Doing Battle with "the immune system of our culture"
Tom Sgouros and Sara Myklebust co-edited this new advocacy paper jointly issued by Americans for Financial Reform Education Fund and Georgetown University’s Kalmanovitz Initiative for Labor and the Working Poor:
INVESTING FOR THE COMMON GOOD: HOW WORKERS’ PENSIONS CAN HELP SOLVE THE HOUSING CRISIS
I see in this a boldly pioneering, creative-edge, but right-for-our-times, step towards breaking new ground for building new social spaces for a new kind of Fiduciary Activism made possible by innovations in fiduciary finance that rectifies the corrupted code of financialized fiduciary duty.
The paper expresses the current lore of fiduciary duty for a pension trust as follows:
[The fiduciary duty of pension trust] is often interpreted too narrowly to mean that trustees have a duty to seek the maximum short-term return of each individual investment period.
This is not “too narrow”. It is incorrect.
Let’s go back to the beginning.
First, a trust is a legal form of ownership for control over money or other property that is vested by one person - the trustor - in another person - the trustee - for the purpose of delivering a specific benefit to a third person - the beneficiary.
There are numerous variations on this basic triumvirate of trustor-trustee-beneficiary.
In the case of a pension trust, the trustor is most often a workplace that agrees pursuant to an agreement with all or some part of its workforce to establish a trust for the purpose of aggregating contributions to be made in increments over time, by or on behalf of current workers who are also future retirees, in amounts calculated according to the laws of actuarial science as being sufficient to keep the trust, as a mutual aid society, ongoing and able to make contractually calculated payments to contractually qualified workers at contractually specified intervals, for as long as there are workers qualified to received payments now, or in the future.
A key feature of the actuaries’ specifications in their design of the trust as a mutual aid society for an evergreen population of current and future retired workers is that the trust will be able to realize at least an actuarial cost of money through investment, and that the trust will not ever lose any of the money aggregated into the trust through its investment activities.
This can be restated as an instruction in the documents creating the trust, that the trustee is required to invest the money aggregated into the trust for income as well as safety to assure income security in a dignified retirement to an evergreen population of current and future retired workers though payment as and when due, without doubt or delay, of contractually calculated amounts to contractually calculated recipients at contractually specified intervals until there are no more workers, current or retired, who are working for or entitled to an income in their own personal and private dignified retirement.
Aside from this instruction to invest money for income and safety to assure security and dignity for as long as it takes (which, for all practical purposes, is forever), the documents creating a pension trust give the pension trust trustee complete discretion in how they choose to invest those funds, to meet those instructions.
The law of fiduciary duty, however, says, in effect:
Well, you have absolute discretion, under the terms of the document that grants you control, yes. But there are constraints on your exercise of that discretion.? You must act with prudence in the exercise of your discretion, and you must act in undivided loyalty to the instructions in the document that granted you that control.
The legal standard of prudence and loyalty is the prudent person, as a legal avatar for the common sense of reasonable people familiar with such matters.
We can see from the Employee Retirement Income Security Act (ERISA), as a proxy for the law of pension trusts more generally, how this standard is applied in the case of a pension trust.
The prudent person standard requires that a fiduciary act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.
We can weave a generalized expression of the aims of every pension trust from snippets taken from four different legal sources in this way:
The character of a pension trust is derived from the private laws of its creation, and include:
The capacity of a pension trust fiduciary derives from the character of the trust, and this is where the “under the circumstances then prevailing” requirement of prudence becomes important.
Before 1972, the capacity of a pension trust was limited by what is sometimes known as the New York Rule of the Legal List, that constrained pension trust fiduciaries to lending money at interest, much like a bank, but with permitted borrowers limited to governments, high credit quality corporations and real estate. The emphasis was on safety, even at the expense of income.
In 1972, the law recognized that circumstances had changed with recent new learning about how prices move in the stock markets, and how diversification of trading positions across industries over time could effectively mimic, on a portfolio basis, the performance of the market, overall, if the portfolio was large enough. This is known as Modern Portfolio Theory.? In reliance on that new learning, the Legal List came to be replaced by the Prudent Person.
This new rule was widely accepted as giving pension trust fiduciaries permission to participate in what are now known as the capital markets, as Asset Owners Allocating Assets Across Asset Classes, and within asset classes, selecting Asset Managers peer benchmarked by Consultants for excellence in maximizing the highest possible profit extraction from other market participants, and from the economy and society, more generally, through price-taking in the public, or financially engineered value creation in the private, alternative, capital markets, solely in the financial best interests of capital markets professionals on the axiomatic assertion that what is best for capital markets professionals will also always be best for current and future retired workers, and for all of us.
This is the current state of the art of pension trust investing today, with pension trusts typically allocating about 60% of the money they control to interest-bearing koans/debt, in the manner of a banker but without the constraints of the Legal List, and 40% to profit extraction through securities trading, in the manner of a capital markets professional.
This practice has seen the prudent person replaced by the prudent investor.
This is too narrow. The word “investor” is specially encoded to mean a participant in the capital markets, so that the lore is more correctly described as “the Prudent Participant in the Capital Markets”.
What gets lost in this corruption of the code of fiduciary duty for pension trust fiduciaries is a duty of loyalty to the instructions in their constituting documents, which are to invest money for income as well as safety to assure income security in a dignified retirement to evergreen populations of current and future retired workers, for as long as there are current or future retired workers working for or entitled to income security in their own personal and individual dignified retirement.
Volatility and growth become the order of the day. If profit requires extraction, so be it. And if extraction results in the oppression of workers, and the destruction of their quality of life, well somehow that gets justified as being in the best interest of those workers, relative to their retirement.
Go figure.
Private Equity, as detailed in the advocacy paper, is one of the most extreme examples of this twisted logic of extracting from workers to provide for workers.
Private Equity also points to the innovation in fiduciary finance that can rectify this lore to the law, and realign pension trust investment practices with the security and dignity of current and future retired workers.
Private Equity uses the circa 1983 vintage technologies of spreadsheet math, desktop publishing and digital communication to financially engineer profit extraction through value creation. Mostly, they do that financial engineering with money they source from pensions.
This proves that pensions have the capacity, and have had it since 1983, to financially engineer investments in financing for enterprise of any size, in any business, anywhere in the world.
If we look at Real Estate apart from Private Equity, and at Tax Credit Equity for Affordable Housing and Renewable Energy, we will see that these technologies of spreadsheet math, desktop publishing and digital communication can also be combined with the size, purpose and time of a pension trust to financially engineer socially beneficial cash flows through negotiated agreements on equity payback to an agreed cost of money, plus opportunistic update, from enterprise cash flows prioritized by contract for suitability, longevity and fairness, to align the values of their investment choices with the interests of current and future retired workers for whose retirement they are making those investments.
This shows us that pension trusts can be upgraded from financially engineering the oppression of workers in a dystopian economy to financially engineering socially beneficial cash flows for the dignity of workers in the right economy for forming a secure society, and keeping it ongoing into a dignified future, for us all.
If pension trust fiduciaries can upgrade, doesn't their fiduciary duties of prudence and loyalty constrain them to?
And as they do, that will create a new social space for a new kind of fiduciary activism through bargaining for worker dignity, and the common good, in the right economy.