Public Pension Fund Divestment: A Fiduciary Risk?

April 10, 2007 ( - Executives at public pension funds may be faced with an impossible challenge: how do they follow divestment laws when doing so may mean running afoul of their fiduciary duties by not making decisions based solely on what generates maximum participant returns?

The head of one prominent public fund trade group, who contends he does not oppose the underlying social reform agendas supporting the divestment initiatives such as those focusing on companies with ties to Sudan or Iran or terrorist states, asserts that plans should not be put in this rock-and-a-hard-place position.

“Pension fund allocation should be guided by fiduciary responsibility to the participants alone,” said Hank Kim, executive director and counsel for the National Conference on Public Employee Retirement Systems (NCPERS). He warns that there is an inherent danger in allowing social legislative agendas to guide investments and that dumping holdings in Sudan-linked companies (or other similar divestment mandates) “could undermine plan sponsors’ target of getting the highest investment returns for their participants.”

Lawmakers in North Carolina, Maine, New Jersey have already passed measures that require their state’s public pension funds to dump investments in Sudanese government-linked companies and proposals are still on the table in Colorado and Maryland, with the most recent push by Florida lawmakers for funds to shed holdings in both Sudan and Iran’s energy sector (See FL Lawmakers Push for Iran-Sudan Divestment ).  

Identifying Companies

Part of the difficulty in coping with the divestment issue is how plans even know which holdings they have to sell off. Kim pointed out that funds ordered to divest their funds have no comprehensive list of rogue companies, nor do the have guidelines to help them decipher how strong a company’s ties must be to Sudan to be considered aiding the government .

Kim said this exercise becomes particularly more difficult for local governments that have fewer resources to figure out which companies have direct or indirect ties to Sudan.“Funds are confused about what they need to do,” said Kim. “They are trying to balance their fiduciary responsibility to get real returns with the being good citizens of the state.”

They might be able to get some help from vendors who have found a niche in compiling lists of companies with connections to Sudan, Kim said.  According to NCPERS, KLD Research & Analytics (See Firm Unveils Sudan Involvement Database ), Institutional Shareholder Services and the Conflict Securities Advisory Group (See  Data Helps Investors Screen for Sudan Investments ) are peddling such lists.

Kim also expects to see more opposition by the courts to such measures as was the case in February, when a federal judge in Illinois ruled that a state law limiting pension investments and state banking business in Sudan-linked countries was unconstitutional (See  Court Block Illinois Sudan Law ). U.S. District Judge Matthew Kennelly said the federal government reserves the power to regulate foreign trade.

NCPERS supported Kennelly, according to Kim, who argues that the “federal government should be the final arbiter of foreign policy.”

Weighty Opposition  

The California State Teachers Retirement System (CalSTRS) withdrew its support for such broad divestment legislation last week that would ban investment in companies that do business in Iran or terrorist states (See  CalSTRS Opposes Broad Investment Bans ) when the fund’s board voted to oppose two measures pending in the legislature. The board said such bans could hurt investment returns and cost the fund money.

The move by the $163.5 billion-fund will likely have reverberations, as CalSTRS, along with the California Public Employees Retirement System (See  CalPERS Votes to Bar Sudan-related Investments ), have been known to set the pace in the pension industry.