Will Arnold smash state employees’ piggy bank?

Surrounded by birch trees and honeysuckle vines, CalPERS’ sprawling headquarters on Sacramento’s P Street gives the appearance of having been deliberately camouflaged. Nothing on the outside of the building even has the pension fund’s name on it. Inside, however, it’s another world. An expansive lobby with a tropical courtyard and six-story-high sunroof suggests the casual elegance of a resort hotel. Yet, the pension fund is fast outgrowing its spacious digs. Even now, heavy machinery is clearing ground across the street for a new $250 million expansion of the campus.

With carpeted corridors and acoustical walls and ceilings, the CalPERS headquarters is a quiet place to work—except during the one week a month when its board members claim a 200-seat auditorium at one end of the building as their seat of power.

Board meetings can spark drama. Last year, for example, when the board was set to vote on whether to keep its $65 million investment in the Philippines, Filipino activists arrived in buses from San Francisco to pack the auditorium. The country’s ambassador to the United States took the podium to urge board members to keep the investment, despite CalPERS’ concerns about Philippine tax laws covering banking and child labor. After the board voted not to divest, Philippine President Gloria Macapagal Arroyo broke the news to her country in a radio interview, and the Philippine stock market hit a 12-week high.

But such instances are the exception.

For the most part, board meetings of the nation’s largest and arguably most influential public pension system are sparsely attended and about as dramatic as watching paint dry. That’s because many decisions related to CalPERS’ enormous portfolio occur in obscure committees—composed of subsets of the board—whose recommendations the entire body often rubber-stamps with little or no public discourse. During a recent meeting, the board took recorded votes just twice. “It’s entirely possible for an outsider to sit through a CalPERS meeting and not realize what he has just witnessed, and that’s apparently how [board members] prefer it,” said retiree Charlie Oates, who once published a newsletter for CalPERS members.

But the lack of public drama belies the private power that CalPERS and its $183 billion in assets can wield.

For decades now, the overwhelming majority of CalPERS’ 13 board members have been Democrats with strong ties to organized labor. Six members are elected directly by members of public labor unions. The Legislature, controlled by Democrats, gets to pick another member. Two of the four ex officio members—state Treasurer Phil Angelides and Controller Steve Westly—are Democrats.

Under Democratic control, CalPERS has been a leading voice in corporate governance issues, repeatedly roiling America’s business leadership with a high-profile divestiture of tobacco stocks, controversial aid to those seeking to depose Michael Eisner as chief executive officer (CEO) of the Disney Corp., and a long-running push for increased numbers of independent directors of public companies. At the same time, CalPERS also has been something of a Democratic piggy bank, with hundreds of millions of dollars in “alternative” investments funding the business efforts of a variety of campaign donors and party insiders, from Los Angeles grocery billionaire Ron Burkle to San Francisco investment banker Richard Blum—who happens to be the husband of U.S. Senator Dianne Feinstein—and on to former Vice President Al Gore and his plan to create a youth-oriented cable-TV channel.

Over the last few months, Governor Arnold Schwarzenegger has pushed a series of “reforms” of state government, one of which was supposed to change the way in which state-worker pensions are funded and, inevitably, force change at CalPERS. The proposed pension-reform initiative of 2005 has been pulled, yet the governor’s office and a legislative leader are now claiming that they will put a pension-reform measure on the ballot in 2006. The Republican governor is presenting his move as a matter of fiscal accountability, a way to help balance California’s budget while eliminating “platinum-plated” pensions for public workers. Democrats and their allies in organized labor are fighting back by calling the move an assault on low-paid public workers. At a recent rally at the Capitol, anti-Schwarzenegger protesters carried signs that read “Our retirement is not for sale.”

So far, neither side has explained that the fight over CalPERS isn’t, at its core, simply a fight over pensions. It is a fight for control of an investment portfolio, the shape of which exerts more global financial influence than the entire economies of many—and probably most—sovereign nations. It is a battle royal for a measure of political power that is all but incalculable.

In his budget proposal last year, Schwarzenegger had nothing but praise for California’s public-employee pension system. The object of his acclaim is referred to as a “defined benefit” system because it guarantees a specific amount of money throughout a retiree’s golden years. “State employees will continue to be secure in the knowledge that a volatile investment market will not affect retirement benefits, because they will continue to be covered by a defined-benefit retirement plan; this is a stark contrast to the concerns of many private-sector employees,” the governor declared in January 2004.

But that was then.

