59
High Performance Investing:
Harnessing the Power of Pension
Funds to Promote Economic
Growth and Workplace Integrity
Jayne Elizabeth Zanglein*
Texas Tech University School of Law
Lubbock, Texas
With assets of more than $4.8 trillion, 1 pension funds are in a
unique position to invest their assets so as to promote national
economic growth. In the past, many innovative and profitable pension
fund investments were thwarted by the Department of Labor's lack of
guidance and support for pension funds wishing to make innovative
investments. However, recently the Department of Labor has taken a
strong position encouraging economically targeted investments (ETIs)
and shareholder activism by pension funds. 2 The Department also has
endorsed the concept of "High-Performance Workplaces''3-workplaces
that "view their workers as valuable assets and make investments
accordingly."4 These recent encouragements by the Department of
Labor are likely to influence pension fund investments in some respect. 5
*Associate Dean and Professor of Law, Texas Tech University School of Law;
J.D. State University of New York at Buffalo, 1980; B.M.E. Berklee College of Music,
1975.
1. Labor Department Moves to Increase Shareholder Activism by Pension Plans,
26 Sec. Reg. & L. Rep. (BNA) Vol. 26, at 1057 (July 29, 1994). Secretary ofLabor Robert
Reich recently noted that pension assets total $4.6 trillion and explained: "Since that
figure is so unfathomably large, let me put it in perspective. If $4.6 trillion worth of
one-dollar bills were laid end-to-end, they would stretch a distance equal to 907 round
trip journeys from Washington, D.C. to the moon." Hearing on Pension Investments and
Economic Growth Before the Joint Economic Committee, 103d Cong., 2d Sess. (1994)
(testimony of Robert B. Reich, Secretary of Labor), reprinted in Federal Document
Clearing House Congressional Testimony (June 22,1994).
2. See Department of Labor Interpretive Bulletin 94-1 on Economically Targeted
Investments, 59 Fed. Reg. 32,606 (June 23, 1994); Department of Labor Interpretive
Bulletin 94-2, 59 Fed. Reg. 38,860 (July 29, 1994).
3. See U.S. DEPT. OF LABOR, ROAD TO HIGH-PERFORMANCE WORKPLACES: A
GUIDE TO BETTER JOBS AND BETTER BUSINESS RESULTS (1994).
4. Id. at 2.
5. My optimism is not overwhelming. In a previous article I concluded that most
pension fund trustees and investment managers do not understand or follow advice
given by the Department in the Avon Letter, see infra note 16, with respect to proxy
voting. Jayne Zanglein, Who's Minding Your Business? Preliminary Observations on
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11
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This article6 will explore the mechanisms through which private
pension funds,' in compliance with the Employee Retirement Income
Security Act (ERISA),8 can promote economic growth, primarily
through economically targeted investments, shareholder activism, and
high-performance workplaces.
Part I: Economically Targeted Investments
A. Introduction
"Economically Targeted Investments" (ETIs) have been defined by
the Department of Labor as "investments selected for the economic
benefits they create apart from their investment return to the employee
benefit plan.''!! Collateral benefits obtained through ETIs include
"expanded employment opportunities, increased housing availability,
improved social service facilities, and strengthened infrastructure.''lO
In June 1994, the Department of Labor issued an interpretive
bulletin on economically targeted investments l l in an effort to make
Data and Anecdotes Collected on the Role of Institutional Investors in Corporate Governance, 10 HOFSTRA LAB. L.J. 23, 52-70 (1992). See also Teresa Ghilarducci, U.S. Pension
Investment Policy and Perfect Capital Market Theory, CHM.LENGE, July, 1994, at 4.
6. This article draws, in part, from two previous publications: JAYNE ZANGLEIN,
SOLELY IN OUR INTEREST: CREATING MAXIMUM BENEFITS FOR WORKERS THROUGH
PRUDENT PENSION INVESTMENTS (AFL-CIO LAWYERS COORDINATING COMMITTEE, 1992)
and Jayne Zanglein, Pensions, Proxies and Power: Recent Developments in the Use of
Proxy Voting to Influence Corporate Governance, 7 LAB. LAW. 771 (1992).
7. This article focuses on private pension funds governed by the Employee
Retirement Income Security Act (ERISA). Many of the examples given in the article
involve public pension funds, however, because these funds have typically been the most
vocal about their pension investments. Where ERISA would prohibit the conduct of the
fund, the reader will be advised. Articles on public pension fund investments include
Patrick S. Cross, Note, Economically Targeted Investments-Can Public Pension Plans
Do Good and Do Well?, 68 IND. L.J. 931 (1993). See also Maria O'Brien Hylton, "Socially
Responsible" Investing: Doing Good Versus Doing Well in an Inefficient Market, 42 AM.
U. L. REV. 1 (1992); Ian LanofT, Investing in Economically Targeted Investment (ETI)
and Infrastructure Investment Products, reprinted in PLI, PENSION PLAN INVESTMENTS
1994: CONFRONTING TODAv'S LEGAL IssUES (May 18,1994) (which both analyze ERISA).
8. 29 U.S.C. § 1102 et seq.
9. Department of Labor Interpretive Bulletin 94-1 on Economically Targeted
Investments, 59 Fed. Reg. 32,606 (June 23, 1994), codified in 29 C.F.R. § 2509.94-1
(1994).
The definition of ETI is controversial. The Advisory Council Work Group on ETIs
states that ETIs have three identifying characteristics: (1) they provide competitive
rates of return; (2) they target a capital gap; and (3) they have a collateral economic
benefit. U.S. Dep't of Labor Advisory Council on Employee Welfare and Pension Benefit
Plans, A Clearinghouse or Network for Economically Targeted Investments (Nov. 1993)
at 7 [hereinafter Advisory Council ETI Report]. The Advisory Council notes that "[a]n
ETI is .... in the eye of the beholder." Id. The Council observes that when a fund makes
an investment where a capital gap does not exist, the fund "is merely displacing another
traditional investor"-not making an economically targeted investment designed to
address a market inefficiency. Id. at 8-9. See also Ghilarducci, supra note 6.
10. Hearing on Pension Investments and Economic Growth Before the Joint
Economic Committee, 103 Cong., 2d Sess. (1994) (testimony of Olena Berg, Assistant
Secretary of Labor), reprinted in Federal Document Clearing House Congressional
Testimony (June 22, 1994).
11. See supra note 9.
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Harnessing the Power of Pension Funds
61
clear12 the Department's long-standing13 policy that "all things being
equal," a pension plan may make an investment which contains a
collateral or social benefit. 14 The Department has consistently
12. See Hearing on Pension Investments and Economic Growth Before the Joint
Economic Committee, 103 Cong., 2d Sess. (1994) (testimony of Robert Reich, Secretary
of Labor), reprinted in Federal Document Clearing House Congressional Testimony
(June 22, 1994) where Secretary Reich stated with respect to the issuance of the interpretive bulletin: "[Iln an effort to clear away any confusion that may surround this
matter, the Department is issuing an Interpretive Bulletin that clarifies the law and
codifies our long-standing position."
13. The Department's position dates back to at least 1980, when Ian Lanoff, then
Pension Administrator for the Department of Labor stated that while ERISA "does not
exclude the provision of incidental benefits to others, the protection of retirement
income is, and should continue to be, the overriding social objective governing the
investment of plan assets." Ian Lanoff, The Social Investment of Private Pension Plan
Assets: May It Be Done Lawfully Under ERISA?, 31 LAB. L.J. 387, 389 (1980). However,
Lanoff was cautious about investments designed to achieve incidental social benefits
and was aggressive in initiating litigation against funds which openly pursued a policy
of investing to create employment opportunities for plan participants. See, e.g., Donovan
v. Walton, 609 F. Supp. 1221 (S.D. Fla. 1985), affd sub nom. Brock v. Walton, 794 F.2d
586 (11th Cir. 1986). Lanoff cautioned that "[tlo introduce other social objectives may
be to dilute this primary objective." 31 LAB. L.J. at 389. Lanofffurther admonished that,
"[Ilt may not be consistent with ERISA standards to pursue .... [social goalsl, with
plan assets, except as incidental to the fundamental ERISA purpose of assuring retirement income." Id. at 391.
The Department has issued many advisory opinions on the issue. In a 1988 opinion,
the Department clarified:
The Department has construed the requirements that a fiduciary act solely
in the interest of, and for the exclusive purpose of providing benefits to, participants and beneficiaries as prohibiting a fiduciary from subordinating the interests of participants and beneficiaries in their retirement income to unrelated
objectives. Thus, in determining whether and to what extent to invest in a
particular investment, a fiduciary must ordinarily consider only factors relating
to the interests of plan participants and beneficiaries in their retirement
income. A decision to make an investment may not be influenced by a desire
to stimulate the construction industry and generate employment, unless the
investment, when judged solely on the basis of its economic value to the plan,
would be equal or superior to alternative investments available to the plan.
PWBA Advisory Letter from Robert J. Doyle to James S. Ray (July 8, 1988).
See also Letters from Department of Labor to John Kenney (June 3,1980) (AO.
80-33A); to George Cox (Jan. 16, 1981); to Theodore Groom (Jan. 16, 1981); to
the Trustees of the Twin City Carpenters and Joiners Pension Plan (May 19,
1981); to William Chadwick (July 21, 1982); to Daniel O'Sullivan (Aug. 2, 1982);
to Ralph Katz (Mar. IS, 1982 and Oct. 23, 1985) (AO. 85-36A); to William
Ecklund (Dec. 18, 1985 and Jan. 16, 1986); to Reed Larson (July 14, 1986); to
James Ray (July 18, 1988); to Gregory Ridella (Dec. 19, 1988) (AO. 88-16A);
to the Honorable Jack Kemp (Nov. 23, 1990); and to Stuart Cohen (May 14,
1993).
14. See PWBA Advisory Letter from Department of Labor to Gregory Ridella (Dec.
19, 1988) (AO. 88-16A) (stating that in making investment decisions, plan fiduciaries
can be influenced by factors unrelated to the plan's expected investment return only if
such investments "would be equal or superior to alternative available investments");
Letter from Department of Labor to George Cox (Jan. 16, 1981) (stating that a fiduciary
can consider factors unrelated to investment return only if, in the fiduciary's judgment,
the course of action taken would be at least as economically advantageous to the plan
as any alternative course of action); Letter from the Department of Labor to James S.
Ray (Jan. 16, 1981) (stating that a fiduciary can consider collateral benefits in making
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11 THE LABOR LAWYER 59 (1995)
construed ERISA's requirement that a fiduciary act "solely in the interest of," and "for the exclusive purpose of providing benefits to participants and their beneficiaries"l5 as "prohibiting a fiduciary from
subordinating the interests of participants and beneficiaries in their
retirement income to unrelated objectives."l6 However, according to the
Department's recent bulletin on economically targeted investments, a
fiduciary may invest plan assets in an ETI "if the ETI has an expected
rate of return that is commensurate to rates of return of alternative
investments with similar risk characteristics that are available to the
plan, and ifthe ETI is otherwise an appropriate investment for the plan
in terms of such factors as diversification and the investment policy of
the plan."l7 .
This imposes no new legal requirements on ETIs. In fact, the
Department stated in the bulletin that "[t]he fiduciary standards applicable to ETIs are no different than the standards applicable to plan
investments generally."l8 Thus, in order to evaluate the appropriateness of an economically targeted investment, the general fiduciary
duties of ERISA must be evaluated. This will be discussed further in
Section I.D below. First, the nature and structure of common ETIs will
be examined.
B. The Nature and Structure of ETIs
Historically, pension plans have been reluctant to invest in
economically targeted investments because: (1) they are typically
complex and time-consuming investments; (2) there is a lack ofprofessional support to advise fiduciaries on ETIs; (3) there is an erroneous
belief that ETIs are unlawful and fiduciaries fear personalliability;l9
an investment decision only if the fiduciary determines that the investment containing
the collateral benefits is expected to provide an investment return to the plan commensurate to alternative investments having similar risks).
15. 29 U.S.C. § 1104 (1994).
16. Interpretive Bulletin 94-1, 29 C.F.R. § 2509.94-1 (1994). See also Letter from
Department of Labor to Helmuth Fandl, Chairman of the Retirement Board of Avon
Products, Inc., at n.4 (Feb. 23, 1988) (hereinafter Avon Letter, reprinted in Pens. Rpt.
(BNA) Vol. 15, No. 9 at 391 (Feb. 29, 1988) (stating that the exclusive benefit rule
prohibits "a fiduciary from subordinating the interests of participants and beneficiaries
in their retirement income to unrelated objectives.")
17. Interpretive Bulletin 94-1. The Department of Labor has described this standard as requiring a "risk-adjusted market rate of return." Olena Berg, Assistant Secretary of Labor, U.S. Dep't of Labor, Address before the Center for Policy Alternatives
Conference on Economically Targeted Investments: Creating Community Capital, Mar.
22,1995.
18. Interpretive Bulletin 94-1.
19. Russ Wiles, Investment Tactic Is Termed Risky; Coast Study Warns of
Conflicts, ARIZ. REpUBLIC, July 7, 1993, at AI. A 1994 Survey by Institutional Investor
found that 90% of the respondents believe that ETIs are "a bad idea because they divert
managers from their prime focus: returns." ETIs? No Way, INSTITUTIONAL INVESTOR,
July 1994, at 201. Of the 90% who believe ETIs are a "bad idea," 10% believe they can
lead to serious losses; 12% believe they can lead to underperformance; and 76% believe
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Harnessing the Power of Pension Funds
63
and (4) because ofwidespread publicity that occurs when an investment
goes bad. 20 The Department of Labor has attempted to alleviate some of
these problems through the issuance of the interpretive bulletin and
the creation of the newly-established ETI Clearinghouse.21 However,
problems still persist due to the nature and structure of ETIs.
A 1993 study by the Institute for Fiduciary Education concluded
that "economically targeted investing is growing only modestly
and ... the subject still elicits strong opinions, both positive and negative, from the pension fund community."22 In the preamble to the
Department ofLabor's recent interpretive bulletin on ETIs, the Department recognized that "a perception exists within the investment
community that investments in ETIs are incompatible with ERISA's
fiduciary obligations."23 The Department issued the interpretive bulletin "[i]n order to eliminate this misconception''24 and encourage investment in ETIs.
In its survey on ETIs, the Institute for Fiduciary Education asked
119 public pension funds to list reasons why they have not made
economically targeted investments. Thirty-seven percent25 of the funds
stated that the principal reason they did not invest in ETIs is because it
conflicts with fiduciary duty.26 Eleven percent said that ETIs take too
much staff time; eleven percent said ETIs are not statutorily authorized; eight percent said they did not invest in ETIs because "no one
asked us to invest in an ETI"; four percent said that their legal counsel
had advised against ETIs; and four percent said they found no
they divert from the primary goal of a fiduciary-to maximize returns. Id. See also
Advisory Council ETI Report, supra note 9, at 1.
20. Several public pension funds received much bad publicity when ETIs went
sour. The Kansas Public Retirement System lost about $236 million from investments
in real estate, savings and loans, and private placements that went bad. The Missouri
State Employees Retirement System ran into problems after some of the companies in
its venture capital fund flied for bankruptcy. The Connecticut State Trusts' investment
in Colt Manufacturing, a ploy to save 1,000 jobs, went sour when Colt flied for bankruptcy. See CENTER FOR POLICY ALTERNATIVES, ECONOMICALLY TARGETED INVESTING
BY STATE-WIDE PuBLIC PENSION fuNDS (1993), at 19-20, 22-23, and 28. See also Iowa
Pension, ETI Settle Fee Dispute, VENTURE CAP. J., Oct. 1994. See also CENTER FOR
POLICY ALTERNATIVES, supra for list of discontinued statewide ETI programs; INST. FOR
FIDUCIARY EDUC., ECONOMICALLY TARGETED INVESTMENTS, A REFERENCE FOR PuBLIC
PENSION fuNDS, at 9 (1992).
21. Hearing on Pension Investments and Economic Growth, (testimony of Olena
Berg), supra note 9. See also Advisory Council ETI Report, supra note 9.
22. INST. FOR FIDUCIARY EDUC., ECONOMICALLY TARGETED INVESTMENTS: A
REFERENCE FOR PuBLIC PENSION FuNDS (1993).
23. Interpretive Bulletin 94-1, supra note 9. The Institute for Fiduciary Education
found that "[tlhe most frequent reason expressed by retirement systems for not investing in ETIs was the belief that doing so conflicted with the pension fund's fiduciary
duty." INST. FOR FIDUCIARY EDUCATION, supra note 22, at Executive Summary.
24. INST. FOR FIDUCIARY EDUC., supra note 22, at Executive Summary.
25. Id. at B-2 (Table B-8).
26. The survey asked the respondents to list and rank reasons, therefore, some
funds reported more than one reason. Id.
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11 THE LABOR LAWYER 59 (1995)
perceived need for ETls.27 Thirty-eight percent of the funds surveyed
invested in ETls;28 fifty ETI programs totaled $19.8 billion. 29
Of the 23 funds who responded, most invested in fixed income
(33.3%), followed by venture capital (23.5%), real estate (21.6%), equities (7.8%), alternative investments (7.8%), and private placements
(5.9%).30 The primary objectives for the ETI investments were economic
development (job creation and business development) and housing: 31
Target
No. of ETIs
Business Development
Job Creation
Home Ownership
Rental Housing
Assisting Low- and ModerateIncome Persons
High Technology Development
Assisting Minority and
Women-owned Business
Assisting Plan Participants
Increasing Tax Revenues
U mon Labor
34
24
21
12
11
9
4
2
1
1
The surveyed funds categorized their ETls: 54% of funds invest in
ETls which target residential housing; 21.7% invest in other real estate
ETls; 15.2% invest in small business loans; 30.4% invest in venture
27. Id.
28. Id. at B-1 (Table B-4).
29. Id. at B-2 (Table B-6).
30. Id. at B-1 (Table B-5). Numbers do not total 100% because of rounding. A 1993
survey by the Center for Policy Alternatives found that of 60 state ETI programs, 30%
invested in housing, 23% in venture capital, 20% in small business, 17% in private
placements, and 10% in other ETIs. CENTER FOR POLICY ALTERNATIVES, ECONOMICALLY
TARGETED INVESTING BY STATE-WIDE PuBLIC PENSION FuNDS 5 (1993).
31. INST. FOR FIDUCIARY EDUC., supra note 22, at 13-14; Table 10. A 1994 survey
by Institutional Investor found the following breakdown:
Housing related
44%
Venture capital
44%
Small business loans
8%
Substantial equity investments
in small, growing local businesses
4%
Substantial equity investments
in established local businesses
12%
Real estate or construction
loans (commercial)
24%
Investment in well-traded
stocks of major local
companies (ETI related)
12%
Minority owned businesses
8%
Other
24%
Again, numbers do not add up to 100% because respondents selected more than one
response. ETIs? No Way, INSTITUTIONAL INVESTOR, July 1994, at 201.
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Harnessing the Power of Pension Funds
65
capital ETIs; and 36.9% invest in other types ofETIs including private
placements, certificate of deposit programs, and limited partnerships.32
Some ETIs are based on standardized investments such as mortgages and mortgage-backed securities, which are "standard, insured
and salable in the secondary mortgage markets, providing a liquidity
not often found in ETIs.''33 These investments entail less administrative
expenses and staff time than other types of ETIs.34 Additionally, it is
easy to find professionals who can develop a customized mortgagebacked securities program.3S
However, other ETI programs suffer from high administrative
costs due to their complexity and the amount of staff time required to
develop, implement, and monitor the program.36 A report issued by the
New York State Industrial Cooperation Council in 1990 observed that
economically targeted investment programs "can be very time consuming and challenging" to establish and administer. 37 Direct investment
programs are difficult to manage and consultants often are not easily
available to develop the program. Additionally, many of these programs
are illiquid investments. 3S
The survey conducted by the Institute for Fiduciary Education
listed various aspects of targeted investments and the difficulty
involved in the implementation of each aspect. Liquidity and the
procurement of a competent asset manager tied as the most difficult
aspect ofETIs.39 Over fourteen percent of plans experienced great diffi-
32. INST. FOR FIDUCIARY EDUC., supra at note 22, at 14 (Table 11). Other types
of investment categories include mortgage-backed securities, apartment development
loans, and real estate.
