CalPERS and Conflicts: What Was It Thinking?

In 2007, I reported extensively on the relationship between CalPERS and Pacific Corporate Group, a private equity advisory and investment firm based in La Jolla, California. PCG had just suffered a massive personnel shakeup, but still got two new mandates from CalPERS after agreeing to alter its organizational structure.

It was a classic quid pro quo, and showed that CalPERS would go out of its way to give PCG the benefit of its doubts. Not illegal. Just old-boys cozy.

All of this came rushing back yesterday, when reading an LA Times piece about possible conflicts of interest between CalPERS, PCG and placement agent Alfred Villalobos. I tried creating a graphical representation of the relationship, but it was simply too messy (triangle-shaped, with arrows going every which way). So let’s try this:

  1. PCG was hired by CalPERS, to advise on two investments being marketed by Al Villalobos.
  2. PCG recommended both deals, including a $600 million transaction in exchange for a 10% stake in private equity firm Apollo Global Management.
  3. PCG also attempted to sell a piece of its management company to CalPERS, and was represented on the deal by Al Villalobos. The deal did not ultimately transpire. peHUB has learned that PCG originally hired ARVO in February 2006, and later met with CalPERS staff about the deal. It did reach the CalPERS board level until after the Apollo deal closed.
  4. PCG made CalPERS aware of the possible conflicts of interest in regards to Al Villalobos shortly after being retained to advise on Apollo (download letter). CalPERS did not object (download full statement given to LA TImes)

PCG was just one of many consultants hired by CalPERS on the Apollo deal, and its role was mostly limited to advising on whether such a transaction would fit into CalPERS’ investment strategy. Other advisors included PricewaterhouseCoopers (on Apollo’s portfolio valuations), Lazard (deal valuation opinion) and Pension Consulting Alliance. None of the four objected.

Why did PCG hire Villalobos for its own sale? We don’t know for sure, although one source tells us that Villalobos came up with the idea of selling an equity stake in PCG to one or more public pension systems, and that it was therefore “his deal.” Another source, however, says the notion of bringing outside investment into PCG predated Villalobos’ involvement. PCG so far has declined to comment.

It is worth reiterating that neither CalPERS nor other pension systems ultimately invested in PCG’s management company. This certainly could be seen as evidence that any appearance of impropriety is just a mirage. On the other hand, it also could be seen as evidence that Villalobos was in position to influence PCG — whose support of the Apollo deal indirectly led to millions in placement fees for Villalobos.

But no matter which scenario you prefer, CalPERS should have objected.

CalPERS apparently was satisfied by a reported Chinese wall between PCG’s consulting and investment groups, but the firm was trying to sell a piece of its management company. In other words, PCG was asking CalPERS to buy the sky over that Chinese wall. Moreover, that separation was only put into place in early 2007, as part of that management reorg that CalPERS itself insisted upon.

The PCG-Villalobos connection may not have led to back-scratching, nor did it necessarily illustrate such intentions. But there was no way at the time for CalPERS to know, nor could it keep tabs after the die was cast. This is why potential conflicts are supposed to be killed in their cribs, and why CalPERS has a vetting process to do just that.

Some might argue that PCG passed the buck by sending CalPERS a disclosure letter rather than passing on the Apollo assignment, but it was CalPERS that dropped the ball. How on earth did the pension system not see the potential conflict that PCG itself pointed out? And, if CalPERS approved this arrangement, who knows what else met its anosmiatic smell test…