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Millions Squandered on Middlemen?

Submitted by Leo Kolivakis on 10/06/2010 23:41 -0400

Kris Hundley of the St-Petersburg Times reports, Public pension funds keep quiet on millions paid to middlemen:

Florida's public pension has invested about $2 billion in two dozen private funds since December.

Rather
than approach the pension's staff directly, half the funds used
middlemen to get in the door. They paid these well-connected placement
agents millions of dollars for making introductions and setting up
meetings. Average finder's fee: about $1.5 million.

Florida's
money managers at the State Board of Administration say using placement
agents is routine and no cause for concern. But after such
intermediaries were found to be at the heart of kickback scandals at
public pensions in New York and California, those states have taken
tougher stands.

New York's state
pension has banned the use of placement agents. California has put
limits on their pay and plans to post their compensation on the state
pension's website.

And just last week, in the wake of problems
at public pension funds, the Securities and Exchange Commission started
requiring registration of placement agents.

Ashbel C. Williams
Jr., the SBA's executive director, boasted that Florida's rules are
even stricter. He told his agency's investment advisory council last
week: "Our policy goes beyond the SEC's. We require disclosure of the
compensation they've been paid."

There's
just one catch: Williams' definition of disclosure does not extend to
Florida's pensioners or taxpayers. His agency gets to know what the
middlemen are paid. But the public — told that pension investments are
made on merit, not on who you know — cannot find out how much money
changed hands before a deal went down.

The reason? The SBA won't release the information if investment funds want to keep it secret. And they all do.

For
example, Florida recently invested $100 million of pension fund money
with GSO Capital Partners. The company said disclosing what it paid a
placement agent would "harm our business efforts."

Baloney,
says Christopher Tobe, a veteran financial adviser and trustee of the
Kentucky Retirement Fund. Tobe is among the growing number of experts
who say funds that use third-parties, rather than going directly to a
pension plan, are perpetuating an unnecessary and poorly regulated
system that's proved vulnerable to abuse.

"It's blatant
corruption," he said. "There's really no reason for placement agents
unless you want to get money to somebody through the back door."

For
a few months last spring, the SBA didn't give fund managers the option
of exempting placement agent pay from public records requests. In
seven deals where their fees were disclosed, placement agents received a
total of about $12 million, about 1.5 percent of Florida's total
investment of $825 million.

The lowest reported commission was
$250,000 paid by Energy Capital Partners, a private equity firm, to
Park Hill Group for "scheduling meetings." Florida invested $100
million with Energy Capital Partners.

P2 Capital Partners,
meanwhile, got the same result — a $100 million commitment from Florida
— but paid its placement agent, C.P. Eaton, $3.65 million. Eaton's
duties? "Establish LP (limited partner) relationships."

Knight
Vinke signed a $250 million deal with Florida and paid its placement
agent, XT Capital Partners, up to $1.25 million for services it
described as "strictly ministerial."

Why did some funds feel the
need to pay a third party to run interference with the state, while the
rest landed approximately the same total investment without the extra
cost?

"Maybe they weren't as attractive a fund," said Tobe, the Kentucky pension trustee. "They had to have some extra juice."

Girard
Miller, a former member of the Governmental Accounting Standards Board
and veteran fund manager, points out that pensions like Florida
already pay millions of dollars to independent consultants to screen
potential investments.

"So why
on earth is it necessary for legitimate and competent investment
advisers to a pension fund to hire a mercenary?" Miller asked in a
column last year in Governing magazine.

Florida
typically pays a fund 1 to 2 percent to manage its investment, so a
$100 million deal could mean as much as $2 million to the fund manager.
The placement agent's commission generally is taken from the management
fee.

Williams, the SBA's executive director, said the fact that fund managers pay placement agents mean they cost the public nothing.

But
Susan Lerner, the head of Common Cause New York, said taxpayers end up
footing the bill. "The funds that use these intermediaries negotiate a
somewhat higher management fee so that nothing comes out of their
profit margin," she said.

"Those fees just get passed through. The public is paying for it."

Miller,
who has been involved in both selling and buying funds, called
placement agents "a deadweight cost on the investment industry."

"Having
sat on both sides of the table at final presentations for 25 years,''
he wrote, "I can tell you that there is really no value added to the
analytical process from marketers that cannot be delivered by the key
players."

