A culture of cavalier corruption?

By Paul Mackintosh - 25/03/13

So Fred Buenrostro, the former CEO of CalPERS, has finally been indicted by a federal grand jury and been charged civilly by the SEC after a protracted series of pay-to-play enquiries at the US$249  billion pensions giant, America's largest.

The financial crisis has led to many prescriptions that banks should shun moral hazard, return to their roots of prudence and reliability, become responsible members of society, spin off their arms invested in the hairier asset classes, and generally ditch the other-people's-money mentality. And yet here you have a pension fund, of all things, rather than a rapacious amoral bank, behaving in such a cavalier, corrupt way with people's retirement money. What kind of culture of public accountability allows that? Alfred Villalobos, Mr. Buenrostro's opposite number in the alleged fraud, is ex vice mayor of Los Angeles. And interestingly, the CalPERS Wikipedia entry makes no reference to the affair.

What this whole scandal reflects about the state of municipal administration in the US is a question for a different forum. But it is hard not to conclude –  if you're me –  that it was private equity that corrupted CalPERS. Yes, any asset class in theory could have given Mr. Buenrostro the opportunity to award some alleged $14 million in improper placement fees to Mr. Villalobos. And no one is claiming that Apollo Global was anything beyond the innocent occasion of all this. But the commitment to Apollo was around $3 billion. With such large chunks of money in play, is it any wonder if temptation strikes?

The whole culture of private equity, in its pre-crisis guise at least, appears all too likely to foster moral hazard. The private fundraising model, with closed-door discussions and the informational equivalent of covenant-lite loan packages in terms of performance disclosures, could not be less transparent and accountable. Relationship-based access combined with billion-dollar allocations is a patently toxic combination. Even the former rules on publicity during fundraising inadvertently encouraged the privileged access myth. And yes, placement is not private equity per se. But is this more than simply outsourcing the moral hazard and reputational risk?

And yes, in certain cases this structure can generate outperformance. But any industry hostage to the top-quartile/top-decile configuration is obviously not getting it right that consistently. Could more transparency improve that 25%-or-less success rate? Possibly.

Of course, that was then. We are post ILPA, post the listing of some of the industry's biggest players with the commensurate disclosure requirements. Has the culture of the industry changed permanently for the better? Perhaps. Has the proportion of moral hazard in the system diminished? You be the judge.