May 2, 2016

The Importance of Upholding Fiduciary Responsibility

Activist organizations and their allies seem to have their sights set on politicizing public pension funds by changing the long held definition of fiduciary responsibility. But the Department of Labor (DOL) makes it crystal clear that the fiduciary responsibility of a pension plan rests entirely on economic factors, as stated on their official page:

“The primary responsibility of fiduciaries is to run the plan solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses. Fiduciaries must act prudently and must diversify the plan’s investments in order to minimize the risk of large losses.”

The DOL is the federal entity in charge of defining fiduciary responsibility and interpreting and upholding the Employee Retirement Income Security Act (ERISA). According to the DOL, failure to minimize risk and provide benefits can lead to direct court action against fiduciaries that “breach their duties under ERISA.” Recently, however, some politicians and environmental activists have entered a slippery slope by over-emphasizing the terms “environmental, social and governance (ESG),” leading them to question the long held legal definition of fiduciary responsibility. In particular, some activists advocate for using divestment as a statement of political opposition, intentionally muddling their interpretation of fiduciary responsibility and consequently putting beneficiaries’ assets at risk.

For example, in Vermont, Governor Peter Shumlin has launched a campaign urging the state pension fund to divest from coal and ExxonMobil assets, despite strong pushback from the State Treasurer who has repeatedly noted “divestment is not the appropriate strategy for our fund and is counter to our fiduciary responsibilities to the fund and its beneficiaries.” In the same vein, VPIC Chair Tom Golonka also pointed out in a recent interview that financial advisors have urged the state to maintain its energy investments and even see energy holdings as “a strategic move to add.”

While investors maintain a positive outlook on energy holdings, the cost of dropping fuels is certain: the state treasury has calculated that divestment would inflict $10 million per year in lost returns and $8.5 million in transactional costs on the Vermont pension fund. These costs of divesting would ultimately be paid by the state and the Vermont pension beneficiaries themselves.

According to lawmakers, the proposed Vermont divestment from fossil fuels and the California Public Employees’ Retirement System (CalPERS) divestment from tobacco directly threaten the security and mandate of these institutions. Robert Klausner, a lawyer specialized in public employee pension funds explains why divestment, by its very nature, contradicts fiduciary responsibility because of its “material, adverse effect on any objective measure.” Klausner explains,

“Divestment has a real cost which can only be made up, in the final analysis by a greater burden on the pension plan sponsors. Divestment, and particularly the projected multi-million cost to Vermont, threatens the security of those programs and also further strains the public fisc.”

If funds divest to make a political statement about fossil fuels, which in turn causes serious detriment to portfolios, then divestment is a clear violation of fiduciary responsibility. And divesting from fossil fuels has been shown to negatively impact diversification and returns in the long run. Tufts, Pomona, Williams and Swarthmore have all studied divestment and found the costs to be substantial. Swarthmore alone estimated the cost of divestment at $200 million over the span of 10 years. And according to a University of Chicago study, divestment would also entail high management fees and compliance costs that would prevent schools form providing key financial aid benefits and program funding.

What divestment boils down to is quite simple: it is a violation of fiduciary responsibility. When financial returns to plan beneficiaries are not protected and upheld at all costs, then the pension fund has violated its commitment to help state employees have a financially secure retirement. ESG principles might be good secondary considerations, but they should never take precedence over the accepted and enforced definition of fiduciary responsibility.