Fees and placement agents: A news analysis

For help in getting investments from CalPERS, private-equity funds paid the firm of a former CalPERS board member, Al Villalobos, $50 million in fees.

But what if the investment firms put the fees paid to marketers such as Arvco, the Villalobos firm, into the management fees they charge CalPERS for investing the pension fund money?

Then CalPERS would be paying the hefty fees collected by Arvco and other “placement agents,” the little-known but lucrative line of work put in the national spotlight by a public pension scandal in New York.

The placement agent fees paid by investment firms are not supposed to be passed along to the pension funds.

But it’s a possibility that the nation’s two biggest public pension funds, the California Public Employees Retirement System and the California State Teachers Retirement System, have thought about.

Documents released by CalPERS this month show that the pension fund knew the private-equity funds would pay placement agent fees to the Villalobos firm, but did not want the cost of the fees passed on to CalPERS.

“The cost to CalPERS of the investment is not increased by the placement fee or expense reimbursement paid by ACOF (the private-equity fund) to ARVCO,” said a form sent to Apollo Management by CalPERS.

The forms show that Apollo agreed to pay Arvco a $25,000-a-month retainer fee for a year, in some cases, and to reimburse expenses for first-class air travel and lodging as well as “chauffeured town cars” to and from major airports.

CalSTRS released a report in June on placement agent fees paid by its investment firms for a three-year period — a total of $32 million in fees on 33 investments worth $5.2 billion from 2006 through 2008, mostly real estate, not private equity.

A half-dozen of the CalSTRS investments have a footnote that says: “The management fees have been reduced by any placement fees and interest charges.” So, does that mean the management fees on the other investments included placement fees?

Definitely not, said CalSTRS spokesman Ricardo Duran. He said the footnote is a glitch on a first-time report and actually applies to all of the investments, not just a half dozen. The list’s headline says the “fees are not paid by CalSTRS.”

Because of a disclosure policy adopted three years ago, CalSTRS was able to respond quickly to a request for placement agent information from state Treasurer Bill Lockyer, who sits on both the CalSTRS and CalPERS boards.

CalPERS did not adopt a disclosure policy until last May. Now CalPERS is asking investment firms to voluntarily disclose placement agent fees they have paid in the past.

The CalPERS release of the Villalobos fees was a response to a Public Records Act request by the Wall Street Journal. The big payments prompted CalPERS to hire a law firm, Steptoe and Johnson, to conduct a “special review” of placement agent fees.

CalPERS had already hired a consulting firm in May, Houlihan Lokey, to review ways to reduce management fees for private-equity firms such as Apollo and real estate and hedge funds, the Los Angeles Times reported last week.

The release of information about the Villalobos placement fees and a look at ways to reduce private-equity management fees are a reversal of previous CalPERS positions.

CalPERS made little response to a Public Records Act request three years ago for information about Villalobos and other placement agents, saying its relations with “top-tier private equity funds” may be harmed.

“CalPERS has been advised by a number of general partners that CalPERS’ current status as an ‘investor of choice’ will be damaged if we provide confidential information of the type requested,” Marte Castanos, CalPERS senior counsel, said in a letter dated July 12, 2006.

“In addition, some top-quartile general partners have recently expressly refused to allow CalPERS to invest with them because of concern over disclosure issues,” Castanos wrote.

Earlier in this decade CalPERS refused to release information about management fees paid by private-equity funds and other investment firms, drawing a lawsuit from the California First Amendment Coalition that was settled five years ago.

A New York Times report of the settlement said private-equity funds and other “alternative” investments can generate larger returns, but also produce big losses.

“That has prompted some analysts to question whether the alternative investments are appropriate for government pension funds, which must fall back on the taxpayers if they get into trouble,” the Times story said on Dec. 8, 2004.

After the stock market crash last fall, a CalPERS decision to increase its investments in private-equity funds was criticized in a Times story last July, drawing a response from Joe Dear, the CalPERS chief investment officer.

Reuters made a similar criticism in a package of stories last week, going into the history of CalPERS investments in recent years.
One of the things not in the stack of Villalobos documents released by CalPERS this month is a description of what placement agents do to earn the big fees — $13.2 million for the Villalobos firm on a single CalPERS investment deal with Apollo.

The legal papers have Arvco agreeing to make “reasonable best endeavors” to get investments for Apollo and boiler-plate language about abiding by the law. Apollo may have given Arvco some help in seeking CalPERS investments.

“In addition, Apollo maintains a full-time staff of marketing and investor relations personnel who assisted in marketing the investment to CalPERS,” say the forms submitted to CalPERS by Apollo.

The CalSTRS report in June contained a defense of placement agents.

Nicholas Bienstock, an adjunct assistant professor at Columbia University, cites his own private equity firm, Savanna Real Estate, as an example of how placement agents are needed to help smaller firms get money from institutional investors.

“The biggest firms (Goldman Sachs, Morgan Stanley, Carlyle, Apollo, etc.) don’t need third-party placement agents,” Bienstock wrote. “Their size enables them to bring this function in-house.”

Nonetheless, the documents show Apollo giving Arvco more than $42 million in fees for CalPERS investments in seven different funds.

A Wall Street Journal story earlier this month mentioned Fred Buenrostro, the CalPERS chief executive officer from 2002 until 2008. He reportedly went to work for Arvco last August.

The Journal said CalPERS staff sometimes felt that Buenrostro “pressured them to look favorably on deals where Arvco was a placement agent.”

Buenrostro told the newspaper he would “make introductions to staff and if there were questions about the investment process, I would answer them … The CIO (chief investment officer) had the role of making recommendations to the investment committee.”

Reporter Ed Mendel, long considered the state’s premier budget writer, covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. He currently covers public pension issues. His stories are at http://calpensions.com.