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Will Pension Funds Have to Foot Bill For PE Firms in Collusion Settlement?

In September, seven investment firms ended a years-long lawsuit by agreeing to a $590 million settlement with corporate shareholders who were accusing the firms of colluding to keep prices down during the “buyout boom”.

But for pension funds, the ramifications of the settlement are just beginning as they wonder how the costs of the settlement will be divided among the investment firms and their limited partners.

From the Wall Street Journal:

The California State Teachers’ Retirement System is in ongoing discussions with private equity firms involved in a collusion case about how the costs of the settlements will be shared with limited partners, said Christopher J. Ailman, the pension system’s chief investment officer.

At the center of these discussions is where the responsibility for making the settlement payments lies–in the funds from which the firms made the investments or the firms themselves–and if both are responsible, how the payments and related legal fees should be split.

“That’s still being discussed,” said Mr. Ailman. “Different firms are taking different tacks.”

[…]

Mr. Ailman called the suit “frustrating” and blamed the case on the practice of frivolous lawsuits being made against corporate acquirers.

“It’s disappointing that there are still lawyers chasing after these funds,” said Mr. Ailman, adding that the collusion suit, “in particular, is frustrating because we think it’s without merit.”

Mr. Ailman said that in general, fund documents stipulate clearly that any legal expenses related to fund investments should be covered by the fund. But that shouldn’t entirely absolve the private equity firm that manages the fund because as the general partner, the firm has a fiduciary duty toward its investors.

“I always say to my GPs that ‘What’s written there is the bottom-line agreement,’” said Mr. Ailman. “‘We [also] shook hands and have an intellectual agreement. You are my agent. You are the fiduciary to us. We invest together.’”

More background on the settlement, from the WSJ:

The lawsuit, filed by certain shareholders of companies that were acquired during last decade’s buyout boom, alleged that the firms-Blackstone Group, Kohlberg Kravis Roberts & Co., TPG Capital, Carlyle Group, Bain Capital, Goldman Sachs Group Inc. and Silver Lake-colluded to keep prices down while bidding for companies during that time frame.

By early September, all seven firms had settled with the plaintiffs, ending a seven-year litigation process and making the firms liable for a total of $590.5 million in settlement payments.

All the firms in the lawsuit denied wrongdoing and said they decided to settle the case to avoid further distraction and litigation expenses.

Pension Funds: Hedge Funds Should Meet Benchmarks Before Charging Fees

Pension funds and other investors called for changes Tuesday in the way hedge funds charge fees.

The proposed changes were outlined in a statement by the Alignment of Interests Association (AOI), a hedge fund investor group to which many pension funds belong.

The group said that hedge funds should only charge performance fees when returns beat benchmarks, and that fee structures should better link fees to long-term performance.

More details from Bloomberg:

The Teacher Retirement System of Texas and MetLife Inc. are among investors that yesterday called on managers to beat market benchmarks before charging incentive fees in a range of proposals that address investing terms. Funds should base performance fees on generating “alpha,” or gains above benchmark indexes, and impose minimum return levels known as hurdle rates before they start levying the charges, said the Alignment of Interests Association, a group that represents investors in the $2.8 trillion hedge fund industry.

“Some managers are abiding by the principals to some extent but we are hoping to move everyone toward industry best practices,” said Trent Webster, senior investment officer for strategic investments and private equity at the State Board of Administration in Florida. The pension plan, a member of the association, oversees $180 billion, of which $2.5 billion is invested in hedge funds.

[…]

To better link compensation to longer-term performance, the AOI recommended funds implement repayments known as clawbacks, a system in which incentive money can be returned to clients in the event of losses or performance that lags behind benchmarks. The group said performance fees should be paid no more frequently than once a year, rather than on a monthly or quarterly basis as they are at many firms.

AOI also called on the hedge fund industry to lower management fees – or make operating expenses more transparent so higher management fees can be justified. From Bloomberg:

Management fees, which are based on a fund’s assets, should decline as firms amass more capital, the investor group said.

“We need good managers, not asset gatherers,” Webster said. “The incentives are currently skewed.”

[…]

Firms should disclose their operating expenses to investors so they can assess the appropriateness of management fee levels, the group said.

“Management fees should not function to generate profits but rather should be set at a level to cover reasonable operating expenses of a hedge fund manager’s business and investment process,” the AOI said.

The fees should fall or be eliminated if a manager prevents clients from withdrawing money, according to the group.

Hedge funds typically utilize a “2 & 20” fee structure; but in the second quarter of 2014, hedge funds on average were charging “1.5 & 18”.

Photo by TaxRebate.org.uk via Flickr CC License

Brazil Fines Pension Fund Over Board Voting Violation

Brazil’s securities regulator fined one of the country’s largest pension funds Tuesday for violating rules regarding the election of board members of Brazilian companies in which the pension fund is invested.

