Ohio Police and Fire Pension Shifts to Gold Amidst Uncertainty

In wake of the stock-market drop off early this year due to COVID-19, state and local investment funds lost an estimated $1 trillion dollars in assets, even as it’s hidden from beneficiaries due to a lack of transparency in reporting earnings. As states have continued to fall behind on their pension obligations since the recessions of the 2000s, they have steadily increased their proportion of investments in risky asset classes to make up for years of consistent underperformance. Additionally, with the decrease in business activity caused by the virus, states have lost significant tax revenue to help cover the expanding shortfall.

Changes in US monetary policy are effecting how institutional investors look at removing risk in their portfolios. The Federal reserve announced its intention to maintain low interest rates, even if inflation rises above its traditional benchmark of 2%, through at least 2024. The potential for higher inflation than interest rates removes some of the appeal of traditional fixed income bonds and treasury notes. To protect against this inflation risk, pension funds are now looking increasingly at gold and precious metals as an asset class.

Responding to these trends, the Ohio Police & Fire Pension decided to shift 5% of its allocation into gold by increasing its leverage to try to protect its beneficiaries against a downturn in the bond market. They join Texas Teacher Retirement Systems as the only two state or local pension systems to hold precious metal investments. Wyoming had a contentious public debate earlier this year between a newly elected state treasurer and his career deputy over the possibility of investing in gold, after the state lost $300 million investing in third world debt.

Ultimately, the decision to invest in bonds remains hotly debated within the investment space. However, many of the factors that might deter retail investors, including storage issues and higher capital gains rates, do not apply to pension funds. For gold to provide a better counterweight to equities, it requires a downturn in the bond market. Thus, a pension fund diversifying its low-risk assets by adding gold alongside traditional fixed income could further hedge risk against a downturn in the bond market. However, given the consistency with which their active management strategies fail to keep pace with general market recovery, an increased allocation into low-risk assets, including gold, could help pension managers protect assets.

Ethical Investing’s Shifting Winds Force Law Firms to Be Nimble

This article originally appeared in Bloomberg Law on September 25, 2020.

Companies looking to tap into the $12 trillion market for sustainable and socially responsible investments face myriad challenges—including moving targets and shifting political winds.

That’s where the lawyers come in. The boom in investors looking to bankroll companies advancing certain environmental, social, and governance priorities has ramped up demand for law firms that can help businesses live up to the wide array of expectations.

“There’s no uniform body of criteria or objectives” for gauging a company’s commitment to ESG principles, said Heather Palmer, a partner at Sidley Austin LLP. There are plenty of acronym-heavy organizations that recognize companies for voluntary ESG commitments, but no “coalescence around a specific standard,” she said.

Nimble law firms are responding by creating specialized legal teams across practice areas to demystify current ESG standards, from diversity and executive compensation obligations to global pollution initiatives. They’re also helping prepare for new U.S. restrictions on ESG investing from President Donald Trump’s administration.

ESG-related assets topped $12 trillion in 2018—an 18-fold increase from the $639 billion in play two decades ago—according to the Forum for Sustainable and Responsible Investment, which has been tracking ethically motivated investing since 1995.

BlackRock Inc. CEO Larry Fink declared sustainable investing the “strongest foundation for client portfolios going forward,” in a January letter.

“We’ve really reached sort of a tipping point,” Melissa Bender, an asset management partner at Ropes & Gray, told Bloomberg Law. “ESG integration is here to stay.”

New Kids on the Block

Some firms are treating ESG as “the next new thing,” Ropes & Gray strategic transactions partner Michael Littenberg said. But the principles have been steering financial decisions for decades, he said.

Whether they’ve been parsing ESG for a few weeks now or grappling with the underlying issues since the Watergate era, the number of Big Law firms assembling one-stop shops to quell fears about the multifaceted investment strategy keeps growing.

Winston & Strawn LLP joined the fray in August, unveiling a new ESG advisory team dedicated to making sense of it all. Partners Mike Blankenship and Eric Johnson tapped nearly a dozen attorneys who’ve made careers out of troubleshooting issues like shareholder activism, regulatory compliance, and crisis management.

