Bad Real-Estate Deals Haunt Detroit's Pensions Amid Bankruptcy

Tuesday, 23 Jul 2013 10:10 AM

 

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In 2006, businessman Robert Shumake asked trustees of Detroit’s two pensions to hand him $27 million to invest in real estate.

George Orzech, a fire battalion chief who still represents uniformed workers on their fund’s board, found one thing odd:

“Anybody who knows the first names of trustees in a first meeting has already had meetings with people,” said Orzech, who unsuccessfully opposed the plan. “It was a political deal.”

Shumake, whose real-estate broker’s license had expired four years earlier, became embroiled in a federal case that led to indictments of a former city treasurer and pension officials on charges of bribery, extortion and kickbacks that cost the systems more than $84 million, the U.S. Justice Department said.

A litany of such deals gone wrong shows how a municipal retirement system for 30,000 employees and retirees — propped up by $1.4 billion in borrowed money — became a cash cow for a select few. Now, these bad investments are coming back to haunt workers and pensioners as the city proposed slashing their benefits in its filing last week of the biggest municipal bankruptcy in U.S. history.

Emergency Manager Kevyn Orr, appointed to oversee the city, wants to restructure $18 billion in debt and long-term obligations and is asking creditors to accept less than 20 cents on the dollar. Detroit’s pensions are underfunded by as much as $3.5 billion in part because of unrealistic assumptions of 8 percent annual investment returns, Orr has said. The pensions say the gap between assets and obligations to retirees is $700 million, according to a June 20 statement.

Long-Time Coming

“Detroit has been working its way to a level of insolvency for decades,” Orr said at a news briefing after the bankruptcy filing. The city was “continuing to borrow, continuing to defer pension payments, continuing not to pay its bills on time, continuing a deepening insolvency.”

On July 19, a Michigan judge ruled that Detroit’s Chapter 9 filing violated the state’s constitution by harming pension benefits. Michigan’s attorney general has appealed. U.S. Bankruptcy Judge Steven W. Rhodes in Detroit set a hearing for tomorrow to consider giving the city protection from lawsuits.

Though authorities have investigated past investments authorized by the two pension boards, personnel changes have occurred on both with changes in city administrations. The present general retirement system trustees are acting responsibly, said the board’s legal counsel, Michael VanOverbeke. He said the fund has fared well compared with other public pensions.

Probe Ordered

In June, Orr ordered city investigators to review pension investments, as well as operations and other aspects of employee-benefit programs.

The funds are sustained by contributions from the city and its employees, as well as returns from investments in stocks, bonds, private equity and real estate. Trustees, who are chosen by workers, retirees and mayors or serve because of the municipal office they hold, don’t necessarily have investment experience. One is a pastor.

Real estate and related investments made up 17 percent of the assets of the police and fire pension and 15 percent of the general employee fund, according to their 2011 annual reports.

Orzech and other members say questionable deals were made during 2006-08, when the boards were influenced by then-mayor Kwame Kilpatrick, a Democrat who did prison time for perjury and now faces sentencing for a March 11 conviction on federal corruption and racketeering charges.

Property Losses

The city’s $2 billion General Retirement System lost $16 million in fiscal 2011 when it wrote off a housing development near Sarasota, Florida, that collapsed after the real-estate bubble burst, according to pension fund records. The $3.1 billion Police and Fire Retirement System lost about $15 million on 1,100 vacant acres 30 miles east of Dallas that was to be sold to homebuilders.

A 2006 loan guarantee for a Westin hotel and condos in downtown Detroit cost the funds $14 million.

That was just in real estate. The funds lost more than $20 million investing in a telecommunications company started by a Detroit businessman, $30 million on a cargo airline and almost $70 million on collateralized debt obligations — derivative securities backed by a pool of bonds, loans and other assets.

Guilty Plea

Chauncey Mayfield, a real-estate adviser, has pleaded guilty to bribery charges, according to the Justice Department. The U.S. Securities and Exchange Commission said in a May 2012 complaint that Mayfield flew Kilpatrick and former city treasurer Jeffrey Beasley to Las Vegas for a weekend that involved golf, rooms at the Venetian Resort Hotel Casino, concerts by Toni Braxton and Prince and massages at the Canyon Ranch Spa.

The posts held by Kilpatrick and Beasley made them ex- officio trustees of both pensions.

On June 10, the SEC said Mayfield took $3.1 million from the police and fire pension to buy two strip malls in California. Other executives at the firm tried to cover it up, the SEC said. Mayfield and his firm agreed to settle the case by paying back the stolen amount.

The Kilpatrick administration’s sale of $1.4 billion in debt to fund the pension created a pool of money that attracted speculative deals, said Orzech, the firefighter.

“There was a group of bad actors and they’ve been busted,” he said.

Tightened Up

Orzech, 57, who was first elected to his board in 1988, said it otherwise had a good track record and that new members have tightened control. He said Orr exaggerated the shortfalls in an effort to take control of retiree assets.

Under Michigan law, Orr can remove the boards if they have less than 80 percent of assets to cover promised obligations. Orr said the general-employee pension may be as little as 60 percent funded.

While board members dispute Orr’s claim, it’s clear that real-estate investments, at least, haven’t done well.

The value of property and related assets, such as mortgages, held by the general-employee pension plummeted almost 47 percent, or $293.2 million, between June 30, 2008 and June 30, 2012, according to reports filed with the state treasurer. The police and fire pension real-estate investments declined 33 percent, or $228.3 million.

That compares with a 3.6 percent gain for that period by the National Council of Real Estate Investment Fiduciaries property index, which gauges a pool of almost 7,200 commercial properties acquired by pensions and nonprofit investors.