33. Id. Pension Funds own about $200 billion in mortgage-related securities, about
13% of the market. Tina Ruyer, This New House, PLAN SPONSOR, Nov. 1994, at 16.
34. INsT. FOR FIDUCIARY EDUC., supra note 22, at 14.
35.Id.
36. Id. See generally Clearinghouse Could Remove Barriers to Pension Fund
Investment in Housing, Pensions & Benefits Daily (BNA), Sept. 27, 1993.
37. N.Y. STATE INDUSTRIAL CoOPERATION COUNCIL, COMPETITIVE PLUSECONOMICALLY TARGETED INVESTMENTS BY PENSION fuNDS 7 (1990). See Fran
Hawthorne, Social Investing Gets Down to Business, INSTITUTIONAL INVESTOR, Sept.
1993, at 98:
The biggest headache for many pension funds has not been measuring ETIs
but creating them. Until recently almost nothing was available off-the-shelf.
Each time a pension fund wanted to buy mortgage securities to encourage lowcost housing, it had to reinvent the wheel. And arranging ETIs is a cumbersome
process that can involve piecing together funding from various government and
nonprofit sources, or working with community groups to screen and train
borrowers. It typically takes New York City two years to get an ETI from initial
concept to board approval.
38. INST. FOR FIDUCIARY EDUC., supra note 22, at 15. Most funds expect to hold
an ETI investment (other than mortgage-backed securities) until maturity. Id. Some
funds avoid the problem of illiquidity by making short-term ETIs: 3 year or 3 month
certificates of deposit, or two to five year mortgages. Id. About 7.5% ofthe ETIs surveyed
were investments that matured in one year or less. Id.
39. Id. at 18 (Table 16).
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11 THE LABOR LAWYER 59 (1995)
culty in each of these two areas. Other aspects such as public opinion
and participant opinion presented no great difficulty.40
Percentage Reporting Difficulty
Aspect
Return/Risk
Requirements
Liquidity Level
Requirements
Board Concerns
Internal Staff
Considerations
Politician Concerns
Public Opinion
Participant Opinion
Litigation
Procurement of a
Competent Asset
Manager
Expenses of Operation
Development of a
Performance Benchmark
Operating This ETI
No
Some
(moderate)· I
Great
14.3
75.5
10.2
30.6
22.5
55.1
70.1
14.3
4.0
24.5
46.0
44.1
38.3
61.7
69.3
48.0
55.8
61.7
36.2
6.1
6.0
0
0
2.0
14.3
37.5
71.4
60.0
14.3
2.5
31.7
29.6
65.8
68.1
2.4
2.3
Lee Smith, Executive Director of Excelsior Capital Corporation, a
New York not-for-profit corporation established by fonner Governor
Mario Cuomo to encourage pension funds to make economically
targeted investments, has commented on the difficulties faced by
pension funds who wish to make economically targeted investments:
ETIs have existed for over a decade and their creation and
implementation has often been a slow and arduous task. This type
of capital market innovation is not a well developed practice nor is
it well understood .... Especially when first created, the design and
implementation of ETIs is labor intensive and a costly process. Often
times ETIs require .... the coordination of several different parties
that have previously not worked together. Coordinating these various groups is difficult work. And because of this necessary labor
intensity and the scale, the net fees from these investments often
cannot compete with those other more established investment
products ....
While it is widely believed that this barrier will be substantially
reduced as vehicles become standardized, it is unlikely that this will
occur in the near future .... While it is not necessary to "start from
scratch with each investment," it is also incorrect to assume that all
ETIs are easily transportable.
A second impediment to full acceptance of the legitimacy of ETIs
is the lingering presence of mixed signals from the DOL under previ40. [d.
41. [d. This category combines responses for "2" through "4" on a 5 point scale.
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ous administrations. Many pension fund managers remain skeptical
about the legality of ETls under ERISA. For fund managers the
possible negative consequences of an ERISA violation far outweigh
the potential benefits of making an ETI.42
The Department of Labor has tried to address these concerns by
establishing the ETI Clearinghouse.43 The purpose of the Clearinghouse will be to serve as a resource for funds who wish to develop an
ETI program. The Clearinghouse will showcase successful ETI
programs developed by public and private pension funds and will
prepare case studies of ETIs in the United States, "cross-referenced by
investment category and collateral benefit."44 The Clearinghouse also
will collect performance data on ETIs.45 The Clearinghouse will serve a
tremendous function if it provides technical assistance to pension
funds. The Clearinghouse should be a place where fund representatives
can call to obtain basic information on types of ETIs, the basic legal
requirements under ERISA, a timetable of events which must occur
before the program can be implemented, examples of prototype
programs, information on pooled investments that other funds can
invest in without establishing their own ETI, and other information on
ETIs. Upon request, the Clearinghouse should act as a liaison between
the Department and funds who wish to establish an ETI program. This
will alleviate concerns about the legality and prudence of ETI investments and potential prohibited transactions. The Clearinghouse also
should be able to put fund managers in contact with other fund managers who have developed similar programs, and investment managers
and consultants who are willing to work with funds to develop ETI
42. Hearing on Pension Investments and Economic Growth Before the Joint
Economic Committee, 103d Cong., 2d Sess. (1994) (testimony of Lee Smith, Executive
Director of Excelsior Capital Corporation) reprinted in Federal Document Clearing
House Congressional Testimony (June 22,1994).
43. Id. (testimony of Robert B. Reich, Secretary of Labor). See also Advisory Council ETI Report, supra note 9, at 10-25.
44. Id. See also Hamilton Securities Gets DOL Contract to Establish First
Clearinghouse on ETIs, 21 Pens. & Benefits Rep. (BNA) 1925 (Oct. 10, 1994).
45. This presents some potential difficulties. Pension plans which are contemplating ETIs are often concerned with setting performance benchmarks. See generally
INST. FOR FIDUCIARY EDUC., supra note 22, at 19-23. The Department expects that the
Clearinghouse will "attempt to establish performance benchmarks for the various types
of economically targeted investments based on the asset class within which they would
naturally fall." Patricia Limbacher, ETI Clearinghouse Building Blocks Laid, PENS. &
INVESTMENTS, March 7, 1994, at 23. Richard Ferlauto, Associate Director of the Center
for Policy Alternatives, counters: "The most appropriate role for a clearinghouse is not
to create benchmarks, but to provide detailed case study analyses of a broad range of
ETI investments by investment target and evaluate the success of the investment
according to its function in enhancing the performance of the fund portfolio." Patricia
Limbacher, Federal ETI Clearinghouse Needed, O'Cleireacain tells DOL Meeting, PENS.
& INVESTMENTS, Sept. 20, 1993, at 8. Olena Berg, Assistant Secretary of Labor says
that "ETIs should be measured by the same performance benchmarks as the rest of the
portfolio." Greg Joslyn, Pension Czar Focuses on Big Picture, MONEY MGMT. LE'ITER,
Apr. 25, 1994, at S7. See also Advisory Council ETI Report, supra note 9, at 15-17.
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11 THE LABOR LAWYER 59 (1995)
programs. This would at least put fund managers in touch with other
people who are knowledgeable about ETI programs, as the literature
and resources on ETI programs is limited.
C. Types of ETI Programs
ETI programs come in various forms ranging from relatively simple
programs such as mortgage loan programs and targeted certificates of
deposits to complex transactions such as the acquisition or funding of an
on-going business. This section will describe the various types of ETI
programs starting with programs that are easier to develop and administer and progressing to complex, time-consuming transactions.
1. Pooled ETIs
Commingled real estate accounts are the simplest forms ofETIs for
the investor. They provide liquid, diversified investments with certain
guaranteed returns and subsidies. 46 Open-end commingled real estate
pools are similar to open-end mutual funds. Investors can purchase
shares at any time; however, most funds restrict the redemption of
shares. Because the capital for redemption is derived from the fund
itself, if capital is available, shareholders can redeem their shares. If
capital is unavailable, the shareholders must wait until enough capital
has accumulatedY There are many pooled real estate funds in which a
pension fund can invest.
The AFL-CIO sponsors the Housing Investment Trust (HIT) and
the Building Investment Trust (BIT). These programs have invested
over $1.3 billion in real estate projects, funded the construction ofmore
than 33,000 housing units, and created more than 19,000 union
constructionjobs. 48 According to the AFL-CIO 1993 Convention Report,
46. Hearing on Pension Investments and Ecorwmic Growth, supra note 10 (testimony of Stephen Coyle, Chief Executive Officer of AFL-CIO Housing Investment Trust).
47. In contrast, closed-end funds:
allow a one time infusion of capital at their formation and then are closed to
new investors. The funds are blind pools in that there are no assets in the fund
prior to the capital contributions of the investors. They usually have a specific
term, such as ten years, and earnings and proceeds from sale are distributed
rather than reinvested. Investors buy the assets at cost rather than on
appraised values since the assets are acquired after the formation of the fund
and no new shares are sold thereafter.
Address by Marc Gertner, Legal Consideration of Employment-Generating Investments
20, at the Investment Inst. in Las Vegas, Nev., sponsored by the Int'l Found. of Employee
Benefit Plans (Mar. 1989). Before investing in a closed-end pool, trustees should closely
examine the pool's investment strategy and the expertise of the manager of the pool.
Real estate foundations are similar to closed-end pools. While these were popular
in the 1980s, their popularity have declined with the advent of newer investment vehicles such as targeted certificates of deposit. For more information on real estate foundations, see JAYNE ZANGLEIN, SOLELY IN OUR INTEREST: CREATING MAxIMUM BENEFITS
FOR WORKERS THROUGH PRUDENT PENSION INVESTMENTS 102-104 (AFL-CIO LAWYERS
COORDINATING COMMITTEE 1992).
48. Jill Hodges and Neal St. Anthony, Investing for 2 Goals; Pension Funds Are
Urged to Meet Social Goals While Fulfilling Their Fiduciary Duty, STAR TRIBUNE,
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"[t]he Housing Investment Trust and Building Investment Trust
consistently provide secure investments with competitive returns while
generating employment, increasing the nation's housing stock and
spurring local community development."49 The Building Investment
Trust has earned an annualized return of7.8% since inception. 50
The AFL-CIO Housing Investment Trust is a pooled, commingled
real estate fund that invests in union-built housing.51 The Building
Investment Trust invests in commercial and industrial ventures. 52 The
two funds have combined assets in excess of $1.3 billion. 53 More than
400 pension funds invest in the Trusts. 54 The Trusts provide resources
to build union construction that otherwise would not be built. For example, after the 1992 riots in Los Angeles triggered by the Rodney King
verdict, the Trusts pledged $75 million to rebuild the riot-torn city.55
The AFL-CIO Investment Trusts recently teamed up with the
Department of Housing and Urban Development and Fannie Mae to
form the National Partnership for Community Investment. 56 Over the
next five years, the Partnership expects to fund construction of up to
12,000 affordable housing units and 1 million square feet ofcommercial
real estate.57 The Partnership predicts that this construction will create
20,000 new jobs in construction and related industries. 58 HUD Secretary Henry Cisneros stated that the project "brings resources together
in a creative way and provides the opportunity for pension funds to
invest in people and rebuild communities."59 The pension funds which
invest in the project will invest in a mortgage-backed security, not in
the housing itself.50
Oct. 29, 1993, col. 6., at 10.
49. Id. HIT's five-year net annualized rate of return was 11.2% as of December
31, 1993. Hearing on Pension Investments and Economic Growth, supra note 10 (testimony of Stephen Coyle, Chief Executive Officer of AFL-CIO Housing Investment Trust).
50. Helen Kanovsky, (kneral Counsel for AFL-CIO Housing Investment Trust,
Address before the Center for Policy Alternatives Conference on Economically Targeted
Investments: Creating Community Capital, Mar. 22, 1995.
51. Hearing on Pension Investments and Economic Growth, supra note 10 (testimony of Stephen Coyle, Chief Executive Officer of AFL-CIO Housing Investment Trust).
52. Id.
53. Helen Kanovsky, (kneral Counsel for AFL-CIO Housing Investment Trust,
Address before the Center for Policy Alternatives Conference on Economically Targeted
Investments: Creating Community Capital, Mar. 22, 1995.
54. Hearing on Pension Investments and Economic Growth, supra note 10 (testimony of Stephen Coyle, Chief Executive Officer of AFL-CIO Housing Investment Trust).
55. Coordination of Snafus Stall Aid to Post-Riot LA., CITY & STATE, Dec. 14,
1992, at 18.
56. Job Creation, Affordable Housing Goal of Union Pension Partnership, 20 Pens.
& Ben. Daily (BNA) 1370 (June 28, 1993).
57.Id.
58.Id.
59. Job Creation, Affordable Housing Goal of Union Pension Partnership, 20 Pens.
& Ben. Daily (BNA) 1370 (June 28, 1993).
60. Id.
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The Multi-Employer Property Trust, a union-oriented real estate
fund founded in 1982, now has assets of$782 million and 95 participating plans.61 The Trust invests in 100% union built construction.62 The
Fund's 5.6% annualized rate of return over the five year period ending
September 30, 1993 made it one of the top performing open-end
commingled real estate equity funds. 63
Banks and insurance companies have also sponsored pooled funds
that make economically targeted investments. Union Labor Life Insurance Company (ULLICO) started the "J for Jobs" program in 1977.64
The Fund has assets of$650 million and 157 pension funds invest in the
program.65 Every one million dollars invested by the J for Jobs program
creates 32,000 hours of construction work. 66 J for Jobs provides "mortgage commitments [which are] contingent on all construction work on
the project being done by unionized contractors and subcontractors."67
Robert Georgine, chairman and chief executive officer of ULLICO
states "all mortgages are committed at market rates so participating
pension funds get a competitive return on their investments.''Il8 The
Fund had a ten year annualized rate of return of 9.75% for the period
ending June 30, 1994.69 In fact, the J for Jobs program was one of the
top performers in Pension & Investments' Performance Evaluation
Report for the open-end fund universe. 70 This stellar performance
caused one reporter to comment: "The perception that loans made by
Taft-Hartley pensions to real estate projects built with union labor are
more concerned with making work than making money is being eradicated by the steady performance [of these funds].''71
Prudential Realty Group's Union Mortgage Account (UMA) is
another top performer with an annualized return of 10.1%for the three
year period ending March 31, 1993. 72 UMA "is an open-end commingled
61. Shepard Burr, Investor Relations for Landon Butler & Company, Address
before the Center for Policy Alternatives Conference on Economically Targeted Investments: Creating Community Capital, Mar. 22, 1995.
62. 6 Commit $24 Million to MEPT Fund, PENS. & INV., Aug. 22, 1994, at 43.
63. Joel Chernoff and Christine Philip, Pension Funds Under Pressure: Push for
Targeted Investments Increases Under Clinton, PENS. & INV., Feb. 22, 1993, at 1.
64. Union Pension Funds Moving to Support Projects that Hire Only Organized
Labor, 18 Pens. Rep. (BNA) 577 (Mar. 25, 1991).
65. Michael Steed, ULLICO, Address before the Center for Policy Alternatives
Conference on Economically Targeted Investments: Creating Community Capital,
Mar. 22, 1995.
66.Id.
67. Financing for Real Estate Projects, NAT'L MORTGAGE NEWS, Sept. 19, 1994, at
29.
68.Id.
69.Id.
70. Terry Williams, Union Realty Funds Make Successful Showing, PENS. & INV.,
August 23, 1993, at 16. The Fund's prior ten-year annualized return of 10% placed the
fund as the second top-performer over the ten-year period ending March 31, 1993.Id.
71. Id.
72.Id.
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account which invests primarily in fIxed-rate mortgages and construction loans on properties to be built or substantially renovated by
contractors employing one hundred percent union labor."73 Kevin R.
Smith, a UMA portfolio manager states, "The objective of the Account is
to provide stable income returns from quality investments which stimulate union construction.''74 Where possible, UMA will invest a participating fund's deposits in the geographic jurisdiction ofthe participating
plan. 75
Recently several new funds have emerged. The CIGNA America
Fund was created in 1994 with a goal of generating a "competitive rateof-return to a union pension plan while also making loans supporting
enterprises with a substantial unionized work force."76 Since its inception, the fund has invested more than $60 million in enterprises which
support organized labor. 77 Mellon Bank Corporation established a
subsidiary, Access Capital Strategies Corporation, in late 1994 to make
economically targeted investments for pension fund clients. 78 David
Sand, chief executive officer of Access Capital Strategies states, "Many
public pension funds would like to invest in their own communities, but
also want the advantage ofa portfolio that is diversifIed geographically.
Because the commingled funds we intend to advise will be structured as
national pools combining funds from clients around the country, our
goal is to make it possible for plan sponsors to achieve both of their
objectives.''79 Access Capital Strategies also is willing to work with
pension funds to create affordable housing. David Sands claims: "Our
job is to take our client's market rate money and blend it with other
funds such as foundations who can provide subsidies" to achieve
economically targeted investments.so
73. PRUDENTIAL REAL ESTATE INVESTORS, MORTGAGE INVESTING FOR JOINTLY
TRUSTEED PLANS (undated brochure circa 1990).
74. Id.
75. Id.
76. CIGNA Expects Expanded Union Interest in Retirement Savings, PR NEWSWIRE, Nov. 30, 1994. Robert L. Whalen, portfolio manager for the CIGNA America Fund
states:
We will continue to pool .... a mix of privately placed and publicly traded securities. Each loan from the Fund must, in one way or another, support organized
labor. Investment quality loans will be made to entities employing union labor,
for new project fmancing employing union labor, and to f1nns engaged in leasing of union-made products.
CIGNA Fund to Promote Future of Organized Labor Tops $60 Million, PR NEWSWIRE,
Sept. 2, 1994.
77. CIGNA Expects Expanded Union Interest, supra note 76.
78. Mellon Establishes New Registered Investment Adviser Subsidiary to Make
Economically Targeted Investments, PR NEWSWIRE (Nov. 18, 1994).
79. Id.
80. David Sand, President, Access Capital Strategies Corp., Address before the
Center for Policy Alternatives Conference on Economically Targeted Investments,
Mar. 23, 1995.
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Massachusetts Financial Services Co. recently established the
MFS Union Standard Trust which has two open-end mutual funds
designed for investment by union pension funds: the Union Standard
Equity Fund and the Union Standard Fixed-Income Fund.81 The funds
will invest in "companies with expanding employment opportunities,
increasing the availability of affordable housing, building or improving
schools or health-care facilities, or assisting minority or women-owned
businesses."82
This partial listing of commingled open-end ETI funds shows that
ample opportunities exist for pension funds that wish to make targeted
investments. The funds are attractive as they are simple, liquid, diversified investments. However, some pension funds would prefer to take a
more active role in investments. Targeted CDs are a first step toward a
more active role.
2. Targeted CDs
Many funds in the construction industry have discovered that they
can create union jobs and affordable housing with minimal risk by
negotiating targeted certificates of deposit with local banks. In Brooklyn, New York, three employee benefit plans deposited more than $20
million in certificates of deposit at Brooklyn's Crosslands Savings Bank
at competitive rates of return in an effort to create low risk affordable
housing.83
The certificates of deposit financed a project by the Brooklyn
Ecumenical Cooperatives, a coalition of thirty-six churches, one synagogue, and two hospitals to construct 114 apartments: forty-nine
market rate condominiums, thirty-four moderate income condominiums, and thirty-one low-income, limited-equity cooperative apartments
ranging between $5,000 and $15,000. The low-income units are subsidized by the State of New York Housing Trust Fund.84 This investment,
which earned competitive rates for certificates of deposit, provided the
union pension funds with collateral benefits-jobs for their members
and affordable housing.