The new team is the “culmination of issues around human capital that we’ve seen for many, many years,” employment litigator Cardelle Spangler said. She said diversity and inclusion initiatives, as well as campaigns to bolster equality are increasingly part of ESG analysis.

In a pandemic-ravaged world where money is already tight and politically motivated investors vote with their wallets every chance they get, Blankenship urged companies to embrace ESG or risk irrelevance.

A recent McKinsey & Company report polling nearly 600 C-suite executives and investment professionals supports Blankenship’s theory.

ESG programs “will contribute more shareholder value in five years than today,” 80% of respondents said. And 83% said they’d pay a premium—up to 10% more—to acquire a company with a positive ESG record over one with failing marks.

The Trump administration, however, is throwing cold water on ESG investing.

A proposed Labor Department rule aims to curb ESG investing by forcing fiduciaries to justify including the popular funds in work-sponsored retirement plans. The department said federal law requires fiduciaries to put financial security above “non-pecuniary” goals like combating climate change, human rights, or shunning weapons manufacturers.

Littenberg said Ropes & Gray is currently working with more than 200 clients, ranging from asset managers to influential trade groups, on ESG-related issues. Latham & Watkins LLP also has an ESG task force that features attorneys with various specializations around the world.

Watchdog Soup

Meanwhile, stakeholders keep moving the goalposts—on a constantly shifting playing field.

The United Nations Principles for Responsible Investment, for instance, asks individuals to consider ESG factors as part of their decision-making process, while the Global Reporting Initiative urges companies to report the social and environmental impact of their operations around the world.

The nonprofit Institute for Pension Fund Integrity called for clarity about ESG-centric business dealings in its Aug. 27 brief. “Companies should take the extra step to convey how they define ESG and how it impacts their investment strategies,” the group wrote.

If only it were that simple.

Stacey Mitchell, a partner at Akin Gump Strauss Hauer & Feld LLP, said bringing companies up to speed on ESG often involves highlighting “potentially overlapping, or at times, conflicting legal obligations” they hadn’t considered. Taking a holistic approach is critical, she said, because ESG considerations stretch far beyond corporate boardrooms.

Mitchell called middle management the “front-line workers when it comes to ESG issues,” mapping out scenarios where environmental compliance managers at mining companies and HR leaders at technology firms make judgment calls that have ripple effects throughout the supply chain.

Recent moves by the Trump administration also throw plan retirement administrators into the mix. The proposed Labor Department rule would impose significant new reporting requirements on retirement plan administrators that consider ESG in investments.

Josh Lichtenstein, a Ropes & Gray partner, said the additional reporting requirements could ensnare “funds that just include ESG considerations as part of their risk evaluation framework” rather than the activist entities the administration appears to want sidelined.

“If all funds that consider ESG factors at all in investing are caught up by the rule then almost every fund would be subject to it,” Lichtenstein said.

That could mean new litigation risks for plan sponsors.

“Any time you require fiduciaries to take additional steps you run the risk of plaintiffs saying they didn’t do that additional work,” even if they have an excellent investment process,” Lichtenstein said.

Winston & Strawn benefits lawyer Mike Melbinger said he’s been monitoring another ESG crackdown, from the Securities and Exchange Commission. That agency, along with the Labor Department, is moving to regulate proxy voting power by ESG investors.

The new regulations are unlikely to put a dent in ESG investing, according to Melbinger.

“The real world has kind of moved on and is doing this,” he said.

