Saturday, August 15, 2015

Private Equity Insanity at NYCERS – Another $500M Down the Rat Hole

On January 1, 2006 Scott Stringer took office as the Manhattan Borough President. As such he became a trustee (1/5th vote) of the NYCERS Board of Trustees. He continued in these two positions for the next eight years.

As of January 1, 2006 NYCERS had investment contracts with 38 private equity managers and 5 real estate limited partnerships.

By December 31, 2013, eight years later, the number of private equity contracts had risen to 136 and the number of real estate contracts had risen to 43.

Then on January 1, 2014 Stringer took office as the NYC Comptroller. As such he continued to be a trustee (full vote) of the NYCERS Board and for better or worse he became the designated investment manager for NYCERS.

As of March 31, 2015 the number of private equity contracts had continued to increase to 143 and real estate contracts to 48.

For over nine years Stringer has approved or actually signed the contracts with these managers.

On July 21, 2015 Stringer along with 12 other state treasurers sent a letter to Mary Jo White at the SEC complaining about the billing and reporting practices of private equity firms. See quote below.

Among the four types of private equity firm expenses—management fees, fund expenses, allocated incentive fees, and portfolio-company charges, a portion of which serve as offsets or contra-expenses to limited partners—only directly billed management fees are easily segregable and therefore regularly disclosed. Though private equity firms generally disclose information on all types of fees, it is often reported deep in annual financial statements and is not reported directly to limited partners on a quarterly basis. This lack of clear and frequent reporting has resulted in an uneven approach to fee disclosure from private equity general partners to limited partners.

One tangible example of inadequate expense reporting relates to portfolio company monitoring fees. Limited partners, such as state pension portfolios, are typically eligible for an allocation of fees that private equity managers collect from their portfolio companies. However, this limited partner share is usually not transferred to the limited partner, and instead it is maintained by the manager and used as an offset against payment of management fees. The calculation behind this offset is often opaque to the limited partner, making consistent disclosure of private equity expenses to the public extremely challenging.

. . .

We welcome the opportunity to continue dialogue on this very important issue, and stand ready and willing to assist the SEC in the consideration of this concept.

Nowhere in the letter does Stringer mention that over the last nine years he is partially responsible for putting place the secret and defective contracts that allow general partners to avoid publicly and properly reporting their billing costs to NYCERS. Don’t expect the SEC to do anything about this problem.

It is obviously not Stringer’s total fault that NYCERS is saddled with these secret and outrageous contracts. It is, however, crystal clear that NYCERS should be aggressively extracting its assets from all of these limited partnerships. Some small percentage of them may be valuable but the vast majority of them are losing propositions. Under no circumstances should NYCERS be entering into any new private equity contracts.

On top of these expense reporting problems there is currently no public accounting of the performance of these investments at NYCERS. No one knows what the loss or profit position is with respect to any of the NYCERS private equity and real estate partnerships, whether terminated or currently active.

So what does Stringer do next? On August 4, 2015 Stringer announces that the five city pension will be investing $500M additional funds in private equity deals. He wants to give minority and women owned firms the same chance to extract money from the five city pension funds as the old white guy firms have been doing for years. See quote below:

(New York, NY) — On Tuesday, New York City Comptroller Scott M. Stringer and New York City Pension Fund Trustees announced a $500 million expansion of the City Pension Funds’ Private Equity Emerging Manager program, which brings the total amount invested or committed with Emerging Managers to more than $14 billion — including over $11 billion invested or committed to Minority and Women-Owned Businesses Enterprises (M/WBEs). The expansion of the program also includes a formal graduation policy for private equity Emerging Managers to facilitate the City Pension Funds’ ability to continue to invest with the best-in-class private equity emerging managers after they have out-grown the Emerging Manager program.

I could write a whole series of postings about M/WBE investment programs for public pension plans. Bottom line, they are just like the “old white guy” programs, garbage except they cost more money and are supercharged with political influence.

Sunday, June 28, 2015

Follow Up on the IT Budget Boondoggle at NYCERS

On March 12, 2015 the NYCERS Trustees approved a $2.25M budget allocation to be squandered on a mindless IT conversion project.

