"Professionalizing" Pensions

Luis Navas and Brad Kelly recently wrote a brief article entitled “New Governance Models Pay Off For Pensioners: The American vs. Canadian Pension Fund Experience.”  The piece describes the professionalization of Canadian pension funds: more internal asset management, better salaries:

Most public pension funds in the U.S. are managed within government and are often just an extension of the state treasurer or comptroller office. Boards of Directors of these funds are also commonly comprised of government bureaucrat appointees and elected politicians. In Canada, public pension funds are moving away from this historic management style and are taking a more progressive approach to money management. . . .

It is hard for stakeholders and Boards of Directors to embrace the understanding that  higher compensation levels are required to attract and retain top talent. However, once Teachers’ broke the barriers and began realizing the benefits, it did not take long for other Canadian pension funds such as the Canada Pension Plan Investment Board (CPPIB), Ontario Municipal Employees Retirement System (OMERS), Caisse de dépôt et placement du Québec (Caisse), and most recently Alberta Investment Management Co. (AIMCo) to follow.

During their transformations, each pension fund altered its governance philosophy, adopted market competitive compensation levels and incentive designs, recruited top talent, and internalized most, if not all, of their investment activity and expertise.

The more time I spend analyzing the issues confronting US public pension plans, the more I am convinced that the problem is not that there is not enough governance over public pension plans, but too much, or rather, the wrong type of governance.  Many of the legal structures used to promote good governance, such as boards with trustee-like fiduciary duties, do not serve pensioners as intended. Partially, this is a function of the relative lack of accountability of pension boards compared to other board/beneficiary relationships like corporate boards, which are increasingly beholden to shareholders, and private trust trustees, who are much more likely to be successfully sued for breaches of fiduciary duty.  Additionally, governance by elected and appointed officials often politicizes pension boards, reducing their effectiveness and returns (see, e.g., Romano).  Professionalization, aside from the savings funds receive by in-sourcing investment management (and avoiding significant fees even in years where the external asset managers produce no significant returns), can help to insulate funds from political pressures. How?  The professionalization I’m thinking of includes not just in-sourcing asset management, but rethinking the pension governance model entirely.  The point is nicely made by Kirkland partner Jonathan Henes, writing on the NYC pension reform proposal:

New York City studied the best investing models to bring the governance of its pension funds into the 21st Century. For instance, New York City looked to Ontario’s Teachers’ pension funds, which is known to be top of its class, and observed that 95% of its investment decisions are made by professional investment managers. With Ontario’s Teachers and other best-in-class pension systems mind, New York City is proposing to completely restructure the management of its pension funds.

Rather than 5 boards and 58 trustees, the proposal will bring together the 5 pension plans under one roof to be managed by professional investors and a non-partisan staff. If approved, New York City will take the politics out of its pension plans and will streamline the asset management process. This restructuring is critical as the pension money needs to be protected and have the greatest opportunity to realize a reasonable rate of return.

SWF Infrastructure Investing

SWF and infrastructure investment seem to fit well together for so many reasons: long-term projects, long-term investors, huge amounts of capital, huge capital requirements, and so on.  It is a surprise, then (at least to me), that it has taken so long for SWF infrastructure investment to gather momentum (Ashby Monk and colleagues have a paper explaining some of the challenges and potential solutions to these challenges).

An Arab Times article reports a recent study KFH-Research indicating that “despite the recent poor performance of subscriptions and money gathering, infrastructure funds are expected to attract more investors and to continue achieving reasonable growth; especially after the growing trend to spend funds on in infrastructure projects and the participation of the private sector in those projects.”  Among these investors are SWFs. The report states that:

In recent years, sovereign wealth funds have also begun to play an increasingly important part in the infrastructure investor landscape, gaining significant exposure through both infrastructure funds and direct investments. Infrastructure assets appeal to sovereign wealth funds as they offer the potential for steady, inflation linked cash flows over long time periods. . . .The popular areas for infrastructure investments by sovereign wealth funds are Asia and Europe. Approximately 45% of sovereign wealth funds that invest in the asset class target opportunities in Asia, with the same proportion having a preference for Europe. In comparison, 42% seek infrastructure investments in North America, while MENA is favoured by 32%. The majority of the sovereign wealth funds investing in the MENA region are domestic investors such as Dubai International Capital and Abu Dhabi Investment Council, which have an emphasis on domestic development. In the last year there has been a marked increase in the number of sovereign wealth funds targeting global infrastructure investments. At present, 52% of the sovereign wealth funds investing in infrastructure target global investments, a significant increase on last year’s figure of 41%. This desire among sovereign wealth funds to acquire a globally diversified infrastructure portfolio suggests that whilst many of these investors historically gained exposure as a means of aiding development in their home nations, now more and more are seeking infrastructure assets for the value they can add to an investment portfolio.