The SEC Takes Much-Needed Steps Toward Modernizing the Shareholder Proposal Rule

The Securities and Exchange Commission (SEC) met today to finalize proposed changes to the Exchange Act Rule, which sets standards for companies subject to federal proxy rules to include shareholder proposals in their proxy statements. These updates come in the wake of extensive work done by SEC staff to evaluate the proxy process and shareholder proposals across the board, and represents a major step toward modernizing the shareholder engagement process to reflect modern investment trends and set up more productive company-shareholder engagement.
The new rule would update the criteria for the inclusion of shareholder proposals in proxy statements, setting a time commitment of three years of investment in a company before a shareholder’s proposal may be considered. Furthermore, the rule would increase the level of shareholder support a proposal must receive to be eligible for resubmission at a company’s future shareholder meetings. Shareholder proposals may also be excluded from proxy statements if a proposal does not meet certain eligibility or procedural requirements. Finally, the “resubmission” threshold under which a proposal may be reconsidered after being voted on previously is significantly increased.
The Institute for Pension Fund Integrity commends the SEC for taking action to build greater constructive engagement between shareholders and the companies that they have invested in, ensuring better-functioning capital markets that prioritize long-term financial stability while at the same time reducing misuse of the shareholder proposal process. According to research from Harvard University, only ten filers accounted for 74 percent of all shareholder proposals in 2019. This lopsided trend indicates that real shareholder engagement has been diluted, and instead a select group of activists are attempting to game the system by using the shareholder proposal process to meet their personal agenda. Today, the SEC rightfully acknowledged the cost imposed to shareholders for proposal proponents’ actions as justification for the change to this rule.
Under these updated regulations, we believe that there is less likelihood of special interests sidetracking the agenda of public companies with little regard to broader shareholder interests and investment returns. By facilitating better communications between shareholders and companies, investors will be able to make more informed decisions and the influence of outside proxy advisory firms, which have not been shown to act in the best fiduciary interest of their clients, will be curbed. As noted previously by IPFI President Christopher Burnham, “A process for review and rectifying flaws in the research and recommendations by proxy voters better legitimizes the process and ensures that shareholders are voting with accurate information.”
As stated by SEC Commissioner Elad Roisman, “The proposed amendments would facilitate constructive engagement by long-term shareholders in a manner that would benefit all shareholders and our public capital markets.” With little change to rules governing the proxy submission process in over fifty years, and a troubling decline in publicly traded U.S. companies over the past several decades, this proposal is welcomed and well-overdue.

Commentary: The Department Of Labor Takes Much-Needed Steps Toward Ensuring Fiduciary Obligations

This article originally appeared in Forbes on September 22, 2020.

The time to ensure that pension fund managers are bound by their fiduciary obligation to their beneficiaries and not by any other political motives is now. Prioritizing issues other than pure financial returns may be an acceptable strategy for individuals managing their own money or for corporate board rooms contemplating the future of their company, but for fiduciaries, prioritizing any kind of self-interest or ulterior motive over maximizing returns is a dereliction of duty.

Over the past several months, the Department of Labor has begun to take steps to curb this trend, releasing two new regulatory proposals seeking to re-affirm the responsibilities of pension fund fiduciaries. The first proposed rule examines tax-qualified retirement plans governed by ERISA in order to determine the extent to which Environmental, Social, and Governance (ESG) considerations factor into investment decisions. The question at hand is whether the plan managers, bound by fiduciary duty to their beneficiaries, are sacrificing investment returns or increasing risks to meet ESG goals unrelated to participant’s bottom-line financial interests. The second rule seeks to re-evaluate the outsized role that proxy advisory firms have played in pension fund investment and the associated costs that have been passed down to beneficiaries.

As a former state treasurer of Connecticut, I have personally overseen the management of a public pension system. It is not possible to fully protect the financial security of a plan’s beneficiaries if those charged with managing a pension fund are trying to build an investment strategy around nonfinancial considerations. Decisions on new investment strategies, whether they are driven by political reasons or simply as an attempt to chart a new path forward, must be made in the boardroom. There are many laudable social initiatives that individuals, religious endowments, schools, and other private entities may wish to consider. However, it is never correct to impose personal political motives on pension funds. This principle is even more prevalent given the financial ramifications that the economic fallout of the COVID-19 pandemic has had on pensions.

The Department of Labor should be applauded for taking these necessary steps toward clarifying and correcting guidance on the fiduciary obligations of pension fund managers. As Labor Secretary Scalia noted, these actions aim to “remind plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.”

Despite these efforts, public pensions are still vulnerable to ESG strategies. The trend towards “impact investing” has permeated the proxy voting industry, where two firms effectively control significant numbers of shareholder votes in thousands of publicly traded companies. These votes would be an important weapon against ESG policy that does not serve the shareholders, but under the current rules mostly serve an ideological agenda separate from the interests of retirees and public employees. For this reason, the Department’s second proposed rule clarifying the roles and responsibilities of proxy advisory firms and the obligations that fund managers have toward their proposals is of the utmost importance.

