Friday Letter Relationship scars

The SEC’s ban on unregistered placement agents is a step forward for the fundraising market, but it doesn’t erase scars left by the pay-to-play scandal. Meanwhile, controversy surrounding recent comments made by a Blackstone executive further highlights the complex relationship between private equity firms and one of their key sources of capital.  

Two recent news items – one highly consequential and one that may merely be the result of a misunderstanding – illustrate the extremely sensitive nature of the relationship between the private equity industry and one of its most important sources of capital: US public pensions.

First was this week's news that the US Securities and Exchange Commission decided a policy to battle pay-to-play in the public pension world. The commission approved a nationwide rule that bars private equity firms from hiring unregistered placement agents to solicit commitments from public institutions.

The rule also restricts GPs from seeking capital commitments from public pensions influenced by politicians to which the GPs have made campaign contributions.

The SEC started weighing new rules last year after the exposure of a pay-to-play scheme in New York involving political fixers strong-arming private investment firms into paying sham finder’s fees. The scandal raged through New York, spread to New Mexico and made its way to the West Coast, embroiling stalwart LPs CalPERS and LACERS.

This new rule is a step forward for the fundraising market, but it doesn’t fully reverse the damage done by the pay-to-play scandal. The issue of campaign contributions was always a distraction and a temptation between fund managers and certain pension officials, and now the gray line between political support and undue influence no longer needs to be navigated by general partners.

But another recent event shows how fragile the relationship is between GPs and LPs. A seemingly routine comment made by Byron Wien, the vice chairman of Blackstone Advisory Partners, has blown up into a full-on PR fiasco.

During a 5 January webcast for Blackstone clients, Wien said, “the retirement benefits for state workers, really not only in New York, California and New Jersey, but throughout the country, are very generous. Too generous. And it is very hard to change that. . . but I think we have to be more realistic,” he said, according to Pensions and Investments. “We literally can’t afford the benefits we have given our retirees in state and local governments. And we have to change that.”

The spirit of Wien’s statement is accurate – pensions around the country are suffering from bloated obligations and an inability to meet them. The recession has only made this problem more evident, as the performance of investment portfolios has dropped even further.

But the way Wien worded his observation – “too generous” – is what really hit a nerve, a point made by Pat Stryker, a trustee of the New York City Employees’ Retirement System.

“My people make $19,000 a year and to hear that my people who don’t make enough money should have their pensions trimmed too. . . that was too much for me,” Stryker wrote in a letter to Pensions and Investments.

Several other US public pensions, including CalPERS, got involved in countering Wien’s statements. The backlash came at a most inopportune time for Blackstone, as it works to close its sixth fund, which had a target of $15 billion but looks to be closing somewhere between $10 billion and $12.5 billion.

Underperforming pensions have only three ways to fix their predicament – they must force increased contributions, cut benefits, or find better-performing strategies. Since the first two options seem politically unfeasible (as evidenced by Stryker's letter), the last option has been a big focus of late, and this has been good news for managers of private equity funds, a strategy seen as having the ability to outperform.

These recent events reveal a simple truth as to the reality private equity firms face – their rapport with public pensions will undoubtedly go on, but as in any long relationship, there will be scars.

PS – key legal, financial and operational issues challenging private equity firms today are covered in-depth by sister news site PrivateEquityManager.com. You will now find a direct link to Private Equity Manager from PEO's homepage.