The Baltimore City Retirement Systems: Heading for Trouble

EXECUTIVE SUMMARY

Baltimore City has two pension funds for non-elective officials, a Fire and Police Fund with about $2 billion in assets and a fund for other employees (ERS) with about $1.3 billion.

Until three years ago, the Boards of the two funds met together and maintained a common investment policy, one element of which was heavy reliance on specially recruited minority fund managers, many of them affiliated with the Rev. Jesse Jackson’s Wall Street project. Both boards maintained a ‘Fund of Funds’ administered by a former Philadelphia Finance Director whose political activities in Philadelphia and Bermuda have generated intense controversy; she continues as manager of the ERS ‘Fund of Funds’ according to the most recent ERS annual report. Several fund managers, not all minorities, have been involved in serious embarrassments in other jurisdictions; the ERS has been slower than the Fire and Police Fund in replacing such managers.

In the year 2001 Mayor O’Malley exhorted the two boards to engage in more local and social investing, and caused a contract with a national firm to be rejected three times by the Board of Estimates His position was criticized by Thomas Taneyhill, the then Executive Director of both funds, and by Stephan Fugate, Chairman of the Fire and Police Fund

Subsequently the Mayor appointed his ‘point man’ for the issue to the ERS board, and Taneyhill ceased to be its Executive Director. The Fire and Police Board then decided to determine its investments independently, and replaced its principal investment advisor (who continues as advisor to the ERS fund) and most of its fund managers.

Overall investment performance of the ERS was .81% below its benchmark of index funds in 2002-03, 1% below its benchmark in 2003-04 and .7% below its benchmark in 2004-05, the shortfall in returns in these three years amounting to about $33 million. The returns of the Fire and Police Fund for 2001-02 were 1.3% below its benchmark and for 2002-03 were 3.7 % below its benchmark. Since the investment policies of the two funds diverged, the Fire and Police Fund was 1.3% above its benchmark in 2003-04 and 1.9 % above its benchmark in 2004-05.

In the year 2001, relying on good investment earnings in the previous year, ERS employees were provided by the City administration with $63 million in unfunded new benefits and in the years 1999 and 2000 Fire and Police employees were similarly provided with $92.1 million in unfunded benefits

Because of upheavals in the Police Department, there has been a marked increase in early retirement claims against the Fire and Police Funds.

The City has spent an aggregate of about $10 million each year on fund managers and about $2 million each year on brokerage commissions to produce results poorer than those that could have been obtained from investing in index funds. Although the Mayor’s exhortations in favor of local and social investment produced little change in preexisting ERS investment policies and did not prevent the Fire and Police Fund from changing its policies, they may be credited with the ERS Board’s reluctance to make changes and with the addition of several minority firms (including, for a time, the infamous Chapman and Co.) as recipients of brokerage commissions. Percival and Co., by far the largest recipient of brokerage commissions in both funds, has received $697,564 in brokerage commissions in the last three years and is a major contributor to the O’Malley campaign. Unlike the situation in Philadelphia, there is little evidence of significant campaign contributions by investment advisors.

The skimming off of surpluses to provide new unfunded benefits in good investment years, together with mediocre or worse investment performance and an escalation of disability claims in the Fire and Police system has caused both funds to go into actuarial deficits. Fund surpluses totalling $140.7 million as of June 30,2000 have been transformed into deficits totalling $168.1 million as of June 30, 2005, a swing of $308.8 million in five years. A substantial portion of this change is due to poor investment performance, common to all pension funds, in two years , but most of it is due to the avoidable causes listed. These deficits endanger recently granted benefit improvements and sharply increase the annual contributions required of the City, to the detriment of other municipal services. Recently, both funds have plunged into risky hedge-fund investing; early results are not encouraging.

Pension fund problems are not unique to Baltimore City. Defined benefit plans are vulnerable to increases in longevity, concessions to buy peace in union contracts, and political manipulation of investments, as well as to declines in markets. The state funds, which are ten times the size of those in Baltimore City, now have a $5 billion actuarial deficit, half of which is attributable to investment returns below benchmarks in the years 1997-2002 , returns among the worst in the country, and half of which is due to the two bad market years 2000-02.The state administration, like that in the city, has failed to make about $267.5 million in actuarially determined contributions in the last three years, though these represent less than 1% of the state fund; the City’s by-passed contributions since 1999 aggregate $155 million, about 5% of the two city funds. The state fund appears to have abandoned politically-driven choices of advisors, and its returns have recently improved. Montgomery County, also of interest in a political year, has a much smaller problem, because its government long ago caused non-fire and police employees to be placed in a defined contribution plan; its Fire and Police Fund totals only about $2 billion. Its investment returns are well above average, and its investments do not appear to have been politically driven. Its actuarial deficit, however, has risen at a rate higher than that of the state and city funds due to new unfunded benefits.

This body of experience should have consequences. Defined benefit plans should be phased out in favor of defined contribution plans, as in Montgomery County. They should not be expanded, as demanded by the state teachers’ unions. All funds, not just new ones, should be subject to the newly enacted Uniform Management of Public Employees Retirement Systems Act . The Mayor should not have his present ability, through control of the Board of Estimates, to overrule the retirement boards. The Boards managing investments should be given investment expertise, and more of their advice and brokerage executions should be performed in-house, Disability retirement standards should be tightened.

Baltimore City has three retirement systems: a small system for elective officials, a large Fire and Police system, and an almost equally large Employees’ Retirement System for other municipal employees. The latter two systems have combined assets well exceeding $3 billion. The systems each partake of the general problems endemic in public retirement systems, together with some special recently created problems of their own. What are these problems?

  1. The systems are defined benefit systems. They are non-contributory, hence they are subject to expansion during labor contract negotiations, promises of future benefits not coming home to roost until the politicians negotiating them have left office. Because fixed benefits are provided, the actuarial assumptions underlying them are subject to invalidation by increases in life expectancy, particularly if they are not frequently updated. They are costly to administer, since they generate disputes about benefit entitlements, they require actuarial advice, and the investing is done centrally, not on the basis of beneficiary choices. For these reasons under-funding of both public and private systems is endemic, and many large corporations are therefore terminating their defined benefit systems and converting to ‘defined contribution’ systems with individual earmarked accounts. The general administrative costs of the Baltimore City Employees’ Retirement System alone amounted to $1.882 million in 2004-05, (2004-05 Report, 364). As of August 2004, the Employees’ system had a staff of 26 and the Fire and Police system a staff of 24. Declaring a purpose to double their staffs, they recently moved out of rent-free quarters at City Hall into a BEDCO-managed building where their space increased tenfold and where they were scheduled to pay an additional $408,000 per year in rent, as well as $2.6 million in renovation costs. D. Donovan, “City Officials Reject Bids to Renovate Offices: Spending Board Advises Two Pension Agencies to Negotiate Lower Rent”, Baltimore Sun, August 26,2004, Ex.D hereto..
  2. The systems are managed by financially unsophisticated amateur boards. The Employees’ Retirement System, for example, is administered by a seven-member board, four members of which are elected members chosen by employees, two members who are appointed by the Mayor, and the City Comptroller, ex officio. While the Comptroller is an accountant, only one of the Mayoral employees has experience in investment management, the other being a former City Solicitor. The four elected members include a retired Employees Retirement System administrator, who may have some relevant experience, a Deputy Labor Commissioner, an office supervisor with the Police Department and a phlebotomist with the Health Department. Given that Baltimore is a city with a significant number of large banks, mutual funds, brokerage firms and academic institutions, this does not appear to be the strongest investment management team that could be assembled. The Fire and Police Board has even less investment expertise, consisting of the Comptroller, three police and three fire representatives, a lawyer, and the Executive Director of the France-Merrick Foundation, a mayoral appointee and the only board member with a primary background in investment management.

