Will Alabama Vote to Transfer Funds from the Alabama Trust Fund?

First, a little history.  In 2010, Alabama’s legislators proposed an amendment to Alabama’s constitution that would have transferred $100,000,000 a year for ten years from the Alabama Trust Fund “to provide for a ten year road, bridge and other transportation related construction and improvement program.”  Because the ATF was set up as a permanent, irrevocable trust under the state’s constitution, funds could not be taken from the trust except in accordance with the language in the constitution itself.  So when the state found itself strapped for cash and in need of road repair funds, it could not simply drain the fund.  Two things were required: first, 3/5ths of the Alabama State Legislature would have to approve the amendment, and second, the amendment would have to be placed on the ballot and approved by a majority of the state’s voters.  The legislators approved the amendment, but voters did not:  

Amendment 3 (Road and Bridge Construction)
Result Votes Percentage
 No 702,340 57%
Yes 530,017 43%

So in 2012, we see the same kind of drama unfolding again: a state desperate for funds and legislators “reluctantly” seeking to transfer funds out of the ATF.  Call me cynical, but I suspect that Alabama’s governor and its legislators learned their lesson from the 2010 vote.  Instead of seeking funds for roads, why not seek funds for Grandma?  The ballot measure this time around is entitled the “Alabama Medicaid Amendment, Amendment 1“, as opposed to 2010’s “Alabama Ten Year Road and Bridge Construction Program, Amendment 3.”  The amount sought by the 2012 Amendment is larger on a per-year basis ($145.8 million), but would only draw funds from the ATF for the next three years. 

I could be wrong, but I will be surprised if the amendment passes when it goes up for a vote on September 18.  I also applaud the enshrinement of the ATF in Alabama’s constitution.  As I discuss in my paper on U.S. permanent trust funds, it is exactly for the purpose of guarding against short-term political opportunism and encouraging budgetary diligence that most of these types of funds are created under the state constitution (the amendment of which requires approval of the state’s voters) rather than existing merely as creatures of statute (the amendment of which requires approval by the legislators only).

Qatar Increasing its Holdings? More News on Glencore/Xstrata

Reuters reports that Qatar Holdings will seek (or is already seeking) to purchase additional shares of Xstrata if the deal with Glencore falls through.  Under UK takeover rules, Glencore would not be allowed to vote its shares in the deal.  Qatar is thus able to block the merger, which by statute requires approval of 75% of the disinterested shares, with only 12% of Xstrata outstanding shares (and, it seems, a little help from other shareholders).  A merger partner other than Glencore could approach the company and would not face as significant of a voting hurdle, however, and Qatar apparently sees this as a legitimate concern.  The SWF is looking to obtain more than 25% in order to have the ability to block other takeover attempts. 

Again, I find myself wondering why the Qataris are holding so firm against this deal. I note that Qatar Holdings is not alone in its assessment that a merger with Glencore is not in Xstrata’s shareholders’ interest: Bloomberg reports that proxy advisor ISS seems to agree with the Qataris that the deal would not create a lot of value for shareholders (the deal is “marginal on economic merit”), which may explain why the Qataris have a few likeminded shareholders who are also willing to block the merger.  Xstrata’s management obviously thinks it would be better off with Glencore, but I suspect the proposed £173 million in Xstrata executive retention payments may have something to do with that.

SEC Adopts "Conflict Minerals" Rule

As part of the Dodd-Frank rulemaking–a mountain of rules that the Securities & Exchange Commission has been struggling to implement over the past two years–yesterday the SEC finalized its “conflict minerals” disclosure rules.  The rules require “issuers with conflict minerals that are necessary to the functionality or production of a product manufactured by such person to disclose annually whether any of those minerals originated in the Democratic Republic of the Congo or an adjoining country.”

The enabling legislation, the Dodd-Frank Act, contains a discussion of the purposes of the rulemaking.  As summarized by the SEC:

[I]n enacting the Conflict Minerals Statutory Provision, Congress intended to further the humanitarian goal of ending the extremely violent conflict in the DRC, which has been partially financed by the exploitation and trade of conflict minerals originating in the DRC. This section explains that the exploitation and trade of conflict minerals by armed groups is helping to finance the conflict and that the emergency humanitarian crisis in the region warrants the disclosure requirements established by Exchange Act Section 13(p).

Similarly, the legislative history surrounding the Conflict Minerals Statutory Provision, and earlier legislation addressing the trade in conflict minerals, reflects Congress’s motivation to help end the human rights abuses in the DRC caused by the conflict.

The new rules can be found here.  I don’t have much to add to the discussion of desirability of the rule beyond what has been said by Professor Bainbridge and SEC Commissioner Troy Paredes (both of whom argue that the rules go well beyind disclosure)  No doubt, the DRC is a humanitarian tragedy.  The question is whether this rule does anything to meaningfully address the tragedy.