Public pension funds have used targeted CDs to create small-business loan pools. Colorado has established a program in which "the
81. Union-Oriented Funds Designed for Pension Plans, PLAIN DEALER, May 16,
1994, at 2C.
82. [d. When selecting companies to invest in, the Funds:
will consider the degree to which a company's work force is unionized, whether
the company manufactures products on a union boycott list, whether the
company is or has been involved in strikes or lock-outs and whether the
company has demonstrated a pattern of non-compliance with applicable labor
or health and safety laws.
[d.
83. Union Made, Union Paid, CITY LIMITS, Oct. 1988, at 10, col. 1.
84. New York-Based Funds to Finance Rehabilitation, LAB. & INVESTMENTS
(Indus. Union Dep't, AFL-CIOl, Dec. 1987-Jan. 1988, 1, at 2.
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State's pension puts assets into FDIC-insured certificates of deposit.
These resources are then used to provide small businesses with muchneeded long-term fixed-rate financing at a reasonable COSt."85
The Pennsylvania Treasury Department also has created a linked
deposit program to support economic development.86 The goal of the
program "is to help create and retain jobs by placing deposits of
Commonwealth funds in banks and savings & loan associations that
will, in turn make specific loans to new or expanding small businesses
in Pennsylvania."87 Since its inception, the program has created or
saved more than 12,000 jobs in Pennsylvania through investments in
excess of$120 million.BB
The eligibility requirements include the following:
• Loan proceeds must be used for the establishment, expansion, or
acquisition of a business located and operating within the
Commonwealth of Pennsylvania.
• The business must be organized for profit.
• The company must employ fewer than 150 people at the time of
the application.
• An application form documenting the number ofjobs to be created
or retained must be submitted.S9
Companies that meet these eligibility requirements must go
through a simple application procedure. First, the company applies for
a business loan from a bank or savings and loan application. The bank
evaluates the loan according to its own lending criteria. If the loan is
approved, the bank forwards a linked deposit application to the Pennsylvania Treasury Department. The Treasury Department evaluates
applications and allocates funds based on three criteria: (1) the number
of jobs created or saved (2) the ratio ofjobs created or saved to dollars
loaned (at least one full-time job, or its equivalent, should be created or
saved for every $15,000 to $25,000 loaned); and (3) the level ofeconomic
need in a given region. 90
The Treasury Department then "purchases a certificate of deposit
(CD) in the eligible lending institution at an interest rate of 100 basis
85. Pension Investments: Public Hearings Before the New York State Pension
Investment Task Force 245 (1989) (testimony of Sally Hemandez-Piniero, then Executive Director, NYC Financial Services Corp.)
86. This discussion of the Pennsylvania Treasury Department program is adapted
from SOLELY IN OUR INTEREST, supra, note 6, at 133-134.
87. PENNSYLVANIA TREASURY DEPARTMENT, THE PENNSYLVANIA TREASURY
DEPARTMENT'S LINKED DEPOSIT PROGRAM (undated brochure) [hereinafter LINKED
DEPOSIT PROGRAM.
88. Catherine Baker Knoll, State Treasurer, Commonwealth of Massachusetts,
Treasury Bank Programs, Dec. 1, 1992. See also Treasurer Catherine Baker Knoll
Announces the Treasury Department's $100 Million 'Invest in Pennsylvania'Local Bank
Program, PR NEWSWIRE (Jan. 3D, 1991) [hereinafter Local Bank Program]; Pension
Funds Should Target Investments to Boost State's Economy, Pens. & Benefits Daily
(BNA), Nov. 12, 1991.
89. LINKED DEPOSIT PROGRAM, supra note 87.
9O.Id.
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points (one percent) below either the bank's posted one-year CD rate or
the average CD rate statewide, whichever is the higher rate.''!!1 The
deposit is fully insured or collateralized. The loan rate is "detennined
by the bank based on its usual credit considerations. That rate is then
discounted by an amount equal to the reduction applied to the CD
rate.''!!2 The tenn of the certificate of deposit cannot exceed seven years,
and rates are adjusted annually.
In 1991, Pennsylvania started an "Invest in Pennsylvania" local
bank program which is designed to invest state retirement assets in
Pennsylvania "Main Streets .... instead of Wall Street.''93 The
program allows the state pension funds to purchase fully collateralized
certificates of deposit from Pennsylvania banks. The "one-year CD
purchases will provide funds to depositories to invest in job creation
and retention in their communities.''94 Over $100 million of pension
fund assets have been invested in this program. 95
These types of programs cannot be implemented by private pension
plans if they involve a reduced rate of return; however, the procedure
utilized in Pennsylvania's Linked Deposit Program provides useful information on the structure of linked deposit or targeted CD programs.
Pension plans may wish to create targeted CD or linked deposit
programs that guarantee rates commensurate with the rates offered by
comparable certificates of deposit or which offer competitive returns that
are subsidized by government agencies or non-profit organizations.
3. Mortgage Loan Programs
Many pension funds have developed mortgage loan programs for
plan participants and beneficiaries. ERISA 408(b)(1)96 allows a plan to
make loans to plan participants and beneficiaries ifthey:
1. are available to all participants and beneficiaries on a reasonably equivalent basis;97
91. Private funds governed by ERISA cannot invest assets at below-market rates.
29 U.S.C. § l108(b)(l)(1994).
92. Linked Deposit Program, supra note 87.
93. Local Bank Program, supra note 88.
94. [d.
95. Catherine Baker Knoll, Treasurer, Commonwealth of Pennsylvania (undated,
untitled fact sheet, circa 1992).
96. 29 U.S.C. § l108(b)(1) (1994).
97. 29 C.F.R. § 2550.408b-l(b)(l) (1994). Loans must be made available to all plan
participants without regard to race, color, religion, sex, age or national origin. In deciding whether to grant a loan, trustees may consider only those factors which would be
considered in a normal commercial selling by an institution in the business of making
similar loans. For example, the decision whether to grant a loan may be based on the
creditworthiness or need of the applicant. Such criteria, if adopted, must be objective
and must be set forth in plan documents. The loan must be non-discriminatory in operation as well as in form. Acommon loan provision which might create a problem is the
minimum loan requirement. If the minimum loan requirement is too high, lower paid
or less senior employees may be ineligible for a loan. The Department of Labor has
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2. are not made available to highly compensated employees98 in
amounts greater than the amount made available to other
employees;
3. are made in accordance with specific provisions regarding such
loans set forth in the plan;99
4. bear a reasonable rate ofinterest;lOO and
established a "safe harbor" minimum loan amount of $1000. Loan minimums which do
not exceed $1000 will not cause a loan program to fail the reasonably equivalent test.
[d. at (b)(2).
98. "Highly Compensated Employee" is defmed by I.R.C. § 414(q). Greater loans
may be made to highly compensated employees if the size of the loans which are available to other groups of employees bears a reasonable relationship to accrued vested
benefits. For example, a plan may establish a loan maximum which is based on a
percentage of the employee's vested accrued benefit, even though it means that larger
loans will be available to highly compensated employees. 29 C.F.R. § 2550.408bl(c)(2)(ii).
99. Loan provisions must be in writing and disclosed to all participants. These
provisions need not be set forth in detail in the plan. It is sufficient for the plan to
authorize the trustees to establish a loan program. The program can be described in
the summary plan description and set forth in detail in the loan application forms. 29
C.F.R. § 2550.408b-1(d). If the plan makes 25 or more loans per year, it must comply
with the disclosure requirements of the federal Truth-In-Lending Act.
The summary plan description must:
1) authorize the plan fiduciary to establish a loan program and adopt program
rules.
2) identify the person or entity authorized to administer the loan program.
3) set forth the procedure for applying for a loan.
4) state the objective criteria upon which the loans will be granted or denied.
5) set forth any limitations on the types and amount of loans offered.
6) describe the procedure for determining a reasonable rate of interest.
7) list the types of collateral which may be used as security for the loan.
8) describe the events which constitute a default and the steps which will be
taken in the event of a default.
[d. at (d)(2). The summary should also describe the method of repayment, payroll deduction authorization, promissory note provisions, spousal consent requirements and the
procedure to appeal the denial of a loan.
For more information on these requirements see Welytok, Loans to Employee Benefit Plan Participants After the Final Department ofLabor Regulations, EMPLOYEE BENEFITS JOURNAL (lnt'l Found. of Employee Benefit Plans), June 1990, at 23. Copies of
sample mortgage loan program documents can be found in JAYNE ZANGLEIN, SOLELY IN
OUR INTEREST: CREATING MAxIMUM BENEFITS FOR WORKERS THROUGH PRUDENT
PENSION INVESTMENTS at Appendix E (AFL-CIO Lawyers Coordinating Committee
1992).
100. Department of Labor regulations provide that a loan will be deemed to provide
a "reasonable rate of interest" if the loan "provides the plan with a return commensurate
with the interest rates charged by persons in the business of lending money for loans
which would be made under similar circumstances." 29 C.F.R. § 2550.408b-l(e) (1994).
Interest rates must be established in accordance with an objective formula
described in plan documents. Rates may be set at rate offered for comparable loans at
several local institutions. Rates may be fixed or variable; however, a fixed rate must be
reviewed and adjusted for future loans and loan renewals. [d.
The regulations provide the following example:
Plan P makes a participant loan to A at the fixed rate of 8% for 5 years. The
trustees, prior to making the loan, contacted two local banks to determine
under what terms the banks would make a similar loan taking into account
A's creditworthiness and the collateral offered. One bank would charge a variable rate of 10% adjusted monthly for a sinlilar loan. The other bank would
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5. are adequately secured. lOl
When drafting plan documents, counsel must take into consideration
Internal Revenue Code 72(p) which excludes mortgage loans from
treatment as taxable plan distributions if certain conditions are met.
The maximum loan period is five years, except for loans for the
purchase of a principal residence. 102 The loan must be amortized in
substantially equal payments and payments must be made at least
quarterly.103 The loan, when added to the outstanding balance of any
other plan loans of the participant, cannot exceed the lesser of:
1) $50,000, less the highest outstanding balance of plan loans
during the one year period ending on the day before the loan was
made over the outstanding balance of plan loans on the day the
loan is made; or
2) the greater of
(a) 50% of the present value of the participant's nonforfeitable
accrued benefit or
(b) $10,000. 104
A 1993 survey offorty-three public pension plans conducted by the
Center for Policy Alternatives found that fourteen of the surveyed plans
have established ETIs that invest in single family housing, three plans
have established ETIs for multi-family housing, and two have created
housing rehabilitation or construction ETIs.lo5 Most single-family housing ETIs are mortgages for low and moderate income families and mortgage-backed securitiesyJ6 Connecticut "has provided $160 million in
charge a fIxed rate of 12% under similar circumstances. Under these facts, the
loan to A would not bear a reasonable rate of interest because the loan did not
provide P with a return commensurate with interest rates charged by persons
in the business of lending money for loans which would be made under similar
circumstances.
29 C.F.R. § 2550.408b-l(e) Example (l) (1994).
For a history of the term "reasonable rate of interest" see SoLELY IN OUR INTEREST,
supra note 6 at 108-110.
101. In order to be adequate, the security must be the same type and amount as
a commercial lender would require. 29 C.F.R. § 2550.408b-l(O (1994). Up to 50% of a
participant's accrued benefIt or account balance may be used as collateral for the loan.
[d. at (0(2).
If trustees require or accept collateral other than accrued vested interests, the
collateral must be tangible property such as real estate, motor vehicles, or bank
accounts which may be sold, foreclosed upon or otherwise disposed of upon default. The
value and liquidity of the collateral must be such that it can be reasonably anticipated
that a default will not cause the plan to lose the principal or accrued interest from the
loan. The Department of Labor will evaluate the adequacy of the collateral in light of
the nature and type of collateral that would be required in the case of an identical,
arm's length transaction in a normal commercial setting. [d. at (0(1).
102. I.R.C. § 72(p)(2)(B) (1994). Any amounts repaid after this five year period will
be included in the taxpayer's gross income.
103. I.R.C. § 72(p)(2)(C) (1994).
104. See I.R.C. § 72(p)(2)(A) (1994). Any loan which exceeds the lesser of these two
amounts is includable in gross income. [d.
105. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 6.
106. [d.
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affordable mortgages to over 1,400 buyers who [would] not otherwise"
qualify.lo7 Under the State Treasurer's Affordable Residential Mortgage Plan (STAR), waivers are given for the reserve of two months'
principal, interest, taxes and insurance, and a higher debt-to-income
ratio is approved. lOB Once the loans are made, the STAR mortgage portfolio is traded for Fannie Mae mortgage-backed securities. 109
Similar programs are offered in Massachusetts, New York, and
PennsylvaniaYo Massachusetts has implemented the Middle Class
American Dream Plan, which allows a five percent down payment (two
percent of which can be supplied by persons other than the borrower), a
liberalized obligation-to-income ratio, and a waiver of the two-month
reserve. 111 Loans are converted to mortgage-backed securities issued by
Fannie Mae. 112 To date, the program has made mortgage loans to 2,500
families. 113
Private pension funds should exercise extreme caution in developing mortgage loan programs that depart from rates "commensurate
with the interest rates charged by persons in the business of lending
money for loans which would be made under similar circumstances"114
as it would violate ERISA to charge below market rates. llS Also, mortgages must be "adequately secured" and waivers of reserve accounts
may undercut the obligation to provide adequate security. Even though
the mortgages are later sold in the secondary market, the investments
must be prudent at the time they are made.
4. Direct Real Estate Investments
Most pension funds have real estate holdings. Defined benefit plans
invest approximately 21 % of plan assets in real estate, mortgage backed
securities, and GICs, while defined contribution funds invest 19% in real
estate. ll6 Multi-employer plans invest 16.2% in real estate. ll7
Many pension funds directly invest in real estate (i.e. they
purchase the property directly rather than through a pooled fund).
Direct real estate investments require great time-commitment and
expertise. The investment may be managed in-house or through an
investment manager. Direct real estate investments offer more control,
107. Id. at 19.
108. Id.
109. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 6.
110. See id. at 23-26, 30-31, 35-39.
111. Id. at 24.
112. Id.
113. Tina Ruyter, This New House, PLAN SPONSOR, Nov. 1994, at 16, 22.
114. 29 C.F.R. § 2550.408b-l(e) (1994).
115. Pension funds could participate in such a program if they receive a competitive
rate of return. This is possible only if other investors subsidize the investment. See e.g.
notes 121-131 and accompanying text.
116. Vineeta Anand, Private Pension Assets Rise 8.9%, EBRI Says, PENS. & INV.,
May 2, 1994, at 27.
117. Id.
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flexibility, and the potential to make higher rates ofreturn than passive
investments. However, they are time-consuming, administratively
costly, and risky. The Fund must consult with many experts in deciding
whether to invest in real estate and how to structure the transaction.
Real estate investment managers, ERISA attorneys, real estate attorneys, brokers, and accountants will work with the plan fiduciaries on
the transaction. Direct real estate investments also may expose the
fund to decreased liquidity, increased risk, and limited diversificationYs These disadvantages have prompted many funds to steer away
from direct real estate investments.
Direct real estate investments may be regarded as ETls if they
create jobs that would not otherwise be created1l9 or if the investment
targets a capital gap such as low-income housing that otherwise would
not be funded.
Two California pension funds 120 provide an example of how direct
real estate investments can be structured to fill a capital gap. These
funds recently teamed up with World Savings and non-profit Bridge
Housing Corporation to form the WorldlBridge Initiative which will
fund the construction of "4,000-5,000 very low, low, and moderate
income housing units over the next three years."121 Donald Terner,
president of Bridge Housing Corporation states, "After 35 years in the
field of affordable housing, this is the closest thing to a miracle I have
ever seen."122 More than $300 million has been committed to the project,
$225 million of which was invested by pension funds who expect to
receive a competitive rate ofretum. l23 The participation of the pension
funds was made possible by philanthropic investors who do not expect a
competitive return: World Savings contributed $15 million in interestfree start-up money and the Ford Foundation "is providing grants and
concessionary loans to enable WorldlBridge to bring other non-profit
organizations into the pension fund relationship and to help maximize
affordability for low income families."l24 Terner notes:
We cannot overstate the significance of the World/Bridge Initiative as a blueprint for others to follow and build upon. By utilizing
the heretofore untapped relationship between non-profit developers
and the pension funds and by including traditional financing sources
118. See Section I.D, infra for discussion of legal aspects of pension fund
investments.
119. This typically occurs when the construction is guaranteed to be built 100%
union.
120. California Public Employees' Retirement System (CalPERS) and California
State Teachers' Retirement System (CalSTERS).
121. World I Bridge Initiative Provides Over $300 Million to Fund Construction of
Up to 5,000 Affordable Housing Units During Next Three Years, Bus. WIRE, Mar. 14,
1994. Wells Fargo Bank, Bank of America, and the Ford Foundation are other investors
in the initiative. Id.
.
122. [d.
123. Id.
124. Id.
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such as thrifts and banks, [we have created] a new solution to the
persistent problem of America's need for affordable housing. 125
In making this investment, the pension funds took care to ensure
that they would receive competitive rates of return. All subsidies were
made by institutions which are not governed by ERISA.
In 1993, the Community Investment Demonstration Program was
created by Congress. l26 This is the first federal program to offer incentives exclusively to pension fund investors to finance affordable multifamily rental or limited equity cooperative housing. 127 Through this
program, pension funds can make loans subsidized by Section 8 rental
income. 128 The loans are later converted into Fannie Mae or Freddie
Mac mortgage-backed securities. l29 Coalitions between pensions, the
federal government, and philanthropic funds allow pension plans to
invest in affordable housing while still receiving a competitive rate of
return. However, a recent attack on Section 8 rent subsidies may jeopardize these types of partnerships. lao
5. Venture Capital
Private pension funds invest about one-third of the capital raised
by venture capital funds. 13l In 1994, pension funds invested between
$15 billion and $18 billion in venture capital. 132 A 1993 survey by the
Center for Policy Alternatives found that 23% of state-wide retirement
systems surveyed invest in venture capital. 133 Pension funds are
attracted to venture capital because it provides "double-barreled benefits":134 it creates jobs and yields high investment returns.
Venture capital is equity financing usually supplied to small,
emerging firms by investors who anticipate a substantial return on
their investment when the company matures. Although venture capital
is a high-risk investment, historically, small, emerging businesses have
produced higher returns than traditional investments. l35 This compensates the investors for the higher risk.
125. Id.
126. Pension Funds and Economic Growth, supra note 10 (testimony of Stephen
Coyle, Chief Executive Officer, AFL-CIO Housing Investment Trust).
127. Id.
128. Id.
129. Id.
130. Joan Pryde, Section 8 Rent Subsidies for Multifamily Housing May Be Up for
Chopping, BOND BUYER, Mar. 2, 1995, at 3.
131. Venture Capital in the 80's: An Institutional Investor's Perspective, VENTURE
CAP. J., Dec. 1994. In 1984, private pension funds committed over $1 billion in private
venture capital funds. Id.
132. Rep. Jefferson, Panelists Examine Pension Funding for Minority Firms, Pens.
& Benefits Daily (BNA), Sept. 19,1994. Public pension funds "accounted for 48% of total
pension fund investment in venture capital in 1992." Mercedes M. Cardona, Investors
Returning to Venture Capital Market, PENS. & INV., Nov. 15, 1993, at 10.
133. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 5.
