Part Three: The Regents Club: Conflicts of interest are nothing new at UC, but they may be getting worse
“It is just amazing that these regents are enriching themselves at the expense of the institution they are supposed to be leading. We are not talking about one or two isolated instances, or a piddling amount of money but $2 billion. Financially, California is going down like the Titanic, and these people are pocketing the silverware.”
--Ken Boehm, National Legal and Policy Center
--Ken Boehm, National Legal and Policy Center
Historical photo - UC Regents, April 18, 1959
For decades, the UC Board of Regents has consisted of wealthy and politically connected individuals who have often been beset by charges of conflict of interest. The past is prologue.
On June 23, 1974, the Los Angeles Times published an investigation titled, “UC Regents: An Elite Club That Runs a Vast University.” The story revealed that many of the regents were millionaires with little or no background in education policy. Most had plenty of experience leveraging political connections for pecuniary gain. This wealthy group of socialites, lawyers, oil men, and industrialists was out of touch with students and the common people, the Times observed: “They drive fine cars and own boats and airplanes. They belong to the best clubs and play tennis on their own private courts.” And in their dealings with each other, “the camaraderie and gentility of a private club are maintained … Most regents consider it bad form to discuss their finances.”
Today, some 35 years later, this clubby mentality still rules.
Today, some 35 years later, this clubby mentality still rules.
A history of conflict
The UC Board of Regents was created in 1868 to govern the state’s public research universities. Over the years, usually in the wake of financial scandals or charges of conflicts of interest, its structure has been reconfigured.
Currently, the governor appoints 18 of the 26 members to 12-year terms; the regents themselves select a student representative for a one-year term. The balance of voting regents are considered ex-officio, and they are drawn from a constitutionally-mandated list of state officials that includes the governor. In other words, the regents are—and always have been—a fabulously politicized body.
Five years later, the California State Auditor found that Regent Edwin W. Pauley, owner of Pauley Petroleum, had personally profited when university officials steered $10.7 million dollars into one of his company’s business deals. Additionally, the auditor discovered that several regents had conflicts of interest due to business ties with a private real estate firm, the Irvine Company, which was developing the land surrounding a new campus, the University of California at Irvine. Following these revelations, the regents passed a conflict-of-interest policy prohibiting university officials from “making personal gain out of university transactions.”
In the past half-century, the financial pedigrees of many regents have created particular challenges for avoiding conflicts of interest. In 1965, Free Speech Movement activist Marvin Garson responded to a call by the California Federation of Teachers to “investigate the composition and operation of the Board of Regents.” He produced a well-documented study noting that, “taken as a group, the Regents are representatives of only one thing—corporate wealth.” The study observed that the prospect of conflicted interests was very real for the regents, whose “business is carried on in executive session in informal meetings of which no written record may exist. … It is entirely possible for a Regent to telephone his broker with a buy or sell order right after the Committee on Investments decides to buy or sell a big block of shares.”
The regents were also increasingly bound by state laws enacted in the ‘70s to monitor the ethical behavior of public officials. In 1972, voters passed a statewide proposition requiring open meetings of public bodies, which includes the regents. Although some secret sessions are allowed under this law, a large portion of UC’s financial records are considered part of the public record.
Two years later came the California Political Reform Act of 1974, which prohibits public officials from even the appearance of using their position to influence governmental decisions that might be personally beneficial. To increase transparency and accountability, each regent must now file an annual economic disclosure report listing his or her assets in California.
Notwithstanding these safeguards, conflicts of interest continued to arise:
- In 1978, the state auditor found that UC was improperly investing in a corporation that included a regent on its board of directors.
- In the early 1990s, the state auditor reported that some regents were improperly availing themselves of lavish travel and entertainment allowances. This audit unleashed a storm of public outrage, since the regents had simultaneously raised tuition.
- In the mid-2000s, a series of media exposés were published concerning a variety of problems at UC, including excessive salaries and benefits for UC administrators; the regents’ mismanagement of the nation’s nuclear laboratories; and the hiring of an investment firm (Wilshire Associates) with business connections to then-Regent Gerald Parsky.
- During that time period, an employees’ union revealed that then-Regent John Hotchkis had a financial interest in a firm selected to manage $430 million worth of university investments. Additionally, the head of another firm chosen to manage $311 million in UC funds turned out to be Mr. Hotchkis’ daughter.
