HOUSE BILL NO. 139 "An Act providing an exemption from the state procurement code for the acquisition of investment- related services for assets managed by the Board of Trustees of the Alaska Permanent Fund Corporation." 9:00:52 AM REPRESENTATIVE JENNIFER JOHNSTON, SPONSOR, read from a prepared statement to introduce the bill: Thank you for your willingness to consider House Bill 139 this morning. House Bill 139 grants an additional exemption to the state's procurement code to the Alaska Permanent Fund Corporation (APFC) for the purposes of evaluating and managing investments. The types of investments this exemption would apply to are often very profitable for our state. Under existing law, the corporation exempt from the states procurement code when it requires income producing assets or delegates its investment authority. However, they must comply with the state's procurement code when evaluating and managing the assets in which they invest. The change proposed in this bill would allow a timeline that better aligns with the pace of the market in which APFC works and would result in a more streamlined process. 9:02:15 AM Representative Sullivan-Leonard asked for an example of why changing statute would be important for the Alaska Permanent Fund Corporation (APFC). Vice-Chair Johnston answered that the corporation was involved in private equity investments. She indicated that without the exemption, the cost of evaluating private equity was paid to an investment manager that may charge more than the state would thorough contracts with internal expertise. ANGELA RODELL, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND CORPORATION, agreed that there were numerous private investments made by APFC that required subject matter expertise or going through the procurement process to directly invest. Currently, the corporation hired outside managers to swiftly move the transaction forward. The bill would streamline the process and reduce the costs that was necessary to act on the types of investments. Representative Sullivan-Leonard asked for verification that there was a time element involved and by sidestepping the procurement process the investments were quickly secured. Ms. Rodell affirmed the statement. Vice-Chair Ortiz asked how long APFC had been without the exemption. He wondered if there was any downside to making the adjustment. Ms. Rodell answered that they had begun private equity investments in the 2008 to 2009 timeframe and was a more recent development. Vice-Chair Ortiz asked if there was any downside to allowing the change. Ms. Rodell answered in the negative. 9:05:29 AM Representative Knopp considered how the procurement code applied to the work done by APFC. He deduced that the exemption would allow the corporation to enter into short term contracts with external fund managers. He asked how the state's procurement code exemption related to sole source contracts. Ms. Rodell responded that presently the corporation was fully subject to state's procurement code, apart from purchasing investments. She exemplified that the corporation could expend $250 million to buy an office building but it could not directly hire an engineer to inspect the building without going through the state procurement code. She detailed that the code had a timeline for an open bid process that tended to be 14 to 21 days. In addition, a committee to evaluate and score the bids along with a 10-day notice of intent to award was required. The notice time allowed for grievances by the bidding parties. She explained that if a building was for sale that had a 30-day open period to complete the inspection the current procurement process would miss the purchasing window. She added that that the code included a limited process for contracts that were less than $100,000, but in many cases the subject matter requirements were in excess of that amount, which did not make the limited process feasible for APFC. Representative Knopp asked whether the APFC was limited to investments up to $250 million. Ms. Rodell answered the corporation was permitted to purchase any investment of any size. Representative Knopp verified that the exemption was for subject matter analysis with costs exceeding $100,000. Ms. Rodell answered that the $100,000 limit had just been one example. She furthered that any type of expertise; i.e. doctors or medical researchers for a biotech investment - any expertise that was not the acting fiduciary fund managers were the third-party outsourcing referred to by Vice-Chair Johnston. She stated that the exemption was an effort to allow direct investments while eliminating fund manager fees and having the expertise at the table to act within a timely manner. Many investment purchases operated on a short timeframe of up to 3 months. Representative Knopp asked whether the investments operated under earnest agreements. 