When Lawyers Manage Investments
Last week I commented that it was good that the North Carolina pension plan is run by the State Treasurer and not by the State Employees Association of North Carolina (SEANC). As it happens, SEANC continues to attack the pension plan’s third quarter performance. However after reading “Report Concerning Placement Agent Review,” a document issued by the State Treasurer, I have a new fear. The North Carolina pension plan has been taken over by lawyers.
The report is based on a profound misunderstanding of the investment process, and the recommendations, while well intentioned, will hurt the performance and soundness of the pension plan. While newspaper accounts have focused on potential improprieties by former State Treasurer Richard Moore and former CIO Patricia Gerrick, the long-lasting damage is contained in recommendations that the current State Treasurer has already implemented, as well as additional policies that she is still studying.
The outside law firm, Kellogg, Huber, Hansen, Todd, Evans & Figel (Kellogg Huber) and the Treasurer’s General Counsel, Jay Chadhuri, who prepared the recommendations and new policies, envision investment decisions as an impartial process in which all conflicts are addressed by disclosures, recusals, processes, attestations, and policy manuals. For example, Kellogg Huber suggested that the State Treasurer should recuse herself if she has some type of prior personal or professional relationship with a money manager or placement agent. The law firm suggests that the Treasurer ought to engage an ad hoc panel or investment committee. While the final report didn’t agree to the recommendation, it proposes that the state’s CIO make the decision instead of the State Treasurer when she’s conflicted. Aside from whether these ideas would require a statutory change, both of them are preposterous.
Here’s the reality of the investment process. It is filled with conflicts, prior relationships, and politics. This is true at public funds, college endowments, and private foundations, and it isn’t confined to hiring managers. The fiduciary’s job is to navigate through these conflicts and reach a reasonable investment decision, whether it’s hiring an investment manager, changing the asset allocation, or engaging the legislature to amend the investment statute.
Clearly, the State Treasurer and her staff will from time to time have personal or professional conflicts. Those conflicts need to be acknowledged and disclosed. However, the report goes off in the wrong direction when it requires that these issues need to be reported to a compliance counsel as well as a fiduciary counsel. The only one who must know about these conflicts is the fiduciary, so she can weigh the investment analysis, advice, and recommendation against the conflict, even if it is her own conflict.
The report goes on to recommend that the Treasurer either give up her role of sole fiduciary or institute an investment committee to act as an intermediary approval step between staff recommendations and her final approval. There’s nothing wrong with either of these models, but they will not do anything to deal with conflicts or politics. The appointment of additional fiduciaries would undoubtedly involve a political process requiring some combination of executive appointment and legislative confirmation. If the additional fiduciaries have the requisite investment expertise, they had better come to the job with all sorts of professional and personal relationships that are the by-product of experience in investment management.
Moreover, if the lawyers think that the multiple fiduciaries will address the issues raised in their report, they ought to conduct a detailed examination of the politics and conflicts built into the conduct of investment committees. For example, plenty of pension plans with investment trustees and committees fell prey to improprieties by placement agents in other states. During my tenure as CIO, I heard all manner of political intrigue from my fellow-CIOs, who served at the pleasure of investment committees instead of a sole fiduciary.
A fiduciary is a position of trust. The recommendations in this report attempt to replace trust with policies and procedures. An investment process run on a heavy dose of reports and forms and reviewed by multiple tiers of lawyers will produce mediocre results. The State Treasurer cannot avoid facing and dealing with conflicts by shunting them off to lawyers or memorializing them in reports. Moreover, instead of instilling trust in the Investment Division’s analysts, asset class directors, and CIO, the report’s recommendations treat these professionals with suspicion. Their time is to be spent filling out forms and continually reaffirming their honesty, instead of doing the real work that is managing investments.
I am not saying that a pension plan should be run without policies and procedures. However, when those policies look like the Internal Revenue Code, they destroy instead of nurture the investment process.
In tomorrow’s post, I want to discuss the findings that led to lawyer’s hijacking the investment process. I will also post a primer on the role of placement agents and consultants for those readers not familiar with these functions in the investment process.