The Pension Offensive
Public pension officials are getting aggressive about holding companies accountable for portfolio losses.
It's not just the bear market. Public pension officials have suffered from the vagaries of the stock exchange in the past. What's pushing them now to flex their muscles and demand corporate refunds and reform is the feeling that they've been had.
"The Enrons of this world caused this to happen," says Max Patterson, executive director of the $1.6 billion Houston Firefighters' Relief and Retirement Fund. "The magnitude of damage was so severe that all of a sudden you have governors and state legislators demanding action be taken." The most persistent call is for funds to recover losses, but there's also pressure on them to be more aggressive in holding corporations and investment-bank advisers accountable in the future.
As a result, pension officials have begun policing corporations, muscling their way into boardrooms and hauling CEOs into court. Although it's a role CalPERS, the $150 billion California retirement- fund giant, has been playing for more than a decade, public pension plans generally have avoided going on the offensive. Now that's changing. "We're coming after corporate America," says Michael Fitzgerald, the treasurer of Iowa who is a trustee of his state's retirement fund. "Even if we're small, we're taking up arms."
In terms of recovery, there is a marked move toward class-action lawsuits--banding together to go after culpable corporations, boards of directors, accounting firms, investment bankers or any other responsible party that might have money in the bank. Security litigation was a hot topic among officials attending the National Association of State Treasurers annual meeting and a pension conference in June. It certainly got Fitzgerald's attention. Iowa's $15 billion pension fund lost upwards of $32 million on WorldCom stocks and bonds alone.
Under Fitzgerald's direction, Iowa is hiring a law firm to monitor cases having to do with corporate malfeasance. If Iowa has an investment in any of those companies--especially investments such as those in WorldCom that were bought when the fraud was taking place-- the state will file lawsuits against the corporate boards, the underwriters selling the state the company's bonds and the accounting firms auditing the corporate books. The state will also work in concert with other state retirement plans that have suffered similar losses. "We've never done this before," Fitzgerald notes, "but it makes sense for pension funds to carry the mantle and sue these companies ripping us off."
California has already taken the lead in a class-action suit against Enron. And the political barometer is rising in other states. While Massachusetts has signed on to the action against Enron, State Treasurer Shannon P. O'Brien, who is running for governor, was criticized for not initiating the suit. O'Brien's political opponents are making a campaign issue out of what they call her lack of aggressiveness against Enron.
It isn't just the companies themselves that are drawing the fire of litigation. The Florida State Board of Administration, which oversees the $90 billion statewide retirement fund and which lost $300 million in Enron investments, is suing Alliance Capital, an asset management company. Alliance managed to snap up Enron equities for the retirement fund even as the energy company was spiraling toward bankruptcy.
Meanwhile, three of California's statewide pension funds filed a $318 million lawsuit against six banks that underwrote WorldCom bonds. The basis of that suit is that investment bankers failed to do adequate due diligence before bringing the bonds to market.
The list of lawsuits goes on. The big names that are usually in the fray, such as the New York State Common Retirement Fund, are keeping their lawyers busy, but so are smaller, less high-profile funds such as the Retirement Systems of Alabama.
Apart from litigation, there's the matter of calling corporations to account and changing the way they govern themselves. North Carolina Treasurer Richard Moore will give you an earful about pension funds "utilizing our market clout to make these markets better and safer for all investors and our pensioners." As Moore points out, pension funds have the leverage to force change: Of the roughly $12 trillion in investments in public marketplaces in the United States, roughly two- thirds of it is owned by either mutual funds or pension funds--and in many instances pension funds are the largest clients of mutual funds.
That's market clout. But that leverage is dispersed--among pension funds and within the funds themselves. In most state and local funds, equity holdings are managed by outside money managers. Not only do the public funds use managers to buy and sell stocks, they also tend to delegate their proxy rights to those managers, reducing the state's or locality's ability to determine corporate policy.
Moore says he is setting up new ground rules for the ways in which money managers interact with his fund. He will require that they ask specific governance and accounting questions about companies they buy and give the fund's trustee--Moore--a "score" on the quality of the corporation's financial transparency and on related accounting issues.