9:09:30 AM Ms. Rodell replied that earnest agreement features were not part of private investment transactions. Co-Chair Wilson asked how much business the APFC had lost because it lacked the exemption. Ms. Rodell replied that the answer was difficult to quantify. She shared that APFC looked at 6 to 10 investment opportunities each year that required the process and had passed on roughly five to ten investments each year. Co-Chair Wilson asked whether APFC had passed on the investments because they did not have the exemption or if other reasons applied. Ms. Rodell responded that the reasons varied and when the corporation identified the process as a problem, they hired a fund manager to handle the process. Co-Chair Wilson understood that the APFC could bypass the state's process, but it was more costly without the exemption. Ms. Rodell replied in the affirmative and confirmed that it was much more expensive. Co-Chair Wilson asked for documentation showing the costs. Ms. Rodell answered that the documentation was difficult to provide but would comply. She explained that when APFC sought investments through a fund manager, the manager was entitled to a share of excess profit and a threshold of performance was added to the contract. In the case of excess profit over and above the expected return, the excess was referred to as "carried interest." The fund was entitled to a percentage; the industry standard was 20 percent of the excess profit went to the manager and 80 percent to APFC. The exemption would mean APFC captured all the excess profit through direct investing. She accentuated that the process made it difficult to quantify to costs. The corporation had been attempting to make more direct investments through internal managers. The bill did not ask for a full procurement code exemption. The bill would provide expanded authority when considering direct investments allowing APFC to bring in expertise and return more excess profit to the state. Co-Chair Wilson asked for information on the process they used in the past five years. She wanted to determine how often APFC had to use the outside process Ms. Rodell just described. Ms. Rodell agreed to follow up. 9:13:02 AM Representative Carpenter deduced that the corporation could do what it wanted to do; it just took longer. Ms. Rodell affirmed. Representative Carpenter asked whether there was a higher risk involved in doing things in a shorter time period. Ms. Rodell answered that when APFC conducted due diligence on an investment the window was open for a specific time period - typically 30 to 45 days. The state procurement code did not enable APFC to act within the timeframe. She detailed that in terms of risk, the ability to hire subject matter experts within 10 days and work closely with them for 30 days versus relying on outside investors created a different risk profile. There were risks to both processes, but the effort was to provide more comfort in the due diligence process, not increase risk. Representative Josephson construed that APFC paid a fee for an expert through an investment manager and subsequently paid them a share of the profits from a successful investment. He asked for verification. Ms. Rodell responded affirmatively. She recapped the process she had explained earlier. Representative Josephson restated his question whether the manager profited from Alaska's investments. Ms. Rodell responded in the affirmative. She furthered that the investment manager acted as the fiduciary and needed to evaluate the investment and access risk for their investors. The investor was at risk and did not serve their interests to "rubber stamp" an investment. 9:17:16 AM Representative Josephson gave an example of APFC wanting to purchase a building in Manhattan. He asked whether what the corporation paid for the investment was a matter of public record. Ms. Rodell answered in the affirmative and added that all the expenses associated with investments were reported quarterly. Representative Josephson asked whether the process could be taken advantage of. He hypothesized a situation where the state had always hired the same architect in Denver. Ms. Rodell thought it was a fair question. She believed that it was necessary for the corporation to continue to maintain an internal process that scrutinized and distributed contracts. The corporation used a number of outside consultants to weigh in and ensure a procedure "passed the smell test." She elaborated that the performance of the funds portfolio was an indicator of the quality of the due diligence undertaken by APFC. She expected that the investments would perform well. Representative LeBon thought the discussion was "mixing apples and oranges." He elaborated that the issue was about the global market for venture capital investments and working with a fund manager to invest in a business. Ms. Rodell answered that all the issues encompassed in the entire discussion were relevant and included his example as well as an engineer evaluation of a building and a market assessment to sell "widgets in Europe." Representative LeBon asked for verification that APFC would still have the fiduciary responsibility to perform diligence and was not trying to shortcut the process. Ms. Rodell replied in the affirmative. Representative LeBon surmised that the corporation was attempting to build a base of expertise in order to make many types of investments and was seeking the flexibility to call on the experts quickly in a timeline that fit the opportunity to make the investment and respond to market opportunities. He asked whether his statement was "fair." Ms. Rodell agreed with his summation. Co-Chair Wilson asked whether it mattered if there was an in-house versus external manager. Ms. Rodell replied that if APFC undertook the process they had to operate through the procurement process versus when the corporation hired an external manager and invested in a fund the transaction was exempt from the procurement process. Co-Chair Wilson asked whether the arrangement was exclusive to buildings. Ms. Rodell reiterated that the process was for any type of investment. 