Wall Street's Secret Pension Swindle?
In the national debate over what to do about public pension shortfalls, here’s something you may not know: The texts of the agreements signed between those pension funds and financial firms are almost always secret. Yes, that’s right. Although they are public pensions that taxpayers contribute to and that public officials oversee, the exact terms of the financial deals being engineered in the public’s name and with public money are typically not available to you, the taxpayer.Ted Siedle, aka the pension proctologist, wrote another excellent article for Forbes, North Carolina Pension's Secretive Alternative Investment Gamble:
To understand why that should be cause for concern, ponder some possibilities as they relate to pension deals with hedge funds, private equity partnerships and other so-called “alternative investments.” For example, it is possible that the secret terms of such agreements could allow other private individuals in the same investments to negotiate preferential terms for themselves, meaning public employees’ pension money enriches those private investors. It is also possible that the secret terms of the agreements create the heads-Wall-Street-wins, tails-pensions-lose effect — the one whereby retirees’ money is subjected to huge risks, yet financial firms’ profits are guaranteed regardless of returns.
North Carolina exemplifies the latter problem. In a new report for the union representing that state’s public employees, former Securities and Exchange Commission investigator Ted Siedle documents how secrecy is allowing financial firms to bilk the Teachers’ and State Employees’ Retirement System, which is the seventh largest public pension fund in America.
The first part of Siedle’s report evaluates the secrecy.
“Today, TSERS assets are directly invested in approximately 300 funds and indirectly in hundreds more underlying funds, the names, investment practices, portfolio holdings, investment performances, fees, expenses, regulation, trading and custodian banking arrangements of which are largely unknown to stakeholders, the State Auditor and, indeed, to even the (State) Treasurer and her staff,” he reports. “As a result of the lack of transparency and accountability at TSERS, it is virtually impossible for stakeholders to know the answers to questions as fundamental as who is managing the money, what is it invested in and where is it?”
Before you claim this is just a minor problem, consider some numbers. According to Siedle’s report, this huge pension system now is authorized to invest up to 35 percent — or $30 billion — of its assets in alternatives. Consider, too, that Siedle’s report shows that with such a large allocation in these risky alternatives, the fund “has underperformed the average public plan by $6.8 billion.”
So what is happening to retirees’ money? As Siedle documents, more and more of it is going to pay the exorbitant fees charged by the Wall Street firms managing the pension money.
“Fees have skyrocketed over 1,000 percent since 2000 and have almost doubled since (2008) from $217 million to $416 million,” he writes, adding that “annual fees and expenses will amount to approximately $1 billion in the near future.”
The details get worse from there, which makes Siedle’s report a genuine must-read for anyone who wants to understand the larger story of public pensions. After all, North Carolina is not an isolated incident. In state after state, the financial industry is citing modest public pension shortfalls to justify pushing those pensions to invest more money in riskier and riskier high-fee investments — and to do so in secret.
It is a story that isn’t some minor issue. On the contrary, the fight over that $3 trillion is fast becoming one of the most important economic, business and political stories of modern times. The only question is whether the story can even be told — or whether those profiting off secrecy can continue hiding their schemes from the public.
The need for regulatory intervention by the U.S. Securities and Exchange Commission in the North Carolina state pension alternative investment stand-off between the State Treasurer and her deep-pocketed Wall Street allies, on the one hand, and the stakeholders committed to safeguarding the $87 billion pension, on the other, cannot be overstated. The same situation exists at countless other public pensions around the nation, in states such as Illinois, Kentucky, Rhode Island and South Carolina. At stake is nothing less than the fiscal viability of state and local governments across the country, as well as state employees’ retirement security.
The following is a summary of a 147-page forensic investigative report of the North Carolina pension which was filed with the SEC this week. My firm, Benchmark Financial Services, Inc. was retained by the State Employees Association of North Carolina, SEIU Local 2008, to conduct this preliminary review. Benchmark identified widespread potential violations of law within the pension which we believe should be investigated by the SEC, Internal Revenue Service and law enforcement.
Janet Cowell is neither the first North Carolina State Treasurer to abuse her power as sole fiduciary of the state pension nor, absent radical structural reform, will she be the last. Pay-for-play has long been a problem in the state’s pension system. For more than a decade state treasurers have handed out billions of dollars in public assets to money management and other firms that contribute to their political campaigns.