He is also going to use his stock proxies more aggressively to send signals to corporate leaders about what kind of actions and behavior his fund, as an owner of the company, will tolerate. Moore plans to target such practices as the use of stock options, loans to corporate officers, the independence of directors and corporate pay. "We are the largest owners of corporate America," he points out. "We need to do a better job of acting like owners."
The Houston Firefighters Fund has been practicing corporate- governance pressure for years. The fund regularly votes the proxies in companies it owns. What's more, "if we see things we don't like, we don't just vote no," Patterson says. "We write them letters and tell them why." As to delegating proxies, Patterson, who is on the board of the Government Finance Officers Association, points out that money managers "don't pay attention to corporate-governance issues. They focus on financial numbers."
While a fund such as CalPERS has a huge staff and can readily assign personnel to corporate-governance issues, even small funds can find ways to do it. Houston Firefighters has only four investment professionals on staff and they've been able to add governance issues to their portfolios. "It's a question of whether it's important enough," Patterson argues.
Many funds that have not wanted to be openly active--or feel they don't have the resources to be--have stayed abreast of corporate- governance issues through membership in the Council of Institutional Investors. The council was formed in 1985 to keep its members informed and let them know what actions they could take to support positions important to public pension funds. While some of the 120 public- pension members are high-profile funds--CalPERS, for instance, is a member--many are not and they have tended to leave it to the council to testify before Congress and deal with the Securities and Exchange Commission on relevant issues.
Since the Enron and WorldCom debacles, however, a number of council members are on a more militant track. "We've been hearing from funds that are normally very quiet," says Peg O'Hara, the council's managing director. "In the past, corporate governance was kind of regarded as peripheral to a fund's true duty. It wasn't something to draw attention to. That could change."
O'Hara notes that when pension funds band together to make their will felt, they can be effective. A decade ago, many funds united in a decision not to invest in companies that did business with apartheid- ruled South Africa. "Some people thought the divestment campaign was an equal factor in getting results--along with the selective contracting some state and local governments adopted," O'Hara says, adding that a united move to force corporate-governance standards could work, too.
But there are other considerations in using investments to change policy. One of them is the impact on portfolio performance. The limits on South Africa-related investments may have been successful politically, says Girard Miller, chief executive officer of ICMA Retirement Corp., but the sanction-conscious investments did not outperform the general market in the long term, and once South Africa started putting reforms in place, funds that held on to sanction policies were punished in the marketplace.
Nevertheless, Miller (whose retirement group offers services to public employees in defined-contribution plans that let them control their own investments) says his company is interested in corporate governance and sees a need to develop a symposium on the issues.
Beyond trying to influence policy in corporate boardrooms, several pension funds are working together to weigh in on the governance of the investment banks that advise them on investments. With North Carolina, New York and California in the lead (and representing some $400 billion in investments), several funds are demanding that any Wall Street firm that does business with them--be it as money managers or bond underwriters--agree to take steps to limit the influence its investment bankers have over analysts who make research recommendations for investors.
The action comes in response to a lawsuit on this issue that was brought earlier this year against Merrill Lynch by New York Attorney General Eliot Spitzer. In settling that suit, Merrill agreed to limit conflicts of interest. Fund officials have contacted Wall Street firms with requests for similar changes. For North Carolina's Moore, the issue is a no-brainer. "You can't do business with a firm that has a system that encourages bad information," he says.
The joint effort also is key. "To really make this thing work, I need more market force than just the $60 billion that I represent," Moore says. His goal is to form a coalition representing $1 trillion in assets.
Yet for all the aggressive action they've taken so far--lawsuits, the exertion of proxy power, the demands on Wall Street firms--and the talk of more to come, there is plenty of skepticism about whether the activist attitude will last.
"The issue might not sustain itself long enough for people to truly change," Patterson says. "A pension fund will jump on a band wagon and rally around and raise hell with managers and companies. As the market takes off again, though, it will slip back into the way it did things. Basically, pension plans react to where the fire is."