Can we get some more SWF help here in the US to mitigate our infrastructure crisis?

Pension Funds and Class Action Litigation

When I teach my students about what corporate and securities class action lawyers do, I try to present their role critically but fairly: I label them as claim entrepreneurs who (hopefully) have a disciplining effect on managerial behavior, but also often simply act as a tax on ordinary transactions and corporate behavior with no meaningful governance impact. I typically tell the story of the Hammer Museum in LA, as related by my business associations professor at UCLA, Steve Bainbridge; in essence, Armand Hammer used $89 million of Occidental Petroleum’s money to build a museum in his name. Class action lawyers, acting for the shareholders, brought a derivative suit against the directors. The lawyers were paid, but what was the benefit to the shareholders? The museum was to be renamed to acknowledge Occidental (it wasn’t), and shareholders were offered a “first look” at the museum when it opened, at the cost of only $40 a ticket.

The Private Securities Litigation Reform Act of 1995 created a presumption that the lead plaintiff in a given securities class action should normally be the shareholder with the most money at stake. The idea behind this was to put those with the most skin in the game in charge, in the hopes that they would do a better job of supervising their lawyers than the professional plaintiffs who were hired by Milberg Weiss. The significant positions held by pension funds in many public companies make them natural candidates for lead plaintiff status, hence the courtship of pension funds by class action law firms. Rather than eliminating potential conflicts of interest in class action litigation, however, the PSLRA generated different ones, as made clear in an illuminating speech by Edward Siedle.  Here are a few of his important takeaways:

For years I’ve urged public pension officials to scrutinize the arrangements they enter into with class action law firms, just as they vet investment consultants, money managers, brokers and anyone else doing business with their funds. Nevertheless, scrutiny of lawyers by public pensions remains severely limited–and not just among pension officials.

For example, in 2009 New York Attorney General Andrew Cuomo who was going after allegedly crooked investment consultants for bribing their way into doing business with the state’s giant pension fund, stated that he would not subject class action law firms (from which he reportedly received large campaign contributions) to similar scrutiny for similar behavior.

Given that the Invasion of the Class Action Securities Lawyers is a very recent event—largely a phenomena of the new millennium – it is not surprising that the issues related to arrangements between these law firms and public pensions have yet to be adequately addressed. This is a new development in the world of pensions. . .

If you’re looking for lawyers to represent you when the next Enron scandal surfaces in the pages of the Wall Street Journal, these guys are very likely to be tough litigators up to the task. However, I wouldn’t necessarily call what these firms do “monitoring your portfolio for potential fiduciary breaches or violations of law.” Further, if all they’re doing is suing for widely-known wrongdoing, do you really need a monitoring arrangement at all? Simply hire firms on an as-needed basis.

It’s important for public fund boards to keep in mind the narrow services the class action securities law firms actually provide, as opposed to the expansive capabilities these firms often claim. Further, the contract between monitoring firms and public funds should reflect the actual services being provided “for free” and firms which are not performing pursuant to their contracts should be terminated. . . .Disclosure of political contributions and fee-sharing arrangements should also be required and fully understood by boards. Local counsel should be required to annually disclose any compensation, derived from any source, related to the pension.

The entire speech is well worth a read.


