The Secret Is, 'Everybody Gets Rich Except the People Who Put Money In'

In a recent speech to private equity investors, Securities and Exchange Commission (SEC) Chairman Gary Gensler said hedge funds and private equity firms must provide far greater transparency about the fees that they are charging their clients.

"More competition and transparency could potentially bring greater efficiencies to this important part of our capital markets," said Gensler, who formerly worked on Wall Street. "This could raise the returns for the pensions and endowments behind the limited partner investors. This ultimately could help workers preparing for retirement and families paying for their college educations."

Efforts to increase transparency and expose the widespread abuses by high flying Wall Street players of the pension funds of teachers, firefighters, cops, and bus drivers could soon be coming to a head in Ohio.

Due to an active group of retirees and the assistance of a former Ohio Attorney General, both the Ohio State Auditor and the Ohio Department of Securities have launched inquiries into the Ohio State Teachers Retirement System (STRS), a $100 billion pension that has launched billions of dollars of investments into the riskier corners of the market, namely private equity and hedge funds.

"Ohio could be the first place where the secrecy surrounding public pensions and their investments in risky, speculative and high-fee investment vehicles could be looked at in a serious way," said Ted Siedle, a former SEC attorney and longtime pension whistleblower.

Pointing out that pension funds across the country have routinely invoked "trade secrets" exemptions to deny the public information about investment performance and fees, Siedle said the actions taken by the state auditor and securities commissioner "could be the beginning of the end" of such secrecy — not just in Ohio, but nationwide.

$8.6 billion in losses

Former Ohio public school teacher Dean Dennis hadn't paid too much attention to what was going on underneath the hood of the Ohio STRS that had paid his modest pension since he retired in 2008, after teaching for 35 years. That changed in 2013, when the fund began to cut the cost of living adjustment (COLA) he had been promised as part of his pension when he retired.

"First they eliminated our COLA for one year, and then reduced it from 3 percent to 2 percent for another three years, and then by 2017, they took the COLA away and it's never been restored," said Dennis.

Outraged, Dennis started two Facebook pages—one public, one private—that now have a combined 24,000 members, all united to hold the Ohio STRS accountable. Along with two other retirees, Dennis launched petitions to restore their lost COLA, and they now have over 50,000 signatures. And with the help of the 19,000-member Ohio Retired Teachers Association, Dennis raised $75,000 to hire Siedle to perform a fiduciary review of the pension fund.

While Siedle told The Daily Poster that he has yet to receive what he considers essential information about the operation of Ohio STRS, he says his review so far has revealed structural problems within the pension fund.

In his report released on June 7, Siedle found that, relative to a benchmark recommended in the last comprehensive performance audit of the fund, the Ohio STRS' $27 billion in investments in private equity, real estate, and hedge funds has cost the pension "$8.6 billion or $2.5 million per trading day for 14 years." On the other hand, according to the report, "Restoring the COLA benefit would cost less than $1 million ($890,000) per day."

The alternative investment industry's "2 and 20" fee mode (2 percent of assets and 20 percent of performance, typically over a threshold rate) can be 10,000 percent higher than the fees paid to low-cost index fund managers, who can charge fees as low as 0.035 percent of invested assets. At the same time, alternative investment funds typically deliver performance that fails to beat the market.

Rudy Fichtenbaum, a board member at STRS with a Ph.D in economics, agreed with Siedle's concerns about the state pension fund. "The pension is going into private equity and other alternatives where they are paying huge fees and taking gigantic risk," he said. He was also troubled by the illiquidity of private equity and alternatives, which make it difficult for pension funds to get their investments back quickly. The process can take years, if it happens at all.

Fichtenbaum added, "Largely the agenda and the narrative [of pension fund board meetings] is really controlled in my observation fairly tightly by the [STRS] staff." According to Fichtenbaum, this arrangement has led the pension staff to " delay any consideration" of reinstituting cost-of-living adjustments, while at the same time receiving $10 million in total bonuses.

It's clear the STRS staff is "very out of touch with retired members," Fichtenbaum said.

"It's mind-boggling"

The alternative investment industry has always operated under a tight veil of secrecy. Unlike publicly traded companies that have reams of publicly available information filed with the SEC, alternative investments file only a limited set of information. This means that unlike stocks, bonds and mutual funds, there is no publicly verified information about how well these investments perform.

Critical investment questions, like how much risk and debt a specific fund is taking on, are often hidden in closely guarded contracts, offering documents and prospectuses. Alternative investment managers' business contracts are typically not available through public records requests, due to alternative investment managers' assertions of trade secrets privilege and public records exemptions created by state governments.

But such investment information is essential because some alternative investment funds have a habit of going broke. The Dayton Daily News earlier this year investigated the cautionary tale of Panda Power Funds, quoting a STRS spokesperson saying: "From 2011 to 2013, State Teachers Retirement System of Ohio invested $525 million with Panda, but the investment is now valued at zero."

Siedle is working to obtain additional documents from STRS to shed light on its alternative investments—but so far, the process has proven difficult.

"We've asked for documents using industry standard terms, and they're fighting with us about what these terms mean," said former Ohio Attorney General Marc Dann, who is assisting Siedle in his record requests. "It's mind-boggling for all of us."

Dann expects Siedle to ultimately prevail in seeking the documents.

Dann drew a connection between STRS' conduct and the infamous Coingate scandal, which revealed that Ohio Republican leaders were rewarding campaign contributors through investments made by the Ohio workers compensation fund, including into the highly speculative market of rare coins.

"In the case of Coingate, the investments they chose to make were based on political decisions and rewarding campaign contributors," said Dann. "We think there's a really good chance that that is what is happening here."

Thanks to the efforts of Siedle and Dann, plus the pressure campaigns of energized Ohio retirees, state leaders are finally starting to act. The office of the Ohio State Auditor confirmed to The Daily Poster that an investigation into STRS is active and ongoing, although a spokesperson declined to provide further comment on the matter.

Soon these endeavors could pay off. As Siedle put it, "Ohio could be the first place where this secrecy is lifted."

Robin Rayfield, executive director of the Ohio Retired Teachers Association, agrees it's high time to address the issues facing STRS' investments.

"Everyone gets rich who has any association with STRS," said Rayfield, "except the people who put money in."