SEC commissioner Daniel M. Gallagher acknowledged the problems with the proxy industry as far back as 2013, noting that the current system is not built to increase company value or generally operate on behalf of shareholders, but rather to serve the interests of the proxy advisory companies themselves. While the proposal is a step in the right direction, it is important to think not only about how pension money is invested, but also how the voice that comes with a stake in any given company is used. Until we reform the proxy voting industry, that voice will be vulnerable to the whims of third parties.

One major issue which is not adequately addressed by the Department’s proposed regulations is the issue of “robo-voting,” a practice which has long allowed for the proxy advisory firm duopoly to pursue a personal agenda with limited scrutiny. Under this practice, some fund managers have simply accepted the voting recommendations of proxy advisors automatically, blindly moving forward on proxy firms’ recommendations without consideration of their overall fiduciary impact on the fund. The growth of robo-voting in the industry is understandable given the cost savings that pension plans can accrue as a result, but the desire to implement sound cost-saving measures cannot be upheld if proxy voting is relied upon to determine the course of action on contested issues. In these instances, fiduciaries should end their reliance on proxy voting in order to ensure that all final decisions are truly in the best interest of beneficiaries.

While more work is needed, it appears that the Department of Labor is finally in a position to implement much-needed reforms to a pension system that has for too long neglected the underlying financial security of its beneficiaries. Given the widespread problem of unfunded pension liabilities, the economic fallout from the pandemic, and increased politicization of pension investments, a re-commitment to fiduciary responsibility is a welcome sight. The retirees of this nation deserve as much.

Commentary: Trump’s Labor Department Seeks to Clean Up Left-Wing Abuses of Pensions

This op-ed originally appeared in TownHall and affiliated outlets on September 15, 2020.

For pension beneficiaries across the country, the recent proposals by the Department of Labor are a positive step towards ensuring that accountability and fiscal responsibility take precedence over any other considerations.

Two new rules are currently being weighed. The first, for which the department is currently in the process of sorting through public comment, concerns the role of environmental, social, and governance (ESG) investments in ERISA-backed pension funds. The second takes aim at “proxy voting,” examining the outsized roles that proxy advisory firms have in investment decisions and examining whether their recommendations are always economically beneficial to pensioners.

These rules rightly reaffirm a fiduciary’s obligation to prioritize financial returns over alternative investment strategies in the management of ERISA-managed pension fund assets. As a former Treasurer of the State of Ohio and Mayor of Cincinnati, I have had firsthand experience overseeing a pension system and I take seriously the responsibility of a fund’s management team to provide financial security to the men and women who rely on their pension or 401K for a secure retirement.

Last November, SEC Chairman Jay Clayton remarked that a chief complaint “was the concern that [shareholders’] financial investments—including their retirement funds—were being steered by third parties to promote individual agendas, rather than to further their primary goals of being able to have enough money to lessen the fear of ‘running out’ in retirement or to leave money to their children or grandchildren.” In putting forth these two regulations, the Department of Labor is taking clear steps to also address this concern.

In the case of the first rule, fiduciary duty obliges pension fund managers to only consider ESG investments when they add value to a fund. When such investments will not improve the financial performance of the fund, or the decision to invest in them is based on political motives, they should be forgone. According to a study by the Pacific Research Institute, ESG funds were “43.9 percent smaller compared to an investment in a broader, S&P 500 index fund,” after 10 years. As ESG strategies become more fashionable, there is cause for concern that financial returns will be replaced by politics at the top of asset managers’ considerations.

The question of pensioner’s financial interests is further addressed in the recent proposed rule by the DOL. The proxy system has long been taken advantage of by outside actors without fiduciary responsibilities, preventing sound advice from reaching the nation’s pension and investment funds and retail shareholders. There is currently a duopoly in the system, in which two companies, Institutional Shareholder Services (ISS) and Glass Lewis, control the overwhelming majority of the proxy advisory market. These firms are not obligated to adhere to fiduciary duty like ERISA plan managers, and abdicating authority over proxy voting in such a way violates fund managers obligation to plan participants.

The proposed rule is a good step in the right direction by the Department of Labor, but more should be done around proxy advisors’ role in a process called automatic or robo-voting. Some fund managers allow proxy advisors to vote their proxies, often without the ability or impulse to consider the recommendation. In other words, fund managers blindly vote the recommendation without consideration of the impact to the fun. Such a practice disenfranchises pensioners and should be curbed. The Securities and Exchange Commission issued guidance on this front to asset managers in June of this year, and DOL should adopt this guidance as a part of the rule.