    The Boards of course have claims adjudication as well as investment management functions; that fact, inherent to defined benefit plans, helps weaken their financial competence.

  3. The systems must invest huge sums of money. The limited expertise of the boards leads to employment of large numbers of investment advisers, usually in several bureaucratic layers, as well as brokers to execute transactions. Each investment transaction generates a broker’s fee, frequently a fund manager’s fee, and not infrequently contributes to several layers of advisers’ fees. In a municipal setting, there is great pressure to ‘spread business around’; thus the Employees’ Retirement System, instead of executing stock and bond sales in-house, using discount brokers and the internet, in the year ending June 30, 2005 engaged no fewer than 32 brokerage houses at a cost of $782,263. No fewer than 35 investment advisory firms were employed, the system incurring direct fees to investment managers and consultants in the same year aggregating $3,230,455. In addition to these fees, fees are earned by the managers of mutual funds in which the Employees’ Retirement System alone in 2004-05 invested $225,079,131.
  4. Municipal employees’ pension systems are essentially unregulated. At one time, municipal bond issuance was similarly unregulated, but numerous scandals led to enactment of regulations restricting the more glaring conflicts of interest and kickback schemes. No such regulations exist in this sphere. A recent S.E.C Report concluded that the pension consulting business, over which the S.E.C. has only limited regulatory power under the Investment Advisers’ Act, was rife with conflicts of interest. (Securities Exchange Commission, Staff Report Concerning Examinations of Select Pension Consultants (May 16, 2005)), Ex.G hereto As a result, it has been estimated that net yields on public pension plans are characteristically about 1% lower than yields on comparable private plans. Since the investments of such plans aggregate $10 trillion nationally, the costs of defective management may amount to as much as $100 billion per year.

    Even by this melancholy standard, the Employees Retirement Fund has recently not done well. In 2004-05, it underperformed its benchmark of index funds by .74% chiefly due to under-performance in international equity, though fixed income also underperformed. The ERS ranked in the 53rd percentile of Callan’s public fund universe,. 2005 Report, 41, and was also below median for three and five year periods..In 2003-04, it underperformed its benchmark of index funds by 1.02% “primarily due to under-performance in International Equity. The ERS ranked in the 76th percentile of Callan’s public fund universe for one year and below median for 2, 3 and 5 year periods.” 2003-04 Report, 39. In the preceding year, 2002-03, it underperformed the benchmark by .81% and ranked in the 71st percentile of Callan’s public fund universe for one year, though above the median for 2, 3 and 5 years, 2002-03 Report, 39. See Ex. K hereto.

  5. Because political actors have a perverse incentive in labor negotiations to concede future rather than present benefits, the costs of such systems tend to escalate over time. The Baltimore City systems well illustrate this tendency.

In April 2001, benefits under the Employees’ Retirement System were amended by “increasing the formulas for service and non line of duty disability retirement for all classes of membership; establishing a new non-line-of duty death benefit for members who have twenty or more years of service credit; lowering the eligibility requirements for line of duty disability; reducing the Workers’ Compensation offset provisions for disability and death benefits; and increasing or establishing survivorship benefits for eligible spouses and eligible minor children of members who selected the maximum benefit and retired prior to June 29, 1989.” Employees’ Retirement System 2004-05 Annual Report, note 5 pg.32.

No added City contributions were made out of tax revenues to pay for these new benefits. Instead, “the City Administration elected to pay the $63.2 million cost of these improvements for the first 20 years by utilizing a portion of the System’s net unallocated excess earnings as of June 30, 2000, which totalled $86.4 million at that date.” Id.,32-33. ( The 2003-04 Report shows the surplus as of June 30,2000 to be not $86.4 million but $91,926,056. By June 30,2005, the benefit change together with investment shortfalls had turned the surplus into a deficit of $63,650,543, an adverse change of $155,576,599 in 5 years. The system was 107.5% funded on June 30,2000; as of June 30, 2005, it was 95.7% funded. See Ex. H hereto.

In earlier years, an increase of 3% in benefits of members retiring prior to June 28,1991 increased actuarial liability by $35 million in 1992. Liberalized benefit provisions, including one allowing retirement after thirty years regardless of age, increased unfunded actuarial liability by $26.6 million in 1993. In 1996, $58 million in surplus was applied to shorten the eligibility period for new retirees to begin receiving post-retirement benefit increases and to make other changes. 2002 Report, 30-31.

The Fire and Police System was victimized by similar politically-driven benefits changes. In 1989, in order to create vacancies for affirmative-action purposes, normal service retirement was made available after 20 rather than 25 years of service, and service-connected disability payments were made available not merely to officers incapacitated from all service on the force but to those “incapacitated from duties of job classification”.Baltimore City Code, Retirement Systems, secs 34(a)(1)(e and f). These changes have produced police and fire forces that are more diverse but less experienced. They continue to impose heavy financial and operational costs long after the affirmative-action objectives giving rise to them have been met. See the observations of Peter Saar, then of the Baltimore City Police Department, in the last four pages of Calvert Institute, The Baltimore Criminal Justice System: The Judges Speak (July 2003). Disability retirements are frequently used as a management tool to get rid of high-ranking officers and employees when there is a change in departmental leadership. The Baltimore Police Department has had five such changes in leadership during the present Mayoral administration. Disability benefits, as distinct from age-related benefits, are difficult to actuarially forecast with accuracy. The explosion of them is a major cause of the San Diego pension scandal, in which it was found that no less than 22% of retirees drew disability pensions. PensionTsunami.com, January 3, 2006. The Baltimore ERS percentage as of June 30, 2004 was a more modest 11.3%. 2004-05 Annual Report, 77, but the percentage of disability retirees in the Fire and Police fund was 22.8%.

Ordinance 42 of 1996 added a new deferred retirement option plan and made other changes increasing actuarial liability by $10 million, $24 million of surplus was used to fund this new liability and to absolve the City of $12 million in contributions required for fiscal 1997.

Ordinance 97-164 of 1997 authorized the City to use surplus to reduce its required contribution, and $10 million of surplus was applied to this purpose. In fiscal 1999, $30.4 million of surplus was applied to eliminate the City’s required contribution.

Ordinance 00-49 of 2000 provided a 1% increase to existing retirees, a reduction in the member contribution for one year, and improvements to the DROP plan reducing the time period for eligibility, The entire added cost of $61.7 million was funded out of surplus (2004 Report,30-31). Temporary actuarial surpluses are created by temporary upward swings in the investment markets; when they are appropriated by politicians to provide new benefits or to absolve municipal administrations from funding benefits, the cushion necessary to protect against market downswings disappears.

