Sunday, May 10, 2009

The New York Common Fund Scandal

Thanks for bearing with me throughout the hiatus. Truthfully, aside from the Chrysler bankruptcy, there wasn't a whole lot going on. However, if you've been reading the financial times or the wall street journal you'll have come across several stories regarding Cuomo's latest smackdown involving one of New York's largest pension plans. Why should you care about this? Because some of the underlying details actually get to the problem with decision making in the institutional world that is equally applicable at the individual level.

Here's what happened. The New York Common Fund is a public pension fund, one of the largest in the world. The fund is being investigated for allocating funds to money managers who made political/personal contributions. That's basically it. Most public pension funds have a Board of Directors acting as a check and balance on what the internal investment team is doing to avoid conflicts such as these. However, at the New York Common fund, they have a sole decision maker, the Comptroller. This Comptroller allegedly allocated money to several external money managers who investigators say also contributed heavily to the local political party. These "contributions", ahem...bribes were made by investment managers directly (think hedge funds and private equity funds) and also by placement agents. Placement agents are basically hired by hedge/private equity funds to help them raise money. They are paid a commission on any money they bring in. Cuomo says these placement agents paid fees to the comptroller, or his party, in exchange for several millions of dollars worth of commitments. Also, the NY Common fund hired consultants that almost had discretionary authority and approved several of these allocations. It's messy. Of course now it's turned into a massive witch hunt that will ripple across the institutional universe. I'm not to naive to think this doesn't go on elsewhere.

There are obvious lessons here, but a couple I think we can apply personally. The first mistake is having a sole decision maker. It's a stupid idea for institutional investors and it's a stupid idea for individuals. You should never make a major money decision without a second opinion. You need someone else to help you think through the idea and help you discover if perhaps you are seeing something that simply isn't there. Second, many pension funds rely on consultants for opinions. This might seem like a good idea. But not taking any action unless a consultant approves such action is essentially giving de facto discretionary authority. This can be equally damaging. So if you don't want to make decisions on your own, and you don't want to rely too heavily on a consultant (or perceived "expert"), what do you do? Something in the middle. Make sure you listen to others but use some good judgment. Ask yourself, why would this individual be considered an expert in a certain field? What are his motives? Are they aware of other opportunities? Are they on the hook for the decision? Do they have money at stake (in other words, if I lose, do they lose?)?

Being honest of ones intellectual and behavioral limitations could save thousands of dollars. It's not enough to be right or wrong, but to be right or wrong for the right reasons (or something like that). Good luck.

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