Wall Street's License to Steal?
Wall Street has put the squeeze on the city to the tune of $1 billion, a report due out Tuesday claims.Martin Z. Braun of Bloomberg recently reported, Wall Street Fees Paid by NYC’s Pension Funds Climb 28%:
As much as $723 million worth of unnecessary fees and bad deals, coupled with $300 million in bank subsidies should be rejiggered, says a study from a new left-leaning coalition called New Day, New York Coalition.
"New York City could be saving $1 billion annually just by changing the way it does business with Wall Street," one of the report's authors, Connie Razza, director of strategic research initiatives at the Center for Popular Democracy, told the Daily News.
The study, dubbed "Leveraging New York's Financial Power to Combat Inequality," kicks off a week of events organized by the group, culminating in a rally set for Thursday at Foley Square.
The coalition, whose members include veterans of Occupy Wall Street, labor unions such as 1199SEIU, and faith organizations, says its goal is to "draw attention to the ways Wall Street and big corporations continue to siphon resources away from average New Yorkers and point toward solutions that would help reduce inequality and build economic fairness."
Mirroring a key campaign theme of Mayor-elect Bill de Blasio, the report notes the huge disparity between the city's haves and have-nots, with the 1% controlling a whopping 40% of the city's income.
The city and its pension funds have tremendous leverage that can be used to bridge the gap, the study says: $350 billion that travels through the financial system.
"We should be using that leverage to demand a different relationship" with Wall Street, Razza said.
Among the key findings: the city, its pension funds and the MTA pay $563 million in Wall Street fees each year.
Rather than pay out megabucks to Wall Street big shots, the city should set up an in-house group to manage its pension assets and bond offerings, the report recommends.
That suggestion comes on the heels of a recent city report that showed fees paid by New York City pension funds surged by 28% to $472.5 million in the year ended June 30.
The idea of bringing the management of the city's money in-house isn't new.
New York's former chief investment officer, Larry Schloss, recommended just that before he recently stepped down. A number of public pension funds in Canada, including Ontario's $126 billion teachers' pension fund, have already moved in that direction.
But achieving that goal here is a long shot, said Leo Kolivakis, publisher of Pension Pulse Blog.
"Attracting and retaining qualified managers to manage money in-house is a huge challenge," Kolivakis told the News.
Patrick Muncie, a spokesman for Mayor Bloomberg, noted the financial services industry's crucial contributions to the local economy.
"The financial services sector is a critical driver of New York City's economy, providing more than 400,000 jobs and generating $3 billion in tax revenue last year alone," he said.
A spokesman for outgoing New York City Comptroller John Liu said the report encapsulates many of the comptroller's efforts, including "better and more cost-effective in-house management of pension assets."
The report "effectively and succinctly aggregates the real underlying issues of deepening inequality," Liu said in a statement.
Reps for de Blasio and incoming New York City Comptroller Scott Stringer, declined to comment.
Other recommendations of the report include holding banks to firm commitments to improve the community in exchange for the $300 million a year they receive in subsidies.
Scott Stringer vowed during his successful campaign for New York comptroller to reduce the $370 million in fees the city’s five pension funds pay money managers and consultants annually. His job, which starts Jan. 1, just got harder.
The charges climbed to $472.5 million in the year ended June 30, enough to pay the salaries of 6,440 teachers, a city report shows. The 28 percent gain is more than double the return on the $137.4 billion retirement system’s assets in the same period. In the past seven years, investment expenses for the pensions, which are overseen by the comptroller’s office, surged by $280 million.
“I’m going to take a hard look at all of our fees,” Stringer, a 53-year-old Democrat, said in a statement. “We need to limit costs, ensure payments are commensurate with performance and leverage our size and relationships with other pension funds to negotiate lower fees.”
The growing cost underscores the challenge Stringer and municipal officials across the U.S. face in reducing pension-management fees and boosting returns as the gap between promises to retirees and the assets they have to pay for them has widened to $1 trillion, according to data compiled by Bloomberg. New York’s funding deficit alone totals $72 billion.
