Opinion

INVITATION TO A SCAM

ATTORNEY General Andrew Cuomo has alleged vast corruption in the massive taxpayer-guaranteed state pension fund, bringing criminal charges against political consultant Hank Morris and the fund’s former chief investment officer, David Loglisci.

That news should end one pension-reform debate: These retirement funds shouldn’t be going into so-called “alternative investments.”

Cuomo says that Morris, after helping Alan Hevesi win the comptroller’s job in 2002, began “to exercise control over certain aspects of the [pension fund], including the alternative-investment portfolio, valued then at $9.8 billion.” With Hevesi the sole trustee of the state’s then-$140 billion fund, this task was easy to accomplish.

After allegedly installing Loglisci at the fund to help him out, Morris sought millions of dollars in fees and favors from firms seeking to manage the pension fund’s money.

As the indictment notes, the Comptroller’s Office set up a process for the chief investment officer (Loglisci) to approve investments in “alternative” asset classes. With inside cooperation assured, Morris then took money “as an agent” from investment companies eager for New York’s business.

Eventually, Morris and Loglisci amassed $4 billion in alternative investments whose managers reportedly had paid fees and the like. “Defendants also blocked proposed [pension fund] investments where the private-equity fund or hedge fund would not pay MORRIS GROUP members or associates,” Cuomo reports.

The alleged wrongdoing posed grave risk to the taxpayer. If investments in the fund, for public-sector employees’ guaranteed retirement income, fall short, taxpayers must make up the difference.

And while Cuomo doesn’t mention it, it’s no coincidence that all this happened in the pension fund’s “alternative investment” allocation which state law limits to a small percentage of the total fund. It was key to the whole alleged criminal enterprise.

What are “alternative” investments? They’re private-equity deals, hedge funds and “funds of hedge funds” types of investments that are not publicly traded on any exchange and so are dangerously opaque, with a value that’s almost entirely subjective.

For a public pension system to invest in them is a minefield of risk for the taxpayers even when public officials are being honest. When that’s not the case, it’s a ticking bomb.

About that reform debate: While all of this alleged criminal activity was going on, Hevesi, Loglisci and others were unsuccessfully lobbying the Legislature to remove the limits on how much cash the pension fund could invest in such alternative asset classes.

Back then, in 2005, E.J. McMahon and I warned that removing these limits was a bad idea, since “hedge funds and other ‘alternative’ investments are opaque. . . Politicians and taxpayers should know the value of the entire pension fund at all times with reasonable accuracy. . . Even Wall Street’s private bankers the bankers of the very rich are wary of the lack of easy price information at hedge funds and private-equity investments.”

And our analysis presumed honesty. The fresh allegations reveal a darker picture.

Morris and pals could carry out their alleged scheme only because alternative investments are so opaque. And if the indictment is correct, they appear to have understood this quite well.

As long as they were working with alternative investments, it would be hard for anyone with suspicions to question why they were forking over taxpayer money to managers who returned average or poor performance because it would be harder to ferret out such performance.

Yet even honest managers of state pension funds probably shouldn’t be allowed to delve into “alternative investment classes.” It’s hard for politicians (indeed, anyone) to choose the best investment advisers. High fees for good performance may not be worth it because that good performance may fall apart, while the fees are already spent. And in bad times, the public may not know the true liability for taxpayer losses for months or years, because of those murky valuations.

Then there’s the mess California faces: This year, its state pension funds have faced “cash calls” on their alternative investments. That is, under agreements signed with fund managers, the pension systems have to pony up more money to put into flailing investments just when they’re suffering big losses.

But there’s almost no better argument against allowing state pension funds to dip taxpayer money into “alternative investment” classes than the fact that, if Cuomo’s allegations are proven in a court of law, former stewards of the state’s fund understood intuitively that “alternative investments” could serve as the perfect opaque breeding ground for corruption.

Indeed, this is a good time to think about switching to a strategy of passively investing the taxpayers’ money in straightforward, transparent and cheaper investments.

Nicole Gelinas, a contributing editor at City Journal, blogs at nyfiscalwatch.com.