On May 10, 2015, two months later, I released a sharp criticism, of the project.

On May 12, 2015, two days later, the NYCERS executive director, Diane D'Alessandro, released an unsigned memo notifying the NYCERS staff of the fabulous five year IT conversion project.

So after two months D'Alessandro finally decides to let the troops know what she is doing, exactly two days after I point out the insanity of her project. She starts as follows:

As you may know, NYCERS is embarking on a major information technology (IT) and business system project to replace our now 35-year-old legacy pension administration system - PROD, the core of all NYCERS business functions. The project, known as the Legacy Replacement Project (LRP), will affect almost every aspect of our work at NYCERS, taking at least five years to complete.

She carefully describes the vote by the trustees as follows:

At its March 2015 meeting, the NYCERS Board of Trustees conceptually approved the LRP and adopted a budget that funds early project phases.

She also announces an internal PR campaign:

This is major NYCERS project. As a first step, we have begun a series of meetings to brief everyone on the project and to get your input regarding the initial phase of planning.

Without doubt D'Alessanro will be looking to drag in a ton of consultants for this project. She does, however, want to ensure the staff that she supports them totally:

I want you all to know that NYCERS is committed to providing our staff with the resources and support necessary to ensure success at all stages of this project. We will continue to keep you informed and seek your input as we progress.

You can't make this stuff up.

Just for Laughs

As part of the $2.25M, D'Alessandro got $500,000 for a sole source contract with Gartner. Of that amount, $310,000, is supposed to cover the cost of producing a RFP for the vague conversion project. There is nothing vague about its $132M price tag.

So what does Gartner do? They go looking for a recognized public pension expert who has substantial IT background. That probably is a good idea, since they don't particularly know much about public pension systems. Needless to say, neither does NYCERS.

In turn, Gartner contracts with a IT staffing firm to find such an expert.

On May 14, 2015, this firm reaches out to such an expert with the idea of hiring him and assigning him to the the Gartner contract.

On May 18, 2015 the firm calls the expert and describes the assignment. It becomes quickly clear to the expert that this assignment is part of the NYCERS IT conversion fiasco.

I will let you all guess who the expert was.

The expert was kind enough to let the firm know that, in spite of his intense interest in the project, D'Alessandro would never allow him to work on the project.

Monday, June 1, 2015

Lawsky - What Happened to the Public Pension Audits?

Lawsky is leaving NYS - DFS.

What happened to the audits of the seven state and city pension funds?

Sunday, May 10, 2015

Budget Insanity at NYCERS

On March 12, 2015 the NYCERS Trustees approved the NYCERS FY-2016 administrative budget. It was Diane D'Alessandro's tenth annual adiministrative budget proposal as executive director.

The key numbers are listed in the table below. For comparison purposes I added FY-2006, my last budget as executive director, and FY-1996, NYCERS's last budget under the city's budget structure. The 1996 budget was draconian to say the least. You can see from the table that the NYCERS's budget has increased by 43% over the last ten years or 4.1%/year.

NYCERS: Admin. Budget Over the Years

FY-2016FY-2006FY-1996
FT Positions 401342155
PT Positions 35 130
PS $30.2M $20.0M***
OTPS $19.4M $14.7M***
Sub-total $49.6M $34.7M$8.0M
Fringe $8.2M $4.1M$0
Total $57.8M $38.8M$8.0M

What is extraordinary about this budget is that it is the beginning of a delusional spending spree on IT upgrades. It is being called the "Legacy Replacement Project". It proposes to spend $132M over a five year period, staring with $500,000 to be paid to Gartner, Inc. and $1.75M to other consultants to be named later. At the meeting D'Alessandro indicated that she was going to pay $310,000 to an outside firm to write a RFP for this "grand" project. Listed below is the five year spending bonanza.

  • 2016 - $ 2.25M
  • 2017 - $ 9.91M
  • 2018 - $27.86M
  • 2019 - $46.00M
  • 2020 - $46.24M

To OMB's credit they complained about the $310,000 RFP. The trustees, however, approved this budget in spite of making noise about the long term cost of the project.

You would think, considering how well funded that the NYCERS budget is, that the NYCERS staff would be able to write their own RFP. But D'Alessandro got that part right, her staff can't do the job.

