Notes on a (PSPRS) scandal

The Arizona Republic leads it web page today with this story by Craig Harris: Pension trust in federal inquiry.  The pension trust in question is PSPRS.  The article implies a suspicion of wrongdoing in how PSPRS valued its real estate investments.  For some background, the following articles by Randy Diamond in Pensions and Investments* provide good information about what this is all about:

• Hacking says law firm hired to investigate Arizona Public Safety staff's complaint (7/19/2013)
• Appraisals become issue in Arizona's real estate investments (9/2/2013)
• Another Arizona Public Safety investment staffer resigns (9/11/2013)
• Arizona Public Safety suspends investment staff bonuses (9/26/2013)
• Arizona Police Association requests criminal investigation of PSPRS investment cover-up  (9/27/2013)
• Arizona Public Safety Fund needs to change valuation on Desert Troon portfolio - auditor general (12/6/2013)

 * The website may only allow you to look at two articles before asking you to register.  Closing your browser, clearing your history, and relaunching it seems to allow you to look at two more articles.

There is also this Auditor General's Letter and this PSPRS' Official Response Letter:  Both letters contain a lot of accounting jargon relating to how real estate investments should be valued, but as I read them, the main issue was that PSPRS and Desert Troon were using values that were based on "future development plans" for their property, rather than more conservative measures of current market value.  Once more appropriate valuations standards, based on comparable sales, were used a new valuation was calculated showing a $20 million overvaluation at the end of fiscal year 2013.

At this stage, it is impossible to tell where this is going, but one thing stands out.  The initial Ernst & Young (EY) valuations stated that PSPRS was overvaluing its Desert Troon real estate portfolio by $89.9 million and $82.2 million at the ends of fiscal years (FY) 2012 and 2013, respectively.  However, when EY redid the valuations using the standards required by the Arizona Auditor General, the new valuation for FY 2012 showed only a $24.7 million dollar overvaluation, and the new valuation for FY 2013 actually showed a $4.4 million undervaluation.  These new EY valuations (using comparable sales) are closer to Desert Troon's own valuations than EY's initial valuations.  The initial EY evaluation was undervaluing the Desert Troon portfolio by $65.2 million for FY 2012 and $86.6 million for FY 2013.

PSPRS must follow the FASB and GASB accounting standards, and the Auditor General reiterated that in its report.  The Auditor General did not suggest any wrongdoing, and the different valuations done by the same auditor show that appraising an asset like the Desert Troon portfolio is difficult and can vary wildly depending on the evaluation criteria.  Desert Troon's own valuation using projected discounted cash flows based on future development plans is not permissible according to FASB and GASB and should not have been used, but it ended up being closer to the final, accepted valuation of the Desert Troon portfolio than EY's initial valuation.  Maybe this was just luck, or maybe Desert Troon has the expertise and experience to evaluate the properties it owns and manages.

From my vantage point way on the outside, I am not seeing where there is any wrongdoing.  A bad decision, though one approved by the Board of Trustees, perhaps, but with full transparency and no cover-up.  Of course, this has all the trappings of a scandal: resignations, missing documents, lawyers, and federal agents handing out subpoenas.  We will have to wait and see what happens, and whoever has to go through the three million pages of financial documents has my sympathy.