Even as he pushes a constitutional-reform agenda that includes measures to rein in public spending, redraw the state’s political boundaries, and make tenure more difficult to attain for California’s 715,000 public-school teachers, Schwarzenegger continues to want to overhaul the retirement system that he once hailed. Declaring that costly pensions for teachers and 1.4 million other public-sector employees have to go, the governor wants to scrap defined-benefit pensions for state workers hired after July 1, 2007, and replace them with so-called defined-contribution plans, the 401(k) model familiar to workers in the private sector.

On the surface, the arguments pro and con are enough to make the average person’s eyes glaze over. But beneath the debate over Schwarzenegger’s proposal lurks a political struggle of epic proportions, with the popular Republican governor taking direct aim at CalPERS, long dominated by California’s labor unions and a crown jewel of the state’s Democratic Party establishment. (CalSTRS, the pension fund to which the state’s teachers belong, also would have its defined-benefit plans placed on the chopping block.)

If Schwarzenegger eventually gets his way, observers say, the nation’s largest public pension fund—whose billions of dollars in investments within California often have been deployed to suit the wishes of powerful and well-connected Democrats—could be squeezed into oblivion. Not coincidentally, untold billions of dollars for future management fees of 401(k) accounts could flow out of CalPERS and into the coffers of Wall Street firms whose political sensibilities are more in keeping with those of the governor and his conservative backers.

Just as significantly, experts say, CalPERS’ role as a leading voice for shareholder rights—which long has angered Republicans and their corporate allies—could dissipate entirely over time as the current participants in its traditional pension program, whose proxy votes CalPERS gets to cast in corporate elections, retire and die off. “CalPERS’ [corporate] opponents have been waiting for a very long time for a moment like this,” said Barbara O’Connor, director of the Institute for the Study of Politics and Media at California State University, Sacramento. “Now they may finally see their chance.”

As a political gesture, state Finance Director Tom Campbell’s February appearance before a CalPERS committee at the pension fund’s headquarters a few blocks from the state Capitol was predictable. Hastily instigated by Campbell himself after word leaked that the pension fund’s board was about to formally oppose the governor’s reform initiative, which it soon did, his two-hour visit played out like a suspense film whose plot the panel already knew.

Still, Campbell did his best to convey the impression that despite proposing to radically alter the way the 800-pound gorilla of pension funds conducts its business, Schwarzenegger really intends CalPERS no harm. He even gushed about the pension fund. “[CalPERS] rightly identifies its good performance record. It’s better than good. It’s a very fine performance record,” Campbell effused.

As the governor’s messenger, Campbell was merely reciting the line that has been Schwarzenegger’s mantra since January, when he gave his blessing to a proposed law introduced by Assemblyman Keith Richman, R-Northridge, that would amend the state Constitution to allow the pension system’s overhaul. This is the line: The state, awash in red ink, no longer can afford to offer what is widely considered to be among the nation’s most generous public-employee pension plans.

Schwarzenegger challenged the Democrat-controlled Legislature to work with him in advancing the Richman legislation (along with the rest of the governor’s reform agenda). Should lawmakers continue to resist, the governor has threatened to take the matter directly to voters in a 2006 ballot measure, to be voted on in June of that year, supporters say. Just last week, Richman’s bill died in a committee dominated by Democrats. Richman’s chief of staff, Dan Pellissier, said trying to work on the reform through legislation failed because of the power of public-employee unions. “We tried to eliminate the crushing burden of retiree costs. The public-employee unions and their vassals in the Legislature killed much-needed reform,” said Pellissier.

Now, Richman will turn back to the initiative process and work with the governor on a new petition to take to the voters directly.

Calling the pension system “another financial train on another track to disaster,” Schwarzenegger presents his argument for switching from traditional pensions to 401(k) funds for future workers as an effort to shift more of the burden for state employees’ retirement savings from taxpayers to the workers themselves. That, understandably, has not sat well with teachers, firefighters, police officers and other government workers. They rallied 10,000 supporters to the Capitol last week to protest against the governor and his reform efforts. There were numerous signs declaring that Schwarzenegger should “keep his hands off our pensions.” The unions insist that public-sector employees often are paid less than workers in the private sector and that the relatively generous pension benefits play a large role in the state’s ability to attract and maintain quality personnel.

