INVESTIGATION: Investment Firms Not Sharing Vendor Discounts with RI Pension Fund
Thursday, June 25, 2015
Two private equity firms in which the state pension fund has invested a combined $70 million have admitted to securing discounts from attorneys and other vendors but failing to share those savings with their investors, according to disclosures filed with the U.S. Securities and Exchange Commission.
Rhode Island currently has $40 million split between two funds managed by First Reserve, a global firm with headquarters locally in Greenwich, Conn. An additional $30 million is with the Carlyle Group, based in Washington, DC.
In an SEC filing last March, the Carlyle Group revealed that “in certain circumstances” advisors and other vendors such as law firms “charge different rates or have different arrangement for services provided to Carlyle, CIM, their affiliates and/or employees … as compared to services provided to Advisory Clients or portfolio companies, which results in more favorable rates or arrangements than those payable by Advisory Clients or such portfolio companies.”GET THE LATEST BREAKING NEWS HERE -- SIGN UP FOR GOLOCAL FREE DAILY EBLAST
In other words, a law firm may compose employee contracts for the Carlyle Group at a discount, but when the same firm handles the legal work associated with an new investment, the firm charges the new investor top dollar.
First Reserve has language nearly identical to Carlyle's in its filings.
The disclosures were first reported nationally by the New York Times on June 13.
‘Intentional wrongdoing’
“Why are we paying an inflated fee when they’re getting a discount?” said Marcia Reback, a newly reappointed union representative on the State Investment Commission, which oversees billions in state retiree funds. “It seems to be fraudulent.”
“This is one of the reasons that the fees are higher than they should be,” said Ted Siedle, a Forbes.com contributor and outspoken skeptic of pension reform and the use of alternative investments, such as private equity.
The state’s turn to alternative investments first came under fire by Siedle in a series of columns in mid-2013. Siedle has questioned the secrecy, low performance, and high fees associated with such investments. Siedle most recently completed a crowd-funded investigation into the state pension system which claimed to have uncovered $2 billion in preventable losses in the state pension fund.
“There’s just a million ways this stuff happens and it’s all shrouded in secrecy,” Siedle said.
In the Carlyle Group’s filing, the possible difference in vendor fees is described as a potential conflict of interest for the firm. Siedle said the conflict arises because the firms identified in the New York Times report have a fiduciary duty to protect investors but instead are charging higher fees then they know they can get.
“It’s intentional wrongdoing,” Siedle said.
And he says state treasurers are complicit. “They don’t know. They don’t want to know and they agree that they will not disclose what the fees are.”
New state Treasurer Seth Magaziner has taken some steps towards greater transparency. In an apparent break with his predecessor, Governor Gina Raimondo, he published the management and performance fees for a number of alternative investment firms, as GoLocalProv previously reported. Now, Reback says she is pushing for the publication of additional hidden fees that may not be included in those disclosures.
State treasurer says ‘no direct evidence’ of inflated fees
A spokeswoman said Magaziner is concerned about fees. “Treasurer Magaziner remains concerned about the level of fees charged to the pension system by private equity firms, which is why he pushed the State Investment Commission to require full disclosure of all fees and expenses that these funds charge to the pension system for the first time ever,” said the spokeswoman, Shana Autiello. “We are following the national discussion about potential abuses of vendor fee arrangements with great interest.”
She said the Treasurer’s office has no direct knowledge of any overcharging. “At this time, we are not aware of any direct evidence that Rhode Island has been unfairly overcharged due to general partner vendor discounts, but we are continuing to monitor the situation and push for greater transparency from fund managers,” Autiello said.
She did not specifically comment on whether Carlyle, First Reserve, or any firms had shared their policies on vendor discounts with the state. Nor did Autiello comment on whether the Treasurer’s office would be reviewing its previous agreements to identify any investments in which it had lost out on those discounts.
But she said as part of its due diligence the Treasurer’s office “will ask fund managers to share their policy on vendor discounts” in order to obtain “the best possible terms for Rhode Island.”
Michael Downey, the president of AFSCME Council 94, which represents state employees, said the situation reinforces the need for greater transparency in the state pension system.
“RI Council 94 AFSCME believes that greater transparency on fee structures and incentives, such as vendor discounts, supplied to hedge funds and-or private equity funds are necessary. Vast sums of taxpayers,’ active employees,’ and retirees’ funds are placed in these investment mechanisms. Council 94 believes that the public’s right to know, with significant public financial assets at stake, trumps a company’s right to keep their business practices proprietary,” Downey said.
SEC plans further action
A spokeswoman for First Reserve declined comment. Officials at Carlyle did not respond to a request for a comment.
The state invested in Carlyle in 2014, during Raimondo’s tenure as Treasurer. Its investment in First Reserve dates back to 2004, when Paul Tavares was Treasurer, state records indicate.
Those records show that, in terms of fees, Carlyle and First Reserve both charge 20 percent performance fees, like other private equity and other alternative investment firms. Last year, only First Reverse received performance fees on one of its two funds, in the amount of $293,435.
In terms of management fees, both firms are in the mid-range for private equity firms. Carlyle was paid $515,496 in management fees in the last fiscal year at a rate of 1.5 percent on $30 million invested. First Reserve received a total of $146,215 to manage $40 million split between two funds it oversees. First Reserve’s rates are somewhat lower, at one percent and 1.36 percent, according to state investment records.
The SEC filings do not contain information on the vendors employed by those firms and the different rates the firms charge, preventing any immediate identification of potential costs to any of their investors.
When asked to comment, an SEC spokeswoman provided a copy of a May 13 speech by Marc Wyatt, the SEC’s Acting Director of the Office of Compliance Inspections and Examinations, who said the public should expect additional enforcement actions by the SEC against private equity firms.
“It is reasonable to assume that the next year may bring additional private equity actions by the SEC’s Division of Enforcement, and so we anticipate heightened awareness of reputational and headline risk by the investor community,” Wyatt said. “[W]e can expect additional Enforcement recommendations involving undisclosed and misallocated fees and expenses as well as conflicts of interest.”
Wyatt also called for greater transparency as private equity firms expand their client base of investors. “Only through complete and timely disclosure can advisers, as fiduciaries, discharge their obligation to put their clients’ and investors’ interests ahead of their own,” he said.
Tips on potential corruption at the local or state level, misspending, abuse of power, and other issues of public interest can be sent to [email protected]. Follow Stephen Beale on Twitter @bealenews
Related Slideshow: RI Pension System’s Highest Paid Investment Firms
Below are the highest paid investment firms by the state pension system. Two types are listed: hedge funds and private equity firms. Firms are listed in order of least to highest rate of pay. Firms at the same rate of pay are ordered according to the amount of the payment they received, from least to greatest. For each firm, the name, type, management and performance fee rates, and the amounts paid for each are shown, along with the total. In instances where a firm had more than one fund, information is provided for each individual fund. Data are from a newly published online report of investment expenses for the state pension system. Note that the Treasurer’s office has declined to disclose information for 18 private equity firms due to confidentiality clauses.
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