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Problems Relating to Secret Local Govt Pension Fund Agreements with Private Equity Firms
Monday, October 20th, 2014
Robert Wechsler
Gretchen Morgenson's investigative piece in yesterday's New York Times
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.
Covering General Partners' Litigation Settlements
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.
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.
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.
Fiduciaries Signing Away Fiduciary Duties
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.
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.
Solutions
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.
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.
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.
Robert Wechsler
Director of Research-Retired, City Ethics
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Covering General Partners' Litigation Settlements
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.
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.
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.
Fiduciaries Signing Away Fiduciary Duties
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.
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.
Solutions
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.
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.
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.
Robert Wechsler
Director of Research-Retired, City Ethics
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