Friday, May 16, 2014

Predictably, Politics Trumps Investments

Predictably, Politics Trumps Investments

Earlier this week State Treasurer Janet Cowell announced that she has decided to defer her decision concerning oversight of North Carolina’s pension investments until 2015.  The Treasurer serves as sole fiduciary in North Carolina.    At the end of April the N.C. Investment Fiduciary Governance Commission recommended that a board, chaired by the Treasurer, oversee the pension’s investments.[1]  A minority of the Commission endorsed the existing sole fiduciary model.  In my Sunday column in the News & Observer on May 3rd,[2] I sided with the minority report.

The State Treasurer did put forward four other recommendations contained in the Commission report.  She called for an outside accounting firm to audit the plan and for an outside consultant to review investments every four years.  She asked for increased flexibility in hiring and paying staff.  Finally, she proposed enhanced reporting on investments and clarification of the public records laws.

The reaction from the Treasurer’s most  “frequent and vituperative critic,”[3] the State Employees’ Association of North Carolina, was entirely predictable.  The News & Observer reported that “Ardis Watkins, SEANC’s legislative affairs director, ripped into Cowell’s specific recommendations as well as the lack of any action on the salient issue of who determines the state’s investments.”  Here’s my favorite quote from the paper’s coverage:

It is crazy-making to us. Our members’ futures are at stake, literally. Ms. Watkins had nothing substantive to say about either the deferred decision or the recommendations.  Hyperbole makes good press, but lousy policy.

While SEANC is totally off base in declaring that their members’ futures are at stake, there is reason to be disappointed in the Treasurer’s deferred pronouncement.  I think I understand the Treasurer’s political decision.  There’s no consensus on the sole fiduciary issue either in the Commission report or the General Assembly.  Moreover, the General Assembly only conducts a short session in even numbered years.  Thus, the Treasurer may have calculated that there was little reason to stake out a position that might not be implemented in the next couple of months.

I think the deferral reflects poorly as a substantive investment decision.  As the pension’s fiduciary, the State Treasurer has to make all sorts of tough investment decisions.  Nearly every investment has a series of pros and cons and risks and rewards.  There’s almost always a reason to delay a decision and seek more information.  However, investment leadership requires the fiduciary (be it a board or individual) to make the decision.  In this case, the pros and cons of a sole fiduciary or investment board have been thoroughly explored and cogently presented.  In my opinion, politics trumped investments.
The other recommendations seem to reinforce the political motif.  In my view, the proposals are either unnecessary or astoundingly vague with one exception: internal staffing.

Additional Staff

The Investment Division is understaffed and underfunded relative to its responsibilities.  I agree that the State Treasurer needs to have the authority to hire and retain appropriate professional staff.  My scars from battling for investment positions and salaries are still visible after more than a decade.  While Treasurer’s Moore and Cowell made some improvements, my reason for resigning have not been addressed.  Here’s what I said in a column in Pensions & Investments:

The Legislature has not had the vision to rectify the gross inadequacy of staffing and compensation in the investment division, as I noted in my letter of resignation. In my 25-year professional career, I have never seen an investment organization so inadequately staffed or compensated.

We do not have the financial resources to conduct formal studies. However, from various public summaries and our own internal surveys, we know our employees are compensated at roughly 50% of other large public funds; we know our staff is less than half the size of comparable plans; and, we know our budget is less than one-third that of similar funds. As a result, it is a virtual certainty that the existing staff will disappear with time, and that our state will not be able to meet the investment challenges of the next 10 years.[4]

Engage an external auditor

While I don’t have a problem with an external auditor for the pension, I don’t see why this requires any legislative action.  The Treasurer hires all sorts of lawyers and consultants without any specific endorsement from the General Assembly, which is as it should be.  If the plan requires an external auditor, a firm should be retained. 

There’s a bit of irony in this proposal.  As support for engaging an external auditor, the Treasurer cites the limitations of the State Auditor’s staff.   In other words, the pension plan is going to have to incur a significant new expense because the State isn’t willing to make those resources available within Office of State Audit.  This problem sounds like the very same challenge the Treasurer is trying to solve within the Investment Division. I think the State Treasurer should work with the State Auditor and the General Assembly to make sure the State Auditor has the staff needed to review pension investments.  If both the Investment Division and Office of State Audit are inadequately staffed, perhaps the Treasurer should stop investing in alternatives until we have sufficient oversight.

Mandate an independent review of the state’s investments every four years

Taken as an individual proposal, a quadrennial review makes some sense.  However, this review comes on top of the extensive policies, procedures, and fiduciary reviews already implemented by the State Treasurer.  I’ve written extensively about the calcification of the investment process.[5]  On the one hand, the Treasurer wants to increase and retain staff in order to better manage the plan.   On the other hand, she continues to amass legal processes and reviews that undermine the trust and commitment to staff.  At some point, there will be no reason to increase salaries because the staff won’ have the discretion that would warrant increased compensation. 

All these reviews seem to be about answering the political critics instead of investing the assets of the pension plan.  The layers of process, the number of lawyers, and the level of consulting fees continue to go up, but the vituperativeness of the critics never diminishes.

Reporting and Public Records Clarification

It’s hard to disagree with a recommendation that promises greater transparency and proper protection for sensitive investment information.  However, there’s nothing in the Commission’s report or the State Treasurer’s letter to the General Assembly that provides any specifics.  After all the time and money that has been spent investigating placement agents, supporting the Commission, and answering SEANC’s public records request, I’d expect some detailed proposals.   What is going to be reported?  What should be withheld?  The State Treasurer and her staff are the experts on these subjects: What are their recommendations?

This debate over a sole fiduciary, the adequacy of staffing, the need for an external auditor, the requirement of a quadrennial review, and the questions over transparency and disclosure are all borne out of the pension’s increased investment in alternatives.  We’re still not having a substantive discussion.  As long as politics remain the dominant consideration, the substantive investment question about the efficacy of alternative investments will not be addressed.

[3] I can’t do any better than David Ranii’s brief description of SEANC’s attitude.
[5] see, “When Lawyers Manage Investments, December 12, 2013.

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