Tobe recently blew the whistle on Kentucky's fund when
he learned it paid placement agents $15 million in fees since 2004
after years of denying it used these intermediaries. In response to his
complaints, the SEC opened an informal inquiry into the Kentucky
system last month.

Tobe and Miller
suggest that if placement agents are used, their fees should be capped
at about $200,000. "That still rewards a skilled marketer for
presenting the advantages of an investment product to a large fund,"
Miller wrote.

In New York, the deputy comptroller and several
placement agents and fund managers pleaded guilty to running a
pay-to-play scheme at the public pension. The pension has recouped more
than $120 million from parties accused of wrongdoing.

In
California, a former CalPERS board member turned placement agent is
accused of taking more than $50 million from funds in return for
steering business to the pension. CalPERS now encourages funds to
submit their proposals online.

"There's no reason for them to
pay someone to call us or to set up a meeting," CalPERS chief
investment officer Joseph Dear said in June. "Our door is open."

After
reading this excellent article, two things struck me. First, I'm
wasting my time blogging. With all my connections to senior officers at
public pension funds, I should be investing in spiffy suits, nice shirts
and ties, setting myself up in easy lane peddling funds to them. I will
charge a small nominal fee for "arranging meetings". I am, of course,
being sarcastic. I'd rather stick a fork in my eye than peddle funds to
LPs.

The second thing that struck me in this article were the
excellent comments by Tobe and Miller. As I've repeatedly stated, the
overwhelming majority of middlemen are utterly useless. They're just
financial parasites looking to skim off the management fee. Sure the
funds love them, especially if the LPs sign over big fat multi-million
dollar cheques, but the bottom line is that excessive fees paid to
middlemen opens the door to serious abuse.

I always tried to
avoid middlemen. Most of them are just slick marketers who try to get
you to invest in funds using lame sale pitches. I prefer meeting the
managers, asking the tough questions. I remember middlemen calling me
saying "I can get you capacity in so and so's fund". My eyes would roll
and I'd politely tell them that I'm not interested. If I was interested,
I'd tell them to send over the senior fund managers.

Finally,
I agree with Tobe and Miller. At a minimum, fees paid to middlemen
should be capped and publicly reported in the annual report (same for
all fees paid to external consultants). However, if you ask me,
middlemen should be eliminated altogether. Period.

If US pension funds paid their staff properly, recruiting qualified
people, they wouldn't need any middlemen whatsoever. Funds would send
their documents directly to the staff who are trained to properly screen
them before conducting a thorough due diligence. This is all common
sense, and it amazes me that in this day and age, underfunded pension
funds continue to squander millions on useless middlemen.

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Wed, 11/10/2010 - 05:32 | 715531 cheap uggs for sale

Thu, 10/07/2010 - 11:10 | 632207 williambanzai7

Former Comptroller of NYS pleaded guilty today for this kind of skimming.

Thu, 10/07/2010 - 09:29 | 631939 Bob

KICKBACKS??!!!!

How could you possibly imagine such a thing? These are fudiciary servants you're talking about.

On the other hand, they are still human, technically.

Bob's Rule: If even I would think of doing it, for at least a passing moment, other people would do it. And, if it's even legal to do so, they are doing it.

Duh!

Not only that, but imagine how many people must know about it. They should consult an attorney specializing in Qui Tam actions--even a secretary can get extremely rich simply by doing the right thing.

Thu, 10/07/2010 - 08:43 | 631838 bullet

a simple solution to make it all legit..

a middleman union

Thu, 10/07/2010 - 08:39 | 631825 Commander Cody

In the Land of Fraud everybody gets a piece of the action, except the "investor".

Thu, 10/07/2010 - 08:36 | 631821 New Revolution

The AG in every state should investigate these things,... its interstate commerce and the Feds won't do it. Follow the money.... I'll wager at 10 to 1 that some of that money,... a damn good share of it, goes back into the pockets that make the decisions where the fund money goes. It's a payoff scheme and anyone that can't see that right off on the surface of things is either lying to themselves or in line to pocket some of the fun(n)dy money. How blatent is this? Just like most of the 2B2Jails, Geithner, Baranke and most HFM they should all face RICO charges and be serving time in JAIL. The New American Revolution is coming my friends.

Be there.