Reuters reports:

Brazil’s securities industry watchdog CVM fined late on Tuesday the pension fund owned by workers of state-controlled oil producer Petróleo Brasileiro SA (PETR4.SA) for participating on the election of board and fiscal council members that was reserved only for minority shareholders.

In a statement, the CVM imposed total fines of 800,000 reais ($311,700) on Petros, as the fund is known. The watchdog also issued warnings to but did not fine the workers’ pension funds of state-run banks Banco do Brasil SA (BBAS3.SA) and Caixa Econômica Federal SA [CEF.UL] for the same cases.

The decision underpins the mounting conflict of interest between pension funds like Petros and the government, which joined forces in recent years to boost their decision-making power in Petrobras, as the oil producer is known, at the expense of minority shareholders.

[…]

While funds belong to workers in those state-run companies, their management is usually tapped among union members with strong ties to the government.

The hefty stakes that Previ, Petros and other funds in state companies have amassed in a handful of Brazilian companies for years allow them to appoint board members and key personnel.

Petros and the other two funds, known as Previ and Funcef, respectively, can appeal the CVM decision before the National Monetary Council – which is Brazil’s highest economic policy-making body.

Petros is Brazil’s second-largest pension fund.

CalSTRS Commits $290 Million to European Real Estate Funds

CalSTRS has committed $293 million to two funds that invest in European real estate. The moves are part of the pension fund’s planned third quarter real estate commitment of $900 million.

Details on the investments from IPE Real Estate:

Commitments of $200m and €75m were made to TCI Fund Management’s Real Estate Partners Fund I and Meyer Bergman European Retail Partners, respectively.

The investment in TCI Fund I, which invests in first mortgages backed by trophy assets in Western Europe and the US, has been placed into CalSTRS’s core portfolio.

CalSTRS said the assets backing the mortgages were the key appeal, alongside the income-producing potential of the strategy.

Net IRR for CalSTRS’s core assets is between 6% and 8%.

The commitment from CalSTRS represents 25% of TCI’s targeted $800m capital raise.

CalSTRS’s view that there is a strong market opportunity for European value-add retail was behind its decision to back Meyer Bergman.

The pension fund also cited a lack of available new development in Western Europe.

The fund will target Germany, France, the Nordics and the UK.

The two commitments, part of $900m approved for real estate during the third quarter, come alongside a $100m allocation to Pramerica Real Estate Investors’ PRISA II open-ended fund.

The $6.5bn fund has an income-generating core component and a non-core, build-to-core and lease-up component.

CalSTRS, with assets of $187 billion, is the second-largest public pension fund in the United States.

Photo by Stephen Curtin

Do Public Pensions Need Federal Regulation?

The federal law ERISA – the Employee Retirement Income Security Act of 1974 – regulates many aspects of private pension plans.

Should public pension funds be beholden to similar federal regulation? Alicia H. Munnell of the Center for Retirement Research explored this issue in a recent column published on MarketWatch.

Munnell writes:

In a recent meeting, an expert very supportive of public-sector employees raised the question of PERISA. These initials are shorthand for federal regulation of state and local pension plans—essentially extending some or all of the Employee Retirement Income Security Act of 1974 (ERISA), which covers private-sector retirement plans, to the public sector.

I had not thought about such legislation since the early 1980s, and am not sure how I feel about it. On the one hand, proposals these days with regard to federal regulation tend to have a punitive tone—focusing mainly on getting public plans to stop using excessively high discount rates. On the other hand, serious underfunding in some plans is usually the result of delinquent behavior on the part of the sponsor.

So some regulation might be helpful, particularly now that the Governmental Accounting Standards Board (GASB) has clarified that its financial reporting standards do not constitute funding policy guidance, leaving a vacuum when it comes to public pension funding policies. But it is not clear that federal legislation could actually include funding requirements.

Munnell explores the origins of ERISA, and the reasons the federal law wound up covering private plans:

Here’s what I remember from the old days. Originally, governmental plans were included along with private plans in the legislative proposals leading up to the passage of ERISA. In the end, Congress exempted public plans from the Act and instead mandated a study of retirement plans at all levels of government to determine: 1) the adequacy of existing levels of participation, vesting, and financing; 2) the effectiveness of existing fiduciary standards; and 3) the necessity for federal legislation. The study concluded that serious problems existed and that federal regulation was necessary.

The experts believed that the federal government had the constitutional authority under the Commerce Clause of the Constitution to regulate reporting, disclosure, and fiduciary standards of state and local plans. On the other hand, the imposition of funding standards might affect the fiscal operations of state and local governments in a way that could threaten the sovereignty of the states. Hence, early legislative efforts omitted any funding regulation.

