Pension funds, as investors, have long trended toward passivity – but aggressiveness is increasingly their hallmark. In a recent raft of proxy proposals and litigations, pensions have emerged from the background. No longer the quiet shareholder, they are actively working to advance their own goals, both operating and strategic.

Some active funds are engaging in proxy battles (often submitting the same proposal to multiple companies for consideration at the annual meetings).  This season, pension funds have taken a particular interest in corporate governance, disclosure and regulatory issues. On the governance front, compensation issues have been particularly hot battle for pensions. For example, the Firefighters' Pension System of the City of Kansas City, Missouri, Trust and the City of Philadelphia Public Employees Retirement System jointly filed a golden parachute proposal to Verizon.  Similarly, the Massachusetts Laborers’ Pension Fund submitted a proposal to Moody’s requesting that the board adopt a policy requiring the chairman to be an independent director who has not previously served as an executive. In addition, Citigroup received a proposal from the Central Laborers' Pension Fund requesting that the company's board of directors initiate a process to amend the company's corporate governance guidelines to adopt and disclose a detailed CEO succession planning policy.

Disclosure issues and the hopping regulatory climate are also hot points for pension fund proxy advocacy.   Halliburton received a proposal from the New York City Police Pension Fund and the New York City Fire Department Pension Fund that would require disclosure of the company’s political contributions.  CVS Caremark, meanwhile, received a proposal from the New York City Employees' Retirement System, the New York City Teachers' Retirement System, the New York City Police Pension Fund, the New York City Fire Department Pension Fund, and the New York City Board of Education Retirement System requesting that the board issue a report to shareholders on how the company is responding to rising regulatory, competitive and public pressures to halt sales     of tobacco products.  The companies receiving the proxy proposals above have submitted No Action Letters to the SEC this year, but only in the last case did the SEC reply that there appears to be some basis for the company’s position and allowed exclusion of the proposal. The Commission’s implied support may have added fuel to the Funds’ advocacy fire.

Some particularly aggressive pension funds have even gone as far as suing to stake out their position.  These suits are interesting in their own right, but are also interesting in light of regulatory requirements, discussed in greater detail below.  For instance, just yesterday, two large U.S. pension funds – California Public Employees' Retirement System (CalPERS) and California State Teachers Retirement System (CalSTRS) – filed suit in the Southern District of New York against Bank of America, contending that the bank's management mis-stated or omitted material information about Merrill Lynch's financial before shareholders voted on the merger. In a suit similarly spurred by pension fund losses, filed in a New Jersey superior court last week, the State of New Jersey sued former executives and directors of Lehman Brothers, claiming that misrepresentations led to the state’s pension funds losing $118 million on investments in the now-bankrupt financial firm.  The state is alleging violations of federal securities laws, negligent misrepresentation, breach of fiduciary duty, fraud and aiding and abetting, among other charges.   Notably, U.K. pension funds are even entering the fray. In a case filed in New York as a class action against the Royal Bank of Scotland, plaintiffs, including two prominent British pension funds, allege that RBS “falsely reassured” investors about the bank’s stability just prior to its share price decline last year.  That suit, presumably, is also an attempt to recover losses.

Pension funds are subject to the Employment Retirement Income Security Act (“ERISA”) and related regulations.  The ERISA cloud leads to caution on the part of both pension funds and hedge funds that receive funds from pensions. Absent this caution, there is a serious risk that the funds themselves could be swept into the regulation that burdens ERISA-governed pensions, due to what is known as the “look through rule”.  The concern centers around the amount of investment that hedge funds receive from pensions.  Essentially, if one pension holds more than 25%, or if three pensions collectively hold more than 25% of a hedge fund, the fund could become subject to ERISA regulations.  (Of note: ERISA rules were amended slightly by the Pension Protection Act of 2006, but their essence stayed the same.)  Among ERISA’s perceived handcuffs are fiduciary duty rules, manager registration requirements, transaction requirements and government report mandates that would impose a higher standard than hedge funds must typically meet.  Consequently, there has traditionally been a leaning toward passive investment by pension funds. Now, though, pension funds seem to be throwing passivity – and caution – to the winds, as they step into the middle of the financial crisis to try to recover.  

Pension funds have been in the spotlight recently as lobbyists, activist investors igniting proxy battles, and catalysts fueling the fire of litigation against companies which are barely treading water in this economic climate.  The moral of the story of the activist pension fund is that pension funds matter more than ever.  It seems pension funds are being taken more seriously – the California Public Employees' Retirement System said recently that it has withdrawn a majority of shareowner proposals filed last fiscal year after successfully engaging companies to make corporate-governance changes.  And all of this is in the current environment where most are underfunded.  Imagine if they were fully funded and had even greater resources at their disposal.  If funds continue to blur the line between ERISA-governed and ERISA-exempt, pension participants, the funds themselves and their attorneys, not to mention hedge funds, should not be surprised to see increased regulation in their futures.  

Published: March 24, 2009