The Seattle City Employees’ Retirement System had one of the worst investment returns of any large public pension over a decade, triggering higher costs for the city and taxpayers. Behind the system’s struggles: allegations ranging from mismanagement to misconduct.

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In the summer of 2015, officials overseeing the city of Seattle’s retirement fund realized that one of their investments was in trouble.

By this point, the manager of the investment, Capital Point Partners, had been the subject of complaints and litigation in multiple states going back more than a decade. New Mexico authorities had accused him of leveraging his political clout to reap millions of public dollars. Yet officials at the Seattle City Employees’ Retirement System knew none of this.

Today that investment is worth less than what the retirement system paid for it roughly a decade ago. With $5.5 million on the line, it was the kind of lapse that Seattle’s $2.8 billion retirement fund could have shrugged off had it been an isolated one. It wasn’t.

In the years before the financial crisis, Seattle’s retirement system bet on a series of complex investments that backfired, from a local biofuels company to a Cayman Islands hedge fund. Behind the system’s struggles were allegations ranging from mismanagement to misconduct, leaving in their wake rising pension costs increasingly shouldered by the city and taxpayers at more than $100 million a year, a Seattle Times investigation has found.

The Seattle City Employees’ Retirement System had a worse return on investment over 10 years than 97 percent of large state and local pensions, according to a Times review of 2016 data for more than 160 plans compiled by the Center for Retirement Research at Boston College. SCERS had counted on earning at least a 7.5 percent annual return but made only 4.1 percent, leaving the fund about $1 billion short of retirement obligations.

“Frankly, I was shocked at the condition that I found there,” Tim Burgess, a former mayor and City Council member, said of his first term as chair of the retirement board in 2012. “There was misconduct involved there and we, the pension fund, lost tens of millions of dollars.”

The allegations, which haven’t been publicly reported, concern actions by a former chief investment officer, according to Burgess and another former elected official.The city ultimately paid a six-figure sum to secure the exit of the investment officer. It later reached an even costlier settlement to remove his boss for performance issues not related to the allegations, according to records reviewed by The Times.

While it is difficult to quantify the effect of mismanagement on investment earnings, the results have been disappointing by SCERS’ own standards. For the decade that ended in 2016, the fund earned less than its performance benchmarks in eight out of 10 years.

Jeff Davis
Jeff Davis

Some public officials have argued Seattle would be better off handing over management of its pension investments to the Washington State Investment Board — as many cities do — which has consistently earned better returns than SCERS. Instead, Seattle has taken a different course, more than doubling the retirement system’s payroll between 2012 and 2016, among the steepest increases of any city department.

Current SCERS executives attribute the subpar investment earnings in part to the lack of expertise among staff prior to 2009. A report by SCERS’ investment consultant shows its latest three-year return was in the top 25 percent of large public pensions.

As of February, the fund’s market value was about 71 percent of what it owes in future benefits, up from a low of 54 percent in 2009. (An 80 percent ratio is considered healthy by pension experts.)

“I do not deny there were poor investments made in the past,” said Jeff Davis, who became the retirement system’s executive director in 2017. “If there’s something that we should have done differently in the past five years, I’m not really clear on what that is.”

Yet even now some advisers have questioned whether SCERS is relying on unrealistic projections — including a 7.5 percent long-term investment return — in its plan to cover future retirement costs. If these assumptions turn out to be too optimistic, the public costs of funding pensions could well go up.

 

 


“Aren’t I in charge of operations around here?”

SCERS (often pronounced “serz”) provides guaranteed, lifetime payments to eligible employees when they retire. Workers pay into the system, the city kicks in additional money and SCERS invests the funds to generate enough income to cover future payouts. Investing became increasingly critical as the City Council made retirement benefits more generous from 1975 through 2001.

Mel Robertson
Mel Robertson

In the late 1990s, the job of tending to SCERS’ investments belonged to its assistant executive director, an accountant named Mel Robertson.

Often described as the system’s chief investment officer, Robertson had no prior professional experience managing investments, according to his résumé — nor did anyone else on staff. A consultant tracked the portfolio’s performance but provided little in the way of investment advice.

Robertson presented investment opportunities to the seven board members that govern SCERS, and won accolades from some. “I rave about the job Mel Robertson has done,” one former board member wrote in a Spring 2008 newsletter for city retirees.