Of course, without the results of the RFP where did the $132M amount come from.

In fact over the last ten years D'Alessandro should have been standardizing NYCERS applications on a current client/server platform using a relational database system. This process was underway in 2005 when she first appointed. But thankfully the old CICS/VSAM systems were so well made that they have survived long after the point when they should have been retired. Thank God for small favors.

D'Alessandro, unfortunately, was appointed to her current job in 2005 without any prior relevant experience by Martha Stark and a bunch of compromised trustees. D'Alessandro had never managed anyone. She is not a lawyer, nor an accountant, nor an actuary. She had never worked for a pension system and she had absolutely no IT experience. What she was and still is, is grossly incompetent.

To make the situation worse, the current IT director was working as the NYCERS call center manager when D'Alessandro moved her to the agency's IT division in 2007. At that point she had no IT experience either. Six months later D'Alessandro makes her the director of the IT division. It reminds of when Rudy put a key punch salesman in charge of DoITT. She is as incompetent as D'Alessandro.

D'Alessandro submitted a five page justifying her budget proposal. It is a classic example of using a lot of words to create a fog, lots of hand waving and saying nothing except give me $132M. I actually don't think D'Alessandro wrote the summary. Five pages is far too much work for D'Alessandro. It looks like a cut and paste job from some marketing crap.

This is the justification for $132M.

MAJOR PROJECTS

In a continued effort to provide greater operational efficiency, enhanced customer service and improved quality and production, NYCERS is proposing to undertake a major information technology (IT) and business system replacement project that will streamline and consolidate all applications and functions into a single data repository for common use throughout the agency.

The project which will be known as the Legacy Replacement Project (LRP) will be conducted in three stages over a minimum of five years. The LRP will require a commitment of resources to be phased in over that time.

In order to ensure the success of the LRP, NYCERS is proposing two associated projects including a communications project designed to accommodate expanded electronic interaction with clients and a change management project to address staff training, coaching, and leadership development needs.

You can always spot a IT disaster from the start. It has a long time frame and they don't tell you what they are going to do in the first week of the project, the second week of the project, third week of the project,... You get the picture. Oh yeah, it will also cost a lot of money. I will guarantee you that this project will fail.

When I left NYCERS in 2005, NYCERS had one of the best IT departments in the city. The agency had:

  1. between 60 and 65 IT professionals on staff
  2. an integrated mainframe (VSE) and a network system (Windows Server 2003)
  3. all major work operations automated running under CICS using VSAM and DB2
  4. an advanced web site which allowed members and retirees to view their own specific data.
  5. an imaging/workflow system covering all paper based applications for all members and pensioners.
  6. a dedicated document scanning division
  7. a tested computer disaster recovery plan (we were researching a full business recovery plan and site)
  8. a standardized accounting package running on the network supporting both pension and administrative operations
  9. a nightly backup process of all files including the Exchange Server
  10. a project to upgrade major applications to DB2.
  11. an advanced Avaya based call center with its own backup PBX.
  12. a modern customer service center with its own integrated queuing system
  13. an on-site fully equipped training center.
  14. a proximity card system for both time keeping and security.
  15. a separate network system for the security and a full camera subsystem.

Returning to the executive summary, it is not only short on details about the project but it also has a great deal of deceptive information. The following are a few quotes out of D'Alessandro's write-up along with some clarifying comments.

RECENT HISTORY

Over the past nine years, NYCERS has made significant infrastructure improvements.

Document Management

NYCERS continues to ensure the preservation and security of all vital records and to promote an environmentally sound approach to document management. This effort includes the incorporation of all incoming documents into the NYCEWORK system in an electronic format and the ongoing digitization of historical paper documents.

In 2014, NYCERS prepared, scanned and indexed over 200,000 incoming documents and converted over 1 million historical records into digital images. Since the inception of the document management project, over 38 million paper records have been imaged, saving approximately $600,000 in document storage fees.

From this quote you would think that document management was introduced during the last few years. In fact, it was there when D'Alessandro walked in the door. The system in place at that time used a software package called Staffware. It was working well but it was being stressed by the volume of documents that NYCERS was dealing with. It actually continued to function up until 2014 when a new software package, Filenet/NYCEWORK, was finally put into production. I wonder where the $600,000 in saved storage fees came from?

