As public pensions across the nation continue to spiral downward, pension trustees and participants, unions, and taxpayers in states including Alabama, California, Florida, Kentucky, Illinois, Ohio, North Carolina and Rhode Island are increasingly raising their voices to urge the SEC to stop rampant mismanagement of pension investments and looting by Wall Street. While the SEC has been slow to respond to public pension stakeholders, last week the federal securities regulator surprisingly subpoenaed records from the $66 billion Pennsylvania state pension fund related to possible improper gifts exchanged between Wall Street firms and any representatives of the state pension or the state. (Earlier this year, the FBI and federal prosecutors launched a criminal probe of PSERS immediately after the fund’s board issued a statement revealing its doubts about the figure it endorsed in its most recent annual financial results.) The time for enhanced protection of state and local government pensions—often called the “dumbest investors in the room” by Wall Street—by securities regulators is decades overdue. Hopefully, the SEC will step-up scrutiny of mismanagement and fleecing by Wall Street of government worker retirement funds.
Over a decade ago, in August 2010, Christopher Tobe, the sole member of the Board of Trustees of the Kentucky Retirement Systems with expertise in pension investment matters, became the first public pension trustee to file a whistleblower complaint with the SEC. Upon learning of the existence of so-called “placement agents” involved in brokering certain KRS investments, Tobe filed a whistleblower complaint and entered into an agreement to voluntarily provide information to the SEC.
Shortly thereafter, Tobe contacted the Federal Bureau of Investigation because he had reason to believe multiple violations of law had occurred related to certain investments made by KRS, involving the management of $1.3 billion in KRS assets and in excess of $14 million in undisclosed placement agent fees.
In response to his whistleblower complaint, the SEC conducted a formal inquiry into the multiple potential violations of law at KRS complained of by Tobe.
Tobe requested independent counsel in connection with the SEC investigation of KRS because, as a whistleblower, he was concerned that his interests might diverge from the interests of other parties who may have participated in the wrongdoing he complained of to the SEC and FBI. I was briefly retained by the pension to serve as Tobe’s independent counsel and submitted the findings of my investigation to the SEC—much to the chagrin of the pension.
When the SEC promptly responded and investigated Tobe’s allegations, he was hopeful. “I really believed the SEC understood the gravity of the industry abuses I had uncovered—even when my fellow board members did not,” he told me recently.
For reasons that remain unclear, after meeting with pension representatives the agency failed to take any action. KRS continues to be one of the worst funded state pensions in the country and currently is mired in litigation regarding management of its investments by secretive Wall Street hedge and private equity funds.
In 2013, my firm was retained by Rhode Island Council 94 of the American Federation of State, County and Municipal Employees, AFL-CIO, to conduct a four-month forensic investigation of the $8 billion Retirement System of Rhode Island. Our key findings included that state officials had secretly agreed to permit hedge fund managers to keep the pension in the dark regarding how its assets were being invested; to grant mystery hedge fund investors a license to steal, or profit at its expense using inside information; and to engage in potentially illegal nondisclosure practices.
Our 106-page report was referred to the SEC for further investigation and appropriate action. Bear in mind, this was the first forensic investigation of a state pension ever undertaken—an investigation commissioned by a leading national government employee union with 1.6 million members.
In 2014, several Chicago City Council members asked the SEC and city inspector general to investigate whether campaign contributions to Mayor Rahm Emanuel from executives at Wall Street investment managers with city pension business violated local ethics or federal pay-to-play rules.
Also, in 2014, an organization representing 55,000 North Carolina state employees (State Employees Association of North Carolina or SEANC) asked the SEC to investigate “widespread potential violations of law” involving State Treasurer Janet Cowell’s handling of investments from the $87 billion state retirement system, following the release of the findings of a forensic investigation the organization commissioned from my firm. The key findings communicated to the SEC included:
- $30 Billion in Secret Accounts: In an unprecedented decision, Cowell had entered into agreements with a number of Wall Street money managers to keep secret from all stakeholders, including the General Assembly, where $30 billion (35 percent) of North Carolina’s Teachers’ and State Employees’ Retirement System (TSERS) assets were invested.
- Pension Losses of $6.8 Billion: Cowell’s political manipulation of the state pension plan and self-described “experiment” with high-risk alternative funds, including real estate, hedge funds and asset-backed securities had cost North Carolina $6.8 billion.
- Total Fees to Wall Street Skyrocketed to $1 Billion: We estimated total fees paid to Wall Street money managers had risen 1,000 percent to approximately $1 billion — at least half of which ($500 million) had not been properly reported by Cowell to the General Assembly and the public.
- Treasurer’s Reports Violated State Law: North Carolina law mandated full disclosure of all direct and indirect investment management and placement agent fees in the Treasurer’s Government Operations reports to the General Assembly. Cowell failed to make these disclosures.
- Potential for Corruption: Pay-for-play had long been a problem with the state’s pension system for more than a decade and under Cowell the potential for these quid-pro-quo relationships had grown.
In 2015, my firm conducted the first “crowd-funded” forensic investigation of a state pension—again Rhode Island—and released its findings to the public, as well as the SEC. Three hundred and fifty private citizens, including pension participants and state taxpayers, pledged funds over the internet to bring this project, titled Double Trouble: Wall Street Secrecy Conceals Preventable Pension Losses in Rhode Island, to life.
