SACRAMENTO, Calif. - State Controller Kathleen Connell has sued the board of CalPERS for allegedly violating state law by giving 10 internal portfolio managers pay hikes above state guidelines and setting up its own payroll system when the controller refused to implement the raises.
In response, officials of the $165 billion California Public Employees' Retirement System said they had the authority to pay the portfolio managers at a higher rate under Proposition 162, the 1992 amendment to the state constitution that gave the retirement system broad investment authority and protects it from political meddling.
The lawsuit would provide the first court test of CalPERS' independence under the law.
In their searing response, CalPERS executives said the lawsuit "would, if successful, seriously threaten the ability of CalPERS to maximize and enhance its investment performance." In the release, Chief Executive Officer James E. Burton said: "The alternative to hiring employees with these skills is to contract with private money managers, who would all charge fees astronomically higher than the salaries the CalPERS board has set."
Observers privately portrayed Ms. Connell's action as both a desire to curb CalPERS' independence and as politically motivated. Ms. Connell is in a difficult six-way race to become mayor of Los Angeles; the primary election is slated for April 10. "This appears to be politically motivated," said one observer who is close to CalPERS who asked not to be named. "This issue is not a new issue. It's an attempt to get more ink."
Ms. Connell's campaign did not respond by press time to a request for comment.
In her lawsuit, filed Jan. 31 in Sacramento Superior Court, Ms. Connell also claimed that CalPERS illegally had quadrupled per diem payments to various board members, to $400 a day. She also charged CalPERS had surpassed a 25% state cap on reimbursing public agencies for time spent by board members on CalPERS business. For example, CalPERS reimburses 90% of board President William Crist's salary to his employer, the California State University in Stanislaus. Ms. Connell serves as a CalPERS board member by law but is not personally affected by either policy.
But her charge that CalPERS illegally gave 10 investment professionals, who are exempt from civil service rules, raises of 11% each could threaten the fund's ability to attract and retain qualified investment staff, CalPERS officials warned.
The raises, approved last April by the board, increased the salary range for the 10 managers to $88,000 to $105,000. CalPERS' internal portfolio managers also receive incentive compensation, which is not at issue.
After months of haggling, the state Department of Personal Administration, headed by Marty Morgenstein, another CalPERS board member, refused to approve the new salary range. Department officials are understood to believe that exempting a growing number of CalPERS employees from state civil service rules is a threat to the civil service system. (Civil service employees meanwhile were awarded a 4% raise.)
"We declined to approve the increase requested by PERS but we are continuing to discuss (other options) with them," said Fred Buenrostro, who represents Mr. Morgenstein on the CalPERS board.
As a result, on Oct. 20 CalPERS issued its own exempt pay letter directly to Ms. Connell, who, as the state's chief financial officer, cuts California's paychecks.
Second payroll system
Ms. Connell balked at honoring the request. CalPERS officials decided to circumvent Ms. Connell and set up their own payroll system to issue checks to the 10 portfolio managers. CalPERS officials also wrote officials in the controller's office that the controller's office would be responsible for undoing any overpayments, although the controller continued issuing checks.
A paper issued by the CalPERS press office says the pension fund "has been experiencing increasing difficulty in recruiting and retaining highly skilled investment managers" during the past three years. The paper states that it has taken CalPERS two to three times as long to fill its internal portfolio management positions as it takes private firms to fill comparable positions.
CalPERS released a table revealing it has taken from six to 14 months to fill internal portfolio manager jobs during the past two years, compared to two to five months elsewhere; and many candidates have turned down jobs because of the salaries. In the worst case, 193 candidates turned down a job managing mortgages and other asset-back securities; it took 12 months to fill the post.
"To get the caliber of people to run this system, the way the market is, you have to pay more," said William Rosenberg, who is named in the suit as one of three board members who received the higher travel per diems.
Below industry average
Meanwhile, CalPERS has been revamping its compensation program for top investment officers. A study by Watson Wyatt Worldwide, San Francisco, for CalPERS reveals the pension fund - even after its recent 11% base salary hike - pays well below the financial services industry.
For example, the base salary of Chris Doffing, CalPERS' internal active manager, was more than 30% below the median salary available elsewhere, assuming the top-of-the-scale pay of $105,000 a year. And the most recent bonus paid out for that job - $44,848 - is one-fifth of the industry median bonus of $222,821.
For higher level jobs, the comparison gets even worse. The position held by Mark Anson, CalPERS' senior investment officer for public equity, carried a salary range of $143,750 to $184,000, or 45% to 57% of the median industry range. And the most recent bonus paid - $109,138 - to that job is a measly 11% of the $963,289 median industry bonus.
Based on Watson Wyatt's recommendations, CalPERS' performance and compensation committee is slated to vote on the following proposed changes at its Feb. 21 meeting:
* Review survey data every two years, instead of three; all new hires made in the past two years were at the top of their salary ranges.
* Increase base salary ranges.
* Allow increases in an individual's base salary rate based on labor market fluctuations, in addition to annual performance reviews.
* Create a multiyear incentive structure on top of annual bonuses to put compensation more in line with long-term investment objectives.