Striking it Rich Money managers get more, children get less

Striking it Rich Money managers get more, children get less

Published March 5, 2019

Second of four parts

A little more than a decade ago, lawmakers gave an obscure board the power to invest the state's oil and gas revenue — money designated to benefit Texas schoolchildren — with outside fund managers.

Then fracking boomed, pumping billions in royalties into the coffers of the Texas School Land Board. Big-name businessmen showed up quickly, hoping to be chosen to handle the investments and to gather the fees that came with the duty.

And the campaign contributions flowed. Big donors received lucrative partnership agreements. Investment managers charged hundreds of millions in fees.

Lines were blurred, and in some instances, crossed.

Since the land board started investing with outside fund managers on behalf of the state's K-12 endowment in 2006, it has committed or invested nearly $3.7 billion with companies run by friends, business associates or campaign donors.

Those donors together have given more than $1.4 million since 2006 to board members or elected officials with the power to appoint them, a Houston Chronicle investigation reveals.

And they've since charged the fund more than $218 million in fees, records show.

While the fees climbed during the past decade, the amount of money the $44 billion Texas Permanent School Fund sends to schools has declined, in real dollars, compared with the two decades prior.

Rep. Donna Howard, a Democrat from Austin, said it's time to reassess how the school fund is managed.

"Without the right oversight, the PSF is ripe for conflicts of interest," she said. "We have a responsibility for due diligence here."

BROKEN TRUST: Texas' huge school endowment pays out less and less for schoolchildren

Howard's staff said she would soon call for a legislative study, to report back to the House by the next session.

When lawmakers gave the board the authority to invest with outside managers in 2005, it restricted the qualifications to regulated businesses like banks, insurance companies and investors registered with the Securities and Exchange Commission. But two years later they amended the law, removing that requirement. So for many companies doing business with the board, the SEC's stringent federal "pay-to-play" regulation, effective in 2011, does not apply.

That left the door open for campaign contributions to the Texas Land Commissioner, now George P. Bush, and to the politicians with the power to appoint the other two members of the board — the governor and attorney general.

Since 2006, executives with companies doing business with the land board have given more than $71,000 in campaign contributions to Attorney General Ken Paxton; more than $112,000 to former Land Commissioner Jerry Patterson; more than $121,000 to Bush; more than $284,000 to former Gov. Rick Perry; and more than $715,000 to former attorney general and current Gov. Greg Abbott.

Beneficiaries of the land board's investments include some of the most influential businessmen in the state — leaders of multibillion-dollar companies, appointees to prestigious governing boards and mega-donors who fuel political campaigns.

The SEC last summer sanctioned executives with Houston-based EnCap Investments $500,000 for making contributions to several candidates, including those with power to appoint land board members, that violated the federal "pay-to-play rule." The regulation prohibits investment advisers to public pension and other funds from receiving compensation within two years of making a campaign contribution of more than $350 in one election cycle to a politician with the power to sway decisions.

Other companies doing business with the board made contributions to candidates within the two-year time frame, campaign finance and board records show, but they are not all required to register with the SEC.

State lawmakers are proposing changes to the land board this session, including expanding the size of the board to reduce the potential for conflicts of interest.

An oil and gas executive who sits on the board has declared conflicts of interest with energy private equity companies that invest billions for the fund. Bush has recused himself four times since he took office in 2015, citing "personal relationships."

"There are situations," Bush said after a board meeting last fall, "where over time I have met an individual that happens to be in a fund and out of an abundance of caution will recuse myself."

The land board now controls about $10 billion of the Permanent School Fund portfolio and invests heavily in private equity and real estate. The remainder is under the stewardship of the State Board of Education, an elected, 15-member board.

The education board also invests billions of dollars with outside managers and requires them to register with the SEC or be a bank or insurance company.

In response to a public records request, the education board reported it paid $101 million in fees in 2017, up from $14 million in 2008. But that is not a full accounting.

Fund managers typically charge a 1 percent to 2 percent management fee and then take a cut of about 20 percent of the profits once returns surpass a set hurdle.

Unlike the land board and several other Texas public investment funds, the education board did not start systematically tracking the cut of profits charged by fund managers until October 2017.

David Bradley, a former member of the education board, called the fees for one set of investments, the so-called hedge fund of funds, "horrendous." The board spent $188 million in fees on those funds from 2008 through 2018.

"We spend probably 80 percent of our fees on 7 percent of our portfolio," Bradley said, "and it's earning us 3 and 4 percent."

Holland Timmins, the chief financial officer for the education board's portion of the school fund, said the hedge funds of funds are designed to help diversify their investments and "provide downside protection in an ugly market."