Thu, 10/07/2010 - 03:48 | 631517 JW n FL

Pay to Play in Florida? EVERYWHERE? Noooooooo! say it ain't so Joe / Leo.... say it ain't sooo?!

SEC Adopts New Measures to Curtail Pay to Play Practices by Investment Advisers FOR IMMEDIATE RELEASE
2010-116

Washington, D.C., June 30, 2010 — The Securities and Exchange Commission today voted unanimously to approve new rules to significantly curtail the corrupting influence of "pay to play" practices by investment advisers.

http://www.sec.gov/news/press/2010/2010-116.htm

But the SEC said they were stoping the practice, everywhere?!

Thu, 10/07/2010 - 03:31 | 631511 cashcow

Middlemen, estate agents, employment agents etc. these parasitic leeches push up prices for everyone. I would place them high up on the order of head chopping priority should all this collapse.

Thu, 10/07/2010 - 03:08 | 631496 alexwest

LEO dont flatter yourself... please pal

#After reading this excellent article, two things struck me. First, I'm wasting my time#blogging. With all my connections to senior officers at public pension funds,

there's a reason that instead of making cheese you'are

blubbering here FOR FREE.. and its A:

after reading your stuff on ZH I dont think there's idiot

who would pay u anything...

seems you just dont get it..

sorry pal

alx

Thu, 10/07/2010 - 09:01 | 631880 csmith

...instead of making cheese...

And I'm sure the "cheese" you produce Alex has an aroma all its own.

Thu, 10/07/2010 - 08:26 | 631796 WSP

Not sure where that attack is coming from, but I can tell you the following:

I don't trust the market, BUT, I do believe that my wife should invest in her retirement fund and she always has "fee" free through a popular low-cost mutual fund family. Several years ago, a slick suit wearing thug showed up at the county office, took the manager of pensions out for a round of golf, agreed to give him kickbacks, and now, in order to invest in the a set of low quality funds, she has to pay 6% for each contribution---YES, 6% off the top each and every contribution, FOR NOTHING. What's worse, the fund choices she has now are all corrupt public pension fund favorites that are high cost, low return.

Listen, I realize that we probably should not even be saving in her retirement because most likely the government will seize these funds in the future to pay unfunded liabilities, but if they don't, we feel we must save for retirement, yet, some slick suited thug has now stepped in front and takes 6%, FOR NOTHING, and then gives kickbacks to the corrupt county officials that went along with it.

You tell me, is Leo right that these middlemen are crooks! They offer NOTHING, yet, get 6% right off the top and to make matters worse, force high cost, low return lagging mutual funds as the only choice.

Oh, and the funds she used to invest in before the parasite showed up----consistently ranked high with steady, reliable returns that were not hurt that bad during this bear market. The funds she now has to invest in----mostly corrupt fund families in tight with the government.

Thanks Leo for posting this information. It would be nice to forward it to the pension manager for the county, unfortunately, it might hurt my wife's career because the way these criminals work, they don't like to be exposed for the thugs they are.

Thu, 10/07/2010 - 08:17 | 631728 Leo Kolivakis

You must be one of those middlemen who called me one day peddling a fund "with a high Sharpe ratio".-:)

Alex, what I do for free is a service, and if you look at who reads my blog every day, you'd realize it. The stats are all there -- public knowledge. As for people paying me, I really don't care. I earn my money working and trading. Blogging is my hobby, it relaxes me at night writing things as I see them. Nobody gives you anything in life, you have to earn it. The last thing I'd ever want to do is call my friends at public pension funds peddling shitty funds that charge alpha fees for beta products.

Thu, 10/07/2010 - 10:25 | 632068 bIlluminati

Screw Sharpe ratio (although I aim for >1. I'm marketing on my Thorp and Kelly ratios and zeo delta.

What's the Kelly criterion when the signal to noise ratio is less than zero?

Thu, 10/07/2010 - 03:01 | 631490 williambanzai7

Middleman is another word for retired pension executive or politician.

Thu, 10/07/2010 - 00:49 | 631362 Coldfire

I am shocked, shocked that this kind of thing would happen with other people's money.

Thu, 10/07/2010 - 08:48 | 631848 Sudden Debt

I feel your amazement also!

People spending others people money like it's only paper that can be printed out of thin air!

I can't believe people can do this...

And they don't even work for the government! IMAGINE!

Millions Squandered on Middlemen?

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