Pensions should be, and once were, apolitical entities. At the Institute for Pension Fund Integrity, where I sit on the board, we are singularly focused on that objective—getting politics out of pensions and protecting the financial security of America’s workforce. I applaud the Department of Labor’s efforts to further codify the most basic tenet of fiduciary duty: investment decisions should be governed by considering risk and returns, not the political agenda of a third party. As I have previously noted, “public pension funds are already underfunded and underperforming.” Let us not exacerbate the issue by appeasing the special interest groups to the detriment of private sector labor workers and retirees across the country.

Pension fund managers need to be reminded that they are charged with acting on behalf of individuals who sacrificed a portion of their wages every payday with the expectation that their money would be handled with care, not used to promote the interests of political actors. The proposed rule changes are an important step towards fulfilling these obligations.

Ken Blackwell served as Treasurer of State of Ohio and as a member of the U.S. Department of Labor Advisory Council on Employee Welfare and Pension Benefit Plans. He is a trustee of the Institute for Pension Fund Integrity.

Rhode Island Treasurer Announces Withdrawal from Purchases from Leonard Green

Rhode Island Treasurer Seth Magaziner announced that the state plans to stop buying future funds from private-equity firm Leonard Green in the face of controversy over their control of Prospect Medical, a hospital system with facilities in Rhode Island, Southern California, Pennsylvania, Connecticut, and New Jersey. Magaziner controls the $8 billion fund, and cited Prospect Medicals track record of siphoning millions of dollars in excessive fees and mortgage payments from patients and employees in his decision to stop future purchases

“[Leonard Green] has extracted value from Prospect Medical hospitals, including St. Joseph’s Hospital and Our Lady of Fatima Hospital in Rhode Island, at the expense of patients and employees. These actions have left already-vulnerable communities with fewer healthcare resources,” Magaziner wrote in a public letter to Leonard Green. “Under my administration, the Rhode Island pension system has adopted new standards to avoid investment risks associated with socially destructive business practices,” Mr. Magaziner added, concluding that Rhode Island would no longer purchase funds from Leonard Green.

Prospect Medical was bought by Leonard Green in a $363 million deal in 2010. Rhode Island first invested in Leonard Green’s fund, Green Equity Investors V, in 2007. Since that purchase, the Green Equity fund has produced a return of 18.39%, or 2.33 times net return on investment multiple.

Leonard Green has come under fire recently from all sides, with activists and even Congress joining in. The mismanagement of Prospect Medical may be inappropriate, and it’s fair for individuals and lawmakers to call foul where they see it. While this move from Rhode Island may therefore be cheered on by some, it is important to remember that the Treasurer and state of Rhode Island have a fiduciary responsibility to public employees paying into the state’s pension. 

Adopting “standards to avoid investment risks associated with socially destructive business practices” may be good politics, but it’s not clear that this is good for retirees who deserve to receive their promised benefits. Refusing to purchase funds from one firm limits the ability of the state of Rhode Island to maximize their overall pension returns by excluding one possible area of investment. This move by Magaziner brings into question the nature of his role as a fiduciary, and deserves more scrutiny.

U.S. National Security & the I Fund

It is no secret that the U.S. and China have recently experienced diplomatic tensions, but we now see its effects bleeding into the financial sector. The Department of Labor (DOL) recently announced a rule change to the Employee Retirement Income Security Act of 1974 (ERISA) dictating that pensions should not be used to solve the world’s problems through Environmental, Social, and Corporate Governance (ESG) investing.  Similarly, Labor Secretary Scalia ordered the Thrift Savings Plan (TSP) to not include Chinese companies in its investment options within the I Fund. It is important to note that the I Fund is an international stock index that tracks the investment performance of Morgan Stanley Capital International: Europe, Australasia, and the Far East Index, also known as the MSCI EAFE.

In his letter, Secretary Scalia states that changing the tracking index from the MSCI EAFE to MSCI All Country World ex USA Index would place billions of dollars “in risky companies that pose a risk to U.S. national security.” In the same fashion, Chairman Clayton of the U.S. Securities and Exchange Commission (SEC) warned in April that Chinese disclosures are sparse and that investors should be cautious when considering Chinese equities. 