Aside from that question, what strikes me about the rule is that it shows the SEC’s continued transformation from an agency primarily focused on disclosure to an agency increasingly focused on corruption: insider trading, the Foreign Corrupt Practices Act, and conflict minerals, among other things.  I see the SEC’s enhanced role in corporate governance issues (sometimes, of course, through Congressional fiat, but often on the SEC’s own initiative) as partially an SEC effort to fight on yet another front in a war against corruption.  I am not trying to argue that the SEC should not fight against corruption as a general matter–of course it should, within its Congressional mandate–but in an agency with limited financial resources, I question whether the SEC’s resources are being put to their best use as the SEC increasingly shifts to what seems to be a more litigation-driven agency.  I can’t imagine how the SEC’s anti-corruption and corporate governance initiatives have not invariably diverted resources away from the simple but crucial task of improving disclosures; instead, the rules have made disclosures increasingly cumbersome, opaque and less useful to investors, often of dubious value in actually protecting investors, and, at the same time, much more expensive for companies to produce. (Although it won’t help companies from a cost perspective, perhaps XBRL is the best hope of making disclosures useful for investors again–one could create the company disclosure equivalent to a simple nutritional label, for example.)  Anti-corruption efforts are certainly important to the SEC’s mission to protect investors, but I fear that the SEC’s expansion from its central role as a disclosure regulation agency has had and will have unintended consequences that are not in the best interests of investors.

Glencore Refuses to Budge on Xstrata Deal

Yesterday Glencore again publicly resisted demands by SWF Qatar Holdings to increase its offer for Xstrata.  Qatar Holdings has increased its holdings in recent months so that it may be able to block the deal.  The price of Xstrata dropped 1% yesterday after Glencore’s chief, Ivan Glasenberg, expressed his willingness to walk away from the deal.  Shareholders vote on September 7.  The merger would require approval of 75% of the shareholders, excluding Glencore.  If the deal fails to go through, Glencore must pay a $468 million fee to Xstrata. 

I suspect that Qatar Holdings will blink–there is obviously a lot of uncertainty about how hard China’s landing will be, and Glencore’s offer of 2.8 shares for each Xstrata share seems increasingly generous.  Qatar Holdings has stood firm on its demand for 3.25 shares.  What does Qatar know about Xstrata, Glencore, and/or market conditions that no one else seems to know? 


(image: Forbes)

China to the Rescue?

The Financial Times reports on the attempt to buy the UK’s Horizon nuclear facility by a consortium of investors led by a Chinese SOE.  The UK arguably has been the most open OECD country to Chinese state investments; the report mentions chancellor George Osborne’s January 2012 visit to China, during which he actively sought Chinese investment in UK infrastructure projects.  Some politicians–and public opinion generally–do not seem to be squarely behind such investments:

The British government says the Horizon deal is a matter for the owners, Eon and RWE, the German utilities. However, some UK officials are closely involved and are aware that any bid would have to be acceptable to politicians and the ­public.

This sensitivity explains why officials would prefer the Chinese bidders not to hold majority equity stakes in Horizon and have ensured that they have partnered with companies from other countries. Yet the billions of pounds required to fund the construction of new nuclear plants – likely to come from Chinese lenders – means that in reality the successful consortium could be dominated by Beijing.

“They really are desperate to get this deal off the ground,” said one person familiar with the talks. “If the Chinese are the only option then they have no choice, but that doesn’t mean people aren’t uneasy.”

Similar sentiments were expressed in the US in late 2007/early 2008, as SWFs invested in US financial firms. Significantly, however, as the LSE’s Mark Thatcher notes in a recent paper,

Both Labour and Conservative governments have rejected new legal controls based on overseas state ownership. . . . today ministers [cannot block an investment, but] can only order . . . an investigation on much narrower grounds, notably a potential threat to national security, media pluralism or financial stability. Instead of legal restrictions, UK policy makers have sought an institutional framework based on voluntary ‘soft law’ instruments to protect ‘competitive markets’.

What this means, as a practical matter, is that while the UK and sovereign investors must still be sensitive to the public response to sovereign investment in UK enterprises, it has created a legal structure that has less risk of political holdup than under the foreign investment regulation of the US, Australia, and many other OECD countries.  Less risk of political holdup = more investments.  This result is borne out in Thatcher’s calculation of the total number of SWF investments in the US versus the UK (excluding Norway’s investments): 197 US, 341 UK.  To put the number in context, the World Bank reports a 2011 market capitalization of 15.6 trillion for US domestic listed companies (of which Apple makes up a large chunk!) versus a UK total market cap of 1.2 trillion.

