While there are many articles discussing the yawning divide between the Wall Street financial industry and everyone else, there are few that really point out how this is happening. One example finally came to light recently: investment management fees.
All states have pension funds for their public employees. The pension funds don't just put their money in a bank to earn 1/2 percent interest for a year. They look for ways to maximize their return on their investments. Considering that hedge fund managers make up a significant fraction of the billionaires in this country, they would seem to be doing a good job, right? So state and local employee pension funds have been looking to Wall Street for ways to ensure that there will still be money in the fund when their employees retire to finance the obligations of the pension.
In These Times reports that pension funds are paying very large sums of money to managers of their money. For example, their article estimates that CalPERS paid $440 million in management fees to private equity firms. Their article further goes on to say that most states are reporting only half of the actual fees paid for management since there are "performance fees" when the investments perform well. They also provide the caveat that private equity firms are reporting returns without any third party verification of same. In other words, these private equity firms could be doing exactly what Bernie Madoff did, without anyone the wiser for it.
While the fees are disconcerting, the bigger problem is the lack of transparency. In These Times also reports that states are, on average, only reporting 50% of the total management fees paid to Wall Street private equity firms. Apparently, terms of these management agreements are trade secrets and cannot be disclosed.
There is a problem with this line of thinking: the agreements are treated as secret law. that line of thinking goes against a very simple principle in American Jurisprudence. Secret laws are prohibited. How can we avoid breaking a law if it is secret? I know I couldn't. But private equity firms would like for everyone else to be penalized for their special, secret law, the terms of their agreements with their pension funds.
If we're talking about two sophisticated investors, two people who have the experience and the means to support such investments, that would be one thing. But what we're talking about is the law of agency. When an employee joins a retirement system, he is entering into an agency agreement. That is, the retirement system is representing the interests of the employee. When the agent enters into an agreement with a private equity firm to manage an investment, he is not the only person bound by the terms of the agreement. The employee is also bound by the same terms.
If the terms of the agreement between the pension fund and the private equity firm are not disclosed to the employee who pays into the retirement fund, can we really say that the employee is bound by the agreement if he does not have access to the terms and conditions? More to the point, can the taxpayer be held liable for such an agreement? Can the employee and the taxpayer then be held liable for the mistakes of the agent?
Personally, I can't see any justification for the secrecy. When a private equity firm enters into an agreement with a public pension plan, it enters into public service, through and by an agency agreement. As an agent of The People, there is no privacy and no secrecy can be allowed within the context of the agreement. The People need to know what is being charged and when so that they can be sure their agents are working in the public interest.