When Los Angeles County Employees Retirement Association’s Board of Investments kicked off its May 13 meeting with a public comment session, reminders of the grim reality of the coronavirus crisis were already inescapable. Board members called in from their home offices while chief investment officer Jonathan Grabel sat in the empty conference room of the $54.5 billion fund.
But the session served as a reminder that the coronavirus crisis has larger ramifications. Labor union Unite Here and several laid-off employees of Areas USA pleaded with LACERA to act on their behalf in a dispute with the company and its private equity owner, PAI Partners.
“In the midst of an unprecedented global health pandemic, Areas is refusing requests to pay for healthcare benefits for its laid-off concessions workers,” Unite Here’s Jordan Fein said on the call.
The Areas workers were from LAX, Miami International Airport and Chicago O’Hare International Airport. They spoke about the strain of losing their jobs and health insurance as a result of the pandemic.
Ethel Farfan, who worked for Areas as a bartender in Miami for 10 years, said Areas had previously been a good place to work. “I feel betrayed by the company because when they gave me the layoff, they told me I would have to pay for my health insurance. How am I going to pay my health insurance when I don’t have income?” she asked, adding that her husband suffered from diabetes and had to visit the doctor regularly. “We are asking you, LACERA and Areas, to keep on taking care of your workers by paying their health insurance.”
LACERA is a limited partner in PAI Europe VII, a 2017 vintage fund, to which it committed €150 million ($169 million). Last year, the union and Areas workers appeared with concerns about tensions between the company and workers since PAI acquired Areas in 2019.
“LACERA trustees and staff took their fiduciary duty to manage risk associated with the labor situation at Areas very seriously. That engagement worked, as [LACERA] staff and trustees know, and Areas resolved agreements, resulting in labor peace in multiple cities,” Fein said. “We were hopeful these actions presented a new beginning for Areas’ relationship with our union and our sister affiliates and our members. But as you’ve heard from workers… this does not appear to be the case.”
An evolving strategy
Union presence at the LACERA meeting represents an evolving strategy among labor advocates and other special interest groups: instead of directly agitating against an investment firm to try to force change, the organizations show up at public pension meetings and ask those institutions to use their position as capital allocators to alter portfolio company behavior.
Public pensions represented 35 percent of all the capital that flowed into private equity funds worldwide in 2019, according to Preqin data. They, like all private equity LPs, are passive partners with little recourse to force GPs to change as long as those managers follow the terms of their fund contracts, or limited partner agreements.
Where such LPs can be effective is with the threat of not opening up their wallets for a manager’s new fund. This is especially effective with managers who have a harder time raising money, and in an environment where, in general, funds are harder to raise because of broader economic turmoil. It can be an activist group’s last hope, and often the arguments presented are through the prism of environmental, social and corporate governance, or ESG.
“We engage with limited partners only after general partners are unresponsive or unwilling to take steps we believe can mitigate headline risk, reputational risk and human capital risk associated with their hospitality investments,” Unite Here’s Fein says.
Regardless of the issue – mass incarceration, fossil fuels, bail bonds, predatory lending, wealth inequality or gun control – activists and politicians are taking aim at LPs, something that had not really occurred until recent years. It shows an evolving attitude and sophistication on the part of activist groups about where exactly the pain points lie when it comes to a private equity firm.
Fossil fuel divestment
Earlier this year, Georgetown University announced that it would fully divest its $1.8 billion endowment from fossil fuels over a 10-year period.
Georgetown’s private equity program is not large, valued at $71.6 million as of June 30, 2019. It is not clear whether it has any investments in oil and gas-related private funds, but the pledge specifically included private investments.
Georgetown’s statement made waves, coming amid general pessimism about fossil fuel investments that was only compounded by the collapse of the oil market due to the coronavirus crisis.
One player that reveled in the Georgetown divestment was GU Fossil Free, a group of students, faculty and alumni. On its Twitter page, the group posted a celebratory message: “We are thrilled that our university has taken this important step in supporting climate justice, student voices and financial accountability.”
