(January 7, 2014) — The State Employees Association of North Carolina (SEANC) announced yesterday that it has hired Benchmark Financial Services, Inc. to conduct a forensic investigation into the $83 billion pension fund.
The Tar Heel state’s pension may be experiencing problems similar to those in South Carolina and Rhode Island: transparency issues, unnecessarily high management fees, risky investments, and covered up placement agent payments among others.
Representatives of the union said their concerns have been brewing for a long time. Performance continued to decline over the last few years and yet the state treasurer and sole fiduciary of the 11th largest American pension fund kept pushing for riskier alternative investments.
“We believe the wolves of Wall Street are at our door and knocking,” SEANC’s Dana Cope said in a press release. “Given the treasurer’s expanded alternative investments authority that bleeds money in fees, we’re not going to wait until our retirement system is in near collapse like a Rhode Island or South Carolina to find out answers to pressing concerns about the state’s retirement system.”
It was ultimately Treasurer Janet Cowell’s request for a report on placement agents during former state Treasurer Richard Moore’s tenure between 2002 and 2008 that prompted the union to hire the firm.
“We found through the treasurer’s recent placement agent report that North Carolina was ripe for abuse,” SEANC’s Communications Director Toni Davis told aiCIO. “Folks were hosted by investment fund managers on expensive outings.”
According to the 131-page report issued in December, the fund found almost $15 million from eight investment managers using placement agents.
“These are problems that are well-known in the marketplace,” Benchmark Financial Service’s President Ted Siedle told aiCIO. “Conflicts of interest are pervasive in the industry. These are some of the very significant red flags that we’ll investigate into.”
Siedle said he plans to dig into conflicts of interest, total management fees, disclosure practices, risks undertaken by non-traditional investments, and potential violations of US Securities and Exchange Commission laws, among broader transparency problems.
“Lack of transparency is often the case when there is a high allocation to alternatives—they’re not publicly traded and often insinuate corruption of the investment process,” Siedle said.
Adding fuel to the fire, the state General Assembly passed legislation allowing the pension to invest up to 34% of its assets to “risky ventures such as hedge funds and real estate that often come with very high fees from Wall Street managers” last year. Cowell pushed further before the year’s end, driving the cap to 36%, claiming the fund was too invested in fixed asset classes.
Performance, however, failed to rise in turn, according to SEANC. The 2012 annual report showed a significant underperformance of hedged strategies—one-year return was -6.52%, well below its customized benchmark return of -2.57%.
“It is ironic that Treasurer Cowell is using these dismal results showing underperforming alternatives as her rationale for wanting to throw more money down that rabbit hole.” Ardis Watkins, SEANC’s legislative affairs director, said in a press release.
In December, Cowell was confident in reporting a 4.89% gain for the quarter ending September 30, 2013 and a 9.97% return for the 12-month period.
“North Carolina’s pension is solid,” she said in a press release. “We have successfully navigated the market turbulence of the past few years. Future challenges include low interest rates and slower growth relative to historical standards. That’s why I am committed to continuing to diversify the portfolio to keep it growing for the families across our states who depend on it.”
The issue then moves to high—and sometimes invisible—management fees.
“We don’t really know how much we’re spending in fees,” SEANC’s Davis said. “There isn’t a report put out anywhere that would delineate that information in the way we would like to have it.”
Instead, Davis said the pension fund should divest from risky alternatives completely with a 65% allocation to stocks and 35% to bonds.
However, Andy Silton, former chief investment advisor to the North Carolina state treasurer, claimed this would be an even riskier option particularly if crises such as the dot.com bust and 2008 were to hit again.
“Many of the treasurer’s commitments to alternatives are relatively recent and thus haven’t had enough time to contribute to or hinder the pension plan,” Silton wrote in a blog post. “The role of alternatives in driving returns will be determined in the next five or 10 years and hasn’t been determined with the release of the third quarter report.”
A major factor of the continued concern for the pension fund may be rooted in the state statute declaring Cowell and her 25-member investment team as its sole fiduciary. North Carolina is one of four states to have such a system.
“It’s far too much money to be trusted in the hands of one person, no matter who that person is,” said SEANC’s Cope.
Davis told aiCIO that the union was pursuing legislation to overhaul the current system—one with checks and balances.
Cowell was unavailable for comment on the prospective investigation but her spokesman, Schorr Johnson, said the treasurer “is sponsoring an independent and objective assessment of the governance structure for the state’s investments.”
Benchmark Financial Services’ Siedle said North Carolina won’t be the last public employees’ union to request such forensic inquiry: “Whether plan sponsors like it or not, we have entered a new era in which public sector workers demand full transparency regarding all investments, including hedge funds, venture and private equity holdings, and oppose Wall Street pillaging of public pension honey pots.”
Related content: Half a Billion in Fees: How Two US Public Pensions Spent It, SEC Lets Kentucky Off the Hook Over Placement Fees