Minnesota Mirage: Sleight of Hand
The damning findings of a long-anticipated independent expert forensic investigation of Minnesota's state pensions--funded by concerned teachers--were released today in 110-page report.
The Executive Summary of an independent expert forensic investigation of the Minnesota Teacher Retirement Association and State Board of Investment pension funds commissioned by nearly 2,800 members of the Minnesota Educators for Pension Reform Facebook Group is presented below. The entire 113-page report is also attached below.
At the outset of the participant-funded investigation—approximately 6 months ago—we filed requests pursuant to state public records laws asking for key documents related to the state pensions’ investment programs.
Over the past six months, we were provided with nothing.
Yesterday, immediately before the anticipated publication of this report, the State Board of Investments finally released a few of the documents we requested 6 months ago—in an apparent attempt to delay the damning report until after the Vice Presidential debate next week and national Presidential election in November. It seems that since the Chairman of the Board of the SBI was Governor Walz, who is now the Democratic Vice Presidential candidate, there is some concern pension mismanagement or wrongdoing under his watch could undermine confidence in his leadership skills—at least with respect to investment matters. Walz recently disclosed, while responsible for overseeing a $140-plus billion fund established to provide retirement security for tens of thousands of state workers, he has never owned a stock or a bond.
Any analysis of documents withheld from public scrutiny prior to September 25th—the date of the report—may be provided in subsequent reports. Minnesota educators see no need for further delay resulting from months of inexcusable state efforts to thwart public scrutiny.
Minnesota Mirage: Sleight of Hand
Executive Summary
Transparency in government has long been acknowledged in America as essential to a healthy democracy. The Minnesota Government Data Practices Act creates a premise that the government data is available to the general public unless otherwise established by a statute, law, or rule. With the exception of specified documents, the law regards all documents from public agencies to be government data.
Transparency is especially critical to the prudent management of trillions of dollars invested in America’s state and local government pensions. Indeed, the single most fundamental defining characteristic of our nation’s public pensions is transparency. Of all pensions globally, our public pensions—securing the retirement security of nearly 15 million state and local government workers, funded by workers and taxpayers—are required under our state public records laws to be the most transparent.
While transparency is widely accepted as “the right thing to do,” there is ample evidence indicating greater transparency leads to better outcomes. On the other hand, forensic investigations reveal that greater secrecy inevitably leads to fraud, mismanagement and waste.
Transparency, which would add not a single dollar of additional cost to the Minnesota Teacher Retirement Association (TRA) or Minnesota State Board of Investment (SBI) could, through exposure, swiftly cure all that ails both pensions—highly suspect performance claims; massive undisclosed, excessive and potentially bogus investment fees and expenses; reckless risk-taking; unaddressed conflicts of interest, mismanagement and potential malfeasance.
Transparency, which would add not a single dollar of additional cost to the Minnesota Teacher Retirement Association (TRA) or Minnesota State Board of Investment (SBI) could, through exposure, swiftly cure all that ails both pensions.
Public pensions primarily invest government workers retirement savings in securities and funds which are regulated on both the federal and state level. Our nation’s securities laws require that securities issuers and fund advisers register with regulators, disclose financial and other significant information to all investors—including public pensions—as well as prohibit deceit, misrepresentations, and other fraud. The statutorily mandated disclosure information is commonly provided to all investors in the form of prospectuses, offering memoranda, annual reports, performance reviews and other documents.
Thus, in public pension matters, we are concerned with two levels of transparency: Investment firms must be transparent in their dealings with pension boards and staffs overseeing investments, so these individuals can fulfill their fiduciary duty to diligently safeguard pension assets. Pensions, in turn, must be transparent to the public for stakeholders to understand the investment program, and, equally important, evaluate whether pension fiduciaries are prudently performing their duties.
Despite the primacy of public scrutiny, tellingly, there is no mention of, or commitment to transparency in TRA’s Mission Statement.
Our investigation reveals TRA and SBI have long abandoned transparency choosing instead to collaborate with politicians, public pension industry insiders and Wall Street to eviscerate Minnesota public records laws and avoid accountability to stakeholders. Predictably, tens of billions that could have been used to pay state retirement benefits have been squandered as transparency has ceased to be a priority.
