For years, institutional investors have dogged the corporate world to improve its governance practices. But many of these same institutions haven’t been practicing good governance themselves.
Just ask New Jersey’s public school teachers, who recently learned that state officials diverted $3.1 billion from their pension funds using artificially high investment returns and other “Enron-like” accounting. Or consider the plight of the city workers in San Diego, where governance lapses and breaches of fiduciary duty by former retirement board members contributed to a $1.4 billion unfunded liability. More recently, details have surfaced about how New York’s former state comptroller misused state funds for personal use.
Even my former employer, TIAA-CREF, suffered its own governance problems in 2004 when two trustees were forced to resign after it was revealed they were doing side business with the fund’s independent auditor, Ernst & Young.
Let me be clear. Public pension programs and other institutional funds are excellent tools to plan, save for and manage the costs of providing a decent retirement. A well-run system takes dollars today and pays for liabilities 30 to 50 years from now.
But the above examples are not the first — nor likely the last — to painfully illustrate the need for institutional investors to take a serious look at their governance practices. If they don’t, we all pay the price.
In New Jersey, for example, legislators are scrambling to come up with assets to cover the state’s $3.1 billion IOU to future beneficiaries. That figure doesn’t include the six years of lost potential investment return.
And the public isn’t happy. Why should they be, when they continue to pay for a system that takes money from education, transportation and health-care programs instead of diligently saving and investing as it is supposed to do?
Last year, a group of fund professionals and academic experts organized by Stanford Law School — and of which I am the chairman — began a long-overdue dialogue: Who’s in charge of the funds and do they have the skill and systems in place to protect our assets from theft and malfeasance?
The result of our work was the development of a set of best-practice principles for improving fund governance. The recommendations, which focus on pension funds, university endowments and charitable funds, are rooted in one overarching goal: making funds more accountable to their beneficiaries.
The first principle is transparency. We ask that funds clearly define and make publicly available their governance rules. Second, we recommend steps for funds to identify their leadership structure and better articulate roles and authority. Third, we define core competencies that individual trustees should possess, namely, the financial and legal acumen to confront and prevent attempts to play fast and loose with fund assets. Fourth, we propose tough and transparent policies to address conflicts of interest so that fund decisions are based on fiduciary principles and not on politics. And finally, we offer guidelines to establishing processes to manage internal and external contracting relationships.
When people read our report, the logical response will be to question why these principles have not been observed up to now. We are not asking for the impossible. In fact, for years public corporations have been employing many of these ideas in their own governance, ironically because of the advocacy of the very organizations that need to improve their own governance.
To be sure, the diverse forms of institutional investors make it impossible to develop a “one-size-fits-all” approach to regulating fund governance. But in light of today’s current system, which is rife with opportunities for abuse or mismanagement, our best-practice principles offer a road map to a more secure savings and investment environment — one that we hope will prevent another New Jersey or San Diego from happening.
If we don’t try to fix our problems now, it’s only a matter of time before Congress steps in the breach.
Peter Clapman is president and chief executive officer of Governance for Owners USA Inc., Scarsdale, N.Y., a unit of Governance for Owners Group LLP, London, a corporate governance advisory firm and activist money manager, and chairman of the committee on fund governance of the Stanford University Law School Institutional Investors’ Forum.