In New York City, we have an antiquated set of tenant protection rules known as rent control, by which the city sets limits on what landlords can charge for certain rental properties.
As with any free market distortion, rent control creates some unintended side effects, such as the guy who chooses to live his entire adult life in the two-bedroom apartment he took over from Aunt Carla. More worryingly, rent control and a related, less stringent programme called rent stabilisation, fuel a shadow economy in which free market forces ultimately get their way. Tenants illegally sub-let their rentcontrolled apartments at full fare and pocket the difference; building superintendants demand payment for access to rent-stabilised apartments; landlords avoid spending money to maintain rent-controlled properties. A rule meant to protect elderly city residents ended up covering the New York rental market with a layer of sleaze.
The US pension system has an element of rent control to it, with hugely valuable assets placed in control of under-paid people. This too can lead to sleazy side effects.
The latest example of this is the case of Henry Morris, a political consultant who has been accused of extracting payments from private equity firms in exchange for securing capital commitments from the New York State Common Retirement Fund. The pension's chief investment officer until 2006, David Loglisci, has been accused of making clear on several occasions that New York State Common would not do business with a GP unless a fee or other beneficial economic arrangement were struck with one of Morris's several front companies.
A complaint from the SEC does not allege that any of the private equity firms caught up in the scandal knew that the fees they paid to Morris's firms were illegitimate.
The state of affairs that gave rise to the Morris scandal would be best addressed by the US adopting the Canadian model of pension management, by which public assets are managed by separate, professional entities that pay private market wages and are relatively insulated from political influences. But that transformation may never arrive, and in the meantime GPs need to get more serious about helping to stamp out unusual fee-takers.
Shamefully, the New York State Common scandal comes only a few years after the very similar and equally depressing Connecticut State Treasurer scandal, which saw treasurer Paul Silvester and one of the fund managers who paid fees to Silvester's friends go to prison.
One more scandal in the mould of Loglisci and Silvester, and the US public pension investment market will find itself with a new regulatory superstructure in the mould of the State of New Jersey Casino Control Commission. Ever since news of the New York State Common charges broke, I have had private conversations with placement agents, GPs and pension officials who have told stories involving dubiously credentialed people jumping out right around the time a GP visits a public pension. These incidents range from laughable – a person calling a placement agent to insist that the State of XYZ never does any business without his blessing – to disturbing – a self-appointed consultant tells a GP “see how much power we have” after a public pension commitment is withheld.
Governments have attempted to deal with the massive imbalance between pension staff pay and the value they oversee daily by imposing draconian gift-taking rules. This addresses a symptom, but not the disease. You can't buy an investment staff member a Coke, for example. But you can make a political donation to one of his elected board members, who may or may not have influence over the investment selection process.
The conflict of interest problem is particularly acute in pension systems that have “sole fiduciary” models – like Connecticut and New York State Common, where a single elected official makes all investment decisions. The purse-strings held by these individuals confer immense influence. Within a single decade two sole fiduciaries appear to have been absolutely corrupted by this power.
Can we set up a “finder fiend” hotline, or something like that? It is not enough for GPs and their placement agents to simply say no to these types. They should, as John McCain might say, “make them famous”. Light them up and send them scampering. Fees paid to self-proclaimed pension influencers make the entire alternative investment industry look bad, and threaten it with further regulations that, at the very least, may impose on GPs the kind of controls more commonly used to combat organised crime.