TRA Response to Public Record Request: Pension Has None
As a result of TRA’s confusing structure, the initial daunting challenge pension stakeholders seeking fundamental information regarding TRA’s investments encounter is determining who to ask, for what and how.
On April 11, 2024, we submitted our initial public record request for information regarding TRA to TRA itself electronically.
In response, TRA admitted it does not have access to, or possession of, any of the fundamental investment documents we requested related to the pension’s assets. As a result, clearly TRA’s board has not over the years and, indeed, cannot fulfill its fiduciary obligations to review such investments for prudence. While TRA’s handbook states its Board has “knowledge regarding pension investments,” absent relevant documents and reports, the Board cannot possibly be knowledgeable as to TRA’s specific investments. In reality, TRA’s board exercises no fiduciary oversight of the trust’s investments whatsoever. Any claims to the contrary are grossly misleading to pension stakeholders.
SBI Complete Failure to Respond to Public Record Request
Given the lack of clarity regarding the governmental entity holding documents related to TRA’s investments, we also requested the very same data from the Minnesota State Board of Investment—the entity which actually manages TRA’s assets.
We received nothing.
Since early April, we have not been provided with any of the data requested regarding TRA’s basic investment operations from TRA or SBI. We have not been informed SBI does not possess the data or that any of the data we requested are nonpublic.
The lack of cooperation by TRA and SBI was all-the-more surprising given that both pensions were well-aware that this forensic review was commissioned, as well as paid for, by thousands of participants, with the stated objective of improving management and oversight. Pension fiduciaries solely concerned with the best interests of participants and beneficiaries should welcome, not obstruct, a free independent review by nationally recognized experts. Further, given the profound concerns stakeholders have long raised, it is clear both pensions could benefit from an independent review by experts—this time not of their own choosing.
In conclusion, TRA claims it has no data to disclose regarding its investments and SBI has chosen to simply not respond to repeated requests for such data. Whether SBI even has the data requested is unknown.
As a result, it is simply impossible for stakeholders in Minnesota’s state pensions (including participants and taxpayers)—no matter how sophisticated or diligent—to determine whether the assets in such funds are prudently invested, properly valued and safely custodied, or even exist.
In summary, despite any state laws mandating transparency: Public pensions in Minnesota are not subject to public scrutiny.
Public pensions in Minnesota are not subject to public scrutiny.
TRA Records Participant Calls Without Consent; TRA and SBI Refuse to Record Board Meetings
Finally, while teachers have long pressed the TRA Board to enhance transparency by recording its meetings (so that active teachers and other stakeholders who are unable to attend meetings held during the workday can be informed as to its dealings), audio recordings of such meetings were stopped at some point in the past supposedly on advice of legal counsel (apparently the Attorney General)—without explanation.
We note that public pension board meetings around the country are routinely recorded, both on audio and video and even broadcast live via audio web stream. There is simply no good reason TRA participants or stakeholders should be denied the opportunity to scrutinize Board actions through recorded meetings.
There is simply no good reason TRA participants or stakeholders should be denied the opportunity to scrutinize Board actions through recorded meetings.
Indeed, recording of the meetings would quickly expose that the TRA Board neither possesses nor reviews key information regarding the pension’s investments. (We note that SBI also does not record its Board meetings to enhance transparency.)
While TRA will not record its own Board meetings, recent data provided by TRA pursuant to individual public record requests reveal the pension routinely records telephone conversations with participants—without notice or consent—and internally disparages participants critical of its operations, unbeknownst to them. Clearly, TRA and SBI opposition to recording their own Board meetings yet willingness to secretly record calls from, as well as comment upon participants is indicative of a culture of defensiveness and hostility toward stakeholders.
State and National Effort to Undermine Forensic Investigation
Internal documents provided by TRA in response to an individual public records request reveal an aggressive, preemptive secretive effort on the national level—including state pension officials in California, New York, Ohio, Rhode Island and Minnesota, as well as education unions and public pension industry allies to undermine the participant-funded investigation. These efforts began as soon as the participant-funded investigation was openly proposed on GoFundMe but before it was even funded. As alarming as the documents provided are, other documents—presumably more damning—were withheld by TRA supposedly pursuant to the attorney-client privilege.