Cowell has taken this quid pro quo to a new level as the Teachers’ and State Employees’ Retirement System of the State of North Carolina (“TSERS”) has grown to $87 billion and disclosed fees paid to Wall Street have skyrocketed 1,000 percent. Cowell’s political manipulation of the state pension fund has cost North Carolina $6.8 billion in fees and lost investment opportunities during her tenure.
The unchecked ability to steer tens of billions in workers’ retirement savings into hundreds of the highest-cost hedge, private equity, venture and real estate funds ever devised by Wall Street, in exchange for political contributions to her campaign and to the campaigns of other influential politicians, makes the Treasurer today arguably the state’s most powerful elected official.
The profound lack of transparency related to these risky so-called “alternative” investments provides investment managers ample opportunities to charge excessive fees, carry out transactions on behalf of the pension on unfavorable terms, misuse assets, or even steal them outright. Worse still, the Treasurer has betrayed her fiduciary duty by entering into expansive agreements with Wall Street to keep the very details of their abuse of pension assets secret — including withholding information regarding grave potential violations of law.
Kickbacks, self-dealing, fraud, tax evasion and outright theft may be designated as confidential pursuant to the North Carolina Trade Secrets Protection Act, says the Treasurer.
On a more granular level, Cowell’s efforts to thwart disclosure have helped mask potential violations including, but not limited to the following: fraudulent representations related to the performance of alternative investments; concealment and intentional understatement of $400 million in annual alternative investment fees and expenses to date; concealment of approximately $180 million in placement agent compensation; the charging of bogus private equity fees; violations of securities broker-dealer registration requirements related to private equity transaction fees; securities and tax law violations regarding investment management fee waivers and monitoring fees; self-dealing involving alternative investment managers; mystery investor liquidity and information preferences, amounting to licenses to steal from TSERS; pension investment consultant conflicts of interest; predatory lending and life settlement related fraud.
Further, the Treasurer has invested billions of dollars of pension assets in North Carolina private equity funds and companies via an initiative with dubious economic prospects and which has the markings of political influence-peddling.
In our opinion, billions in TSERS investments can only be explained by the improper collateral benefits they provide to the Treasurer — as opposed to any supposed investment merit.
Absent reform, corruption of TSERS is likely to cost the state’s public workers and taxpayers billions more over the next few years and leave in place a system under which Cowell’s successors will compound the financial damage.
Today, TSERS assets are directly invested in approximately 300 funds and indirectly in hundreds more underlying funds (through fund of funds), the names, investment practices, portfolio holdings, investment performances, fees, expenses, regulation, trading and custodian banking arrangements of which are largely unknown to stakeholders, the State Auditor and, indeed, to even the Treasurer and her staff.
As a result of the lack of transparency and accountability at TSERS, it is virtually impossible for stakeholders to know the answers to questions as fundamental as who is managing the money, what is it invested in and where is it?
It is indisputable that TSERS’ disclosed investment management costs alone (i.e., not including the enormous hidden costs revealed in this report) have skyrocketed in recent years and are projected by the Treasurer to steeply climb. Investment risk has grown to a record crisis level. Performance of hedge funds, private equity and real estate alternative investments has been beyond bad — horrific — for over a decade. Pay-for-play and transparency reforms promised by the Treasurer have failed, year after year, to materialize — despite multiple costly expert reviews paid for by the pension.
Worse still, the Treasurer has refused to comply with a new state law, which specifically requires full disclosure of all direct and indirect pension investment management and placement agent fees.
Treasurer’s Lack of Transparency
Forensic investigations of pensions require access to evidence. Contrary to initial public statements by the Treasurer indicating a willingness to cooperate with our investigation, she has made conducting this review of potential violations of law on behalf of TSERS stakeholders far more difficult by withholding the overwhelming majority of the information we requested.
Throughout her tenure, the Treasurer has stated repeatedly in public that she is committed to transparency. In contrast, she has proved unwilling to disclose to the public even the minimum pension information required under state law. Further, her office has, in our opinion, released information regarding TSERS to the public that has often been left intentionally incomplete and made deliberately misleading.
It is also notable that the Treasurer has failed to disclose certain significant investment manager fee and performance data that even her oft-criticized predecessor, Richard Moore, had voluntarily provided.
All of the financial information we requested in connection with this investigation was readily available to Cowell and her staff and of obvious materiality to TSERS participants, taxpayers and investors.
Perhaps most disturbing, in response to our specific requests the Treasurer refused to disclose offering memorandum and other key documents (including information regarding millions in placement agent fees) related to TSERS’ costly, high-risk alternative investments, citing supposed “trade secret” concerns raised by the alternative managers.