Trailing Returns

The recent investment performance of the Detroit funds has dragged down overall returns. In four of the past five years, the general-employee pension lagged behind the median returns of public funds with more than $1 billion of assets, according to Wilshire Associates’ Trust Universe Comparison Service. The police and fire pension trailed the median in three of the past five years.

Past deals plague both funds, though the general-employee pension aims to reduce real-estate to 8 percent of investments from 14.5 percent, according to its consultant.

One of its biggest money-losers was a $16 million bet in 2006 on a development near Sarasota. The Villages of Avignon was to comprise 1,300 condominiums, townhouses and single-family homes on almost 300 acres, according to filings related to $2.7 million of municipal bonds used to finance infrastructure. The Florida developer was Robert D. Barwick.

Investments Recommended

The investment was promoted to the board by Capozzoli Advisory for Pensions Inc., a Northville, Michigan-based firm.

Joe Capozzoli, on a “due diligence” visit to Florida, gave former city councilwoman and pension fund trustee Monica Conyers a $200 Burberry sweater, the Detroit News reported, citing testimony by Capozzoli to a grand jury. Conyers pleaded guilty in 2009 to taking bribes to support a contract with a waste recycler.

By November 2007, construction at the Villages of Avignon stopped as the housing bubble burst, according to bond filings.

The general retirement system valued the investment at $16 million as late as June 30, 2010.

The general pension gave an additional $11 million to Capozzoli, who invested it in a proposed 130-unit condominium project in Gulfport, Mississippi, that was never built, and in lofts in downtown Detroit.

Millions Gone

As of June 2011, the pension had written off the $16 million investment in the Florida development while the other two investments were valued at $725,000, according to its financial statement.

In December 2011, the fund blocked Capozzoli from spending more of its money and hired an auditor. In March, the pension board hired a law firm to consider suing Capozzoli, according to meeting minutes. The board hasn’t filed such a complaint.

A woman who answered the telephone at the Capozzoli residence told a reporter to stop calling.

The pension boards’ relationship with Shumake, 44, began in 2006. The former high-school track star’s blog says he considers Don King and Donald Trump role models. He approached the pensions to invest in commercial and residential real estate, according to lawsuits the pensions brought against Shumake and his company in Wayne County Court in 2011.

Shumake told fire and police trustees that he was a broker and attended the “Larry Pino Institute of Finance,” the board’s complaint said. Shumake’s real-estate license had expired, according to state records. The institute doesn’t exist, according to the suit. On his company’s website, Shumake is described as a Morehouse College graduate who heads the Detroit City Council Alternative Finance Committee.

Values Decline

The general-employee pension invested $12 million with Shumake’s fund, Inheritance Capital Group LLC, and the police and fire fund invested $15 million, according to the complaint. The stakes were valued at $1.7 million and $11.6 million respectively as of June 30, 2011.

In 2007, Shumake approached the two boards with another deal, involving five General Motors Co. warehouses. He proposed buying the properties and leasing them back to the automaker, sharing the profits with investors. The $44 million deal was supposed to net the pensions a return of about 10 percent, meeting minutes show.

In August 2007, at a restaurant in Detroit, Treasurer Beasley demanded $250,000 from an unidentified businessman in return supporting the proposal, according to the March 12, 2012 indictment of Beasley. The following month, the pension boards approved the investments, the indictment said.

Frat Boys

Beasley, a one-time fraternity brother of Kilpatrick, has pleaded not guilty. He didn’t respond to a request for comment through his lawyer.

Ultimately Beasley received $70,000, with the payments stopping when the treasurer left office in 2008 following Kilpatrick’s resignation, according to the Beasley indictment. The architect of the leaseback deal, who wasn’t charged, also paid for a Miami Beach, Florida, vacation and hotel rooms in Detroit for Beasley and his mistress, the indictment says.

The businessman also covered the costs of an excursion from Florida to the Bahamas for police and fire pension trustee Paul Stewart, Stewart’s mistress and an unnamed trustee, according to a 2013 indictment charging Stewart with corruption.

Stewart declined to comment, said his lawyer, Elliott Hall.

Shumake’s firm, ICG Real Estate Advisors LLC, sought bankruptcy court protection in April 2012, listing a $40 million debt to Detroit’s general-employee pension. Shumake, who hasn’t charged, filed for personal bankruptcy in January. He didn’t respond to telephone calls seeking comment on the cases.

Misled Funds

The pensions said in a court filing related to Shumake’s bankruptcy that companies he controlled misused $5 million from their Inheritance Capital Group investments. Shumake also misled them about a consulting arrangement related to the lease-back deal, paying a top aide to Kilpatrick $546,000, the funds said in the filing.

The two pension boards have taken over operations of the five warehouses, Orzech said. The $20 million invested by the police and fire pension is currently valued at $14 million, according to Bruce Babiarz, a spokesman.

The leases have generated $2.7 million in income since 2007, Orzech said.

“It’s not going at a 9 percent clip, which was the target,” Orzech said. “But it’s still generating income.”

VanOverbeke, the general retirement system’s Detroit-based lawyer, said the ill-starred investments are part of history.

“In any investment portfolio of any individual or corporation or pension fund, you can find some investments that were not successful,” he said.

Different Approach

“The individuals sitting as trustees today are conducting appropriate due diligence, meeting with their investment consultant, adopting board governance policies and procedures and things of that nature,” VanOverbeke said of his board.

Current police and fire pension trustees want to avoid repeating poor decisions, said Mark Diaz, 38, a board member and the Detroit Police Officers Association president.

“We’re there to make damn sure it never happens with us,” Diaz said by telephone. “We have a lot of skin in the game. I want to be an old man not concerned about where my meager pension is going to come from.”

© Copyright 2014 Bloomberg News. All rights reserved.

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