Out of Control Investment Fees

Every June the NYCERS actuary presents to the trustees his estimate of what the pension costs will be for the next year. The total bill for FY-2012 is $2.587B. The city's share of that cost is $1.403B. The rest is charged to other participating employers.

As part of the $2.587B amount, there are two non-benefit items. They are investment expenses and administrative expenses. The charge for investment expenses is $204M and for administrative expenses, it is $55M.

The $204M figure grabbed my attention when I saw it. I have previously complained about obscene growth in investment fees but there is a real kick to the actuary's $204M charge.

I have listed below the investment fee charges since 2000. I can not believe that the trustees think these increases are rationale.

1. $27.2 (2000)
2. $38.5 (2001)
3. $40.0 (2002)
4. $40.6 (2003)
5. $31.6 (2004)
6. $46.4 (2005)
7. $00.0 (2006)
8. $53.8 (2007)
9. $80.9 (2008)
10. $114.5 (2009)
11. $134.5 (2010)
12. $161.1 (2011)
13. $204.4 (2012)

In 2006, the city had the law changed so that expenses were paid two years after the fact rather than one year, thus producing a payment holiday.

On a smaller scale administrative expenses have gone up 40% since 2005, from $35.3M to $55.1M. Does anyone think that service at NYCERS has increased 40% over that time period. It sure wasn't the completion of the disaster recovery site.

Let Sleeping Dogs Lie.

I just received my quarterly pension PR letter from Comptroller Liu. Liu couldn't resist the temptation to claim credit along with the trustees for the pension funds' good investment performance during FY-2011 (June 30, 2011).

Number one, this is like taking credit for the sunshine. The S&P 500 index went from 1030 (6/30/2010) to 1320 (6/30/2011) during FY-2011, a 28% increase.

Number two, this also means the trustees and the Comptroller are responsible for losses when they occur, like the $3.5B that NYCERS lost in the last 3 months.

The best we can hope for from the trustees is not to screw things up too much. They are the last people in the world that anyone would willing trust money to. Of course, Bloomberg has managed to raise his own personal net worth to $19.5B from $4.5B since coming to office.

Accounting Problems with Investment Fees at NYCERS

In May, 2010, in response to a FOIL request I received a copy of NYCERS internal accounting charts of investment expenses for FY-2008 and FY-2009.

This year NYCERS has chosen to deny my FOIL requests for the accounting charts for FY-2009, FY-2010, and FY-2011.

Each year, on December 31st, NYCERS files a Comprehensive Annual Financial Report (CAFR) for the previous fiscal year ending on June 30th. This report includes a detailed listing of all investment vendors under contract to NYCERS and the fees paid to the vendors. This reporting is on an accrual basis. In plain English, that means if you don’t have the billing data when you are closing the books, you make a best guess at the amount, enter that amount, and make offsetting entries in the next year report when the data comes in. You don’t leave the entry blank.

As I have mentioned in the past NYCERS does not control the payment process for the investment vendors. The Comptroller does. NYCERS is dependent on the Comptroller for the billing and payment data needed for the accounting function. It is very clear why you normally don’t run a business like this. You have no way of vouching for the correctness of your accounting statements.

In this defective arrangement, when NYCERS receives billing and payment notices from the Comptroller’s Office, it records that information in its internal spreadsheets. This should be the basis of what appears in the CAFR statement. That is not what is happening. While the CAFR amounts are incomplete, the internal charts at NYCERS are even more incomplete.

Here is what is happening at NYCERS.

NYCERS currently has 92 managers of registered securities, 141 private equity managers, and 39 real estate managers. On its face, having this many managers is a red flag of a system out of control.

The FY-2009 CAFR statement quoted investment expenses at $138.1M. The corresponding internal NYCERS accounting chart amount is $97.4M, a $40M shortage.

The FY-2010 CAFR amount was $175.2M. NYCERS is now refusing to disclose what amount is recorded in its internal accounting chart.

The FY-2009 CAFR listing was missing entries for

• 2 managers of registered securities
• 27 private equity partnerships
• 8 real estate partnerships.

The FY-2009 internal chart was missing

• 8 managers of registered securities
• 28 private equity partnerships
• 7 real estate partnerships.