Some form of public plan legislation was introduced in each of the next four Congresses. While reporting, disclosure, and fiduciary standards may sound dull and routine, the proposed federal regulation met with passionate opposition during its long legislative history in the early 1980s. Opponents claimed that most public plans were under large systems that were generally well managed, and the public sector had not seen the flood of participant complaints witnessed in the private sector. Supporters contended that major reporting and disclosure deficiencies still existed and that the problems would persist since a major conflict of interest often exists between the goals of elected officials and sound financial management. In the absence of adequate reporting and disclosure, public officials could grant generous benefit increases and shift the costs to future taxpayers.

The two sides battled it out for several years but, in the end, no legislation was enacted for the federal regulation of state and local plans. My sense at this point, three decades later, is that federal regulation would be useful given the importance of state and local plans to the economy and the well-being of millions of workers. But the effort to pass such a bill would be worthwhile only if the legislation included funding requirements. And only the lawyers know whether funding requirements could pass constitutional muster.

Read Munnell’s entire piece here.

Jury Will Hear Rhode Island Pension Lawsuit; Trial Set for April

A Rhode Island judge sided with the state on Tuesday when she ruled that a jury will hear the lawsuit over the state’s 2011 pension reforms.

More details from WPRI:

Taft-Carter said that while she disagreed with state lawyers’ arguments that they had a constitutional right to a jury trial in the pension case, she would use her discretion to grant a jury trial in light of what she said is the Rhode Island Supreme Court’s long-stated preference for using juries.

“Being mindful of the importance of a jury trial in this country, and our Supreme Court’s expressed preference in favor of having questions of facts to be tried before a jury even where equitable claims are involved, the court is satisfied that these cases should be properly tried before a jury,” Taft-Carter said from the bench.

[…]

R.I. Superior Court Judge Sarah Taft-Carter read her lengthy decision about the jury trial from the bench Tuesday morning at Newport County Superior Court, where she is currently assigned to hear cases. She announced the trial date after conferring with lawyers from both sides in a closed-door status conference.

At stake is whether Rhode Island legislators acted constitutionally three years ago when they reduced future retirement benefits to shave roughly $4 billion off the shortfall in the state’s pension fund for government workers and taxpayers.

Reactions from lawyers on both sides of the case:

John Tarantino, a lawyer for the state, said he was pleased by Taft-Carter’s decision but that it was too early to say when jury selection would take place or how many jurors there would be. “We think a jury should decide it,” he told reporters. “I’m a big believer in jury trials.”

Lawyers for the union plaintiffs declined to comment on the state’s legal victory Tuesday.

[…]

Tarantino and the other lawyers representing Gov. Lincoln Chafee and General Treasurer Gina Raimondo argued in court filings that the state, as a defendant, has a constitutional right to a jury trial and should be allowed to have jurors decide the case, rather than just Taft-Carter ruling on her own. The lawyers representing the unions and retirees opposed the idea, saying it didn’t fit the legal issues at hand.

The state’s 2011 pension reforms were especially controversial because they applied to all workers and retirees, not just new hires.

Video: Public Pension Issues in 2014 and Beyond

This presentation, Public Pension Issues in 2014 and Beyond, was given by Paul Angelo at the 2014 CSG National Conference. Angelo is the Senior Vice President and Actuary for Segal Consulting

The video description reads:

Shortfalls in state-run retirement systems continue to grow, and in the 2012 fiscal year, the gap between promises to state workers and funding in the accounts reached $915 billion. Unfunded pension obligations can have significant implications for a state’s fiscal stability, including lower credit ratings, increased borrowing costs and the diversion of state resources away from other spending priorities like infrastructure and education.

New Chicago Treasurer Aims to Invest Pension Money Locally

Chicago treasurer Kurt Summers was sworn into office this week and quickly unveiled plans to increase the amount of pension money that goes toward Chicago-based investments.

His plans, from the Sun-Times:

[Summers] wants to hold an annual investor conference for the 200 fund managers who already get Chicago’s money and for hundreds more who desperately want a piece of the $50 billion pie.

At that conference, local entrepreneurs, many of whom have trouble getting access to capital to fund their innovative ideas, will get a chance to present their ideas to make the case for investment.

If Summers has his way, the city’s investment decisions will be based, in large part, on how much of the money is being invested in Chicago neighborhoods.

“We’re gonna bring them to Chicago. We’re gonna show them Chicago entrepreneurs and businesses and neighborhoods. And we’re gonna use our own capital. We’re gonna walk the talk, basically, and look to invest in Chicago,” said Summers, who is running unopposed in the Feb. 24 election.

“Today, we’re basically investing anywhere else but Chicago. And we’re telling the rest of the world that we don’t think Chicago is a worthy investment for our portfolios. That’s not the message we want to send. We’re also telling people in Chicago that we’d rather put our money anywhere else in the world but here. And that’s also not the message we want to send. We’re gonna change that.”