Riskier Investing
To help shore up their funding, retirement systems such as New York’s have turned to riskier and more expensive asset classes, such as private equity, hedge funds and real estate, to hit targeted annual returns of 7 percent to 8 percent. Money managers of those funds typically charge 2 percent of assets they oversee, plus 20 percent of profits, which is higher than traditional stock and bond funds.
New York City’s pensions had 11.6 percent of their assets in such alternatives at the end of fiscal 2013, compared with 4 percent in fiscal 2006, according to city comprehensive financial reports. Blackstone Group LP (BX), Apollo Global Management LLC (APO), and Pacific Investment Management Co. are among the city’s almost 250 money managers.
As the pension has moved into such alternative investments, its costs have increased to about $8 billion this year from $1.5 billion in 2002, when Mayor Michael Bloomberg took office.
“The long-term trend in asset allocation for most funds is a move to more private markets,” said Alan Torrance, a partner at Toronto-based CEM Benchmarking Inc., a consulting company. “Private markets are more expensive than public markets.”
Retiree Benefits
U.S. pension-fund costs increased by 0.26 percentage point on average from 2001 to 2010 as retirement systems shifted money to alternative assets that aren’t managed in-house, according to a 2012 report by CEM for New York City’s pensions. For a fund with a $1 billion in assets, the average increase is equivalent to $2.6 million.
Fees erode investment gains crucial to funding benefits for New York City’s more than 237,000 retirees, and future payments to 344,000 employees. The pensions have a 10-year average annual return of 7.5 percent, compared with a 7.2 percent gain for public pensions with more than $5 billion in assets, according to Santa Monica, California-based Wilshire Associates.
“We constantly work to reduce fees across all asset classes, including shedding poorly performing managers, moving public-market funds into indexes, and negotiating lower fees in alternatives,” Matthew Sweeney, a spokesman for outgoing Comptroller John Liu, said in an e-mailed statement.
“It’s misleading to cherry-pick one year and compare a rise in fees with the rate of return,” Sweeney said. “Many alternative investments, such as private equity and real estate, have front-loaded fees that don’t generate returns for several years.”
Since Liu took office in 2010, the funds have increased in value to $144 billion from $100 billion, Sweeney said. He said alternative investments have reduced risk.
Managing In-House
The pensions believe alternative investments will diversify their portfolio against events such as the stock market collapse in 2008 and provide attractive, risk-adjusted returns, he said.
Before departing last month to become president of investment adviser Angelo, Gordon & Co., the city’s chief investment officer, Larry Schloss, recommended that the pensions hire staff with Wall Street experience and pay them higher wages to manage money in-house. That would reduce fees and boost returns, he said.
New York City is the only one of the 11 biggest U.S. public-worker pensions that doesn’t manage any assets internally.
Ontario ModelAccording to aiCIO, New York City and South Carolina’s retirement systems each shelled out just under half of a billion dollars to asset managers in the most recent fiscal year. Both public defined benefit schemes outsource effectively all of their assets to external investment firms. Allocations to alternatives are by far the most expensive part of each system’s portfolio—and both are under fire for doling out excessive fees.
Schloss pointed to Ontario’s C$130 billion ($126 billion) teachers’ pension fund, which manages most of its assets internally. The fund has returned an average 9.6 percent annually on its investments since 2003, 1.6 percentage points better than New York’s funds.
Trustees of the city pension funds, who include representatives of unions, were skeptical and didn’t adopt Schloss’s strategy.
They also balked at a plan proposed by Mayor Michael Bloomberg and Liu two years ago to overhaul management of the funds. The five boards, which have a combined 58 trustees, were to be pared down to a single 12-member panel that would set investment policy. The move would drive down costs, improve decision-making and boost returns, the mayor and comptroller said in October 2011.
In a July interview, Stringer, who is finishing his term as Manhattan borough president, said the city doesn’t need to pay a lot more to get talented money managers. The comptroller’s office could attract public-spirited employees, “the best and the brightest,” without paying Wall Street salaries and bonuses, he said.
“Any time we bring down consultant fees and streamline the bureaucracy, that’s more money for schools and cops on the other side,” he said.
Investments in alternatives to stocks and bonds, such as private equity and real estate, more than doubled to 24 percent of public-pension portfolios between 2006 and 2012, according to Cliffwater LLC, a Marina del Rey, California-based firm that advises institutional investors.
