By Christopher B. Tobe, CFA,CAIA Trustee KY Ret. Systems 2008-2012
I killed a Hedge Fund because I felt I had to as a Fiduciary for a $14 billion Public Pension Plan. This fund Arrowhawk Capital partners was conceived in corruption, and that, along with its mediocre performance sealed its fate.
I joined the Kentucky Retirement Systems (KRS) as a Trustee in April 2008 the only one of nine with any investment experience whatsoever and was at the time an investment consultant with NEPC. I
I was not allowed on the investment committee from April 2008 to April 2009 because of ?seniority?, but in January 2009 legislation was proposed to require an investment expert on the investment committee.
While the legislature did not have time to pass it by March the KRS chair put me on the investment committee in April 2009 because the legislative intent was clear. As an investment committee member I immediately started asking questions about placement agents, but the staff and other trustees looked at me dumbfounded, leaving me with the impression they did not know what I was talking about and they did not know of any placement agents even attempting to do business at KRS. At the February 2009 investment committee we approved a 5 allocation to a hedge funds with an established large fund of funds which was consistent in the way I was making initial public pension first time hedge fund investments with my clients at NEPC. KRS Chief Investment Officer (CIO) Adam Tosh even mentioned this fund of fund structure in interviews with trade magazines and said that RV Kuhn?s our consultant would assist in the search.? I started digging in a number of areas of what I considered shady investment practices, and at the August 2009 board meeting I was kicked off the investment committee in a secret session with no reason
recorded in the minutes. I remained a trustee because that removal would require a formal open process.
While investment committee meetings are normally held every 3 months, KRS, within a few weeks of kicking me off had called a special meeting of the Investment Committee on September 29,2009 with the apparent goal of seeding $200 million with Arrowhawk Capital Partners. Contrary to Tosh?s earlier comments in the press Arrowhawk was an individual hedge fund not a fund of funds which diversify any potential operational risk (i.e. Madoft) that a single fund may face. But most disturbing was that Arrowhawk was a start-up hedge fund with no established investment track record and was KRS? first-ever hedge fund investment. Within 2 days Arrowhawk has announced
this $200 million win in the trade magazine P&I. I had never heard of Arrowhawk before I found about this entire secret deal through the press, not through any official KRS channels,
even though I was still a trustee.
It appears that secret backroom deals were cut by Arrowhawk and staff in July or August to get the majority of their seed money from public pensions. Within 2 weeks Arrowhawk announced another $100 million win with San Jaquin County, which I later heard was contingent on Kentucky seeding the plan first. In this same P&I article it announces that ?Arrowhawk Capital Partners LLC finally launched its first hedge fund Sept. 1 with $500 million from institutional investors?
iii Not only was their no RFP issued by the plan or any of the consultants, but it appears that investment staffs at both KRS and San Jaquin had cut deals prior to September 1, 2009 to get into Arrowhawk at least 4 weeks before there was any official board knowledge or approval.
I was fairly inactive. being kicked off the investment committee, until I was forced back on by legislation requiring investment experts onto the committee in April 2010. I did however write an e- mail to the Chair of the Investment Committee concerning my reservations about Arrowhawk and the rumor of a placement agent Glen Sergeon making millions off of Kentucky. Back on the investment committee I continued to ask about placement agents and continued to receive back blank stares. On June 20, 2010 CIO Adam Tosh left town to work for Rogers Casey.?
On August 4, 2010 KRS staff disclosed for the first time to the Trustees the existence of placement agents and $13 million in fees buried in a stack of over 50 pages to members of the investment committee. This internal audit had KRS staff cutting secret placement agent deals since 2004. The largest placement agent fee paid was over $2 million paid by Arrowhawk to Glen Sergeon. The audit (or the fact we had placement agents) was deliberately kept secret from the full board of trustees and the public. It appeared to me that the CIO Tosh had cut a deal with KRS management to keep the existence of placement agents secret until he had secured ajob in the private sector.
While some parts of management were aware for six plus years we found documentation that the current senior management team was fully aware of all of the major findings in January 2010 and keep it secret from the board for 8 months. On August 19,2010 at the Board of Trustees meeting I declared I was sending a note to the SEC in an open meeting for the record, which was my official start as a SEC whistleblower.
During several KRS public meetings I asked our independent investment consultants about this transaction. In fact KRS consultant Pete Keliotis of SIS said they had regular professional contact with Arrowhawk and no placement agent was needed. In fact neither KRS investment consultants R V Kuhn nor SIS was aware a placement agent was paid. It seems that the placement agent was paid $2 million for doing nothing since our consultant could have helped us hire Arrowhawk for free as part of their normal retainer fee.
Meanwhile there was limited Kentucky press on the issue and the Governor asked the auditor to do a review in the fall. The blog press in Kentucky continued to write about the scandal. v
Forbes was working on a major story but it was not released until May 2011, but had some
important observations such as ?One that paid Sergeon?s firm over $2 million was the Arrowhawk Durable Alpha Fund-an outfit that couldn?t have won over public officials with its track record because it was brand-new ?.. In April the Kentucky board
fired longtime director Michael Burnside amid concerns that he?d withheld information on placement agents from trustees. vi It is my opinion that this bad publicity along with mediocre performance sealed the doom for Arrowhawk.
