Social Investing and Fiduciary Responsibility

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Social Investing and Fiduciary Responsibility

• Presentation for the IPERS Investment Board
• February 2, 2001

Gregg A. Schochenmaier, General Counsel Manager,
Legal Communications Unit
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Introduction

• The purpose of this presentation is to inform
  Investment Board Members about the concept of
  social investing and to discuss what fiduciary
  responsibilities it has regarding this topic.

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Why discuss this issue?

• Investment Board requested it
• Fiduciaries need to understand this issue
• Purpose of IPERS
• Local implications
• National implications

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What will be discussed

• Define social investing
• Review legal standards surrounding social
  investing issues
• Investment Boards implementation of these
  standards through Investment Managers

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What is social investing?

• Definition elusive
• Economically targeted investments (ETI)
• Shareholder activism
• Preferences for certain investment managers
• Socially screened investments
• Divestitures

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What law governs this issue?

• Iowa Code 97B.7
• Iowa common law
• Internal Revenue Code

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Iowa Code 97B.7

• Derived from Iowa common law
• Prudent person standard
• exercise judgment and care which persons
  exercise ... in the management of their own
  affairs
• not for the purposes of speculation
• in regard to the permanent disposition of the
  funds
• considering probable income and safety of their
  capital
• Not a prudent expert standard

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Iowa Code 97B.7

• Fund can own any kind of property and investment
  that a prudent person would acquire on their own
• Must give consideration to the facts a prudent
  person should know when making such an
  investment, including how the investment relates
  to total value of fund
• What is appropriate consideration?
• Investment designed to further purpose of system
• taking into consideration risk of loss and
  opportunity for gain
• Portfolio composition with regard to
  diversification

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Iowa Code 97B.7

• Liquidity current return of investments
  relative to needed cash flow requirements
• Projected return relative to funding objectives
  of the system
• Consistent with this paragraph (97B.7),
  investments made under this paragraph shall be
  made in a manner that will enhance the economy of
  this state, and in particular, will result in
  increased employment of the residents of this
  state.

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Iowa Code 97B.7

• Exclusive benefit rule
• All moneys paid or deposited into this fund are
  to be used for the exclusive benefit of the
  members and beneficiaries or contingent
  annuitants
• to pay retirement claims for members
• to pay refunds
• to pay costs for administration of the
  retirement system

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Iowa Common Law

• Restatement of Trusts (Second)
• 170 - Duty of Loyalty sole interest and
  exclusive benefit rules
• 174 - Duty to Exercise Reasonable Care and
  Skill prudence rule
• 227 - General Standard for Prudent Investment
• contains these duties care, skill, caution,
  diversification, loyalty, impartiality,
  delegation supervision of agents
• Common law governs in absence of a statute

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Internal Revenue Code

• General qualification requirements for a pension
  plans tax-exempt status, including IPERS
• 401(a) incorporates the common law standards,
  such as the duty of loyalty
• 401(a) Preamble contains an exclusive benefit
  rule that is very similar to Iowa Code 97B.7
  and common law
• pension plan must be for the exclusive
  benefit of the plans covered employees and their
  beneficiaries, and that it must be impossible
  for any part of the corpus or income to be used
  for or diverted to, purposes other than the
  exclusive benefit of the employees or their
  beneficiaries

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Internal Revenue Code

• 401(a)(1) - all contributions received by the
  plan must be for the purpose of distributing to
  such employees or their beneficiaries the corpus
  or income of the fund accumulated by the trust
• 401(a)(2) - under the express terms of the
  trust, it must be impossible for trust assets to
  be diverted to purposes other than the exclusive
  benefit of the employees or their beneficiaries
  prior to the satisfaction of benefits due under
  the plan

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What do these legal authorities require of
fiduciaries in the context of social investing?

• An IPERS fiduciary has a responsibility to act
  prudently and to manage IPERS investments for the
  exclusive benefit of IPERS members and
  beneficiaries
• The Iowa Code requires that all investment
  decisions for the IPERS Trust Fund must be made
  not for the purpose of speculation, but based on
  consideration of the risk of loss and
  opportunity for gain the probable income and
  safety of the investment proper diversification
  based on modern portfolio theory liquidity to
  fund cash flow requirements and, return on
  investments relative to the funding objectives of
  IPERS

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What do these legal authorities require of
fiduciaries in the context of social investing?

• An investment that enhances Iowas economy or
  increases job growth in Iowa must pass the same
  tests as any other investment
• The fact that the investment is an Iowa
  investment can be considered when, and only when,
  the factors that are used to make an investment
  decision are equal between competing investments

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Your role regarding Investment Managers

• These rules apply to all fiduciaries of the
  System
• Investment Managers are fiduciaries of the
  System because they exercise full discretionary
  authority over Trust Fund assets by virtue of
  their delegated authority from the Investment
  Board
• Improper for fiduciary to delegate full
  discretionary authority, then attempt to exercise
  the same or a portion of that authority by
  directing an Iowa investment
• Investment Manager can claim a breach of
  contract and/or breach of fiduciary
  responsibility by IPERS

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Your role regarding Investment Managers

• Once delegated, fiduciaries must act prudently
  in the supervision of its agents per Restatement
  of Trusts (Second) 171
• How do we do this?
• Appropriate selection of managers
• Investment Staff meet and review each managers
  portfolio
• Require routine reporting
• On-site visits
• Presentations to Investment Board

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Summary

• All investment decisions must be made under the
  same standards of review
• If an Iowa investment meets the standards, an
  investment is made because its a good investment
  consistent with our portfolio, not because its an
  Iowa investment
• All things equal between an Iowa investment and
  a non-Iowa investment, can give preference to
  Iowa investment
• Dont interfere with delegated discretionary
  authority, but monitor the investment managers
  exercise of that authority
• Questions?