Viewed from a regulatory and public policy perspective, the Treasurer’s practice of withholding relevant information and intentionally providing incomplete or inaccurate disclosures regarding TSERS investments results in: (1) concealing potential violations of state and federal laws, such as those detailed throughout this report; (2) misleading the public as to fundamental investment matters, such as the true costs, risks, practices and investment performance related to hedge, private equity, venture and real estate alternative investment funds; (3) understating the costs and risks related to TSERS investments specifically; (4) misrepresenting the investment performance and financial condition of the state pension to investors in state obligations.
As stated on the website of the SEC:
“The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.”
On the other hand, when state officials and pension funds, such as the Treasurer and TSERS, intentionally withhold or misrepresent basic facts regarding investments material to evaluating investments, the pool of knowledge all investors can rely upon becomes contaminated.
In our opinion, there is simply no reason participants in TSERS who rely upon the investment decisions made by the Treasurer for their retirement security, and other stakeholders, should be provided with unreliable investment information — afforded less protection under the state and federal securities laws — than investors in shares of public companies and mutual funds.
Nation’s Seventh Largest Public Pension Has No Audited Financials
Remarkably, there are no audited financial statements for TSERS, the seventh largest public pension in the nation. We are unaware of any other public pension that completely lacks financial statements audited by either an independent accounting firm or the State Auditor, or both. This represents a major material weakness in the State of North Carolina Comprehensive Annual Financial Report (“CAFR”) which is relied upon by ratings agencies, municipal bond holders and the federal government in providing assistance to states.
In our opinion the lack of audited financial statements for TSERS is indefensible. The limited financial information regarding TSERS which the State Auditor claims to have audited and which is included in the voluminous 300-page CAFR, is of minimal value and is almost certainly incomprehensible to stakeholders.
We found no evidence in the CAFR or elsewhere to suggest that the Treasurer or State Auditor is even aware of the myriad new risks facing TSERS, much less begun to focus upon the emerging critical issues related to alternative investments.
In our opinion, a stand-alone audit of TSERS which would improve oversight and management of pension investments, reveal deficiencies (including fraud and other malfeasance), and produce savings exponentially greater than any limited audit cost, is decades overdue.
Notably, Treasurer Cowell has expressed the opposite view, stating that a separate audit of TSERS would be cost-prohibitive.
We find this assertion to be absurd and recommend that the scope of any future stand-alone audit include responses to the specific stakeholder concerns we have identified in this report.
Treasurer’s Government Operations Reports Violate State Law
As required under relevant law, on a quarterly basis the Treasurer provides a report to the Joint Legislative Commission on Government Operations on the investment activities of the State Treasurer, including TSERS.
In our opinion, given the disorganization, misstatements and omissions therein, there is simply no way that the Joint Legislative Commission on Government Operations, or anyone else for that matter, could possibly monitor or evaluate TSERS investment activity and performance from the information included in these reports.
The incomplete performance information provided in the discussion and other sections in the Government Operations reports results in concealing significant underperformance against the relevant indexes that would be readily apparent if complete performance information were provided in the initial narrative section.
Effective August 2013, state law mandates full disclosure of all direct and indirect investment management and placement agent fees in the Treasurer’s Government Operations reports. Cowell has failed to supplement the Government Operations reports with the newly required information.
In connection with our forensic investigation, on March 17, 2014, we reported the Treasurer’s violations of this law to State Auditor Beth Wood and asked that her office immediately investigate.
A History of Pay-for-Play Abuses
Allegations of improper pay-for-play payments by money managers and other vendors retained by TSERS first emerged in 2005 and were the subject of an early 2007 Forbes article titled “Pensions, Pols, Payola.”
In 2009, the state’s chief pension investment officer was reportedly terminated for soliciting donations on behalf of a local charity. In 2012, campaign donations to Cowell from plaintiff class action and other law firms retained by TSERS surfaced.
Further, recent disclosures by the Treasurer confirm that at least since 2002, TSERS investment managers have been involved in another form of pay-for-play, i.e., paying tens of millions in compensation to influential secret placement agents that may not be properly registered under the federal securities laws.
The identity of all of the placement agents, their registration status and the amounts of the compensation paid, while known to the Treasurer, remain undisclosed to this day — despite repeated recommendations from investment and legal experts retained by the Treasurer to fully disclose them, and in violation of the new state law which mandates disclosure.
