The Use and Abuse of Labor’s Capital

The following post comes to us from David H. Webber of Boston University Law School.

Across the country, public employee retirement systems are investing in companies that privatize public employee jobs. Such investments lead to reduced working hours and often job losses for current employees. [1] Although, in some circumstances, pension fund participants and beneficiaries may benefit from these investments, their actual economic interests might also be harmed by them, once the negative jobs impact is taken into account. But that impact is almost never taken into account. That’s because under the ascendant view of the fiduciary duty of loyalty, pension trustees owe their allegiance to the fund first, rather than to the fund’s participants and beneficiaries. Notwithstanding the fact that ERISA and state pension codes command trustees to invest, “solely in the interests of participants and beneficiaries and for the exclusive purpose of providing benefits,” the United States Department of Labor declared in 2008 that the plain text of the quoted language means that the interests of the plan come first. [2] Under this view, plan trustees should de facto ignore the potentially negative jobs impact of privatizing investments because that impact harms plan members, and not, purportedly, the plan itself. Thus, in the name of the duty of loyalty, the actual economic interests of plan members in plan investments are subverted to the interests of the plan itself (or, at a minimum, to an unduly constrained version of the plan’s interests that excludes lost employer and employee contributions). As a result, public pension plans make investments that harm the economic interests of their members. This turns the duty of loyalty on its head.

In The Use and Abuse of Labor’s Capital, recently posted to SSRN and forthcoming in the New York University Law Review, I challenge this ascendant view of the duty of loyalty and the exclusive purpose rule. I argue instead for a “member first” view of fiduciary duty in connection with fund investments, which would allow fund trustees to consider the jobs impact of investments. I argue that this view is more consistent with the traditional view of the duty of loyalty than is the “fund first” view. My analysis is divided into three sections: a textualist section, an agency costs section, and a section discussing the practical implications of a transition from a “fund first” to a “member first” view.

First, I argue that investing “solely in the interests of participants and beneficiaries” means just that—in the interests of participants and beneficiaries. It does not mean prioritizing the interests of the plan over those of participants and beneficiaries. In so doing, I discuss caselaw that arguably supports a “member first” view. To be sure, the member interests in question must be related to fund investments. Pension trustees do not have a duty to help members balance their checkbooks or buy a house at a fair price. But the traditional purpose of the duty of loyalty is not to create a hierarchy of financial interests of plan members in the investment of their retirement savings, but rather to ensure that trustees place the interests of participants and beneficiaries ahead of their own interests, or those of third parties. Arguably, “fund first” places the interests of third parties—like outside investment managers compensated on the basis of fund performance—ahead of member interests. I also critique what is likely the strongest textual argument for “fund first”, which derives from the second half of the text quoted above, that trustees must invest, “for the exclusive purpose of providing benefits.” “Benefits” is susceptible to different interpretations, and one would think that a “member first” view would depend on a broad definition of the term. But I demonstrate that the “member first” view is consistent with even the narrowest understanding of “benefits”. If one narrowly defines “benefits” as retirement benefits only—the definition least conducive to my argument—one could argue that investing “for the exclusive purpose of providing benefits” means maximizing returns to the fund that pays those “benefits”. Therefore, one might argue, the standard should be “fund first”. But I point out that, for defined benefit plans generally, and public pension funds in particular, retirement benefits are calculated as a direct function of employment terms. A public employee’s retirement benefits are determined by her job title, her seniority, and her income. Jobs arguably have a more direct impact on “benefits” than fund performance. Thus, in considering the member jobs impact of investments, trustees do so, “for the exclusive purpose of providing benefits.”