Some of those same unions, it should be noted, were major contributors to former Governor Gray Davis’ campaign during the 2003 recall election that swept Schwarzenegger into office. “I don’t see anything surprising in the governor’s attacking labor unions while trying to do something for his business and corporate friends,” said Sherry Bebitch Jeffe, senior scholar at the School of Policy, Planning, and Development at the University of Southern California. “He doesn’t figure to lose a constituency there.”

There’s little denying that a pension-reform proposal—which has the backing of an array of business and anti-tax groups, including the California Chamber of Commerce and the Howard Jarvis Taxpayers Association—would hit future state workers directly in the pocketbook. Under the current CalPERS system, for instance, workers and employers (whether state, county or local governments) each contribute the equivalent of about 11 percent of the workers’ pay to their retirement savings, with CalPERS investment returns accounting for the rest. Workers’ contributions remain fixed in good times and bad. But, depending on what sort of returns are available in the stock market, state and employer contributions may fluctuate wildly.

The reform proposal would cap the amounts that the state and employers contribute—as little as 6 percent as the maximum for many employees, with higher percentages for public-safety workers and others, including schoolteachers, who do not participate in the federal Social Security system. The cost of death and disability benefits that are a standard part of defined-benefit plans would become a negotiated item, with workers expected to pick up at least a share of the cost, a prospect that especially rankled police and firefighters. When pulling the original initiative proposal, the governor said he wanted to look at this aspect again and “get it right.”

Workers hired after the change became law would no longer be guaranteed fixed retirement amounts for life, as are current participants in the system. Like private-sector participants in 401(k) plans, public-sector workers would assume the risk for their retirement savings returns.

Proponents say the change is needed because the system is unsustainable: The state’s contribution to annual retirement costs was $160 million in 2000, but for the current fiscal year the state will pay $2.6 billion to retirees above what CalPERS’ investments and worker contributions can provide. Under the contribution caps contemplated by the reform proposal, the state would be off the hook for most of that $2.6 billion, supporters say. “Public employees should not get better pensions than the private sector,” says Karen Hanretty, spokeswoman for the California GOP. “Our tax dollars are paying for gold-plated pension benefits that are bankrupting state and local governments.”

Democrats and their labor-union constituents say that’s misleading, insisting that even with the costly benefit enhancements that CalPERS approved for members in the 1990s, 80 percent of the state’s increased obligation to the pension fund in recent years is attributable to the stock market’s swoon, which whacked CalPERS investment returns. They contend that while the existing contribution formula has resulted in the state having to pony up big time after the stock-market crash, under the same formula there were years in the 1990s, when the market was churning out record returns, when the state and employers contributed almost nothing. “The $2.6 billion [argument] is an aberration, and the people on the other side know that,” said J.J. Jelincic, president of the California State Employees Association, who worked in the CalPERS investment office for 18 years.

He and others also insist that switching to a 401(k)-type system for future workers does nothing to help the state’s budget crunch in the short term, which is a chief rationale for the reform in the first place. According to the nonpartisan state Legislative Analyst’s Office, the plan “potentially” could produce savings “in the hundreds of millions of dollars to over $1 billion annually” once fully phased in. But even proponents acknowledge that the phasing could take decades.

Experts estimate that a switchover to a 401(k)-type program for future hires—existing pension recipients would have the option to switch but would not be required to do so—actually would cost taxpayers money for the first decade or so. CalPERS actuaries estimate that the added cost of starting up and maintaining what essentially would be dual retirement programs would exceed $1 billion for CalPERS and CalSTRS combined during the first 10 years.

While such arguments are sure to get plenty of ink in the months and year ahead should Schwarzenegger make good on his continuing special-election threat, the governor’s opponents suspect that the real aim of his newfound interest in pension reform is to reduce CalPERS’ considerable influence. “There’s no question that he intends to crumple the power of CalPERS,” said Angelides, state treasurer and a CalPERS board member who also is a Democratic candidate for governor in 2006. Angelides and others see pension reform as the political cover for the governor’s “trying to silence a leading voice for corporate reform in America.”

CalPERS’ power as a reform advocate emanates not only from its size but also from the way it is structured. As a defined-benefit system, it owns the shares of companies in which it invests on behalf of its members, and it is able to vote those shares, or proxies, in corporate elections, giving it enormous clout. It often has used its influence in ways that have infuriated corporate interests, such as the decision in 2000 to sell its tobacco stocks and, more recently, helping to topple Eisner at Disney and Richard Grasso as head of the New York Stock Exchange.