134. Maria Shao, Putting Pensions to Work, BOSTON GLOBE, Nov. 2, 1994, at 45.
135. In 1992, venture capital had an average return of 13.9% as compared with
7.7% for common stocks, making it the highest return for any asset category except
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Venture capital requires long-tenn investment since it usually
takes between five and ten years for the investment to mature. Because
of the long-tenn nature of their liabilities, defined benefit plans can
commit to long-tenn investments and, therefore, are particularly well
suited to venture capital investments.
Although venture capital funds offer attractive returns, there are
some drawbacks. Money is "invested at considerable risk of loss in
potentially highly profitable enterprises .... Unseasoned, untried and
unproven people, products and programs represent a potentially perilous pathway for fiduciaries who operate within a 'prudent expert' environment."l36 Venture capital investment is considered" 'probably the
highest-risk investing' done by .... pension funds."137
Although risky, the Department of Labor has specifically pennitted investments in venture capitaU36 ERISA "explicitly allows for
small-company stocks. Mercedes M. Cardona, Investors Returning to Venture Capital
Market, PENS. & INV., Nov. 15, 1993, at 10.
136. EUGENE BURROUGHS, INVESTMENT SUCCESS FOR THE EMPLOYEE BENEFIT
PLAN FIDUCIARY 82 (1988).
137. Gregory Smith, Sundlun Pushes for Pensions Funds in Venture Capital Plan,
PROVIDENCE JOURNAL-BULLETIN, Aug. 30, 1994, at D-1 (quoting Ivan Vercoutere, of
Pacific Corporate Group). Richard Furled, associate director of the Center for Policy
Alternative says: "Venture capital .... can be deadly if not structured correctly." Patricia Limbacher, Housing a Top Draw for ETIs, PENS. & INV., Sept. 6, 1993, at 2. The
Center recommends that venture capital funds diversify their investments to reduce
risk.. Id.
138. The Department of Labor has issued a plan asset rule which defines a venture
capital operating company. Definition of "Plan Assets"-Plan Investments, 29 C.F.R
§ 2510.3-101 (1994). The entity must invest at least 50 percent of its assets, valued at
cost, in venture capital investments or derivative investments and must, in the ordinary
course of its business, actually exercise management rights with respect to at least one
of the operating companies in which it invests. Id. at (d).
The regulations provide an example:
A plan, P, invests in a limited partnership, V, pursuant to a private offering. There is significant equity participation by the benefit plan investors in V.
V acquires equity positions in the companies in which it invests, and, in connection with these investment, V negotiates terms that give it the right to participate in or influence the management of these companies. Some of these
investments are in publicly-offered securities acquired in private offerings.
During its most recent valuation period, more than 50 percent of V's assets,
valued at cost, consisted of investments with respect to which V obtained
management rights of the kind described above. V's managers routinely consult
informally with, and advise, the management of only one portfolio company
with respect to which it has management rights, although it devotes substantial resources to its consultations with that company. With respect to the other
portfolio companies, V relies on the managers of other entities to consult with
and advise the companies' management. V is a venture capital operating
company and therefore P has acquired its limited partnership investment, but
has not acquired an interest in any of the underlying assets of V. Thus, none
of the managers of V would be fiduciaries with respect to P solely by reason of
its investment. In this situation, the mere fact that P does not participate in
or influence the management of all of its portfolio companies does not affect its
characterization as a venture capital operating company.
Id. at <j)(5). If the company is not a venture capital operating company, the underlying
assets of the company are considered plan assets, and the manager of such company is
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untested, unseasoned investments" such as venture capitalJ39 In the
prudence regulation issued by the Department of Labor, the Department observed that the relative risk of a specific investment neither
makes it per se prudent nor per se imprudent. 140 In 1989, David Walker,
then Assistant Secretary of Labor, stated that "ERISA allows investments in high-risk and/or reduced liquidity vehicles such as venture
capital, certain forms of real estate or non-investment grade bonds, as
part of an overall investment strategy.''!41 However, Walker cautioned
that before deciding to make such investment, "the plan fiduciary must
determine whether or not its plan is capable of bearing any increased
risk or reduced liquidity associated with such investments."142 In recent
congressional hearings, Assistant Secretary of Labor Olena Berg reaffirmed the Department's position that venture capital companies can be
appropriate pension fund investments. 143
Like direct real estate investments, venture capital investments
are time-consuming, management intensive, and require great skill
and expertise. 144 A representative of Pennsylvania Venture Capital, a
program implemented by the Pennsylvania Public School Employees'
Retirement System, observed that "[tJheme investments require a
disproportionate allocation of time to properly monitor and evaluate
their performance."145 Other plan representatives emphasize that
venture capital programs must meet strict fiduciary standards. 146
a fiduciary with respect to the plan. Id. at (a)(2). Since ERISA's fiduciary rules apply
to all plan assets, this would place an onerous burden on the plan. For example, if the
plan wholly owns a business venture, then the operations of the business would be plan
assets. The trustees would be required to make all decisions with respect to the business
venture in accordance with ERISA's fiduciary duties.
139. Interview with Pension Administrator Robert A.G. Monks-Part I, LAB. &
INvESTMENTS (Indus. Union Dep't, AFL-CIO), May 1984, at 4. See also Pension Investments: Public Hearings Before the New York State Pension Investment Task Force 187
(Mar. 3, 1989) (testimony of David Walker, Assistant Secretary of Labor for Pension
and Welfare Benefits, U.S. Dep't of Labor).
140. Preamble to Rules and Regulations for Fiduciary Responsibility; Investment
of Plan Assets under the "Prudence" Rule, 44 Fed. Reg. 37,221 (June 26, 1979), codified
at 29 C.F.R. § 2550.a-1 (1990).
141. Pension Investments: Public Hearings Before the New York State Pension
Investment Task Force 187 (1989) (testimony of David Walker, Assistant Secretary of
Labor).
142. Id. at 186.
143. Pension Investments and Economic Growth, supra note 10 (testimony of Olena
Berg, Assistant Secretary of Labor, U.S. Dep't. of Labor).
144. Id. (testimony Lee Smith, Executive Director, Excelsior Capital).
145. INST. FOR FIDUCIARY EDUC., supra note 22, at 53.
146. Id. As with all pension investments, procedural prudence is important with
respect to venture capital investments. One commentator describes the process:
Investment proposals .... come to the venture pool through many different
networks: associates of firms fmanced previously, referrals from investment
bankers and lawyers familiar with the general partner, and so on. For every
thousand proposals received by a venture capital firm, approximately 90 percent
are immediately rejected on the basis of their falling outside the group's area of
interest or clearly being unviable. The remaining 10 percent receive a first round
evaluation, of which ten to fifteen pass muster. A second round evaluation
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Recently, the Union Labor Life Insurance Company (ULLICO)
created Separate Account P, which identifies small to medium size
companies that need capital and employ union employees. 147 For example, Vought Aircraft, which was formed after the bankruptcy of LTV,
requested financing from ULLICO.148 At the time, Vought Aircraft
employed 10,000 employees, 5000 of whom were represented by the
UAW.149 ULLICO provided $5 million capital to Vought subject to ratification of the collective bargaining agreement between Vought and the
UAWand payment ofback benefits. l50 As a result ofthe financing, 5000
union jobs were saved. 151 The deal was good for ULLICO as well: two
years later the company was acquired and ULLICO received a 75%
internal rate of return on its investment. 152
Many public pension funds have started venture capital programs.
Massachusetts has aggressively pursued this avenue, "tout[ing] the
Bay State as 'The Venture Capital'. "153 In late 1994, the Massachusetts
State Teachers' and Employees' Retirement System (MASTERS) and
the Pension Reserves Investment Trust (PRIT) announced plans to
establish a $50 million venture capital firm which will invest in small
and midsize Massachusetts companies. 154 Greg White, executive director of the board that administers PRIT says: "We think that directing
reduces this to three or four. This process may take a few weeks or several
months.
LAWRENCE LITVAK, PENSION fuNDS & ECONOMIC RENEWAL 62 (1981).
Every aspect of the potential investment must be analyzed:
The venture firm will study the product and attempt to evaluate the feasibility
of the manufacturing program, looking at costs, quantities, quality, etc. The
market will be surveyed to determine its potential and competitive nature. The
ability of the small company to operate effectively will be evaluated. The
venture firm will attempt to gain insights into the management and reputation
of the company and its products by contacting many informed people--employees who are no longer with the firm, knowledgeable people in related businesses, suppliers and even competitors (with permission of the small business).
Financial analysis will also be applied to the numbers part of the business.
Technologies and capacities of the business will be evaluated with varying .
degrees of thoroughness.
Rubel, Dealing with Venture Capital Firms, in RUBEL, GUIDE TO VENTURE CAPITAL
SOURCES (1977), quoted in LITVAK, supra note 146.
147. Michael Steed, ULLICO, Address before the Center for Policy Alternatives
Conference on Economically Targeted Investments: Creating Community Capital, Mar.
22,1995.
148. [d.
149. [d.
150. [d.
151. Michael Steed, ULLICO, Address before the Center for Policy Alternatives
Conference on Economically Targeted Investments: Creating Community Capital,
Mar. 22, 1995.
152. [d.
153. Putting Pensions to Work, supra note 134. Massachusetts law requires the
state to "invest funds as much as reasonably possible to benefit and expand the
economic climate of the Commonwealth, consistent with sound investment policy." [d.
154. [d.
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dollars into Massachusetts will generate jobs. [But] this is not a social
program. This is an economically driven program. We want the
returns."155 The fund hopes to earn 15 to 20 percent annually.l56
PRIT has previous experience with venture capital funds. In 1978,
PRIT invested $2 million in the Massachusetts Technology Development Corporation (MTDC), a venture capital fIrm. MTDC has earned
an average annual return of 16%, created about 5,000 jobs, and generated $9.6 million in state tax revenues. 157 Loans are limited to $500,000
and are only made to early-stage companies. 15s
Tennessee boasts about the success of its venture capital program
that in ten years created 16,000 new jobs and fInanced 26 companies
with current combined revenues of more than $1 billion.159 The original
$30 million seed money to start the Valley Venture Fund came from a
settlement received from Gulf Oil Corporation (now Chevron) to
compensate ratepayers for overcharges. l60 Pension funds and other
investors contributed to the fund which now totals $546 million. 161
Thirty-one percent of the fund is invested in companies at the "conceptualization stage,"162 18% is invested in companies which are just
starting to do business, and 26% is invested in established companies. 163 The fund will not be able to calculate its total return until it
divests all of its investments in about two years. 164 Of the portfolio,
three investments were "total writeoffs"165 and the rest appear to be
profItable. One investment made a 100% return on its investment. l66
New York has created a not-for-profIt corporation, Excelsior Capital, "to link pension investors with capital gaps in the New York
area."167 Excelsior Capital researches and develops new fInancingvehicles for pension funds. 1GB Potential investments must meet three criteria. They must: (1) provide opportunities for risk adjusted market
155. Id.
156. Id.
157. THE CENTER FOR POLICY ALTERNATIVES, supra note 20, at 25-26.
158. Id.
159. Pamela E. Foster, Fund Creates 16,000 New Jobs, NASHVILLE Bus. J., Aug. 1,
1994, at 1.
160. Id.
161. Id. Ironically, Tennessee state law does not permit state pension funds to
invest in venture capital, and so the funds invested come from other sources.
162. Less than 2% of all U.S. venture capital is invested in seed companies because
of the risk and time commitment involved. Greg Abel, A Cool $19 Million Bet: Maryland
Venture Capital Trust Invests Venture Capital Funds, BALTIMORE Bus. J., July 29, 1994,
at 3.
163. Foster, supra note 159.
164. Id.
165. Id. This is not unusual with respect to venture capital funds. Venture capital
is risky; some investments fail. However,' the profits from successful investments
usually more than offset the writeoffs.
166. Id.
167. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 30-31.
168. Id. See also Pension Funds and Economic Growth, supra note 9 (testimony of
Lee Smith, Executive Director, Excelsior Capital Corporation).
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conditions [with prudent] rates of return; (2) [allow] feasible implementation based on legal authority, transaction costs, and the appetite of
institutional investors for the asset class; and (3) offer tangible collateral benefits to the New York State economy.169 The Excelsior Fund was
created to "fIll a financing gap for middle-market companies with sales
ranging from $10 to $500 million per year."170 Returns for the funds are
expected to be close to 20%.171
Some venture capital funds have not fared well. Missouri had a bad
experience with venture capital. In 1987, the State enacted legislation
that required the State Employees Retirement System to invest 3-5% of
plan assets in small Missouri businesses. 172 The Retirement System
established Missouri Venture Partners, with an ill-suited acronym of
MVP, to make small business loans primarily to companies for expansion, but also for start-ups or acquisitions. 173 Investment decisions were
made by MVP's general partner without the approval of the Retirement
System. 174 Thirty-five million dollars were allocated to the program. 175
During 1988 and 1989, MVP invested $5.5 million in five companies. 176 Two of the companies filed for bankruptcy in 1989. 177 The
Retirement System withdrew from the partnership because it had no
investment control. l78 In 1992, the law which required the venture capital investments was repealedJ79
6. Private Placements
Pension funds also invest in private placements which are risky,
high yield investments, often offering as much as 100% returns on
investment. 18o Private placements are stock or bond issues sold by a
169. THE CENTER FOR POLICY ALTERNATIVES, supra note 20, at 30-31.
170. Id. at 31. See also Joel Chernoff, Excelsior Pool Nabs Corporate Funds, PENS.
& INV., Feb. 22, 1993, at 32.
171. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 31.
172. Id. at 28. State mandates are unwise. Pension investments must be prudent
and a mandate to invest a certain percentage of plan assets in a specified asset category
encourages pension funds to invest without adequately assuring the prudence of the
investment if prudent investments are unavailable.
173. Id.
174. Id.
175. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 28.
176. Id.
177. Id.
178. Id.
179. Id. A recent study by the Wharton School shows that public pension funds
which are required to make in-state investments achieved returns .8% less than
expected. Patricia Limbacher, In-state Investments Don't Boost Returns; Study Shows
Decline of 8 Basis Points, PENS. & INV., Jan. 24, 1994, at 73. The Department of Labor
does not directly govern public funds. Furthermore, the Department has never
mandated investments in ETIs. Such a move would be foolish as trustees must have
the flexibility to make investments which are best for the fund.
180. Jennifer Lachanski, Pension Funds Eye Private Placement Market, CORP. FIN.
WK., Oct. 10, 1994, at 1.
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corporation directly to an investor without registration under the Securities Act. They are time-consuming investments. l8l James W. Brown,
Chief of Staff for the Governor of Pennsylvania, recently testified that:
[A]t present, there is no easy way for public pension funds to make
significant investments in business and commercial loans. Pension
funds can buy securities backed by home mortgages or .... they can
buy common stock of large, publicly traded companies. However,
their only access to small business loans is through private placements, which are so labor intensive that few are done. The board of
a $25 billion fund, which meets every six weeks, has to focus on
broad issues such as asset allocation and manager performance. It
cannot review and approve more than a few $10 or $15 million business loans as part of a private placement program. Moreover, private
placements are illiquid: once bought, they must be held. l82
Despite these difficulties, some pension funds have invested in
private placements. Because private placements are amortized, longterm, fixed interest loans, they can be attractive investments for
pension funds:
Pension funds have long-term liabilities and need to invest in
assets that have similar time horizons. Pension funds can make
fixed-rate loans because, unlike banks, they aren't subject to fluctuating interest rates on their assets. The interest rates received on
private placements are usually higher than those available on similar maturity, publicly-traded corporate bonds. As the funds have
grown in size, the drawbacks of private placements-the illiquidity
of the investment and the higher risk involved in financing companies of average credit quality-have become more manageable for
pension funds. l83
The Wisconsin Investment Board (WIB) was one of the first retirement funds to implement a private placement program. The program
has been in effect for more than twenty years. I84 Approximately 16% of
the fund's assets are invested in private placement loans. I86 The portfolio has assets of $3.4 billion. I86 More than $300 million has been
invested in Wisconsin companies,187 For example, the fund invested in
Harley-Davidson and Land's End:
181. Hearing on H.R. 2600: Creating a Secondary Market for Business and
Economic Development Loans, Before the Subcommittee on Economic Growth and Credit
Formation of the Committee on Banking, Finance and Urban Affairs, lO3d Cong., 1st
Sess. (1993) (testimony of James W. Brown, Chief of Staff for the Governor, Commonwealth of Pennsylvania), reprinted in Federal Document Clearing House Congressional
Testimony (Oct. 7, 1993).
182. [d. Brown recommends securitization of small business loans: "A liquid fIxed
income security which happens to channel capital into business development and job
creation is a win-situation for public funds." [d.
183. N.Y. STATE INDUSTRIAL COOPERATION COUNCIL, COMPETITIVE PLUSEcONOMICALLY TARGETED INVESTMENTS BY PENSION FuNDS, at 25 (1990).
184. [d. at 27.
185. See id. $3.5 billion of the $22 billion fund is invested in private placements.
186. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 43.
187. N.Y. STATE INDUSTRIAL COOPERATION COUNCIL, supra note 183, at 27.
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Harley-Davidson's turnaround is a well-known story of how
American manufacturers can restore their competitiveness. On the
verge of bankruptcy when WIB began working with the company,
the revived fIrm is a dramatic success story and an important source
of jobs in Wisconsin. The Chicago-based recreational clothing business, Land's End, located a warehouse in Wisconsin in part because
of a WIB loan. Land's End went on to borrow a total of $15 million
in order to expand its Wisconsin operations. l88
The Wisconsin Investment Board had an average coupon for the fIxedrate portion ofthe private placement portfolio of 10.86% as of June 30,
1992. 189
Other public pension funds have implemented private placement
programs. The Retirement Systems of Alabama have a private placement portfolio that has outperformed its corporate and government
securities investments. 1oo For example, the fund's $100 million investment in the Alabama Pine Pulp Company will yield 12% per year over
twenty-two years.t 91 The Pennsylvania Public School Employees'
Retirement System (PSERS) has allocated $500 million to private
placements. 192 So far, it has participated in six private placements. 193
These descriptions of successful ETI programs show that pension
funds can prudently invest in ETIs that provide collateral benefIts. In
the next section, the legal requirements of prudent investments will be
explored.
D. The Legal Parameters 194
Because ETIs are governed by the same standards as other plan
investments, it is necessary to examine ERISA's fIduciary duties to
determine the propriety of an economically targeted investment. The
decision to make a plan investment is governed by ERISA's fIduciary
duties as defIned in ERISA section 404(a)(1).195 Four separate duties
are imposed on plan fIduciaries: the duty to act solely in the interest of
plan participants and benefIciaries,t96 to act prudently,197 to diversify
plan assets,198 and to act in accordance with plan documents: l99
188. [d.
189. CENTER FOR POLICY ALTERNATIVES, supra note 20, at 44.
190. [d. at 13.
191. [d.
192. [d. at 36.
193. [d.
194. This section is adapted from JAYNE ZANGLEIN, SOLELY IN OUR INTEREST:
CREATING MAxIMUM BENEFITS FOR WORKERS THROUGH PRUDENT PENSION INVESTMENTS
9-10(992). It has been updated.
195. 29 U.S.C. § 1l04(a)(l) (1994).
196. 29 U.s.C. § l104(a)(I)(A) (1994).
197. 29 U.s.C. § l104(a)(1)(B) (1994).
198. 29 U.S.C. § 1l04(a)(I)(C) (1994).
199. 29 U.S.C. § 1l04(a)(I)(Dl (1994).