The value of the pension fund had surged along with a red-hot stock market. Like other public pensions, SCERS hunted for higher returns by snapping up more complex investments like private equity and hedge funds, which grew to make up about 25 percent of its portfolio.

Among the more exotic bets was the Epsilon Global Active Value Fund II, a Caribbean-based fund whose strategy included investing in “distressed or mismanaged companies,” according to a confidential fund document. SCERS also acquired a stake in Imperium Renewables, a biofuels firm with offices in Seattle that planned a public stock-offering to expand.

A private accounting firm hired by the city to audit SCERS, however, was raising concerns about the lack of documentation and monitoring of such investments, records show. A new executive director, Cecelia Carter, also began asking questions when she arrived in January 2008.

Cecelia Carter
Cecelia Carter

Carter, who had run a public pension in Kansas City, was taken aback by Robertson’s response when she met with him about a pending audit in March 2008. He objected to turning over certain investment records to auditors and was angry and confrontational, Carter wrote in a memo warning him that he could face disciplinary action.

“I’ve been doing this for 16 years,” Robertson said, according to Carter’s memo. “Aren’t I in charge of operations around here?”

Robertson acknowledged he’d asked the question repeatedly “and never received a definitive answer,” he later wrote in response to Carter’s reprimand. He did not believe he had been “inappropriately loud.” As for the audit, he said, “There was no refusal to provide data.”

Carter’s suspicions only grew. In a later memo, she accused Robertson of investing SCERS funds on his own while telling the board that the money was still being managed by investment firms. He responded that the money had been moved into index funds temporarily and that he didn’t recall any trading on his part. “There was no deliberate attempt to mislead,” he said.

Carter was also uncomfortable with how Robertson seemed to push investing in Imperium Renewables even after it canceled plans to go public, jeopardizing its potential to expand. SCERS ultimately lost money on the deal.

“Given the large amounts of money entrusted to our care, this pattern of behavior raises real issues for me regarding whether you should continue in this position,” Carter wrote in June 2008. “The retirement system cannot afford to have someone at your level taking such risks.”

Robertson dismissed the criticism, responding that an industry publication had singled out Seattle as “among the more sophisticated plans of our size.”


“Did we call the police?”

By the fall of 2008, as a wave of mortgage defaults triggered a global financial panic, SCERS was among public pensions hit hard. It booked a $620 million loss for 2008 and shed about a third of its value. The losses were more than market-inflicted: Auditors found that SCERS’ investments had not been properly monitored, partly due to a “lack of qualified personnel,” and they shaved $50 million off the fund’s value, state records show.

Robertson’s employment at SCERS ended in February 2009. City records initially reflected he had been fired but were later corrected to show his job was eliminated. Jean Godden, a former City Council member who chaired SCERS at the time, said Robertson had made investments without consulting the board, and that “there was a suggestion that he was close to the people with whom he was investing.”

She added, “Whether it actually crossed the line into something that was misconduct, I can’t be sure. But it was close.”

Burgess, who took over as board chair in 2012, said that soon after starting he reviewed an investigative file on Robertson kept by the City Attorney’s Office. In his view, the file showed “misconduct.”

“My initial reaction was to say to the staff there, ‘Did we call the police?’ ” he said, referring to documents he recalls detailing Robertson’s relationship with investment firms. He no longer remembers specifics.

Tim Burgess
Tim Burgess

Robertson, who has worked for King County as an analyst since 2010, didn’t respond to phone messages or emails seeking comment. When a Times reporter came to his office, he said, “Will you stop harassing me? Please leave.” He didn’t respond to written questions handed to him.

After The Times requested records on Robertson earlier this year, city lawyers said that a physical file on him was destroyed in 2016 under its records-retention policy. They withheld or almost completely redacted more than 20 electronic files, saying they were protected by attorney-client privilege or other exemptions. The undisclosed records included documents related to the Epsilon investment and a letter from Seattle’s chief civil attorney to the accounting firm auditing SCERS.

Burgess said that some documents he recalled reading in 2012 were no longer available when he recently reviewed city records on Robertson, including ones not disclosed to The Times. According to Burgess, one of the remaining documents laid out what he called “negligence and a very clear breach of fiduciary duty,” but it also stated there was “no evidence of unlawful behavior,” he added.

The Times asked the SCERS board to use its discretion to release the records. At a meeting in March, the four board members present declined. Councilmember Sally Bagshaw, the board’s chair who hadn’t been present, reviewed some of the legally privileged documents and recommended that the board release them. In April, with Bagshaw again absent, the same four board members declined.