GU Fossil Free is just one of many organizations pushing for fossil fuel divestment at universities across the country. In February, 59 schools took part in a national day of action to call for divestment. Last year, the annual Harvard-Yale football game was interrupted when divestment activists stormed the field. Soon after the Georgetown decision, two Harvard faculty groups asked the school’s management to divest from fossil fuels. Harvard’s endowment, valued at $40.9 billion as of June 30, 2019, is the nation’s largest, rivaling the size of many public pension systems.
“If it is wrong to destroy the planet, it’s wrong for institutions to profit from that,” says Connor Chung, a Harvard freshman and member of Divest Harvard. “We see the climate crisis as the moral crisis of our generation.”
Many activists cite a 2018 United Nations Intergovernmental Panel on Climate Change report that claims there are only 12 years (from 2018) to limit the catastrophic consequences of climate change.
The pressure has not been limited to university endowments. Divestment activists have become a common sight during public comment sessions for the US’s two largest pension funds, California Public Employees’ Retirement System and California State Teachers’ Retirement System. Often, these calls come from youth-oriented activist groups like the Sunrise Movement.
Despite impassioned pleas, these efforts have not so far been successful. At a November 2019 CalPERS meeting, CIO Ben Meng said the pension had a fiduciary duty to focus on maximizing returns. CalPERS declined to comment for this story. In a report from last year, CalSTRS said fossil fuel divestment would have a “negative impact on the health of the fund, while severely limiting our ability to shape corporate behavior for long-term sustainable growth.”
“CalSTRS gives all individuals wishing to provide public comment the opportunity to do so at our board meetings, and we welcome and fully consider their comments,” a spokesman says.
Not all pensions have been so resistant. In January 2018, New York City mayor Bill de Blasio and comptroller Scott Stringer announced the city’s five pension systems would begin to divest from fossil fuels within five years. In January 2020, they announced that three of those funds had hired Meketa Investment Group to advise on the divestment process. New York City teachers’ retirement system also contracted with BlackRock Financial Management.
“New York City is leading the charge toward a clean, green, sustainable economy and we will continue working together with all stakeholders to push for a resilient future,” Stringer says to Buyouts in a statement.
The prison industry
Another hot-button issue in recent years is the prison industry. In 2019, an organization called Worth Rises successfully persuaded Pennsylvania State Employees’ Retirement System to nix a $150 million commitment to Platinum Equity’s fifth fund. Platinum has exposure to the prison industry through its prison telecommunications business Securus, a California company that manages the phone systems for the Pennsylvania Department of Corrections.
According to its website, Worth Rises is dedicated to “dismantling” the prison industry. They feel it profits from the exploitation of victims of mass incarceration and police brutality. “Through our work, we strive to pave a road toward a safe and just world free of police and prisons,” its website says.
“When you’re doing organizing, you need to identify people’s pressure points. You identify the pressure points by identifying their vulnerabilities,” says Bianca Tylek, founder and executive director of Worth Rises. “For these firms, their larger vulnerabilities are their investors. That’s what they care about.”
But Worth Rises and the PE Stakeholder Project, a union-backed activist group, failed to convince Penn SERS’ sister system, Pennsylvania Public School Employees’ Retirement System, to call off a $300 million commitment to the Platinum Equity fund.
Last August, spokesman Steve Escak said the system’s board of trustees “certainly listened and considered the input from the advocacy groups, but on balance believe that the new Platinum fund is a good investment.” PSERS declined to comment further for this story.
Community health care
In April, Teacher Retirement System of Texas’s board of trustees heard from the PE Stakeholder Project and community activists from Texas and Connecticut about its investment in a Leonard Green & Partners fund that purchased hospital operator Prospect Medical Holdings. The PESP also authored a report on Leonard Green’s investment in Prospect Medical heavily criticizing the firm.
Activists took issue with Prospect’s decision to close three hospitals in San Antonio, Texas last year, soon before the outbreak of the coronavirus crisis, as well as its management of several Connecticut hospitals, which have had low federal quality ratings. They demanded that Texas Teachers put pressure on Leonard Green to return its fees and dividends from the Prospect investment and to pressure the company to sign an agreement with local Connecticut activists stipulating how it will help the community.