On the one hand, the documents reveal TRA and SBI staff and Board members, state legislators and officials (including the offices of Governor, Attorney General and Legislative Auditor) were panicked, believing the proposed investigation posed “many serious risks to the agency and pension fund. Specifically, TRA’s reputation as a trusted government agency is going to be questioned.” Further, these parties reasoned that since TRA does not manage its investments, the investigation would be focused on SBI which “invests assets for not just TRA, but the Minnesota State Retirement System, the Public Employees Retirement Association, volunteer fire relief plans, state cash accounts of over 400 state agencies, and the non-retirement program that provides investment options to state trust funds and various public sector entities. Therefore, all of those groups, entities, and entities’ boards would be impacted” by the investigation. Anxious state officials proposed asking Education Minnesota, an organization made up of 477 local unions and 84,000 members, including active and retired teachers, “to publicly support TRA and the SBIs’ integrity.”
During the fundraising period, a member of the Facebook Group received a phone call from a TRA Board member who encouraged her to drop the effort. She also received phone calls from Retired Educators Association of Minnesota leadership “in an attempt to talk the Group out of the proposed investigation.”
Once the investigation was under way, between June and August, Facebook Group members met with SBI CIO Jill Schurtz on 6 occasions and fielded her numerous phone calls and text messages. In those meetings and phone calls, Schurtz asked the Group to drop their public records request multiple times, and stated that they “didn't want their name associated with the investigator who took a "scorched Earth" approach in investigating wrongdoing.” Schurtz also stated that she would help set up meetings to connect the Group with key players in pension reform and offered to bring in an auditor to determine the normal cost of Tier I and Tier II pensions.
On the other hand, public pension organizations to which TRA and SBI pay membership dues and attend their lavish conferences at luxury venues—the National Council on Teacher Retirement and National Conference on Public Employee Retirement Systems—assured state officials that any investigative findings would be “a worthless big pile of opinions” and “lies.”
The National Council on Teacher Retirement and National Conference on Public Employee Retirement Systems assured state officials that any investigative findings would be “a worthless big pile of opinions” and “lies.”
These allies organized Zoom meetings with pension officials in other states opposed to participant-initiated transparency reforms and secretly provided opposition research to media—specifically targeting reporters who had already met with members of the Facebook Group.
The self-proclaimed Minnesota Center for Fiscal Excellence publicly posted in a blog: “Our prediction right now is that this is going to turn up absolute bupkis, and that teachers contributing to this fund are wasting their money.”
“Our prediction right now is that this (investigation) is going to turn up absolute bupkis, and that teachers contributing to this fund are wasting their money.” - Minnesota Center for Fiscal Excellence
When Minnesota officials, including the Governor, public pension boards and staff, representatives of State or Legislative Auditors, Attorneys General, legislators and public pension industry allies preemptively, aggressively target individuals who are working on behalf of pension participants to ensure public scrutiny of public monies—to undermine their reputations and investigations—the public should be very concerned. These schemes are rarely exposed but when they are (as in Minnesota), the public, regulators and law enforcement should ask:
Why did Minnesota government officials responsible for overseeing state pensions immediately assume an independent, expert review would uncover anything seriously wrong, e.g., mismanagement or wrongdoing? What did they know about the state’s pensions that so worried them they were compelled to preemptively strike out?
TRA “Endangered” Funding Status
According to its financial statements, TRA is an administrator (emphasis added) of a multiple employer, cost-sharing retirement fund which provides retirement, disability and survivor benefits to Minnesota’s public educators. It is also stated that, for financial reporting purposes, TRA is considered a pension trust fund (emphasis added) of the State of Minnesota. Total plan assets of the TRA fund as of June 30, 2023 were $28.2 billion. For the fiscal year ended June 30, 2023, the funded ratio of the pension was 76.9 percent, a decrease from 82 percent a year earlier.
Under the federal scheme (i.e., Pension Protection Act of 2006) designed to address alarming funding problems encountered by many multiemployer corporate pensions, at 76.9 percent funded, TRA would be considered in the Yellow Zone for endangered and would be required to adopt a funding improvement plan designed to increase its funding percentage.