The FY-2010 CAFR listing was missing entries for

• 2 managers of registered securities
• 31 private equity partnerships
• 6 real estate partnerships.

Again NYCERS will not disclose the internal accounting chart for FY-2010 and therefore we don’t know the number of missing managers for FY-2010 in this chart.

The bottom line is that NYCERS accounting for investment fees is out of control as seen from defects in both the CAFR and the internal accounting reports. Aggravating this lack of control is the enormous amounts of money at play in these fees. The fees for FY-2011 are on track to reach $220M.

The following is another sign of a system adrift. In a September 7, 2011 Bloomberg article, the Comptroller refused to disclose the recipients of $32M in fees that NYCERS paid in FY-2010 under the cover of organization fees for private equity and real estate partnerships.

The Comptroller claimed an exemption from the state Freedom of Information Law. The actual response was that the payments “are derived from information from the private equity companies and real estate partnerships which if disclosed would cause substantial injury to the competitive position” of the firms. This is the same reason NYCERS gave me for refusing my FOIL request this year for NYCERS internal accounting charts for Investment fees.

I can not imagine how disclosing what NYCERS paid a vendor would hurt the vendor’s competitive position. Independent of the state FOIL law, all NYCERS distributions are public record since they have to be approved by a resolution of the Board of Trustees. Such resolutions must be voted on in public session of a board meeting. This is all designed to protect against fraud and corruption.

As a point of reference, the NYC Teachers Retirement System does not report paying any organization fees.

All of this is a clear sign of an unacceptable risk to the integrity of the assets of the system.

The NYS Insurance Department just finished its multi-year examination of NYCERS. I will be curious if they comment on this glaring failure of financial control. The last report, unfortunately, covered only FY-2000 to FY-2002 and was only released in June, 2009.

Phantom Disaster Recovery Site at Long Island City

In 1997, after NYCERS received independent budgeting authority, we began developing a computer disaster recovery plan. In conjunction with IBM and its Sterling Forest site we constructed a process where we were able restore our computer systems at Sterling Forest along with our key operations. This plan only supported about 50 operations employees.

In February, 2000, we moved NYCERS from 220 Church St. to 335 Adams Street in Brooklyn. This new office site had 3 general office floors (21 to 23) and a mezzanine site where we located our customer service center, our call center, and medical board division for handling disabilities.

After of 9/11, everyone in the New York metropolitan area became very aware of the potential for wide spread disasters.

In early 2004, NYCERS experienced two minor business interruptions at our new office site. One was a broken sprinkler pipe on the 24th floor and the other was a fire in an electrical closet on the 8th floor. The water damage was minor but the fire closed the 3 main office floors for a week. We were lucky that the mezzanine still had power. We had installed a second data line from Sterling Forest to the mezzanine along with the main data line on the 23th floor. We also had installed a backup PBX in the mezzanine which allowed the call center to operate after two days.

While the recovery was a great success, it was clear to me that any long term outage would be unacceptable with respect to agency’s work load and the management our staff of 370 employees.

I proposed to the trustees as part of the FY-2005 budget package that NYCERS should explore a possible alternate work site in the event of a local disaster at 335 Adams Street. We would be looking for site within the city, on a different power grid, with decent mass transit access, capable of housing at least 250 workers at one time, capable of being linked up to Sterling Forest, 335 Adams Street, and other city data centers, and finally not too expensive.

The site would have to have the potential to be fully outfitted but we would start with only a minimal kernel for immediate operations. This would include a full technology infrastructure. We would slowly install non-critical equipment over time. In the event of a disaster, we would expedite that process. The site would have the added advantage of allowing us more frequent and realistic disaster testing.

I was looking for a 5 year lease with an option to renew. I was hoping the city would have developed a local DR site for general city agencies within that time frame. That was wishful thinking. I had told the trustees that after we had identified a site, I would present them with a total cost proposal and plan for their final approval.

The Deputy Director of Administration, Niki Browne, was in charge of the search. Late in 2004 Ms. Browne identified a potential site in Long Island City. It was, however, warehouse space and had many issues to be resolved. Unfortunately in June of 2005, Ms. Browne was removed from the project and it was turned over to Karen Mazza. Needless to say, this project is above her pay grade. In fact, Mazza, a lawyer, has serious problems with filling out time sheets, handling her emails, and analyzing legislation.