“Many investors are rightfully concerned about the risks of investing with asset managers that raid safety net hospitals, drive retailers into bankruptcy, or evict tenants during a pandemic,” the group says.
PE Stakeholder Project is a registered 501(c)3 non-profit organization. Executive director Jim Baker tells Buyouts its funding comes from “labor unions, civil rights groups and foundations.”
PESP says it has engaged with all of Leonard Green’s LPs. And PESP tells Buyouts that Texas Teachers does “not anticipate any adjustments at this time” to its investment program. The pension declined to comment further.
Leonard Green disputed or rejected almost every single number from the PESP report, labeling them “wildly inaccurate” or “conjecture.” Prospect Medical rejected calls to sign the Connecticut agreement. Leonard Green also told Buyouts it was in the process of selling its interest in Prospect Medical to the company’s management. Last year, Prospect received a $1.55 billion investment from Medical Properties Trust that allowed it to retire its outstanding debt.
“We believe we have enabled the company to continue the tough work of turning around troubled safety net hospitals and providing important services to their local communities,” Leonard Green & Partners said in April.
In early June, several members of Congress sent Leonard Green managing partner Jonathan Sokoloff a letter detailing many of the same issues with Prospect Medical. A spokesperson for Leonard Green says that “LGP shares Prospect’s dedication to the health and safety of Prospect’s patients and takes very seriously Prospect’s duty to the communities it serves.”
Unite Here was back at LACERA’s June 10 meeting, and they brought more Areas employees with them via teleconference.
Among them was Sabino Jarquin, who was laid off in March and later that month became ill with the coronavirus. He spent five days on a ventilator and under sedation and had to continue to receive care without medical insurance. “It is very sad for me all and the other employees and I hope you help us with that,” he said. Coincidentally, the board heard presentations on both PAI as well as a proposed framework for how to handle outreach in general – with the expectation that it will only increase going forward.
Board chair David Green said he received 126 emails based on public comments in the last month, and that he requested the presentation in order to make sure they were being responsive. “Up to this point, it’s felt like we’ve had kind of a piecemeal, ad hoc way of putting this together and responding situation-by-situation,” he said.
Senior investment officer Scott Zdrazil said most public pension systems do not have such a framework in place, but two funds recently expanded their policies because they have received more requests, and those requests have been more assertive.
Board member Wayne Moore said the same was likely to happen to LACERA – and that it would need to be ready and aware of what that meant. “One of the risks that might cause us to think, is that once you put yourself out there as a reasonable arbiter of various views on the role of our pension fund in our environment, then people are going to come to you and you’d better be ready to deal with that,” he said. “These kinds of things are going to continue to come up the larger we get and the more visibility what we’re doing has in the public.”
ESG and human capital
Concerns like these are an example of how ESG has come to take an increasingly important position in the investment world. The United Nations has even laid down the Principles of Responsible Investment, referred to as the PRI, to which almost 2,400 private equity firms, including PAI Partners, are signatories.
These guidelines are intended to ensure that investments do not do any harm. At the June 10 LACERA meeting, board member Herman Santos brought up the apparent tension between a pension’s fiduciary duty to its stakeholders to make accretive investments and its general social responsibility.
Steve Rice, LACERA’s general counsel, says that can be misleading: “ESG is a way of considering risk factors that are created by forces in the broader world, and we have to acknowledge that. If we turn a blind eye to it then we’re not performing our primary fiduciary duty.”
A December 2019 update to LACERA’s corporate governance and stewardship guidelines includes a section on “PRI and ESG Incorporation.”
“LACERA seeks to steward its investments in a responsible manner that promotes sound corporate governance and sustainability practices and mitigates the downside risks that governance failures present,” it reads. “We believe consideration of investment-relevant ESG factors helps achieve stable financial returns and fulfill our mission.”
These factors include “environmental risks such as climate change and resource scarcity, and social factors like how companies access and manage human capital.” Nevertheless, like Texas Teachers, the LACERA board took no action on the PAI Partners investment.
