Did CalPERS Bend Its Own Standards?

The fund's advisers got fees from an Enron partnership for recommending the deal

For years, the California Public Employees' Retirement System (CalPERS) has staked out the moral high ground by calling companies to task for cronyism, conflicts of interest, and rubber-stamp boards.

But lately, CalPERS own image has been challenged. It was a big investor in Enron Corp.'s off-balance-sheet partnerships. CalPERS has said that "a core of Enron executives deceived everyone--from the individual investor to many sophisticated investors." On Feb. 21, CalPERS called for such reforms as a commission on financial conflict of interests. Yet, documents BusinessWeek obtained by a state open-records request show CalPERS had its own conflicts of interest with Enron.

The documents show the role that Pacific Corporate Group (PCG), a La Jolla (Calif.) investment adviser, played in steering the fund to commit more than $750 million to Enron partnerships. PCG provided what should have been independent advice on investments for CalPERS, yet it effectively earned commissions when some deals closed. Some of the money came from Enron--by agreement of all three parties. CalPERS says the arrangement, which was legal, was a way to get more from consultants but was abandoned in 2000. "There are no perfect fee structures," says Michael Flaherman, chairman of CalPERS' investment committee. "We've changed [them] multiple times since that deal was done." PCG officials wouldn't comment, citing client confidentiality.

Still, the documents shed light on the relationships between large U.S. pension funds and their lightly regulated advisers. These 200-odd gatekeepers are supposed to give impartial advice on investments and managers but often play conflicting roles.

In 1989, PCG, a well-regarded 35-person firm run by Christopher Bower, an accountant by training, started picking investment managers for CalPERS--for $295,000 a year. PCG brought its first Enron deal in 1993: a $500 million natural gas partnership called Joint Energy Development Investments (JEDI I). CalPERS took 50%. PCG got $375,000 when the deal closed and $375,000 per year for monitoring it, all paid by CalPERS. It also stood to get a multimillion-dollar payout if the investment hit its benchmark, which it didn't.

In 1997, CalPERS asked PCG to look at Enron Energy Services, a retail energy unit, and the $1 billion JEDI II fund. PCG stood to gain $750,000 if either deal went through and $375,000 if neither did. But this time, the Enron affiliates, not CalPERS, paid the fees. CalPERS pledged $500 million for JEDI II but invested only $175 million.

Other fund managers and consultants say such a fee structure was highly unusual. Flaherman says the idea was to motivate PCG to find new investment ideas. "One would want to give them an incentive to beat the bushes," which a flat advisory fee didn't do, Flaherman says. "Otherwise, we'd end up paying them to sit in their bathrobes." But for the past two years, the fund has used a pool of firms and has kept the initial investment review and the continuing work separate.

PCG did flag a big problem with LJM3, a partnership to be run by Enron Chief Financial Officer Andrew Fastow. It got paid only for assessing LJM3, which never got off the ground. It noted that CalPERS risked a PR disaster by buying into a partnership headed by a public company executive that bought its assets from that company. "As a champion of activist corporate governance," reads the PCG assessment, "CalPERS should be prepared to address its participation in a fund that utilizes such fiduciary duality." But it did recommend the investment.

What did CalPERS earn on PCG's three Enron deals? It made $132 million on the first, broke even on the second, and lost $37 million on the third. Net gain: $91 million. But Cal-PERS lost $105 million on Enron stocks and bonds. PCG also led the fund to a $500 million gain in a partnership with Comcast Corp. PCG now manages a $500 million fund for CalPERS that invests directly in private deals.

Ultimately, CalPERS' relationship with PCG might have been profitable. But as the fund urges the financial world to root out conflict of interests, it would be helpful if it would share its own experiences wrestling with this devil.

By Christopher Palmeri and Ronald Grover in Los Angeles

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