These chickens came home to roost. A note in the 2004-05 Fire and Police Fund Annual Report (pg.33) observed:

“A plan provision that required that excess earnings be credited and deficit earnings be charged to certain actuarial accounts expired on June 30, 2005. The purpose..was to segregate excess positive earnings that could then be used by the City to reduce its required employer contributions to the plan and by the plan membership to ‘purchase’ benefit improvements. The reserves were initially used for these two purposes. Subsequently, however, because of the downturn in the global equity markets in fiscal years 2001 through 2003, the reserves have instead accumulated net deficit earnings of $412.8 million as of June 30, 2005. The plan provision now requires that the Board of Trustees apply the deficit in the reserves in accordance with an appropriate asset valuation method. The City administration has requested that the deficiency be recognized as an investment loss over a five year period. It is expected that the City’s employer contributions to the plan will substantially increase in future years due to this deficiency.” (Emphasis added)

Similarly, the 2004-05 ERS Fund Annual Report notes that some previously granted benefit increases may now be at risk:

“The deficit today may not be sufficient to warrant reduction of past benefit increases. This situation will be monitored to determine appropriate actions by the Trustees if the fund is seen as being in jeopardy.” (Page 56)

In addition to these disabilities, common to most public pension systems with fixed benefits, Baltimore has recently added two others:

  1. The Mayor has exhorted the retirement system boards to engage in social investing, and particularly in investment in local companies. See G. Epstein, “Pension Leaders Lambaste O’Malley; Mayor’s Demand for Local Investment of Funds Causes Rift; O’Malley Demands Pension Funds be Invested Here”, Baltimore Sun, July 26, 2001, Ex. A hereto. The Mayor caused the Board of Estimates to reject an ERS investment contract with a national firm on three occasions in order to require it to promulgate guidelines for investment in local firms. “Don’t bring it back to the Board of Estimates until you have [the investment guidelines}. You understand me? Good. You’re excused.” An ERS guideline requiring that local firms be considered was viewed as insufficient. “I’d really like them to...quit refusing to invest in Baltimore.” The Mayor acknowledged that the ERS board’s rejection of a proposal by Sterling Venture Capital headed by Michael Bronfein, a member of a committee for “O’Malley’s last major fund-raiser prompted his interest: O’Malley said Sterling’s rejection merely highlighted for him the lack of a pension board policy on local investment.”

    See also G. Epstein, “Pension Investing has Risks for City...Political Influence a Pitfall”, Baltimore Sun, July 29, 2001, Ex. B hereto, referring to an address by the Mayor to the two pension boards in which he talked about setting aside portions of the funds for local investing and giving “preference to local companies and investment funds vying for dollars.”

    The Boards then agreed to look at local investment firms. G. Epstein, “Mayor Wins on Subject of Pension Funds: Officials to Interview Area Brokers, Weigh Local Investments. $3.3 billion at Issue. Some are Concerned that Political Patrons Will Profit by System.”, Baltimore Sun, December 16, 2001, Ex. C hereto:

    “[Nathan] Chapman is one of a handful of local minority investment managers that the O’Malley administration wants the city pension boards to consider hiring. Chapman, who did not return a telephone call seeking comment, gave a presentation to the fire and police investment committee Thursday. ‘My hope would be that if he can produce a good product that he’s chosen,’ said City Solicitor Thurman W. Zollicoffer, Jr., who has been Mayor O’Malley’s point man in discussions with retirement officials. ‘The minority companies cannot be overlooked.’ This is not the first time the city has considered investing with Chapman. In 1993, Comptroller Jacqueline F. Mc Lean pushed a plan to invest $10 million in his broker company, and later was accused of misleading trustees about his major campaign fund raiser for her. Mc Lean left office in 1994 under a cloud of criminal charges unrelated to Chapman, and the plan soon fell apart.’”

    Chapman’s firm was not hired as an advisor, but received about 3% of the ERS’ brokerage commissions, $18,252, in 2001-02. In the same year, it received $40,305, or about 3 ½ % of the Fire and Police fund brokerage commissions, falling off to $9,952 in 2003 and $8,327 in 2004. The discussions of brokerage fees in the Annual Reports were amended to include a statement that “Investment managers are expected to give first preference whenever possible to brokerage firms with offices located in the Baltimore Metropolitan Area.” 2001-02 ERS Annual Report, 45; Fire and Police Fund Annual Report, 44,. The principal beneficiary of this new policy was Percival Financial Partners Ltd., a minority Baltimore firm which received $12,081 in 2001-02, $53,941 in 2002-03, $178,923 in 2003-04 and $159,416 in 2004-05 in brokerage commissions from the ERS . In 2004-05 it was the leading firm; in 2003-04 it accounted for more than 25% of the total and two and a half times the share of the runner-up. Its principal, Kenneth P. Taylor, is a $4,000 contributor to Friends of O’Malley . Percival also received $29,061 in brokerage commissions from the Fire and Police fund in 2002, $129,098, or nearly 12% of the total, in 2003, $104,227 in 2004, and $71,959 in 2005.

  2. As in other cities with large minority populations, a considerable degree of affirmative action has been brought into play in the selection of investment managers. This did not commence during the O’Malley administration, but has become accentuated during it.

The two major funds will be discussed in turn:

Employees’ Retirement System

The Chief Investment Advisor of the Baltimore ERS is Callan Associates, Inc., a national firm which has been recently sued by the City of San Diego for failure to disclose consulting payments received from 213 different money managers, including 14 of the 16 funds it recommended to San Diego. K. Ryan, “State Pension Advisors on the Hot Seat: Callan Draws Scrutiny over Investment Results, San Diego Lawsuit”, Crain’s Chicago Business, September 15, 2005.

Two of the ERS’s six equity managers, i.e. selectors of individual domestic stocks, Davis Hamilton Jackson Associates of Houston and The Edgar Lomax Company of Springfield, Virginia appear on national rosters of leading minority investment firms; the six firms combined managed $320.1 million in 2004-05, earning direct fees of something more than $1.1 million. The latter sum was shared with three venture capital and private equity managers directing $28.4 million in investments, none of them minority firms. The Lomax firm runs a mutual fund, the Edgar Lomax Value Fund, which produces mediocre but not disgraceful results; it has a three-state Morningstar rating, is at the 69.99th percentile in its category, i.e. 7 of 10 firms have better results, and as of November 30,2005 had a five-year average return of 4.25%.

The ERS in 2004-05 had $225.1 million invested in eight mutual fund groups, four of which, Alicia Capital Investment Advisors of Atlanta, Profit Investment Management of Silver Spring, Denali Investment Advisors of San Diego and Opus Capital Management of Cincinnati appear on rosters of minority firms. In addition, the ERS’ Group Advisor for all investments in what the Annual Reports characterize as an “Equity Fund of Funds” is FIS Funds Management, Inc. of Philadelphia, another listed minority firm, whose principal is Tina Poitevien. The mutual fund portfolio generated direct fees of $379,914. See Ex. J hereto.