"We work very hard to reduce fees every way possible," he said, adding that the board has trimmed fees by eliminating some outside managers and having staff directly manage more of the costly alternative investments internally.

For years, the SBOE failed to track the cut of profits charged by outside fund managers. This represents only a portion of its fees.

State law changes

The land board's role used to be limited to sending revenue from oil and gas royalties and land sales to the education board, which invested the money on behalf of the 165-year-old endowment.

But that changed in 2001, when the Legislature gave the land board the power to retain the royalty revenue and invest it. At first, it could buy only real estate, but by 2006, through changes in state law, it started hiring investment firms and getting deep into private equity, pools of cash that invest mainly in private companies.

In 2006, the land board paid nearly $2 million in fees, adjusted for inflation. In 2017, it counted $92.8 million in fees -- and there could be millions of dollars more in expenses, reflected in the land board's quarterly investment reports. The board's staff has not explained the difference between its fees and expenses. The fund had invested more than $5.4 billion with outside fund managers as of last September.

RELATED: Read our entire series here

The Chronicle's investigation, based on thousands of pages of records obtained through more than 100 public information requests, found the land board has operated largely in secrecy, discussing key information about investments — including fees — only in executive session, behind closed doors.

The board contends, and the attorney general agrees, that state law protects its partnership agreements and audits of its funds from public view and has refused to release them. For years, it labeled its quarterly investment reports "highly confidential."

Internal reports obtained by the Chronicle show the land board's portfolio since 2006 has returned 3.8 percent annually after fees are subtracted.

A typical index fund with 60 percent stocks and 40 percent bonds earned about 7 percent annually over the same period.

"They pay so much in fees," said Jeffrey Hooke, who spent 30 years working in private equity and now researches it for Johns Hopkins University. "You just can't overcome that."

The 'pay-to-play' rule

Last summer's SEC sanction of EnCap Investments focused on a $25,000 donation to Abbott and a $60,000 donation to an attorney general candidate. The land board has committed $1.8 billion with EnCap Investments and its affiliates.

Mark Havens, the deputy land commissioner, said the SEC reached out to him and other staff members about EnCap as part of its investigation. Havens said he explained that land board deals are initiated by the investment staff and managers, vetted by a third party and advisory committee and then brought to the board.

"Their primary area of concern was, do the land board members come to you and say, 'Hey, you should look at this,'" Havens said. "We explained that clearly, no, this has never happened."

But the Chronicle found a deeper system of patronage that dates back at least a decade and involves powerful and prominent Texas businessmen from the Rio Grande to the Oklahoma border.

Spheres of Influence A network of connections surrounds the School Land Board, which controls $10 billion of the Permanent School Fund’s portfolio. Donations have flowed from companies that the board has invested in to Gov. Greg Abbott, who appoints a board member, and board chairman George P. Bush. Board member Gilbert Burciaga has business relationships with companies that have received board investments. Bush and Burciaga have recused themselves numerous times. Click on each element for details.

Believes in 'good government'

Some of the deals have paid off for the board.

Welcome Wilson Sr., a Houston commercial and industrial property developer, and his family gave Perry at least $12,000 in 2005 and 2006. Then, in 2007 — as the first signs of the recession were beginning to appear and lenders were tightening credit — the School Land Board committed $27 million to Wilson's company. It later increased its investment to $92.6 million.

Wilson's company has since charged the land board least $3.6 million in fees. And he and his family have kept donating: Since 2007, Wilson, his family and at least one company executive have given more than $210,000 to governors, attorneys general and land commissioners, including more than $96,000 to Patterson. His fund, the GSL Property Fund 21, has earned the land board 11 percent a year over more than 11 years.

Asked if he was concerned about the appearance of pay-to-play politics, Wilson, 91, said no.

Welcome Wilson, Sr.

"There is no pay to play," Wilson said. "I've been making contributions to public officials for 70 years. I continue to do that because I believe in good government."

Investors Dan E. Patterson and Tim Moore, now chiefs of a Plano real estate investment firm called The McKinney Fund, also got in line. Patterson — no relation to the former land commissioner — had donated nearly $19,000 to Perry over the previous decade. The land board committed to invest $50 million with McKinney in 2008 and another $50 million in 2013.

Then, in 2013, McKinney executives began donating to Bush's nascent campaign. In 2017, Dan Patterson and Moore gave Bush $10,000. In August 2018, Bush's land board re-upped with McKinney one more time, approving another $75 million for the firm. Bush recused himself from that vote, saying he had a "personal relationship" with Patterson, dating to his time in the private sector.

McKinney has made $8.5 million in fees since 2008. Its investments have earned the land board 11 and 14 percent annually, respectively, over the life of the funds.

