Friday, March 29, 2013

NYS Insurance Department - Strange Delay

Since 1937, the NY State Insurance Department (“Department”) has had supervisory authority over NYCERS. See Section 13-183 (NYC Administrative Code) below:

§ 13-183 State supervision. The retirement system shall be subject to the supervision of the department of insurance in accordance with the provisions of sections three hundred seven, three hundred eight, three hundred nine, three hundred ten, three hundred eleven and three hundred twelve of the insurance law, so far as the same are applicable thereto, and are not inconsistent with the provisions of this chapter.

This statute requires NYCERS, as of March 1 of each year, to file an annual report with the Department. The Department controls the format of this report and requires a great deal of detail about NYCERS assets and operations. In some ways, it is comparable to fillings that the SEC requires public corporations to make.

The statute also requires the Department to conduct a periodic audit (“examination”) of NYCERS.

Over the years, the Department has conducted this examination of NYCERS on a five year cycle. The last full five year examination was 1995-1999.

In 2004 the Department began what I thought was going to be the 2000-2004 examination. By law, NYCERS is required to pay the cost of the examination. By July 2005, a draft of the examination was completed according to the Department. I was forced out as NYCERS executive director in March, 2005. During 2004, there was an ongoing conflict between the Department and the NYC Comptroller over investment issues at NYCERS.

As a point of interest, there was also conflict between the Department and the NYS Comptroller over the examination of the NYSLERS. In retrospect, there probably was a lot to have conflict over.

For an unknown reason the Department did not release the final NYCERS examination until June 25, 2009. In addition, the examination only covered 2000-2002, a three year period as opposed to the standard five year period. No reason was given.

This report highlighted 4 key findings:

  1. NYCERS should make a greater effort to facilitate the examiner’s request for information on future examinations.
  2. NYCERS did not have a comprehensive Investment Policy Statement that governed, controlled, and monitored its investment activities.
  3. The NYCERS Board’s interactions with the Comptroller (BAM) and legal counsel (NYC Corp Counsel) indicate that the trustees need to be diligent regarding the inherent potential institutional conflict of counsel.
  4. With regards to loaned securities, the Board and the Comptroller’s office did not give clear guidance to Citibank (custodial bank for city pension assets) on how to deal with downgraded securities in the portfolio.

The first item reflects the Comptroller’s reluctance to turn over documents to the Department.

The second item motivated the trustee to prepare an investment policy statement.

The third item is an ongoing dilemma. Legal advice given by NYC Corp Counsel to NYCERS is always subservient to Corp Counsel’s commitment to the mayor. The trustees, however, should require the Corp Counsel to include a declaration on all written legal advice that there is no conflict between the interests of NYCERS and the mayor with respect to the given advice. If there is, Corp Counsel should recuse itself.

The fourth item involves securities lending and the risk of default on securities held in the multi billion dollar leveraged portfolio that the custodian bank maintains for NYCERS. NYCERS is very shy about publicly reporting on the assets in this portfolio. Securities lending is a very complex process. General details are not readily available. Securities lending, however, is one of the biggest operations on Wall Street.

In FY-2009 NYCERS began paying the Department for a new examination. The normal pattern would be an examination for the 2005-2009 time frame. The 2003-2004 period, however, is still unreported and may be picked up in the current examination.

Tuesday, March 26, 2013

Hedge Fund Schizophrenia

I just read a great article about the whiz kids over at the Comptroller's office "transitioning" the city's five pension funds into hedge funds. Don't you just love those glitzy words like transitioning. They make you feel so warm inside.

Of course, I also just read a more skeptical article offering sympathy to the beneficiaries of the funds for the folly of this move.

In the same vain I also read a March 7, 2013 Wall Street Journal article titled "Stop Hedging Around" which confirms the fact that when the city pension funds decide to go into a new investment, it is time to get out of that investment. The same author wrote a 2011 article titled "The Truth about Hedge Funds" for Smart Money. No wonder there is a public pension crisis in this country.

The mayor is now worth $27B up from $4B when he first became mayor in 2002. Where is that investment expertise when it comes to the city pension funds?

Monday, March 25, 2013

Growing Private Equity Problems: NYCERS and Yucaipa

I have previously commented on serious problems with NYCERS private equity investments.

On March 23, 2013, on the front page of the NY Times business section, there was an article about Yucaipa and the NYC pension funds. Yucaipa is a private equity firm which has been doing business with NYCERS since 2004.

I remember the 2004 board meeting where NYCERS decided to hire Yucaipa. The meeting was about to end when the DC-37 representative raised his hand and presented a resolution to allocate money the a firm named Yucaipa. The resolution was seconded and adopted. The meeting then closed. There usually is a certain amount of discussion when committing money to an investment manager. I leaned over to the chair and asked what had just happened and her response was "Don't ask.".

