idea of efficiency wages.

We don’t actually know exactly what Buenrostro’s pay packet was but we do have an indication from his successor:

A CalPERS spokesman in Sacramento said he wasn’t sure what Stausboll would earn as CEO, but that the job’s annual salary range previously set by the fund’s board was $224,000 to $336,000. She also will be eligible for an annual bonus worth up to 40% of her base pay.

A third of a million is obviously pretty good pay for someone on the public dime, even in fund management. But compared to the wider industry averages it’s a pittance:
Hedge fund professionals have seen higher compensation for the third consecutive year, with the average salary for an entry-level analyst at a mid-performing hedge fund totaling $335,000 in 2013, an industry report has found.

Portfolio managers at large hedge funds should also be grinning right now, given that average salaries have reached $2.2 million, the 2014 Glocap Hedge Fund Compensation report, released Thursday found.
Hedge fund management and pension fund management are not exactly the same thing, this is true, although they are close neighbours. And we should also note that CalPERS is one of the largest pension fund investors with some $260 billion under management. But if we take this idea of efficiency wages seriously then we might start to say that paying the CEO of one of the largest pensions funds less than the starting salary of a closely comparable job then we’re not in fact being efficient about the wages being paid. For we want the salary and income of those handling those vast sums to be too high for them to consider damaging the investment performance of the fund in order to gain some increase to their own income.
This is of course a subset of the principal/agent problem. If someone’s responsible for investing $260 billion then how do we make sure that they invest it to the benefit of the fund holders, the principals, rather than to the benefit of the manager, the agent? As with other finance industry professionals, as with other occupants of C suites around the country, one answer is to pay them in wages and salary more than they could be making from crooked dealings. It’s therefore possible that very high wages, those millions of dollars a year, are in fact efficient wages.

Sadly, this is precisely the opposite of what CalPERS was doing around the turn of the century:
For two years running, the members of the board of the California Public Employees’ Retirement System, the roughly $150 billion pension plan commonly called Calpers, have been at one another’s throats.

The state controller, an elected official who serves on the board, successfully sued Calpers to limit its investment managers’ pay — a policy that recently helped prompt the fund’s chief investment officer to quit.
How limited was that pay?
The latest sign of trouble at Calpers came two weeks ago, when Daniel Szentes, the chief investment officer, quit after only 15 months. He told the board that his resignation was prompted in part by a recent court ruling that would force Calpers to trim the salaries and bonuses of some of its investment managers, making it harder to recruit talent. Salaries range from $88,000 to $105,000, according to Calpers, a fraction of what many money managers make in private industry.
We cannot, of course, link those limits on pay directly to the Buenrostro events of a few years later. There are bad apples in any barrel and they don’t have to be indicative of any larger trend; they can just be bad apples. But it is interesting that theory tells us that there could be a good case for very high salaries among those who manage money in order to deter little side deals that increase income. And that an organisation that deliberately and specifically paid well under market salaries found side deals going on.

To put the entire idea of efficiency wages into a nutshell: pay people enough that they’re too scared to steal from you for fear of losing their well paid jobs. And the more money people handle the more that pay is going to have to be given that there’s a great deal more they can steal. All of which is one explanation, perhaps not the complete one but at least part of it, why salaries in finance and fund management are so high: because Buenrostro.
I agree with the thrust of this argument and have repeatedly warned my readers the U.S. public pension problem is centered around lack of proper governance. Unless U.S. lawmakers reform pension governance -- which includes independent investment boards and hiring and paying qualified pension funds managers -- nothing will prevent America's looming pension disaster.

Unfortunately, paying pension fund managers big bucks, like we do in Canada, won't root out all forms of corruption, bribery and kickbacks. Some people know how to work the system in their favor and won't accept outright bribes but they will invest huge sums in funds in return for a cushy job once they leave their pension job. (You'd think there are sensible rules in place preventing such abuse!)

And if there is collusion at the highest level, there is virtually nothing that can prevent bribes of senior public pension fund managers. Good luck proving that money wasn't transferred to some secret offshore bank account. You'd need the FBI, RCMP, Interpol to get involved to uncover such an elaborate plan.

Luckily, the vast majority of public pension fund managers don't engage in shady activity but I've seen enough crap in my career which is why nothing shocks me. This includes board of directors and senior pension fund managers being flown around in a manager's private jet and managers trying to bribe me and others with fancy dinners and expensive wines (like Chateau Petrus), sex escorts and outright money offers.

I recounted one of those encounters in a comment on where are the customers' yachts:
I'll never forget my due diligence experience with some of these charlatans. It took me less than 15 minutes to figure out Norshield was a Ponzi scheme. Johnny "X" (John Xanthoudakis) walked into the boardroom sporting a tan, wearing a fancy Italian suit, smiling with his bleached white teeth, flaunting his "incredible risk-adjusted returns," a perfect 45 degree line. When I told him they are "too good to be true," he asked me if there was anything he could do to "facilitate an investment" (code for "how much to bribe you?"). That meeting was over fast. Amazingly, municipal pension plans in Quebec invested hundreds of millions in this joke of an outfit (too many of them are on the take; you better believe it is time to take action on municipal pensions).
And in another comment on tackling Quebec's pension deficits: biggest beef is governance. When I was working at the Caisse investing in hedge funds and funds of funds, it took me 15 minutes to figure out Montreal's Norshield Asset Management was a fraud. Amazingly, the city of Laval and Sherbrooke invested millions in this fund of funds run by John Xanthoudakis, a real slick (and not particularly bright) snake. It made me wonder how many city officials he greased to get them to invest in his Ponzi scheme.

Governance, governance, governance! I can't stress this point enough. Everyone wants a piece of the pension pie and now more than ever, pension fund managers and their supervisors need to be vigilant. 
Last I heard, Johnny "X" opened up a restaurant and is lucky to be alive. He screwed over some pretty tough Cretans and Sicilians in Montreal, the type of people you never cross. He was roughed up bad by Cretan businessmen at a golf tournament (he was an idiot to show up there). And one Sicilian mobster brought him to his bar, beat him, and told him flat out: "If I don't get my money back, I'm going to first poke out your right eye with my finger and then your left one." (of course, he got his money back but many small investors lost it all and are now suing the Royal Bank of Canada).

I'm telling you, you can't make this stuff up! There is an old Greek saying, "he who has honey on his fingers can't help but lick 'em." As Quebecers watch in disbelief all the shady construction activity being revealed at the endless Charboneau Commission, there are other scandals that are being totally ignored, like the Caisse's ABCP scandal which the media is covering up (much sexier exposing shady construction deals involving Italian businessmen than going after French Canadian financial elites).

Below, Frazier & Deeter Forensic Accounting Partner David Sawyer discusses fraud prevention, detection and deterrence. Sawyer is a Certified Fraud Examiner and licensed Private Investigator as well as a CPA. Listen to his comments carefully, he knows what he's talking about and far too many pension funds don't have the proper internal controls to detect and prevent fraud.