The investment return assumption used by TRA was reduced effective July 1, 2023 from 7.5 percent to 7 percent, as recommended by the actuary for the plan. The 2023 unfunded actuarial liability of the pension was $35 billion, an increase from $31.6 billion a year earlier. If the net pension liability were calculated using a discount rate which is one percentage point lower than the current assumption, i.e., a more realistic 6 percent rate, the current underfunding would soar to approximately $40 billion.
TRA Complex Structure Amounts to “Sleight of Hand”
The state’s $140 billion in public retirement fund assets, including TRA, are invested under the authority and direction of the SBI and are commingled in various pooled investment accounts, commonly referred to as the Combined Funds. TRA does not own any underlying assets, but instead owns a participation in the pooled Combined Funds. That is, each participating retirement fund owns an undivided participation in the Combined Funds’ pooled investment accounts.
The Combined Funds structure creates unnecessary complexity, heightened risks and a profound lack of transparency.
Prudent practice dictates that pension assets be overseen by the plan sponsor, separately custodied and held in the name of the plan. Plan investment holdings should be clearly identified/disclosed to participants so that participants can judge for themselves whether the assets are suitable and properly managed.
Having TRA's assets custodied elsewhere, held in another plan's name, in opaque funds under the authority and direction of others amounts to a "sleight of hand." No reasonable participant would accept the additional risks to their retirement security the Combined Funds structure creates—assuming any participant could even understand the risks related to the Combined Funds.
Worse still, there are no benefits from the Combined Funds structure. While SBI claims that by pooling the assets, it can offer institutional investment management at a low cost, the available evidence indicates that the fund has increasingly embraced high-cost investment vehicles that fail to perform competitively. Potential economies of scale are not realized, as a result of mismanagement by SBI. The Combined Funds structure has historically merely served to obscure, or conceal investment underperformance and facilitate underreporting of investment fees and expenses.
TRA’s assets are overseen by three different boards—TRA, SBI and the Investment Advisory Council (IAC), all of which are fiduciaries to the plan. TRA is governed by an eight-member Board of Trustees consisting of five elected representatives, one representative of the Minnesota School Boards Association, the Commissioner of the Department of Education, and the Commissioner of Minnesota Management and Budget. All members of the SBI Board are elected officials—the Minnesota Governor (who is designated as Chair), State Auditor, Secretary of State and Attorney General. The SBI governance structure is fundamentally flawed in that none of these politicians has any pension expertise and all may receive campaign contributions directly or indirectly from investment firms holding (or seeking) lucrative contracts to manage the massive state fund’s assets. Indeed, the Chairman of the SBI Board, Governor Walz, according to recent financial disclosures has never owned a stock or bond. The legislature has also established a 17-member Investment Advisory Council (IAC) to supposedly advise the SBI and its staff on investment-related matters.
Remarkably, despite an apparent abundance of board oversight, even a cursory review of TRA and SBI reveals glaring, obvious deficiencies and inconsistencies which should have been identified and addressed years ago by one or more of the boards.
Despite an apparent abundance of board oversight, even a cursory review of TRA and SBI reveals glaring, obvious deficiencies and inconsistencies which should have been identified and addressed years ago by one or more of the boards.
Failure to Monitor and Fully Disclose Skyrocketing Investment Fees and Expenses
It is well established that sponsors of retirement plans have a fiduciary duty to ensure the fees their plans pay money managers for investment advisory services are reasonable. In turn, reporting investment results to pension stakeholders in both gross- and net-of-fee terms gives them a clear, easy way to view the impact of fees on fund performance.
However, neither TRA nor SBI disclose investment returns both gross- and net-of-fees to stakeholders. In our opinion, the only reason to report total returns on a net of fees basis only is to conceal the total fee amounts—fees which have skyrocketed in recent years.
Equally disturbing, SBI’s Annual Reports include an unusual, prominent warning which indicates the pension has chosen to withhold important fee information from its Board because the pension mistakenly believes the Board should “focus” exclusively on net results, i.e., disclosure of investment fees and expenses would be a mere distraction.
SBI’s Annual Reports include an unusual, prominent warning which indicates the pension has chosen to withhold important fee information from its Board because the pension mistakenly believes the Board should “focus” exclusively on net results, i.e., disclosure of investment fees and expenses would be a mere distraction.