Today, UC’s current operating budget is $20 billion. The various endowment and retirement funds totaled $63 billion at the end of 2009. With such an enormous amount of public funds in play, the regents are bound to meticulously adhere to state laws and university policies that prohibit self-dealing. It is incumbent upon those individuals who are charged with overseeing the UC pension and endowment funds to avoid influencing or voting on investment decisions that potentially, actually, or even appear to affect their personal business affairs.
The current crop of regents has failed to consistently hold itself to these ethical standards—especially when it comes to private equity investments.
The private equity fiasco
Private equity investing is attractive to sophisticated investors and large institutions because it has the potential for large returns. But unlike deals that take place on public stock exchanges—where sales and purchases are public information and regulated by the U.S. Securities and Exchange Commission—the realm of private equity is opaque, largely unregulated, and extremely difficult to exit should a deal go bad.
After Patricia Small left the UC Treasurer’s office in 2000, the number of private equity partnerships in UC’s portfolio doubled. By 2003 the amount of money placed in private equity had more than tripled, and in 2009, the university’s books carried a balance of $6.7 billion committed to 212 private equity partnerships, which consist primarily of leveraged buyout funds See Leveraged Buyout of Texas Public Utilities for additional players!--more than ten percent of the investment fund total of $63 billion!
These have not proven to be prudent investments, overall. As of spring 2009, UC’s return on the private equity portfolio was running at a negative 20 percent for the fiscal year, asserted Treasurer Marie Berggren's annual report. And according to operating reports made by Berggren to the investment committee, much of the loss to that portfolio was tied to the souring of leveraged buyouts during the recession.
In a leveraged buyout, private equity firms act as a “general partner” by arranging private investment opportunities to purchase companies or real estate. The general partner finds “limited partners”—typically institutions, pension funds, or wealthy individuals—to invest in that fund. (The limited partners have little or no say in how the fund operates since it is being managed by the general partner.) The capital provided by the limited partners is used as a down payment for the purchase, and a large bank loan covers the remainder of the sale price. (Kinda sounds a bit like kiting.)
Although leveraged buyouts can be lucrative for both the limited and general partners, the buyout can also take on a predatory quality. In this scenario, the limited partners have the most to lose.
Here’s how the darker version of these deals go down: Once a company has been acquired, the investors can off-load the responsibility for paying back the large bank loan onto the company itself. At the same time, the new owners can strip the acquired company of cash and other valuable assets to pay dividends to the general partners. Looted companies often collapse from a lack of operating capital brought about by trying to pay off the combination of the unsustainable debt burden and the dividend payouts.
Collapse can cause the limited partners to lose their entire investment. The private equity firm’s general partners may survive because they can charge their investors management fees regardless of a deal’s outcome. While less predatory leveraged buyout acquisitions can certainly benefit both the acquired company and all of its investors, the companies involved in the UC deals discussed in this story, for the most part, do not fall into the beneficial category.
In 2009, Ms. Berggren reported that the average annual “internal rate of return” for the retirement plan’s private equity portfolio since 1979 was a mere 1.8 percent. But fixed-income investments had generated an average annual rate of return of 6 percent over a similar period. The only sector of the portfolio that fared worse than private equity was private real estate.
After Ms. Small left her post as UC treasurer, the university’s allocation to private real estate deals increased from nearly zero to $4.5 billion in less than a decade. By mid-2009, the private real estate portfolio had lost an astonishing 40 percent of its value.
Nonetheless, this notable shift in strategy toward alternative investments—leveraged buyouts, in particular—has had clear benefits for individual regents, as detailed in this investigation. And good government experts question the ethics of these investments. “The investment committee’s act of increasing UC’s allocation to private equity was an extraordinary conflict of interest,” said Robert Weissman, president of Public Citizen. “Some of these regents obviously had vested interests.”
These have not proven to be prudent investments, overall. As of spring 2009, UC’s return on the private equity portfolio was running at a negative 20 percent for the fiscal year, asserted Treasurer Marie Berggren's annual report. And according to operating reports made by Berggren to the investment committee, much of the loss to that portfolio was tied to the souring of leveraged buyouts during the recession.
In a leveraged buyout, private equity firms act as a “general partner” by arranging private investment opportunities to purchase companies or real estate. The general partner finds “limited partners”—typically institutions, pension funds, or wealthy individuals—to invest in that fund. (The limited partners have little or no say in how the fund operates since it is being managed by the general partner.) The capital provided by the limited partners is used as a down payment for the purchase, and a large bank loan covers the remainder of the sale price. (Kinda sounds a bit like kiting.)
Although leveraged buyouts can be lucrative for both the limited and general partners, the buyout can also take on a predatory quality. In this scenario, the limited partners have the most to lose.