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[A] fiduciary shall discharge his duties with respect to a plan solely
in the interest of the participants and beneficiaries and(A) for the exclusive purpose of:
(i) providing benefits to participants and their beneficiaries; and
(ii) defraying reasonable expenses of administering the plan;
(B) with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like
capacity and familiar with such matters would use in the
conduct of an enterprise of a like character and with like aims;
(C) by diversifying the investments of the plan so as to minimize
the risk of large losses, unless under the circumstances it is
clearly prudent not to do so; and
(D) in accordance with the documents and instruments governing
the plan insofar as such documents and instruments are consistent with the provisions of this title and title IV.2OO
1. The Exclusive Benefit Rule
ERISA section 404(a)(l)(A) requires plan fiduciaries to act solely in
the interests of plan participants and beneficiaries and for the exclusive
purpose of providing plan benefits and defraying reasonable expenses
of plan administration. 201 These two requirements,-"solely in the
interest" and "exclusive purpose,"-eombine to form a statutory duty of
loyalty. Under this rule, fiduciaries must act "with an eye single to the
interests of participants and beneficiaries"202 and may not place themselves in a position in which they are required to compromise their duty
of undivided loyalty to plan participants. 203
Although the Department has interpreted section 404(a)(1)(A) as
prohibiting fiduciaries from subordinating retirement assets to "unrelated objectives,''204 the Department has never taken the position that
all collateral benefits are prohibited. 205 The Department has explicitly
stated that:
There is nothing in ERISA, however, requiring that an investment decision be wholly uninfluenced by the desire to achieve social
or incidental objectives if the investment, when judged solely on the
basis of its economic value to the plan, is equal or superior to alternative investments otherwise available. ZOO
On another occasion, a Departmental spokesperson stated that
although the exclusive benefit rule "does not exclude the provision of
200. 29 U.S.C. § 1l04(a)(l) (1994).
201. 29 U.S.C. § 1l04(a)(1)(A) (1994).
202. Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982), cert. denied, 459 U.S.
1969 (1982) (citations omitted).
203. [d.
204. Avon Letter, supra note 16.
205. See supra, notes 13 and 14.
206. Address by Dennis Kass, Assistant Secretary of Labor, Pension and Welfare
Benefits Administration, Current Developments at the Department of Labor, at the
Annual Conference in Las Vegas, Nev., sponsored by the Int1 Found. of Employee Benefit Plans (Nov. 1986), reprinted in INT'L FOUND. OF EMPLOYEE BENEFITS PLANS,
EMPLOYEE BENEFITS ANNUAL 235, 236 (1987).
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incidental benefits to others, the protection ofretirement income is, and
should continue to be, the overriding social objective governing the
investment of plan assets."207 The Department has also stated "that
under ERISA pension plan investments must be made based upon what
is in the economic interest of the plan as a separate and distinct legal
entity established for the purpose of providing retirement income, [and]
that other considerations can be considered provided that they are incidental and do not compromise the required investment decision.''208
In advisory opinions, the Department has repeatedly emphasized
that plan investments must be made solely in the interest of plan
participants and beneficiaries but collateral benefits may be considered
if the investment is otherwise "equal or superior to alternative investments available to the plan."209 In response to an inquiry made on
behalfofULLICO concerning its Mortgage Separate Account J, a mortgage pool for union-built properties, the Department stated that investment in the J Account would be not prudent if it provided the investor
"with less return, in comparison to risk, than comparable investments
available to the plan, or if it involved a greater risk to the security of
plan assets than other investments offering a similar return.''210 The
Department warned that the interests of participants and beneficiaries
cannot be subordinated to unrelated objectives. 211 The Department
stated that the J Account investments would not violate ERISA section
404 if the loans are offered at "rates prevailing in the overall mortgage
market.''212 However, the "decision to make an investment may not be
influenced by a desire to stimulate the construction industry and generate employment unless the investment, when judged solely on the basis
of its economic value to the plan, would be equal or superior to alternative investments available to the plan.''213 Thus, it is not sufficient to
simply charge the prevailing rate; the investment must be equal to or
better than alternative investments with similar risk and return
characteristics.214
207. Ian LanofT, The Social Investment of Private Pension Plan Assets: May It Be
Done Lawfully Under ERISA?, 31 LAB. L.J. 387, 389 (1980).
208. Pension Investments: Public Hearing Before the New York State Pension
Investment Task Force, 190-91 (Mar. 3, 1989) (testimony of David Walker, Assistant
Secretary for Pension and Welfare Benefits, U.S. Department of Labor) [hereinafter
New York Hearings].
209. PWBA Letter to James S. Ray (July 8, 1988).
210. Id.
211. Id.
212. Id.
213. Id.
214. See also PWBA Letter to Gregory Ridella, Chrysler Corporation (AD. 88-16A)
(Dec. 19, 1988) (in which the Department stated: "A decision to make an investment
may not be influenced by non-economic factors unless the investment, when judged
solely on the basis of its economic value to the plan, would be equal or superior to
alternative investments available to the plan").
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Courts have agreed with the Department's interpretation of the
exclusive benefit rule. In Donovan v. Walton,215 the district court for the
Southern District of Florida held that "by adopting the 'exclusive
purpose' standard, Congress did not intend to make illegal the fact of
life that most often a transaction benefits both parties involved.''216
ERISA "does not prohibit a party other than a plan's participants and
beneficiaries from benefiting in some measure from a prudent transaction with the plan."217
In Donovan v. Bierwirth,218 the Second Circuit ruled that trustees
will not violate their duty ofloyalty by "taking action which, after careful and impartial investigation, they reasonably conclude [is] best to
promote the interests of participants and beneficiaries simply because
it incidentally benefits the corporation or, indeed, themselves ... .''219
Similarly, in Morse v. Stanley, the Second Circuit held that "[i]t is no
violation of a trustee's fiduciary duties to take a course of action which
reasonably best promotes the interest of plan participants simply
because it incidentally also benefits" another party.220
Opponents of ETIs often cite the exclusive benefit rule as a legal
impediment to economically targeted investments. During congressional hearings on economically targeted investments, Representative
Jim Saxon, an ardent opponent of ETIs,221 asked Secretary of Labor
215. 609 F. Supp. 1221 (S.D. Fla. 1985), affd sub nom., Brock v. Walton, 794 F.2d
586 (11th Cir. 1986).
216. 609 F. Supp. at 1245. See also Martin v. Fellen, 15 Employee Benefits Cas.
(BNA) 1545, 1556 (8th Cir. 1992) (holding that an "ESOP fiduciary is not prohibited
from peing on both sides of a transaction involving the ESOP's assets, but he must
serve both masters (or at least the ESOP) with the utmost care and fairness" and
"[wJhen a fiduciary has dual loyalties, the prudent person standard requires that he
make a careful and impartial investigation of all investment decisions").
217. 609 F. Supp. at 1245.
218. 680 F.2d 263 (2d Cir. 1982), cert. denied, 459 U.S. 1069 (1982).
219. Id. at 271. In Trenton v. Scott Paper Co., the Third Circuit held that "the fact
that a fiduciary's actions incidentally benefit an employer does not necessarily mean
that the fiduciary has breached his duty." 832 F.2d 806, 809 (3d Cir. 1987), cert. denied,
485 U.S. 1022 (1988).
220. Morse v. Stanley, 732 F.2d 1139, 1146 (2d Cir. 1984).
Most violations of the exclusive benefit are blatant. Examples of breach of the duty
of loyalty include: Marshall v. Kelly, 465 F. Supp. 341 (W.D. Okla. 1978) (where plan
made a loan to a fiduciary); Donovan v. Daugherty, 550 F. Supp. 390 (S.D. Ala. 1982)
(when trustees unlawfully extend benefits to themselves); Wright v. Nimmons, 641 F.
Supp. 1391, 1402 (S.D. Tex. 1986) (when a fiduciary treats plan assets as if they were
his own property); Marshall v. Mercer, 4 Employee Benefits Cas. (BNA) 1523 (N.D. Tex.
1983), rev'd on other grounds, 747 F.2d 304 (5th Cir. 1984) (when a trustee fails to take
action to collect loans made by the plan to himself and his corporation); Dasler v. E.F.
Hutton & Co., 694 F. Supp. 624, 632 (D. Minn. 1988) (when a fiduciary broker churns
a plan account to receive greater commissions).
See also Investment ofPension Plan Assets: Hearings Before the Subcomm. on Oversight of the House Comm. on Ways and Means, 100th Cong., 2d Sess. 181 (1988) (testimony of William Posner, Assistant Director; Employee Plans Technical and Actuarial
Division, Internal Revenue Service, U.S. Dep't of the Treasury).
221. Representative Saxon calls ETIs "PTIs"-politically targeted investments. In
1993, he introduced a bill (H.R. 5120) to prevent economically targeted investing. Maria
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Robert Reich whether the Department's interpretation that collateral
benefits are permissible contradicts the exclusive benefit rule. 222 Secretary Reich replied:
The statute says exclusive benefit. Does this mean that we
cannot consider these other possible advantages of investment, even
assuming that we can get the same risk adjusted rate of return?
And the department, again, in letter after letter, advisory opinion
after advisory opinion has said no, that's not what the statute
means. Exclusive purpose under the law means that you can't weigh
those things against the return, but as long as you perform your
obligation as a fiduciary to get that return, it's perfectly appropriate
to take into consideration those other things.=
The exclusive benefit rule does not prohibit economically targeted
investments as long as the primary objective of the investment is to
make a prudent investment with a competitive rate of return for plan
participants and beneficiaries.
2. The Prudence Rule
The prudence rule224 requires fiduciaries to act with "the care, skill,
prudence, and diligence under the circumstances then prevailing that a
prudent man acting in a like capacity and familiar with such matters
would use in the conduct of an enterprise of a like character and with
like aims.''225 This rule imposes "an extremely high standard of
conduct,"226Iike that of a fiduciary in an express trust. 227 This standard
is "the highest known to the law.''228
The Department has created a safe harbor for fiduciaries making
investment decisions. 229 If a fiduciary complies with the prudence regulation, the investment will be deemed to be prudent. However, if a fiduciary does not comply with the prudence regulation, the investment is
not imprudent per se. 230
In order to reach the sanctuary of the safe harbor, the fiduciary
must act only after giving appropriate consideration to those
facts and circumstances that, given the scope of such fiduciary's
investment duties, the fiduciary knows or should know are relevant
to the particular investment or investment course of action involved,
including the role the investment or investment course of action
Shao, Putting Pensions to Work, BOSTON GLOBE, Nov. 2, 1994, at 45.
222. Hearing on Pension Investments and Ecorwmic Growth, supra note 10.
223. Id.
224. 29 U.S.C. § 1l04(a)(l)(B) (1994).
225. Id.
226. Marshall v. Mercer, 4 Employee Benefits Cas. (BNA) 1523, 1532 (N.D. Tex.
1983).
227. Donovan v. Bierwirth, 680 F.2d 263, 272 n. 8 (1982).
228. Id.
229. Preamble to Rules and Regulations for Fiduciary Responsibility; Investment
of Plan Assets under the "Prudence" Rule, 44 Fed. Reg. 37,221 (June 26,1979).
230. Id.
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plays in that portion of the plan's investment portfolio with respect
to which the fiduciary has investment duties. 231
When considering an investment, the fiduciary must determine
whether the investment reasonably furthers the purposes of the plan,
taking into consideration the risk ofloss and the opportunity for gain. 232
The fiduciary must consider the following factors in relation to the
entire portfolio:
(1) the composition of the portfolio with regard to diversification;
(2) the liquidity and current return of the portfolio relative to the
anticipated cash flow requirements of the plan; and,
(3) the projected return of the portfolio relative to the funding objective of the plan. 233
The Department of Labor has added a fourth factor: "consideration
of the expected return on alternative investments with similar risks
available to the plan. "234 The Department recently clarified this factor:
[B]ecause every investment necessarily causes a plan to forego other
investment opportunities, an investment will not be prudent if it
would be expected to provide a plan with a lower rate of return than
available alternative investments with commensurate degrees of
risk or is riskier than alternative investments with commensurate
rates of return. 235
Thus, a fiduciary may not sacrifice return to obtain a collateral benefit
and proposed investments must be compared with available alternative
investments with similar risk and return characteristics.
The Department has also clarified that the prudence rule does not
require fiduciaries to invest only in conservative investments. The
Department has stated that the
relative riskiness of a specific investment .... does not render such
investment either per se prudent or per se imprudent .... [T]hus,
although securities issued by a small or new company may be a
riskier investment than securities issued by a "blue chip" company,
the investment in the former company may be entirely proper under
the Act's "prudence" rule. 236
The Department has refused to issue a list of legally permissible
investments because "no such list could be complete.''237 Indeed, the
Department recently praised ERISA because it doesn't specify a legal
list of permissible investments: "One of the remarkable things about
ERISA as a statute has been its flexibility, because it doesn't prescribe
exact investment policies."238
231. Id.
232. Id.
233. Id.
234. Interpretive Bulletin 94-1, supra note 9.
235. Id.
236. Preamble to Rules and Regulations for Fiduciary Responsibility; Investment
of Plan Assets under the "Prudence" Rule, 44 Fed. Reg. 37,221 (June 26,1976).
237. Id.
238. Hearing on Pension Investments and Economic Growth, supra note 10.
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Some opponents of targeted investing have argued that ERISA
requires fiduciaries to make investments which will produce the maximum return for the plan with the least amount ofrisk. 239 Courts have
disagreed, however. In Foltz v. U.S. News & World Report Inc.,240 a
district court ruled that ERISA "section 404 creates no exclusive duty of
maximizing pecuniary benefits.''241 In Anderson v. Mortell,242 the court
observed that a fiduciary has no duty to "achieve the highest possible
price" on the sale of securities.243 More recently, in Ershick v. United
Missouri Bank,244 the court held that ERISA does not create a duty to
maximize pecuniary benefits. 245 The duty to maximize returns on
investments would place an unreasonable and impossible burden on
fiduciaries. Return cannot be evaluated in isolation: return depends
upon the risk factor involved. Fiduciaries should optimize investment
returns in comparison to other available investments with similar risk
characteristics. Fiduciaries should never sacrifice investment returns
to achieve a collateral objective and the value of the collateral benefit
cannot be factored into the rate of return.
Thus, under the prudence rule, it is legally permissible to invest in
ETIs under the appropriate circumstances. However, as numerous
courts have noted, it is not the success of an investment viewed in hindsight that determines the prudence of the investment.246 Rather, it is
239. Interpretive Bulletin 94-1, supra note 9, makes clear that investments are to
be compared to comparable investments: a plan cannot make an investment if the
return would be less than other investments of similar risk and the plan cannot make
an investment if the risk would be greater than investments of similar return. The
bulletin does not require the investment to have the best of both worlds: the highest
return and the lowest risk. Instead, the comparison is the highest return of investments
with similar risk characteristics.
240. 865 F.2d 364 (D.C. Cir. 1989), cert. denied, 490 U.S. 1108 (l989).
241. Id. at 373.
242. 722 F. Supp. 462 (N.D. m. 1989).
243. Id. at 470.
244. 12 Employee Benefits Cas. (BNA) 2323 (D. Kan. 1990), affd, 14 Employee
Benefits Cas. (BNA) 1848 (lOth Cir. 1991).
245. 12 Employee Benefits Cas. (BNA) at 2327.
246. Debruyne v. Equitable Life Assur. Society, 720 F. Supp. 1342, 1349 (N.D. m.
1989), affd, 920 F.2d 457 (7th Cir. 1990) (stating that "[t]he fiduciary duty .... requires
prudence not prescience."); GIW Industries, Inc. v. Trevor, Stewart, Burton & Jacobsen,
Inc., 10 Employee Benefits Cas. (BNA) 2290, 2300 (S.D. Ga. 1989), affd, 895 F.2d 729
(lUh Cir. 1990) (holding that a "court must consider the conduct of the fiduciary not
the success of the investment, .... and the court must evaluate the fiduciary's conduct
from the perspective of the 'time of the investment decision' rather than from 'the
vantage point of hindsight.' "(citations omitted)); Donovan v. Walton, 609 F. Supp. 1221,
1238 (S.D. Fla. 1985), affd sub nom., Brock v. Walton, 794 F.2d 586 (l1th Cir. 1986)
(stating that "[o]ne must resist the knee-jerk reflex to pronounce an investment prudent
or imprudent based on the success of the venture, for ERISA is concerned with the
soundness of the decision to invest." (quoting Leigh v. Engle, 727 F.2d 113, 124 (7th
Cir. 1984)). See also New York Hearings, supra note 85, at 198 (testimony of David
Walker, Ass't Secretary of Labor for Pension and Welfare Benefits Administration, U.S.
Dept. of Labor) (stating: "What we don't do in ERISA is we don't second-guess people.
We don't employ hindsight"l.
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the procedural process by which the investment decision was made that
determines its prudence. In Marshall v. Glass / Metal Association and
Glaziers and Glass Workers Pension Plan,247 the district court for the
district of Hawaii held:
ERISA does not require that a pension plan take no risks with
its investments. Virtually every investment entails some degree of
risk, and even the most carefully evaluated investments can fail
while unpromising investments may succeed. The application of
ERISA's prudence standard does not depend upon the ultimate
outcome of an investment, but upon the prudence of the fiduciaries
under the circumstances prevailing when they make their decision
and in light of the alternatives available to them. 248
The court held that the fiduciaries failed to satisfy the prudence rule
"[b]y committing Plan assets without adequate procedures and evaluation of the risks involved and alternatives available."249 Procedural
prudence will be discussed in more detail later.
3. The Diversification Rule
The third requirement imposed by ERISA section 404(a)(1) is the
duty to diversify plan assets "so as to minimize the risk of large losses,
unless under the circumstances it is clearly prudent not to do SO.''250 The
diversification rule requires trustees to reduce exposure to the risk of
large losses:
Diversification of investments is the practice whereby funds are
committed to different classes of investments which are characterized by different types of risks. The theory upon which the practice
is based is that by allocating funds to different types of investments,
the potential losses which might occur in the area due to a particular
economic event will be offset by gains in another area. Even if such
a loss is not offset, its impact is at least limited to a relatively small
portion of the fund.
Conversely, by pursuing a strategy of non-diversification, an
investor runs a risk of incurring substantial losses if the particular
investment vehicle chosen performs badly, or if one of few large
investments chosen performs badly. Under such circumstances a
particular negative economic event can devastate the entire plan or
a great portion thereof. 251
247. 507 F. Supp. 378 (D. Haw. 1980).
248. [d. at 384.
249. [d. See also Donovan v. Mazzola, 2 Employee Benefits Cas. (BNA) 2115
(N.D.Cal. 1981), affd, 716 F.2d 1226 (9th Cir. 1983), cert. denied, 464 U.S. 1040 (1984),
in which the court held that plan trustees acted imprudently when they made a loan
without obtaining or reviewing basic documentation including financial statements,
project plans, and an accurate market study. The court also found that the trustees
failed to monitor the use of the loan proceeds after the loan was made.
250. 29 U.S.C. § 1104(a)(l)(C) (1994).
251. Donovan v. Guar. Nat'! Bank, 4 Employee Benefits Cas. (BNA) 1686, 1688
(S.D. W.Va. 1983).
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ERISA's legislative history provides additional guidance:
A fiduciary usually should not invest the whole or an unduly
large proportion of the trust property in a single security. Ordinarily
the fiduciary should not invest the whole or an unduly large proportion of the trust property in one type of security or in various types
of securities dependent on the success of one enterprise or upon
conditions in one locality, since the effect is to increase the risk of
large losses .... If he is investing in mortgages on real property he
should not invest a disproportionate amount of the trust in mortgages in a particular district or on a particular class of property so
that a decline in property values in that district or of that class
might cause a large loss.252
Congress "intended that the geographic dispersion be sufficient so
that adverse economic conditions peculiar to one area would not significantly affect the economic status of the plan as a whole."253 Congress
indicated that "[b]y spreading asset purchases throughout a number of
varying types of securities or investments, a fiduciary may protect to a
certain extent against the fortunes of a particular field of business or
industry, and thereby minimize the risk oflarge losses. "254 The Seventh
Circuit has held:
When investment advisors make decisions they do not view individual investments in isolation. Rather, the goal is to create a diversified portfolio that balances appropriate levels of risk and return
for the investor. The risk of a given investment is neutralized somewhat when the investment is combined with others in a diversified
portfolio. The risk inherent in the entire portfolio is less than that
of certain assets within the portfolio. Ideally, after diversification
only market risk remains. Likewise, the return from a portfolio over
time should be more stable than that of isolated investments within
that portfolio.255
The Department of Labor has not established a maximum percentage that can be invested in one geographic area or one type of investment. 256 Diversification depends upon the facts and circumstances
surrounding each plan and investment.257 Under certain circumstances, the decision not to diversify might be prudent.258
252. H.R. REP. No. 1280, 93rd Cong., 2d Sess. 304 (1974), reprinted in 1974
U.S.C.CAN. 5038, 5085.