Profit Management has a mutual fund, the Profit Fund, with a sub-par record. It has a two-star Morningstar rating, ranks at the 83.99th percentile in its category, i.e. 5 of 6 funds produced better results, and as of November 30, 2005 its five-year average return was 1.06%. Profit made no Maryland political contributions save for an abortive $500 contribution to Prince George’s County Executive James Johnson.

Alicia, once represented by Marianne Spraggins, an activist in both New York and Georgia Democratic politics, gave $500 to Friends of Sheila Dixon in 2003, $325 to Friends of [the late] Pete Rawlings, and $1000 to the Kathleen Townsend gubernatorial campaign. She was recently described as “president of Buy Hold America, the U.S.marketing company for a Black-owned Canadian money management firm, [who] has more than 20 years experience negotiating corporate financial investments.” P. Edwards, “Power Broker Marianne Spraggins travels the world looking like a million bucks. Her smartest investment? Ultrafeminine suits.”, Essence.com, October 2005. She has moved on to a Canadian mutual fund group. Alicia’s affiliate, Atlanta Life Investment Advisors, runs three domestic fund portfolios. According to Alicia’s website, as of September 30,2005, its Large Cap US Core portfolio had net returns from its inception of 12.95% versus 8.79% for the S and P 500; its Large Cap US Growth portfolio had net returns from inception of 7.13% versus 7.97% for the Russell 1000 Growth Index; and its Large Cap US Value portfolio had net returns from inception of 18.15% versus 11.4% for the Russell 1000 Value Index. It is unclear whether Baltimore ERS funds have been invested in any of these portfolios, whose overall performance is quite respectable.

Opus lists on its website only a Small Cap Value portfolio, claiming net returns since its inception in 1996 of 14,8% as against 13.1% for the Russell 2000 Small Cap Value Index.

Denali appears not to maintain a website. It is made up of former portfolio managers for the San Diego Employees Retirement Board who describe themselves as “the only credible Native American owned [investment] firm.” It manages portions of portfolios for the San Diego and Calpers systems. The San Diego City System suffered an increase of $530 million in unfunded liabilities in the 2003 fiscal year, and a $1.37 billion increase over a three-year period, losses ascribed to bad investments, increased life expectancy, salary increases, and disability retirements. North County Times.com, March 29,2004. The system was 67.2% funded; a deficit of $2.4 billion was predicted by 2011. San Diego Union, February 3, 2004. The San Diego pension scandals resulted in the resignation of the Mayor and the indictment of several fund trustees

The ERS in 2004-05 had a fixed income portfolio of $424.4 million with four managers, three of whom, Hughes Capital Management,Inc. of Alexandia, Va., Utendahl Capital Management of New York and MDL Capital Management, Inc. of Pittsburgh were listed minority firms. The fixed income portfolio generated fees of $681,458 in 2003-04.

MDL has not been an active Maryland political contributor, its only donation being $2000 to the unsuccessful Prince George’s County Executive campaign of Major Riddick, former Chief of Staff to Gov. Glendening. Hughes contributed $250 to the campaign of Controller Joan Pratt; Utendahl made no Maryland contributions.

The ERS in 2003-04 had an international equity portfolio of $65.5 million, with one manager, not a minority firms, generating fees of $454,471. It also had $54.3 million in real estate investments, managed by three firms, generating direct fees of $138,368.

The results obtained by the ERS with all this expert assistance have been, to put it mildly, unspectacular. The performance of domestic equities and mutual funds are not broken out separately in the Annual Reports; their total performance yielded a return of 8.3% in 2004-05, .2% higher than the Russell index, 21.0% in 2003-04, .5% higher than the Russell 3000 index, and a return of minus .57% in 2002-03, 1.34% less than the benchmark. The fixed income portfolio yielded 6.4% in 2004-05, .4% below the Lehman Brothers benchmark, minus 2.6% in 2003-04, .6% better than the Lehman Brothers benchmark, and 10.4% in 2002-03, exactly at the benchmark. The international equity portfolio yielded 13.9% in 2004-05, 3.1% below its benchmark, 23.4% in 2003-04, 9.1% below the MSCI benchmark, and minus 7.8% in 2002-03, 1.34% below the benchmark. The real estate portfolio yielded 15.5% in 2004-05, .3% above its benchmark, minus 1.1% in 2003-04, 11.9% below its benchmark, and 8.9% in 2002-03, .79% above its benchmark. Private equity performance was not broken out in 2004-05 or 2003-04; in 2002-03, the ERS’ 19.5 million in private equity depreciated by 14.67%. Hedge fund investments had a yield of .2% in 2004-005, as against a benchmark of .4%. See Ex. K hereto.

Overall portfolio performance of the ERS was 3.14% in 2002-03, .81% below the benchmark, 13.1% in 2003-04, 1% below the benchmark, and 9.1% in 2004-05, .7% below the benchmark. . Had benchmarks been reached in these three years, the ERS would have contained about $33 million more than it did on June 30,2005, reducing by half its $63.7 million actuarial deficit as of that date.

Nor was this under-performance anything new. While for the five years ending in 2004, the ERS had an average return of 3.6%, as against 3.1% for its benchmarks (2004 Report,44), its performance in the preceding five year period ending in 1999 involved an average return of 17.5% as against a return of 19.4% for its benchmarks. (1998-99 ERS Annual Report, 37) The domestic equity portfolio underperformed by 4.1%.

The major contribution to the recent shortfalls was that provided by the International Equities portfolio, none of which was managed by minority managers. One of its principal managers, Putnam International of Boston has been the subject of a major investment scandal involving self-dealing by its managers. See S.E.C. v. Justin M. Scott et al, No. 03-12082 EFH in the United States District Court for the District of Massachusetts; testimony of William Galvin, Secretary of the Commonwealth of Massachusetts, before the Subcommittee on Capital Markets, U.S.Senate, November 6, 2003. $24 billion has been withdrawn from Putnam since the federal and state complaints in Massachusetts, by state funds including those of California, Rhode Island, Pennsylvania Teachers, Washington State, Vermont, Iowa, Massachusetts, Arkansas, and New York State Teachers. See “Galvin Unloads on Putnam, Pulls Pension Funds”, Massachusetts Retirees Online, January 2004. The other principal international equity manager, Bank of Ireland Asset Management, is said to have “had an ‘annus horriblis’, losing several key staff members and significant capital outflows.” “New Entrants Help Boost Indigenous Asset Management Sector,”, [Irish] Finance-magazine.com, December 2005. See OPERS News.com, December 20, 2004, reporting on the withdrawal of $420 million by the Ohio Public Employees’ Retirement System. These two managers have recently been replaced, but the ERS’ principal response to their demise has been to drastically downsize its international portfolio, from 15.5% of portfolio in 2003-04 to 11,1% in 2004-05. This downsizing almost perfectly coincided with a boom in international markets.

If Baltimore’s minority investment managers, collectively, are chargeable with nothing as yet save mediocrity, recent news reports suggest that as to at least two of them, Baltimore has narrowly dodged a bullet.

