Pay to Play: Lessons for Calpers

Calpers, the largest public pension fund, is being rocked by a "pay to play" scandal, according to Gwen Robinson writing at ft.com (here). Calpers is reported to have disclosed that a former board member received $50 million in fees for arranging the placement of investments that saddled the California taxpayers with potential losses. The origin of Gwen's report is a Wall Street Journal article by Craig Karmin and Peter Lattman available here (subscription required).

The WSJ article, as quoted by Gwen, specifically identifies Arvco Financial Ventures, headed by Al Villalobos, who served on Calpers’ board 1993-95. The implication is that this is only one of many investigations underway. The entire Calpers situation raises the question of how much fraud, deceit, double dealing and blatant ethical violations have undermined public pensions all over the country.

The basic problem we have is the intersection of fiduciary responsibility with profit opportunity. In all too many cases, those with profit opportunity take an entirely different view of fiduciary responsibility than those without that opportunity. What is defined as corruption is often determined by the self-interest of the definer. As the chief character in the movie Wall Street shouted: "Greed is good!" If the loser to the greedy winner is another greedy person, but just less skillful, maybe the shout out can be defended. But, what if the losers to greed are widows and orphans?

I believe this problem does not just exist for the titans of Wall Street. There is an endemic problem. Let me give an personal example, changed in just enough detail to protect individuals who deserve no special notoriety.

As the board member of a country club, I was assigned the responsibility for getting bids and selecting a landscape contractor to install new landscaping at the club. I was given the leeway to make judgments about trade-offs between price and quality.

I got two bids from contractors with whom I had no relationship. The third bid I got from the landscaper who does planting bed maintenance for me at my residence. The bids came in at $8,000, $6,600 and $7,800. The $7,800 bid came from my residence landscaper. I reviewed past projects for all three landscapers and felt the quality was equivalent. All three worked from the same specifications and provided the same guarantees. It seems simple that contractor #2 ($6,600) should get the job.

Contractor #3 gave me a proposition: If he got the contract, he would give me a 10% discount on my residential work for the next year. That would have been about a $320 savings for me. The contractor said that this was a standard referral fee procedure for his business. I immediately asked him if he would give the referral fee to discount the country club bill. He was astounded. No one in a similar circumstance had ever asked that question. I told him it was a simple matter of ethics. After thinking for many seconds, he said that he could understand what I was getting at. After that he said he would discount the country club job by a full 10% ($780), not just the $320 I would have gotten.

It turns out that, after discussing the three bids ($8,000, $7,020 - revised - and $6,600) with several board members, we selected the low bid. When I recounted how the $7,800 was discounted to $7,020, to a man the opinion was that I should have taken the personal discount and not have discussed the matter with anyone. I should have just considered it compensation for the work I did for the club. I told each person they needed to study ethics. Several have since told me they have thought about the situation and agree with my position on ethics. A couple of them have told me they have fundamentally changed their attitude about ethics based on this experience.

Society is riddled with people of questionable ethics. Unfortunately, too many of them have gotten into positions where they have been able to victimize large groups of people. My personal example involves such a small amount of money that a skeptic may say it doesn't compare to $50 million moral hazards. I can only say that an ethical society will not be corrupted by the amount of money involved. After all, remember the story about the woman who said she would accept a million dollars for an illicit encounter, but then became indignant when the offer was lowered to $100. She said, "One hundred dollars? What kind of woman do you think I am?"

The response came back, "We've already established what kind of woman you are. Now we are haggling about price."