Patterson and Moore did not return phone calls.

The three-member school land board has invested heavily in private equity in recent years, leading to rapid growth in the fees charged by fund managers. State Land Board fees are calendar year and include carried interest charged by fund managers, but not expenses reported in quarterly investment reports

EnCap Investments

By far the biggest recipients of the land board's investments are EnCap Investments, the Houston-based energy private equity company, and its San Antonio-based affiliate, EnCap Flatrock Midstream, a pipeline financier.

EnCap is one of the largest energy private equity firms in the country, investing more than $22 billion in more than 240 companies since 1998.

Its founders and managing partners have a long history of making campaign contributions to powerful Texas politicians. Its executives donated more than $62,000 to Perry and Abbott between 2003 and 2007, when the land board invested with EnCap for the first time, signing off on $50 million.

The campaign donations continued to flow to politicians, as the land board's investments with EnCap and EnCap Flatrock grew to $195 million by the end of 2010.

Solutions Texas politicians have a long history of trying to protect the Texas Permanent School Fund. But they haven't always succeeded in enacting reforms. However, there are proposals that lawmakers, auditors and experts have suggested would improve the administration and transparency of the state's public K-12 endowment. Click here to read about these possible solutions.

Then EnCap found itself in the spotlight during Perry's race for governor against former Houston Mayor Bill White, who obtained an internal memo from a whistleblower inside the state's teacher's pension fund, the Teacher Retirement System of Texas, that alleged that he'd been pressured to change his recommendation against investing with EnCap.

White linked that with donations by EnCap executives to Perry and charged that: "Rick Perry has taken care of his friends and they have taken care of him."

An investigation by the retirement system and a district attorney in Austin found no wrongdoing.

And in 2010, the SEC finalized its pay-to-play rule, effective in 2011, that barred firms such as EnCap from making contributions for two years before collecting compensation from a public entity that invests with them.

But donations by an EnCap executive continued into 2014. After the SEC sanction last summer, the company said: "EnCap is pleased to have reached resolution with the U.S. Securities and Exchange Commission, which puts their inquiry into certain personal campaign contributions behind us."

By the time EnCap was sanctioned, the land board already had committed more than $1.6 billion to EnCap and EnCap Flatrock funds.

The companies, meanwhile, have charged the land board more than $143 million in fees and carried interest, which is a share of expected profits.

A small, conflicted board

The small size of the School Land Board — three members — was a focus of a report issued by the Legislature's Sunset Advisory Commission in November. While the commission made no accusations of wrongdoing, it pointed to the frequency of recusals and recommended expanding the board's size.

"In fiscal year 2017, an SLB member was absent, abstained or recused himself from one-third of all SLB votes," the report said. Similar boards in other states have as many as 12 members. Not only would this reduce the impact of recusals, but it would allow for subcommittees of the the board to more thoroughly examine deals, the commission said.

One of the land board members, Gilbert Burciaga, has recused himself at least seven times since joining the board in 2015. Burciaga is chairman of Houston-based ARM Energy and a former director at power company Dynegy.

In 2013, Burciaga gave $10,000 to Abbott's run for governor. He gave another $35,000 in 2014 and $25,000 in the summer of 2015. Three months later, Abbott appointed him to the land board. (Burciaga gave Abbott another $100,000 last year.)

John Wittman, a spokesman for Abbott, said campaign contributions played no role in the appointment: "Mr. Burciaga's extensive experience in the energy industry makes him uniquely qualified to sit on this board. One factor never considered in the appointments process is whether or not an individual has contributed to the governor's campaign."

"Proof of that is that more than 70 percent of Gov. Abbott's appointees have never contributed to him and less than one percent of the Governor's donors have been appointed to positions of service," said Wittman. "To suggest otherwise would be false and a disservice to the character and quality of the individuals who are appointed to selflessly serve the state without compensation."

EnCap first came up for a vote before Burciaga in November 2016. By then, the land board had already committed to invest in EnCap funds a dozen times. And the company asked for its biggest single commitment yet — $300 million.

Burciaga recused himself and did not vote.

SOLUTIONS: The Permanent School Fund is broken. Here's how it can be fixed.

In 2011, one of his companies, U.S. Infrastructure Holdings, had accepted a $100 million investment from EnCap Flatrock. And his other company, ARM Energy, was engaged in the buying and selling of oil and gas, among other things, with multiple EnCap-backed companies.

"We do a lot of physical and financial trading with a lot of their portfolio companies," Burciaga told the Chronicle after a land board meeting last year but didn't identify which ones. "Oh, God, there's quite a few."