Although the Employee Thrift Advisory Council has labeled discussions on the I Fund as partisan, members of Congress from both sides of the aisle have argued that investing in China would be a danger to U.S. national security. They note: 

“The constituent firms of MSCI ACWU ex-US IMI include military contractors to the People’s Liberation Army, like the Aviation Industry Corporation of China and China Unicom, which supply military aircraft and telecommunications support to militarized artificial islands in the South China Sea. It also includes firms like Hangzhou Hikvision Digital Technology, which was recently added to the U.S. Department of Commerce’s Entity List and produces surveillance equipment the Chinese government currently uses to oppress and detain approximately one million Uighur Muslims and other religious minorities, as well as ZTE Corporation, which was fined last year for violating U.S. sanctions law for business activity with Iran and North Korea and which Congress has enacted a law to prohibit the U.S. federal government from procuring.” 

Along with the White House’s decision to end a new China-inclusive benchmark, the Federal Retirement Thrift Investment Board (FRTIB) voted to delay implementing a new index for the I Fund which would give opportunity for foreign investment. The White House is currently in the process of nominating new members to the Thrift Board. 

A new Trump-nominated majority on the Thrift Board may be indicative of future U.S. economic policy towards China. These recent moves on the hands of both Democrats and Republicans raise several questions: Should our pension system should be treated as a chess piece in U.S. foreign policy? Is our return on investment greater than threats posed by foreign adversaries? The Institute for Pension Fund Integrity (IPFI) believes that these sorts of decisions, whether or not to keep China out of TSP’s I Funds, must be guided by data-based conclusions around the long term growth of our pension funds.

Proxy Proposal Angers Institutions

This article by Brian Croce originally appeared in Pensions & Investments on September 7, 2020.

A Department of Labor proposal requiring ERISA-governed fiduciaries to cast proxy votes only when there is an economic impact on the retirement plan is misguided, sources say, but stakeholders from the business community have applauded the initiative.

“It’s just a reflection of the fact that institutional investors have become more aware of corporate governance as an element of shareholder value and corporations don’t like that,” said Nell Minow, Washington-based vice chairwoman of ValueEdge Advisors, which advises institutional investors on corporate governance issues. “The DOL is trying to give a great big fat giveaway to the very last people they should be concerned about to the detriment of (participants).”

Will Hansen, executive director of the Plan Sponsor Council of America and chief government affairs officer at the American Retirement Association in Washington, said the PSCA is concerned that the proposal is a step too far in regulating the activities of plan sponsors.

“While plan sponsors appreciate the ability to have guidance on when they do not need to exercise their proxy rights, some plan sponsors still seek the ability to always exercise their proxy rights,” Mr. Hansen said. “In addition, PSCA is unaware of any evidence that there is a significant problem with the use of plan assets in proxy activities.”

In continuing its recent flurry of rule-making proposals — which includes an effort unveiled in June stipulating that ERISA plan fiduciaries cannot invest in ESG vehicles that sacrifice investment returns or take on additional risk — the Labor Department on Aug. 31 proposed a rule to ensure that ERISA plan fiduciaries “keep their eyes properly focused on the interests of ERISA plan participants,” a senior official said on a call with reporters.

What to consider

The proposal would apply to the fiduciary who is ultimately responsible for a plan’s proxy voting and shareholder engagement efforts, whether internally or externally managed. It outlines specific steps fiduciaries must take when deciding whether to exercise shareholder rights and voting proxies, including a requirement to consider the likely impact on the investment performance of the plan; investigate the material facts that form the basis for any particular proxy vote or other exercise of shareholder rights; and maintain records on proxy voting activities and other exercises of shareholder rights.

“The plan fiduciary must never subordinate the interests of participants and beneficiaries in their retirement income or other benefits to unrelated objectives, including promoting non-pecuniary goals,” the senior Labor Department official said.

The U.S. Chamber of Commerce, which has long advocated for regulations curtailing what it calls “nuisance” shareholder resolutions and the outsized influence of proxy advisory firms, welcomed the Labor Department’s initiative.