One of Baltimore’s recently terminated fixed-income managers, MDL Capital Management, lost $215 million in 13 months in leveraged bond investments for the Ohio Bureau of Workers’ Compensation. Several Ohio public agencies have withdrawn their investments, as has Bermuda’s Public Funds Investment Committee and the Chicago Teachers’Pension Fund. See Exhibits R and S hereto.The Ohio losses resulted from “aggressive bets on interest rates and bonds in a hedge fund strategy that went awry.” It was also alleged that “MDL managed about $70 million of the Government of Bermuda’s $1.2 billion pension fund starting in 2001 and, according to published reports in Bermuda’s Mid Ocean News, lost ‘almost all’ of that allocation before its contract was terminated late last year.” The Pittsburgh Post Gazette reported that MDL’s fixed income fund “placed 501st out of 549 funds in its category.” The Retirement Board of Allegheny County asserted that “MDL is the poorest performing of the four bond firm managers the pension plan uses. Over the three years ended March 31st, the $22.2 million the firm manages for the county retirement plan has earned 2.8% compared with the 5 percent to 6 percent returns earned by comparable investment funds.” It was also said to have underperformed relevant indices in 13 consecutive quarters. Common Ground Common Sense.com, “More on MDL Capital Investment”, June 10, 2005, Ex. R hereto.1

MDL, together with another Baltimore ERS-employed minority fund manager, Davis Hamilton Jackson and Associates was said to have been introduced to Bermuda’s Public Funds Investment Committee by Tina Poitevien of Philadelphia’s FIS Funds Management, Inc. , listed as the “Group Advisor” with respect to the Baltimore ERS’ “Fund of Funds” in all reports since at least 1999 through 2005. See Ex. J hereto. Both MDL and Davis Hamilton Jackson “were replaced recently [by the Bermuda fund] as a result of poor performance.” Id. As a result of the losses in Ohio, Poitevien was discharged as a consultant to the Ohio Bureau of Workmen’s Compensation, although she warned the Ohio fund in November 2004, after losses in the MDL investment were already apparent to Ohio authorities, .that MDL had hired too many people to make sound investments and that “Clients should therefore consider termination or substantially reducing their exposure” C. O’Connor, “Consultant Poitevien Loses Ohio Job”, [Bermuda] Royal Gazette and Mid Ocean News.com, July 2005, Ex. V hereto; S.Eder and J.Boak, “Documents Show How BWC Pumped Cash into Failing Fund,” Toledo Blade, June 17, 2005, Ex. S hereto. The [Bermuda] Royal Gazette in July 2005 reported that:

“A lengthy article in last Sunday’s Pittsburgh Post-Gazette, headlined “Scandal spills onto Pittsburgh entrepreneur”, described the rapid growth of MDL, which profited indirectly from the political clout of the Rev. Jesse Jackson. ‘Following mergers with Rockwell International and Mc Donnell Douglas, aircraft maker Boeing wanted to change its investment mix and, under pressure from the Rev. Jackson’s Rainbow/PUSH coalition, wanted to put more pension money into the minority-owned firms. Boeing joined MDL Capital’s client roster with an allocation of $200 million [in addition to] a pension fund allocation of $40 million from Sprint, also at the prodding of Rainbow/PUSH’s Wall Street Project, making 1999 a breakthrough year ..MDL, .. had started from scratch in 1993. A year later, Rev. Jackson’s group talked defense contractor Raytheon into dividing approximately $800 million in pension funds between three minority firms including MDL, which reached a pinnacle of $4.4 billion under management helped by additional funds from Boeing and Sprint. But it has been slipping away since’, reported the Post-Gazette. ‘Raytheon confirmed last week that it had dismissed MDL about two years ago for poor returns, and both it and Sprint say they no longer entrust their pension funds to the company.’ At last count, MDL managed $2.8 billion, but that was before a recent exodus prompted by the revelations in Ohio.”

Poitevien, a native of Jamaica, was hired as the City of Philadelphia’s in-house investment manager on a 5-4 vote of that city’s pension board in 1990. In November 1990, the City Council, over the objections of some of the employee unions, voted to allow the pension fund to buy Philadelphia loan notes, in spite of the city’s lower than junk bond rating. B.Warner and A.Twyman, “Council OKS Pension Loans”, Philadelphia Daily News, November 23, 1990. Poitevien served as chief investment officer of the pension fund until 1994.”[I]ts financial performance lagged way behind its counterparts around the nation. Poitevien said that was not a reflection of her own performance, but the result of state legal restrictions that limited the fund’s investments in the stock market. See B. Warner, “Street donor now pension advisor. Small but politically connected firm knocks major firm off contract”, Philadelphia Daily News, December 13, 2003,4, Ex. L hereto.

In late 2003, Poitevien was chosen as the Philadelphia Pension Board’s chief outside consultant, in place of Mercer Investment Consulting, an affiliate of which provides actuarial services to the Baltimore ERS. . Over the preceding five years, the Philadelphia Pension Board had paid more than $40 million in consulting fees. “Hoping for seats at that gravy train, the money managers have become major investors in local politics. [Mayor] Street alone has raised more than $700,000 from pension fund managers over the past six years…Poitevien gave $1,000 to Street when he was running in 1999 and another $6,000 in the last two years. Her other recent contributions include $7,500 to Gov. Rendell, $500 to Republican fundraiser Bob Asher and $175 to state treasurer Barbara Hafer. Employees of Mercer…have not donated to Street, Rendell or any other state candidates in the last four years.” Id. Poitevien’s employment, for $250,000 to $300,000 annually was approved by a 5-2 vote and was opposed by the Philadelphia controller’s office and the firefighters’ union.

“Sources said that city Managing Director Philip Goldsmith told his representative to skip the meeting, rather than rubber-stamp Poitevien’s appointment….The city has so far refused to release minutes of the meeting or to let reporters listen to a tape of the proceedings…When the Pension Board’s current investment officer, Anthony K. Johnson, was asked to identify his recommendations among six finalists, he named three other firms he preferred over FIS…Poitevien said in its new role, FIS would give up running $68 million in the Pension Board’s ‘opportunity fund’ overseeing the work of nine relatively small managers. Over the past three years, those FIS managers have lost an average of 2.3 percent annually–a slightly better record than the 3.4 percent loss in the benchmark indices that the Pension Board considers comparable.” Id.

