Pennsylvania Schools' board woes reflect myriad issues at public plans

U.S. public retirement system boards face a multitude of challenges in how to approach governance because of an overall lack of guidance.

One such panel, the Pennsylvania Public School Employees' Retirement System board, faces a reckoning over its governance even as the retirement system it oversees is under federal investigation over an error in its reported investment figures.

Rick Funston, CEO of governance consultant Funston Advisory Services LLC, said in a phone interview that most public plan trustees have never had experience working with operating companies or serving on a board, and as a result, "It's really hard for them to know what's expected of them."

While legislation in states nationwide generally provides information on how public plan boards are composed and what their responsibilities are, there is a lack of genuine information on how they are supposed to function, he said.

"There's really not much instruction on what are the appropriate lines of relationships between board, executives and advisers," Mr. Funston said. "Generally, how would a board know what questions to ask and provide constructive challenges as part of its fiduciary duty? Because they have a duty when they delegate to do so prudently. The board is assigned the overall responsibility for direction and control, but they don't do the work, so they hire executives and advisers to advise them."

Mr. Funston said, "The problem goes to the fundamental issue of how they perceive their fiduciary duty. Public pension trustees are held to the highest legal standard, higher than that of a corporate director, and the reason for that is the potential for conflicts of interest."

The difficulties in perceiving fiduciary duties are made clear in a recent report Mr. Funston's firm completed for PennPSERS, which has found itself under federal investigation after revealing its own internal investigation on investment reporting errors in March 2021. The system has not disclosed the nature of the error or when it occurred.

Funston Advisory Services' report, commissioned by the $72.5 billion Harrisburg-based system in December 2020, said the 30-member board with 15 voting trustees has become fractured and must find common ground for reform.

The report cited a growing minority of trustees who have expressed strong concerns about the system's direction, their confidence in the senior executives, the independence of their external money managers and consultants, the current asset allocation, and the transparency, reliability and timeliness of materials provided for the board's decision-making.

The situation has progressed to a point in which that minority has consistently provided nay or abstain votes on various investment decisions.

"Dissent or split votes may be appropriate in certain instances but generally are not an optimal continuing method for addressing governance or operational issues," the report said. "Diversity of opinion is essential to avoid the perils of groupthink but should ultimately be used to focus a board on development of a cohesive policy direction."

One recommendation in the report is that the board make improvements in investment policy that could provide a basis for delegating manager selection and termination to investment staff rather than the current policy of requiring board approval.

The report found that among the 20 largest state retirement systems, PennPSERS is one of only two (the other is the $146.1 billion New York State Teachers' Retirement System, Albany) that has significant resources devoted to internal money management but still requires board approval for the hiring of all external managers. The report also notes that large systems that have relatively high alternatives allocations "overwhelmingly delegate manager selection to investment staff." PennPSERS' current private markets and real assets allocation target is 30%.

Regarding the PennPSERS board's decision-making regarding investments, the report said the board has not fully identified which decisions it must approve, leading to "no clear direction to staff on the (board's) expectations for decision diligence and the requirements for its approval," according to the report.

While the report was delivered on Dec. 16, the collection of data had been completed in May 2021, so it does not address developments that have taken place at the system since that point.

In November, the board voted for the retirement of James H. Grossman Jr., chief investment officer, and Glen R. Grell, executive director, who are currently serving as senior advisers before their imminent departures on May 1 and Feb. 28, respectively.

The removal of the system's two senior executives followed six board members in June calling for Messrs. Grossman's and Grell's removal from their respective roles following the discovery of errors in its reported investment figures. The resolution calling for a vote for new leadership was ultimately withdrawn with no reason given.

The report says that a number of recommendations made by the Pennsylvania Department of the Auditor General in 2017 have yet to be adopted by the state's general assembly, including a requirement for a minimum amount of investment knowledge in order to "guide informed investment decisions and promote effective oversight of investment operations," as well as clarification of the trustees' fiduciary duties.

The report says there is no structured process at PennPSERS for selecting topics for continuing education, and there are no required areas of expertise for board members.

Mr. Funston said based on his firm's research, 15 states require governance and investment training for trustees, although he noted the list may not be complete.

He added the lack of expertise among U.S. public pension plan boards creates the big question for trustees: How can they trust advice, and how can they trust the advisers are really loyal to the beneficiaries and the participants?

Mr. Funston said the basic problem is the structure of boards in the U.S. requires the appointment of part-time volunteers dealing with huge sums of money affecting millions of people who are not "remunerated in any meaningful way for their service." These include retired teachers, elected officials and as trustees appointed by elected officials.

Funston Advisory Services' report for PennPSERS paints a picture of a board that has lost trust overall.

"Certainly, rebuilding trust will be an incremental and potentially prolonged process, but the work needs to begin immediately," the report says. "For the foreseeable future, the emphasis must be on 'verify then trust' while remaining professionally skeptical."

"The (board) needs to find the common ground for reform and move forward in unison. Stakeholders need to be reliably informed and understand PSERS' response and plan. While PSERS' current circumstances present difficult governance challenges, these fundamental governance reforms need to be addressed quickly and demonstrably," the report says.

Other report recommendations include reforming PennPSERS' committee structure. According to the report, the board has 10 standing committees, considerably more than the average of six to seven among public plans, each with seven members vs. a typical four to six members. Additionally, the report says the system's bylaws reveal a "random listing of committee responsibilities" for most of the committees and a lack of any formal charters.

The system also has not fully integrated the recommendation to include the biographies of board members on its website. According to the report, the biographies of only 17 board members are currently provided.

Christopher Santa Maria, chairman of the PennPSERS board, said in an email that the board has accepted the report and "we intend to review all of the recommendations over the coming months and look forward to making PSERS a leader in public pension governance and administration."

The full report is available on PennPSERS' website.

Pennsylvania Schools' board woes reflect most public plans' reform issues

An overall lack of guidance bedevils efforts to reform U.S. public retirement system boards, a governance consultant says.