Problems Relating to Secret Local Govt Pension Fund Agreements with Private Equity Firms
<a href="http://www.nytimes.com/2014/10/19/business/retirement/behind-private-eq…; target="”_blank”">Gretchen Morgenson's investigative piece in yesterday's New York <i>Times</i></a>
is extremely disturbing. According to her research, local and state government
pension funds have taken huge risks, and then allowed them to be
hidden from the public, by signing agreements with private equity
firms that make their terms confidential, including (1) their high fees and
questionable clawback provisions, (2) their provisions for investors
to be charged for litigation losses or settlements by the equity
firm, and sometimes (3) provisions allowing equity firm general
partners to not have a fiduciary duty to the pension funds.<br>
<br>
<b>Covering General Partners' Litigation Settlements</b><br>
Morgenson focuses on one costly example where No. 2 and No. 3 came into
play. With respect to No. 2, a buyout fund started in 2004 reached a
$115 million settlement of a suit that its insurance policy didn't cover, so investors
will have to. These investors include several local and state pension funds (many state funds administer local pension funds). No one outside the pension funds,
including their beneficiaries, not to mention taxpayers who will
have to make up for shortfalls, knew this was a possibility.<br>
<br>
When asked for copies of their agreements with equity firms, pension
funds said the agreements were confidential, because that's the way
equity firms wanted them to be. The firm argued, "These are
voluntarily negotiated agreements between sophisticated investors
advised by skilled legal counsel." The pension funds' argument is
that the firms wouldn't let them invest if they didn't sign a
confidentiality statement. That doesn't sound very "sophisticated"
to me. It's not as if the pension funds couldn't have used their
associations to discuss the issue, and make a joint announcement that
they would not sign any confidentiality statements, because they are required to act transparently.<br>
<br>
One of the most fascinating things about Morgenson's article is that
she somehow got hold of an agreement, and describes some of its most
damaging provisions.<br>
<br>
<b>Fiduciaries Signing Away Fiduciary Duties</b><br>
With respect to No. 3, the suit that was settled (it included several
other private equity firms) involved allegations that the firms had
"colluded to suppress the share prices of companies they were
acquiring." In other words, they were not fulfilling a fiduciary
duty to their investors, the way mutual funds and just about every
other fund is required to do.<br>
<br>
One reason this could happen is that, apparently with the approval
of "skilled legal counsel," pension fund officials, who have a
fiduciary duty to both beneficiaries and taxpayers, secretly
undermined their own fiduciary duty by agreeing that the private
equity firms might not have a fiduciary duty to them and their
beneficiaries.<br>
<br>
<b>Solutions</b><br>
First of all, it should not be up to pension funds to decide whether
or not to make their agreements public, nor to agree to a
confidentiality statement. Any official or attorney who agrees to
such confidentiality or tries to block an FOI request should be
removed from their office or job. Any official or attorney who
approved the confidentiality of the agreements involved in the suit
should admit it publicly, apologize to the public, and take full
responsibility (administrative, not fiscal) for any monies paid by
the funds pursuant to these suits, not to mention any losses
potentially caused by the conduct that was the subject of the suit.<br>
<br>
Rules must be changed. Either the local legislative body or an
independent auditor or comptroller should have to publicly approve,
after a public hearing with a written comment period, any
confidentiality provision, any signing away of fiduciary duty, and
any fee, clawback or other provision that may cut into a pension fund's
returns. Preferably, pension funds should join together in refusing
to sign such provisions.<br>
<br>
If private equity firms know that confidentiality, fee, and
fiduciary duty provisions will be publicly discussed, they will be
much less likely to ask for them. If they truly believe it's not
worth the trouble, they can exclude public pension funds and take
the chance that this will undermine the trust other customers place
in them. I don't think they'd want to take this chance.<br>
<br>
Robert Wechsler<br>
Director of Research-Retired, City Ethics<br>
<br>
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