253. [d.
254. GIW Industries, Inc. v. Trevor, Stewart, Burton & Jacobsen, Inc., 10 Employee
Benefits Cas. (BNA) 2290, 2303 (S.D. Ga. 1989), affd, 895 F.2d 729 (11th Cir. 1990).
255. Leigh v. Engle, 858 F.2d 361, 368 (7th Cir. 1988), cert. denied sub nom., Estate
of Johnson v. Engle, 489 U.S. 1078 (1989).
256. Lanka v. O'Higgins, 810 F. Supp. 379 (N.D.N.Y. 1992). The Conference Report
states that "[tlhe degree of investment concentration that would violate this requirement to diversify cannot be stated as a fIXed percentage, because a prudent fiduciary
must consider the facts and circumstances of each case." H.R. REp. No. 1280, 93d Cong.,
2d Sess. 304, reprinted in 1974 U.S.C.CAN. 5038, 5084.
257. See Marshall v. GlasslMetal Ass'n, 507 F. Supp. 378, 383 (D. Haw. 1980).
258. ERISA § 404(A)(1)(C) imposes an obligation to diversify "unless under the
circumstances it is clearly prudent not to do so." 29 U.S.C. § 1104(a)(lXC) (1994). See
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In Donovan v. Mazzola,259 the district court for the Northern
District ofCalifornia held that the trustees' general inexperience in real
estate loans was not a defense to their imprudent conduct in exposing
the pension fund to the large risk ofloss resulting from the high concentration of assets in a single type of investment. The loan violated
ERISA's diversification rule by subjecting a disproportionate amount
(approximately fifty-three percent) of pension fund assets "in a single
investment, subject to a common set of risks associated with a single
geographic location, a single product type, and the specific project and
property involved.''260 The court described the portfolio:
Taken together with assets already invested, and assuming a
total portfolio of $20 million by November 20, 1979, the $650,000
loan brought the total proportion of the Fund's total assets invested
in the capital market for real estate to approximately 81%; in mortgages, to approximately 73%; and in mortgages on certain specialized properties, to approximately 73%; laborll1 zang zangg loans to
one investment to approximately 12%;] and in mortgages secured by
Northern California real estate, to approximately 47%.261
The court compared these percentages to the prevailing standards
in the field of institutional portfolio management and found that no
more than one-third of the pension fund assets should have been
invested in real estate. 262 The court also stated that plan assets generally should not be invested in a single type of real estate product, but
should be diversified by product, location, project, and property.263
The trustees had not established an investment policy.264 The court
implied that the trustees should have developed guidelines concerning
the amount of plan assets that can be invested in debt and equity, and
Reich v. King, 18 Employee Benefits Cas. (BNA) 1801, 1804 (D. Md. 1994) (trustees have
the burden of proving that their decision not to diversify is "clearly prudent"; prudence
under the diversification rule is the same as the prudent person rule of ERISA
§ 404(AX1XB». In Reich v. King, the district court denied the Secretary of Labor's motion
for summary judgment which claimed that the trustees' failure to diversify is a per se
violation of the diversification rule. 18 Employee Benefits Cas. (BNA) at 1806. The trustees had invested 75% of plan assets in mortgages and notes, 72% of which was secured
by residential real property in one county. [d. at 1802. The remaining mortgages were
secured by real estate in three neighboring counties. [d. The court refused to grant
summary judgment, holding that non-diversification is not a per se violation of the diversification rule and that a material fact existed as to the prudence of the trustees' decision
not to diversify. [d. at 1805-06. Later, the court granted the trustees' motion to dismiss,
holding that the trustees had met the burden of showing that the decision not to diversify
was clearly prudent. Labor Department Loses Lawsuit Over Trustees' Failure to Diversify,
21 Pens. & Benefits Rep. (BNA) 2281-2282 (Dec. 5, 1994).
259. 2 Employee Benefits Cas. (BNA) 2115 (N.D. Cal. 1981), affd, 716 F.2d 1226
(9th Cir. 1983), cert. denied, 464 U.S. 1040 (1984).
260. [d. at 2128.
261. [d. at 2128-29.
262. The court considered testimony of the Department of Labor's expert witness
who stated that pension fund assets should be diversified in order to meet the prevailing
standards in the field of institutional portfolio management. [d. at 2126.
263. [d. at 2128.
264. [d. at 2132.
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short or long term investments. 265 Also, the trustees should have
adopted policies concerning geographic distribution of the properties
securing the real estate loans, the type of business activity associated
with the borrower or with the securing property, the maturity dates of
the various debt instruments, the amount of plan assets invested in
construction loans as opposed to permanent loans, and the amount
invested in real estate loans to the same or related lenders. 266
In Marshall v. Teamsters Local 282 Pension Trust Fund,267 the
district court for the Eastern District of New York held that ERISA
"requires diversification under circumstances where commitment of a
high percentage of the assets of a plan to a particular investment or
class of investments casts doubt on the prudence of the investments.''268
Trustees of a Teamsters pension fund invested $20 million in a permanent first mortgage on a ten acre lot on the Las Vegas "Strip," where a
hotel and casino were to be erected. Because the loan, which involved
36% of plan assets was so large, the court held that trustees had
violated the diversification limit imposed by ERISA.269
Additionally, the trustees had violated the trust agreement which
limited investments in anyone investment to twenty-five percent ofthe
fund's total assets at market value, unless the trustees specifically
determined that such limitation would be imprudentPO No specific
finding ofimprudence was made by the trustees. 271
The court described the factors which made the investment
extraordinarily risky:
(a) The project might not be completed for lack of equity capital.
(b) The project might not be completed because of strikes, increase in
cost of construction, or poor management of construction.
(c) If completed, the hotel business may fail because of poor management, competition, or adverse economic conditions, or Las Vegas
might lose its lure to gamblers because of competition in other
parts of the country if gambling is legalized in states where it is
now forbidden.
(d) If completed, the gambling casino may fail because of poor
management or adverse economic conditions or competition.
(e) Government guaranteed Ginnie Mae certificates are available
bearing approximately the same interest rate as provided in the
permanent mortgage.
(0 The [10 acre lot] .... is saleable at a price in excess of cost, and
it is imprudent and improper for the trustees to use a risky loan
as a means of selling the . . . . property or showing increased total
assets of the fund, knowing the sale price is in excess of market
value. It smacks of gimmickry.
265. [d.
266. [d.
267. 458 F. Supp. 986 (E.D. N.Y. 1978).
268. [d. at 990.
269. [d. at 991.
270. [d.
271. [d.
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(g) The loan represents a disproportionate commitment of the assets
of the fund. 272
These factors, combined with the direct violation of the twenty-five
percent limit imposed by the trust agreement, influenced the court to
find that the investment was imprudent and that the trustees had
violated the diversification rule. 273
In Brock v. Wells Fargo Bank,274 trustees were enjoined from
making a $4.5 million loan to a real estate developer, where evidence
strongly suggested that the trustees had not investigated the investment with the care required by ERISA.275 Although the loan only
equaled thirteen percent of the plan assets, the Department argued
that the diversification and prudence rules had been violated. 276 The
court granted a preliminary injunction, relying primarily on the failure
of the investment. 277 The case was settled and a real estate consultant
was retained to monitor the project. 278
Several cases have involved such high percentages of plan assets in
one type ofinvestment it is not surprising that the Department ofLabor
challenged the investment. In Freund v. Marshall & Ilsley Bank,279 the
court noted, "it can hardly be disputed that the investment of virtually
all of the Plan's assets in loans to affiliated companies, on its face,
represents a complete failure to diversify the investments of the
Plan.''2Bo In Marshall v. Mercer,281 the court observed, "it should be obvious that a concentration of 85% to 90% of the Plan's assets in a single
class of investments is little or no diversification at all.''282 In Marshall
v. O'Donnell,283 the court held that loans of ninety-nine percent of plan
assets to parties in interest violated the diversification rule. 284 Donovan
272. Id. at 991-92.
273. Id. at 990-992.
274. 7 Employee Benefits Cas. (BNA) 1221 (N.D. Cal. 1986).
275. Id. at 1221.
276. Id.
277. Id.
278. See also Sandoval v. Simmons, 622 F. Supp. 1174 (C.D. ill. 1985) in which the
court held that an investment of 12% of plan assets constituted non-diversification.
However, in contrast to the cases previously cited, in Sandoval, the court emphasized
the business acumen of the trustee, describing him as a "brilliant, self-made man ....
[H]is rise in the fmancial community is something of which legends are made." Id. at
1209. Although a violation of ERISA was found based on failure to diversify and conflict
of interest, the court focused on the expertise of the trustee in determining whether a
violation had occurred.
279. 485 F. Supp. 629 (W.D. Wis. 1979).
280. Id. at 636.
281. 4 Employee Benefits Cas. (BNA) 1523 (N.D. Tex. 1983), rev'd on other grounds,
747 F.2d 304 (5th Cir. 1984).
282. Id. at 1535.
283. Civ. Action No. R-81-28 (D. Md., Jan. 28, 1981). See Litigation: Employee
Advised ofNonparticipant Status Prior to ERISA May Not Bring Federal Court Action,
Pens. Rep. (BNA) No. 329, A-13, A-15 (Feb. 16, 1981).
284. Id. See also Freund v. Marshall & nsley Bank, 485 F. Supp. 629 (W.D. Wis.
1979) (virtually all of plan assets loaned to sponsor); Marshall v. Kelly, 465 F. Supp.
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v. Guaranty National Bank 285 involved the investment of ninety-seven
percent of plan assets in mortgages in the area of Huntington, West
Virginia. 286 In Marshall v. Carr,".87 an investment of eighty percent of
plan assets in Alaska real estate was criticized by the Department of
Labor. 288 In Whitfield v. Tomasso,289 the trustees committed as much as
eighty-nine percent of fund assets to certificate of deposits in one insurance company.290 Investment of eighty-five percent of plan assets in one
geographical area was found to violate ERISA's diversification requirement in Brock v. Citizens Bank ofClovis. 291
Trustees of an Operating Engineers pension fund in West Virginia
who invested ninety-seven percent of fund assets in mortgage loans in
the Huntington area, were challenged by the Department of Labor in
Donovan v. Guaranty National Bank. 292 The court explained that in
times of economic uncertainty, diversification becomes increasingly
important as a prophylactic measure to guard against losses caused by
unforeseen economic events. 293 Because the trustees had committed
virtually all of the plan assets to illiquid investments, they were unable
to take advantage of rising interest rates. As a result, the real rate of
return on their investments declined. The court rejected the trustees'
contention that the plan assets were diversified because of the large
number of individual loans. 294 The court enjoined the trustees from
making any further loans until the percentage of assets invested in
mortgages was reduced to one-third and suggested that the trustees
would violate the diversification rule if they invested more than onethird of plan assets in anyone type ofinvestment. 295
Similarly, the Department of Labor attacked the decision of the
trustees of the Alaskan Teamsters pension fund to invest eighty
percent of plan assets in loans and other assets secured by Alaska real
341 (W.D. Okla. 1978) (almost 70% of plan assets loaned to sponsor).
285. 4 Employee Benefits Cas. <aNA) 1686 (S.D. W.Va. 1983).
286.Id.
287. Civ. Action No. A81-017 Civ. (D. Ala., Jan. 19, 1981). See Litigation: Labor
Department, Alaska Teamsters Reach Settlement Agreement in Investment Dispute,
Pens. Rep. (BNA) No. 326, A-14 (Jan. 26, 1981).
288.Id.
289. 682 F. Supp. 1287 (E.D. N.Y. 1988).
290. Id. at 1301. The court held that investments were merely a scheme to kick
back money to certain trustees. The court also questioned the experience of the trustees
and held that they were unfamiliar with the investment process and had not investigated the feasibility of the investments or the fmancial soundness of the insurance
company. The court criticized the trustees because they did not retain an expert who
was knowledgeable with respect to investment in insurance companies before they made
the investment.
291. 841 F.2d 344, 345 (lOth Cir. 1988), cert denied, 488 U.S. 829 (1988),
292. 4 Employee Benefits Cas. (BNA) 1686 (S.D. W.Va. 1988).
293. Id. at 1688.
294. Id. at 1689.
295. Id. at 1691.
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estate. 296 The case was settled and according to the consent order, the
trustees were enjoined from investing in Alaska real estate for three
years or until non-Alaska real estate holdings were increased to fiftysix percent. 297 This case seems to indicate that, under certain circumstances, it may be proper for a fund to invest as much as fifty-six
percent of plan assets in real estate holdings in a single state.
In Brock v. Citizens Bank of Clovis,298 the court held that investment ofsixty-five percent of plan assets in commercial real estate in the
vicinity of Clovis, New Mexico violated the diversification rule. 299 Prior
to filing a lawsuit against the trustees, the Department of Labor
warned the trustees to reduce the plan's investments in real estate to
thirty percent ofits assets. 3OO The court ruled that because all ofthe real
estate investments were in one type of security, the fund was not
protected from a multitude of risks. 301 Once the Department proved
non-diversification, the burden shifted to the trustees to show prudence
notwithstanding non-diversification.302 The trustees failed to meet this
burden. 303
In Martin v. Walton,304 the Department challenged the investments
of the Operating Engineers Local 675 Pension Funds. The Department
had previously lost a lawsuit against the trustees for making belowmarket mortgages to plan participants and beneficiaries, for building
the Fund's administration building one hundred percent union, and for
negotiating a lease for office space with the union. 305 The court found
that the Department of Labor's bark was "worse than its bite''306 and
ruled against the Department on all issues. 307
By the late 1980s the trustees of the Operating Engineers Local
675 Pension Fund had invested most ofits assets in real estate in South
Florida. 308 The Fund's portfolio included a Hilton hotel, two office parks,
296. Marshall v. Carr, Civ. Action No. A81-017 (D. Ala., Jan 19, 1981).
297. [d.
298. 841 F.2d 344 (lOth Cir. 1988), cert. denied, 488 U.S. 829 (l988).
299. [d. at 345.
300. [d.
301. [d. at 346.
302. [d. The legislative history of ERISA indicates that if "diversification on its
face does not exist, then the burden of justifying failure to follow this general policy
should be on the fiduciary who engages in this conduct." CoNF. REP., supra note 252,
at 304, reprinted in 1974 U.S.C.C.AN. 5038, 5084. See also Freund v. Marshall & llsley
Bank, 485 F. Supp. at 639; Marshall v. GlasslMetal Ass'n, 507 F. Supp. at 384; Fine v.
Semet, 514 F. Supp. 34 (S.D. Fla. 1981), affd, 699 F.2d 1091 (lith Cir. 1983).
303. [d.
304. Case No. 90-6587-CIV-Marcus (S.D. Fla.l.
305. Donovan v. Walton, 609 F. Supp. 1221, 1224 (S.D. Fla. 1985), affd sub nom.,
Brock v. Walton, 794 F.2d 586 (lIth Cir. 1986).
306. [d. at 1238.
307. [d. at 1225 n.3.
308. Telephone interviews with Dennis J. Walton, business manager of International Union of Operating Engineers Local 675, AFL-CIO (July, 1991).
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some undeveloped land, and the Fund's administrative offices.309 Later,
the hotel and one of the office parks were sold for a large profit, significantly reducing the amount of fund assets invested in real estate. 310
Due to unfavorable economic conditions, the purchasers ofthe hotel and
office park defaulted on their purchase-money mortgages. 3ll The trustees foreclosed and reacquired the properties.312 This reacquisition,
along with an increase in plan benefits, left the trustees with insufficient liquid assets to pay benefits.
The Department of Labor rued a complaint against the trustees for
lack ofdiversification and liquidity.313 In its complaint, the Department
alleged that approximately ninety-five percent of Fund assets were
invested in real estate in South Florida. 314 The trustees raised several
defenses: that any lack of diversification was clearly prudent under the
circumstances then prevailing, that the trustees always followed procedural prudence, and that any losses were the result of market conditions beyond the control of the trustees. 315 The Department settled the
case and the court issued a preliminary injunction against the trustees
and appointed a receiver and named fiduciary.316
This case illustrates the problems that can be caused by lack of
diversification. While the Fund still owns valuable properties, the trustees are unable to pay monthly pension benefits in addition to the enormous costs of the court-approved receiver and the consultants hired to
resolve the Fund's liquidity problems. The chairman of the board
resigned, and the duties of the trustees have been drastically curtailed
by the court.317
ERISA's diversification rule provides important protections for
plan participants and beneficiaries. The court interpretations of the
rule are logical and consistent with the fundamental purpose of
ERISA-to ensure that plan assets are available at retirement.
Because the rule is a flexible rule which is dependent on relevant facts
and circumstances, ERISA's diversification requirement should not be
an obstacle to economically targeted investments.
4. The Plan Document Rule
The final requirement is the plan document rule. ERISA Section
404(a)( 1)(0) requires fiduciaries to act "in accordance with the docu309. [d.
310. [d.
311. [d.
312. [d.
313. Dole v. Walton, 12 Employee Benefits Cas. (BNA) 2385 (S.D. Fla. 1990).
314. Complaint lJ[14, Dole v. Walton, Case No. 90-6587-CIV-Scott (S.D. Fla.). The
trustees have denied this allegation.
315. Answer, lJ[ 37-39, Dole v. Walton, Case No. 90-6587-CIV-Scott (S.D. Fla.).
316. Dole v. Walton, 12 Employee Benefits Cas. (BNA) 2385 (S.D. Fla. 1990).
317. [d. See Martin v. Walton, 773 F. Supp. 1524 (S.D. Fl. 1991).
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ments and instruments governing the plan insofar as such documents
and instruments are consistent with the provisions" of ERISA.318 Plan
documents include the plan description, summary plan description,
collective bargaining agreement, trust agreement, contract, investment
management agreement, investment guidelines, and other instruments under which the plan was established or is operated. 3i9
In Martin v. Harline,320 the district court for the District of Utah
held that a corporate board of directors violated the plan document rule
when they failed to follow plan documents which required them to
appoint a committee to assist the plan trustee and to report to the
board. 321 The court held that the plan imposed on the directors a duty to
oversee the plan trustee and that the directors failed to follow the plan
document's requirements in violation of ERISA section 404(a)(I)(D).322
The court held that "[uJnder ERISA and the common law, a fiduciary
has the fundamental duty to follow the trust document and is liable for
losses if he does not do SO.''323 The court noted that if a trust agreement
defines how a power must be exercised, "the fiduciary must strictly
adhere to those terms."324 Good faith is not a defense and neither is reliance on advice of counsel.325
D. Procedural Prudence: How to Prudently Establish an
ETI Program
Most ETI programs have been successful. Yet, it is the failures that
are publicized and remembered. Professor Jeanne Patterson recently
summed up ETI programs: "If it's done right and works out, good; if it
doesn't work out, you shouldn't have done it.''326 This sounds like advice
that all plan attorneys would like to follow: no one wants to represent
the fund whose investments go sour. However, the success or failure of
a plan investment is not a measure of the plan's prudence under
318. 29 U.S.C. § 1104(aX!)(D) (1994).
