Experts Needed
Companion text to the technical explainer segment of the December 2023 Knowledge Session from Legal Voices for the Future...
Is Growth Fiduciary?
Experts, and other People Who Care, are needed today to help protect the important social constructs of Workplace Pensions and Civil Society Endowments. These constructs are important parts of our modern social architecture for making the social choices through which we shape the world in which we live. These constructs are important to each of us, personally and individually, because they shape our own personal and individual possibilities for living well within that world.
But the fiduciary stewards of our Pensions & Endowments have lost their way. Their money has "gone missing" in the wilds of modern market capitalism. We need to organize a search-and-rescue. To find them. And bring it home to its true purpose.
The fiduciary money aggregated into Pensions & Endowments is all but invisible to our common sense of money and finance in the world today. It is seen, when it is seen at all, only as tucked inside the Wall Street machine: a source of money for market capitalism on a global scale.
And yet the institutions that aggregate this money are the lawful owners and fiduciary controllers of plenary powers of discretionary authority over tens of trillions, collectively, worldwide, in society’s shared savings. They control, as a social construct, more money, with more cohesiveness of purpose, than any nation-state. Or any multi-national corporation. Or any affiliation of nation-states, or corporations.
All this money is controlled by individuals who act, institutionally, as fiduciaries. That means they have a legal duty to provide future financial security to qualifying populations of qualifying individuals. These qualifying populations are so large, and so representative of all of society, that the future that our Pensions & Endowments are chartered to deliver to some, directly must also be, of necessity, the same future that we all will live in, consequently.
So what are these fiduciaries doing with all this money that they control?
What is the future they are providing to some, directly, that is also the future for all of us, consequently?
In the UK, the social cause champions Make My Money Matter, working in collaboration with pension experts, Phoenix Group, recently published a report exploring the use of UK pension and retirement savings to finance action on climate.? This Report got written up in Reuters, by staff writer Tommy Wilkes.? In his article, Tommy tells us:
“British pension funds have 3.7 trillion pounds in assets but much is held in low-risk government bonds.? The government has unveiled plans to encourage funds to invest more in infrastructure and startups, to boost economic growth.”
The reference to “low-risk government bonds” is old-school thinking about fiduciary prudence, the old lore, if you will, of fiduciary duty.
The reference to “growth” is new thinking - well, new since the 1970s -? and the prevailing lore of fiduciary prudence.
Mostly, today, pensions (also endowments, but the real money is in pensions, and the legal construction of the pension provision is more specific, so we are going to concentrate for now on pensions) are giving away control over the money we entrust to their prudence and loyalty to self-named "investment" professionals who are expert in knowing what to buy and when to sell on Wall Street, or in the City.
The expertise that these experts-in-knowing-what-to-buy-and-when-to-sell are expert in is timing the market: being able to sense and anticipate the “movements of the herd”.
And that is all about growth in market clearing prices on a variety of so-called "financial assets", in diverse public or private alternative markets for maintaining market clearing prices for "such assets".
Although many pensions deploy much, if not most, of their money into debt and debt-alternative financings, it is money deployed as equity in public and private alternative markets that bends the arc of enterprise towards Growth as 19th Century PROGRESS into an infinitely receding Frontier, through technological innovation and economies of scale, that got reduced during the last decades of the 20th Century to simple numerical increases in transaction volumes measured in prices paid in money, that has become the defining pathos of modern market capitalism in the 21st Century, severing our connections between quantities of money and quality of life.
How Forever Machines became Growth Machines
Which brings us to our question, Is this commitment to growth by pensions really fiduciary?
This question makes no sense unless there is an alternative that could be taken, but is not actually being taken.
My contention is that negotiation is that alternative.?
Pension fiduciaries, individually and collectively, control so much money that they have the size, the purpose and the time that it takes to use technology to negotiate with enterprise directly on formulas for sharing in enterprise cash flows that are prioritized for the recovery of actuarial costs of money from fiduciary sources. Through negotiation, pension fiduciaries can engineer financing agreements that are purpose-built to fill their fiduciary duties to the future, as the forever machines they are legally constituted to be.
This gives them an alternative to speculating on growth in share prices.
But, with some small exceptions, they mostly are not negotiating. Instead Pensions & Endowments are asset allocating to extract profits by financing growth. Why are they doing that?
Let’s consider quickly the way in which the law has evolved to be what is the norm today, of financing Growth to deliver on the pension promise of security ongoing into the future, forever.
