The $209.1 billion California Public Employees' Retirement System, the largest defined benefit fund in the country, displays a Jekyll-and-Hyde personality.
On the one hand, its corporate governance activism has become a model for other pension fund and institutional investors. It has demonstrated a strong correlation between good corporate governance and shareholder performance.
On the other hand, its own internal governance appears to have bred allegedly corrupt behavior on the part of members of the CalPERS board of trustees and staff — going all the way to the top, and allegedly compromised the integrity of its investment process. The alleged corruption is not an instance of a rogue staffer, but the alleged actions of members of CalPERS' leadership.
CalPERS' board of trustees should bring in a management consulting firm to help it restructure its internal oversight, including its decision-making process, revamp checks and balances, and ensure accountability, and it should ask for legislative support to reform the structure of the system. The Sacramento-based system also should draw on lessons from the success it has achieved in urging good governance practices that promote accountability and sustainable performance at corporations.
To its credit, CalPERS last October initiated a review of its placement agent fees and activities, and since then has toughened or recommended stronger placement agent and ethical policies, and it restructured its agreement with Apollo Global Management LLC, saving a total of $125 million in fees over five years.
But its internal governance problems risk affecting the integrity and success of its corporate governance activism. That activism, a Wilshire Associates Inc. study shows, has contributed to boosting CalPERS' investment performance.
Even following the financial market crisis of 2008 and early 2009, its shareholder activism program achieved an unprecedented success. As a result, for 2010 it dropped its focus list identifying companies with poor corporate governance and poor shareholder performance, the first time it has done so since the program began in 1988. The reason is each of the companies CalPERS screened for consideration as candidates, except for one in the process of an acquisition, improved its corporate governance practices and had positive performance for the past year.
At the same time CalPERS was attaining success in corporate governance, its internal governance allegedly allowed abuses that appear to have cost the fund millions of dollars, again reflecting a direct relationship between the quality of governance and performance.
Fred R. Buenrostro Jr., CalPERS CEO from 2002 to 2008, was charged, along with Alfred Robles Villalobos, a CalPERS trustee from 1992 to 1995, in a civil complaint filed May 5 by Edmund G. Brown Jr., California state attorney general, in Los Angeles Superior Court. They are accused of fraudulent and unlicensed securities broker-dealer activities related to pay-to-play investment activities that helped to steer $4.8 billion of CalPERS' investment business to particular firms, resulting in $47 million in commissions being paid to ARVCO Capital Research LLC. ARVCO, also charged in the compliant, was founded and owned by Mr. Villalobos.
Mr. Villalobos allegedly showered favors on Mr. Buenrostro while he was CalPERS CEO, spending tens of thousands of dollars on him, according to the suit. For example, Mr. Villalobos hosted at his Lake Tahoe home and paid for a large part of Mr. Buenrostro's wedding in 2004, the suit alleges. In 2005, ARVCO or Mr. Villalobos paid for a substantial part of the cost of Mr. Buenrostro's 10-day trip around the world, even though Mr. Buenrostro submitted $5,071 as expenses to CalPERS, the suit claims.
The suit also implicates but does not charge Charles P. Valdes, who had been CalPERS investment committee chair, and Leon G. Shahinian, senior investment officer overseeing alternative investments. Mr. Villalobos or ARVCO allegedly contributed to Mr. Valdes' campaign for board trustee and paid for trips, including to the Academy Awards and possibly to Dubai. Also, Mr. Villalobos or ARVCO allegedly paid for Mr. Shahinian's trip to an event at the Museum of Modern Art in New York.
Mr. Shahinian “did not disclose to the CalPERS board that he had just returned from an all-expenses paid trip with Villalobos to New York, even though Mr. Shahinian recommended to the CalPERS board it invest up to $700 million in Apollo Global Management, a firm for which ARVCO served as a placement agent,” the complaint states.
A statement from ARVCO and Mr. Villalobos said, “We vigorously deny allegations in the … complaint.” It said they have been cooperating in the investigation. “We … are confident that … ARVCO, Mr. Villalobos and Mr. Buenrostro will be completely vindicated.”
Mr. Buenrostro couldn't be reached at ARVCO.
CalPERS, which could see clearly problems in corporate governance in companies in which it invested, neglected to examine firms with which it invested, and their placement agents, as well as its own internal governance. It should commission a study similar to the Wilshire study to estimate the cost to it of its internal problems. Fortunately, its corporate governance activism apparently has offset some of the losses from its own internal poor governance.