Unfortunately, while Staffware needed to be either upgraded or replaced, Filenet runs significantly slower than Staffware did. That in turn has created incremental delays at every step of every process in the agency. It has created havoc with the production levels for all major functions in the agency.

This is an example of a mismanaged project being put into production so that management doesn't have to say it made a mistake. We saw this problem with the CityTime project.

While we are talking about mistakes, there have been two major IT disasters at NYCERS in the last nine years costing millions of dollars. One was the DB2 project and the other is the infamous Long Island City disaster recovery site. At least when the DB2 project was cancelled, the bleeding stopped. The LIC-DR project is a never ending cancer.

When I left NYCERS in 2005, the IT department with the help of two consultants was slowly converting over our major VSAM files to a DB2 relational database platform. We had already had two significant systems running under DB2 but there was a long term need to shift all major files over to the relational model. Two months after I left the project was cancelled. Subsequently NYCERS entered into a contract with IBM/Blue-Phoenix to do the DB2 conversion. That project dragged on for years, cost millions, and eventually failed. NYCERS even tried to sue IBM but with very little relief.

Business Continuity

The Long Island City business recovery site enables NYCERS to restore business operations and critical applications in the event of a disaster. This ensures the sustainability of operations and reduces the potential for data loss. Business recovery time is within four hours and the data recovery point is within 30 minutes.

From this quote you would conclude LIC-DR is a success. That is not true in any sense.

The lease on the LIC-DR project was signed in 2006 and NYCERS still does not have a Certificate of Occupancy for the site. I have previously written about this mess. It is not clear what is the legal status of having employees on that site.

For the record, the rent at LIC-DR is $530,000 for FY-2016 plus another $400,000 for other ancillary lease charges. The site has serious water leakage, asbestos, and plumbing problem. The lease comes up for renewal in the spring of 2016. Let's see what the decision will be then.

And in this season of delusion, NYCERS is planning a tertiary disaster recovery site. They even started buying hardware ($250,000 in FY-2015) for this mythical site. Some people just don't get it.

Business Process Automation

NYCERS continues to streamline business processes and leverage infrastructure investments to improve service delivery. As a result, NYCERS has achieved efficiencies in areas including loans and survivor benefits. On-line loan processing time has been reduced from 10 business days to five business days.

In this quote D'Alessandro appears to claim to have automated loans and survivor benefits in the last nine years and that the turnaround time on loans has been dropped from 10 to 5 days. Actually in 2005 both loans and survivor benefits were fully automated. The loans were the first applications automated in the early 1980's and also the first application to be integrated into the imaging/workflow system in 2002. In 2005, if you filed a loan application by Tuesday, NYCERS mailed a loan check to you that Friday. You would wonder why D'Alessandro would have made the above statement.

While all this craziness was going on with the great IT upgrade, D'Alessandro also threw in a request for 12 new employees with salaries of $720,000. No explanation was given. This was on top of 6 new employees in FY-2015, again with no explanation. Since 2013 the full time staff has gone from 372 to 401 and part time staff from 12 to 35. Why are there back logs with production work? Can you imagine what A.C.S. could do with that kind personnel increase.

Wednesday, April 15, 2015

A Message to the New NYCERS Chairperson

You have a huge problem. Your designated investment manager, the NYC Comptroller, is doing a terrible job with investing NYCERS assets, this Comptroller and the last three. NYCERS has an average annual rate of return over the last 15 years of 2.89%.

The Comptroller, however, has the backing of DC-37 which is the largest city union and also a NYCERS trustee. Between the three city unions on the NYCERS Board and the Comptroller these trustees control four votes, a majority of the total seven votes on the Board.

These votes control investment decisions, disability decisions, the NYCERS administrative budget and the budget subsidies from NYCERS to the Comptroller. The three unions are bound together because of disability votes at the Board. They need to back each other up to be able to get closely contested disability cases resolved in their favor.

Without the annual investment delegation from NYCERS Board of Trustees, the Comptroller has very little political influence. With the change in the City Charter in 1990 the mayor essentially controls the Comptroller’s administrative budget. This totally compromises his operating capabilities and his political influence.