319. See e.g., ERISA § 104(bX2), 29 U.S.C. § 1104(b)(2) (1994). Courts have ruled
that plan documents also include a deadlock arbitration award, Ironworkers Local 272
v. Bowen, 695 F.2d 531 (11th Cir. 1983); and a memorandum in which the trustees'
instructions are described, Clarke v. Bank of New York, 687 F. Supp. 863 (S.D.N.Y.
1988). See also Schoenholtz v. Doniger, 628 F. Supp. 1420 (S.D.N.Y. 1986); Delgrosso v.
Spang & Co., 769 F.2d 928 (3d Cir. 1985), cert. denied, 476 U.S. 1140 (1986); Donovan
v. Daugherty, 550 F. Supp. 390 (S.D. Ala. 1982); Winpisinger v. Aurora Corp. ofIU., 456
F. Supp. 559 (N.D. Ohio 1978).
320. 15 Employee Benefits Cas. (BNA) 1138 (D. Utah 1992).
321. Id. at 1149.
322. The violation of the plan document rule was independent of any violation of
the prudence rule which also imposes a duty of oversight on the trustees. Id.
323. Id. (citing Dardaganis v. Grace Capital, Inc., 889 F.2d 1237, 1241-1242 (2d
Cir. 1989».
324. Id. (citing G. BoGERT, THE LAW OF TRUSTS AND TRUSTEES, § 551 at 7 (2d ell.
1980».
325. Id. (citing RESTATEMENT (SECOND) OF TRUSTS § 201 cmt. b (1959».
326. D. Jeanne Patterson, Who's Counting? ETI Returns, Economic Impact, PENS.
& INV., Sept. 20, 1993, at 12.
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ERISA. Instead, courts look at the process by which the investment
decision was made, and the care with which the program was implemented and monitored.
Under ERISA, prudence is a procedural test which is applied without regard to hindsight. In Reich v. Valley National Bank ofArizona,3z7
the district court for the Southern District of New York identified the
prudence rule as "an objective standard that focuses on the conduct of
the fiduciary in causing the [plan] .... to make the investment.''328 An
analysis of procedural prudence determines "whether the individual
trustees, at the time they engaged in the challenged transactions,
employed the appropriate methods to investigate the merits of the
investment and to structure the investment.''329
In Debruyne v. Equitable Life Assurance Society,330 the district
court for the Northern District of Illinois considered whether an investment manager breached his fiduciary duty by investing eighty-one
percent of plan assets in equities and convertible instruments in October 1987 just before "Black Monday.''331 The court rejected the argument that the manager should have decreased investments in
securities and increased investments in bonds before the stock market
crashed:
To obtain this rather unremarkable insight, plaintiffs need not
have consulted an experienced fmancial analyst. Given the benefit
of hindsight, even a complete novice at financial planning would
conclude that defendants should not have maintained a substantial
investment in stock at a time when the stock market crashed. In
applying ERISA, however, this court cannot judge defendants'
investment decision from the vantage point of hindsight. Rather, the
court must consider the prudence of defendants' conduct at the time
they made the investments.332
The court refused to "hold defendants liable for an inability to predict
the stock market crash. The fiduciary duty requires prudence not
prescience.''333
Similarly, in GIW Industries, Inc. v. Trevor, Stewart, Burton &
Jacobsen, Inc.,334 the district court for the Southern District of Georgia
327. 17 Employee Benefits Cas. (BNA) 1257 (S.D. N.Y. 1993).
328. [d. at 1273. See Katsaros v. Cody, 744 F.2d 270, 279 (2d Cir. 1984), cert.
denied, 469 U.S. 1072 (1984) (stating that "[p]rudence is measured according to the
objective 'prudent person' standard").
329. Fink v. Nat'l Sav. & Trust Co., 772 F.2d 951, at 955 (D.C. Cir. 1985) (quoting
Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983), cert. denied, 464 U.S. 1040
(1984». In Lanka v. O'Higgins, the court stated that the prudence rule requires a fiduciary to "employ proper methods to investigate, evaluate and structure the investment."
15 Employee Benefits Cas. (BNA) 2851, 2859 (N.D.N.Y. 1992).
330. 720 F. Supp. 1342 (N.D. Ill. 1989), affd, 920 F.2d 457 (7th Cir. 1990).
331. [d. at 1343.
332. [d. at 1348. (citation omitted).
333. [d. at 1349.
334. 10 Employee Benefits Cas. (BNA) 2290 (S.D. Ga. 1989), affd, 895 F.2d 729
(1lth Cir. 1990).
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stressed that it is inappropriate to use hindsight to determine the
prudence of an investment:
[I]t is always easiest to evaluate the wisdom of investments in
hindsight. ERISA does not make a fiduciary an insurer of a plan's
assets or of the success of its investments. As one court has noted,
"ERISA does not require that a pension fund take no risk with its
investments. Virtually every investment entails some degree of risk,
and even the most carefully evaluated investments can fail while
unpromising investments may succeed." Thus no conclusion of
mismanagement or ineptness follows automatically from the fact
that an investment does not yield a return. The ultimate outcome
of the investment is not the yardstick by which the prudence of the
fiduciary is measured. The court must consider the conduct of the
fiduciary not the success ofthe investment, and the Court must evaluate the fiduciary's conduct from the perspective of the "time of the
investment decision" rather than from the "vantage point of
hindsight. "335
Fiduciaries can prudently implement economically targeted
investment programs ifthey take care to follow the following guidelines
for procedural prudence.336
1. Periodically Review Plan Documents
Fiduciaries and counsel must periodically review their plan documents to make sure that the trustees are acting in accordance with plan
documents. The trustees should carefully monitor plan investments to
make certain that limitations established in an investment policy statement or other plan document are not being violated. 337
Trustees must frequently review all plan documents to ensure that
they do not unintentionally violate any terms of these documents. For
example, trustees should review their trust agreement, investment
335. Id. at 2300 (citations omitted).
336. For another perspective, the Center for Policy Alternatives recommends "five
best practices" for successful ETI programs:
1. [Establish a] set ofETI policies and procedures that allow for objective analysis of a proposed investment and avoid political interference in the decision
to make any specific investment ....
2. [Use ETIs to] fill an identifiable capital gap ....
3. [Make sure] ETIs yield risk and cost-adjusted market rates of return.
Government and private intermediaries are used to provide insurance and
subsidies and perform managerial functions that keep ETI security, yield,
and administrative costs in-line with standard investment benchmarks.
4. [Incorporate ETIs] into an overall fund strategy of geographic and asset
diversification ....
5. [Regularly evaluate] ETI investments to insure that they continue to meet
performance and diversification guidelines ....
CENTER FOR POLICY ALTERNATIVES, supra note 20, at 11.
337. For an example of an investment management agreement and sample investment guidelines, see SoLELY IN OuR INTEREST, supra note 6, at Appendices Band C.
For an example of an ETI Policy Statement, see Hearing on Pension Investments
and Economic Growth, supra note 10 (testimony of William Dale Crist, President of
CalPERS).
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management agreement, and investment guidelines before making any
investment decisions. This basic ERISA requirement was overlooked by
Grace Capital, an investment manager for the Fur Manufacturing
Industry Retirement Fund. 338 In its investment management agreement with the Fund, Grace Capital agreed to "manage the Account in
strict conformity with the investment guidelines promulgated by the
Trustees .... and with all applicable Federal and State laws and regulations."339 The investment guidelines limited investment in common
stock to "25% of the cost of the securities in the Account.'':l40 Later, the
limitation was increased to fifty percent. 341
Although Grace Capital recommended an additional increase in
order to invest more than fifty percent in equities, the trustees refused
to increase the limit. 342 Over a fifteen month period, equity investments
steadily increased from fifty-four to eighty-one percent. 343
The Trustees sued Grace Capital. The court held that by agreeing
to act as the Fund's investment manager, Grace Capital had assumed
the statutory obligation to act in accordance with plan documents
including the investment management agreement. 344 The court further
held that Grace Capital had breached its fiduciary duty to the Fund by
exceeding the fifty percent limitation established in the investment
management agreement. 345 The court rejected the defense raised by
Grace Capital that in the investment business, "percent guidelines
merely establish a rough demarcation zone to assist the manager in
portfolio allocation."346
Similarly, in Martin v. Harline,347 the district court for the District
of Utah held that a fiduciary is liable for any losses resulting from the
fiduciary's failure to follow plan documents. 346 A periodic review of plan
338. Dardaganis v. Grace Capital, Inc., 664 F. Supp. 105, 107 (S.D.N.Y. 1987), affd
in pertinent part, 889 F.2d 1237 (2d Cir. 1989) on remand, 755 F. Supp. 85 (S.D.N.Y.
1991).
339. 664 F. Supp. at 107.
340. [d.
341. [d.
342. [d.
343. 664 F. Supp. at 107.
344. [d. at 108.
345. [d.
346. [d. at 109. The court also rejected the investment manager's defense that the
trustees waived strict compliance with the guidelines by failing to enforce the limitation.
The court stated that "[t]he limitation provision was designed to protect the interests
of the Fund's participants and beneficiaries .... [T)cbhe Trustees should not be able,
by negligence in enforcing the Agreement, to waive the requirements of the Agreement
designed to protect those beneficiaries." [d. at 110. See also Marshall v. Teamsters Local
282 Pension Trust Fund, in which the court held that plan trustees violated
§404(a)(1)(D) by investing 36% of plan assets in one investment when the trust agreement contained a 25% limitation. 458 F. Supp. 986, 991 (E.D.N.Y. 1978).
347. 15 Employee Benefits Cas. (BNA) 1138 (D. Utah 1992).
348. [d. at 1149.
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documents will ensure that plan investments do not violate the terms of
any plan documents.
2. Prudently Delegate Investment Duties
ERISA requires pension assets to be held in trust by one or more
trustees349 and a pension plan must be established and maintained
pursuant to a written trust agreement. 350 Fiduciaries who have authority to control and manage the plan either must be named in the trust
agreement, or the trust agreement must specify a procedure by which
the fiduciaries are chosen.
Trustees must have exclusive authority and discretion to manage
and control plan assets, with two exceptions. Under one exception,
named fiduciaries 351 may delegate fiduciary duties (other than trustee
responsibilities)352 to other persons, such as investment managers. 353
For example, trustees may delegate the authority to manage, acquire or
dispose of plan assets to one or more investment managers. 354 The
procedure for allocating or delegating such responsibilities must be
described in the trust agreement355 and the investment advisor must
acknowledge in writing that it is a fiduciary with respect to the plan. 356
Under the second exception, the trustees may allocate fiduciary duties
(other than trustee responsibilities) among named fiduciaries. 357
Where fiduciary duties have been properly allocated or delegated,
the remaining trustees will not be liable for any act or omission of such
person unless the trustees violated the fiduciary duties with respect to
the allocation or delegation358 or unless the trustees would otherwise be
349. ERISA § 403(a), 29 U.S.C. § 1103(a) (1994).
350. ERISA § 402(a), 29 U.S.C. § 1102(a) (1994).
351. ERISA § 402(a)(2), 29 U.S.C. § 1102(a)(2) (1994). In a Taft-Hartley plan, typically the "named fiduciary" is the joint board of trustees. The Department of Labor has
ruled that the designation of the joint board as the entity which has authority to control,
manage and administer the plan, is sufficient to comply with the requirement in
§ 402(a) that a "named fiduciary" be provided in a plan instrument. Questions and
Answers Relating to Fiduciary Responsibility, ERISA LB. 75-5, § 2509.75-5 (FR-2)
(1975).
352. "Trustee responsibilities" include any responsibility provided in the trust
agreement to manage or control the assets of the plan, other than a power under the
trust agreement to appoint an investment manager. ERISA § 405(c)(3), 29 U.S.C.
§ 1105(c)(3) (1994).
353. ERISA § 405(c)(1)(B), 29 U.S.C. § 1105(c)(l)(B) (1994).
354. ERISA § 402(c)(3), 29 U.S.C. § 1l02(c)(3) (1994). ERISA § 3(38), 29 U.S.C.
§ 1002(38) (1994) defmes an "investment manager" as any fiduciary (other than a trustee or named fiduciary) (A) who has the power to manage, acquire, or dispose of any
plan asset; (B) who is (i) a registered investment adviser under the Investment Advisers
Act of 1940; (ii) a bank; or (iii) an insurance company; and (CJ who has acknowledged
in writing that he is a fiduciary with respect to the plan.
355. ERISA § 402(b)(2), 29 U.S.C. § 1102(b(2) (1994).
356. ERISA § 3(38),29 U.S.C. § 1002(38) (1994).
357. ERISA § 405(c)(1)(A), 29 U.S.C. § 1105(c)(1)(A) (1994).
358. ERISA § 405(c)(2), 29 U.S.C. § 1105(c)(2) (1994), provides that the named fiduciary shall only be liable to the extent that:
(A) the named fiduciary violated § 404(aX1Hi) with respect to such allocation
or designation (ii) with respect to the establishment or implementation of the
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liable under the co-fiduciaryrules. 359 One attorney notes: "By allocating
and delegating, the fiduciary is essentially taking some of the responsibility off his or her shoulders. We emphasize some because it is very
important to remember that in its designation of other fiduciaries, the
primary fiduciary must adhere to the prudence standards ofERISA.''36O
3. Prudently Select and Monitor Experts
If a fiduciary "does not possess the education, experience and skill
required to make a decision concerning the investment of a plan's
assets, he has an affirmative duty to seek independent counsel in
making the decision.''361 The failure of an inexperienced fiduciary to
seek the advice of an expert is a violation of the prudence rule. 362
According to one court: "[A] pure heart and an empty head are not
enough.''363
In Martin v. Harline,364 the court held:
Corporate directors who appoint fiduciaries who are untutored
and inexperienced in the operations of an employee benefit plan and
the investment of its assets owe a special duty to the Plan to ensure
that the appointed fiduciary clearly understands his obligations,
that he has at his disposal the appropriate tools to perform his
duties with integrity and competence, and that he is appropriately
using those tools.365
One court has suggested that when selecting an investment
manager, fiduciaries should:
procedure under § 405(c)(l), or (iii) in continuing the allocation or designation;
or (B) the named fiduciary would otherwise be liable under ERISA § 405(a).
359. 29 U.S.C. § 1105(cX2)(B). For example, a violation will occur if the trustee
knew of a breach, or participated in, or concealed a breach. While trustees may, for the
most part, be relieved of liability by delegating investment duties to an investment
manager, an investment manager cannot escape liability by allocating or delegating his
authority. Also, trustees have a duty to monitor the investment advisor.
360. Jeffrey D. Mamorsky, Primer on Fiduciary Responsibility Under ERISA,
Address before the 1988 Annual Conference sponsored by the Int'l Found. of Employee
Benefit Plans, INTL FOUND. OF EMPLOYEE BENEFIT PLANS, EMPLOYEE BENEFIT
IsSUES-THE MULTIEMPLOYER PERSPECTIVE 43 (1989).
361. Katsaros v. Cody, 568 F. Supp. 360, 367 (E.D.N.Y. 1983), affd in pertinent
part, 744 F.2d 270 (2d Cir.), cert. denied sub nom., Cody v. Donovan, 469 U.S. 1072
(1984).
362. [d. See also Donovan v. Mazzola, 716 F.2d 1226, 1233-34 (9th Cir. 1983), cert.
denied, 464 U.S. 1040 (1984), in which the court held that the trustees violated the
prudence rule, by inter alia, retaining and relying on a consultant who they knew or
should have known lacked expertise to analyze the transaction. See Donovan v. Bierwirth, 680 F.2d 263, 272-73 (2d. Cir.), cert. denied, 459 U.S. 1069 (1982). See also Fink
v. Nat'! Savings & Trust Co., 772 F.2d 951 (D.C. Cir. 1985), in which the court stated
that "[a] fiduciary's independent investigation of the merits of a particular investment
is at the heart of the prudent person standard." [d. at 957.
363. Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983), cert. denied,
467 U.S. 1251 (1984).
364. 15 Employee Benefits Cas. (BNA) 1138 (D. Utah 1992).
365. [d. at 1149.
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1. Evaluate the person's qualifications including:
a. His experience in the particular area of investments under
consideration and with other ERISA plans.
b. His educational credentials.
c. Whether he is registered with the Securities and Exchange
Commission under the Investment Advisors Act of 1940.
d. An independent assessment of his qualifications by means of:
i. A widely enjoyed reputation in the business of
investments;
ii. Client references, and/or
iii. The advice of a professional third-party consultant.
e. His record of past performance with investments of the type
. contemplated.
2. Ascertain the reasonableness of fees.
3. Review documents reflecting the relationship to be entered into.
4. Ensure adequate, periodic accountings in the future. 366
Under ERISA, trustees are required to periodically monitor the
investment manager and other fiduciaries to ensure that they have
complied with the plan and ERISA. According to the legislative history
of ERISA:
In order to act prudently in retaining a person to whom duties
have been delegated, it is expected that the fiduciary will periodically review this person's performance. Depending upon the circumstances, this requirement may be satisfied by formal periodic review
(which may be by all the named fiduciaries who have participated
in the delegation or by a specially designated review committee), or
it may be met through day-to-day contact and evaluation, or in
another appropriate ways. Since effective review requires that a
person's services can be terminated, it may be necessary to enter
into arrangements which the fiduciary can promptly terminate
(within the limits of the circumstances).367
In Brock v. Berman,368 the district court for the District of Massachusetts held that a named fiduciary must adequately monitor the
performance of the investment manager. 369 The court ruled that trustees must carefully evaluate, investigate, and select the investment
manager. 370 The court further held that trustees are required to
prudently monitor and reevaluate the manager's performance and
measure the manager's performance against competing managers. 371
366. Whitfield v. Cohen, 682 F. Supp. 188,193 (S.D.N.Y. 1988).
367. H.R. REP. No. 1280, 93rd Cong., 2d Sess. (1975), reprinted in 1974
U.S.C.CAN. 5038, 5082.
368. 8 Employee Benefits Cas. (BNA) 1689 (D.C. Mass. 1987). See also Arakelian
v. National Western Life Ins. Co., 755 F. Supp. 1080, 1084 n.3 (D.C. Cir. 199m, summary
judgment granted in part, 755 F. Supp. 1086 (D.C. Cir. 1990).
369. [d.
370. [d.
371. 8 Employee Benefits Cas. (BNA) 1689 (D.C. Mass. 1987). The wisdom of
comparing investment managers is the subject of debate. When comparing the returns
of investment managers, trustees should take into account that performance as of any
given date will vary widely, because each investment manager has different investment
approaches.
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In Kuper v. Quantum Chemical Corporation,372 the court summarized the rules relating to liability for failure to adequately investigate:
"[L]iability should be imposed for failure to investigate only if an
adequate investigation would have revealed to a prudent fiduciary that
the investment at issue was improvident.''S73 Similarly, in Roth v.
Sawyer-Cleator Lumber Co.,374 the Eighth Circuit noted that "[e]ven if a
trustee failed to conduct an investigation before making a decision, he
is insulated from liability if a hypothetical prudent fiduciary would
have made the same decision anyway.''S75 Therefore, it is incumbent
upon the court to determine how a "'hypothetical, prudent fiduciary'
would have reacted if faced with the [same] circumstances."S76
One attorney describes a checklist trustees must go through:
First, they must prudently select an investment manager.
Second the named fiduciaries must give to the investment manager
selected prudent, meaningful guidelines or a policy statement for the
investment of the trust assets. Finally, on a regular and ongoing
basis, the named fiduciaries must prudently monitor the performance of their investment manager vis-a-vis their guidelines. Therefore, ERISA has given trustees an easy way to limit their liability
and responsibility in the area of their largest risk-investment of
assets. 377
Yet, the reliance on the advice of experts will not fully insulate a
fiduciary from liability.378 In Donovan v. Mazzola, the court stated that
"in evaluating an allegation of imprudence under ERISA, reliance on
counsel's advice is, at most, a single factor to be weighed in determining
whether a trustee has breached his or her duty."S79 Likewise, in Donovan v. Bierwirth, the court held that reliance on legal counsel, without
more, will not "operate as a complete whitewash.''SBO
372. 18 Employee Benefits Cas. (BNA) 1460 (S.D. Ohio 1994).
