Public pension funds, some of the largest financial players in U.S. financial markets, often go under the radar. The largest public pension fund in the United States, the California Public Employees Retirement System, or CalPERS as it is commonly known, has around $303 billion in assets under management, about three times the size of Bridgewater Associates, the world’s largest hedge fund. Yet, as daily readers of the financial press know, one is much more likely to hear about the latest moves by activist investors Bill Ackman or Carl Ichan than the newest investment by a large public pension fund.
In this relative obscurity, some of the nation’s largest public pension funds have been pursuing investment strategies that arguably pursue political goals over the financial interests of their beneficiaries. For instance, in 2015 the New York Common Retirement Fund announced the creation of a $2 billion index that will “exclude or reduce investments in companies that are large contributors to carbon emissions” in an effort to “address global warming.” Last December, CalPERS voted to expand its Tobacco Investment Ban, first instituted in 2000, even though a study found that from the inception of the ban through the end of 2014 CalPERS missed out of up to $3 billion in net investment gains by not investment in tobacco-related businesses. In 2013 Chicago Mayor Rahm Emmanuel pushed for the city’s pension funds to divest from firearms manufacturers even as the New York Times noted that “[m]any public pension trustees remain unconvinced that divesting from gun makers is consistent with their duty to protect the financial interests of retirees.”
These investment strategies are most commonly called “social investing” (Patrick S. Cross, Economically Targeted Investments-Can Public Pension Plans Do Good and Do Well?, 68 Ind. L.J. 931, 935 (1993)). Richard Posner and John Langbein define social investing as the “pursuit of an investment strategy that tempers the conventional objective of maximizing the investor’s financial interests by seeking to promote nonfinancial social goals as well” (John H. Langbein & Richard A. Posner, Social Investing and the Law of Trusts, 79 Mich. L. Rev. 72, 73 (1980)). Pursuing nonfinancial social goals does not come without cost. Remarking on the campaign to divest from South Africa, Langbein and Daniel Fischel noted that “[a]t a minimum, such divestment is inconsistent with maximizing the return to the fund because divesting the shares of offending companies imposes additional transaction costs” (Daniel Fischel John H., ERISA’s Fundamental Contradiction: The Exclusive Benefit Rule, 55 U. Chi. L. Rev. 1105, 1143–44 (1988)). Langbein and Fischel cited the New Jersey Division of Investment’s report that divestment from South Africa cost an estimated $50 million in transaction costs, equal to 1.2 percent of assets (Id. at 1144). Divestment can also cause a fund to lose the benefit of later appreciation in the values of the divested assets, as with CalPERS’s Tobacco Investment Ban.
Most employee benefit funds are severely limited in their social investing activities because of the restrictions of the Employee Retirement Income Security Act (“ERISA”). The Department of Labor’s (“DOL”) regulation under ERISA governing Investment Duties does not include the pursuit of social or political goals in its definition of how a fiduciary can fulfill its duties with respect to a plan (29 C.F.R. § 2550.404a-1. See § 3:40 Miscellaneous fiduciary issues—Social investing, 1 ERISA Practice and Litigation § 3:40). Instead, the regulation defines “appropriate consideration” of an investment strategy as consideration of the risk of loss and opportunity for gain as well as the composition of the portfolio with regard to diversification, the liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan, and the projected return of the portfolio relative to the funding objectives of the plan (29 C.F.R. § 2550.404a-1(b)). The Department of Labor has frequently commented on the ability to engage in social investing while remaining in compliance with fiduciary duties under ERISA. In a 1980 speech a DOL official remarked that “an investment policy which excludes investments based on a social orientation was disfavored by DOL policy makers,” because it conflicts with the duty of prudence and loyalty owed by fiduciaries (3:40 Miscellaneous fiduciary issues—Social investing, 1 ERISA Practice and Litigation § 3:40. See Address of Ian D. Lanoff, reprinted in 7 Pens Rep (BNA) No. 295, at R-17 (June 16, 1980)).
In 1986 another DOL official wrote to Senators Howard Metzenbaum and Paul Simon that social influences would be permitted in an investment if the strategy would not reduce the return or raise the risk of the plan’s investment portfolio (§ 3:40 Miscellaneous fiduciary issues—Social investing, 1 ERISA Practice and Litigation § 3:40. See Letter of Dennis Kass to Sen. Howard Metzenbaum (D-Ohio) and Sen. Paul Simon (D-Ill) summarized in 13 Pens Rep (BNA) No. 23, at 1099–1100 (June 9, 1986)). He also remarked that if certain investments are excluded on social grounds before determining the impact on the plan the fiduciary would not be fulfilling their obligations under ERISA (Id.). One treatise notes that from these policy statements and others “it became generally accepted that ERISA-governed asset management may not be based on social investing” (§ 3:40 Miscellaneous fiduciary issues—Social investing, 1 ERISA Practice and Litigation § 3:40).
You may be wondering how can the New York Common Retirement Fund use pensioners’ money to make a stand against climate change or how can CalPERS divest from tobacco and lose out of a potential $3 billion in gains while still fulfilling their fiduciary obligations. As it turns out, most of ERISA, including its fiduciary obligations, does not apply to state and local government-sponsored plans. A 1978 Pension Task Force Report on Public Employee Retirement Systems issued by the House Committee on Education and Labor noted that in 1974 Congress “excluded governmental retirement systems from the major provisions of ERISA in order that additional information might be obtained regarding whether a need exists for further regulation of government plans” (Committee on Education and Labor, 95th Cong., 2d Sess., Pension Task Force Report on Public Employee Retirement Systems 1 (Comm. Print 1978)). Congress never applied ERISA’s fiduciary standards to public pension funds, and the fiduciary duties of public fund administrators emanate from state law. Some states have enacted statutes governing fiduciary duties of public-plan trustees, but in the absence of any applicable statute the common law of trusts prescribes the bounds of these duties (Withers v. Teachers’ Retirement Sys., 447 F. Supp. 1248, 1254-55 (S.D.N.Y. 1978), aff’d without op., 595 F.2d 1210 (2d Cir. 1979)). This amalgam of state law was not sufficient to protect pensioners in 1978, when the same House report noted that “the current regulatory framework applicable to PERS does not adequately protect the vital national interests which are involved” (Committee on Education and Labor, 95th Cong., 2d Sess., Pension Task Force Report on Public Employee Retirement Systems 1 (Comm. Print 1978). PERS stands for Public Employee Retirement Systems). These problems persist in 2017.
Unsurprisingly, public pension funds present their social investments as return-maximizing for pensioners. In a press release touting the low-carbon index, the New York State Comptroller gushed: “[f]orward-thinking pension funds like the New York State Common Retirement Fund know that moving capital toward a low-carbon economy protects their beneficiaries’ returns.” Yet, immediately following that he noted the index was “one of the fastest ways to address global warming.” Addressing global warming is a noble goal, but under ERISA’s standards it would have no place alongside protecting returns as fund priorities.
It is time to end this disparity. Over 40 years ago, because of “lack of employee information and adequate safeguards concerning [fund] operation]” Congress saw it fit that safeguards be provided with respect to the establishment, operation, and administration” of pension plans (29 USC § 1001(a)). Yet, beneficiaries of government-sponsored plans, those who spent their working years serving state governments, are not afforded the same safeguards. No matter one’s opinion on the causes public plans pursue through social investing, it is time to apply the ERISA fiduciary standards to government-sponsored plans and force public pension employees to focus on returns over politics.