Public Pension Funds Become Political Playthings

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Back in September of 2003, as investors were reeling from sharp declines of shares at troubled companies like Enron and WorldCom, New York State Comptroller Alan Hevesi declared that he was going on a mission to create a ‘sense of outrage’ about corporate malfeasance. As the sole trustee for the state’s then-$90 billion public employee pension funds, Hevesi was in a position to make a lot of waves with retiree money, and so on that day he floated a proposal for a National Coalition for Corporate Reform. Two months later Hevesi led a delegation of heads of public pension funds to the United Nations where he demanded that companies disclose to investors what they intended to do about global warming. Hevesi also directed the state’s pension funds to take the lead in a series of controversial class-action lawsuits against publicly held companies.

Last week, the New York State Attorney General’s office handed down the latest in a series of indictments claiming that even as Hevesi was pursuing those corporate bad guys and making the world safe from climate change, his office was using the giant New York public pension fund to grant payoffs to a political insider in exchange for electoral support for Hevesi, who was forced to resign from office in 2006 on unrelated fraud charges. The case has attracted national attention because one of the firms that agreed to payments is headed by investment banker Steven Rattner, who is President Obama’s lead adviser on the task force overseeing the American auto industry. The AG’s investigations are continuing.

The abuse in Hevesi’s office is symptomatic of a growing problem as public employee pension funds housing trillions of dollars in assets become political toys under the control of elected officials or politically appointed boards. The New York AG is making the case that Hevesi’s operatives crossed the line into blatant, illegal pay-for-play. Other cases in Ohio, Illinois and California have similarly focused on kickbacks and extortion among trustees of public pension funds.

But even in instances where there has been no overtly illegal activity, fund trustees have used these public sector assets for troubling political and personal advantage. Their actions represent an abandoning by the trustees of their fiduciary duty to public employees and to taxpayers, who are ultimately responsible for the cost of pensions if the funds face shortfalls because of mismanagement.

Public pension funds have long been subject to political uses, going back to disinvestment by some funds in companies that did business in South Africa during apartheid. These days, however, the investment decisions of pension overseers are a lot more self-interested, with nothing as grand as defeating apartheid as their aim.

In 2003, for instance, the board of advisors of the California’s Public Employees’ Retirement and State Teachers’ Retirement Systems (Calpers), a group composed of state public sector union officials, voted to reduce holdings in companies that run operations for local governments because public officials were turning to these companies during the recession to reduce spending. One could argue that investing in such businesses, not dumping their shares, during a recession makes lots of sense, but Calpers’ decision was motivated by a desire to pressure these businesses and drive down their shares at a time when local governments were looking for ways to outsource work.

Similarly, New York City’s public sector pension fund, whose trustees include two elected officials, stopped making investments several years ago in firms specializing in privatization services because these firms potentially eliminate public sector jobs by allowing governments to outsource work. Thus the fund, composed of taxpayer dollars, was actively working against taxpayers, who benefit when governments reduce costs.

To justify their machinations with public money, trustees often resort to a tortured logic of the marketplace. Back in 2004, for instance, Hevesi used the state pension fund’s holdings in Sinclair Broadcast Group to threaten the company as it was about to broadcast a documentary critical of Democratic presidential nominee John Kerry. Hevesi, a Democrat, claimed that Sinclair’s plans to air the documentary would undermine the value of the company’s stock because advertisers might boycott the program. A political science professor who had spent most of his life in public office, Hevesi had apparently quickly become an expert on the bottom line of the broadcasting industry once the presidential nominee in his party faced unfavorable coverage from Sinclair.

As pension funds become politicized, they have emerged as a convenient way for trustees to reward allies and campaign contributors. After reform legislation in 1995 made it more difficult for trial lawyers to file so-called ‘strike’ lawsuits against a corporation when its share price declines, public pension trustees cordially stepped into the game and started partnering with the class-action firms as lead plaintiffs in new rounds of lawsuits. Milberg Weiss, a firm which eventually went out of business after several former partners pled guilty to paying kickbacks, was especially active with its contributions in New York and California. It poured $137,000 into Hevesi’s campaign for New York State comptroller and later represented the state pension fund in a big lawsuit against pharmaceutical giant Bayer.

Nor was Hevesi the only abuser. Louisiana’s teachers pension fund was a serial litigant against big corporations, prompting a federal judge to brand the fund a “professional plaintiff” in one ruling denying it class action status.

Over time it becomes difficult to determine whose interests are being served in such cases—taxpayers and employees, or the officeholders and trial lawyers. Under Hevesi, for instance, New York took the lead in filing third-party lawsuits against financial firms like Citigroup that did business with Enron or WorldCom, claiming the financiers enabled corporate malfeasance. The litigation raised eyebrows because at the time New York was a major shareholder in several big financial firms, with a $1 billion stake in Citicorp, for instance. In the end, this third party litigation cost New York more than it earned because the settlements against the firms hammered the price of stocks that the pension fund owned. But the trial lawyers, who had contributed $121,800 to Hevesi’s campaign, did quite well, earning tens of millions of dollars in fees.

Trustees run few risks in such cases because most state constitutions guarantee employee pensions. That means taxpayers will make up any shortfall in investment returns when trustees let political or personal considerations dominate their investment decisions.

There’s no easy solution to this problem because the size of the public sector pension pot is enormous and the money is tempting. Some states have gone to boards rather than sole trustees, but boards can become politicized too, as the infamous (and infamously ineffective) Calpers has demonstrated.

The ultimate solution is to put the investment decisions of public workers in the hands of investment managers selected by the workers themselves, through decentralized 401k-style plans. In such a system, public trustees can only influence the selection of a menu of investment advisers—mutual fund companies, index-fund managers and the like—to serve workers, who would retain individual control over their investments. Such accounts can be designed with limits on risky investments, providing employees with a menu of investment options that made it impossible for workers to place too much of their retirement money in speculative assets, but nonetheless keeps the money in workers’ hands, not trustees.

When California Gov. Arnold Schwarzenegger proposed just such a change several years ago, officials at Calpers brought public pension fund managers together from around the country to wage a ‘national movement’ against the governor. A Calper’s official called the governor’s plan, “part of a concerted effort to break apart the powerful voices of public pension funds." That tells you exactly what these trustees think of public pensions. To them, this is not workers’ money, but leverage that trustees can use for their political causes and ambitions. Nothing will change until we take that leverage out of their hands.

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