By contrast, with most defined-contribution plans, it is the individual who holds stock ownership. Thus, if reform occurs, and CalPERS’ future defined-contribution program is structured like many others, its days as a corporate-governance player could be numbered. “It would essentially atomize CalPERS’ clout on the defined-contribution side of things,” said shareholder-rights advocate Nell Minow, “and over the long term, that would be a tragedy.”

The governor’s supporters, including Campbell, the finance director, have suggested that under the reform measure, CalPERS need not experience such a fate. They’ve implied that a CalPERS defined-contribution program could be structured to allow the pension giant more than a mere bookkeeping role. They’ve suggested CalPERS might be able to offer its own family of funds in the manner of the nonprofit investment company TIAA-CREF while retaining its proxy rights and thus its influence in corporate boardrooms. Campbell’s spokesman, H.D. Palmer—to whom the governor’s office referred all questions for this article—said, “a lot of people have jumped to the conclusion that the [Schwarzenegger] administration wants CalPERS out of the retirement-fund business altogether, which just isn’t true.”

But during his visit with the pension fund’s board members in February—which sources on both sides say has been the only formal communication between CalPERS and anyone from the governor’s office since the reform talk began—Campbell was elusive. When pressed for specifics about CalPERS’ future role, time and again he retreated to the word “if,” as in “if that’s how the implementing legislation is drawn,” and the even more vague “if it is a desirable thing.” And in what had to be little comfort to the pension fund’s stewards, he acknowledged that the first proposed ballot initiative “permits” private managers “to take over” for CalPERS although it does not “require” it.

Campbell himself has described the proposals as “necessarily bare-bones,” as, he says, is to be expected of any measures to amend the state’s Constitution, but others see something different. “The very fact that they have not included assurances about CalPERS leads me to believe that there’s probably every intention to try to diminish CalPERS’ role in the management of any future defined-contribution plan,” said Minow, the shareholder-rights advocate. “It’s a transparent political ploy to get what they want passed.”

The pension board’s president, Rob Feckner, is similarly skeptical: “I think the governor’s mind is already made up and that he’s not really interested in having discussions with us.” And neither is he optimistic about any future legislative compromise. “Anything short of putting the burden on the shoulders of public employees, I don’t think the governor and his people are interested.”

The first of the proposed ballot measures mentions CalPERS in saying that any new employee of a public agency hired after July 1, 2007, “may enroll only in a defined contribution plan of a public pension or retirement system.” It aims to create the California Public Employee Defined Contribution Plan without specifying who would have authority over it, fueling suspicion in the pension-fund camp that the governor and his backers may be intent on trying to bypass CalPERS entirely.

“If CalPERS were left in the position where it still got to vote the proxies [at shareholder meetings], that might not accomplish what the governor is up to, which is to silence the [corporate] activism,” said former CalPERS President Sean Harrigan, who was ousted from the board in January and replaced with a Schwarzenegger ally. Harrigan speculates that Schwarzenegger would like to prevent CalPERS from overseeing any future defined-contribution program “and put it with the [Department of Personnel Administration] or somewhere else under the governor’s control. It really does depend on any implementing legislation. I’m not ready to predict that’s what they’ll try to do, but I wouldn’t put it past them.”

Despite its hard-earned reputation as a corporate-reform advocate, CalPERS has governance issues of its own. One of the world’s largest investors in the secretive venture-capital industry, it grudgingly began to disclose information about some—but not all—of such investments in 2003 only after the San Jose Mercury News filed a lawsuit aimed at forcing it to do so. It similarly rebuffed requests by SF Weekly last year for information about its investments in funds controlled by two powerful Democratic Party patrons, Los Angeles billionaire Burkle and San Francisco investment banker Blum.

As the weekly disclosed, the funds controlled by the men—infused with money from CalPERS—are among the owners of an upstart cable-TV enterprise for young people whose principals are former Vice President Gore and his business partner, Joel Hyatt. CalPERS’ stake in Gore’s San Francisco-based TV venture—originally dubbed INdTV and scheduled to take to the air in August as Current—came from an investment program ostensibly intended to foster economic development in “underserved areas” of the state.

It wasn’t the first time that a CalPERS investment relationship struck some observers as perhaps a bit too cozy. In 2002, the pension fund put $100 million into Premier Pacific Vineyards Inc., a company buying land for growing grapes. The CEO of the firm, Richard Wollack, was a major fund-raiser for then-Governor Davis, who at the time controlled three appointments to the CalPERS board.