As a result of its “focus,” apparently the SBI Board is unaware of the total amounts paid. (Since TRA financial statements do not include this same prominent warning, as well as other important disclosures included in SBI reports, TRA participants are less informed about its finances.)
The shift by public pensions, including TRA and SBI, into more complex, opaque so-called “alternative” investment vehicles, such as hedge, private equity and venture funds, as well as fund of funds has brought dramatically higher investment fees—fees which are often not fully disclosed and may be much more difficult for pensions to monitor.
Worse still, a recent review by the SEC found more than half of about 400 private-equity firms it examined charged unjustified fees and expenses without notifying investors.
Accordingly, pensions which choose to gamble in asset classes—such as private equity funds, specifically cited by regulators for charging bogus fees in violation of the federal securities laws—must establish heightened safeguards to ensure that all fees paid to such managers are properly reviewed and determined to be legitimate, as well as fully disclosed to participants.
Tens of Billions in Undisclosed Fees Paid by TRA and SBI to Wall Street
In terms of disclosed investment management fees, each year for the past 11 years TRA’s financial statements indicate a remarkably low and consistent amount—less than 10 basis points of total plan assets. More implausible, as the pension has invested a greater percentage of its growing total plan assets to high-cost alternative investments—an increase from $2.7 billion to $6.6 billion—disclosed fees have fallen and only fluctuated slightly from year-to-year. This is unbelievable since the fees and expenses related to private assets are well-known to be exponentially greater than those related to traditional assets. (Private funds annually charge substantial asset-based fees of approximately 2%, as well as performance fees of 20% or more.)
We note that a comprehensive study of 54 public pensions from 2008 to 2023 shows fees average 1 percent of assets under management. By that metric, TRA with $28 billion in assets would be expected to pay over a quarter billion dollars a year in fees to fund managers.
In our opinion, it is apparent that total investment management fees and expenses are grossly underreported annually by both TRA and SBI. The overwhelming majority of such fees are not disclosed to stakeholders.
In our opinion, it is apparent that total investment management fees and expenses are grossly underreported annually by both TRA and SBI. The overwhelming majority of such fees are not disclosed to stakeholders.
It appears that only a small percentage—less than 10%—of the total fees have been disclosed to the public.
For example, in 2023, TRA disclosed total investment fees of merely $24 million. We estimate total fees related to TRA’s private equity funds alone that year ranged from $334 million to $467 million. The undisclosed private investment fees in 2023 alone—in a single year— substantially exceed all fees disclosed by the Fund since 2013 ($262 million).
Total TRA undisclosed private investment fees since 2013 amount to an estimated nearly $3 billion.
Like TRA, SBI discloses only a small amount ($83 million in 2023) of the total fees it actually pays Wall Street—an estimated $1.7 billion to $2.4 billion annually.
Over the past decades, we estimate tens of billions in undisclosed investment fees have been paid by TRA and SBI to Wall Street. In our opinion, it is inconceivable, given public attention regarding the inadequacy of public pension investment fee disclosures and the numerous costly experts TRA and SBI have retained to advise them, the pensions are unaware of the massive fees they have failed to disclose in the past—even if they are clueless as to the exact amounts.
An exhaustive investigation into all TRA and SBI past payments to investment managers should be immediately undertaken, as well as recovery pursued with respect to any illegitimate or excessive payments. Given widespread industry abuses (as documented by SEC staff), and TRA and SBI failure to diligently monitor all investment fees and expenses, the likelihood of bogus charges is high, in our opinion. Finally, disclosure of historic costs should be adjusted to correct any past underreporting or errors.
$360 Million in Fees Paid Annually to Wall Street for Doing Nothing
According to the Financial Statements, “TRA has a total of $3.6 billion in unfunded commitments to the investments valued at NAV. Unfunded commitments is money that has been committed to an investment but not yet transferred to the General Partner (Investor).” Whether TRA has any unfunded commitments related to any other investments, not included in the above figures, is unknown at this time.
Among the many controversial practices related to private equity and debt investing is charging investment management fees on “committed capital.” In other words, after the investor makes a capital commitment to a private fund, management fees are charged on the entire commitment amount, regardless of whether the capital is actually drawn or invested. Paying fees on committed, uninvested capital results in exponentially greater expenses on assets under management on a percentage basis.