If the Chair wishes to provide some relief to the mayor from the city’s huge pension burden, he will have to take away the Comptroller’s power over investment decisions.

This is a complicated task. Since 2005, DC-37 has run NYCERS as patronage mill for its flunkies. That starts with the executive director and spreads throughout the agency. This also includes regular employees who have criminal liabilities and are more than happy to do as they are told.

As the mayor’s appointee to the Board of Trustees, the Chair will need to take on both of these political entities. This will clearly be a hard fight. The investment issue cannot be resolved without addressing the investment delegation and the internal rot at NYCERS. The Chair will have to convince DC-37 that it is in its long term interest to reduce investment costs and raise returns. He will also have to commit to totally honest and sympathetic votes on disabilities that come before the Board of Trustees.

In return DC-37 and the other unions will have to not vote for the annual investment delegation to the Comptroller in June. It will also mean, however, that DC-37 will have to accept reform within NYCERS because the Comptroller will no longer have any incentive to allow NYCERS executive staff to run wild with the agency.

In eliminating the Comptroller from investment management operations the Board will have to hire a truly independent investment consultant and hire internal NYCERS staff to track investment activity. You can see why NYCERS also needs to be reformed. Current investment consultants under contract to NYCERS have structural conflict of interest issues involving the investment community. A large part of their revenue comes from the investment community.

While the Comptroller is the statutory custodian, he has contracted out almost all of its functions. The Comptroller has even turned over the the pension payroll operations to FISA, another city agency. There really isn't much left of the old Comptroller's Office. Ed Koch really did out maneuver Jay Golden.

The Trustees should set the target for total fee expenses at 10 basis points. That would have saved $130M in FY-2014 ($184M-$54M). The Trustees could then focus on a basic Russell-3000 US stock index fund & core investment grade bond Portfolio. Maybe the bonds could be indexed also. This will make running the portfolio and hiring staff much simpler.

Note: As of June 30, 2014 NYCERS had $11.8B in US equity index funds with annual fees of $500,000 for FY-2014 with an annual rate of return of approximately 24.5% gross of fees. But at 0.4 basis points the fees don't really effect returns. Yes, that is correct. NYCERS only paid a 0.4 basis point, not even half a basis point for that return. You can see why investment managers get nervous when you talk indexing.

The Trustees can then drop all the garbage asset classes listed below. This won’t be easy because of the crazy contracts the Comptroller’s office has signed in the past. I consider these contracts illegal because of the secrecy clauses.

Asset Classes to be Dropped:

NYCERS: Unproducive Investment Classes: Values and Fees for FY-2014

Asset ClassFees PaidValue as of June 30, 2014Basis Points
Convertible bonds $2.1M $.5B 42
Bank loans $3.1M $1.0B 31
Emerging manager- US stocks $4.4M$1.0B 44
Emerging managers – Foreign stocks $.3M$.05B 60
Emerging managers – US bonds not reported $.1B***
Private equity $58.0M $4.0B (guess)145
Real estate $20.87M $2.3B (guess)90
Infrastructure not reported$.02B***
Hedge funds $15.5M $1.9B (guess)82
Emerging market/active $9.1M $2.3B 39
Developed Market equity $11.8M $5.4B 22
Junk bonds $6.9M$2.1B33
Opportunistic Fixed $16.3M $1.1B148
Foreign bonds $.4M$.3B13
Active US equity $14.2M $5.3B26
TIP bonds $1M $1.5B7
Subsidy to the Comptroller $2.3M
Foreign taxes $8.8M

Thursday, April 9, 2015

They Never Get Anything Right

The Comptroller made a big splash yesterday. He finally discovered after nine and half years that the city pension funds are paying high investment fees and getting nothing for it. Hell, it is worse than that. They are losing money.

One thing he hasn't yet discovered is that he can't add. The fees are $3.5B over the last ten years, not $2.B.