As discussed further below, we estimate a staggering $180 million in avoidable fees has been secretly squandered in payments to dispensable intermediaries for conflicted, unreliable investment advice.
Flawed Sole Fiduciary Governance Structure
The Treasurer is the sole fiduciary of TSERS funds. Along with Connecticut, Michigan, and New York, North Carolina is one of only four states with a “sole fiduciary” model for managing its public pensions.
All other states vest the fiduciary duty to oversee their retirement assets in a committee generally consisting of worker and retiree representatives, state officials and appointed members of the public, as opposed to a single individual.
There is longstanding, broad national consensus that the sole fiduciary structure is deeply flawed.
In January 2014, the Treasurer announced the creation of a supposedly independent, bipartisan commission (consisting of members hand-picked by her) to review the state’s governance structure for investment management. The Treasurer has retained the consulting firm of Hewitt EnnisKnupp-an Aon Company to provide supposedly independent, objective advice to the commission.
In our opinion, it is indisputable that elimination of the sole fiduciary structure should have been the premier priority once the Treasurer Cowell took office given the long history of abuses involving the Treasurer’s office. However, replacing it (as at least one of Cowell’s advisors has recommended), with an investment committee comprised of experienced investment professionals operating in secrecy — an arrangement riddled with potential conflicts of interest, utterly lacking transparency and accountability — is outrageous and blatantly disingenuous.
Public pension reform and secrecy are, in our opinion, fundamentally incompatible.Further, we believe the initial matters any such committee should immediately focus upon are the secrecy surrounding alternative investments and placement agents; hundreds of millions in undisclosed fees; the serious potential violations of law detailed in this report and, finally, the Treasurer’s motivations and actions related thereto.
TSERS’ Escalating High-Risk Alternative Investment Gamble
TSERS’ escalating historic high-risk alternative investment gamble began over a decade ago in 2001. Allegations of impropriety relate back to inception of the failed strategy. Despite recurring controversies and allegations of corruption surrounding the former and current state treasurers over the years, as well as intermittent reports of dismal performance, the state pension has continued to dramatically increase its allocation to alternatives from 0.1 percent to 35 percent today, adding tens of billions to these costly schemes that have been disastrous for TSERS.
Most often, the past and current Treasurer’s justification for increasing alternatives has been the greater returns alternative investments offer—returns that repeatedly have failed to materialize.
Treasurer’s “Experiment” Fails: A Decade of Soaring Fees to Wall Street Has Not Improved Performance
Early on in her tenure, the Treasurer defended shifting more and more pension assets to costly alternative managers, arguing that the hundreds of millions in additional fees to Wall Street would result in improved investment performance.
“We’ll be looking for if we’re paying higher fees for investments they better be performing and giving us a higher rate of return. Otherwise, it’s a failed experiment,” Cowell said.
The Treasurer’s candid admission that the TSERS historic high-risk gamble on alternative investments amounting to 35 percent of $87 billion, or over $30 billion, is an “experiment” is startling. The Treasurer should not be experimenting with tens of billions in state workers retirement savings; rather, as the sole fiduciary, she should be focused upon investing pension assets prudently.
However, even as of this date in 2010, the costly alternative investment experiment had already spectacularly failed — it had been severely underperforming for approximately eight years.
The Treasurer stated in 2010 that the “experiment is on a seven-to-ten-year cycle, and performance and fees will be weighed over that time frame.”
Twelve years after inception in 2002, the alternative investment experiment continues to cost the pension dearly and benefits only Wall Street.
Most important, there is no proof that alternative investments beat the market, as the Treasurer has repeatedly represented to the public. Indeed, possibly the world’s greatest investor, the Oracle of Omaha, Warren Buffet, six years ago wagered $1 million that hedge funds would not beat the S&P 500 over the next ten years. At this point Buffet is still handily winning. The North Carolina state pension is not.
Billions in Underperformance to Date – Worst Yet to Come
In stark contrast to recent statements by the Treasurer that the additional investment flexibility granted by the legislature to permit TSERS to increase alternative investments will improve performance, the investment performance history clearly reveals that TSERS’ alternative investments and the pension as a whole have performed poorly.
Over the past five years, under the Treasurer’s watch, TSERS has underperformed the average public plan by $6.8 billion.