He also has recused himself from votes on investments in other major energy private equity firms, including ArcLight Energy and First Reserve.

Burciaga said he and his company receive no benefit from him sitting on the land board.

"It's my time to give back to the state," he said. "I've been very fortunate myself, and I do this as a volunteer. And I love doing it for Governor Abbott. It doesn't help me out."

'A prominent Republican'

Oil prices had been falling for months when the land board started talks to broker its first deal with EnerVest, a Houston energy private equity firm, in the spring of 2015.

The crash had hit EnerVest twice, first in natural gas prices, and then oil. The company was selling off assets in West Texas' prolific Permian Basin, production rights in South Texas' Eagle Ford shale oil field, and stakes in two Ohio gas pipeline systems.

In June 2015, land board staff reported at a public meeting that they'd started talking to EnerVest executives in March about a possible investment. The board approved investing $150 million in EnerVest Energy Institutional Fund XIV-A.

Bush abstained from the vote, citing a "personal relationship" with John B. Walker, the EnerVest CEO.

"He's a prominent Republican and I've sat at his table at Harris County GOP dinners and out of an abundance of caution I recused myself," Bush later told the Chronicle.

John B. Walker, CEO of EnerVest.

Bush's calendar, obtained by the Chronicle through a public records request, shows a call on the morning of March 6, 2015, with Walker to discuss the Alamo Endowment. Bush was leading the charge to develop and restore the Alamo, a $400 million project paid in large part by private donors. The Alamo Endowment has refused to publicly disclose its donor list.

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Walker gave $50,000 to Abbott in June 2014, about a year before the initial investment with EnerVest. Within weeks of the board's $150 million commitment in 2015, Walker donated $25,000 to Abbott and $5,000 to Bush.

By the spring of 2016, two of EnerVest's earlier private equity funds were struggling under debt. One of the company's lenders, the San Francisco bank Wells Fargo, accelerated EnerVest's payment schedule from $20 million due by that June to $125 million.

In May 2016, the land board committed another $75 million to a limited partnership it created with EnerVest. A few weeks after that, the land board committed another $100 million.

Bush recused himself from both of those votes, too.

The board's latest quarterly report shows off-the-charts returns for the 2016 investments of 45 and 49 percent per year. But there is something unclear about those returns. The report shows $5 million in expenses for those investments but no difference between gross and net returns.

And the 2015 fund, with at least $12 million in expenses, has returned the land board 11 percent annually but just 4.46 percent after fees.

Even with the SEC regulation, businessmen who handle the board's money have found other ways to support — and stay close to — the land commissioner.

Wilson's son, Welcome Wilson Jr., sits on the board of the Alamo Endowment, the nonprofit Bush created after taking office to restore the Alamo.

William Lemmons, a former vice president at Enron Corp. and a founder of EnCap Flatrock Midstream, serves as trustee for the George H.W. Bush Presidential Library Foundation.

And EnCap's David B. Miller, the firm's founder and managing partner, gave about $230,000 to Jeb Bush's PAC in 2015, as George P. Bush campaigned for his father's presidential bid.

Miller also serves on the board of the George W. Bush Presidential Center, which accepts unlimited donations without disclosing it donors.

Staff writers Jeremy Blackman and Matt Dempsey contributed to this report

Part 3: A big "haircut"

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Susan Carroll joined the Chronicle in 2006 and works as an investigative/projects reporter. She was part of the team that was a finalist for the Pulitzer Prize for breaking news for coverage of Hurricane Harvey. Along with colleagues Matt Dempsey and Mark Collette, her 2016 work on the danger posed by chemical plants in southeast Texas won awards from the National Press Foundation and Investigative Reporters and Editors. Carroll previously covered the U.S.-Mexico border for the Arizona Republic and the Tucson Citizen. She can be reached by e-mail at Susan.Carroll@chron.com or by Twitter: @_SusanCarroll

David Hunn came to the Chronicle in 2016 as an enterprise reporter covering energy. He wrote about bankruptcies and debt loads after the 2014 oil price crash and the boom in the Permian Basin that followed. He was part of the team that was a finalist for the Pulitzer Prize for breaking news for coverage of Hurricane Harvey. He previously worked at the St. Louis Post-Dispatch, where he was on a team that was a finalist for a Pulitzer Prize for coverage of a city hall shooting. He recently returned to the Post-Dispatch and can be reached by Twitter: @davidhunn

Mark Mulligan is a staff photographer for the Houston Chronicle where he takes pictures and flies the Chronicle's drone. A native Houstonian, he previously worked at newspapers in Virginia and Washington State before moving home to Texas with his family. Follow him on Twitter and Instagram, or reach him by email at mark.mulligan@chron.com.

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