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PSERS’s own consultant finds the fund’s board has been poorly led and suffers from a lack of trust

The state’s largest pension fund lacks a cohesive plan on how to invest its billions. It has ignored calls to improve its financial reporting. And its auditors looked the other way while PSERS staff engaged in worldwide luxury travel and billed retirees and taxpayers.

Those are some of the findings from a new governance report that PSERS, the giant public school pension plan, commissioned on itself.

Adding to the dysfunction, the Funston report noted, the 15 PSERS board members are deluged with minutiae, buried monthly by roughly 1,000 pages of official documents — nearly the size of Leo Tolstoy’s War and Peace, the report said — in formats that are “disorganized,” full of financial jargon, and often unsearchable.

“The more you flood someone with minutiae, the less it gets read,” said Charles Elson, an expert on corporate leadership and newly retired finance professor from the University of Delaware. “There has been a failure obviously.”

The report, which cost PSERS $400,000, avoids the red-hot areas that remain under federal investigation at the big fund — both the FBI and SEC have been conducting months-long probes — and it never criticizes any fund executive by name.

But in cautious prose, it paints a portrait of an agency board torn by internal divisions, consumed by relatively trivial matters, and frozen on key decisions.

In general, the report documented a range of issues that have spilled into public view over the last year, from the board’s schisms to its at times sharp-edged debates over how to invest.

In a seeming contradiction, the consultants urged the board to both become more involved in making key policies — and to defer more to its large and highly paid executive staff.

State Sen. Katie Muth (D., Montgomery County), who has emerged as the fund’s biggest public critic after joining its board last year, said giving staff more power made no sense.

“There are so many things they want staff to have more control of,” said Muth. “The board is not fully informed as it is.”

She continued: ”Making staff have more decision-making authority with zero board input? That got us where we are. There’s no mystery why we are having this [Funston] investigation. The board didn’t ask questions.”

PSERS posted the report on its website recently as federal prosecutors, U.S. financial regulators, and the FBI continue to examine how the $73 billion fund exaggerated its investment returns and made a string of Harrisburg land purchases with little public explanation. Four top PSERS executives, including its executive director and investment czar, recently announced their departures, climaxing a push by dissidents for a shake-up.

Funston Advisory Services, based in the Detroit suburb of Bloomfield Township, is headed by Frederick Funston, a former executive with the giant Deloitte consulting firm.

His firm’s work on PSERS was carefully circumscribed. Top fund executives, but not the board, were given veto power over Funston’s findings, according to its contract as filed with the state.

Not surprising, the report does not blame individuals, focusing instead on solutions.

» READ MORE: Read the Funston report here

Still, the document describes how a group of rebel PSERS board members has grown month by month, concerned that the fund’s investments have performed poorly compared with similar public funds. The plan badly needs more investment profits to complement the $5 billion a year it receives from taxpayers and the $1 billion from working school employees.

A minority but growing number of trustees “had expressed strong concerns about the direction of the system; their confidence in the senior executives; [and] the independence of their advisors,” the report said.

These rebels, including the current and former Pennsylvania state treasurers — Stacy Garrity and Joseph Torsella — have recently begun to move the pension fund away from costly private investments and into low-cost Vanguard-style holdings, which they say have performed better over time. In a significant action in December, the board agreed to sell the system’s hedge funds and to double stock investments

But PSERS still lacked “a cohesive strategic plan” for its core role of investing, the Funston report concluded.

Funston also noted that PSERS’ board and management had delayed in adopting key recommendations to beef up internal auditing and basic financial accounting, recommended by two previous elected auditors general and by an outside accounting firm and a state pension review commission.

Since Funston began its review, the agency has addressed some of the issues the consultant raised. PSERS has added auditors and set in motion a more intense internal audit it is to review this spring.

The Funston report is notable for what it does not discuss.

It excluded any review of the “miscalculation” of 2011 to 2020 investment returns that had to be reversed and improperly delayed a rise in payroll contributions by 100,000 younger school staff. Several board members see the miscalculation as a case study of the agency’s failure to operate effectively because the decision was made based partly on unaudited financial numbers.

The report also does not include the agency’s acquisition of three blocks of downtown Harrisburg near its office for a redevelopment project that has never been built.

Both the miscalculation and the land deals are a focus of the corruption probe by a grand jury reporting to the U.S. Attorney’s Office in Philadelphia, according to subpoenas obtained by The Inquirer and Spotlight PA.

PSERS executives have repeatedly declined to discuss the agency’s mounting problems, notably keeping virtually silent about the ongoing investigations. In a brief statement last week, the fund said it would not discuss the new consulting report either.

It said it would wait until after it receives a pending internal report on the matters under federal investigation. At that time, that news may well completely overshadow the Funston analysis.

The report also found:

  • Board members spend little time reviewing basic issues, such as how much of the plan should be invested in stocks or bonds, vs. hedge funds, real estate, and other assets. Such core “asset allocation” decisions, not the choice of one manager over another, determine more than 90% of the difference between the best and worst performing U.S. investment funds, according to Vanguard research cited by Funston.

  • Key decisions are strongly influenced by PSERS employees working closely with Wall Street advisers that the staff has recommended. Those outside advisory firms should be chosen by board members, the report urged.

  • Outside advisers who recommend investments should not also verify the accuracy of investment returns and other data. This poses a potential conflict of interest.

  • PSERS should “stream, record and archive” board meetings, which remain unavailable except to the few who attend or watch a live video.

  • Diversity should be made a factor in board membership, along with experience and skills. The volunteer panel is now composed of school staff and school board representatives, legislators, and appointees of the governor. It is almost all white. One member, State Education Secretary Noe Ortega, is of Mexican American ancestry.

In all, 14 of the 15 board members, or their representatives, held at least one interview with Funston. The exception was Torsella, Gov. Tom Wolf’s rep on the board and a longtime PSERS critic. He could not be reached for comment.

In its discussion of the board’s failings, the report focused in part on travel, an area of some embarrassment for the fund.

“For some time, a loss of trust has been growing within” the PSERS board, the report found. This discord in turn delayed action over the agency’s high and unchecked travel bills, the report said.

PSERS for years has operated under a system in which it often never knew its true travel costs, The Inquirer has reported. The fund would leave the job of booking tickets, hotels, and meals to outside money managers who would front the money. But the managers would later bury the charges in overall travel bills that the managers submitted to the fund to be paid by taxpayers and teachers.

The report says the fund had only two staffers auditing travel, even as it promised to take a comprehensive look at the issue. The result was “a travel investigation that was primarily data gathering and not an examination of policies or forming any opinions about controls.”

As for the board, it dithered. Or as Funston put it, “the seeming inability of the PSERB to arrive at a consensus on certain policy issues such as the investment policy and the travel policy resulting in lengthy development times.”

After The Inquirer story was published in April, both Gov. Wolf and the fund acted to limit PSERS travel spending.