Fees on committed, uninvested capital amount to paying managers for doing nothing—no service whatsoever is provided in exchange for the outlandish fee. In our opinion, such fees add insult to injury since these types of alternative investment funds already charge exponentially higher fees than traditional stock and bond funds.
Fees on committed, uninvested capital amount to paying managers for doing nothing—no service whatsoever is provided in exchange for the outlandish fee.
Not surprising, unlike TRA and SBI, savvy institutional investors are increasingly refusing to pay outlandish fees to private investment managers based upon their capital commitments and opting for alternatives that do not charge such fees.
Assuming TRA pays fees of 2 percent on total unfunded commitments, this amounts to an estimated annual waste of approximately $72 million.
As discussed earlier, there is no reason to believe TRA monitors or knows the full fees—including fees on committed, uninvested capital—it pays investments managers and whether those fees are fully disclosed.
Total fees on committed, uninvested capital paid by SBI would be exponentially greater than those paid by TRA, an estimated $360 million annually—for doing nothing.
TRA Brazen Benchmark Bias: $39 Billion Investment Underperformance
According to TRA’s financial statements for fiscal year 2023, performance versus a Composite Index (devised by TRA) indicates the fund has outperformed the Index on a 1, 5, 10, 20, and 30-year basis by 0.2% for each and every period. In our opinion, this same 0.2% outperformance year-in and year-out seems virtually impossible.
To determine the probability of getting five of the exact same return values relative to the Index—0.2%, data was obtained from SBI Annual Reports for the years 2014–2023. The probability of getting the same return value five times was calculated to be 0.0000149 Notably, the exact same outcome of five return values of 0.2% also occurred in 2020.
TRA’s remarkable claims of 0.2% consistent outperformance for all periods stand out. TRA’s performance results amount to, at a minimum, brazen benchmark bias.
The composition of the Composite Index devised by TRA is not disclosed in TRA’s financial statements. Therefore, it is impossible to evaluate whether it is constructed appropriately to gauge performance of the portfolio. Further, absent such disclosure, it is impossible for stakeholders to determine if, when or how the Composite Index may have been changed over time.
SBI’s Annual Report discloses the composition of its Composite Index for the period ending June 30, 2023 for the Public Equity Composite Benchmark and Fixed Income Composite Benchmark. No composite benchmark is disclosed for its highest cost, riskiest investments in Private Markets, including private equity, private credit, resources, and real estate. Later, the Report states SBI reviews the performance of its private market investments, relative to inflation, as measured by changes in the Consumer Price Index. Comparing private markets performance to the CPI’s 2.5% annualized performance is not only absurdly inappropriate but virtually ensures that private markets (and the SBI as a whole) will handily outperform its Composite Benchmark. If SBI investment staff members are paid bonuses for outperforming the Composite Benchmark, they, too, will benefit.
The Public Equity Composite Benchmark disclosed is highly complex, has changed almost yearly since 2016 and was adjusted quarterly in certain years. Further, it is noted that “Prior to 6/30/2016 the returns for Domestic and International Equity were not reported as a total Public Equity return.” The Fixed Income Composite Benchmark is also complex and has been changed repeatedly since 2018. It is impossible for pension stakeholders to determine whether the composition of the shifting benchmarks is appropriate and whether benchmark performance has been calculated correctly.
In a recent article entitled Lies, Damn Lies and Benchmarks: An Injunction for Trustees, investment consulting pioneer Richard Ennis concludes that most public pensions, including Minnesota, exhibit benchmark bias when reporting their performance publicly.
In another article, “Cost, Performance, and Benchmark Bias of Public Pension Funds in the United States: An Unflattering Portrait,” Ennis analyzed the primary performance benchmarks used by 24 large public funds, including Minnesota, in their public reporting. These were benchmarks of the public funds’ own devising. He compared the rate of return of empirically-determined benchmarks to the return of the benchmark each fund reported in its annual report for the 10-years ended June 30, 2020, in order to determine benchmark bias.
In short, he identified significant bias in the returns of benchmarks used by the funds. With respect to Minnesota specifically, for the 10-year-period ended June 30, 2022, Ennis concluded the pension underperformed a representative passive benchmark by 0.26%. On the other hand, for the same period, TRA boasts it outperformed its Composite Index by .40%.
