08 Jul 2020 After Labor Department’s Wise Move, Time To Hold Public Pension Fund Managers To A Return-Maximization Standard As Well
Labor Secretary Eugene Scalia recently announced a proposed rule to require private pension fund managers to maximize risk-appropriate returns rather than indulge their personal policy preferences when selecting investments. When so much of corporate America is mouthing ill-considered platitudes while diverting hard-earned revenues to buy temporary detente with organizations seeking to destroy the whole free-market system, Scalia is wisely restricting pension funds from costly virtue signaling in order to protect workers from old-age penury. This is a great first step, but it doesn’t protect state and local government workers. Taxpayers nationwide – especially those not swept away by trendy green and woke fads – must develop successful strategies for requiring the same rigor of public pension-fund managers.
Institutional investors have increasingly signed on to Environmental, Social & Governance (“ESG”) investing. This investment strategy rewards companies that conform to a set of exclusively leftwing policy goals. These include zero carbon emission before 2050; racial, sex-based and other surface-characteristic quotas for boards of directors and employees generally; and the silencing of any voices that depart from the ever-more-radical demands of the “mostly peaceful protestors” who are doing hundreds of millions of dollars of property damage while tearing up our shared national life. The key institutional supporters of ESG investing have resolutely excluded any proposals, such as those we at the Free Enterprise Project offer, that would protect the interests of all Americans, including our proposal that companies prohibit viewpoint discrimination in their equal employment-opportunity policies.
Some of the institutional investors most committed to ESG investing are state and local public pension funds. (Federalism forbids the Labor Department from regulating these funds.) This creates a public-policy problem. The money in these funds flows largely from taxpayers and public employees themselves. Neither the taxpayers nor the pensioners are uniformly leftwing, and so it is an abuse of power to make uniformly leftwing political investments with their money.
Another problem is fiduciary. In announcing Labor’s proposed rulemaking, Secretary Scalia remarked that “ESG factors often are touted for reasons that are nonpecuniary—to address social welfare more broadly, rather than maximize returns. One prominent firm’s manager has said that its funds may choose investments that offer a below-market rate of return but further the firm’s goal of having a ‘positive effect on corporate behavior and to promote environmental and social progress.’ That trade-off may appeal to some investors, but it is not appropriate for an ERISA fiduciary managing other people’s retirement funds.”
For just these reasons, ESG investing also potentially violates public pension managers’ fiduciary duties. Their task is to maximize returns on investment so that pensions are paid as promised, without taxpayers being unduly overcharged. To the extent managers follow any metric other than value maximization – and especially to the extent that they follow their personal policy preferences to support leftwing ESG metrics instead – they have violated traditional fiduciary law in ways that could subject them to personal liability.
Such personal liability is unlikely to arise in this context, but taxpayers and voters should still find tools by which to foreclose politically motivated investments. Every such investment that decreases pension-fund returns makes taxpayers, in theory, liable for higher taxes. Public employees and retirees are similarly motivated. In many states – Illinois, New Jersey, Connecticut and Kentucky topping the list – pensions are so desperately underfunded, taxes so high, and taxpayers already so exit-oriented that it’s virtually inconceivable taxes can be raised enough to fulfill all outstanding pension promises. In these states, politically motivated investment cuts into employees’ eventual pension payments.
Public-employee unions respond to this math by citing the Contract Clause of the federal Constitution, but it will not avail them. Contract Clause doctrine allows for adjustment of public contracts post factowhen pressing public interests dictate. More importantly: the Constitution is neither a suicide pact nor a charter for state failure. If, as appears true, some states cannot pay the promised pensions without abandoning their obligations to the rest of their citizens, the Constitution will not be interpreted to require them to. Even if it were, the interpretation would be meaningless in practice: everyone who could afford to leave the state would, and the remaining population would by definition not be able to cover the bill.
Taxpayer suits that aim to direct how public funds are spent invariably lose; the courts hold that the taxpayer’s remedy is at the ballot box, not the bar. But a suit by taxpayers directing pension fund managers to invest state taxes flowing to the fund only to maximize returns – the heart of the managers’ fiduciary duty – might fare better. Even better placed will be public employees and retirees who are unquestionably third-party beneficiaries of the fiduciary obligation, and who should be able to sue on that basis, unless explicitly precluded from doing so by state statute.
Another route to cutting off politically motivated investing is statutory. A law requiring that fund managers seek only to maximize returns and to document their decision making and its bases would solve the problem. Politics may bar legislation in many states. The states that have the largest pension imbalances and highest tax burdens are usually very liberal ones. But statutory protections should be pursued everywhere possible, if only as a safeguard against future mischief. And demand for such statutes may rise in unexpected places if public employees and retirees realize that they are unlikely to collect everything promised to them, and that pension managers’ pursuit of personal policy preferences is further reducing their total final recovery.
ESG investing is designed primarily to push American corporations sharply to the left. It will hurt not only shareholders, but taxpayers and public employees generally. Even those who themselves lean left may wish to look to curb this trend, for the sake of their own finances.