Based upon the TSERS investment track record, it is highly likely, in our opinion, that increasing the allocation to high-cost, high-risk alternative investments that have consistently underperformed will result in billions greater performance losses, as well as approximately $90 million in additional disclosed fees paid to Wall Street money managers according to the Treasurer’s estimates.While Wall Street is certain to emerge as a winner under the Treasurer’s politically-driven alternative investment gamble, the stakeholders will, in our opinion, lose ever greater amounts due to rapidly escalating fees and plummeting net investment performance.
The Myth That Alternative Investments Provide Diversification and Reduce Risk
The Treasurer’s argument that high-cost, high-risk alternative funds reduce risk or provide diversification is deeply flawed. Since many of the alternative investment managers may invest a substantial portion of a fund’s capital in a single investment and substantially, or even completely, change their investment strategies at any time, there is no way TSERS can ensure that the alternative funds provide any meaningful portfolio diversification.Siedle's damning forensic report on North Carolina's pension is an eye opener for most people that are absolutely clueless of what really goes on at these large public pension funds. None of this surprises me as I've written on the secret pension money grab and North Carolina praying for an alternatives miracle (South Carolina isn't much better). Over the years, I've also written on abuses at public pension funds and have stuck my neck out plenty of times, most recently on how the media is covering up the Caisse's ABCP scandal.
Further, while the massive additional cost and underperformance of the alternatives at TSERS are apparent at this time, the amount of any potential downside protection afforded is unproven and unknown.
Thus, it is impossible for the Treasurer, consistent with her fiduciary duty, to determine that the known cost related to any supposed risk reduction is reasonable.
Massive Risk, Fiduciary Breaches and Violations of Law Revealed in Alternative Investment Documents
In order to assess the risks, potential fiduciary breaches and violations of law related to the hundreds of alternatives owned by TSERS, we reviewed the private placement offering memoranda related to certain of these investments.
A few of the offering documents we reviewed were provided by the Treasurer in response to our public records request. Other information the Treasurer refused to provide we obtained from independent sources, including the SEC.
The documents we reviewed indicate the alternatives are high-risk, speculative investments; the funds’ investments are highly illiquid subject to enormous valuation uncertainty; the offerings involve serious conflicts of interest regarding valuation of portfolios by the managers themselves and calculations of fees, as well as opportunities for self-dealing between the funds, the managing partners and their affiliates that may, in our opinion, violate state and federal law.
For example, a manager may make investments for his own account in the very same assets in which the fund he manages invests, on more favorable terms and at the expense of investors in the fund, including TSERS. Alternatively, in the event that an investment opportunity is available in limited amounts, the manager may simply seize the entire investment opportunity for himself — robbing investors in the fund he manages, in breach of applicable fiduciary duties.
Accordingly, we recommend further investigation by the SEC of such potential fiduciary breaches and violations of law.
Hedge and other alternative fund offering documents often reveal that investors, such as TSERS, are required to consent to managers withholding complete and timely disclosure of material information regarding the assets in their funds. Further, investors must agree to permit the investment managers to retain absolute discretion to provide certain mystery investors, i.e., industry insiders, with greater information and the managers are not required to disclose such arrangements to TSERS.
As a result, TSERS is at risk that other unknown investors in funds are profiting at its expense—stealing from the pension.
The identity of any mystery investors that may be permitted by managers to profit at TSERS’ expense, as well as any relationships between these investors, the Treasurer or other public officials, should be investigated fully by law enforcement and the SEC. Such arrangements amount to a license to steal from the state pension.
The alternative fund offering documents also generally provide that the funds will invest in portfolio companies that will not be identified to the investors prior to their investment in the fund. As a result, TSERS will not have any opportunity to evaluate for itself information regarding the investments in which the funds will invest. Since pension fiduciaries are required to know, as well as evaluate the assets in which they invest, in our opinion, such provisions render these investments unsuitable for fiduciary accounts.
TSERS alternative funds generally disclose a litany of risky investment strategies they may pursue such as short-selling; investing in restricted or illiquid securities in which valuation uncertainties may exist; unlimited leverage, as well as margin borrowing; options; derivatives; distressed and defaulted securities and structured finance securities.
Further, TSERS alternative investment documents reveal that managers may engage in potentially illegal investment practices, such as investing in loans that may violate the anti-predatory lending laws of “some states” and life settlement policies which give rise to lawsuits alleging fraud, misrepresentation and misconduct in connection with the origination of the loan or policy. In our opinion, an investigation should be undertaken by the SEC into the investment strategies of the alternative funds, as well as any underlying funds, to determine whether any violations of law exist.