In October, 2005, Martha Stark and the trustees appointed Diane D’Alessandro as the new executive director of NYCERS.

On of May 31, 2006, D’Alessandro signed a lease with 30TH Place Holdings, LLC for space on the 10th floor of The Factory Building, 30-00 47th Avenue, Long Island City, NY (LIC). This was the site that Ms. Browne had originally identified. The term of the lease was ten years with an option to renew for 5 years. The dimensions of the space were not specified in the lease. NYCERS began paying rent circa 2/1/2007 ($141,905 for FY-2007).

The annual rents for the ten years are listed at the end of this posting. These amounts do not include taxes, HLtP, or water charges.

In her February 25, 2011 letter to the trustees presenting the FY-2012 budget, D’Alessandro notified the trustees that the development of the disaster recovery facility was continuing. She also stated that the LIC site will have the capacity to house two shifts of 150 people. NYCERS currently has 396 employees and a large number of consultants.

I have recently commented on the fact that as of this past summer basic construction of the LIC site had not yet been started. This is over five years since the lease was signed.

D’Alessandro makes no mention to the trustees of this enormous delay in getting the site operational. She also does not mention the fact that, even if the site is made operational, it will not be able to handle the full current workforce. This is beginning to fit the CityTime pattern as far as the loss of time and money. NYCERS has budgeted over $8.7M from FY-2007 to FY-2012 for the LIC site.

NYCERS actually spent over $2.2M between FY02007 and FY-2009 on the LIC site. As of FY-2010, NYCERS stopped publicly reporting the ongoing rent payments and the associated costs for the LIC site.

This lack of disclosure is not unique to the LIC site. It applies to all NYCERS paid administrative expenses. The trustees no longer have any way of checking on actual spending at NYCERS. You can be sure the Comptroller is not auditing the financial controls at NYCERS. He has enough trouble managing the investment expenses for the pension funds. And, I wouldn’t count on the outside accounting firm either.

My professional opinion is this site is seriously flawed and will never be able to function at any acceptable level as a business disaster recovery site for NYCERS. I suspect that at the time of the lease signing NYCERS had not solved all the operational problems connected to the site and that some of those problems are intractable. Let’s hope NYCERS has the good sense not to extend the lease in 2016.

Annual rents for each year of the ten year lease for 30-00 47th Ave, LIC, NY:

1. $362,076
2. $370,222
3. $378,552
4. $387,070
5. $479,335
6. $490,120
7. $501,148
8. $512,423
9. $523,953
10. $535,742

The Vanishing Act on Investment Fee Reporting

The Problem

In FY-1997, NYCERS paid $17.3M in investment fees for a portfolio worth $31.7B.

In FY-2010, NYCERS paid over $175M in investment fees for a portfolio worth $35.4B.

Yes, that is a 1,000% increase in 14 years.

On its face, this is gross negligence on the part of the NYCERS trustees. Why would anyone pay 10 times more for an inferior product? These numbers are not a mistake. It really is as bad as it appears.

History

Prior to 1987, all NYCERS investment managers were paid directly by the NYC Comptroller from the city budget. In 1987, the trustees approved the direct payment of its equity (stock) investment managers from the assets of the pension fund. This change of payment method was due to a deadlock between the then Mayor, Ed Koch, and the Comptroller, Harrison J. Golden, over the approval of the equity manager contracts at the old Board of Estimate. Before its elimination by Koch’s charter commission in 1989, the Board of Estimate was required to approve all significant city contracts.

From FY-1987 to FY-1996, the NYCERS trustees approved the equity manager’s contracts. The annual cost started at $2M in 1987 and reached $4.6M in 1996. The executive director signed both the contracts and the associated payment vouchers for these managers(S.13-137 of the NYC Admin Code). During this period, the bond managers continued to be paid directly from the city budget.

Out of Control

In FY-1997, the NYCERS trustees surrendered control of all of their investment manager contracts and the associated payment process to Alan Hevesi, the then NYC Comptroller and now convicted felon.