A Philadelphia Daily News investigation found that Philadelphia’s pension managers had donated a total of $1.2 million to Mayor Street and Governor Rendell over a six-year period, records of which were subpeonaed by federal investigators in the fall of 2003. “‘It’s clear to me, if you don’t make political contributions or join a PAC, your odds of getting[ Philadelphia city pension business] are virtually nil, unless you are a really big player’, said one local money manager–not working for the city, who asked not to be identified. ‘That [pension] fund historically has been like a huge slush fund.’” B. Warner and D. Davies, “Pension Managers Gave $1.2M to Pols”, Philadelphia Daily News, December 17,2003,6, Ex. M hereto. Another article about Philadelphia’s change of managers noted that

“After leaving the city in 1994, she [Poitevien] became a partner in the New Orleans pension consulting firm Washington, Hackett, Poitevien and Co. But she left that firm two years later after one partner was exposed as having lied about his college degrees. Poitevien formed [FIS] in 1996…Fiduciary Investment has had difficulties in its relatively short life. It attracted public attention after it paid for the lodging for four Pension Board members, all union representatives, at an 11,000 acre golf resort in Virginia’s Blue Mountains in 2001. In the Nov.24 selection, Fiduciary Invesment won the votes of three of those same trustees…They could not be reached for comment Friday…More recently, Fiduciary Investment was in the news when the $1 billion Nashville pension fund stopped using it this summer amid concerns of how its consultant had been hired by the firm. Nashville’s finance director said officials also were concerned about the accuracy of some material provided by the firm and about some charges that they didn’t realize the fund would face.” M.Fazlollah and J. Tanfani, “Pension Firm not a Top Choice”, Philadelphia Inquirer, December 28, 2003,A01, Ex. N hereto..

In February 2004, a Philadelphia Inquirer investigation noted that “Companies that get government bond work are prohibited from giving to political campaigns, but there’s no such rule in the pension industry…The idea died amid a barrage of flak from the industry and Congress. The city tried to put in an anti pay-to-play rule when it set up the Opportunity Fund in 2000…But in a letter that bluntly described the connection between campaign dollars and pension work, a lawyer for one consultant said such a rule would be bad for business. ‘It is not illegal, and in fact it is common–for FIS and other firms to be solicited for political contributions…by city employees, board members and others with connections to the system, wrote Joshua L. Grimes, a lawyer for FIS Funds Management, Inc….Grimes also wrote that a ban on raising contributions from the smaller managers would ‘adversely affect’ FIS’ ability to do business in other cities.” M.Fazlollah, R.Ciotta and J. Tanfani, “Pension Fund Deals Probed”, Philadelphia Inquirer, February 15, 2004,A1, Ex. O hereto.

Poitevien’s Bermuda experience included allegations that:

“in 2002 Ms. Poievien, alteady government’s pension funds consultant, arranged what [Bermuda Deputy Prime Minister] Dr.Brown termed a ‘fundraiser’ luncheon in his honour. Guests were asked to pay $2,500 to attend the lunch in Washington D.C. with the money going toward Dr. Brown’s personal election campaign fund…Sources have alleged that the guests were all current or potential managers or stockbrokers of the Bermuda Government pension funds, prompting [Bermuda opposition leader] Gibbons to denounce the luncheon as a ‘shocking example of pay-to-play.’ Former…SEC lawyer Edward Siedle suggested attendees may have breached the US Foreign Corrupt Practices Act.” S. Titterton, “You’re a Political Eunach, Gibbons tells Scott”, [Bermuda] Royal Gazette.com, April 2005, Ex U hereto.

In Nashville,[t]he board, which oversees a $1.1 billion pension fund learned that its consultant at Segal Advisors Inc, Orim Graves, joined FIS Funds Management Inc’s hedge fund of funds. His job change came after the pension fund hired FIS in its first hedge fund allocation. Fund officials later terminated FIS, and the appearance of a conflict was one reason.” “Taking a Look at Career Path”, Pensions and Investments Online, August 18, 2003.

In July 2004, the San Francisco City and County Employees Retirement System voted to postpone consideration of an emerging manager program until December 2005, partly on the ground that FIS, one of five finalists, “experienced senior management changes in the last five years.” “San Francisco Holds Off on Emerging Manager Program”, Pensions and Investments Online, July 13, 2004.

Unlike the Fire and Police Fund, the ERS continues with an un-reformed investment policy. Its 2004-05 Report discloses that Poitevien is still in charge of its ‘Fund of Funds’ and that two new minority firms with limited and unpublished records, Brown Investment Advisory, Inc. of Baltimore and Palisades Investment Partners, LLC of Santa Monica, Cal. have been added as regular equity advisors.2 The domestic equity portfolio underperformed its benchmark by .2% in 2004-05. More remarkably still, MDL Capital Management,Inc (Lay) was retained until mid 2005 as a fixed income manager despite its disastrous management in connection with the Ohio Workmen’s Compensation Fund. The portfolio underperformed its benchmark by .4%. The unsatisfactory international managers were replaced, but the ERS’ chief response to mismanagement of its international portfolio was to reduce its size from $163.3 million on June 30, 2004, or 13.08% of total portfolio (2003-04 Report,47), to $65.5 million on June 30, 2005, or 5.57% of total portfolio (2004-05 Report, 49). 2004-05 was a banner year for international equities; the Fire and Police Fund earned 24.1% on its $280.8 million portfolio (2004-05 Report, 44, 47); the ERS earned 13.9% on its shrunken portfolio (2004-05 ERS Report,,46), Ex.K hereto. The reduction of the ERS’ international commitment to 5.57% was purely a function of its need to change managers; its target asset allocation for international equities was 14% (2004-05 ERS Report,47).

Fire and Police Retirement Fund

At least for the year 2001, Callan Associates also served as the overall investment advisor to the Fire and Police Retirement Fund. In that year, FIS Funds Management, Inc. and Tina Poitevien was the group advisor for an “Equity Fund of Funds”, just as she was with respect to the ERS fund. MDL (Lay) and Utendahl were among the three fixed income managers and Putnam and Bank of Ireland among the International Equity Managers. and Lomax was among the Equity Managers, The five year performance of the Fire and Police Fund for the period ending in 2001 was 10.9%, 1% below the benchmark. The Domestic Stock portfolio underperformed the benchmark by 2.7% over the five year period. Ex. K hereto

Among the funds engaged by Poitevien for the 2000-2001 year (and thereafter terminated) for both the Fire and Police Fund and the ERS were Tiffany Capital Advisors and Valenzuela Capital, both minority firms. (2001 Report,41-42)..

Tiffany was the subject of an S.E.C. cease and desist order in S.E.C .v. Tiffany, Case 1A-1988, File 3-10614, Release 1988, October 3, 2001, charging it with representing that it had $560 million under management when it had only $250 million and with exaggerating the number of its individual clients, who were essentially nonexistent. Its last remaining client was the Ohio Workmen’s Compensation Fund which discharged it in October 2003, after it had produced returns of less than 1% per year. See G. Pakulski, “Bureau Stuck With Firm Despite SEC Inquiry”, Toledo Blade.com, January 18, 2006.

Valenzuela managed a midcap fund for the Indiana State Teachers’ Retirement Fund, which, according to the Indiana Fund’s 2002 Report (p.38) generated a five-year return of 4.38% as against 12.58% for the Standard and Poor 400 Midcap index.