When Chicago starts making local investments a priority, Summers said he’s convinced that “the market will follow,” bringing tens of millions of dollars in capital to Chicago neighborhoods.

“We begin by asking the question of every manager that invests with us what their process is for evaluating Chicago investments,” he said.

“In every RFP and every investment management discussion … every board vote, they’re gonna be asked that question. And they’d better have a good answer. If they don’t, they won’t have my support.”

As treasurer, Summers will sit on the boards of five of the city’s pension funds.

How Credit Rating Agencies Reacted to Illinois Pension Ruling

None of the three major rating agencies changed their outlook on Illinois’ credit in the wake of a lower court ruling that deemed the state’s pension reform law unconstitutional.

But rating agencies are certainly keeping a close watch on the state as the reform law moves up to the Supreme Court. And all three agencies had something to say after the ruling.

Moody’s had the harshest take, calling the ruling “credit negative” that leaves the door open for a rating downgrade. Summarized by Governing:

[Moody’s] issued an analysis on Nov. 24 that said the “state’s negative outlook indicates the possibility that factors such as further growth in the state’s pension liabilities will drive the rating lower still.” The state is appealing the decision to the Illinois Supreme Court but Moody’s was wary of its chances and pointed out that the top court this summer indicated in a separate case on retiree health benefits that would adhere strictly to the pension protection clause.

A top Moody’s official commented further in a WUIS report:

“The average state from our perspective or the expected rating for a state is AA1, which is our second highest rating. And so Illinois is A3, so that’s five rating notches below that,” said Ted Hampton, a Vice President at Moody’s Investor Service. “Which is to say, it’s still an investment-grade rating. It’s still a strong rating in the context of every kind of security that we rate. But it’s far below all of the other states.”

Hampton says Moody’s saw Illinois’ passage of the pension overhaul as beneficial, but not enough to move the credit ratings needle – because a court challenge was suspected. The recent court ruling likewise wasn’t not enough to prompt a change, though Moody’s called the decision “credit negative” in a notice sent out Tues., Nov. 24.

“We do get a lot of inquiries about states, particularly Illinois where there are problems that are in the news, and where the situation is in flux. And publishing these comments helps us get our opinion out to those investors, or to the general public,” Hampton said.

Fitch and S&P said the pension ruling didn’t move the needle much as far as the state’s credit rating. From Governing:

Fitch Ratings and Standard & Poor’s were far more forgiving. Both said they had already factored in the likelihood of court challenge into their current ratings for Illinois. “More importantly, from a credit perspective,” S&P added, savings from the pension reform are not included in the fiscal 2015 budget.”

Interestingly, Fitch’s main concern wasn’t the pension ruling. Instead, the agency said the real concern was the expiration of several tax increases. From Governing:

Fitch did note another trouble spot for Illinois’ credit lurking just ahead: the scheduled expiration of temporary tax increases in 2015. “The state passed a placeholder budget for the current fiscal year with a stated intent to revisit the issue after the November elections,” Fitch said. “Taking steps to address the long-standing structural mismatch between revenues and spending would put the state on more solid financial footing, while failure to take action would be a return to past practices and leave the state poorly positioned to confront future downturns.”

Kentucky Teachers’ Pension Continues to Shield Investment Information From Public View

Pension360 covered last month the Kentucky teacher, Randy Wieck, who is suing the Kentucky Teachers’ Retirement System (KTRS) claiming the fund has “failed in their fiduciary duty” by letting the system become one of the worst funded teachers’ plans in the country.

Another component of his lawsuit deals with the lack of transparency surrounding the fund’s investments, a complaint of many stakeholders. Last week, KTRS stoked the flames of that complaint by denying Wieck access to contracts with investment firms.

Reported by the Kentucky Center for Investigative Reporting:

Randolph Wieck, a history teacher at DuPont Manual High School, sent an open records request Oct. 28 to the Kentucky Teachers’ Retirement System, which covers more than 140,000 school system workers statewide. Wieck asked for details of the contracts with some of the investment firms that manage part of KTRS’ $18 billion-plus in assets.

Wieck, who recently filed a lawsuit against the teachers’ pension system, wants to know what his retirement money is being invested in—and how much in fees KTRS is paying to big private equity firms. Among the funds he asked for details on were the Carlyle Global Financial Services Partners II fund and the Blackstone Partners VII L.P. fund.

KTRS denied his request in a Nov. 26 letter. Because KTRS agreed with the investment firms to keep contract details secret, it told Wieck that state law forbade it from disclosing them.

“Disclosure of these trade secrets would permit an unfair commercial advantage to their competitors,” wrote KTRS General Counsel Robert Barnes.

KTRS manages $17.5 billion in assets. The system was 51 percent funded in 2013 — but that ratio could drop to as low as 40 percent once the system begins measuring liabilities according to new GASB standards.

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