The law in question is the law of fiduciary duty. This a time-honored, if somewhat esoteric, principle in the law that goes back hundreds of years, possibly even to Roman times. Possibly even earlier. It is a duty of care, and caring, by one for the interests of another, in the exercise of control over property of some kind.
In the depths of time, this property was often land and fields. In modern times, mostly, it is money.
And in more recent history, going back to the 19th Century, the law of fiduciary duty in the exercise of control over money for the benefit of another flip-flopped between a judge-made rule of the Legal List - this is the old lore of low-risk government bonds - and an evidentiary standard of The Prudent Person, which has become in our times the Prudent Investor.
Some things happened in the US in the 1960s and ‘70s that are important to this transformation of Person into Investor.
First, Ford Foundation.
In 1969, Ford Foundation, a very large civil society endowment based in the US, became inspired by the idea that college costs could be made more affordable to more Americans if university endowments would invest in Growth by trading in stocks on Wall Street - the new lore - rather than just financing security by buying low-risk government bonds - the old lore.? So they commissioned two New York lawyers, William Cary and Craig Bright, to conduct a survey of the law of fiduciary duty as it applied to university endowments, and report back on the question of whether it is fiduciary for universities to trade stocks on Wall Streets. That is, to finance growth.
Messrs. Cary and Bright reported back, correctly, that the lore of low-risk government bonds was not actually the law of common sense prudence and loyalty: the Legal List is not the law, although it is sometimes applied by the courts as an evidentiary substitute for case-by-case fact-based assessments of prudence and loyalty. But prudence and loyalty under the circumstances is the law. And the Prudent Person is the standard of prudence and loyalty.
Second, the Uniform Act
In the US, a Uniform Act is a model piece of legislation that is promulgated by the National Commission on Uniform State Laws. This Commission is a volunteer group of lawyers formed to work out idiosyncratic differences in local laws between various states in the United States when these idiosyncrasies make doing business across state lines, and moving around the country as private citizens, difficult for no good legal or public policy reasons.
In 1972, the National Commission promulgated something they called the Uniform Management of Institutional Funds Act. This Uniform Act made it clear that The Prudent Person is the law (the Legal List is not).
This quickly became the law in some 43 jurisdictions. In 1974, it got picked up by regulations issued pursuant to the new Employee Retirement Income Security Act, (“ERISA”) that governs most company-sponsored pensions in the US.
This incorporation of the principles of the Uniform Act into the rules of ERISA was widely interpreted as giving Pensions the green light to invest in Growth by trading in stocks on Wall Street.
Over time, a new lore evolved the Prudent Person into the Prudent Investor, where “investor” meant someone who buys and sells "investments", meaning stocks, bonds and other so-called "financial assets".? People who made their living buying and selling different kinds of “investments” came to be called (really, began telling us to call them) “investment” professionals.
US lawyer Keith Johnson, emeritus Counsel to the Wisconsin State Investment Board, speaking at a GAIL event, described this situation as follows:
“…the investment professionals have basically pushed out the attorneys from interpreting fiduciary duty”
Two English High Court cases, Cowan, decided in 1984, and Butler-Sloss, decided in 2022, help complete our picture of the current state of play in pension practice.
Cowan involved a pension for coal miners that was being prevailed upon to provide financing to coal companies that were struggling financially, so that coal workers could keep their jobs.? Some pension fiduciaries objected that providing financing to financially struggling coal companies might imperil the longevity of the pension promise entrusted to their care, and that it violated their fiduciary duty to make financing choices in the interest of protecting jobs at the expense of providing security in retirement. The Court agreed.
Butler-Sloss arose in the context of a current dispute in pension and endowment circles about what is popularly called ESG - the practice of considering Environmental, Social and Governance issues when choosing what stocks to buy, hold or sell.? Some argue that fiduciary duty requires pension and endowment fiduciaries to consider only “purely pecuniary” factors - just the money, and maximizing the quantities of money extracted from the markets as trading profits. This arguement seems to draw on some unfortunate phrasing in Cowan, to the effect that the duty of a pension fiduciary is to the financial interests of the pensioners: a better reading, I contend, is that the Court meant that the current and future interests of current and future retirees in their financial security in their retirement is the interest that a pension owes a duty to; not the interest of current workers in keeping their current jobs.? In Butler-Sloss, the High Court held - consistent with my interpretation of the Court's dicta in Cowan - that an endowment has a mission and endowment fiduciaries have the discretion to consider that mission when exercising their plenary powers of discretionary authority over that endowment: their duty is to the instructions in their constituting trust document, and that duty applies to their financing choices, not just their grant making.
