When an investment in the state's public pension dips in value, Florida's money managers say it's unfair to judge investment funds over the short term.
But the State Board of Administration has one pension investment that has been around for nearly 20 years. The deal was negotiated by Ashbel C. Williams Jr., the current SBA executive director, during his first stint with the agency in the early 1990s.
It's the pension's longest-running relationship with a private investment firm. And it's the biggest of its kind, having received $2.5 billion from Florida over the years.
How has it performed?
• The fund's returns are less than one-third of what the pension expected.
• Its managers have charged Florida far higher fees than projected.
• An outside consultant called its performance "unequivocally unacceptable."
Despite the state's recent efforts to end the relationship, the fund's assets are locked up in companies that can't be sold without taking a loss.
The fund's name: Liberty Partners.
$180 million in fees
In the late 1980s, a handful of public pensions were venturing beyond traditional stocks and bonds and putting some of their millions with specialists on Wall Street who invested in private companies. These investments couldn't be turned into cash as easily as publicly traded stocks but offered the potential for big profits when the companies were sold.
In late 1990, Florida's pension officials approached Peter E. Bennett, then managing director of a unit of Merrill Lynch that did leveraged buyouts of mid-sized companies. Florida wanted in on the game.
There was one obstacle: State law at that time only allowed the pension to invest in stocks, bonds and real estate, not private limited partnerships.
Discussions continued through late 1991, when Williams was hired to run the SBA. By September 1992, pension officials found a way to invest in private deals without violating the law.
The solution was something Williams called a "trust parallel to the partnership."
Bennett, along with two colleagues and a buyout specialist from Lehman Brothers, formed Liberty Partners. Their mission: Use their expertise to buy promising companies, cut costs, boost revenue and sell them for a profit. Their sole source of funding? Florida's public pension.
The unusual arrangement proved to be a bonanza for Liberty's managers.
In traditional private equity funds, the general partners have the expense and hassle of raising money from multiple sources. Florida launched the investment with Liberty with a commitment of more than $1 billion and has remained Liberty's only partner.
Unlike a limited partnership, where profits are returned to the investors, Liberty's profits were recycled into the fund, guaranteeing the managers a continuous investment stream.
Though Liberty's general partners eventually put some of their own money into deals, they were not required to do so, as is standard in such partnerships. They shared in the profits, but paid no penalty for losses, as other fund managers typically do.
Liberty's partners also charged Florida more fees than usual in private equity deals. In addition to getting paid for managing the state's money, Liberty collected fees for sitting on boards of directors as well as for buying or selling companies.
Williams, the SBA chief, declined to answer questions for this story, as did Liberty's Bennett. SBA spokesman Dennis MacKee said some of Liberty's services were priced at a discount.
But the cumulative effect of the arrangement was in the general partners' favor. In most private equity deals, management fees are 1 to 2 percent of the annual investment. Liberty's management fees have totaled $180 million over the past 18 years, 7 percent of what the state invested.
MacKee said it is not fair to compare annual fees with fees paid over the lifetime of an investment. So how were Liberty's management fees calculated? MacKee wouldn't say.
What Florida has gotten out of Liberty is even harder to figure.
The state pension expects to get about a 20 percent return on similar private investments. Florida's money managers are so enthusiastic about such investments, they want to increase the pension's holdings in them to offset lower returns elsewhere.
But after nearly two decades, the Liberty fund has returned just 6 percent.
Edward Siedle, a former Securities and Exchange Commission attorney who investigates pension fund abuse, reviewed Liberty's performance and had this question for the SBA: "If you want to break even, why not buy CDs?"
Ten years after first investing in Liberty, the management agreement had been extended twice. Considering a third extension, the state hired an outside consultant to review the arrangement.
The word came back from Alignment Capital Group, of Austin, Texas: Liberty's performance was "unequivocally unacceptable'' and had "far too much risk for the returns involved."
Liberty's managers were supposed to be using Florida's money to buy companies with profit potential. Instead, of 34 companies acquired over the decade, most of the profits resulted from just two investments.
Liberty had written off four companies as worthless, including a $21.4 million investment in a firm called Med Logistics and $31.5 million invested in Gallaher Paper.
(Disappointing investments have disappeared from Liberty's website. Among them were Norwood Promotional Products, which sold marketing giveaways like pens and flashlights and got $130.3 million from Florida; and NutTrade.com, an online purveyor of walnuts and almonds, investment unknown.)
The Alignment Capital report said that thanks to the two big winners, Liberty had outperformed the stock market over the previous decade. But, "On a risk adjusted basis, it (Liberty) has not performed nearly as well as it should have."