In return, as part of an annual renewal resolution, the trustees required the Comptroller to provide an estimate of the total annual fees for the upcoming year along with a detailed listing of each manager and the fee estimate for that manager. The Comptroller was also required to provide, contemporaneously, the amount of the payments made and copies of the supporting audited invoices to the executive director for his/her review.

In a real Catch-22 situation, the Comptroller is also the statutory auditor of all payments made by NYCERS (S.13-103.g of the NYC Admin Code).

At that time, I directed the agency’s accounting division to start maintaining investment expense charts for each year. The chart was designed to record fee expenses by quarter for services incurred during the quarter. The fee amounts entered in the charts were based on the information provided by the comptroller to me as the executive director.

The charts do not close on June 30 each year. The accounting division continuously updates them as data comes in from the comptroller’s office, very often many months after June 30. Strictly speaking, these are not formal accounting documents since they don’t have a closing date but are an historical record of what was paid for services rendered during any given quarter.

Unfortunately, the submitted billing data has never been complete or timely. The estimates of the managers' fees, however, were provided each June with the adoption of the renewal resolution. That is until June of 2010.

As of June, 2010, however, the Comptroller stopped providing the NYCERS trustees with budgeted estimates of the investment fees for the upcoming year. This was the beginning of an effort to cut off information on this fiasco.

My best guess for FY-2011 is $200M and for FY-2012, $225M.

Cover Up

On December 17, 2010, I made a Freedom of Information Law (FOIL) request to NYCERS for a copy of the current investment manager expense charts for FY-2009, FY-2010, and FY-2011. On August 10, 2011, after seven follow up requests, NYCERS refused my request using the following excuse:

Your request is being denied pursuant to §87 2(d) “are trade secrets or are submitted to an agency by a commercial enterprise or derived from information obtained from a commercial enterprise and which if disclosed would cause substantial injury to the competitive position of the subject enterprise”.

I’m not sure which of these excuses NYCERS is using. I’m sure there can be no legal basis for a government agency not reporting the amount of money being paid to a vendor. For background read the 2005 opinion from the NYS Commission on Open Government.

This denial is a sharp change in policy by NYCERS. The agency had previously honored my FOIL requests for these documents. Specifically, on May 28, 2010, NYCERS gave me current copies of the FY-2009 and FY-2008 expense charts.

In addition, NYCERS allegedly published accurate investment fees for each individual manager for FY-2010 in the NYCERS 2010 Comprehensive Annual Financial Report (CAFR). This would support the fact that the data in the FY-2010 investment expense chart is already in the public domain.

Last year, however, I pointed out to NYCES how much the data in the expense charts deviated from the amounts reported in the FY-2008 and the FY-2009 CAFR reports. I expect that NYCERS realized that the agency’s tracking process was seriously broken. In addition, the agency had no way of fixing it since the comptroller office does not have an effective control of the payment process for the investment managers either.

This in turn raises serious questions about the quality of the accounting that is the basis of the formal CAFR reporting of these investment fees.

When a government agency denies the public access to basic information, it usually is because of a desire to hide incompetence but sometimes it is corruption. We need only look at the pattern we saw with City Time to realize that you can never overestimate the incompetence of government agencies.

This fee problem is not restricted to NYCERS alone. The five city pension funds paid a total of $426.9M in investment fees in 2010. This cost item dwarfs almost any other city contract and it is growing at annual rate of 27% since 2005.

In closing, not only does the public not know what the fees are, but neither do the trustees. Well, at least, they've got plausible deniability.

Robert Steel and Pension Delusions

Toady the NY Times reported on statements made by Robert Steel on Thursday at the Princeton Club in Manhattan. Mr. Steel is the mayor’s deputy mayor for economic development. Mr. Steel was speaking about fixing the NYC pension funds.

Mr. Steel thinks that that by increasing the pension funds’ investments in international stocks would produce higher returns for the pension funds. If this is true, what has the mayor been doing for the last nine and half years? He is the dominant trustee on all of the five city pension systems.

Of course, Mr. Steel may be totally wrong about achieving higher returns with increased exposure to foreign stocks. Just imagine owning more Greek, Irish, Portuguese, Spanish, and Italian stocks. Is that a good idea?