9:22:44 AM Co-Chair Foster believed a similar bill had been before the legislature in the past. He asked if there were any negatives that they should be aware of. Ms. Rodell answered that the prior bill provided a full procurement exemption like the full exemptions allowed the ARM Board, Alaska Housing Finance Corporation (AHFC), AIDA, and all other quasi-agencies like APFC. She elaborated that the current bill was a compromise and had been developed by the corporation at the request of the trustees. The change was a priority of the board. She did not see any negative aspects to the bill and ideally would prefer a full exemption. Co-Chair Foster surmised that the answer to the concern was a more targeted procurement exemption. Ms. Rodell affirmed. Representative Carpenter did not want to defend a procurement process that exceeded 50 days, but he did not know the process. He asked what parts of the process would be omitted by the exemption. Co-Chair Wilson interjected that she was trying to understand if the overall procurement system was broken. She felt that it was not the problem of APFC if the whole system was broken. 9:25:41 AM Ms. Rodell answered that the state procurement code was in place to purchase everything state government needed to operate - from pencils to furniture and all other items. She observed that the code was written more for commodity acquisitions than services. The code was designed to give comfort to the public that a competitive process was in place. In APFC's case, the code caused the corporation to pay more for services because they were forced to use an alternative method for necessary investment related services. She believed the balance point had to be weighed. She could not speak to the procurement code and how it worked for other departments like the Department of Transportation and Public Facilities (DOT). The board wanted the corporation in charge of the decision making process to more align with the fund's investment goals. The exemption offered an opportunity for APFC to create more value for the state. She offered that 4 years ago the fund totaled $52 billion and was currently $66 billion after a $2.7 billion transfer in FY 19 to the states Treasury. The corporation took its stewardship seriously and looked for ways to save costs. She believed that the exemption provided the tools for APFC to tap into expertise that was not needed daily and reduced the investment costs thereby, increasing returns. 9:28:55 AM Representative Carpenter needed more clarity on what parts of the process would be eliminated by the exemption. He thought the person in charge of the procurement process was better suited to answer the question. He was concerned there was an "unwieldy" procurement process but did not favor providing exemptions when the process was challenging. He felt that the procurement code served a purpose. He determined that the process needed to be fixed or improved but was not a justification to make exemptions from the process. He concluded that without understanding the process that was being exempted he was unable to support the legislation. Co-Chair Wilson noted that the committee could hear from the Department of Administration (DOA) at a future hearing. Co-Chair Foster referenced Representative Carpenter's concern. He suggested a chart illustrating how the procurement process works. Ms. Rodell referenced a document provided in members' packets [titled "APFC Legislative Initiative: Procurement Streamlining"] (copy on file). She communicated that the timeframe information was included in a chart format. She pointed to the timeline information with and without the procurement code process. Co-Chair Wilson interjected to reference the document. She asked Ms. Rodell to speak to what was eliminated via the exemption. Ms. Rodell responded that the 21 day notice, and the 10 day protest period would be eliminated. Co-Chair Wilson asked what would happen if the protest period was removed. She deemed that the ability to protest a contract award would be eliminated. 9:33:03 AM Ms. Rodell confirmed her conclusion. She maintained that the idea of the exemption was to enable the corporation to hire a subject matter expert without much bidding. She delineated that the contracts would not be sole source contracts but were considered limited source contracts. Very few individuals had the expertise for much of the subject matter. Co-Chair Wilson reiterated her concern that if someone disagreed with the process there would be no period for protest. She suggested shortening the protest period. Vice-Chair Johnston noted that the bill requested a degree of flexibility. She referenced private equity investment and the speed at which the market was operating at present. She pointed to Silicon Valley and the biomedical field as examples. She observed that in order for APFC to get in on the "ground floor" of some of the investments without a