The key finding of the investigation was that redesign of the pension system that was supposed to save taxpayers $4 billion over 25 years, had already—in the first four years— cost the pension $1.4 billion. Total preventable losses identified in the report amount to over $2 billion. As noted by the SEC staff early on, our effort demonstrated that “crowd-funding”—despite concerns of regulators regarding its potential to give rise to a new type of internet-based scamming—could actually be an effective means to expose fraud, mismanagement and other malfeasance related government workers’ retirement monies.
Later that same year, the findings of a forensic investigation of the Jacksonville Police and Fire Pension Fund commissioned by the Jacksonville City Council was submitted to the SEC. Key findings included: Board poor investment decision-making had resulted in at least $370 million in underperformance losses. Board failure to scrutinize investment management fees had resulted in excess fees of $6 million annually or $36 million over the past six years. The Board failed to heed credible warnings of conflicts of interest at a former investment consultant, eventually settling with the firm for $273,696 without analysis or evaluation of any harm caused to the pension. Such conflicts (according to a U.S. Government Accountability Office analysis) might have cost the pension almost 30 percent of its value—$300- $500 million over two decades.
In 2016, my firm successfully completed a second crowd-funded campaign to investigate the causes of the dismal performance of the real estate owned by the Rhode Island state pension and submitted our findings to the SEC. This time, 107 members of the public pledged funds to the project. Our investigation entitled Beyond Bad: A Generation of Mismanagement of Employee Retirement System of Rhode Island Real Estate reported that since 2005, the real estate investments had returned a mere 2.83 percent versus 10 percent for the pension’s current recently-adopted, more forgiving benchmark. Since inception of ERSRI’s real estate investing, over 27 years ago in 1989, the portfolio performed far worse—wretchedly—as the legal duty, known as fiduciary responsibility, to invest assets for the exclusive benefit of participants and beneficiaries had time and again been ignored. Targeting local development and paying rich disclosed and hidden fees of over 4 percent a year to real estate managers netted the pension a mere .69 percent. By way of comparison, Treasury Bills over same period would have provided an annualized return of 3 percent—incurring zero risk. Wall Street had prospered—taking virtually all real estate profits from the pension and leaving the asset-owners next to nothing—as the retirement security of an entire generation of Rhode Island pension participants had been undermined. Real estate underperformance had cost the pension over $500 million based upon the benchmark the pension recently adopted and losses may have amounted to as much as $1 billion.
In addition to the ongoing investigations in Pennsylvania, this year there have already been two forensic investigations of state and local government pensions commissioned by pension participants, the findings of which have been released to the public. (I am also aware of other public pension forensic investigations which have not been disclosed to stakeholders.)
My investigation of the $90 billion-plus State Teachers Retirement System of Ohio commissioned by the 19,000 members of the Ohio Retired Teachers Association was completed in June. The damning preliminary findings have now been reported to Ohio legislators, regulators and law enforcement.
The report concluded the state pension had long abandoned transparency; legislative oversight of the pension had utterly failed; Wall Street had been permitted to pocket lavish fees without scrutiny; investment costs and performance may have been misrepresented; and failure to monitor conflicts may have undermined the integrity of the investment process, as billions that could have been used to pay retirement benefits promised to teachers have been squandered.
Immediately following release of the report, two STRS Ohio board members, Wade Steen and Dr. Rudy Fichtenbaum—both unique in possessing financial expertise—issued statements supporting its findings and calling for further investigation by the pension and law enforcement into the disturbing revelations.
An investigation of the Chicago Policemen Annuity and Benefit Fund was funded by members of the Chicago Police Department Pension Board Accountability Group. According to the report, the CPABF is one of the worst funded public pension plans in the U.S. today with a funding ratio at year-end of only 23%. According to the report, “The toxic mix of defunding the police pension, conflicted and high-risk investments, and poor management of the pension cry out for greater transparency and accountability.”
As Arthur Levitt, Chairman of the SEC stated back in 1999 in connection with the Commission’s review of pay-to-play practices at public pensions, “Today, public funds hold more than $2 trillion of assets. These assets do not belong to the elected officials, and they do not belong to the trustees. They belong to the tens of thousands of firefighters, ambulance drivers, city clerks, bus drivers and other public employees who make our communities work. “Their interests,” as my father said twenty years ago, “must be paramount in investment of that money.”
The tremendous importance of public funds demands that they be managed with complete honesty and integrity and for the sole benefit of their beneficiaries.”
Twenty years later, honesty and integrity continue to be sorely lacking at our nation’s public pensions. These pensions are by no stretch of the imagination managed for the sole benefit of their beneficiaries. To the contrary, the management of investments and disclosure practices are routinely influenced by Wall Street, often through contributions to elected officials. Investment performance is undermined by pervasive industry conflicts of interest and abuses. Pension staff incompetence and self-interest are also profoundly harmful.
The SEC is uniquely positioned to ensure that pensions relied upon by state and local government workers for their retirement security are fully transparent and not plagued by widespread Wall Street abusive practices. Pension board members, including State Sen. Katie Muth on the PSERS board, and Messrs. Steen and Fichtenbaum on the STRS Ohio board (and others known only to me and the SEC), as well as millions of participants nationwide are not only urging the SEC to do its job, but also commissioning/funding investigations of their own to provide a roadmap for the federal regulator.
All the SEC needs to do is follow their lead.