In its 2002 Report, the Fire and Police fund reported returns of -8.6%, 1.3% worse than the benchmark (2002 Report,, 35). In its 2003 report, it reported returns of .8%, 3.7% less than its benchmark. (2003 Report, 38). These two shortfalls alone, applied to a fund of 1.4 billion, translate to a shortfall of $70 million in two years. This disastrous result produced action. The letter of Chairman Stephen Fugate in the 2004 Report noted that

“Three years ago the System’s investment performance severely lagged that of other public retirement plans. Worse yet, the System’s investment managers were uniformly performing well below median compared to others in their peer groups. Concerned with the overall direction of the System’s investment program, the Board of Trustees hired a new investment advisor, [Summit Strategies Group in place of Callan] in October 2002…Many existing investment managers were terminated because of poor performance, because of organizational issues, or because they no longer fit the new structure established by the Board…The System has risen from the bottom to rank in the top third of its peer public fund comparison group at June 30, 2004.” (2004 Report,page 12).

In the 2003-04 year, the Fire and Police fund achieved a return of 16.2% as against its benchmark of 14.9%, ranking in the tenth percentile, and its domestic equity funds outperformed their benchmark by 1.1%. In the 2004-05 year,the Fire and Police fund achieved a return of 12.1%, 1.9% more than its benchmark, ranking in the third percentile, an outstanding result, and its domestic equity funds out-performed their benchmark by 1.8%. The contrast with the ERS is striking. Since its investment policies diverged from those of the ERS, the Fire and Police Fund achieved a two-year return of 28.3%, as against 25.1% for the benchmark funds and 22.2% for the ERS. Ex. K hereto. Among the managers replaced by the Fire and Police Fund between the 2002 and 2003 reports were Poitevien and six “Fund of Funds” managers under her, the Fire and Police fund abandoning the ‘Fund of Funds’ concept. Between the 2003 and 2004 reports, both Putnam and Bank of Ireland were replaced as International Equity Managers. Lomax continues as a Domestic Equity manager and and Utendahl continues among the Fixed Income managers but MDL (Lay) has been replaced, well before the ERS replaced it.

The principal problem afflicting the Fire and Police fund, now that it has addressed its investment performance, is its high percentage of disability retirees, 970 out of 4262 retirees received disability pensions for the year ending June 30, 2005, a percentage higher even than that in the San Diego system, 134 of these were under the age of 44. (2005 Report, 75) The number of new retirees added to the rolls sharply increased from 202 in 2001 to 211 in 2002, 241 in 2003, 345 in 2004, and 314 in 2005. 2004-05 Report,58. In fiscal 2005, the cost of disability retirements exceeded assumptions by $11,359,179. Id.,60.

As a result of the disability retirement problem, and the poor investment returns in years prior to 2003, the Fire and Police fund went from a surplus of $48,762,708 on June 30, 2000, at which time it was 102.4% funded, to a deficit of $104,419,525 on June 30, 2005, when it was only 95.9 % funded, a deterioration of $153,182,233 in five years (2004-05 Report, 30). The combined deterioration of the two funds in the five year period approximating one mayoral term was thus $308,758,822, or about $600 for each man, woman and child in the City of Baltimore.3

Against this background, it is not reassuring to learn.that Baltimore’s two pension funds have recently decided to embark on leveraged hedge fund investing, the type of investing that got the Ohio Workmen’s Compensation Fund into trouble. The Maryland State Retirement Fund has declined to do so: “‘We’re concerned that returns going forward may not be as lucrative as they were in the past’,said Steven Huber, chief investment officer of the Maryland State Retirement and Pension System.” B.White, “Hedge Funds’ Returns Falling: Main Street Investors Moving In May be Disappointed”, Washington Post, August 14, 2005, Ex. T hereto.. “The Baltimore City Fire & Police Employees’ Retirement System put $80 million into hedge funds last year, while the City of Baltimore’s Employee Retirement System put in around $55 million, or 5 percent of assets.” Id. The Fire and Police Fund has not as yet reported its hedge fund results; the ERS reported 2005 returns on its hedge fund investments of .2%, as against .4% for its benchmark. 2004-05 ERS Report,46.

Rosalyn H. Spencer, the director of the Baltimore ERS is quoted as saying:

“‘We are trying to meet our 8%, so our board decided to look at other investment options….We are hoping it can’t get worse’, Spencer said of recent hedge fund performance…Individual hedge funds typically charge high fees, including 2 per cent of assets under management and 20 percent or more of returns above a certain level. ‘Funds of funds’ can add an additional layer of fees. Thomas Taneyhill, executive director of the Baltimore City Fire and Police Employees’ Retirement System, said he is disappointed by the return on the $80 million his system recently invested in ‘funds of funds.’ ‘Performance has been off’, he said…some regulators and analysts are concerned that continued tepid returns from hedge funds could lead many investors to pull their money out at the same time to avoid paying high fees for poor performance–possibly creating a liquidity crisis in which funds do not have enough money to refund investors…’the nature of the shakeout that we see as likely is a run on the bank’, said Peter Stockman, a hedge fund adviser at PA Consulting Group.” Id.. Huber, of the State Retirement System, has “discomfort with the amount of money that’s flowing in” to hedge funds. L.Smitherman, “Pensions Turning to Edgier Investing”, Baltimore Sun, August 24, 2005, Ex. E hereto..

Thus, prompted by mediocre returns on politically managed investments, and politically fostered increased claims against the funds, their managers, under duress from the Mayor, are opting for ‘the tail of the dog that bit you’: a dance of death with riskier investments, frequently managed by untried firms or firms with dubious track records. The recent changes in Baltimore City government pension policy have made the City part of a national crisis from which it had previously stood apart,

It was recently estimated that the nation’s private pension plans suffered from a combined actuarial shortfall of $123 billion, as against $278 billion for public pension plans, and that the true figure for public pension plans might be as high as $700 billion. Assets of public plans were estimated at $2.37 trillion. 90% of public sector employees are included in such plans, as against 24% of private sector plans. The average public sector plan is only 78% funded, in contrast to the Baltimore ERS and Fire and Police funds which until recently were fully funded. See “Sinkhole: How Public Pension Promises are Driving State and City Budgets”, Business Week, June 13, 2005, Ex. F hereto..

The huge sums involved mean that any serious mis-allocation of pension funds has consequence not merely for particular funds but for the economy. Required city contributions to the funds have increased from $45.9 million in 2000 to $71.9 million in 2005 (2004-05 ERS Report,33; 2004-05 Fire and Police Report,31)., and are predicted to sharply rise in the future as past investment losses are recognized. This burden on the City budget potentially affects both its bond rating and its future ability to render services..Notwithstanding this, there continues to be clamor, to which the City administration and ERS has yielded, for the allocation of fund investments according to political and racial criteria. The Rainbow/ PUSH Wall Street Project has been explicit in favoring this approach ; its leader, Rev. Jesse Jackson, is resisting efforts to reform the system that led to the Ohio Workmen’ Compensation Fund losses: “We are going to fight the Ohio elimination plan”, said Rev. Jackson.”If Ohio tumbles, all of the programs in other states will fall.’ www.Rainbow/PUSH.com,January 2, 2006.