The mayor is the founder and majority owner of Bloomberg News parent Bloomberg LP.
Earlier this month, Mary Williams Walsh of the New York Times reported, New York Is Investigating Advisers to Pension Funds:
Public pensions in New York State have some of the most reliable funding in the country, but what happens to the money once it is in the pension system can be less clear-cut.Ted Seidle of Benchmark Financial Services also wrote an article for Forbes earlier this month, stating the list of the 20 pension advisers to receive New York Subpoena may grow:
Now, state financial regulators have subpoenaed about 20 companies that help New York’s pension trustees decide how to invest the billions of dollars under their control to determine whether any outside advice is clouded by undisclosed financial incentives or other conflicts of interest.
“The recent financial difficulties in Detroit serve as a stern wake-up call, demonstrating why strong oversight of New York’s public pension funds is so important,” Benjamin M. Lawsky, the New York financial services superintendent, said in letters sent last month to the trustees of the top state and city public plans.
Detroit’s municipal pension fund suffered severe losses on real estate investments, among other problems, and now that the city is bankrupt, investigators are trying to find out exactly what went wrong. In some cases, certain Detroit pension trustees were taken on junkets dressed up as investment site inspections. And in one instance, an investment promoter paid a bribe to win pension money for real estate projects in the Caribbean but then spent the money building an $8.5 million mansion in Georgia.
Mr. Lawsky said in his letter to New York’s pension trustees that he wanted to look at “controls to prevent conflicts of interest, as well as the use of consultants, advisory councils and other similar structures.” Together, the city and state trustees serve as stewards for $350 billion of retirement money.
Public workers and retirees are not the only ones with a stake in New York’s public pension system. If money is wasted, or invested in assets that lose money, the retirees still receive their checks, but local taxpayers must make up the losses.
Representatives of New York pension trustees said they were cooperating with Mr. Lawsky’s inquiry but already had extensive controls in place to make sure the retirement money in their care was invested properly. State Comptroller Thomas P. DiNapoli, the sole trustee of New York’s big state-run pension system, has called that system “one of the most transparent and accountable public pension funds in the country” in a statement on his website.
The latest subpoenas were sent last week to consultants that range from large firms like Wilshire Associates, Callan Associates, Towers Watson and Russell Investments to smaller firms that are not well known outside the world of institutional investing. Some of the firms advise public pension trustees in New York, but others do not. Mr. Lawsky apparently included both types in his investigation to learn more about bidding processes in general. Some of the subpoenaed firms had submitted unsuccessful bids and are now being asked for their records.
Mr. Lawsky’s subpoenas seek information like the consultants’ pitchbooks on various investment proposals, their compensation practices, their relationships with money managers and their methods of tracking investments that do not trade on public markets. One person briefed on the inquiry said the regulators appeared to be trying to learn whether any consultants were being paid by the firms they recommended, including in-kind payments or job offers.
Public pension funds typically have one or more general consultants who advise the trustees and senior staff members on developing an asset allocation policy, which assigns different shares of the total investment portfolio to stocks, bonds, real estate and other types of assets. In recent years, concerns have been raised that general consultants have been encouraging trustees to shift more pension money into aggressive investments in hopes of earning higher annual returns than can be achieved with stocks and bonds. That exposes taxpayers to greater risks because assets that promise the biggest potential rewards are also generally the most volatile.
In banking and insurance, which Mr. Lawsky also regulates, riskier assets are counted at less than their full value, and financial institutions can be downgraded or even forced to take corrective action if their portfolios are too volatile. Those principles have so far not been applied to public pensions, but Mr. Lawsky said in his October letter that he had “decided to take a new approach to pension fund oversight.”
“Where we find areas that need urgent and prompt corrective action, we may propose new regulations to increase accountability and transparency at those funds,” he wrote.
In addition to their general consultants, New York’s pension funds also work with specialized consultants who handle single asset classes. The state retirement system has separate consultants for private equity funds, hedge funds, real estate, fixed income, international stocks and domestic stocks. The more esoteric the investment class, the higher the fees these consultants are paid because nonstandard investments like hedge funds are generally harder to track and measure.
