May 6, 2009
The sprawling investigation into New York’s pension investments hints at a much bigger problem than the handful of indictments so far would suggest.
What started as an investigation by the New York attorney general, Andrew M. Cuomo, into the state comptroller’s office — where Mr. Cuomo says favors were being exchanged for contracts to invest pension money — has mushroomed into a broad look at
more than 100 firms by attorneys general in at least 30 other states.
A survey of practices across the country portrays a far-reaching web of friends and favored associates: political contributors, campaign strategists, lobbyists, relatives, brokers and others, capitalizing on relationships and paying favors. These influential figures can determine how pension funds are invested, as well as state university endowments, municipal bond proceeds, tobacco settlement funds, hurricane insurance pools, prepaid tuition programs and other giant blocks of public money.
“What has developed is a corrupt system, where Wall Street, various fiduciaries, politicians and corporate managers are draining America’s savings,” said Frederick S. Rowe, a hedge fund manager who serves on the Texas Pension Review Board, an oversight body.
In Texas, lawmakers have been working on a bill to strengthen the state pension board and outlaw outside payments to public pension officials. But the bill has been drastically weakened by local pension officials who argued the law would strip them of their independence.
That may leave it up to the Securities and Exchange Commission to strengthen controls at the federal level. The commission has jurisdiction over investment firms, but not local politicians.
Investing public money on the basis of political considerations, rather than merit, heightens the risk of waste and loss, an urgent issue given the market losses of the last year. In 2007 the Government Accountability Office studied a group of pension funds known to be advised by consultants with conflicts of interest, and found their average yearly investment returns were 1.3 percent lower than those of other pension funds.
That may sound small, but it can severely erode a fund over time because the losses multiply.
“If compound interest is the eighth wonder of the world, then it’s the plague of all time when it’s working against you,” Mr. Rowe said.
Mr. Cuomo has said it is too early to estimate the size of any losses caused by the improprieties in New York. Even if the losses cannot be measured, though, he considers it essential to stop the uncontrolled peddling of access.
“You can’t put a price tag on public integrity,” Mr. Cuomo said in a recent news conference. “We have to be sure the system works and people have trust in the system.”
In recent weeks, the New York comptroller and officials in other states have issued rules barring the use of intermediaries — often called placement agents — who are paid by money managers to open doors and help them win allocations from state and local governments. But even those restraints, long resisted, may not work well. Across the country, an examination of practices suggests that time and again pension officials are making poor investment choices and incurring losses because personal connections skew their decision-making.
Consider DV Urban Realty Partners, which won $68 million from five public pension funds in Chicago. The firm was founded by a nephew of Mayor Richard M. Daley and proposed using the money to improve neglected neighborhoods that were central to the city’s 2016 Olympics bid.
So far, the investments have lost money. Now the city inspector general is investigating whether the mayor’s nephew exerted improper influence, but is having trouble because some of the pension funds have declined to respond to subpoenas. Robert G. Vanecko, the mayor’s nephew, has said he did not trade on his family connections.
In Texas, the city of Fort Worth’s pension fund decided to diversify into hedge funds. To help choose which ones, it hired Consulting Services Group of Memphis, which recommended that the city create a custom basket of hedge funds that paid management fees to Consulting Services Group.
Fort Worth embraced its recommendations and invested in the Bayou Fund, a fraud scheme that was exposed in 2005, and then in the Ponzi scheme operated by Bernard L. Madoff. Ruth Ryerson, who has since joined the Fort Worth pension fund as chief investment officer, says that Consulting Services was conflicted because it was collecting fees from both parties in the deal.
In New Mexico, the former chief investment officer of the state teachers’ pension fund has filed a lawsuit saying he was forced out after he opposed a $40 million investment in mortgage-related securities. The investment was made anyway, and the securities are now worthless. The lawsuit describes an informal network of state officials, political insiders and campaign contributors stretching to Illinois.
The disgruntled officer, Frank Foy, says these people worked in concert to talk him into making the investment, then worked together to remove him from office when he did not cooperate. His lawyer, Victor R. Marshall, said the campaign was orchestrated by David Contarino, a chief strategist to Gov. Bill Richardson. Mr. Contarino denies the accusations.
As Mr. Foy describes it, Mr. Contarino also exerted his influence to persuade another state funding pool to put $50 million in similar mortgage securities. That was the State Investment Council, headed by Governor Richardson.
Gary B. Bland, the state investment officer, denied the accusations in a court response in February, calling Mr. Foy’s lawsuit “a political witch hunt.” Since then, the New Mexico state council has begun reviewing whether investment firms paid fees to anyone in connection with obtaining the state’s business. That review was prompted by the New York investigation of placement fees.
The New Mexico council recently disclosed that a top fund-raiser and political ally of the governor, Marc Correra, was paid a placement fee by the investment firm that sold the toxic mortgage securities criticized by Mr. Foy. The records also show that Mr. Correra has been paid roughly $11 million as the placement agent for more than 20 other investments — all private equities, hedge funds and complex structured debt — that have come through the investment council’s door since Governor Richardson took office in 2003.
Investments like those promoted by Mr. Correra, called alternative investments, are controversial for public investment funds to invest in because there is not a ready market for them should the government suddenly need money. They are hard to value, too, and they carry higher risks in the pursuit of higher returns. The investment firms that offer them tend to earn much higher fees, which means a bigger cut for the placement agents.
Mr. Correra’s lawyer, Ronald L. Rubin, said his client earned his fees through hard work and believed he had complied with all the rules. “He wants to follow the law,” said Mr. Rubin, with the firm of Tannenbaum, Helpern, Syracuse & Hirschtritt in New York.
Governor Richardson has suspended new investments in private equity firms, hedge funds and other alternatives.
The current investigations into influence peddling across the country are virtually all connected with investments that expose taxpayers to the greatest risks, and that pay money managers the highest fees, cutting into future returns.
“Money that’s gone can’t compound,” said Mr. Rowe, the hedge fund manager on the Texas Pension Review Board. “The savings pool can’t grow to the extent that it should.”
Mr. Rowe, who has been outspoken about the need for tighter controls on public pension money, was chairman of the Texas Pension Review Board until last year, when he was removed by the governor of Texas, Rick Perry.
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