For this princely fee, the combined five city funds had an average annual rate of return of 5.68% for the ten years. A simple stock index/core bond return for the ten years was 6.59%. That difference translates into a loss of $18.8B ($163.3B - $144.5B)

So what is the Comptroller going to do about it? Not a damn thing. Of course, he could go public with all the secret investment contracts and and the cash flow histories of all the terminated alternative investments. The newspapers would have field day with that.

Where are all the brilliant trustees?

One of the absolute laws of nature is: Never trust anyone, especially with your money.

For the record, here are the fees for the last ten years:

  • 2014: $522M
  • 2013: $473M
  • 2012: $370M
  • 2011: $396M
  • 2010: $427M
  • 2009: $339M
  • 2008: $310M
  • 2007: $262M
  • 2006: $193M
  • 2005: $158M

Another point of confusion is the total value of the five city pension funds. As of June 30, 2014 is was $144.5B, not $175.4B. You don't include the $32.9B that is in the teacher's TDA fund and the police & fire VSF funds. This money does not cover any pension liabilities.

Friday, April 3, 2015

The Comptroller's Office and Simple Arithmetic

NYCERS released its FY-2014 Comprehensive Annual Financial Report (CAFR) on Jan. 1, 2105. This report is submitted to the GFOA every year and is supposed to be a standardized financial report for all state and local government entities in the US. In addition, it is supposed to provide information to the general public, especially to actual and potential lenders, about the entity’s financial health and the level of risk involved with lending to the entity.

There is a significant section in the NYCERS CAFR dealing with investment details that are prepared by the NYC Comptroller’s Office. This is the first report produced by the current Comptroller. In this section on page 114 is a chart of the rates of return for the total portfolio and the major assets classes within the portfolio covering the three years 2012, 2013, 2014. There are also 3 year, 5 year, and 10 year averages. The chart alleges that the rate of return for the NYCERS portfolio for FY-2014 was 17.04% compared to a benchmark of 16.81%. There is no supporting documentation for this number but a reasonable person would conclude that it is accurate.

The audited income statement in the CAFR (page 82), however, tells another story. Based on numbers in the income statement which were signed off by the outside CPA firm, the opening balance for the NYCERS portfolio on 7/1/2013 was $47,194.6M and the closing balance as of 6/30/2014 was $54,422.0M. The income statement also indicates that NYCERS had a positive cash flow of $691.0M in FY-2014. Based on these numbers NYCERS had a total rate of return of 13.85% in FY-2014, (($54,422.0 - $691)/ $47,194)-1).

This same pattern has been occurring, at least, as far back as 2010 as you can see from the figures below drawn from prior CAFR’s:

  • - Year: Reported vs Actual
  • - 2014: 17.04% vs 13.85%
  • - 2013: 12.24% vs 8.81%
  • - 2012: 1.32% vs -1.14%
  • - 2011: 23.12% vs 19.39%
  • - 2010: 14.09% vs 10.68%

The other figures quoted in this schedule on page 114 are much more difficult to compute and I have no confidence that the Comptroller was any more successful with the math for these numbers. In particular, he quoted 15.2% rate of return for NYCERS’s private equity contracts. I suppose he is referring to the eight contracts that terminated in FY-2014. Of course, you might easily be misled and think that he was referring to the entire class. That would wrong and he is very carefully never to report rates of return for open contracts.

But let’s get back to 15.2%. Of the eight contracts that closed in FY-2014, either by exiting or sale on the secondary market, the Comptroller is not providing any cash flow histories for these contracts. Not only do I think the 15.2% is incorrect but I think the rate of return on these closed contracts showed a loss like the Allegra contract. If I am wrong, all we need is the cash flow histories on the eight contracts to compute their correct rates of return. If I am right, you will never see their cash flow histories.

What makes this more outrageous is that over the last 15 years, members of NYCERS have contributed $5.4B out of their own paychecks into NYCERS along with $21.8B of taxpayers’ money that has also been contributed. Oh, I forgot. Members are taxpayers too.

If the Comptroller’s Office cannot perform simple arithmetic, then the NYCERS Board of Trustees has a serious problem with renewing its annual delegation of investment authority to the Comptroller.

The fact that the rates of return are consistently inflated raises the suspicion that it was done on purpose. The investment figures are not audited. NYCERS actual average annual rate of return over the last 15 years is 2.89%, a little scary.