New York State’s private equity consultants received $2.1 million for their work last year, for example. Hedge fund consultants were paid about $1 million, while the consultants working with ordinary United States stocks received just $63,000, even though such securities represent a much larger share of the fund’s total portfolio.
Pension trustee duties are especially sensitive in New York, one of the few remaining states with a pooled system governed by a sole trustee instead of a board. New York’s immediate past sole trustee, Alan G. Hevesi, became the target of a wide-ranging pay-to-play investigation led by Andrew M. Cuomo, the attorney general at the time. Mr. Hevesi was eventually found, in effect, to have sold pension investment contracts to money managers, and served 20 months in a medium-security prison. He was released on parole last December.
That scandal generated calls to replace New York State’s sole trustee with a board, which were unsuccessful. Instead, Mr. Hevesi’s successor as sole trustee, Mr. DiNapoli, instituted a number of reforms and control measures intended to ensure that investments were chosen on the merits instead of secret payments.
Senior officials of the New York State pension fund said they had screened all of their consultants after the scandal and were satisfied that their bidding process was competitive and ethical. They said they did not think their investment consultants charged money managers to be included in their databases. Nor did they permit the pension system’s stock-trading business to be directed to any particular brokerage firms as part of an overall compensation package.
The New York officials said the state fund’s investment staff now reviewed all bids, whether for consulting work or investment contracts. They said a separate group of state employees reviewed the bidders’ proposals for how they wanted to be compensated. They said their outside consultants carried out the initial searches for investment managers, but the fund’s staff reviewed the finalists, doing background checks, site visits and other evaluations.
The offices of the New York State Teachers’ Retirement System and New York City Comptroller John C. Liu were closed for Election Day, and no one could be reached to comment on Mr. Lawsky’s investigation.
New York state financial regulators have subpoenaed 20 companies that advise public pension trustees around the country on how to invest the trillions in assets under management in government plans. According to an informed source, this is an ongoing investigation of the pension consulting industry, initially targeting firms that have advised New York funds, or pitched services to them. The investigation may broaden to include other pension advisory firms nationally.Seidle has been relentless in exposing the secret pension money grab. He's been particularly critical of Gina Raimondo, Rhode Island's Treasurer, and his report, Rhode Island Public Pension Reform: Wall Street License to Steal, does raise important points that merit a closer look.
The firms subpoenaed are in the business of providing advice regarding allocation of pension assets and selection of managers, as opposed to actually managing money. The advice they are paid by pensions to provide is supposed to be objective—uncorrupted by any payments to the gatekeeper-evaluator from the money managers under review.
In recent years, however, the Department of Labor, the Securities and Exchange Commission, and the General Accountability Office have each publicly stated that conflicts of interest related pension advisers are widespread, and that these conflicts have resulted in reduced returns and higher fees for retirement investors.
New York’s inquiry into public pension advisers should come as no surprise.
As I noted in the findings of my forensic investigation of the Rhode Island state pension a few weeks ago, Rhode Island Public Pension Reform: Wall Street License to Steal, the investment consultant retained by the Rhode Island State Retirement System to review and recommend hedge fund and other alternative investments, Cliffwater LLC, had disclosed in its regulatory filings with the SEC that it received compensation from the investment managers it recommended or selected for its clients. “A conflict of interest arises under these circumstances because the consultant may recommend managers to the pension based upon such undisclosed compensation it receives, as opposed to investment merits,” I wrote. In my report I recommended that the SEC look into the facts behind the firm’s disclosures.
Cliffwater was not included in the firms that have received New York subpoenas to date but Pacific Corporate Group, a former Rhode Island pension adviser and Pension Consulting Alliance, a current adviser, were.
The 20 firms subpoenaed were:
Aksia; Albourne America; Callan Associates; Courtland Partners Ltd; Gallagher Retirement Services; Hamilton Lane; Hewitt EnnisKnupp, Inc.; LP Capital Advisors, LLC; Mercer; Pacific Corporate Group; Pension Consulting Alliance; Russell; RV Kuhns & Associates; Situs Strategic Advisors, LLC; Smith Graham & Company Investment Advisors, LP; Stepstone Group LLC; The Townsend Group; Torreycove Capital Partners LLC; Towers Watson; and Wilshire Associates.
