Atlanta pension funds defrauded by adviser, SEC alleges

Digging deep

Tens of thousands of Georgia workers and retirees depend on public pension funds for their retirement, and taxpayers can be on the hook for shortfalls. That’s why the Atlanta Journal-Constitution has examined the funds and issues affecting them.

Thursday’s action by the Securities and Exchange Commission echoes findings from an Atlanta Journal-Constitution investigation that began in 2013.

The AJC revealed that the adviser to the city of Atlanta's three pension systems had recommended that they invest in its own fund. That arrangement would guarantee the firm — Gray & Co. — lucrative fees and potentially millions of dollars more if the fund performed well. That raised questions about whether Gray & Co. had a conflict of interest by serving as both adviser and fund manager. The AJC investigation also raised questions about whether the arrangement violated a recent Georgia law allowing public pensions to use alternative investments. Wary of the risks of such investments, the law put limits on how much the pensions could invest and what kinds of funds qualified.

As the investigation continued, the AJC found that when Gray & Co. founder Larry Gray was pitching his fund to public pensions, he was paying off a sizable federal tax lien and a $1 million lawsuit settlement that accused him of fraud. But Gray had failed to disclose those problems to state and federal regulators, although investment advisers are usually required to disclose unpaid liens and settlements.

Later, the Atlanta General Employees’ pension board called for an audit of the Gray fund. Days later, Gray resigned as its adviser. A month later, he also resigned his role advising the Atlanta police and fire pensions, though the AJC later learned he has continued to advise those pensions on a month to month basis. Gray & Co. also continued to manage the investment fund for all three pensions, under a 10-year agreement.

Gray continued to serve as adviser to the pension fund for MARTA, as well as to pension funds for Fulton County Schools and the Fulton-DeKalb Hospital Authority.

Pension systems for Atlanta police, firefighters, transit workers and other government employees were defrauded by the pensions’ investment adviser, federal regulators alleged Thursday.

The U.S. Securities and Exchange Commission said that Buckhead-based Gray Financial Group and its two top executives — President Larry Gray and co-Chief Executive Robert Hubbard IV — steered the public pensions to invest in the firm’s own fund, though the investments did not comply with state law.

In recommending that fund, Gray and his firm also violated securities law by making “material misrepresentations” about it, including that there were other investors in the fund when in fact there were none, the SEC said. As a result of the investments, the firm has collected more than $1.7 million in fees, SEC said.

“We allege that Gray Financial Group and its senior officials put their own interests ahead of their clients, and Gray deliberately misrepresented that the recommended investments were permissible under Georgia law,” Walter Jospin, director of the SEC’s Atlanta regional office, said in a prepared statement.

“Public pension funds and their beneficiaries deserve better from their advisers,” he said.

The allegations echo findings of a 2013 Atlanta Journal-Constitution investigation into the pension adviser.

An administrative law judge will hold an initial hearing on the allegations within the next 60 days. If the judge decides the allegations are true, Gray Financial Group and its executives could be ordered to pay civil penalties and disgorge any gains.

The sanctions could also result in Gray’s firm being barred from collecting any more investments into the fund from public pensions in Georgia until it meets the restrictions in the state law. That law allowed most of the state’s large public pensions to invest in so-called “alternative investments” of private equity, hedge funds and real estate, if the investments met certain criteria.

Gray did not respond to a phone message seeking comment. But his attorney, Terry Weiss, wrote in an email to the newspaper that the SEC’s case is “without merit.”

Weiss filed a federal lawsuit against the SEC on Gray’s behalf in March, alleging that the agency’s administrative hearing process is unfair and unconstitutional. The lawsuit also disputes the agency’s interpretation of the Georgia law. It seeks to have the case against Gray’s firm, which does business as Gray & Co., moved to federal court.

“The SEC is once again bringing its charges in an unconstitutional and home-cooked administrative proceeding rather than trying a case before an impartial U.S. district court and a jury of one’s peers,” Weiss wrote in the email. “Gray Financial will vigorously defend itself and continue to fight the SEC in federal court, as well as in these administrative proceedings.”

The AJC’s 2013 investigation found that while Gray’s firm was serving as a paid investment consultant to MARTA and three City of Atlanta pension systems, it recommended that they invest in GrayCo Alternative Partners II, a fund owned by the company. Those investments amounted to $80 million and guaranteed the company a 1-percent annual management fee for a minimum of 10 years.

The newspaper’s article raised questions about the apparent conflict-of-interest in Gray’s company advising the pension systems to invest in a company-owned fund. It also raised questions about whether the Gray fund had enough outside investment and enough investors to satisfy state law.

State law restricts Georgia pensions from investing in a fund unless it has at least $100 million in total investments and at least four other investors already in the fund. The state law also bars any public pension from holding more than 20 percent of the total fund’s investments. The Legislature imposed the restrictions because alternative investment funds are more expensive and risky than standard stocks and bonds, but also hold the promise of higher returns.

The SEC said Gray’s investment proposal to the pensions violated those restrictions.

Shortly after the law went into effect in 2012, the SEC said, Gray recruited Atlanta’s three pension plans and MARTA’s union pension plan to invest a total of $77 million in a new fund investing in several private equity and real estate investment funds by the end of 2012.

Two of Atlanta’s pension funds, for police and general staff, agreed to invest $28 million and $21 million respectively, exceeding the 20 percent cap, the SEC said. Likewise, the fund never met the requirement for four other investors or the $100 million minimum, the agency said.

“Gray Financial Group breached a fiduciary duty to public pension fund clients by recommending investments it knew did not comply with legal requirements,” Andrew J. Ceresney, director of the SEC’s Division of Enforcement, said in a prepared statement.

The other investors in the GrayCo fund were MARTA’s union pension and the Atlanta firefighters’ pension, with $13 million and $15 million at the end of 2012, according to the SEC.

Anne Torres, a spokeswoman for the city of Atlanta, said the pension boards are independent from the city and it has no role in the lawsuit. However, the city’s finance chief and head of human resources sit on all three boards.

After the AJC’s stories, Atlanta Mayor Kasim Reed pushed for the pensions to drop Gray as advisor. Gray resigned as the largest pension’s adviser, and he later resigned from the police and firefighter funds.

But Torres said Thursday that Gray has continued to advise the police and firefighters’ pensions on a “month-to-month basis” — 18 months after his resignation.

The MARTA pension board’s lawyer is “reviewing the allegations against the company,” said spokeswoman Alisa Jackson. “Since this is an active investigation, (MARTA) will have no further comment at this time.”

Gray also advises other local agencies’ retirement plans, including Grady hospital’s and the Fulton County Schools’, neither of which invested in the GrayCo fund. Those agencies also did not respond to the AJC’s interview requests.