I thought you might be a interested in the asset/fee history of Yucaipa at NYCERS lsited in the chart below. Of course, you need remember that the annual asset values are only guess from Yucaipa. In addition, NYCERS has no control over the payment of the fees and is only reporting numbers that some other entity gave them. But on their face these numbers are depressing.

In 2006, Horatio Sparkes,the Comptroller's representative went to work for Yucaipa. In 2004 the Comptoller's Office negotiated and signed the NYCERS contract with Yucaipa.

Here is another wrinkle in the Yucaipa story.

Yucaipa's History with NYCERS: (2004 - 2012)

Yucaipa American Fund 1 Yucaipa American Fund 2 Yucaipa Corp Initiative II
Year AssetsFees AssetsFees AssetsFees
2004 $0 $777.105 na na na na
2005 $38.95M $961,943 na na na na
2006 $71.56M $1,802,694 na na na na
2007 $66.52M $1,515,547 na na na na
2008 $64.79M $583,494 $29.37M nr $4.71M nr
2009 $51.94M $34,764 $41.09M $1,552,397 $4.36M $820,536
2010 $56.53M $580,399 $84.75M $2,220,000 $11.65M $826,086
2011 $60.73M $869,949 $104.85M $1,549,912 $9.07M $658,907
2012 $63.19M $637,938 $163.04M $423,574 $24.46M $624,375

Who's Helping Who?

September 26, 2011 - NY Times:

Amalgamated Bank (the nation's only union-owned bank) announced on Sunday that WL Ross & Company (Wilbur L. Ross) and the Yucaipa Companies (Ronald W. Burkle) would each invest $50M in the bank. The two firms will each receive 20% of the bank's common shares. Previously the FDIC ordered the bank to raise its capital ratio to 7% which had slipped to 6.2%.

NYCERS has $3.9B invested in an S&P 500 index fund managed by the Amalgamated Bank. It also has reportedly $163.02M invested in three private equity partnerships run by the Yucaipa Companies. It is not clear exactly how much NYCERS has in the Yucaipa partnerships because no one knows for sure how much NYCERS has invested in any of its private equity partnerships.

Wednesday, March 20, 2013

Word of Warning

This is a sober warning of pension fund indictments and the types of dangers that threaten public pension plans. The warning was written by Edward "Ted" Siedle, a former S.E.C. attorney and a contributor to Forbes.

I wonder what happened to the perjury investigation at NYCERS?

A Small Touch of Lunacy

This is an old posting from 2009. Someone recently asked me a question about this issue. I realized I had withdrawn this posting. The content is still relevant today except for the change in the interest rate from 8% to 7% as of July 1, 2011 and that we now know that any decision Martha Stark was involved with must be viewed with skepticism. Also in an unsettling way this subsidy has grown. In FY-2012 NYCERS paid the Comptroller's Office $1.98M.

In 2004, Martha Stark and the other NYCERS trustees decided to start paying the NYC Comptroller’s Office for investment functions which the city had previously funded through the regular city budget process. See NYCERS resolution R#1 adopted on April 27, 2004.

These payments to the Comptroller show up in his city budget as non-governmental grant revenues. It appears that other city pension funds have also adopted this payment scheme. As a reference, this “grant” money to the Comptroller's Office was $4,167,779 in FY-2010 and $4,169,799 in FY-2011.

The city, however, must by statute reimburse NYCERS two years later for these payments to the Comptroller along with 8% interest per annum.

Correction: These payments to the Comptroller are being considered investment expenses under Setion 13-705.b of the NYC Admin. Code. See quote below. The impact of this interpretation is that these payments are blended into the city's annual pension cost and spread out over long periods of time. After eleven years of these payments, however, the annual charge is getting close to full replacement in the following year.

b. Notwithstanding any other provision of law to the contrary, such expenses as may necessarily be incurred by a retirement system in acquiring, managing and protecting investments of its funds may be paid from any income, interest or dividends derived from deposits or investments of such funds.

If this all sounds confusing to you, that is because it is confusing.

It is also deceptive. When the City Council sees a non-governmental grant in an agency’s revenue budget, the Council correctly concludes that the tax payers of the City of New York are not funding that revenue stream. In this case, however, the taxpayers are in fact not only funding this revenue stream but also incurring a debt which becomes due in future years with an 8% or 7%(net of fees) annual interest rate.

Why would the mayor’s representative on the NYCERS Board agree to this distorted budget scheme, saddle the city with an 8% debt, and create this deception in the city budget. Why not just let OMB allocate the necessary funds to the Comptroller’s expense budget to cover the statutory investment work?

Maybe OMB thought that the Comptroller already had sufficient funds to do the work. Maybe OMB didn’t know that NYC Admin. Code mandates that the city repay the “grant”, with interest, to NYCERS. Maybe the “grant” funding allows the Comptroller to escape some types of oversight, like salary limitations. Maybe city hall, in fact, didn’t know about this payment scheme at all. Maybe, maybe, maybe…

Of course, once the NYCERS trustees decided to start paying for these investment services, shouldn’t the board have sought open bids or issued an RFP for these investment services? The trustees could also have hired internal NYCERS staff to perform the investment functions. Both of these approaches are covered by state statue and would not have distorted the city budget.

