The story so far:
In 2013, The Atlanta Journal-Constitution began looking at public pension investments into a so-called alternative fund created by pension adviser Larry Gray’s Buckhead-based company. The newspaper found that Gray & Co. was advising MARTA and all three Atlanta pension systems on investments when he recommended that they invest a combined $63 million into his fund. The AJC also found that the investments didn’t appear to comply with a new state law on alternative investments. In subsequent stories, the newspaper found that at the time Gray & Co. was making its pitch, Gray was facing $425,000 in federal tax liens and was paying off a $1 million debt from a lawsuit that accused him of fraud. None of those debts were disclosed to federal and state regulators, the newspaper found. Gray & Co. resigned from its adviser role with the Atlanta pension systems following the AJC’s reports. In May, the U.S. Securities and Exchange Commission filed a civil complaint against Gray & Co., saying 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. Gray & Co. is suing the SEC in an attempt to get the hearing moved to federal court, instead of being heard by an SEC administrative law judge.
Atlanta’s largest city employee pension is looking at its legal options to cut off future investments or recover losses from a controversial money manager’s fund, after a recent audit showed that two deals lost $4.5 million.
In one deal, Buckhead-based Gray & Co. invested in a California start-up company, US Community Lending Holdings, that became insolvent in about two years. The investment, which promised a 10-percent return, ended up losing $3.5 million.
In the other deal, Gray & Co. used $1.8 million in pension fund money to buy part ownership of a New York investment manager — 5 Stone Green Capital— then kicked in $3.2 million for the firm to invest. The combined investment was worth just $4 million as of the end of last year, the audit says.
Larry Gray, founder of Gray & Co., said in an interview that it is unfair to look at the performance of any one or two investments. He said that his company’s fund has provided the public pension investors with an overall 7-percent return — well ahead of 1.1-percent return for all similar, high-risk alternative funds for the same period, according to Preqin Ltd., an industry research firm. The two deals were the Gray fund’s only losing bets.
“We have 12 investments and one is not doing well and I decided to write it down,” Gray said. “They’re not all going to go up. They’re not all going to work out. But we’re proud of our overall performance.”
However, someone investing in a less-risky mutual fund mimicking the S&P 500 index would have earned an average annual return of almost 18 percent during the same period and paid a small fraction of the 2.8 percent in fees and expenses charged by Gray & Co.
Doug Strachan, chairman of the Atlanta General Employees Pension board, said his group has been in “continual contact with our legal counsel” about whether it has to continue investing in the Gray & Co. fund, as its contract requires.
Strachan said the board has been trying to find out the nature of U.S. Community Lending’s insolvency and if it was the result of normal market volatility. Gray would not comment on the company during a recent interview with the Atlanta Journal-Constitution.
Strachan said if there are other causes for the insolvency, “I will endeavor to understand every reasonable action at my disposal to mitigate further loss, and ameliorate the loss through whatever recovery options are available.”
The Atlanta General Employees Pension board recently ordered a third forensic audit of the Gray & Co. investment fund and hired a former U.S. Securities & Exchange Commission attorney to advise the board.
“I think that I may reasonably state that our continual requests to talk with Gray & Company about (his company’s fund), to interview 5 Stone Green and US Community Lending, and pulling the trigger on three forensic audits demonstrates a collective deep concern over certain aspects of the investment, and a will to ferret out whatever it is that it is possible to do to alleviate those concerns,” Strachan told the AJC.
Legal but opaque
All three of Atlanta’s employee pensions and a MARTA pension signed 10-year contracts with Gray’s fund in 2012, after a new state law allowed public pensions to put money in alternative investments such as private equity, real estate and distressed and start-up companies.
At the time, Gray & Co. was paid to advise those pension systems on investments, and his recommendation that they invest in a fund created by his own firm raised concerns about a conflict of interest, as detailed in a 2013 Atlanta Journal-Constitution investigation.
Each of the contracts guarantee the company an annual management fee of at least $630,000, plus a share of investment profits if the funds perform particularly well.
Gray at the time said the GrayCo Alternative Partners II could earn returns topping 20 percent. The fund also was set up to tamp down risks, at least in theory. Instead of investing directly, as other alternative funds usually do, Gray set up a “fund of funds” that invests in multiple other funds.
But it strayed from that strategy to make the direct investments in US Community Lending and 5 Stone Green Capital.
Gray said his company made direct investments in the two companies because “we saw the opportunity for good returns.” He said such investments are allowed by GrayCo’s agreement with the pension investment partners, and that they were made after a “pretty rigorous due diligence process” to investigate the two firms.
He declined to discuss the specifics of GrayCo’s dealings with either company, or what the company’s process is for evaluating potential investments.
Such direct investments by a fund of funds are typically legal but “involve obvious conflicts of interest and obvious dangers,” said Edward “Ted” Siedle, a former SEC attorney who now conducts forensic investigations for pension clients. Siedle is not involved in the Atlanta pension case.
“Funds of funds are opaque, high-cost investments,” he said. Partners in such funds “often don’t know what their investments are.”
And that has been the case with the MARTA and three Atlanta city pension systems invested in the Gray fund — at least until the general employees fund ordered the first audit of the Gray & Co. fund after the AJC articles.
The audit shows that at the end of 2014, the pensions had invested almost $42 million. GrayCo’s $33.4 million investment in 10 funds earned a $6.8 million profit. But the $4.5 million loss from the investments in US Community Lending and 5 Stone Green Capital wiped out much of those gains, according to the audit by an outside firm.
Meanwhile, expenses and fees for the GrayCo fund were $1.1 million, the audit says.
Gray said that these types of investments often lose money in the early years and earn big gains later.
Anne Torres, a spokeswoman for Atlanta Mayor Kasim Reed, said it is unclear if the police and fire pension systems will participate in the new audit. MARTA declined to answer questions submitted by the newspaper.
Meanwhile, Gray is facing a legal challenge that could result in his firm being barred from collecting more investments from public pensions in Georgia.
In May, the SEC alleged that two of the firm's executives, including Gray, defrauded Atlanta and MARTA employees by steering their pensions to his fund, even though the investments didn't comply with state law.
The SEC said Gray also misled the pensions by claiming there were other investors in the fund. Its civil complaint against Gray is pending before a federal administrative law judge — although Gray & Co. has sued the SEC in an attempt to move the proceeding to federal court.
Torres said the city’s budget must cover any pension shortfalls, so officials are watching the SEC process closely. Employees’ promised retirement income is not altered by the performance of the investments, Torres said.
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