One of those board members, Sherri Crawford, said she was concerned that waiving the privilege could set a precedent. The other three — Lou Walter, Jean Becker and Robert Harvey Jr. — either declined to comment or didn’t respond to a request.

Records that the city did release show that Robertson filed four appeals of his dismissal, and the city settled with him in 2010. The city’s payout totaled more than $100,000 including back pay and $50,000 in damages. He was placed on a list to be reinstated to a city job — with one exception: The agreement barred him from ever working for SCERS again or seeking a position on its board.

As Carter moved to overhaul SCERS, she hired a full-service investment consultant, and brought on two staffers with professional investing experience. But she found herself continuing to deal with the fallout of Robertson-era investments.

The agreement with Epsilon — signed by Robertson — had provided minimal transparency. The Epsilon fund loaned money to a Minnesota firm that proposed buying and selling consumer electronics — but that turned out to be a multibillion-dollar Ponzi scheme, court records show. SCERS eventually took control of the fund through legal action but never recovered its $20 million.

Carter had her own struggles, from allowing the fund’s cash account to be overdrawn to conflicts with staff. More than four years into her tenure, SCERS’ investment returns continued to lag its targets even as the stock market surpassed its pre-crisis value.

While Carter had inherited much of the pension fund’s morass, Burgess said, “it was pretty clear she was not going to be the person who was going to lead us out of it, either.” In June 2013, the board eased her out with a settlement that paid her more than $330,000.

Carter is currently executive director of the Omaha School Employees’ Retirement System. She didn’t respond to phone or email messages seeking comment.

The next executive director didn’t come from a national search. He came out of retirement.


“Things were in shambles”

Ken Nakatsu had never worked for a public pension or managed investments, but he was a seasoned government executive, having run departmental operations under Mayor Greg Nickels. Now, Burgess asked him to help get a sense of what was going on at SCERS.

“It was clear that things were in shambles,” Nakatsu recalled. “The board had no confidence in what they were doing.”

The trouble wasn’t only on the investment side. In August 2013, the city auditor revealed widespread problems in how SCERS staff calculated retirement payouts, many of which were done by hand. Of 30 cases that auditors reviewed, 22 had errors.

Ken Nakatsu
Ken Nakatsu

Though most of the errors concerned relatively small amounts, the auditors concluded that SCERS’ practices were “vulnerable to error and abuse” and that most of the weaknesses were “issues that have been known to SCERS staff members for years.”

SCERS continued to be dogged by investments made during the Robertson era, like the funds it placed with Houston-based Capital Point Partners in 2007 to invest in small, privately held companies. By then, managing partner Alfred Jackson had drawn attention for winning business managing public funds while being linked to financial contributions to key state officials, according to news reports from 1998 to 2002.

“We did not know that,” said Lou Walter, who has served on the retirement board since the late 1990s. “Would we have selected them? No, if we had known that.”

Jackson, a former wide receiver with the Atlanta Falcons, drew more scrutiny in the following years — but not from SCERS.

In 2011, the New Mexico State Investment Council sued Jackson, alleging he reaped millions in investments and fees in a pay-to-play scheme. Jackson denied wrongdoing. He settled the lawsuit in 2014 for $775,000. A securities filing shows that Capital Point investors like SCERS were responsible for covering much of the settlement along with Jackson’s legal expenses.

It’s common for investors in a fund to cover the legal costs of the manager — unless those costs stem from wrongdoing, according to legal and business experts.

Despite media coverage of the litigation, it wasn’t until 2015 that SCERS officials learned that Jackson’s legal costs had reduced the value of the fund. It was then that they found out that their Capital Point investment had been sold to a publicly traded company where Jackson became chairman.

The city hired a law firm charging rates up to $745 an hour, and teamed up with other Capital Point investors to try to undo the sale to Princeton Capital, records show. A settlement removed Jackson as chairman and negotiated a lower investment fee.

Jackson didn’t respond to requests for comment.

SCERS remains a shareholder in Princeton, whose stock has fallen 92 percent since April of 2015 to 11 cents a share. Its return on investment was a negative 0.7 percent as of last September, records show. Princeton’s chief executive resigned in September after federal authorities charged him with fraud in a college-sports bribery scandal.

