The State Board of Education doesn't confine its dysfunction and discord to battles over what should be in history and social studies textbooks and how to teach science and grammar. The elected 15-member board also watches over the Permanent School Fund, an endowment of more than $23 billion that helps to pay for textbooks, salaries and the like.
When it comes to investing what is the state's second-largest fund (only the Teacher Retirement Fund is larger), the internal rivalries on the SBOE can cause trouble; members don't always trust their colleagues, their staffs, or their consultants when it's time to make complex decisions. And only a few members of the SBOE have any real grounding in large-scale finance. Legislative efforts to put responsibility for the fund into more professional hands have failed, though lawmakers vow to try again.
Consider what happened in the summer of 2008, when a group of SBOE members, led by members David Bradley, R-Beaumont, and Rick Agosto, D-San Antonio, soured on their investment consultant, R.V. Kuhns. The company, they said, had gotten too close to the staff of the Texas Education Agency. It was time to dump R.V. Kuhns, they decided, and find a new consultant. The new group they chose, NEPC, had the lowest ranking of the companies considered by the TEA staff — not that they cared what the staff had to say.
Member Pat Hardy, R-Weatherford, didn’t like what she heard, so she Googled “NEPC and Madoff.” “I’ll be John Brown if this article didn’t come up,” she says, referring to a story in a Connecticut paper that explained how NEPC was being sued by the town of Fairfield after its $41 million pension fund was lost as part of one of Ponzi schemer Bernard Madoff's hedge funds. She printed out a copy of the article and made plans to distribute it.
Agosto argued that the lawsuit was simply an effort by a town that had made a bad decision and wanted to sue whoever it could. He said that NEPC didn't invest Fairfield's fund with Madoff, a fact that NEPC itself asserted in a letter to the SBOE. (The lawsuit is still pending.) “For somebody who’s intelligent to actually accuse NEPC of hiring Madoff — they don’t know what they’re talking about,” he says.
Hardy was more than willing to admit she was no expert — “I don’t understand business well,” she concedes — but says she wanted the board to know “there is something not pretty about this company,” especially after staff showed it would cost hundreds of thousands more, and provide fewer benefits, to go with NEPC. Bradley insisted that the SBOE needed to switch as soon as possible, and NEPC would be a better choice, even if it cost more. “We didn’t hire number two, we fired number one,” he says of the staff’s assessments.
Ultimately, the majority of the board voted with Agosto to keep the article from being included into the record. They said, in essence, that Hardy, a public school teacher, simply didn’t understand the nature of the investments or the lawsuit. It took a year, but NEPC became the official investment consultant for the Permanent School Fund.
"None of them understand it"
Created in the state constitution, the PSF isn’t like most state funds. It directly impacts the state budget by supplementing educational costs. When PSF investments don't produce enough income, as was the case last year, the Legislature must look elsewhere — to taxpayers, for instance — to find money to pay for textbooks and other basic school needs. But lawmakers have no say in the fund’s management. Neither does the comptroller, the state's chief financial officer. The SBOE has complete control over it, and its members aren't required to have any experience with investments.
None of this bothers Bradley, who chairs the board's School Finance Committee. He insists that throughout public policy, people make decisions on issues about which they have no direct expertise. “If you sit on the mental health commission, do you have to be retarded?” he asks. “If you sit on the [Texas Alcoholic Beverage Commission], do you have to be a drunk?”
So, the logic goes, why should those making investment decisions need to know about finance?
“None of them understand it,” says Rep. Scott Hochberg, D-Houston, of SBOE members.
Even though they have no say in the matter, legislators want confidence that those making the decisions know what they’re doing. “There was a lot of reaction last session, rightfully so, to the fact that all of our funds were severely down,” says Sen. Robert Duncan, R-Lubbock, the Capitol's unofficial guru of endowment funds. “Certainly there were questions: 'Well, did we take too much risk?' 'Did the bonus system incent too much risk?’”
The other big independent endowment funds — Teacher Retirement System, Employee Retirement System, Permanent University Fund, and Permanent Health Fund — each make sure that at least most of their board members are experts in finance. TRS, PUF and PHF explicitly require a majority of members to have such a background. ERS board appointees are almost always financial experts (they also have elected employee members), but there’s an additional independent advisory council that meets separately and offers advice.