Back in the US, we are seeing continued efforts to interpret fiduciary duty as requiring pension and endowment fiduciaries to extract maximum profit through opportunistic share price trading without regard to the real world consequences of those trades on the quality of life that we all can live.
We are seeing this in so-called anti-ESG campaigns being launched by what we call Red State Attorneys General.
We can also see this in a proxy suit currently pending in New York against the New York City Employees Retirement System, alleging that divestment from hydrocarbons companies is a violation of NYCERS fiduciary duty to maximize profit extraction through share price trading.
More recently, we can see this in the UK, with the recent appointment of new "minister of common sense" to Prime Minister Sunak's new cabinet: :"common sense" is supposed to be "anti-ESG" in the "purely pecuniary" crowd.
Is that really what our shared common sense is, in fact and law?
Money. Money. So Much Money.
Why is all this important to us, as lawyers and as citizens, even if we, ourselves, do not represent Pensions or Endowments, or do transactional work in finance, or are not even lawyers with a professional interest and responsibility in the integrity of the law?
Size.
The amount of money in the world today set aside to provide financing for enterprise through pensions and endowments has become so large that we are all directly and personally affected by the choices that these fiduciaries make about the money that we entrust to them. So we all have a vested interest in what the rules are that govern how these people make their choices for what to do with the money they control.
The Make My Money Matter Report shows us that in the UK alone, some 1.7 trillion is controlled by what are called Defined Benefit pension plans, with a similar sum held in Defined Contribution retirement savings account, which gives us some 3.3 trillion of society’s savings pegged to security nether future.
In the US, there is some 4 -5 trillion aggregated into public pension plans, alone. The OECD puts the number at some 24 trillion, worldwide. Plus another 26 trillion held as retirement savings.
This is A LOT of money, and how it gets deployed has a BIG effect on the kind of world in which you, and I, and all of us, can and will live.
So, we all should take a very keen interest in how that money actually is being deployed. And as lawyers, especially, we have special standing to ensure that accepted practices in the deployment of this fiduciary money are actually fiduciary, according to the law, whether we are acting in the pubic interest, or as advocates for clients.
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A Savings Account Is Not A Pension Promise
One last bit of Big Picture context that calls for clarification is the distinction between Defined Benefit pensions and Defined Contribution retirement savings.
A defined benefit pension is a promise that is earned by workers as part of their total compensation for the work that they do.? It is a promise that is provisioned through the aggregation of money into self-perpetuating superfunds that are supported by society because they serve some very important social purposes.? These funds are owned by institutions that are legal persons and controlled by individuals who have plenary powers of discretionary authority over the deployment of this money. These institutions, and the individuals who act with the authority of those institutions, are accountable as fiduciaries to the common sense of reasonable people of relevant knowledge and experience as the evidentiary standard of prudence and loyalty under the laws of fiduciary duty.
A defined contribution savings account is an individual's private savings held in their own private account.? These savings may be held in limited purpose accounts, and subsidized by society with special tax benefits that limit how that money can be taken out of those accounts.
But the accounts are custodial and the custodian's powers are administrative, not plenary. And not truly fiduciary.
So a pension is a social superfund with social accountability. A retirement savings account is a private fund, with only private accountability.
Our interest today is in the social accountability of social superfunds aggregated to provision a pension promise. (Although once we start deploying social superfunds directly into cash flow financings, new choices will be made possible for offering sidecar funds in these cash flow financings to retirement savers).
So let’s look more closely at what, exactly, that promise is, and how society provisions that promise for reliability.
The Parts and Subparts of the Pension Promise
You can see from this schematic that there are parts and subparts to the whole of this social construct of the pension promise.
At the core of this construct is a contract.? Usually, a collective bargaining agreement.? This is an agreement between a workplace and its workers that specifies wages, hours, working conditions, hourly rates of compensation and a promise of income to live on in retirement.? That contract has many participants, including future hires, new hires, mid-career workers, workers nearing retirement, recent retirees and long-time retirees.? In addition, we all have an interest in this contract: as citizens, because it has important consequences for social equity and the quality of life in the world in which we all live; as taxpayers, because this promise is subsidized through tax benefits, and in the case of government pensions, especially, we are the ultimate guarantors of the payments being promised in those contracts, through our taxes.
Different groups of workers will have different details agreed appropriate to their compensation.? These are generally designed to insure a continuity of quality of life and standard of living for people in their retirement consistent with the quality of life and standard of living they earn during their working years.
