STUMP » Articles » Reddit-Public Pension Connection: Alternative Assets and Risk » 27 July 2015, 01:02

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Reddit-Public Pension Connection: Alternative Assets and Risk  


27 July 2015, 01:02

I saw a few stories going by regarding suspicions of asset managers and alternative investments recently. At the bottom of this post, you will see a series of posts I made a year ago on the topic, but I saw it coming out again.

One twist I wasn’t expecting was a connection to reddit… or rather, to Ellen Pao.

I had been reading this post by weev comparing Carol Bartz’s treatment to Ellen Pao’s and this bit jumped out at me:

[Ellen Pao] is a fraud just like her husband, who stole a nine figure amount from the pensions of firefighters.


I asked weev about this, and the stories below are connected with what he showed me.


Let me pull the most recent story: Louisiana retirement systems seek $25M in lawsuit against Royal Bank of Scotland

Three Louisiana retirement systems are seeking at least $25 million in damages from the Royal Bank of Scotland after losing $100 million worth of investments in what has been described as similar to a “Ponzi scheme.”

A New York hedge fund, which was run by Fletcher Asset Management, convinced the three retirement systems in Louisiana to invest the $100 million with promises of healthy returns and guaranteed repayments. But that money was actually used in part to repay part of a Royal Bank of Scotland loan in violation of an agreement the Louisiana retirement systems made when they invested, the latest legal filing claims.

The structure employed by Fletcher Asset Management — in which it allegedly took money invested by the Louisiana retirement systems to repay earlier debts and investors — had characteristics of a Ponzi scheme, a U.S. Bankruptcy trustee handling the Fletcher case wrote.

The three pension plans are:

  • Municipal Employee Retirement System of Louisiana, which invested $40 million.
  • The Firefighters’ Retirement System, which invested $45 million.
  • The New Orleans Firefighters’ Pension & Relief Fund, which invested $15 million.

While this is the most recent court case, this goes back years. The legal issues go back to 2011.

July 2011 NYT story on SEC and the pension systems investigating this:

The Securities and Exchange Commission has opened an inquiry into Fletcher Asset Management, a New York hedge fund run by Alphonse Fletcher Jr., a prominent Wall Street investor, according to a person with direct knowledge of the situation.

News of the S.E.C. inquiry comes as three Louisiana public pension systems publicly raised questions about a Fletcher fund. The three pension systems said on Tuesday that they were hiring a team of experts to closely examine the Fletcher fund’s financial records after it was unable to meet their requests to withdraw money from the fund earlier this year.

Mr. Fletcher, 45, already drew headlines in February when he sued the Dakota apartment building on the West Side of Manhattan, accusing it and several of its board members of racial discrimination for denying his application to buy an apartment adjacent to his.

The funds were liquidated in 2012.

Here’s the deal. Fletcher is Ellen Pao’s husband.

They have been involved in all sorts of odd “coincidences” (story from October 2012) And seem to litigate a lot. (from March 2013)

And it gets a little messy with Fletcher, what with all the millions he owes people.

Disgraced former hedge-fund operator Alphonse “Buddy” Fletcher’s broken promises are catching up with him.

A Manhattan judge has ruled that the 49-year-old investor owes his former law firm $2.7 million in unpaid legal bills.

Add that to the more than $140 million in court judgments and tax liens against the Harvard-educated fallen finance whiz and his fund, and you have one of the oddest Wall Street stories in recent memory.
While Fletcher owns three apartments in Manhattan’s exclusive Central Park West Dakota co-op, an $8.85 million self-described castle in Connecticut’s tony Litchfield County, and, with his wife Ellen Pao, a $1.5 million San Francisco home, the ex-hedgie stands accused of cheating Massachusetts and Louisiana cops and firefighters out of more than $100 million and not paying close to $3 million in taxes.

I can see why the Louisiana pension funds are trying to get money out of the Royal Bank of Scotland, because it seems unlikely they’re going to be able to get it out of Fletcher.