Unlike traditional investments, the alternative funds in which TSERS may invest may be managed by investment advisers not registered with the SEC under the Investment Advisers Act of 1940. Further, the funds themselves are not registered as “investment companies” under the Investment Company Act of 1940. As a result, the limited partners lack many meaningful protections of those statutes.
There is no evidence the Treasurer, or the State Auditor, is aware of, or has ever considered, the unique risks related to the lack of these statutory protections.
Alternative investment funds that are incorporated and regulated under the laws of foreign countries, present additional, unique risks which pension fiduciaries must consider. Further, since TSERS’ alternative investment assets are held at different custodians located around the world, as opposed to being held by TSERS’ master custodian, the custodial risks are heightened and should be considered and disclosed to the public.
There is no evidence the Treasurer, or the State Auditor, is aware of, or has ever considered, the unique risks related to foreign regulation and custody of alternative funds. Further, based upon our conversations with the State Auditor, only the Treasurer knows whether the alternative investment funds are, in fact, audited annually — as represented in the state CAFR.
Our forensic investigation into specific potential violations of law we identified involving the hundreds of private equity investment funds in which TSERS invests was severely hampered by the Treasurer’s repeated refusal to provide the documents we requested.
In light of a recent internal review by the SEC indicating that more than half of approximately 400 private-equity firms the SEC staff examined charged unjustified fees and expenses without notifying investors, we requested documents related to such potential violations of the securities laws from the Treasurer. Our request was denied.
Accordingly, in our opinion, whether any of the hundreds of TSERS private equity funds have been charging “bogus” fees to portfolio companies in violation of the federal securities laws is a matter that should be referred to the SEC for further investigation, as well as potential refund to TSERS of its share of any fees improperly charged.
In light of recent SEC whistleblower allegations that private equity firms have been violating securities laws by charging transaction fees without first registering as broker-dealers with the SEC, we requested information regarding such potential violations of the securities laws from the Treasurer. Our request was denied.
Accordingly, in our opinion, whether any of the hundreds of TSERS private equity funds have been charging transactions fees in violation of the securities laws is a matter that should be referred to the North Carolina Secretary of State Securities Division and the SEC for further investigation, as well as potential refund to TSERS of its share of any transaction fees illegally charged.
In light of whistleblower claims that have been filed with the IRS alleging that hundreds of private equity so-called monitoring fees paid by private equity owned portfolio companies are being improperly characterized as tax-deductible business expenses (as opposed to dividends, which are not deductible), costing the federal government hundreds of millions of dollars annually in missed tax revenue, we requested information regarding such potential violations of federal tax law from the Treasurer. Our request was denied.
Based upon our preliminary research it appears that at least three monitoring agreements involving a single TSERS private equity fund may be suspect to re-characterization by the IRS.
Given the hundreds of other TSERS private equity fund investments and hundreds of suspect monitoring fees identified by credible whistleblowers, it seems virtually certain that additional violations of tax law exist with respect to TSERS private equity investments.
Accordingly, in our opinion, whether any of the hundreds of portfolio companies owned by TSERS private equity funds have been improperly characterizing monitoring fees as business expenses in violation of the Internal Revenue Code and costing the federal government hundreds of millions annually in tax revenue is a matter that should be referred to the IRS and SEC for further investigation.
Since the IRS in recent years has been examining the propriety of private equity management fees waivers, which have allowed many fund executives to reduce their taxes by converting ordinary fee income into capital gains taxed at substantially lower rates, costing the federal government billions of dollars annually in missed tax revenue, we requested information regarding potential violations of tax law related to these waivers from the Treasurer. Our request was denied.
Accordingly, in our opinion, whether any of the TSERS private equity funds have been complicit in allowing their managers to improperly convert ordinary fee income into capital gains is yet another matter that should be referred to the SEC and IRS for further investigation.
Treasurer Conceals Investment Fees Will Skyrocket to $1 Billion
While the Treasurer has a fiduciary duty to ensure that fees TSERS pays money managers for investment advisory services are reasonable, as well as a statutory duty to disclose all direct and indirect investment and placement agent fees, she has failed to monitor and disclose all fees paid by TSERS.
The Treasurer has withheld from public disclosure a massive portion of the fees and expenses related to alternative assets, resulting in the dramatic understatement of fees, expenses and risks related to these investments, as well as TSERS as a whole.