All the money contributed to fund this promise gets aggregated into one place, usually some kind of trust under the law.? And control of that money is vested in specified individuals, who serve as fiduciaries.
A Purpose to Replenish the Depletions
We can see how this control works through this visual metaphor of a faucets-and-drains construct (credit: Jon Lukomnik).
Imagine the pension as a basin filled with water.
The basin gets depleted over time, down two "drains", as costs are incurred in its maintenance and administration, and also as current income is paid out to current retirees, in accordance with the specifications in their particular contract.
These depletions get replenished through two “faucets”. One is current contributions added by or on behalf of current workers, each calculated according to the applicable contract. Another is an actuarial cost of money realized by deploying money aggregated into the “basin” as financing for enterprise.
Our question, of course, is how can and should that money be deployed, but before we get there, let’s note that the design specification for the actuarial risk pool that is created and sustained in the law to provision the pension promise calls for current contributions plus actuarial costs of money to offset administrative costs and current payouts, so that the level of money in the basin remains sufficient to keep the whole thing going, reliably paying out contractually calculated payments to contractually qualified recipients over time. Pretty much every month. Pretty much forever.
The payments are always different. The payees are always different. The continuations and contributors are always different. But the dynamic is always the same. Every month. Forever.
Forever Machines
One last visual metaphor, to help us form a picture of what this legal construct is constructed to do.
Imagine an old-fashioned, circa 18th Century waterwheel powering a grist mill, grinding wheat into flour, so the local villagers can bake their daily bread.
Such a wheel cannot turn too fast, or it will break, and there will be no bread. Neither can it turn too slow, or the mill won’t grind, and there will be no bread. It has to be just right, constant and steady. So there is always bread.
To regulate the flow of water in order to regulate the turning of the wheel in order to regulate the grinding of the flour, a river is dammed, and a sluice is constructed to divert a steady flow of water into the wheel.
If the river runs high, excess water is allowed to flow over the dam and continue along the run of river.
If the river runs low, the dam keeps the water levels high enough to maintain the required flow of water down the sluice and into the water wheel.
The mill always grinds. The people always eat.
So, too, with a pension as a modality of money for enterprise to shape the choices that shape our economy, so that we can always have our daily bread, and all the other things will choose to have to live the lives we choose to live.
That economy is the river that sometimes runs high and sometimes runs low.? The pension fiduciary as financier is the dam and sluice and waterwheel. The mill is the contract that provides certainty of income in retirement to workers, according to their contracts. Their daily bread.
The water is cash that flows out of enterprise through the sluice of a financing agreement into the waterwheel of the actuarial risk pool and out through the contract to the workers in their retirement.
The Practical Powers of Pension Fiduciaries
This brings us to the question of what kind of financing agreements pension fiduciaries can and should be entering into, and who they can and should be entering into those financing agreements with.
The "can" part is a function of their powers as financiers.
These include size. Individually, many pensions control billions to tens of billions to sometimes hundreds of billions. Collectively, altogether, they control tens of trillions. Which means, as financiers they are very, very large.? Pensions are, in fact, the largest aggregations of money with a common purpose in the world today. Larger than governments, which are bounded by national interests. Larger than corporations, which are bounded by business competence.
They also include purpose. Pensions, as we have seen, are very programmatic. They have to generate their actuarial required cost on money sufficient, according to the actuaries, to replenish the depletions and keep themselves alive and ongoing into an indefinite future. Forever, really.
And it includes time. Pensions are forever. Their needs are constant and continuing. They just keep going.
This combination of size, purpose and time give pensions the power to negotiate.
Since the 1980s, they have also had access to technology that can be used to model expectations for future enterprise cash flows and to write the private laws of negotiated agreement that will give legal meaning and consequence to those molded expectations
Today, they are using that power to negotiate with only one industry: the Asset Management industry.? And they are using that power to negotiate for only one thing with that one industry: risk-adjusted rates of return on profit extraction from share price trading.
These returns are not determined by the actuarial needs to replenish their depletions and keep their superfunds super full.? They are determined by whatever the markets deliver.
There is an alternative. The Untaken Safer Alternative, of negotiating with enterprise in the real economy directly, through what I call stewardship equity splits designed to deliver fiduciary minimum cash flows from fiduciary grade enterprises.
This new innovation in "how" raises some interesting questions about the "should", including:
And that brings us to the possibility of adapting deliberative processes to create places where we - as lawyers and also as people who care about what pensions do with the money we entrust to them, because we see the importance of these choices that pensions make on the possibilities for living our own best lives - can we contribute our own voices to deliberation on this question of what should pensions do.