Here’s how the darker version of these deals go down: Once a company has been acquired, the investors can off-load the responsibility for paying back the large bank loan onto the company itself. At the same time, the new owners can strip the acquired company of cash and other valuable assets to pay dividends to the general partners. Looted companies often collapse from a lack of operating capital brought about by trying to pay off the combination of the unsustainable debt burden and the dividend payouts.
Collapse can cause the limited partners to lose their entire investment. The private equity firm’s general partners may survive because they can charge their investors management fees regardless of a deal’s outcome. While less predatory leveraged buyout acquisitions can certainly benefit both the acquired company and all of its investors, the companies involved in the UC deals discussed in this story, for the most part, do not fall into the beneficial category.
In 2009, Ms. Berggren reported that the average annual “internal rate of return” for the retirement plan’s private equity portfolio since 1979 was a mere 1.8 percent. But fixed-income investments had generated an average annual rate of return of 6 percent over a similar period. The only sector of the portfolio that fared worse than private equity was private real estate.
After Ms. Small left her post as UC treasurer, the university’s allocation to private real estate deals increased from nearly zero to $4.5 billion in less than a decade. By mid-2009, the private real estate portfolio had lost an astonishing 40 percent of its value.
Nonetheless, this notable shift in strategy toward alternative investments—leveraged buyouts, in particular—has had clear benefits for individual regents, as detailed in this investigation. And good government experts question the ethics of these investments. “The investment committee’s act of increasing UC’s allocation to private equity was an extraordinary conflict of interest,” said Robert Weissman, president of Public Citizen. “Some of these regents obviously had vested interests.”
Throwing good money after bad
The private equity losses should not have surprised the regents. In 2008, Ms. Berggren stated in her annual report to the investment committee that private equity and private real estate investments were “overweighted” relative to other financial vehicles during the boom years. She also noted that the regents’ preference for private investment was disproportionately impacting UC during the economic recession.
Amazingly, in the face of the disastrous performance of private equity and private real estate, Mr. Wachter and Mr. Blum have continued to advise Ms. Berggren to increase UC’s investments in these two ailing sectors. (Mr. Parsky left the board in 2008.)
At the February 2009 meeting of the regents’ investment committee, Mr. Wachter, then the committee chair, observed that although private equity and real estate investments were already “overweighted” in the portfolio, they should be “even more overweighted.” (Wow...that's it...just...wow.)
At an investment committee meeting three months later, Mr. Blum, who was then the chairman of the board of regents, urged his colleagues to continue on the same questionable course. According to the meeting minutes, “Chairman Blum expressed concern that the University might become too risk adverse.”
At the same meeting, Mr. Wachter suggested that UC buy bundles of distressed real estate and mortgage debt to profit off of the collapse of the housing market. (Though a matter of continued debate, experts say such investments are a risky undertaking since another wave of home foreclosures is expected). Recently, Mr. Wachter has championed increasing the volume of UC’s investments in risky timber and oil ventures.
But the entire investment committee is not in lockstep with Mr. Wachter’s and Mr. Blum’s predilection for alternative investments. Regent George Marcus, a real estate executive who sits on the committee, has consistently opposed them. In a March 2010 meeting, he described this strategy of over-emphasizing private equity as the equivalent to “gambling in Las Vegas.”
Posted by Peter Byrne on 09/22/10At the February 2009 meeting of the regents’ investment committee, Mr. Wachter, then the committee chair, observed that although private equity and real estate investments were already “overweighted” in the portfolio, they should be “even more overweighted.” (Wow...that's it...just...wow.)
At an investment committee meeting three months later, Mr. Blum, who was then the chairman of the board of regents, urged his colleagues to continue on the same questionable course. According to the meeting minutes, “Chairman Blum expressed concern that the University might become too risk adverse.”
At the same meeting, Mr. Wachter suggested that UC buy bundles of distressed real estate and mortgage debt to profit off of the collapse of the housing market. (Though a matter of continued debate, experts say such investments are a risky undertaking since another wave of home foreclosures is expected). Recently, Mr. Wachter has championed increasing the volume of UC’s investments in risky timber and oil ventures.
But the entire investment committee is not in lockstep with Mr. Wachter’s and Mr. Blum’s predilection for alternative investments. Regent George Marcus, a real estate executive who sits on the committee, has consistently opposed them. In a March 2010 meeting, he described this strategy of over-emphasizing private equity as the equivalent to “gambling in Las Vegas.”
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