In a letter dated February 27, 2014, we notified Cowell that based upon our preliminary review of the limited information provided in response to SEANC’s public records request, it was apparent that the Treasurer had failed to disclose a significant portion of the hedge fund and alternative investment manager fees paid by TSERS to money managers. Indeed, it appeared that the massive hidden fees she failed to disclose in many instances dwarfed the excessive fees disclosed to us.
The limited investment fee information provided by the Treasurer indicates that disclosed fees have skyrocketed over 1,000 percent since 2000 and have almost doubled since FY 2008/2009 from $217 million to $416 million. In the past fiscal year alone, disclosed fees have climbed from $295 million to $416 million — a staggering increase of more than over 40 percent.
Worse still, according to Cowell, annual investment fees are projected to increase about 10 basis points—another almost $90 million—due to the allocation away from low-cost internally managed fixed income to high-cost, high-risk alternative funds managed by Wall Street.
In summary, the total investment fees as disclosed by the Treasurer are projected to climb to over $500 million.
Unlike traditional investments, such as stocks, bonds and mutual funds, alternative investments are opaque and subject to myriad hefty fees.
Based upon our limited review of TSERS’ investments, we estimate total undisclosed fees will comparably climb to approximately $500 million.
Thus, we estimate total TSERS annual fees and expenses will amount to approximately $1 billion in the near future — almost twice the figure projected and disclosed by the Treasurer.
The increase of disclosed fees in 2013 to $416 million, while alarming, is a gross and intentional understatement by the Treasurer, in support of her failed alternative investment strategy. In our opinion, if the magnitude of the formidable undisclosed fees related to TSERS alternative investments were acknowledged, public acceptance of the Treasurer’s high-risk, underperforming investment gamble would wane.
Past and Present Placement Agent Abuses at TSERS
While Treasurer Cowell publicly acknowledged the importance of adopting a pay-for-play and placement agent policy in 2009, disclosure has not meaningfully improved during her tenure. Further, her investigation of placement agent abuses has languished for the past five years. Placement agent controversies remain profoundly unresolved.
Rather than promote transparency and accountability regarding placement agent usage at TSERS, the record reveals that the Treasurer has intentionally withheld, as well as sought to thwart the release of, damning placement agent information since taking public office.
Cowell did not disclose to the public in May 2009, or at any time subsequent, that she had received a SEC Letter of Inquiry regarding placement agents at TSERS. Worse still, she requested that neither the cover letter nor any other documents provided by her in connection with the SEC Inquiry be released by the SEC to the public in response to a request under the federal Freedom of Information Act. Cowell even asked to be given at least ten days prior notice and an opportunity to object to the Commission to the granting of any Freedom of Information Act request and, if necessary, to seek an appropriate protective order in the courts.
Despite repeated requests from the SEC, the Treasurer failed to disclose even a single placement agent payment amount in 2009.
In April 2010, the consulting firm of EnnisKnupp retained by Cowell recommended that to promote transparency and accountability, details regarding placement agent compensation be posted on the Treasurer’s website for disclosure to the public.
While the Treasurer’s Office implemented certain of EnnisKnupp’s recommendations, it did not and still has not implemented this key recommendation regarding public disclosure of placement agent compensation called for by best practices, according to Ennis.
Worse still, the Placement Agent Policy adopted by the Treasurer in 2009 expressly permits an investment manager or placement agent to designate as a trade secret under North Carolina law the placement agent identity, services and compensation. Cowell has refused to disclose millions in TSERS placement agent payments, claiming trade secrets.
In 2013, the law firm of Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., hired by the Treasurer to review certain placement agent matters, in its Final Report called upon Cowell to disclose placement agent compensation amounts on the Treasurer’s website — as originally recommended in 2010 by EnnisKnupp and ignored by her for more than three years.
To date, the placement agent fee amounts paid by each TSERS manager and the total amount of placement agent compensation have not been disclosed to the public on the Treasurer’s website, or anywhere else.
The incomplete information provided to the public regarding placement agents on her website is so disorganized and unreliable that it can only confuse and mislead the public, in our opinion. Further, as a result of Cowell’s willingness to permit managers to designate certain placement agent fees as secret, the fees disclosed are obviously understated.
Assuming that the Treasurer has enforced compliance with the placement agent policy (which requires disclosure of the fees paid to her), the relevant information is readily-available — indeed already known to her.
According to statements attributed to the Treasurer, a staggering 50 percent of TSERS managers pay placement agent fees that range from 1 percent to 2 percent.