 


Board members for the Seattle City Employees’ Retirement System, from left, Lou Walter, Jean Becker and Robert Harvey Jr., listen to Jason Malinowski, chief investment officer, during a meeting in November. (Ken Lambert/The Seattle Times)
Board members for the Seattle City Employees’ Retirement System, from left, Lou Walter, Jean Becker and Robert Harvey Jr., listen to Jason Malinowski, chief investment officer, during a meeting in November. (Ken Lambert/The Seattle Times)

A costly overhaul

The investment losses have had lasting consequences for city workers and taxpayers. Since the 1980s, employees had contributed 8 percent of their paychecks into the pension fund and the city roughly matched it. To make up for the losses, those contributions had to go up.

Starting in late 2008, city officials struck deals with unions that increased employee contributions up to 10 percent of their pay. The city has footed a much larger share, contributing 15 percent of worker pay into the fund — $108.5 million in 2016 — underwritten by taxes, utility rates and other revenue. Today, departments are squeezed by rising pension costs they are powerless to curb as Mayor Jenny Durkan asks for budget cuts.

Jason Malinowski
Jason Malinowski

At the same time, the costs of operating SCERS itself have surged. The system greenlighted a $15 million project that will partly automate benefits calculations, expected to launch next year. It bulked up its in-house investment team to four staffers, who have stepped up due diligence of prospective investments, including traveling to London to review one such deal. It hired Jason Malinowski, a former managing director for financial behemoth BlackRock, as chief investment officer.

“He really has done miracles, although the noticeable effects of that are pretty subtle and will take some time to realize,” Nakatsu said of Malinowski.

Malinowski and Jeff Davis, who took over from Nakatsu last year, are two of the city’s highest paid employees, drawing salaries of more than $200,000 a year. With other staff additions and consultants, the system’s administrative costs nearly tripled between 2012 and 2016.

With retirement costs rising — the fund paid $169 million in benefits in 2016, 72 percent more than a decade earlier — city officials have taken steps to reduce future pension costs. A new plan for employees hired after 2016 reduces how much they contribute while lowering the multiplier for calculating payouts; officials estimate it will save the city about $200 million over 30 years.

Yet Seattle’s plan to fully fund its retirement obligations by 2043 relies on assumptions about a growing government and investment earnings that, if they don’t materialize, could mean higher costs for taxpayers down the road.


Optimistic assumptions

In the past two years, a committee of investment experts appointed by SCERS has questioned whether it can achieve the 7.5 percent return it is expecting over the long term, calling the assumption “quite optimistic and inconsistent with the reality of a low return environment.”

That target return has been common among public pensions, but many have begun lowering their expectations. Of 164 state and local plans surveyed by the National Conference on Public Employee Retirement Systems in 2017, 85 percent were considering reducing their expected returns or had already done so.

In April, representatives of SCERS’ consultant Milliman Inc. gave board members a “heads up”: The firm anticipated that SCERS would earn only a 6.5 percent return over 30 years. If the board drops the expected return, as Milliman will likely recommend, it would trigger higher contributions into the fund. With employee contributions capped, this would mean the public would foot more of the cost in the near term.

Even if SCERS were to meet its investment goals, the funding schedule assumes that the number of employees paying into the system will increase steadily and help fund retirement payouts. It is unusual for public pensions to incorporate future growth into how much they set aside for retirement costs, leaving them on the hook for higher costs if the growth doesn’t materialize, according to Milliman.

Glen Lee, Seattle’s finance director and a SCERS board member, said the funding plan is based on projections that the city will grow. “Since population growth is generally a good indicator of local government employment growth,” he said, “and generations of City leaders have a track record of increasing City government employment, it is unreasonable to assume no membership growth in SCERS.”

The board will review whether to change its assumptions later this year.

State Sen. Reuven Carlyle, who represents Seattle’s 36th District, has proposed legislation in the past that would give cities the option of transferring pension assets into the $98.4 billion fund managed by the Washington State Investment Board, which has consistently earned better returns than SCERS. A billion dollars invested over 10 years would be worth $242 million more with the state’s return than at SCERS’ rate through 2016.

Seattle pension officials attribute the state fund’s superior performance to a higher tolerance for risk, arguing that a strategy suitable for the state might not be prudent for the city. Another concern, they said, would be having no ability to influence how the funds are managed once transferred to the state.

Carlyle isn’t persuaded. “If you go back over the years, if the city of Seattle had been with the state system, we would have hundreds of millions of dollars more in that system,” he said. “This is less about politics and more about math.”