There is, however, no statutory way for NYCERS to enter into a contract with the Comptroller who is a also a NYCERS trustee. There is, also, a blatant conflict of interest in the fact that the Comptroller is the legal auditor of all NYCERS expenditures including these payments to the Comptroller (NYC-AC Section 13-103.g).

Listed below are actual payments from NYCERS to the Comptroller’s Office for the period from April, 2008 to March 31, 2010.

PeriodTotal PSFringe Fringe Adj. OTPS
April-June, 2008 $405,967$235,981$91,985$44,202$33,798
Post June, 2008 $33,814$20,541$8,007$0$5,266
July-Sept, 2008 $294,917$208,957$81,452$0$4,508
Oct-Dec, 2008 $302,206$210,237$81,951$0$10,018
Jan-March, 2009 $390,613$253,171$109,674$17,921$9,848
April-June, 2009 $351,700$240,901$104,358$0$6,440
Post June, 2009 $17,976 $236$102$0$17,638
July-Sept, 2009 $331,533$232,050$90,453$0$9,030
Oct-Dec, 2009 $307,236$217,659$8,843$0$4,734
Jan-March, 2010 $343,716$243,217$102,686-$4,730$2,543

These figures are a detailed accounting of what money NYCERS is giving to the Comptroller's Office. There is, however, no detail of how the Comptroller is actually spending the money.

For example, which of the Comptroller's employees are being billed to NYCERS, what are their salaries, what are their duties, how many hours a week are they doing NYCERS work, what are their qualifications, what is their work product and how is that work product evaluated. This all would have required the preparation of a detailed scope of services and this was never done.

Sunday, March 17, 2013

Finally the Actuary Gets 7% "Net of Expenses"

On January 30, 2013, the governor signed the law changing the assumed interest rate for the five city pension funds from 8% gross of expenses to 7% net of expenses. This new rate is effective as of July 1, 2011. The rate should have gone into effect on July 1, 2009 when the five year term of the old 8% rate ended. That is two years of underfunding for all of the city pension funds. That does not mean that the new rate is an appropriate rate, just better.

I love Bob's little twist on the new rate, "net of expenses". In plain English this means the new rate is actually higher than 7% when compared to the old 8%.

The expenses in FY-2012 were $486.7M($370.3M investments and ($116.4M administrative). The assets as of June 30, 2011 were $111B. A 7% return is $7.777B, add on the $486M and you have $8.263B. That is a 7.4% rate needed to cover the 7% "net of expenses". The bottom line is that the target rate for 2012 was 7.4% gross of expenses.

Unfortunately, for FY-2012 the five city pension funds fell short of their target by $5.963B. Over the last 13 years the shortfall is $38.375B. Either the trustees are going to have to ramp up their investment skills or the taxpayers are going to have to continue to cover their losses.

Monday, March 11, 2013

Teachers Retirement System - Why is it $4.4B short

I recently became aware that the NYC Teachers Retirement System (TRS) has had a regular and significant negative cash flow as far back as 2000 and maybe further. The total negative cash flow for the 13 years is $8.8B . In plain English a negative cash flow for a city pension fund means that the employee and employer contributions, interest payments, and dividends are less than expenses and pension payments. That leads to liquidating assets to cover the shortfall and creates a permanent handicap when it comes to investment returns.

This raises a question about the actuary's funding strategy for TRS.

None of the other four city pension funds have had consistent negative cash flows over the same time period. As of June, 2012 these four funds have reached or surpassed their pre-crash 2007 values. From the table below you can see that TRS is $4.4B short of its 2007 asset value.

TRS has a serious investment problem. Of course, in FY-2012 the other four funds didn't do so well with their positive cash flows. The five funds managed to turn $1.45B into $306.5M in a market that was was up 3.4% for the year.

The New York State Department of Financial Services (DFS) has not done a statutory examination report on any of the five city pension funds since at least 2003. This is in spite of the fact that the pension funds have paid DFS for the associated audits.

Asset Values and Cash Flows for the Five City Pension Funds: (2007 - 2012)

Pension Fund20072009201220122012
Closing BalanceClosing BalanceClosing BlanaceAsset ChangeNet Cash Flow
NYCERS $42,514.3M $31,903.4M $42,655.3M $246.3M $728.0M
TRS $37,142.8M $23,077.5M $32,774.8M -$826.7M -$472.3M
BERS $2,179.5M $1,536.6M $2,310.6M -$13.0M -$46.4M
Police Fund $21,905.5M $17,424.1M $25,479.9M $731.0M $944.0M
Fire Fund $7,202.7M $5,576.8M $8,124.7M $169.0M $268.0M
Total $110,944.7M $79,518.3M $111,345.3M $306.5M $1,452.4M