At about half the size of the PSF, the $11 billion PUF is presided over by a company of experts: the University of Texas Investment Management Company, or UTIMCO. UTIMCO's board, which also oversees the assets of the University of Texas and the Texas A&M University System, has drawn criticism for its million-dollar bonuses. It has defended the compensation as the price of getting top-notch professional help.
By contrast, for the PSF, each SBOE member can appoint an independent advisor to consult individually on financial matters, but the advisors haven't met as a group since 2003. And there’s little correspondence between the advisors and the state board as a whole.
NEPC, the new consulting firm, says that in addition to the appointed advisors, the board can also rely on the educational materials it provides. “Our responsibility is to make sure that the board has the educational background so they can make informed decisions," says NEPC counsel Dick Charleton. “We try to customize to each of our clients."
A big Chinese wall
SBOE members are split on who should be advising them on the PSF. For Hardy, the TEA staff who handle the day-to-day management of the fund are the primary people to trust. "I feel very confident in their work," she says. She doesn't say the same of NEPC.
It's the opposite for Bradley, who believes the staff is not to be trusted, since they work for the TEA and not for the SBOE. “Staff usually works against the board,” he says. “Sometimes staff can facilitate an agenda of their own.” The consultant, on the other hand, works directly for the board and advises members on how to allocate the fund between cash, real estate and other types of investments. Agosto agrees. “There’s a big Chinese wall between us and the staff," he says.
Agosto is the only member who works in finance. Several members work in real estate, an area of the fund's portfolio that the board has been trying to increase. Member Bob Craig, R-Lubbock, majored in finance at Texas Tech ("with honors," he notes) and has a taken a lead in the fund's management. Craig, along with Hardy, and sometimes with members Geraldine Miller, R-Dallas, and Mavis Knight, D-Dallas, disagrees with the Agosto-Bradly contingent on everything from whom to trust to real estate investments (let the state's General Land Office handle it, he says). “We’re our own little bloc,” Hardy says.
Last year, a Dallas Morning News story reported that Agosto was accused of a conflict of interest in connection with his background in finance. The News said that he and SBOE member Rene Nuñez, D-El Paso, didn't disclose thousands of dollars in gifts from the Boston company AEW Capital Management. A separate News story noted Agosto had prior business dealings with NEPC — including efforts to get the company’s clients to invest in a fund with which he was affiliated — that he did not initially disclose to the board. In both cases, Education Commissioner Robert Scott and SBOE Chairwoman Gail Lowe, R-Lampasas, said the alleged ethics violations were outside their respective jurisdictions.
Bradley thinks that Agosto’s expertise makes him a target: “He is attacked because he is in the industry.” Though there wasn't an investigation, Agosto says the companies have explained the situation, and that his name has finally been cleared to his satisfaction. “The political witch hunt got exposed for what it is,” he says.
Ripe for abuse?
Legislators say that whether or not Agosto had a conflict of interest, the episode illustrates the need for reform of a process that is essentially self-policing. “The fact is that it is ripe for abuse,” says Rep. Donna Howard, D-Austin. “Why wait till some major abuse occurs?”
Last year, Howard filed legislation (HJR 77 and HB 2037) that would have taken the PSF away from the SBOE and put it under the management of a quasi-independent board of financial experts. She notes that Texas is the only state with this system — in other states, education boards focus on policy, not finance. Since altering the fund required a constitutional amendment, the bill had to pass through the House with 100 votes, which it did. Then it arrived at the Senate Education Committee, where it never resurfaced.
Duncan said the bill was one part of a larger push to create a uniform method of dealing with the state’s various investment funds. “I’m not trying to be critical of the state board,” he says. “I’m just interested in making sure we have a management strategy that includes as much qualified expertise as possible.”
Craig thinks that critique has some merit. “I thought it was a good bill,” he says. “I think you need maybe even greater expertise than what we have on the state board.” But Bradley was offended by Craig’s support for the legislation. “Y'all were real happy with it [the status quo] when … you were sitting on the [finance committee] board a year earlier,” he says.
Bradley says taking finance away from the SBOE is dangerous for the economy. Legislators “would love to spend all of the money,” he says, “and we’d like to hang on to it for the kids in the future.” But Howard, who says she'll file the legislation again when the Legislature meets in 2011, says that's just spin. “That’s really a red herring. That’s not possible with the constraints that are placed upon the fund.”
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- NEPC's Letter to Clients Regarding Lawsuit (28.6 KB) DOWNLOAD