Our investigation reveals that TSERS placement agent percentages alone, in fact, range as high as 3 percent. In addition to the percentage fees, there are monthly retainers, expenses and discretionary bonuses included in the agent’s total compensation. We have not factored these amounts, which may be significant, in our estimate below.
It appears that for the past five years Cowell has intentionally withheld from public scrutiny arguably the most significant information regarding placement agent fees — the fact that TSERS has secretly squandered a staggering estimated $180 million in avoidable fees to dispensable intermediaries for conflicted, unreliable investment advice.
Due to the highly significant amounts secretly paid for questionable so-called investment services and the Treasurer’s apparent unwillingness to disclose such placement agent compensation amounts to stakeholders — even as required under state law — we recommend that further investigation by the SEC is needed at this time.
Dubious North Carolina Nexus Investments and Influence-Peddling
A significant portion of TSERS’s alternative investments, including but not limited to the North Carolina Innovation Fund and the other Credit Suisse/North Carolina funds, are invested in private equity funds and companies that are based in North Carolina. Both the current and prior Treasurer have/had policies giving preference to local funds and enterprises.
Pension policies targeting local businesses give rise to heightened concerns regarding potential improper relationships between locals and pension decision-makers that may result in imprudent investments.
In our opinion, many of the local private equity funds and companies in which TSERS has invested clearly lacked the requisite relevant experience and track records generally required by pensions. Not only did TSERS “seed” many of these funds and businesses apparently lacking merit, it continued to leave substantial assets at risk in them long after, in our opinion, it became apparent that their services were uncompetitive.
In our opinion, an investigation by law enforcement and the SEC into the facts and circumstances regarding many of the North Carolina nexus investments should be undertaken and would reveal imprudent decision-making based upon improper relationships, as well as outrageous profiteering.
Treasurer’s Heavy Reliance upon Troubled Credit Suisse
Clearly, Credit Suisse, a firm which has a significant presence in North Carolina in the form of 1,000 employees based in the Research Triangle Park has had a substantial, complex, secretive and highly lucrative relationship with both the current and past Treasurer. Due to the variety of investment services provided, the relationship is fraught with myriad potential conflicts of interest. Further, the firm’s management of investment funds that target North Carolina enterprises is a pivotal, potentially politically sensitive assignment.
In our opinion, in light of the TSERS’s longstanding heavy reliance upon Credit Suisse — a firm involved in numerous grave regulatory controversies globally at this time; the variety of services the firm provides and the myriad potential related conflicts of interest — further investigation of the relationship between the Treasurer, TSERS and the firm by the SEC is merited at this time.
We note that with respect to the majority of alternative investments made by TSERS where the investment managers involved have been permitted to designate the compensation arrangements involving millions of dollars they have entered into with placement agents as “trade secrets” under North Carolina law, Credit Suisse Securities is the named placement agent receiving the secret compensation.
Importantly, while 60 Minutes plugs Michael Lewis' new book and goes after ratings by claiming the U.S. stock market is rigged, the real wolves of Wall Street are thriving, raping large public pension funds on fees. Wall Street has license to steal and plenty of large and powerful private equity and hedge funds are feasting on the pension pig. And they will keep feasting and milking that cash cow dry until there's literally nothing left.
Now, I don't agree with Siedle's characterization of alternative investments as inherently risky. I've seen plenty of smart pension funds, including the great Ontario Teachers, get clobbered on their illiquid hedge fund investments, but that doesn't mean that these investments should be shunned for "less risky" liquid traditional investments.
What I do advocate for, however, is radical transparency at public pension funds, the type that would make the hair on Ray Dalio and Steve Schwarzman's neck stand up. I think laws should be passed forcing all public pension plans around the world to publicly disclose who they are investing with, how much and what are the terms of each of their investments in public and private markets.
I also think public sector unions across the North America should contact Ted Siedle's firm, Benchmark Financial Services, and conduct a thorough and exhaustive forensic investigation of their public pension plan. I say North America because there are shenanigans going on everywhere, including here in Canada, but people remain absolutely clueless. Admittedly, the worst abuses are going on in the United States where the main problem with public pensions remains the lack of proper governance, feeding the Matt Taibbis of this world who love to sensationalize the looting of pension funds.
Below, North Carolina State Treasurer Janet Cowell on the challenges in maintaining public sector pensions (April, 2013). Maybe she should discuss how she is enriching her rich and powerful alternative investment donors, draining her state's pension fund of billions which taxpayers will have to cover in the future. What a scam, more evidence of the real pension Ponzi and Wall Street's license to steal.