I also critique the “investments of equal value rule”, which allows trustees to select an investment for virtually any reason, as long as the trustee is choosing between two or more investments of equal value to the plan. Although this rule improves upon what preceded it, and concedes that factors beyond maximizing returns to the fund may be taken into account (albeit in limited circumstances), I argue that it inadequately safeguards the economic interests of fund members by de facto eliminating the jobs-impact analysis. Even more unfortunately, it allows fund investments to be selected precisely because they undermine participant jobs, so long as the jobs-harming investment’s expected risk/return, diversification, and liquidity properties are equal to those of an investment that does not hurt jobs. In discussing this rule, I reassess an investment made by the Florida Retirement System—about half of whose assets are comprised of teacher retirement funds—in Edison Schools shortly after Jeb Bush won reelection as Florida governor in a heated campaign that involved attacks by Bush on teachers unions, and vice versa. Finally, I discuss how a “member first” view of fiduciary duty works in concert with, and is constrained by, the remaining existing fiduciary duties that govern trustees, including the duties of impartiality, prudence, and diversification.

In Section II, I step away from textualist arguments to assess policy reasons why a “member first” view is appropriate for public pension funds. Three aspects of public pension funds distinguish them from trusts generally or private ERISA funds: (1) unlike the corporate sponsors of private pension funds, the state and municipal sponsors of public pension funds are not subject to the market for corporate control and are not merged into or acquired by other entities; consequently, it is not necessary for the legal architecture to guard against the particularly acute agency costs that manifest in the mergers and acquisitions context (such as the fear that target management will exploit the corporate pension plan to fend off an unwanted acquisition); (2) in contrast to private trusts, public pension funds operate in public where they can be more easily monitored (though they are not subject to as much disclosure as they ideally should be); and (3) public pension fund participants and beneficiaries often elect representative peers to serve on fund boards of trustees, reducing the types of monitoring concerns one might ordinarily face in a private trust. A fourth difference between private trusts and public pension funds (and employee benefit plans generally) is that in the latter case, the fund members also contribute to the fund; they are donors in addition to being beneficiaries. This distinction matters less for the agency cost analysis than it does for a point I address in the paper, specifically, that these conflicted investments inflict a dignitary harm on members. For the first three reasons, some of the ordinary agency cost concerns one might find in a private trust or even a private pension plan may not exist in the public pension context, or exist in different form. Therefore, the shift from a “fund first” to a “member first” view of the duty of loyalty raises fewer agency costs—or at least different agency costs—from those for which trust law fiduciary duties were designed.

Finally, in Section III, I discuss how a “member first” view of fiduciary duty should be implemented and assess the practical implications of such a shift. I argue that the “member first” view will alter the information environment, requiring disclosure and assessment of the jobs impact of fund investments. This new information environment may itself affect investor and investee behavior. I then consider how public pension funds ought to respond to this information, contemplating primarily the case in which a fund is invested, or plans to invest, in a project whose negative jobs impact outweighs its superior returns. I analyze pension choices in this situation using the familiar framework of investor choice: exit and voice, in addition to proactive jobs creation, arguing that these tools can be brought to bear to protect and enhance jobs. In particular, I argue that under a “member first” view, public pension funds could consider the potential risk to their employees of investing in companies that privatize public sector jobs—even if the investee is not actively bidding against its own members—as long as the fund credibly believed that the investment posed a future threat to its members. This would substantially increase the pool of capital that could exit, or exercise voice, over privatizing investments, and enhance the effectiveness of the “member first” view. I also examine the handful of funds that have attempted to implement policies to deal with the privatization issue. Although I discuss my proposal primarily in the context of jobs, it also has implications for a broader sphere of participant and beneficiary concerns, including corporate political activity, corporate tax avoidance strategies, and in-state investments, among others.

The full paper is available for download here.


[1] In many instances, fired public employees turn to public assistance, which at a minimum complicates the argument that such investments benefit taxpayers.
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[2] ERISA does not apply to public pension funds. But the fiduciary duties embedded in state pension codes usually mirror those in ERISA; in some instances, such codes copy ERISA’s fiduciary duties, in others, the duties are the same because they share common antecedents in trust law fiduciary duties. ERISA is regularly cited by state courts in construing state pension codes. In 2008, the United States Department of Labor issued Interpretive Bulletin 08-1, in which it asserted that the plain text of the duty of loyalty and the exclusive purpose rule means “plan first”. See 29 C.F.R. § 2509.08-1 (2008) available at
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