The subprime mortgage meltdown has claimed its first head in the pension fund arena. Coleman Stipanovich resigned Dec. 4 as executive director of the $187 billion Florida State Board of Administration over losses in an internally managed investment pool, now valued around $12 billion, saying he was doing the right thing to restore the confidence of people in the SBA.
But simply hiring a new executive director will not be sufficient to improve the system and to avoid such problems in the future. The responsibility for the problems doesnt rest with Mr. Stipanovich alone, and reform should begin with a thorough examination by outsiders of what went wrong, what failed. First diagnose, then treat.
The Legislature and the SBA should have a forensic audit conducted by an independent firm to uncover what happened in the investment management and oversight of the pool, and also to see the extent if any the missteps might have extended to the investment of the pension fund, the SBAs largest fund.
One cause of the failure appears to be the structure of the board of trustees.
The board consists of the three highest elected officials in the state: Gov. Charlie Crist; Chief Financial Officer Alex Sink; and Attorney General Bill McCollum. All three have potential conflicts of interests as politicians serving innumerable and often conflicting constituencies, while trying to oversee one of the biggest fund management organizations in the country.
In addition, their elected positions dont provide the board with any significant expertise for the oversight of the SBAs investment operations. In fact, they can serve to impede oversight. The attorney general, for example, would be conflicted investigating the SBA, where he is a fiduciary and responsible for its actions.
The structure hasnt engendered accountability or made the SBA operations more transparent. In fact, under the trustees and Mr. Stipanovich, the fund has operated with a great deal of secrecy and lack of communication to making information available, even under Floridas sunshine law.
The Legislature, working with the SBA, ought to seek advice of pension governance consultants on diagnosing the problems and restructuring the board of trustees, and it should look at other major fund boards to serve as models for a structure that will allow the SBA board to act independently, expertly and transparently.
While an improved board structure is being put into place, the Legislature and the current board must also examine the investment management of the SBA assets.
The current trouble at the SBA stemmed from its internal management of the Local Government Investment Pool, a short-term investment fund for municipalities and other government authorities in the state. The pool, by investing in mortgage-related securities, took investment risk that jeopardized its mandate to invest with pre¬servation of principal the priority over investment return. A rush of withdrawals that began after its investment in troubled mortgage securities became known, caused the pools assets, which totaled $27.3 billion as of Sept. 30, to drop to $9.9 billion at the close of business Dec. 20, excluding $2 billion in investments in default or under financial stress.
The SBA manages a total of at least $70 billion internally, including $60 billion of the $138 billion Florida Retirement System. The consultants and the SBA need to re-examine whether it is capable of managing such huge sums internally, especially as it is dealing with different funds with different investment goals. It manages 19 different funds, including the Florida Retirement System, with its long-term horizon, and the local government pool, with its short-term objectives. Can it hire the expertise required to manage assets in todays investment environment, where new investment vehicles are being developed and marketed every day? Does the current board structure have enough knowledge to provide solid oversight of the investment operations, to ask the right questions and to understand the answers?
The SBAs decision to hire BlackRock as interim manager for the pool, and to search for permanent external investment firms to manage the pool, demonstrate the restructuring and restoration of confidence in the pool is beyond the capability of the internal management.
But the SBA cant evaluate properly how to improve its governance and operations without knowing what controls broke down.