As Benjamin M. Lawsky, the New York financial services superintendent, said in letters sent last month to the trustees of the top state and city public plans, “The recent financial difficulties in Detroit serve as a stern wake-up call, demonstrating why strong oversight of New York’s public pension funds is so important.”
Across the nation, those responsible for overseeing the integrity of public pensions hopefully are waking up and smelling the coffee. Anyone who’s ripped-off public pensions and government workers should be starting to sweat.
He provided the complaint to The Providence Journal, specifically asking the SEC to look at:
Investment fees that have been “grossly understated” and “intentionally withheld” from public view;Keep in mind, Ms. Raimondo is one of the people Jim Leech and Jacquie McNish praise in their book, The Third Rail. I gained a deeper appreciation for her after reading the book as she fought a tough battle to slay the pension dragon, but Seidle raises legitimate concerns.
Investment agreements that allow hedge fund managers to withhold information from the state while they share it with other investors, putting them in a position to benefit at the state’s expense, or, as the complaint puts it, “steal from the state pension”;
Raimondo’s claims about the performance of two funds “she formerly managed” and which the state pension fund has since invested in;
Conflicts in which the state’s investment consultant “receives compensation from the very investment managers it recommends or selects for its clients.”
Siedle said his findings provide a more complete picture of Raimondo’s work as general treasurer, including her work on a 2011 state pension system overhaul to address what was seen as a severe pension-funding crisis. The legislation, passed by the Democrat-controlled General Assembly, raised the retirement age, suspended annual cost-of-living adjustments and replaced the state’s defined-benefit pension with a hybrid that includes a 401(k)-style plan.
“If she had slashed the pension costs at the same time as she was slashing the benefits, then she could argue that that’s pension reform. But to slash the benefits and exponentially increase the fees to Wall Street, that’s not reform,” Siedle said. “What I have done for Rhode Island is to draw attention to the other side of the balance sheet, the other side of the income statement, which is how much has been paid to Wall Street.”
A spokesman for Raimondo, a Democrat and likely candidate for governor in 2014, responded Monday by calling Siedle’s claims “misleading political attacks designed to discredit the treasurer and the important reforms that have protected pensions for public employees and retirees.”
As far as investment consultants, you already know my thoughts. Most of them are utterly useless, charging outrageous fees, recommending well-known brand name funds that charge even more outrageous fees as they gather assets from unsuspecting public pension funds praying for an alternatives miracle. It's quite disconcerting and it's high time state auditors look into this (not so) secret pension money grab.
On governance, I need to keep hammering this point, the pension governance model in the United States is all wrong. An increasing number of U.S. public pension funds are moving to emulate their Canadian counterparts, managing more assets in-house, but unless they implement independent and qualified investment boards and start paying their pension fund managers properly, it's a hopeless cause.
That's why when Phyllis Furman of the New York Daily News contacted me yesterday, I told her flat out I was highly skeptical of these new reforms. Nobody is going to go work for a U.S. public pension fund as part of their "civic duty." You need to pay professional pension fund managers properly to attract and retain qualified staff. I'm not talking Canadian-style hefty payouts, but something a lot more in line with the private sector.
Finally, I do realize the shift into alternative investments is more costly and requires specialized advice but don't kid yourself, alternatives are no panacea and they don't reduce risk. I would fire any risk officer who claims otherwise. There are plenty of risks in alternatives and pensions taking on too much illiquidity risk are in for a rude awakening when the next crisis hits.
Luckily for pensions, as long as central banks keep printing, they will postpone the next crisis out by a few more years. Unfortunately, they're sewing the seeds of an even bigger crisis and will stir up more bubble anxiety along the way.
Below, Forbes Magazine writer and founder of Benchmark Financial Services, Ted Siedle, discusses his new report on Rhode Island's pension system - and the results aren't pretty. Unfortunately, this is an endemic problem across the United States and until they get the governance right, mitigating political and union interference, these shenanigans will continue giving Wall Street a license to steal.