They could not get any legitimate business because of their track record, and the backdoor business model through public plans was shut down by the publicity of the scandal.
In June 2011 after a long torturous process (in which they ignored hundreds of documents I sent them) the Kentucky State Auditor (AP A) released a 118 page report, which was, according to several blogs, a whitewash???. The APA could find nothing wrong with placement agents the managers like Arrowhawk and this process. The Kentucky Attorney General did not think it warranted his attention as well.viii However, the SEe continued its investigation.
I knew that the AP A report had many errors and flaws so in doing my fiduciary duty I hired an ex- SEe attorney who was an expert on public pensions to write a 30 page report. He concluded that ?The APA report is remarkable in its failure to adequately address the most obviously troubling issues surrounding use of placement agents at KRS. For example, the APA did not investigate the services actually provided by the placement agents and whether the millions in compensation paid by this public pension to such agents bore any relationship to services the agents actually provided,
or was excessive.. .Byfar the most troublingfinding in the APA report is that the APA, like the KRS Internal Audit, found no evidence of ?pay-to-play at KRS. aix
I believe this report addressed to the SEe highlighted Arrowhawk as the largest more egregious placement agent payment giving it a high probability of pay for play.
Arrowhawk most likely informed KRS staff they were closing in early December 2011. As usual as a Trustee and investment committee member I found out about this via the trade press at the end of December? Arrowhawk?s closing was picked up by Bloomberg on January 2nd and finally our local press at the Lexington Herald Leader (HL) which was published on January 5,2012. xi KRS staff was so incensed that the HL article insinuated they had done something wrong (after they felt the AP A had whitewashed them clean) they published a long tortured report on their web site accusing the HL of ?misreporting. xii
Even after the death of Arrowhawk was announced in January 2012 KRS continues to fight hard to keep information on Arrowhawk and placement agent transaction secret especially from my ex- SEC independent counsel who they feared would turn over information to the SEC. xiii In the report he made several scathing comments. ?Arrowhawk announced that it was shutting down its operations in December, 2011, in the midst of the SEe investigation of placement agent fees paid by KRS. While investment management firms may shutter from time-to-time for any number of reasons,
it is unusual (and a cause for concern) when afirm does so in the midst of an investigation by a regulator
Finally, 1 had reason to believe that Arrowhawk lacked audited financials for all
years of operation of the fund. ?
Because of this the independent counsel on February 1,2012 requested that KRS or its counsel provide him with audited fmancial statements of Arrowhawk. On February 13, 2012, KRS and its legal counsel responded that they had determined that a review of the Arrowhawk financial statements was not ?relevant? to my representation of Mr. Tobe. Later counsel for KRS informed the independent counsel that KRS does not possess audited financial statements for all periods, only periodic unaudited statements. xiv In a story in Forbes the independent counsel had this to say ?1 continue to be amazed at their wildly irrational and defensive responses to legitimate, especially
expert, criticisms. ?zv
Even as KRS liquidates its position and the fund shuts its doors, staff is still defending the hiring decision with Arrowhawk. I can only imagine that this is a defensive position taken while the SEC investigation continues. Hopefully the SEC will set an example in this case since public pensions do not need any more Arrowhawks.
BIO
CHRIS TOBE, CFA, CAIA has 25 years of institutional investment experience with a focus on Public Pension plans. Recently with his own firm he has consulted to major public plans in Texas and Maryland. From 2008-2012 he served as a Trustee of the $13 billion Kentucky Retirement Systems and
served on the Investment and Audit Committees. From 2008-2009 he was a Sr. Consultant with New England Pension Consultants and worked with a number of public pension plans in Missouri, Michigan and Washington DC. While at AEGON 2001-2008 he worked with Public Plans in Montano,
Pennsylvania, New York, and California. While at Fund Evaluation group 1999-2001 he consulted to a number of Public University Endowments.
From 1997-1999 he worked with Kentucky State Auditor Ed Hatchett and published a 40 page report on the investments of both the Kentucky Retirement Systems and the Kentucky Teachers Retirements Systems. Prior to this he worked as a bank trust officer and served as the Joint Economic
Committee of Congress intern for Lee Hamilton. He has published articles on public pension investing in the Financial Analysts Journal, Journal of Investment Consulting, Journal of Performance Measurement, and Plan Sponsor Magazine. He has given 12 presentations on Public Pension
investing to a number of national groups and conferences. He holds an MBA in Finance and Accounting from Indiana University Bloomington and a BA in Economics from Tulane.
He has the taught the MBA investment course at the University of Louisville, and is a 10-time grader for the CFA exam.
As a public pension trustee in 2010 he completed the Program for Advanced Trustee Studies at Harvard Law School and in 2011 he completed Fiduciary College held at the Rock Center at Stanford University.
?http://www.forbcs.comlforbes/2011l0523/fcatures-pensions-glen-sergeon-auditors-secret-agent 3.html
II Alternative Investment News Feb. 9, 2009 Vol X No.5 Institutional Investor
iii http://www.pionline.comlartic1e/20091014/REG/910149994
iv http://www.ralphlong.coml2011/01/cio-skips-town-weeks-before-scandal.html
v http://www.ralphlong.coml20 11/0 I/sergeon-smell-test.htmi
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