What Must Be Done

This chronicle suggests that some major reforms are necessary:

  1. The Baltimore City Charter should be amended to render retirement fund investments independent of Mayoral control. At the least, this means that the Mayor’s control of the Board of Estimates should be qualified by giving him only one vote, rather than three, on retirement fund issues. The action of the Mayor in causing a perfectly legitimate adviser choice by the ERS board to be rejected three times because of the Board’s refusal to inject irrelevant criteria into the selection process constituted a gross abuse of power. Sections 4 and 5 of the Uniform Management of Public Employees Retirement Systems Act recommended by the National Conference of Commissioners on Uniform State Laws in 1997 and adopted in Maryland as to new plans only would completely free the trustees from Board of Estimates and hence mayoral control, in deference to their fiduciary obligations.
  2. The boards should be reconstituted so as to be composed predominantly of persons with financial expertise, or consideration should be given to having two boards for each fund, one for investment management and one for claims management..
  3. The standards for disability retirement in section 34 of the Retirement article of the Baltimore City Code relating to the Fire and Police fund need to be drastically tightened, to encompass only disability from work for the City or at least the department, not disability from current job classification.
  4. The provisions in that section with respect to the Fire and Police Fund, adopted in 1989, allowing retirement after 20 years service rather than 25 should be modified. Consideration should be given to eliminating length of service rather than age related retirements, which were introduced in the ERS fund only in 1993.
  5. More fundamentally, thought must be given to the complete or partial conversion of the systems to defined contribution plans, so as to eliminate actuarial uncertainties, abuse of disability retirements, and the political management of investments. Since the funds’ deficits are still rather modest by national standards, this could be done without much difficulty, following the example of most private businesses. Such a course has been urged for San Diego’s underfunded retirement system. See N. Gelinas, “A Permanent Fund Fix for San Diego”, San Diego Union Tribune, June 1, 2005. It has already been followed by Montgomery County with respect to its employees other than fire and police employees.
  6. The Uniform Management of Public Employees Retirement Systems Act adopted in Maryland 2005 as to new funds only, should be extended to the City systems, which are badly in need of their duty of loyalty and disclosure provisions.
  7. A statutory provision should be adopted expressly precluding political affiliation, race, religion, national origin, and geographic location within the United States as factors in investment decisions. At the least, the language of section 8(a)(5) of the Uniform Management of Public Employees Retirement Systems Act should be adopted, stating that a Board “may consider benefits created by an investment other than investment return only if the trustee determines that the investment providing these collateral benefits would be prudent even without the collateral benefits.” This language is substantially identical to the ERISA regulation adopted by the Department of Labor for private pension plans, 29 C.F.R. sec. 2509-94-1. See J. Langbein and R. Posner, “ Social Investing and the Law of Trusts”, 79 Mich.L.Rev. 72 (1980)
  8. There should be a prohibition on political contributions by pension advisers and brokers similar to that imposed with respect to municipal bond underwriters by Rule G-37 of the Municipal Securities Rulemaking Board established by Congress in 1975. That prohibition bars participants in the municipal securities industry from doing business with public bodies where contributions have been made within the previous two years, with a narrow exemption for contributions of $250 or less where the contributor is a constituent of the recipient with a right to vote. In 2004-05 the ERS paid $3,230,445 to investment managers, consultants and custodians and the Fire and Police fund paid $6,823,471 for the same purposes.
  9. There should be a review and housecleaning of the present fund consultants, and orders for securities resulting from their recommendations should be executed in-house, on the internet, using a limited number of brokers. In 2004-05, the ERS fund paid $782,263 in brokerage fees and the Fire and Police fund paid brokerage fees of $1,388,405
  10. The fund managers should be barred from leveraged investments such as those conducted by some hedge funds. In general, ‘hedge fund’ investing should be avoided, given its costs, customarily 2% of assets and 20% of gains. Few fund managers can regularly surpass benchmarks by 2% and those who can are in demand by institutions whose means and ability to absorb risks far exceed those of the Baltimore pension funds.4
  11. The state should reject proposals, such as those being put forth by the Maryland State Teachers’ Association, improvement in benefits in the state’s defined benefit Retirement System. Instead, any improvement to teachers’ pensions should take the form of contributions on behalf of teachers to the state’s defined contribution Deferred Compensation Plan, whose individually-directed average investment results have surpassed those of the State Retirement Systems in recent years. This will ensure that the State’s $5 billion actuarial funding deficit is not further expanded, and will also insulate funds contributed by the the State from future political manipulation.

    Calvert Notes

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    1. In mid 2005, long after MDL and Hughes were replaced by the Fire and Police Fund, the ERS finally replaced them. 2004-05 Report, 42.

    2. Palisades’ principal, Quinn Stills, was formerly manager of the Dreyfus Premier Strategic Value Trust, which appears to have outperformed its benchmarks during the period of his management of it.

    3. As is elsewhere noted in this Report, under-funding of public pension plans is a national problem from which Baltimore City has previously been largely exempt. The State Retirement Fund, whose assets approach $30 billion, became underfunded as a result of the fall in the market in 2002-03 affecting all pension funds, together with a shortfall in investment earnings of $2.5 billion below return on peer funds resulting from unwise and politically influenced investments, and the recognition of these losses over a five year period together with adverse claims experience resulting from aging of the state work force. These factors, together with the failure of the state to make a total of about $267.5 million in scheduled contributions in the last three fiscal years,(Maryland State Retirement System, 2004-05 Annual Report, 35 produced a decline in the funding ratio from 101.2% in 2000 to 88.2% as of June 30,2005, a deterioration of $4.983 billion in a five-year period.. The five-year rate of return for the period ending on June 30,2002 for the MSRS was 3.21% as against 5.13% for peer funds (2002-03 Maryland State Budget, vol.1,582) which translates into a shortfall in investment earnings of $2.5 billion for that period alone. Its investment performance in more recent years is slightly below benchmarks and political allocation of investments appears to have ended..

    The Montgomery County Retirement Fund unlike the Baltimore plans, is of relatively modest scope in relation to its county’s taxable base. Its total assets are about $2 billion, since new employees other than public safety employees were transferred to a defined contribution plan in 1994. Its investment earnings exceeded benchmarks for the years ending June 30,2004 and 2005,(Montgomery County Retirement System, 2004-05 Report, 48-49) and investments appear to have been allocated on a basis that is not politically influenced. However benefit liberalizations in collective bargaining agreements as well as two bad market years have resulted in severe under-funding. The plan was 98.9 % funded as of June 30, 2000 , a ratio declining to 75.7% % as of June 30,2005, the funding deficit then amounting to $674.5 million, an increase of $649.7 million over a five-year period. (Id.,32) . The plan recognizes investment gains and losses departing from an 8% return over a five-year period; had recent gains been fully recognized, the deficit would have been $44.2 million less.(Id.,53)

    4. Two fund personnel should be commended as having displayed exceptional integrity. Thomas Taneyhill. Executive Director of both city funds to 2002 and of the Fire and Police fund since then, outspokenly criticized the Mayor’s demands for further ‘diversification’ and social investment, as did Fire Captain Stephan Fugate, Chairman of the Fire and Police Fund, (see Exhibits A and B hereto), who also presided over that fund’s separation from the EIS fund in the choice of investment advisors and staff and the recent ‘housecleaning’ of the Fire and Police fund’s investment advisors and consequent dramatic improvement in its investment results.

    Posted in: Efficiency in Government, Report