When we calculated the true performance of the $28 billion-plus pension using empirically-determined benchmarks, we determined TRA underperformance amounted to $39 billion over the past 30 years. In short, had the pension been prudently managed to its risk-adjusted benchmarks, it would be nearly $60 billion today—providing greater retirement security for participants and saving taxpayers billions.
In conclusion, representations that the Combined Funds have outperformed the Composite Index devised by TRA by 0.2% for each and every period seem highly suspect. While experts have proven widespread benchmark bias at public pensions, TRA’s remarkable claims of 0.2% consistent outperformance for all periods stand out. TRA’s performance results amount to, at a minimum, brazen benchmark bias.
“Catastrophic” Tax Consequences of Pension Performance Errors
When large public pension plans misstate their investment performance results—intentionally, or unintentionally—the tax consequences can be “catastrophic,” according to tax experts.
In 2021, when internal documents at Pennsylvania’s largest pension fund—the Public School Employees’ Retirement System—revealed a performance calculation error, the FBI and SEC launched investigations, the fund’s board began its own probe and 100,000 public school employees suddenly faced paying more into the retirement system. The error related to “data corruption” in just a single month—April 2015—over the near-decade-long period included in the performance calculation.
While the one-time error was small, it falsely boosted the $64 billion fund’s performance over a financial quarter just enough to wrongly lift the fund’s financial returns over a key state-mandated hurdle used to gauge performance.
The board had little choice but to fix the number. A top tax lawyer warned the board that failure to do so would be “catastrophic” and force half a million current and retired school workers to pay future income taxes on pensions immediately.
Since both TRA and SBI have failed to provide any of the documents we have requested, we cannot know for certain—and can only estimate—the magnitude of any potential errors or omissions in calculations of performance and investment costs. Further, we cannot know the tax consequences, or other legal and financial implications of any pension miscalculations.
However, with respect to TRA and SBI, the .02% outperformance is consistent over all periods of time over 30 years, not merely a single month in a near-decade-long period. Also, it is apparent that only a small percentage—less than 10%—of the total fees have been disclosed. Coincidentally, as discussed further below, the outside consultant ultimately found responsible for the error at the Pennsylvania pension was Aon—a consultant used by both TRA and SBI.
Finally, in recent years the Securities and Exchange Commission has brought securities fraud charges against the states of Kansas, Illinois and New Jersey stemming from a nationwide review of bond offering documents to determine whether municipalities were properly disclosing material pension liabilities and other risks to investors. Any potential pension performance or investment fee disclosures which are erroneous may be of concern to the SEC.
Private Investment Risks
TRA and SBI have a 25% target allocation to private markets that includes private equity, private credit, real estate and resources. These are the highest-cost, highest-risk of all investments and the least transparent. Due to the heightened concerns regarding these assets, we specifically requested from both TRA and SBI all documents related to these funds.
Our goal in requesting the private market documents was to determine whether these investments were prudent and adequately monitored by pension fiduciaries. TRA responded that it had no such documents related to its alternative investments and SBI—without indicating whether it has any such documents—has provided none to date.
Nevertheless, the risks related to private market investments generally and commonplace industry abuses are well-known. In fact, many of the risks, conflicts of interest involving self-dealing and other abuses are regularly partially disclosed in the offering documents—documents which TRA and SBI have been unwilling or unable to provide to us.
In order to educate TRA and SBI stakeholders as to these risks and abuses, we have provided an initial list related to private equity investments. In our forensic investigations of over $1 trillion in retirement plans, we have never encountered a pension that fully understood the dangers of investing in alternatives and adequately monitored the investments. Clearly, TRA—which claims it does not hold any of the key investment documents cannot fully understand disclosures it has not even seen and monitor the risks consistent with its fiduciary duties. Whether SBI possesses, has reviewed and monitors these high-risk investments is unclear. However, the fact that the pension is, at best, unwilling to release to the public any documents it may have, is alarming.
