Is It CalPERS' Turn to Clean House?

The powerful California pension fund is catching flak for not practicing what it preaches

By Christopher Palmeri

The California Public Employees' Retirement System has long pushed companies to clean up their acts. Now the nation's largest pension fund is getting flak for its own governance practices. But while other pension funds are overhauling their policies on hot-button issues—including campaign contributions and investment middlemen—CalPERS is making only marginal changes.

The worry among shareholder activists is that this new perception may hamper CalPERS' ability to enact change elsewhere. "It's embarrassing for CalPERS," says Charles M. Elson, chair of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "What's the old saying about people who live in glass houses?"

HUGE SUMS AT STAKE

The main concerns center on the pension fund industry's relationship with money managers. CalPERS and the like dole out huge sums of money to financial firms to invest. Some worry that money managers are making campaign donations to elected officials to win lucrative state investment contracts with CalPERS and other pension funds. Others take aim at so-called placement agents, middlemen who get paid for steering those contracts to outside investment firms. As the largest—and one of the most powerful—pension funds, CalPERS is a prime target for critics. CalPERS defends its policies. Chief Investment Officer Joseph Dear says the pension fund takes great care to avoid potential conflicts of interest.

Over the years, the $200 billion pension fund has used its hefty financial clout to push for change at the companies in which it owns shares. It has railed against excessive pay for CEOs, campaigned to eliminate conflicts of interest on Wall Street, and lobbied to give investors a bigger voice at annual meetings. "It's always fun to hear them take companies to the woodshed," says John M.W. Moorlach, a county supervisor in Orange County, Calif. CalPERS called for the ouster of Walt Disney (DIS) Chairman Michael Eisner in 2005 over weak stock returns, as well as New York Stock Exchange (NYX) Chairman Richard Grasso, whose pay the fund called excessive in 2003.

Now CalPERS, which provides retirement and health-care benefits to 1.6 million state workers, is feeling the heat. Prosecutors, regulators, and lawmakers are taking aim at state pension funds for a broad range of ethical issues. For example, New York Attorney General Andrew M. Cuomo earlier this year announced an investigation into pension fund abuses. Other big pension funds are changing their ways in response to the pressure. But CalPERS seems to be resisting.

Consider the issue of campaign contributions. Some money managers with state contracts donate to the campaigns of elected officials, who typically populate the boards of pension funds like CalPERS. The concern is that these contributions could influence how officials award pension fund investment contracts.

The Securities & Exchange Commission is considering a ban on such donations to elected officials. While CalPERS says it supports the SEC's proposal, it has asked in comments to the agency that the ban not apply to political action committees (PACs), political parties, or charities associated with officials, unless the officials are soliciting the contributions. Other states have already implemented these sorts of restrictions. In New Jersey, the donation ban applies to 120 state officials and their PACs. CalPERS says the current disclosure requirements for board members are sufficient.

That may be, but such contributions are raising eyebrows. Former board member Sean Harrigan, for example, solicited large donations from money managers for a union fund while at CalPERS. The longtime union official has been subpoenaed by the SEC and the California attorney general as part of a broader probe into pension fund abuses. "He has absolutely done nothing unethical or illegal," says Harrigan's attorney, Mark Byrne.

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