making local government more ethical

Is It a Conflict for a Pension Fund's Investment Officer to Propose Outsourcing to His Firm?

After all the problems San Diego pension boards have had with conflicts of interest (see my blog post from November 2009), one would think they would be extra-sensitive to further conflicts. But, alas, not in this case.

Last September, the San Diego County Employees Retirement Association (SDCERA) chose to replace its unsuccessful investment officer not with another investment officer, but with an unbid contract to Lee Partridge, for substantially more money (see SDCERA's press release). The catch was that the outsider could not supervise SDCERA's investment employees.

To resolve that problem, according to a recent San Diego Union-Tribune article, Partridge recommended that SDCERA outsource its entire investment program to his company, Integrity Capital, once again on a no-bid basis, with incentives for performance better than market, and with all the downside risk to be taken by SDCERA.

A county supervisor on the pension board suggested there might be a conflict of interest. According to another Union-Tribune article, the board's attorney "said he'd analyzed relevant laws and acknowledged that a perceived conflict may exist, but that none had yet occurred. He said no legal issues would prohibit the board from picking (and paying) Partridge to lead the outsourced investment team." The attorney added, "I think now's not the time to get into a detailed discussion of the legal issues."

It seems that all the elements of a conflict already exist. An individual is acting as a pension board investment officer and yet is pushing a contract by which the same board would outsource its entire investment program to him. What element of a conflict does not yet exist?

As it turns out, another pension board member successfully questioned the no-bid aspect of the outsourcing, and a compromise was reached:  a board subcommittee would select other investment firms to make bids. Not an open competitive bid, but not a no-bid situation.

But can board members who strongly favor someone they already have a close relationship with make a decision on whom to allow to bid and whom to choose that will truly be in the public interest and be seen to be in the public interest? SCERA's CEO "said he believed Partridge was still the top option but allowed the possibility that another firm could be chosen. 'We'll get them in here and make a proposal and compare them to Lee's,' White said. 'At a minimum, it'll validate that Integrity is the best. And if not, we'll select someone else.'"

Ordinarily, outsourcing is intended to save money. But in this case, it appears that, as with the hiring of Partridge at a salary far higher than the stated county salary, a principal goal seems to be to pay people more. According to yet another Union-Tribune article, a trustee for the city's retirement system said, “I have no idea why they did what they did. If I was on that board I would have argued against it and voted against it. I don’t think it’s going to save any money.”

And yet the vote was 7-1 in favor of the plan.

Since everyone considers Integrity Capital to be the best answer to the county's pension investment needs, I looked it up to see who its other clients are. I couldn't find it, nor any links to it. There's Integrity Capital in Palo Alto, a wealth management firm. There's Integrity Capital LLC in Scottsdale, AZ, a commercial mortgage firm. There's even Integrity Capital, Inc. in San Diego, a real estate lender. There's Integrity Capital Corp. in Cranford, NJ, which does home loans, and there's Integrity Capital Partners in Bethesda, MD, a life insurance company.

Clearly, Partridge's Integrity Capital is not trying to create much of a public reputation.

Partridge might very well be the best man for the job. But his involvement in the plan to move SDCERA's investment staff to his firm has tainted the entire process. And the attitude of SDCERA's CEO and of its attorney have further made the plan look improper. No one could believe that SDCERA could make an unbiased decision in the public interest about who benefits from a plan put together by the leading candidate for the contract, even if a few selected others are allowed to make proposals consistent with Partridge's.

Not only does a conflict exist, but it is a difficult conflict to fix unless, of course, Partridge took himself out of the running. Barring that, I think that either the plan should be shelved, or an individual or board completely independent of SDCERA should decide who wins the contract, and it should be open to anyone who wants to bid.

A parting note: we all can profit from the name of Partridge's firm: integrity is capital. Investing in it pays off with interest. Conflicts undermine value and should be avoided.

Robert Wechsler
Director of Research, City Ethics