Their harshest criticism was aimed at Liberty's bookkeeping.
"We reviewed Liberty's investment reporting records and found them to be in a shocking state of disarray and inconsistency, evidence of a remarkable degree of administrative laxity."
Alignment Capital's critique of Liberty was not made public by the SBA but was leaked to an investment newspaper about a year later. A reporter tracked down Williams, who had left the SBA in 1996 and by then was managing director of a Wall Street hedge fund.
"They were terrific people,'' Williams said of Liberty's partners, "and the investments they made were outstanding, and the performance was really good. Not just good.''
Fees, fees, more fees
In 2003 and 2004, Alignment Capital continued to monitor the Liberty contract, focusing on what the consultant called the "particularly egregious'' fees the state paid.
The 2003 report said "less advantageous terms dominate the economics of the relationship" for the state and recommended renegotiating or terminating the contract "as soon as possible." It calculated that over 11 years, Liberty's managers had received $193 million in fees and profits from Florida's investment. (An updated figure is not available because the SBA said it does not track how much Liberty has received in profits.)
"The economic difference between Liberty's current terms and the terms currently available in the market is too great to be sustained," the consultants said. The critique of the pension's biggest private investment was only recently released by the SBA in response to a public records request.
Among the issues cited by Alignment Capital Group:
• Most private equity deals calculate profits on a portfolio's entire performance, with losers offsetting winners. But under the Liberty contract, when a single company sold for a profit, the general partners got a cut; there was no corresponding reduction in their compensation if a company sold for a loss. By 2003, the consultant found this arrangement resulted in Florida giving Liberty executives $60 million more than they would have received under a traditional limited partnership agreement.
• Liberty's executives also kept all the fees charged to portfolio companies for monitoring and transactions. In limited partnerships, most of those fees are usually passed back to the investor. Had Liberty been required to return these fees, the state could have recaptured $22 million.
• Liberty bought both stock and debt of the companies it acquired. This created another source of income for Liberty, which treated interest payments on the debt as profit and took a share.
Asked to comment on the original Liberty contract, SBA spokesman MacKee said: "At the time this was a prudent business decision."
In 2007, Chief Financial Officer Alex Sink raised questions about the Liberty arrangement. The SBA director at the time, Coleman Stipanovich, told Sink by e-mail that he had renegotiated the contract terms to the state's advantage for investments made after 2005.
The contract also set a timetable for Liberty to start selling its assets so the investment, which accounted for about a quarter of Florida's private equity portfolio, would be mostly liquidated by 2012.
But sale plans have been put on hold and Liberty remains the largest concentration of pension dollars with a single private equity manager.
"In light of recent financial market turmoil,'' MacKee said, "time lines have been extended.'
To date, Florida has invested $2.5 billion in Liberty.
It has received $2.4 billion in distributions.
Market value of the unsold companies is less than $500 million.
The Edison deal
Most Floridians had never heard of Liberty Partners until it made a controversial purchase in late 2003. The firm paid $182 million for Edison Schools Inc., a charter school company that had been in business for a decade but never posted a profit.
When it was discovered that Florida's pension was buying a private operator of public schools, the state's teachers' union was up in arms. The Democratic leader of the Florida House at the time, Doug Wiles of St. Augustine, questioned the acquisition.
"I have deep concerns about investing our state employees' retirement funds in a company that seeks to eliminate public jobs,'' he said.
Wiles, who left the Legislature in 2004, said recently that lawmakers were assured the Edison investment was going to be a quick turnaround that would be sold for a profit in three to five years.
Told that Liberty and Florida still own Edison, he asked: "Why would they still own it, except they don't want the embarrassment of having to sell it short,'' for a loss.
The SBA refuses to say how much Florida's $182 million investment in Edison is worth today.
"We do not comment on the value of individual company holdings," MacKee said.
In June, when the SBA's chief got his bosses' approval to triple the pension's allocation to private partnerships and other alternative assets, he promised that such investments would have "appropriate institutional-level transparency.''
MacKee said that transparency does not extend to the public.
"Don't confuse the transparency and knowledge the SBA staff has at the portfolio level and the level of detail that statute provides for us to share in order to protect the value of the investment for the benefit of our participants."
A year ago, Edison gave the SBA an update on its progress. A public records request for the information yielded a 124-page report with 115 pages blacked out.
Left untouched was a page emblazoned with a big arrow, pointing up.
Staff writer Sydney P. Freedberg, Times computer assisted reporting specialist Connie Humburg and researcher Caryn Baird contributed to this report. Kris Hundley can be reached at firstname.lastname@example.org or (727)892-2996.