Thursday, June 2, 2016

Seattle Pension Fund to Shield its Private Equity Partners from Public Disclosure

Last year, the Seattle Pension System tripled its investment in Private Equity, an asset class known for its tax loopholes, controversial business practices, and lack of transparency. This year Seattle lobbied the State Legislature seeking to shield its Private Equity managers from public scrutiny.

And in a few weeks, the City will get its wish. After June 27, 2016, the public pension systems of Seattle, Tacoma, and Spokane will have the authority to reject public disclosure requests concerning the fees and expenses they pay their Private Equity partners (here).

Now, bearing in mind that Seattle was the first big city to adopt a $15/hour minimum wage, doesn't it seem a bit odd that this Citadel of Liberalism and Democratic Socialism would so tightly embrace an investment class that's been described as a vehicle for transferring wealth to the 0.1%?

Why did the City of Seattle capitulate? According to the Retirement Board's April 14, 2016 minutes, the new public disclosure exemption will give Seattle's pension system "greater access to top private fund managers." Why? Because "some [Private Equity] managers have told staff they were not interested unless they were an exception [to public disclosure requirements]."

Shielding Private Equity managers from public scrutiny is not a trivial matter, and I should like to ask Seattle's Mayor and City Council, "How much more expected revenue is required to gain the City's cooperation in concealing Private Equity fees from the public?"

The Private Equity industry claims it needs secrecy to protect its sophisticated analytical techniques from competitors. But a more plausible explanation can be found in a recent study by the Securities and Exchange Commission (SEC), which revealed that more than 50% of a large sample of Private Equity firms were overcharging investors (see here). According to a recent study by Oxford professor, Ludovic Phalippou, "Private equity firms have charged hidden fees amounting to $20 billion to companies" (see here, here, and here).

The SEC findings are actually small potatoes compared with Seattle's own Private Equity misadventures. A few years ago, the City went to court simply to get information on its $20 million investment in Epsilon II, with offices in the Cayman Islands, and a Ponzi scheme stretching all the way to Minnesota (see here). The judge rejected the City's plea, mocking Seattle for demanding transparency after the City's Pension Fund had placed a $20 million bet on "a foreign investment that by its own terms provided for only minimal transparency."

"But this is just one case," it will be objected. The chart below displays Seattle's Private Equity returns compared with Vanguard's low cost Small Cap Growth Index Fund for periods ending on 12/31/2015.

Granted, even the 7-year period in the graph is too short to rule out "bad luck" as the primary cause of Seattle's poor performance. On the other hand, the average annualized returns of Seattle's Private Equity portfolio would be significantly lower than the returns shown in the chart if the SEC and Oxford findings apply to Seattle. If Seattle is confident that its Retirement System isn’t paying any bogus fees to its Private Equity partners, then why not disclose these fees to the public?

Recall to mind the Financial Crisis, Mitt Romney and Bain Capital, Occupy Seattle, the 1% and the 99%. Thinking globally, the City of Seattle publicly condemned “unjust tax systems” and expressed grave concern about “growing income disparity” in Resolution 31337. But acting locally, Seattle officials doubled down on the City's investment in an industry that thrives on “unjust” tax loopholes and is front-and-center in the march toward greater inequalities of wealth and income.

Not to put too fine a point on it, but Seattle's commitment to Private Equity – with both the City's dollars and its readiness to shield its Private Equity partners from public disclosure – is an affirmation of the very same economic arrangements Seattle's elected officials criticized so sharply after the Occupy Seattle protests – special tax loopholes for the 0.1%, increased inequalities of wealth and income, and the distorting influence of big money in politics.

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