Stanford Receiver Seeking to Freeze LIA Assets Loses Appeal

Allen Stanford was an asset manager found guilty of defrauding investors out of $7 billion in a Ponzi scheme.  He is, according to the Justice Department, “a ruthless predator responsible for one of the most egregious frauds in history,” and he is scheduled to be sentenced today.  One of his victims was a Libyan SWF, the Libyan Foreign Investment Company (“LFICO”).  As the court noted, 

LFICO invested $138.9 million in SIB [Stanford International Bank, Ltd.] CDs between March 2006 and August 2007. Starting in October 2008, LFICO began to withdraw significant amounts of money from the Stanford CDs. Between November 2008 and January 2009, LFICO withdrew approximately $51.6 million from its accounts with SIB; according to Janvey, $6.7 million of this was fictitious interest. Despite these withdrawals, at the time the fraud was revealed, LFICO had over $100 million in investments with SIB, making it, in the words of the district court, the “biggest net loser” in the Ponzi scheme.

After the scheme was uncovered, a U.S. district court took control over Stanford’s assets and records and appointed a receiver to provide an organized and equitable recoupment of the assets for Stanford’s creditors, including LFICO. An important part of this process is the pursuit of claims against parties who received preferential treatment prior to or during the bankruptcy or who were, as it is termed in the relevant statutes, “fraudulently transferred” more than their fair share of the assets. An important question for the Stanford bankruptcy case was whether the receiver, Ralph Janvey, would be able to go after funds in possession of LFICO’s parent, the Libyan Investment Authority.  From the decision:

In this proceeding . . . the Receiver does not seek funds belonging
to LFICO. Instead, he seeks funds in the possession of the LIA, another entity
established by the Libyan government. In 2006, the Libyan government
established the LIA for the “object of . . . invest[ing] and grow[ing] the funds
allocated to it.” The LIA is currently the sole shareholder of LFICO.
The Receiver alleges that approximately $55 million to $101 million
dollars in proceeds of SIB had been transferred fraudulently to LFICO. He
further alleges that the transfer of these funds to LFICO had benefitted the LIA,
given the relationship between the two entities. Accordingly, Janvey sought a
temporary restraining order freezing funds in the amount of $54,823,740.83, and
a preliminary injunction preventing the LIA and LFICO from dissipating those
funds, which are currently held in accounts at Citibank, N.A.

The district court held against Janvey on the basis that Janvey had not shown that LFICO had acted for the “benefit” of the LIA and had not shown that the LIA was an alter ego of LFICO, thus there was not the necessary linkage between the parties to justify seizing LIA’s assets.

Lurking behind this case is the Foreign Sovereign Immunities Act.  As Curtis Bradley explains,

The Foreign Sovereign Immunities Act (FSIA) provides that foreign states shall be immune from the jurisdiction of U.S. courts unless the suit falls within a specified statutory exception to immunity. . .  The FSIA does not define “foreign state” directly, but rather provides that for the purposes of the Act a “foreign state” “includes a political subdivision” as well as an “agency or instrumentality.” The phrase agency or instrumentality is in turn defined to include “any entity” that “is a separate legal person, corporate or otherwise” and that is either an organ of a foreign state or has a majority of its shares or other ownership interests owned by a foreign state.

This would seem to make the LIA’s assets immune from seizure.  However, Janvey argued that the FSIA should not apply because LIA did not hold legal or equitable title to the funds since they had been fraudulently transferred from SIB to LFICO for the benefit of the LIA. The 5th Circuit Court of Appeals disagreed, holding that “the Receiver’s argument that the funds are not ‘property of a foreign state’ for purposes of 28 U.S.C. § 1610(d) has no merit because there is no evidence that the funds at issue in this particular case have ever been the subject of a fraudulent transfer by the SIB.” The ruling suggests, of course, that the court would hold that the FSIA would not apply had there been a benefit to LIA.  As the district court explained–an explanation the 5th Circuit seemed prepared to accept–“if the Receiver had shown a likelihood of success on the merits of the fraudulent transfer claim, the Court would likely not afford FSIA anti-attachment protection. Cf. Brenntag Int’l Chems., Inc. v. Bank of India, 175 F.3d 245, 252 (2d Cir.1999) (holding no FSIA anti-attachment protection where defendant had no legal right to the property at issue).” The basis for this interpretation of the FSIA is the “commercial activity” exception in 28 U.S.C. sec. 1605(a)(2), which sovereign funds would do well to remember. As described by the U.S. Supreme Court in Verlinden, “the [FSIA] codifies, as a matter of federal law, the restrictive theory of foreign sovereign immunity under which immunity is confined to suits involving the foreign sovereign’s public acts, and does not extend to cases arising out of its strictly commercial acts.”