“Zombie” Fund Dangers
According to TRA, “the typical liquidation period for alternative investments ranges from 3 to 12 years.” When alternative investments fail to fully liquidate within the stated term of the fund, numerous concerns arise, including whether some or all investment fees will continue to be charged, as well as whether the valuation of portfolio investments and performance reporting has been accurate over the life of the fund.
There is ample reason to believe, in the opinion of experts, that the delayed liquidations may be “red flags” for abusive practices, including, but not limited to, fraudulent valuations.
For example, following the wreckage of the 2009 global financial crisis, many private equity managers (unable to raise new capital because of poor performance) extended the lives of their troubled funds, milking management fees from investors for mediocre and over-leveraged assets for years. These funds were referred to as “Zombie Funds” by the financial press. Major public pensions have been found to be at risk from Zombie funds. A new class of Zombie funds is reportedly emerging today due to the sharp rise in interest rates.
According to TRA’s financial statements, there are 45 out of 193 Private Equity funds owned by SBI that are over the 12-year liquidation and represent 6% of the Private Equity NAV value. There are 8 out of 35 Real Estate funds owned by SBI that are over the 12-year liquidation and represent 1.2% of the Real Estate NAV value. There are 12 out of 32 Real Assets funds owned by SBI that are over the 12-year liquidation and represent 13.2% of the Real Assets NAV value. There are 13 out of 42 Private Credit funds owned by SBI that are over the 12-year liquidation and represent 7.1% of the Private Credit NAV value.
In conclusion, TRA and SBI alternative investments subject to extended liquidations should be examined more fully. There is ample reason to believe, in the opinion of experts, that the delayed liquidations may be “red flags” for abusive practices, including, but not limited to, fraudulent valuations.
Failure to Monitor Pension Consultant Conflicts of Interest
Today it is well established that conflicts of interest involving investment consultants retained to provide objective advice to pensions regarding asset allocation, manager selection and performance monitoring are pervasive throughout the industry. Such conflicts, including but not limited to the receipt of compensation directly or indirectly from investment managers they recommend to pensions, can result in substantial financial harm to pensions. As a result, regulators including the Department of Labor and SEC, have advised plan sponsors they have a duty to investigate such conflicts.
Our review of relevant regulatory filings and disciplinary histories reveals all three of the investment consulting firms TRA and SBI utilize are subject to significant potential conflicts of interest. Since TRA and SBI have failed to provide us with any contracts between the funds and their investment consultants, stakeholders cannot possibly know critical facts such as the range of services the firms provide, whether the firms have adequate insurance coverage to satisfy potential claims involving the massive pensions and whether the pensions have agreed to any limitations on investment consultant liability. Stakeholders cannot possibly determine whether the products and services the investment consultants offer to money managers, and related compensation, which can give rise to serious potential conflicts of interest have been adequately disclosed to plan fiduciaries and are monitored on an ongoing basis.
If TRA and SBI’s investment consultants have failed to properly disclose to the pensions, conflicts of interest and investment manager compensation arrangements, they may have both failed to comply with their advisory contracts, as well as violated statutory fiduciary duties. If TRA and SBI have failed to adequately monitor conflicts of interests involving their investment consultants which could potentially undermine the integrity of the pensions’ investment decision-making process, the Boards may have breached their fiduciary duties to safeguard assets and exposed the funds to enormous risks. Further, the TRA and SBI Boards may have permitted the investment consultants to enrich themselves by the amounts of such manager payments, at the expense of the pension.
Conclusion
In light of the serious ongoing concerns identified, it is generally advisable for stakeholders to contact the State Auditor, Legislative Auditor and Attorney General. However, in this matter, all three of these state offices are potentially conflicted.
The State Auditor is a member of the SBI board. Further, according to the office, her “authority does not extend to TRA or other agencies audited by the Legislative Auditor.” It appears that stakeholders could contact Office of Legislative Auditor (OLA) regarding the statutory authority and process for a petition or special audit. According to OLA, allegations of misuse of state money, resources or data, can be the basis of a special review. Petitioning OLA to essentially audit its prior TRA work might be worthwhile in light of the compelling new information in this report.
Finally, this report was filed with the SEC and provided to the FBI. While the Attorney General appears to be conflicted in this matter due to his involvement with the pensions (as TRA legal counsel and SBI Board member) and having opposed the investigation, he was provided a copy of our findings.