CalPERS’ relationship with Democratic megadonor Burkle, in particular, raises questions as to whether the board has a blind spot when it comes to potential conflicts of interest. Since 2001, CalPERS has invested at least $760 million in private equity funds controlled by Burkle, whose Yucaipa Cos. has former President Bill Clinton on its board. Records show that Burkle has contributed to the political campaigns of both Treasurer Angelides and Controller Westly, as well as to that of former Controller Kathleen Connell, who also sat on the CalPERS board. He also has employed former San Francisco Mayor and Assembly Speaker Willie Brown, who is an attorney, to do legal work, and he hired former board member and actuary Sidney Abrams as a consultant.

As governor, Schwarzenegger is helpless to do much about CalPERS’ Democratic leanings. In January, he appointed Republican insurance-industry executive Marjorie Berte to the board, joining ex officio member Michael Navarro, his appointee to head the Department of Personnel Administration. As part of the political maneuvering that resulted in the recent ouster of former board President Harrigan, Schwarzenegger installed another Republican, real-estate developer Ron Alvarado, as the State Personnel Board’s designated representative. But it may be a while before he gets to name someone else to his liking. The other slot reserved for gubernatorial appointees is occupied by Democrat Brown, whose term doesn’t expire until 2007.

Although cozying up to its friends appears to have become the norm, it is the pension fund’s aggressive corporate-reform agenda that has most angered Republicans and their business allies. CalPERS relentlessly has campaigned for such things as curbs on executive salaries, boundaries between the research and sales departments of investment banks, and new rules to allow shareholders to nominate their own company directors. “There’s no question [CalPERS] has been a major force in those areas, and it undoubtedly has contributed to a backlash,” says Charles Elson, who teaches corporate governance at the University of Delaware.

At times its actions have seemed blatantly political, such as when it adopted an anti-torture policy in response to the Iraq prison scandal and, more recently, urged companies to disclose financial risks from global warming. Last year, the pension fund’s critics cried foul after it voted its shares in a failed attempt to remove Safeway’s CEO, Steve Burd, from the Safeway board only months after a bitter labor dispute in Southern California that pitted Burd against the grocery workers’ union headed by then-CalPERS President Harrigan. (Harrigan’s ouster from the CalPERS board was widely seen as payback on behalf of the union leader’s opponents.)

That episode caused discontent even among the pension fund’s allies. “I do think it has become too political, and I’ve told them so,” said Rich Koppes, CalPERS’ former general counsel. Still, he opposes the pension-reform proposal. “I don’t think you heal the patient by killing it.”

Whether the governor and his backers get the chance to reshape CalPERS will depend largely on how political events play out in the coming months and next year. Pension-reform supporters say that barring a compromise with the Legislature, which appears to be dead, Schwarzenegger is likely to issue his call for perhaps a second special election in 2006, and pension reform will be included.

Citizens to Save California is a who’s who of Team Schwarzenegger. Its board includes Allan Zaremberg, president of the California Chamber of Commerce; William Hauck, president of the California Business Roundtable; Joel Fox, president of the Small Business Action Committee; and Jon Coupal, president of the Howard Jarvis Taxpayers Association. But the team isn’t restricted to California’s borders. Grover Norquist, who runs the influential Americans for Tax Reform in Washington, D.C., and who has close ties to the Bush administration, has said that his group will help promote and finance the measure should it reach the ballot.

For one of its TV spots, Citizens to Save California has turned to Goddard Claussen, the consulting firm whose principals created the 1993 “Harry and Louise” TV ads that helped torpedo Clinton’s health-care reform. Republican operative Mike Murphy, who was Schwarzenegger’s chief strategist during the recall election, also is expected to play a key role in the reform effort, sources say. Murphy’s Washington, D.C.-based consulting firm, DC Navigators, lists the California Manufacturers and Technology Association—which is on board with the governor’s pension-fund plans—among its clients.

CalPERS’ defenders aren’t taking the governor’s efforts lying down. Union leaders, cheered by early polls that show the governor without much traction on the pension issue, are pledging to raise as much money as it takes to counteract the opposition.

Beyond the huge rally at the Capitol, nurses, firefighters and other labor groups have taken to shadowing Schwarzenegger at public events, even crashing fund-raisers with corporate high rollers in Washington and at New York’s trendy 21 Club. “He can run, but he can’t hide,” said Carroll Wills, who heads the 30,000-member California State Firefighters Association and who predicts the governor will get more than he bargained for in tampering with CalPERS. “He started in his Humvee making a big splash. And look, we’ve already got him sneaking into side doors.”