“This proposal will strengthen investor protection and promote the interests of retirees,” said Thomas Quaadman, executive vice president of the Chamber’s Center for Capital Markets Competitiveness in Washington, in a statement. Along with recent actions taken by the Securities and Exchange Commission, the “DOL proposal will ensure that proxy voting is directly tied to the economic return for retirees and follows a transparent and unconflicted process,” Mr. Quaadman added.

In July, SEC commissioners approved sweeping changes to the rules governing proxy advisory firms, including a requirement for those firms to disclose conflicts of interests to clients and allow companies that are the subject of voting advice to be able to access that advice before or at the same time as the advice is disseminated to clients.

Proponents of additional proxy regulation have said that automatic, or “robo” voting, when a proxy ballot is prepopulated with an advisory firms’ recommendation and submitted before client review, is a problem in need of reform, a claim disputed by the institutional investor community throughout the SEC rule-making process.

“This ‘automatic voting’ prohibits pension beneficiaries from having full transparency on the proxy votes that affect them,” said Christopher Burnham, president of the Washington-based Institute for Pension Fund Integrity, in a statement. “The SEC rightfully issued guidance to restrict this mismanaged practice and the Labor Department should similarly issue new oversight to this end. A process for review and rectifying flaws in the research and recommendations by proxy voters better legitimizes the proxy process and ensures that shareholders are voting with accurate information.”

The Labor Department also outlined the “permitted practices” that a fiduciary could adopt in order to comply with the proposal, including voting proxies in accordance with the voting recommendations of a corporation’s management on proposals that the fiduciary has prudently determined are unlikely to have a significant impact on the value of the retirement plan’s investment.

George Michael Gerstein, co-chairman of the fiduciary governance group at Stradley Ronon Stevens & Young LLP in Washington, called that permitted practice a “nudge toward following management’s recommendations.”

Moreover, defining an economic benefit for a plan might be difficult, Mr. Gerstein added. “The way the proposal is currently drafted, I think there’s a real question as to whether long-term benefits that are not easily quantifiable in the here and now will pass muster under the proposal,” he said. “That has a significant consequence because any engagement takes a long time to materialize. If you’re engaging a company board on an ESG issue, it could take months or years to get to the point where there’s greater disclosure or they amend certain practices.”

That outstanding question and whether there’s a true economic consideration for a plan in voting a given proxy are going to present litigation risks, and “it’s going to be incumbent upon fiduciaries to show that they considered these issues,” Mr. Gerstein said.

Comment period

Like its other recent rule proposals, the Labor Department is soliciting comments for 30 days, as opposed to 60 or 90 days, which are more typical.

Mr. Gerstein said the quick comment period indicates the Labor Department’s intent to move fast on this issue and others, which is not uncommon at this point in the legislative calendar. “I think it’s typical for an administration to see that the first term is winding down and they want to get stuff out,” he said, adding that no administration assumes it will be re-elected.

Ms. Minow said the Labor Department is “trying to get all the horses out of the barn before the door closes.”

Maureen O’Brien, Chicago-based vice president and corporate governance director at Segal Marco Advisors, said the 30-day comment period is an “aggressive window in which to solicit comment particularly given the complex and highly impactful nature of the proposal. The apparent goal of the draft rule is a stark departure from how the department has viewed proxy voting for more than three decades.”

After looking over the proposal, Mr. Gerstein said the Labor Department expressed skepticism that proxy voting is in fact beneficial to ERISA plans. “That is a premise they’re starting from,” he said. “So in terms of how the industry thinks about responding in a short comment period, the DOL is going to need some convincing that the voting and the engagement is worth it to plans as long-term investors.”

If implemented, the rule will likely be treated as “an insignificant compliance issue,” because the value and impact of proxy votes is already well established, Ms. Minow said. “Nevertheless, this rule is an atrocity,” she added. “There’s no way that it could withstand a challenge in court, and we’ll do everything we can to make that clear during this idiotically truncated comment period.”

Pennsylvania State Pension Fund Drops Risky Stocks in Widely Praised Move

The Pennsylvania Public School Employees’ Retirement System (PSERS) moved to reallocate $5 billion in assets, moving $2 billion from risky investments made through Bridgewater and BlackRock to more secure stocks, bonds, commodities, and infrastructure investments. This move impacts 8% of the entire funds holdings and will take effect October 1st.

