California Governor’s Plan Could Hurt Private Equity

Gov. Arnold Schwarzenegger has chosen a fight and the National Venture Capital Association (NVCA) is among those that aren’t taking it lying down.

In his State of the State address this month, the Hollywood action hero turned Republican governor likened the state’s pension system to a train on the fast track to disaster. And in a move that he hopes will address California state’s budget woes, Schwarzenegger announced his support to phase out California’s defined-benefit public pensions. Specifically, Schwarzenegger is proposing that all public employees hired beginning in 2007 are placed on defined-contribution plans, akin to 401(k) plans, and do away with the pension portion of the $180 billion California Public Employees’ Retirement System (CalPERS) and the $124 billion California State Teachers’ Retirement System (CalSTRS).

The plan echoes President Bush’s call for privatizing the Social Security system. The governor says that if legislators don’t adopt pension reform – the State Assembly rejected a similar proposal last year – he’ll take it to the voters later this year in a special election.

The NVCA isn’t taking it for granted that the proposal will flounder.

On the contrary, NVCA President Mark Heesen says that in reaction to the “pretty dramatic” proposal, he has brought to Washington, D.C., Katie Merrill, a political consultant who was a senior advisor to Democratic Sen. Barbara Boxer. Merrill will be representing the NVCA’s interests to the California Assembly.

Those interests are substantial, obviously. CalPERS spokesman Brad Pacheco says that that $19 billion of CalPERS entire $180 billion fund is invested in California, including in real estate, stocks and bonds, and its private equity portfolio has commitments totaling $20 billion, 18% of which resides in the Golden State, mostly in Silicon Valley.

“Over the long term, it would erode our investments in both [California and the larger private equity industry],” says Pacheco of the proposal. Those investments are in a variety of venture capital and private-equity funds, from such giants as The Carlyle Group and New Enterprise Associates to the 1-year-old Emergence Capital Partners, which raised the bulk of its inaugural $125 million fund from CalPERS.

Pacheco says that CalPERS is already actively “educating” its members about defined-contributions and defined-benefits plans – including through a debate center that has been newly posted to its website – but CalPERS can’t campaign for a ballot initiative.

CalSTRS also contributes significantly to the private equity industry. As of Nov. 30, the public pension fund had $5.9 billion invested and another $9 billion set aside for un-funded commitments. Clearstone Venture Partners, Austin Ventures and Blackstone Group are among a long list of firms that count CalSTRS as a limited partner.

Though some firms are turning away public pension money – owing to disclosure issues and the Freedom of Information Act rules that bind them – Heesen says that the industry still takes a lot of public pension money when raising funds.

“From a long-term perspective, you want to have as many LPs as possible, and anything that restricts that could impact the venture industry, he says.

CalSTRS spokeswoman Sherry Reser says that CalSTRS is also “educating” its members, though she is more candid about the system pushing for defined benefits to remain as they are. “We strongly believe that the defined benefit program has the most value for public employees,” she says.

The board plans to discuss the issue at its monthly meeting in early February.

“In a defined contribution plan, you and your employer put in money, and whatever happens in the stock market happens,” Reser says. “Even if the market does well, you can outlive your benefit.”

Defined benefits, as opposed to a defined contribution plan, she argues, guarantee a lifetime monthly pension to someone regardless of what monies he has in his account.