Recommended Research: Transition Costs as an Impediment to Pension Reform

Robert Costrell and the Arnold Foundation have recently put out an interesting policy paper on legislative obstacles to transitioning from Defined Benefit plans to Defined Contribution, Cash Balance, and Hybrid plans:

This paper examines the most common of these claims, that structural pension reform requires an acceleration of payments to amortize the old plan’s unfunded liability. The claim has three components:

(i) A rule set by the Government Accounting Standards Board (GASB) requires an accelerated amortization schedule for the Annual Required Contribution (ARC) if the old DB plan is closed to new members;

(ii) GASB rules for the ARC determine state funding policy, thereby driving actual contributions; and

(iii) The GASB rule for closed DB plans is sound policy, since covered payroll shrinks, ending the basis for a rising schedule of amortization payments.

The paper finds that:

    • The first claim is true. GASB accounting standards unambiguously require a shift in amortization methods from “level percent of payroll” – a back-loaded method – to “level dollar” if the old DB plan is closed to new members. This shift in amortization methods accelerates the amortization schedule for the ARC calculation.
    • The second claim is false. GASB sets standards for financial reporting; it does not determine funding policy and does not claim to. Pension plans are required to report the ARC for comparison with the actual contribution, but the actual contribution is set by each state’s statutory authority – either the legislature or the pension board, if that authority has been delegated. These authorities are not bound by GASB accounting standards in setting funding policy, and actual contributions often differ from the ARC.
    • The third claim is false. GASB’s rule assumes that amortization payments must be based on the payroll of DB members alone, a base that shrinks after closing the plan. However, states can and do levy these payments on total payroll – old and new plans alike – and with sound justification. Total payroll growth is unaffected by closing the DB plan, so there is no policy reason to change amortization methods. The rationale put forth by GASB for “level percent” amortization, based on a growing payroll, continues to be satisfied by total payroll. The GASB rule for closed plans, based on payroll of DB members alone, does not seem to anticipate the total payroll approach.

The paper can be found here. Keith Brainard of NASRA provides commentary on the paper here.


Ohio State parking to be leased to QIC

From the Columbus Dispatch:

It looks as if Ohio State University administrators think $483 million is too good a deal to pass up.

Campus officials announced yesterday that they plan to ask the Board of Trustees on June 22 to approve leasing OSU’s roughly $28 million-a-year parking operation to QIC Global Infrastructure and its partner, LAZ Parking, for the next 50 years.

QIC is a long-term investor based in Queensland, Australia, and LAZ Parking is a parking operator based in Hartford, Conn.

The debate over privatizing parking at OSU has been acrimonious and occasionally baffling to me. Some of the arguments offered seem completely detached from the realities of university finance and dramatically overstate the effects of choosing one course or another; I suppose I should have expected this. Some of my frustration with the debate comes from the characterization by some parties (including a prominent student group) of privatization as a kind of corporate takeover of the Gordon Gekko variety. Without spending any effort trying to defend the lease as a general matter (the university administration has already spent great efforts to do so, and I have little to add that could convince readers one way or another; opposing views are also available via the link), the OSU lease debate reminded me that institutional investors often face an image problem. Even a stable, long-term investor like QIC is likely to be viewed with suspicion by affected constituencies. This is not surprising, of course–QIC is a foreign investor looking for a stable ROI, and they will likely anger some constituencies no matter how they manage the lease. I found it interesting, however, that QIC selected someone with local ties–and an Ohio State degree–to chair the project. From the Dispatch:

QIC has asked Ohio State alumnus William J. Lhota, the recently retired president and CEO of the Central Ohio Transit Authority, to be chairman of the project, pending board approval. OSU officials said they didn’t know what Lhota’s exact role would be, but they suspect more details will be revealed at the trustees meeting.

As I argued in a paper several years ago, governmental investors like QIC may be constrained by host country politics. The investors’ investment and management decisions are often directly (and unsurprisingly) affected by these political variables. I don’t mean to suggest that Mr. Lhota is not the right candidate for the job; rather, he may be just the right candidate because of his ties.