Investments in US Traded Firms: A Rough Comparison of China and Norway

Some interesting results emerge when one compares investments in US traded firms by China’s SWF, China Investment Corp. (CIC), and Norges Bank (NBIM), which administers Norway’s Pension Fund-Global, Norway’s SWF.  One can get an estimate of the large ownership blocks of both NBIM and CIC by looking at 13G and 13D filings with the US Securities and Exchange Commission.  13D filings are made when ownership exceeds 5% of a class of a registered company’s shares; 13G filings are also made when ownership exceeds 5%, but in cases in which the ownership is intended to be passive.

The numbers below reflect the total number of filings (not including amendments) for each of the periods presented:









From these rough results, here’s one rough and unsurprising conclusion: CIC experiences higher transaction costs when investing in US firms than does Norway (for a variety of reasons, which can be reduced to the fact that China is China, and the CIC’s investments are more likely to draw scrutiny than NBIM’s), and so the CIC is less likely to take significant positions in US firms–at least directly, that is.  Interestingly, when they go through the costs of making a large investment, the CIC is just as likely to do it as a 13D investment as a 13G, meaning that they are just as likely to take an investment in which they intend to have influence on the firm as an investment in which they intend to remain passive.  NBIM, on the other hand, has not made any recent investments requiring a 13D disclosure.  They did have 10 such investments from 2006-2008, however, with 7 in 2007 alone.


CalPERS In-State Investments on the Chopping Block

Pensions & Investments reports that CalPERS’ investment committee has pleaded with the CalPERS staff not to go ahead with its 5-year plan to unwind its in-state private equity investment program. 

I could certainly understand why the staff would want to 1) protect themselves from the politics that would seem to invariably accompany an in-state investment program, and 2) not have to worry about the in-state investment program returns dragging down the fund’s overall performance (more on that in a bit).   Aside from that, I see in-state investment programs as creating serious questions of political legitimacy.  I believe that the beneficiaries (and, in this, perhaps also the taxpayers generally, since they may be responsible for shortfalls) should support such an investment program.  But why would they in this case?  P & I reports the returns from the program:

The most recent commitment in the program, $560 million to a Hamilton Lane fund of funds in 2006, has shown an internal rate of return of 0.86% as of Dec. 31 compared to its benchmark’s 6.9% return.

Another $475 million committed to 10 managers in 2001 has shown an annualized -6.4% IRR as of Dec. 31 when the performance of one of the funds — the GCP California Fund, with a 94% IRR — was excluded, according to an analysis of the California-only private equity program presented to the board.

It should come as no surprise that the returns are below the benchmarks.  Historically, it is hard to find state-run directed investment programs that perform as well as private investments, in part because such programs have been known to serve as vehicles for political patronage and corruption, but also for the more banal reason that the universe of potential investments is constrained.  Of course, the private returns may not include all of the social benefits that may come from the state-run investments, but there are certainly social benefits from the private investments–it is just that they may not benefit various voters or other particular constituencies in California.  But if the benefits are that great, why not spell out the benefits to the public and take a vote?  Californians (and I write as a native Californian) are used to voting on just about everything. 

Well, as a matter of fact, some proponents of in-state investments attempted to get a proposal on the 2012 ballot that would require “all State and local public pension or retirement systems to invest and maintain at least 85 percent of their assets in California businesses in which at least 70 percent of the employees are employed within California by January 1, 2016.” The initiative did not garner the required number of  signatures.  And thank goodness.  The California Legislative Analyst’s Office offers this appraisal of the fiscal impact of the proposed initiative:

Potential increase in state and local pension contribution costs of billions of dollars per year (as measured in today’s dollars), depending on how this measure is implemented. Unknown, but likely not significant, net long-term change in state economic activity and related state and local revenues.”

If the Legislative Analyst’s Office is right that the investment of 85% of the hundreds of billions in California public pension assets in California businesses is not likely to have a significant, net long-term effect on economic activity and related state and local revenues, what effect will a much smaller program have (besides, of course, likely diminished returns for the fund)?

Recommended Research: Statutes as Contracts? The “California Rule” and Its Impact on Public Pension Reform

Amy Monahan of the University of Minnesota Law School has written an important new work describing the legislative challenges to pension reform.  Here’s the abstract of her article:

State and local retirement plans are underfunded by trillions of dollars, at a time when many states are facing decreased revenues and increased social needs. As a result, many states are actively considering how best to address the problem of state and local pension plan underfunding given their limited resources. In many states, however, courts have held that the statutes establishing state retirement systems created contracts between the state and employees that prohibit the state from making any detrimental changes to the benefits provided to current employees within such systems, even on a prospective basis. This Article examines the development of such a rule in the California courts, a rule that has been widely influential in this area of law, as evidenced by the fact that courts in twelve other states have followed the California Supreme Court’s holdings. This Article demonstrates that by holding that benefits not yet earned are contractually protected, without explaining the basis for finding that such a contract exists, California courts have improperly infringed on legislative power and have fashioned a rule that is inconsistent with both contract and economic theory.

The full article may be downloaded here.

Image: InlandPolitics.com.