That story was from February 2015. Reddit users evidently were trying to post about the case in March, but their posts just mysteriously kept getting deleted.

Not that it was much of a mystery.


But it’s not just Louisiana pension funds that got hit. You think only one set gets bamboozled in these things?

From December 2013, we see questions raised at MBTA pension fund

If you get close enough, the MBTA’s pension fund will remind your eyes and nose of a Florida swamp. You’re pretty sure there’s nasty stuff down there, but it’s hard to see until something pops out of the muck directly in front of you.

Well, Merry Christmas to me. Something unexpected did burble up to the surface just the other day. It was a business called Fletcher Asset Management and an investment account to which the pension fund once entrusted $25 million. But now that account lies sadly empty. Looted might be a better word.

One among several facts that make this particular story extraordinary — even by MBTA standards — is who sold the pension board on the investment in the first place six years ago. That would be Karl White, the man who had been running the pension fund just months earlier.

Shortly after White realized his 2006 candidacy to become chairman of the University of Massachusetts wasn’t going to fly, he quit the pension fund to become Fletcher’s chief investment officer. White quickly sold the MBTA on a new fund but convinced practically no one else to do business with his firm.

Now, White says he actually managed no money at the investment firm that collapsed and went bankrupt in 2012 — well after he left Fletcher. He doesn’t have a clue what happened to the MBTA’s millions.

This could actually turn out to be true. A bankruptcy trustee points his finger at Fletcher’s founder, Buddy Fletcher, who purportedly handled client money in ways that would make Charles Ponzi blush, for most of the investment firm’s problems.

So what was White actually paid to do? Reading the account he gave the Globe’s Beth Healy last week, White sounds like an unsuccessful salesman with a phony title (he called himself a salesman with “gravitas”) who exits — shockingly — when his bonuses dry up. He’s Willy Loman in a camel-hair coat. Maybe it happened that way.

The MBTA fund is run under different rules than virtually every other public pension plan in Massachusetts thanks to a strange twist in the law. It operates as a private trust — not a public entity — and can send most critics away to pound sand when they want more information about the way retirement funds for 12,000 active and retired MBTA employees are managed.

As things work right now, the MBTA pension board isn’t required to hold any open meetings and does not. It can’t be compelled to publish minutes of board meetings and does not. It isn’t subject to state public records laws or oversight by the state ethics commission.

The state’s Public Employee Retirement Administration Commission, which oversees more than 100 public pension funds in Massachusetts, can’t touch the MBTA pension board.

The authority pension fund’s annual reports make the board’s own hand-picked auditors balk because they omit a standard explanation of results by management, something required by generally accepted accounting principles.

It’s worth repeating here that the disappearance of the $25 million entrusted to Fletcher was not disclosed by the MBTA pension fund. Details about that investment gone bad came out of bankruptcy proceedings in New York. Who knows what other ugly MBTA pension details are hidden from public view?

Sounds like some huge governance problems at the MBTA. There is no effective oversight whatsoever, it seems.

But wait, there’s more (from June 2015):

A six-month examination of the MBTA pension fund, led by the whistle-blower who identified the Bernard Madoff fraud, found accounting and investment reporting practices that he says may overstate the financial health of the transit worker retirement plan by as much as $470 million.

The analysis raises serious questions about how the $1.6 billion pension is run, said Harry Markopolos, a Massachusetts-based financial analyst whose warnings about Madoff’s investment scheme were ignored for years by securities regulators.

The MBTA Retirement Fund’s performance appears “too good to be true,” Markopolos said in an interview last week. “Someone needs to go in and count the assets to make sure they’re all really there.”

Markopolos, who enlisted the help of Boston University finance professor Mark T. Williams, presented the findings of their 103-page report on Friday to officials from the US attorney’s office, the FBI, the Securities and Exchange Commission, and the Massachusetts inspector general’s office.


The report, based on the limited data made public by the T’s pension board, studied the fund’s annual reports from 2009 through 2013.