fund manager "it was necessary to be good and somewhat flexible." She provided a historical example of a biomedical fund investment that had done well for the Permanent Fund (PF) and the investment manager. The corporation invested directly before the company went public on the stock market and garnered large profits for the state but also the fund manager. The APFC was starting to get sophisticated enough to do some of the work itself that would involve hiring a small group of market analysts. The question to the committee was whether they wanted to stay with the status quo and be dependent on fund managers and make less on the investment by following the procurement code. Alternatively, did they want a process for APFC to hire someone with strong expertise and bring the corporation to the private equity table. She asked Ms. Rodell how often the option would be used annually. 9:37:30 AM Ms. Rodell answered the fund would use the option approximately 10 to 12 times per year. She reported that APFC was spending $1.2 billion or so on private equity investments per year and guessed the answer based on the calculation. Co-Chair Wilson believed that the committee's due diligence required determining whether the timeframe in the bill was accurate. She thought everyone wanted the fund to have the ability to purchase investments but maintained her concern over relinquishing "checks and balances" that were in place. Representative Knopp shared that prior exemptions from the procurement code with the Department of Corrections (DOC) and the recent sole source contract issues with the new administration created concerns over procurement code exemptions. He wanted to understand the implications. He remarked that managing assets and acquiring them were two separate processes. He wondered whether external fund managers had the discretion to acquire assets or if the decision was made initially through the APFC board. He asked who performed the due diligence. Ms. Rodell answered that external fund managers conducted their own due diligence. Representative Knopp deduced that the exemption would apply to investments by APFC and their internal management. Ms. Rodell replied affirmatively. Representative LeBon surmised that a venture capital firm would already have performed its own due diligence before offering an opportunity to a potential client. Ms. Rodell agreed with the statement. 9:41:37 AM Representative LeBon communicated that a venture capital firm valued its offering and divided the amount into shares that were purchased by a group of investors. He asked whether his statement was correct. Ms. Rodell answered in the affirmative. Representative LeBon stated that when the opportunities were offered time was of the essence. He stated that if a ninety day window of opportunity was offered the bill would be unnecessary. Ms. Rodell affirmed his conclusion. Representative LeBon stated that the investor set the clock. Ms. Rodell agreed with the statement. Representative LeBon was attempting to "frame the discussion" and pointed out the need for the legislation. Representative Josephson noted that there were 50 existing exemptions to the procurement code. The bill would create the fifty-first exemption. He asked how to avoid any sort of long-term "coziness" between the contractor and APFC. Ms. Rodell answered that if the corporation was fortunate to get the exemption the process would be imbedded in the investment policy process that was reviewed frequently by the APFC board. There was a regular review trustees conducted on performance and existing investment manager relationships. The boards reporting requirements extended to the public. She reassured the committee there would be a process in place with the intent to avoid "coziness." 9:45:08 AM Representative Josephson emphasized that along with APFC's ability to be nimble and act quickly the corporation would retain more of the profit that currently went to fund managers. He deduced that the exemption was about increasing profit for the state. He asked for more information regarding the increased profitability under the exemption. Ms. Rodell replied that APFC would report the size of the investment manager fees in total at its upcoming board meeting. She detailed that currently, the carried interest profit sharing piece was in excess of $100 million. The asset class was approximately $9 billion at present and had returns of almost 33 percent in FY 18. The entirety of the fund was not invested in the asset class because it was too high risk and illiquid. She furthered that the goal was a balanced asset portfolio and the current discussion included roughly 12 percent of the fund. When the fees were paid, APFC received 80 percent, but the corporation would like to capture more of the lucrative returns. She explained that the method to capture more of the lucrative returns was to "reduce the levels" - either directly or through a fund. The corporation had used a fund called a "fund to funds." The fund to funds encompassed hiring a fund to choose the funds for APFC that chose the underlying investments or portfolio companies. The corporation initially employed the fund to fund method, but over time APFC had gotten rid of most of the fund to fund categories to reduce expenses and was additionally considering how to reduce reliance on fund managers and allow the corporation to examine portfolio opportunities and invest more directly. The bill would provide a resource to engage in the process more directly. Co-Chair Wilson wondered how the legislature would know whether the exemption was the wrong way to go. She trusted Ms. Rodell but inquired how the legislature could judge whether reinstating the "extra parameters" embedded in the procurement code was necessary if the exemption was unsuccessful. 