Pennsylvania State Treasurer Joe Torsella praised the decision and criticized the investment firms. “It’s time that more pension funds wake up to the fact that Wall Street has, in many cases, sold them something close to modern-day snake oil. What so many active Wall Street managers have sold our nation’s pension funds on is the idea that—for a hefty set of fees—they can help pensions experience almost all of the gains and none of the losses. We need to recognize that for the fantasy it is,” he said in a statement.

“In so many cases, what ends up happening is that the Wall Street managers do worse than fail to deliver value, they end up delivering an expensive failure,” Torsella said. “This move by PSERS is worthy of substantial praise, and shows that Pennsylvania doesn’t have to be at the mercy of expensive and under-performing Wall Street managers.”

This move comes on the heels of the COVID-19 economic downturn that saw PSERS lose 8.17%, or 4.7 billion, in total assets. This loss outperformed comparative pension funds significantly. On the flip side, the overall rate of return on the risk parity investments only surpassed 4% over the last few years while losing 9% in just the first quarter of 2020. Pennsylvania, along with California, Texas, New Jersey, and Illinois, represent over half of the U.S.’s entire pension fund liability at a moment when pension liabilities are at an all time high, highlighting how important this move is to PSERS overall finances. 

“We got as wet as everyone else,” Torsella said, referring to the pandemic and ensuing economic downturn. “And we missed a lot of years that would have had returns. This absolutely, categorically should make us mad,” he concluded. 

Although this case is only one example, this move represents a smart shift that will help support and make pensions more sturdy for years and decades to come. As public pensions often are incentivized to make riskier investments to close the gap between their assets and liabilities and make investments look good on paper, PSERS move is a smart decision that will help secure public school teachers retirement funds. Pension funds should not be making riskier decisions for short term bookkeeping over the long term responsibility and fiduciary duty to retirees.

Department of Labor Seeks to Limit the Scope of Employee Benefit Plan Proxy Voting

In a newly proposed rule, the Department of Labor is seeking to address the widespread trend of proxy voting in ERISA-backed retirement fund decision making, narrowing the scope of such activity so that fund fiduciaries could cast proxy votes only when they would have an economic impact on the retirement plan. The rule, developed by the Department’s Employee Benefits Security Administration (EBSA), ultimately aims to ensure that plan fiduciaries must solely consider factors affecting the value of the plan’s investment rather than sidelining the security of beneficiaries’ retirement income to unrelated goals.
As noted by Secretary of Labor Eugene Scalia in an accompanying press release, “The proposed proxy rule would ensure that individuals responsible for the retirement savings of millions of American workers are voting proxies only where it is financially in the interest of the plan to do so. The proposal would provide clarity and further the prudent management of plan assets and resources.”
The Institute for Pension Fund Integrity applauds the Department’s effort to address the systemic issue of undue influence of proxy advisory firms in shareholder voting, and while the scope of this proposed regulation is limited to ERISA-backed pension funds, we believe that it serves as a key step toward much-needed reforms. As noted in a previous IPFI issue brief, proxy advisory firms play a critical role in determining how institutional investors, such as those who manage public pensions, vote on shareholder resolutions. As fiduciaries, these individuals are obligated to prioritize fiscal returns above all else. However, proxy advisory firms compromise that duty through a lack of transparency, conflicts of interest, and politically motivated voting.
According to IPFI President Christopher Burnham, “The existence of ‘automatic voting’ allows proxy ballots to immediately be cast before inaccuracies can be identified. ‘Automatic voting’ allows proxy votes to be cast on faulty information well before the inaccuracies have the opportunity to be identified. This ‘automatic voting’ prohibits pension beneficiaries from having full transparency on the proxy votes that affect them. The SEC rightfully issued guidance to restrict this mismanaged practice and the Labor Department should similarly issue new oversight to this end. A process for review and a rectifying flaws in the research and recommendations by proxy voters better legitimizes the proxy process and ensures that shareholders are voting with accurate information.”
The Department of Labor’s proposed rule will be open for public comment over the next thirty days. During this time, IPFI will continue to press for a re-commitment to fiduciary duty and the removal of political decision-making from pension fund investment.