In a presentation detailing how it had handled the situation, staff said the firm was “working methodically across the various contracts” it had at Areas, and they were confident the firm had a plan to handle the labor issues. The board discussed the investment further in closed session. A readout posted to the pension’s website said the PAI investment was discussed but no action was taken.
Principal investment manager Christopher Wagner did urge the Board to adopt something akin to the framework Zdrazil presented, though – citing the amount of time Grabel and the staff had spent on Areas.
“I don’t think there’s ever been an instance where staff has spent as much time reacting to this outside party request about Areas,” Wagner said. “I would just implore you to come up with a way that we can address these issues and move on.”
“We actively engage and monitor all external managers within our rights as a limited partner and evaluate their performance prior to any future capital commitments,” Grabel tells Buyouts in a statement. Areas and PAI Partners did not respond to requests for comment.
As the LACERA story illustrates, while LPs do appear to be hearing complaints more clearly, there are still limits to what they can do. “[LPs are] asking more questions than they ever have before; they’re asking harder questions,” says Jennifer Choi, managing director for Industry Affairs at the Institutional Limited Partners Association. “But asking questions doesn’t necessarily translate to a change on the part of the GP because, at that point, the LP is already in the fund.”
Doug Kimmelman, a senior partner at Energy Capital Partners, says GPs rarely feel much pressure from LPs once they have signed an agreement with the firm. “Once they commit to a fund, we can do whatever we want within the mandate,” he says.
“By design, the limited partnership agreement limits LACERA’s liability, risk exposure and management rights,” LACERA’s Grabel wrote in a June 3 memo on the Areas situation. “LACERA relies on PAI to manage all matters relating to PAI Europe VII and its investments.”
However, some LPs have nevertheless found ways to maintain some control over controversial investments.
In 2015, CalSTRS announced it would include an opt-out provision in private equity limited partner agreements for investments in gun manufacturers. This followed controversy over the fund’s investment with Cerberus Capital Management, which owned Remington Outdoors, a firearms holding company. The Bushmaster rifle, which Remington manufactures, was used in the 2012 Sandy Hook Elementary School shooting in Newtown, Connecticut. Contractual obligations and legal constraints limited its options, CalSTRS said at the time.
“Unfortunately, as a limited partner in a private equity investment pool controlled by Cerberus, CalSTRS has very limited rights,” CalSTRS said in a 2015 statement.
Cerberus later provided investors with an opportunity to sell their holdings, which CalSTRS accepted.
‘Make things that seem impossible possible’
Nevertheless, activists of all stripes seem determined to keep pushing for their goals, regardless of the practical limitations faced by LPs.
“If you believe that climate change is happening… then you have to expand your thinking from what’s feasible right now to what we can do to make things that seem impossible possible,” says Alyssa Lee, the former director of Divest Ed, a “national training and strategy hub” for the campus divestment movement.
Union activists like Fein have a more practical calculus, pushing for more concrete financial advantages for their members.
“It has been our experience that general partners often fail to address many ESG risks until limited partners make it clear that they should do so not to ‘help’ the workers, but to protect and even strengthen returns for their beneficiaries,” he says.
LPs and GPs both stress that lines of communication are always open – but those conversations may often not go the way activists might hope, as private equity is an increasingly important asset class for many pensions.
“Private equity firms work closely with their fund investors – pension funds, endowments, and other institutions – to make sure their interests are aligned during their partnerships,” says Jason Mulvihill, chief operating officer and general counsel for the American Investment Council, a private equity trade group. “Private equity fund sponsors take their fiduciary duty to the funds they manage very seriously. Private equity is typically the best performing asset class for their investors.”
Whether that changes may depend on how pensions strike that balance between their stated values and their investment practices – and how they respond to becoming targets of activist organizing.
“Not every dollar is necessarily a good dollar, and often when these issues come up these are issues of values and whether or not the investments that we make comport to a set of values that we have agreed on as a body to espouse,” LACERA board member Gina Sanchez said at the June 10 meeting.
“We want to make money but we want to make money without doing harm to the world.”
How LPs resolve that dilemma may decide how things play out in the future.
Additional reporting contributed by Teddy Grant.