On Thursday he also complained that the pension funds only had a 20% return in FY-2011, while the S&P 500 index had risen 31% in the same period. This statement exposes Mr. Steel’s lack of understanding of pension systems.

The fact that the S&P 500 was up 31% means that a prudent pension could earn 31% on that portion of its balanced portfolio of which it was prudent enough to put in an S&P 500 index fund with its low fee structure. This is what the NYC pension funds generally do but they must also diversify. Only a fool puts all his eggs in one basket.

NYCERS, the largest of the city pension funds, has 34.8% of it assets in US stock index funds, 8.3% in US actively invested stocks, 28.3% position in mostly US bonds, 18% in international stocks, and 10.2% in private equity/real estate limited partnerships. The quoted 20% is a rational return for a prudent investor.

Every investor, however, should do a constant review of comparative strategies in order to make well founded decisions for the future. That is something that the NYC pension funds do not do. Neither does Mr. Steel. I have previously criticized NYCERS investment strategies. There is much that can be done to save a great deal of money.

The mayor has been in office now for nine and half years. Investment strategies can be corrected immediately, as opposed to benefit strategies which take decades. Salary and overtime decisions are also items under direct management control. Why should Albany return authority to the city on pension issues when Albany had to take it away in the first place because of the city’s past mistakes?

Mr. Steel stated that he wants to consolidate the operations of the five city pension systems. The city and the other participating employers might gain some savings but the political hurdles are huge. If the mayor wasn’t able to merge BERS in to NYCERS over the last nine and half years, I don’t think he will have much success in the next two and half years. Besides, the big immediate money is in reforming the investment process. But that will require incredible political integrity, a rare bird.

Loss of Transparency on Investment Fees

In FY-1997 Alan Hevesi, the then Comptroller, made a power grab for full contract and payment authority of the investment managers of NYCERS. In spite of statutory requirement of two person accounting control of the payment process and no statutory authority to delegate contracting authority to a single trustee, the Law Department rolled over for the Comptroller and gave him control.

At the time, I objected to the violation of the statutory requirement that NYCERS approve all payments before the Comptroller paid them. I was amazed that the Law Department ignored the statutory language. Of course, the Comptroller would have had to give NYCERS a copy of each of the investment contracts and that would have exposed the terms of the contracts.

Since FY-1997 until FY-2010, Comptroller Thompson’s last year in office, the trustees have adopted an annual resolution granting this “authority” to the Comptroller. The resolution has always had the clause stating an estimated total cost for the coming year. For example see the clause for FY-2010, R-41 (6/11/09), listed below. In addition, the Comptroller also provided a detailed schedule of individual managers and estimated fees for the coming year.

“Resolved, that the estimated fees allocated to the System for Fiscal Year 2010 shall be approximately $159,941,361.34 and be it further “

But for FY-2011 and FY-2012, Comptroller Liu has submitted resolutions dropping the above resolve clause. See R-1 (6/22/2010) & R-35 (6/9/2011). And, of course, he submitted no detailed schedules of individual fees. The trustees now have no idea what the total amount might be or the estimated amount each manager is going to be paid.

While the Comptroller is supposed to report all payments contemporaneous to NYCERS, the reporting process has always been slipshod. The Comptroller’s office has never given NYCERS a full accounting of what fees he/she has paid in any given year. With the rising costs, however, this weakness is becoming more dangerous. The potential for fraud is huge. The fact that the Comptroller is a statutory auditor of all NYCERS payments is ironic.

The mayor could change this process by having the Law Department issue an opinion stating that the payment process must adhere to S.13-137 of the NYC Admin code and that the trustees do not have the statutory authority to delegate their contracting responsibility to one trustee.

§ 13-137 Payments from funds. All payments from such funds shall be made by such comptroller upon a voucher signed by the executive director of the retirement system.

Since 2003, these fees have accelerated out of control. For the record, the actual investment fees for FY-2010 were $175.2M, $16M more than estimated. In contrast, the fees for FY-2003 were $29.3M.

Considering the current budget constraints, these fees are obscene. On top of this, there is a clear attempt to obscure the scale of these fees.