9:49:39 AM Ms. Rodell answered that she would judge success in the return metric. She explained that APFC determined its returns by measuring itself against a passive benchmark; as if a computer was choosing the investments, and a performance benchmark that indicated how the active managers were performing. The two benchmarks indicated how well the internal staff was performing over and above the external managers. She added that market influences created poor performance and the benchmarks eliminated the "market noise" from the performance to understand where investment selection was driving value to the fund. She noted that each asset class had its own performance benchmark that assessed whether the fund was consistently underperforming. If the corporation was awarding too much to one contract that lead to bad investments it would be reflected in the numbers on a quarterly basis. Representative Sullivan-Leonard stated her support of the bill. 9:51:40 AM Representative Carpenter asked about the value of the investment decision procurement example on the left side of the table on page 2 of the APFC document that illustrated the review process. He noted the inclusion of a Proposal Evaluation Committee (PEC) under the existing procurement process and felt that it was indicative a good review process. He observed that good management of public funds was not adversarial to flexibility for the corporation. He wondered whether a partial exemption "may be at odds with good management." He suggested the committee examine why the procurement process was necessary and answer the question of what exactly was going to be exempt. Co-Chair Wilson noted that an employee from the procurement office at DOA would address the committee at a future meeting. She thought it would be interesting to find out why the procurement steps were initially implemented. Representative Josephson asked what value came from the RFP (Request for Proposals) process. He wondered how the corporation was guided to "names that were predictable" to the corporation. Ms. Rodell replied that the corporation had a network of people it interacted with that held a variety of expertise for the different types of investments. For example, if APFC was looking to invest in an Australian infrastructure project it would probably call for recommendations on expertise from the managers of the two Australian sovereign wealth funds that APFC invested in and had experience with. The RFP process would "make it difficult" to proceed in the manner she just described. 9:55:11 AM Representative LeBon indicated that the opportunity costs that were lost if the corporation never had the chance to follow up on an investment were difficult to measure. Ms. Rodell agreed with the statement. Representative LeBon suspected the procurement process had been written before the inception of APFC. He asked how many other agencies had asked for the same modification from the procurement process. He suspected the answer was very few or none. Ms. Rodell replied that the Alaska Retirement Management Board (ARMB) was completely exempt from the state procurement code. Co-Chair Wilson OPENED public testimony. 9:56:25 AM MIKE COONS, ASSOCIATION OF MATURE AMERICAN CITIZENS (AMAC), PALMER (via teleconference), opposed the legislation. He recounted Ms. Rodells testimony that previous requests for the exemption was not granted. He stated that his faith in the Permanent Fund process was extremely low. He thought once the current Permanent Fund issues were taken care of and the trust of the public had been regained perhaps, he could support the bill. Co-Chair Wilson asked if Mr. Coons would be sending a letter in from AMAC. Mr. Coons replied that he would try. Co-Chair Wilson asked what AMAC stood for. Mr. Coons answered that it stood for the Association of Mature American Citizens. Co-Chair Wilson asked if he was speaking on his own behalf or the organization. Mr. Coons indicated that he was speaking on behalf of the chapter and agreed to send a letter. 10:00:50 AM HERMAN MORGAN, SELF, ANIAK (via teleconference), did not support the bill. He did not trust the legislature. He did not support using money from the Permanent Fund for a gasline. He thought the legislature needed to listen to the people of Alaska. Co-Chair Wilson clarified that the bill was about procurement and not the dividend. Co-Chair Wilson CLOSED public testimony. Ms. Rodell reviewed the zero fiscal note from the Department of Revenue, APFC. She believed the legislation would not increase costs. Co-Chair Wilson asked if the Department of Administration would have to write any regulations related to the proposal. Ms. Rodell answered in the negative. Co-Chair Wilson noted the bill would be heard again. HB 139 was HEARD and HELD in committee for further consideration.