Putin, Russian Pals “Mystery” Partners In Public Pension Deals?

America’s state and local government pensions invest as much as 40 percent of their assets in secretive, offshore “alternative” hedge, private equity, real estate and venture funds which warn that certain unidentified “mystery investors” pay lower fees, are provided greater information about investment strategies and portfolio holdings, have been granted liquidity preferences and receive superior net performance—all at the expense of America’s public sector workers. How many wealthy Russians are “mystery investors” in these pension deals which, according to an internal FBI document leaked last year, criminals and foreign adversaries regularly use to launder money? Wall Street refuses to say and public pensions have promised not to ask. Ironically, the invasion of Ukraine and calls to dump Russian investments to punish the country are drawing attention to the ugly fact that America’s public pensions have long consented to being kept in the dark by Wall Street, abrogating their duty to monitor and safeguard workers’ retirement savings.

America’s state and locally run retirement systems currently manage over $5.5 trillion in public pension fund investments, most of which are held by states. While over half of these assets are invested in traditional stocks, bonds and cash, I estimate approximately 40 percent are invested in what are called “alternative” investments, such as private equity, hedge, and real estate funds.

(According to the National Association of State Retirement Administrators, approximately 27% of public pension assets are in alternatives investments—if you believe the self-reported data.)

As I discuss in my book, Who Stole My Pension? my forensic investigations regularly reveal that public pensions conceal and under-report their riskiest investment holdings. While certain hedge, private equity, and venture funds may be characterized as alternatives, other alternatives such as real estate, precious metals, commodities, distressed debt, infrastructure, inflation-linked bonds, and credit opportunity funds may be misleadingly categorized.

For example, my second investigation of the Rhode Island state pension revealed in 2015 that contrary to the pension’s financial reports, 40 percent of the pension’s investments—not the 25 percent disclosed—had been allocated to secretive alternative investments.

Public pension plans in recent decades have shifted funds away from low-risk, fixed income investments such as government and high-grade corporate bonds and increased their reliance on stocks to boost their investment returns. Over the past 15 years, pensions have increasingly turned to alternative investments which Wall Street promises will provide superior performance and diversify investment portfolios. Thus far, alternative investments have failed to deliver either promised enhanced performance or diversification.

On the other hand, there is no question that the shift toward more complex investment vehicles has brought exponentially higher asset-based fees paid to Wall Street. In addition, pensions are paying billions of dollars in unreported performance fees associated with these alternative investments.

Alternative investments are also far less transparent than traditional stock and bond portfolios. While America’s public pensions are supposed to be the most transparent in the world—subject to public scrutiny through state freedom of information acts—as I discuss in my recent forensic investigation of the State Teachers Retirement System of Ohio, alternative investment managers have uniformly refused to play by the rules applicable to these pensions and have thwarted public scrutiny, rather than embraced transparency.

As a result of this lack of transparency—the failure to provide prospectuses and other material investment information to investors—public pensioners and taxpayers are generally unaware of widespread unsavory alternative industry business practices.

Pensions Can’t Dump Russian Investments They Don’t Even Know They Own

As I detailed in my forensic investigations of the North Carolina and Rhode Island state pensions nearly a decade ago, the offering documents of most alternative funds disclose that investors, such as state pensions, agree to permit fund managers to withhold complete and timely disclosure of material information regarding pension investments in their funds. In the words of one manager, investors “will not have the objective means by which to evaluate its operation or to determine whether it is being followed… further, investors may not have the ability to review the investment positions.” Shockingly, pension fiduciaries have consented to being kept in the dark, abrogating their duty to monitor and safeguard pension assets.

Today, as cries for public pensions to dump Russian investments to punish the country for invading Ukraine are growing, the sad truth is most public pensions have no idea whether their alternative investment funds are invested in Russia. They’ve agreed to allow these Wall Street managers to operate in secrecy.

Putin and Russian Oligarchs “Mystery” Investors?

Worse still, pensions have agreed to permit alternative investment fund managers to retain absolute discretion to allow certain mystery investors to pay lower fees, receive greater information about investment strategies and portfolio holdings, have liquidity preferences and receive superior net performance—all at the expense of America’s public sector workers. The managers are not required to disclose such arrangements to pensions. As a result, the fund managers expressly warn that pensions are at risk that other unknown investors may profit at its expense.

The absolute discretion pensions have granted to certain managers amounts to a license to steal… from the state pension. Finally, offering documents often warn that alternative fund nondisclosure policies may violate applicable laws.

Why on earth would a state pension agree to violations of law? Credit Wall Street salemanship coupled with public pension board incompetence.

So, who are these “mystery investors” America’s public pensions allow—God only knows why—to profit at their expense? We don’t know because Wall Street won’t tell and public pensions have agreed not to ask. We do know, however, that these mystery investors receive preferential treatment because of their wealth and power. Almost certainly, wealthy Russians are included in the mix.

FBI Warns of Foreign Adversaries Laundering Money In Alternative Funds

It’s no secret that the FBI suspects that many alternative investment vehicles are widely utilized for money laundering. In 2019, the FBI compiled a report titled “Financial Crime Threat Actors Very Likely Laundering Illicit Proceeds Through Fraudulent Hedge Funds and Private Equity Firms to Obfuscate Illicit Proceeds.” Then, a leaked May 1, 2020 internal FBI report similarly titled “Threat Actors Likely Use Private Investment Funds to Launder Money, Circumventing Regulatory Tripwires” purported to supplement the January 2019 report “by providing recent reporting of hedge funds and private equity firms used to launder illicit proceeds, and expands the threat context beyond financial threat actors to include foreign adversaries.”

With “high confidence,” the FBI claims it’s simple for criminals and foreign adversaries to launder money through such investment vehicles. To demonstrate, the FBI writes:

Hedge funds and private equity firms receive funds from entities registered in nations that maintain laws conducive to masking underlying beneficial owners, thereby making it harder for US financial institutions and regulators to determine the source of funding. Additionally, hedge funds and private equity firms have been used to facilitate transactions in support of fraud, transnational crime, and sanctions evasion.

For nearly two decades I have argued that the outrageously abusive business practices and nondisclosure policies detailed in alternative fund offering materials cause these investments to be, at a minimum, inherently unacceptable for a public pension, if not illegal.

Yet public pension investments in alternative investments have doubled in recent years and billions in public pension assets across the country are currently at risk from such schemes. The Russian invasion of Ukraine ironically has drawn attention to dangers related to Wall Street secrecy schemes and the need for an immediate, focused response by securities regulators and law enforcement.

Public pension stakeholders should demand to know the identity of any mystery investors who may be permitted to profit at their expense, as well as any relationships between these investors, and elected officials. Better still, your state pension shouldn’t even consider investing in any deal which warns “mystery” investors are profitting at your expense.