It questions whether the fund’s reported investment returns are accurate, including a year when they were identical to the state pension fund’s rate of return. It says that the pension was using outdated mortality tables that understate how much it will owe retirees over the long term. And it says the fund used three different accounting approaches in as many years, with the changes yielding more favorable financial results.

Markopolos began the analysis in December 2013. That month, the Globe reported that the T pension fund had failed to disclose a $25 million loss on an investment in a hedge fund that went bankrupt. The pension fund made the investment in Fletcher Asset Management in 2007, at the recommendation of former T pension executive director Karl White, who had by that point resigned to work for Fletcher.

The attorney general’s office at the time launched an investigation into the Fletcher investment. The Globe is suing the pension fund to obtain records related to the Fletcher transaction.

The researchers working with Markopolos said they focused first on investment returns that were strikingly similar to those of the much larger state pension fund, which are reported earlier each year. In 2009, the returns were identical, at 17.7 percent — a result Markopolos and Williams say has a 1-in-4 million chance of occurring.
Among the key findings of the Markopolos report is the pension fund’s decision to use a different accounting approach to calculate its assets three years in a row. According to the report, that practice alone could account for a $96 million overstatement of the assets.

In a comparison to the seven other major US transit authorities, the T pension system was the only one still using calculations from 1994, according to the report. The others are using updated data from 2000, or custom data sets, the report said.

The T pension raised its actuarial rate of return from 7.5 percent in 2010 to 8 percent in 2011. It fell, to 7.75 percent, on Jan. 1. The state pension fund also is at 8 percent, but after recently lowering its target rate to that figure.

There’s another aspect to that article, but that will pop up in a later post. (hint: 80% Funding Hall of Shame)

I got a link to the presentation, but not the 103-page report. I would love a copy of the full report if possible.

By the way, there’s a familiar name popping up in this report: Harry Markopolos, who literally wrote the book on Bernie Madoff red flags, and he definitely knows what he’s talking about. I highly recommend the book, but mainly the appendices that show Markopolos’s reports to the SEC… the reports that were spot-on and were ignored because the SEC people are lawyers, not finance people.

The MBTA situation is still ongoing.

The Louisiana funds have probably lost their money unless they can claw back money from Royal Bank of Scotland.


Last year, I did a series looking at alternative asset use by a variety of public pensions. Here are some of them:

Not much has changed from last year.

The problem one understands as these stories pile up:

  • the way we value and fund public pension liabilities give extremely strong incentives to chase returns
  • and there isn’t much in the way to tamp down this piling-on-the-risk behavior

In the insurance world, there are risk-based capital rules, where insurers have to hold capital against the risk inherent in the assets they hold to support their liabilities.

Other financial institutions are also supposed to hold such capital, but let’s focus on insurers, especially those who provide annuities, because they are making promises similar to that of public pensions.

They can’t hold this much in “alternative assets” unless it’s for variable annuities, where annuitants understand they’re taking on most of the asset risk.

Risk-based capital rules for insurers were developed in the early 1990s after there was a huge furore over junk bonds (remember Mike Milken?) There was a life insurer that had most of its portfolio in junk bonds and it became insolvent as junk bonds took a dive.

Without getting into it too deeply, insurance regulators realized they had very crude tools to get at risk-taking in insurers, and so RBC was developed, for assets as well as liability-side risks. This tool still exists in insurance regulation.

Most of the “alternative assets” such as hedge funds have RBC charges of 50% of the value.

You may understand why insurers don’t use these too heavily. The bulk of insurer assets are cash, investment-grade bonds, and commercial mortgages. All of these (except cash) have a risk charge.

To be sure, insurers have to hold assets at equal to their liabilities plus the required capital (and they usually hold more than that, so that rating agencies give them good marks.)

Most public pensions don’t even hold the full value of their liabilities. Not sure how one would implement the concept of risk-based capital given that.

But there does need to be disincentives to take on too much asset risk… they seem way too weak at this point.

Even without shenanigans, alternative assets can be very illiquid and volatile, and can cause cashflow problems for pensions.

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