373. [d. at 1467 (citing Fink v. Nat1 Sav. & Trust Co., 772 F.2d 951,962 (D.C. Cir.
1985) (Scalia, J., concurring in part and dissenting in part) (noting that a fiduciary's
breach of duty to investigate and evaluate investments does not necessarily constitute
breach of the duty to invest prudently .... To hold otherwise would be to hold ERISA
fiduciaries who exercise less than absolute vigilance automatically accountable for every
market decline, even if the decline could not have been anticipated through the most
exacting scrutiny.) In Fink, Justice Scalia argued that where a fiduciary fails to
adequately investigate an investment, he is not liable for damages if he "happenedthrough prayer, astrology or just blind luck-to make objectively .... prudent investments." [d.
374. 16 F.3d 915 (8th Cir. 1994).
375. [d. at 919.
376. Kuper, 18 Employee Benefits Cas. (BNA) at 1468. For a more detailed analysis
of fiduciary liability, See SOLELY IN OUR INTEREST, supra note 6, chapter 6.
377. Marc Gertner, Fiduciary Liability and Responsibility: Prudently Limiting the
Risks, Address before the 1986 Annual Conference sponsored by the Int1 Found. of
Employee Benefits Plans (Nov. 1986), IN'r'L FOUND. OF EMPLOYEE BENEFIT PLANS,
EMPLOYEE BENEFITS ANNuAL 1986, at 12 (1987).
378. Martin v. Schwab, 15 Employee Benefits Cas. (BNA) 2135, 2145 (W.O. Mo.
1992).
379. 716 F.2d 1226, 1234 (9th Cir. 1983), cert. denied, 464 U.S. 1040 (1984).
380. 680 F.2d 263, 272 (2d Cir. 1982), cert. denied, 459 U.S. 1069 (1982).
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In Martin v. Schwab,381 the court noted that a "fiduciary's reliance
on professional advice must be reasonable."382 The court held that the
trustees' reliance on the advice of two lawyers who were not ERISA
experts "flies in the face of reason.''383 However, the court said that it
was not suggesting
that one must always defer legal matters to outside counsel. Rather,
fiduciaries must recognize when their own expertise falls short of
the task at hand .... [If the trustees] had the foresight to engage
outside legal advice on the matters .... they would not be in the
position they now find themselves. 384
4. Diligently Investigate the Proposed Transaction
Fiduciaries must exercise "due diligence." They must conduct an
intensive and scrupulous investigation of the proposed transaction. 385
Many lawsuits filed by the Department of Labor have involved inexperienced fiduciaries who were unable to evaluate a complex investment.
In Marshall v. Glass / Metal Association and Glaziers and Glass
Workers Pension Plan,386 the Department of Labor sued trustees for
making an imprudent loan. 387 The court reviewed the trustees' action in
order to determine if they had acted prudently: "[T]he job of the trustees .... is not to adopt the borrower's enthusiasm for his project, but
to evaluate the prospective risks and returns to the Plan."388 The court
held that the trustees failed to meet the procedural prudence requirements "[b]y committing Plan assets without adequate procedures and
evaluation of the risks involved and alternatives available.''3B9
The trustees defended their actions by arguing that they sincerely
believed that their actions were in the best interests of the Plan and
they should not be held to standards of institutional investors.a9o The
381. 15 Employee Benefits Cas. (BNA) 2135 (W.D. Mo. 1992).
382. [d. at 2145 (citing G. BOGERT, THE LAW OF TRUSTS AND TRUSTEES § 556 (Rev.
2d Ed. 1980)).
383. [d. at 2146.
384. [d. See also Roth v. Sawyer-Cleator Lumber Co., 17 Employee Benefits Cas.
(BNA) 2556, 2559 (8th Cir. 1994) (consultation with an attorney is "relevant but not
dispositive"); Morgan v. Independent Drivers Assoc. Pension Plan, 15 Employee Benefits
Cas. (BNA) 2515, 2518 (lOth Cir. 1992) (good faith reliance on the advice of experts is
not a defense); Dole v. Formica, 14 Employee Benefits Cas. (BNA) 1397, 1408 (N.D.
Ohio, 1991) (reliance on counsel is one factor to be considered); Reich v. Valley Nat'l
Bank of Arizona, 17 Employee Benefits Cas. (BNA) 1257, 1271-1273 (S.D.N.Y. 1993).
385. Trustees should be thorough in their due diligence. However, where the cost
of total due diligence would be disproportionate to the value of the investment, trustees
should weigh the protection afforded by due diligence against the cost to the plan. Obviously, more due diligence means that trustees have greater protection. However, trustees should not waste plan assets simply to protect themselves against attack by the
Department of Labor. The amount of due diligence required is a matter of judgment.
386. 507 F. Supp. 378 (D. Haw. 1980).
387. [d. at 379.
388. [d. at 384.
389. [d.
390. [d. In Toland v. McCarthy, the court stated that § 404(a)(1) requires fiduciaries "to take an initiative themselves to cause reasonably available evidence-that is,
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court rejected this defense, holding that "[w]hile there is flexibility in
the prudence standard, it is not a refuge for fiduciaries who are not
equipped to evaluate a complex investment.''391 When trustees make
complex investments, they will be held to the standard of professional
investors: "If fiduciaries commit a pension plan's assets to investments
which they do not fully understand, they will nonetheless be judged, as
provided in the statute, according to the standards of others 'acting in a
like capacity and familiar with such matters.' ''392 As another court said,
"Honest but imprudent trustees can dissipate the assets of a fund with
speed comparable to dishonest trustees.''393
In Donovan v. Mazzola,394 the Department challenged a $2.25
million loan made by a California Pipefitters pension fund. The loan
was extended by an unsecured loan of$650,OOO to a limited partnership
for real estate development. The court found that the trustees made the
loan without obtaining or reviewing basic documentation regarding the
project. The trustees neither sought nor examined the limited partnership's financial statements, the project plans or specifications, or an
accurate market study. Furthermore, once the loan was made, the trustees failed to monitor the way in which the funds were used. The court
evidence substantially bearing upon the plaintiffs claim and available through reasonable efforts to be developed and considered in the decision making process." 499 F. Supp.
1183, 1190 (D.C. Mass 1980).
391. Marshall v. GlasslMetal Ass'n and Glaziers and Glass Workers Pension Plan,
507 F. Supp. 378, 384 (D. Haw. 1980).
392. Id. See also Morton Klevan, Fiduciary Responsibility Under ERISA's Prudent
Man Rule: What Are the Guideposts?, J. TAX'N, 152 (Mar. 1976). "[T]he trustee will be
judged against a counterpart 'familiar with such matters.' Therefore, if the size and
nature of the plan would indicate the need for an experienced manager, the trustee
should not be heard to plead his lack of expertise after his investments go sour." Id. at
154.
The Department of Labor has been criticized for adopting a double standard which
depends on the size and nature of the plan. The Department has shrugged off such
criticism and provided examples:
If we take our apprenticeship fund with $40,000 per month going in and
approximately the same amount per month going out, the range of investments
will be quite limited-depending on the cash flow, much of the funds will be in
a checking account, some will be in demand deposits and perhaps some may
be able to put into some form of short term paper-perhaps a certificate of
deposit or Treasury note. The nature of the plan demands high liquidity and
absolute safety for the funds.
If the plan is a vacation pay plan, which accumulates funds during the
course of the year to pay it out once a year, the need is less to keep a large
percentage of the plan's assets in a checking account. This situation is made
to order for short-term investments. Again, the nature of the plan requires
absolute safety for the funds, inasmuch as the investment time frame is, at the
most, 12 months.
Id. (footnote omitted).
393. Brock v. Robbins, 830 F.2d 640, 647 (7th Cir. 1987).
394. 2 Employee Benefits Cas. (BNA) 2115 (N.D. Cal. 1981), affd, 716 F.2d 1226
(9th Cir. 1983), cert denied, 464 U.S. 1040 (984).
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held that the general inexperience of the trustees was not a defense to
their imprudent conduct.
In Donovan v. Walton,395 the district court for the Southern District
of Florida reiterated that the prudence rule only requires that
trustees vigorously and independently investigate the wisdom of a
contemplated investment; it matters not that the investment
succeeds or fails, as long as the investigation is "intensive and scrupulous and discharged with the greatest degree of care that could
be expected under all the circumstances by reasonable beneficiaries
and participants of the plan.'':l96
The court cautioned that "[o]ne must resist the knee-jerk reflex to
pronounce an investment prudent or imprudent based on the success of
the venture, for ERISA is concerned with the soundness of the decision
to invest.''397
This principle was applied in Whitfield v. Tomasso,39B when the
district court for the Eastern District of New York held that trustees
violated the prudence rule by investing plan assets in uninsured "certificates of deposit" issued by an insurance company.399 The court held
that the trustees should not have invested in these certificates of
deposit because "CDs are generally issued by banking institutions and
not insurance companies."400 The court criticized the trustees for their
lack of procedural prudence:
Had the Trustees caused an appropriate inquiry, they would
have discovered that [Leo] Bloom's name [the founder of the insurance company] was purposely omitted [from the prospectus] because
the laws of the Virgin Islands forbid a convicted felon from serving
as an officer or director of an insurance company .... Appropriate
investigation would have disclosed that Philip Bloom [president of
the insurance company] was an underwater welder by training and
education and had no insurance industry experience ....
The Trustees should have investigated the quality and credit
worthiness of Dome laborll1 zang zanggsurance Company]. In addition, the Trustees should have investigated why Dome was paying 1416% interest while traditional CD and Treasury Bills were paying
8-9% interest. Further, if the Trustees had checked Best's Insurance
Reports they would have discovered that Dome Insurance Company
was not rated. Certainly, they should have been alerted to that fact. 401
395. 609 F. Supp. 1221 (S.D. Fla. 1985), affd sub nom., Brock v. Walton, 794 F.2d
586 (11th Cir. 1986).
396. [d. at 1238 (footnote omitted) (quoting Leigh v. Engle, 727 F.2d 113, 124 (7th
Cir. 1984)).
397. [d. at 1242.
398. 682 F. Supp. 1287 (E.D.N.Y. 1988).
399. [d. at 1301.
400. [d. at 1295.
401. [d.
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The court held that the trustees violated the prudence rule by their failure to adequately investigate the proposed transaction. 402
Andrade v. Parsons Corp. describes the action of trustees who exercised procedural prudence.403 A class action was brought by participants
of an employee stock ownership plan in connection with a leveraged
buyout of the sponsor corporation.404 The district court for the Central
District of California ruled in favor of the defendant fiduciaries on all
three counts, noting that "plaintiffs did not merely fail to meet their
burden; the evidence they presented actually proved the defendants'
case."405 The court described the procedural prudence followed by the
fiduciaries:
Each [fiduciary] .... was informed repeatedly of his obligation
to act solely and exclusively on behalf of the ESOP participants. The
Retirement Committee members evaluated the LBO transaction
from the perspective of the ESOP participants, and hired independent legal and financial advisors to aid them in the evaluation. The
members determined that the ESOP participants would benefit
greatly from the transaction and felt that, in the words of the Chairman of the Retirement Committee, "We would be doing a disservice
to the plan participants if we walked away."406
In sum, the Retirement Committee evaluated the transaction
thoroughly on behalf of the ESOP participants. It retained independent and competent legal and financial advisors to render aid in
the decision-making process. It considered the potential short-term
disadvantages of the LBO, and implemented mechanisms such as
the prop price and the bargain sale to counteract any negative
results of the transaction. Most importantly, the members of the
Retirement Committee determined that the ESOP participants
would receive substantial long-term benefits from the transaction,
and felt it was their duty to go forward with the deal in light of these
benefits. 407
The court concluded that the Retirement Committee acted prudently
and that the committee members did not breach their fiduciary
duties. 408
Andrade v. Parsons Corp. is one of a small number of cases where a
court has ruled that trustees have exercised procedural prudence.
Unlike Andrade, most court rulings on the prudence rule are replete
with examples of how not to make an investment. The central theme of
402. Id.
403. 12 Employee Benefits Cas. (BNA) 1954 (C.D. Cal. 1990), affd, 1992 U.S. App.
LEXIS 18220 (9th Cir. July 31, 1992).
404. Id.
405. Id. at 1961.
406. Id.
407. Id. at 1964. See SoLELY IN OUR INTEREST, supra note 6, at Chapter 10 for an
extensive discussion of cases involving ESOPs.
408. Id.
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these cases is that trustees must follow "procedural prudence"-they
must carefully investigate all aspects of an investment before making a
decision to invest. Trustees who are not competent to analyze these
issues must hire experts who can prudently investigate the proposed
transaction. lt is the methodology used by the trustees and their advisors that is examined to determine the prudence of the investment, not
the success or failure of the investment.409 If the decision to invest is
prudent at the time it is made, the fiduciaries will not be liable even if
the investment subsequently fails.
Some commentators have criticized procedural prudence because it
"favors process over results."410 This is true. ERISA does not engage in
Monday morning quarterbacking: an investment is prudent if the decision to invest meets the procedural requirements of the prudence rule.
lt does not matter if the investment fails, so long as the decision to
invest was prudent at the time it was made.
This standard is appropriate. A standard that favors profit maximization over procedural prudence would run counter to the intent of
ERISA. Fiduciaries would tend to make risky investment simply to get
the highest rate of return. And when market conditions change, the
value of the portfolio could plummet. Additionally, although the
Department of Labor uses an "all things being equal" test, two investments never are really equal. Return and risk vary depending on the
investment and depending on the analyst valuing the investment.
The Department of Labor also endorses the whole portfolio
approach. 4l1 Investments are selected for their role within the entire
portfolio. Investments that are high risklhigh return are balanced by
low riskllow return investments. Yet the prudence ofeach investment is
analyzed separately. Gains made by one investment do not offset the
losses of another investment.412 The result incorporates an "investment
by investment approach"413 into a whole portfolio approach. Although
this rule was meant to be flexible, it has acted as a constraint on
409. In Roth v. Sawyer-Cleator Lumber Co., the Eighth Circuit stated that "the
prudent person standard is not concerned with results; rather, it is a test of how the
fiduciary acted viewed 'from the perspective of the "time of the [challenged] decision"
rather than from the "vantage point of hindsight." , " 17 Employee Benefits Cas. (BNA)
2556,2558 (8th Cir. 1994) (quoting Katsaros v. Cody, 744 F.2d 270, 279 (2d Cir.), cert.
denied, 469 U.S. 1072 (1984) (quoting American Communications Ass'n v. Retirement
Plan, 488 F. Supp. 479, 483 (S.D.N.Y. 1980), affd, 646 F.2d 559 (2d Cir. 1980».
410. Teresa Ghilarducci, U.S. Pension Investment Policy and Perfect Capital
Market Theory, CHALLENGE, July 1994, at 4.
411. The prudence regulations require the fiduciary to consider the particular
investment as well as the role the investment plays within the entire portfolio. 29 C.F.R.
§ 2550A04a-l (1994).
412. See Bank of New York, 35 N.Y.2d 512, 517 (1974).
413. See New York Hearings, supra note 85, at 194 (testimony of David Walker,
Assistant Secretary of Labor for Pension and Welfare Benefits Administration, U.S.
Dept. of Labor ("The way that it works under ERISA is it's an investment by investment
basis."».
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pension fund investments. Pension fund fiduciaries tend to be riskadverse. A 1986 survey of two hundred fiduciaries found that a "significant number of fiduciaries believe that the law precludes" them from
making investments that they would make if they were not governed by
ERISA.414 Perhaps these constraints will be lifted by the Department's
enthusiastic endorsement of investments such as venture capital and
by a more widespread understanding of the protection afforded by
procedural prudence.
5. Diversify Investments
It is impossible to defme diversification in numerical terms. 415 No
bright line test has been articulated by the courts. Each case is dependent on the facts and circumstances involved. However, a trend is emerging. Most recently, in Reich v. Rylands, the Department settled a case
in which the Department alleged that the trustees failed to diversify
plan assets by investing twenty-three percent of the plan's assets with
a Denver real estate investment frrm. 416 The Department alleged that
twenty-three percent of plan assets in one geographical location was too
high. 417 In Donovan v. Mazzola,418 the court applied the thirty-three
percent limitation utilized in institutional portfolio management. 419
Similarly, in Donovan v. Guaranty National Bank,420 the court interpreted ERISA's diversification rule as imposing a limitation of onethird of plan assets in one type of investment.421 In Brock v. Citizens
Bank of Clovis,422 the Department of Labor warned the trustees to
reduce the fund's real estate portfolio to thirty percent of plan assets. 423
When testifying as an expert witness in a stock diversification case,
former Department of Labor administrator, Jeffrey N. Clayton stated
that "a concentration of25% ofthe [plan] assets in one investment is the
maximum acceptable level so long as .... other stocks in the portfolio
are fully diversified."424
414. Bevis Longstreth, Tailoring Prudence: Using Circumstances, Not Absolutes to
Judge Fiduciaries, 125 TR. & EST. 14, 15 (Sept. 1986).
415. The legislative history of ERISA states that "[t]]he degree of investment
concentration that would violate this requirement to diversify cannot be stated as a
fIxed percentage, because a prudent fIduciary must consider the facts and circumstances
of each." CONF. REP., supra note 241, at 304, reprinted in 1974 U.S.C.CAN. 5038, 5084.
416. 1994 Daily Labor Rep. 38, at d30, Feb. 28, 1994.
417. [d.
418. 2 Employee BenefIts Cas. (BNA) 2115, 2126 (N.D. Cal. 1981), affd, 716 F.2d
1226 (9th Cir. 1983), cert. denied, 464 U.S. 1040 (1984).
419. [d.
420. 4 Employee BenefIts Cas. (BNA) 1686 (S.D. W.Va. 1983).
421. [d.
422. 841 F.2d 344 (10th Cir. 1988), cert. denied, 488 U.S. 829 (1988).
423. [d. at 345.
424. Jones v. O'Higgins, 11 Employee BenefIts Cas. (BNA) 1660, at 1666-67 (N.D.
N.Y. 1989).
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It is unlikely that the Department of Labor will specify a uniform
percentage at which non-diversification occurs. Diversification limits
must be established based on the facts and circumstances surrounding
each pension investment and the plan, and will depend, in part, on the
expertise of the trustees. Recently, a Departmental spokesperson
stated that diversification is based on a facts and circumstances test:
"There's no hard and fast rule on thiS."425
Based on court rulings and the Department of Labor's guidelines,
the percentage of plan assets which can be invested in anyone type of
investment or locale depends upon many factors such as the type of
investment, the geographic location, the levels of entry, the number of
investments, the return, and the plan documents. Each of these factors
will be discussed below.
GEOGRAPHIC LOCATION:
A large proportion of plan assets should not be invested in a small
geographic area, such as a county or region. 426 Although, in one unusual
case, the Department allowed the investment offifty-six percent of plan
assets in real estate investments in one state,427 it is unlikely that the
Department and courts would approve of such a high concentration of
plan assets under ordinary circumstances.
TYPES OF INVESTMENTS:
The types of investments must be diversified. Diversification into
asset categories, as well as diversification within asset categories
should be considered. For example, a diversified portfolio might allocate
forty percent of plan assets to stock. Additionally, the stock portfolio
will be diversified as to the industries represented by the stocks. If a
plan invests in real estate, the fiduciary should look at the amount of
plan assets allocated to real estate investments generally, as well as the
allocation within the category ofreal estate. "[I]n order to achieve diversification, pension plan portfolios should contain a variety of investment classes and, within each class, investments should again be
appropriately diversified to minimize the impact oflosses from anyone
investment decision."428 If the pension plan assets are managed by
several investment managers, each manager must diversify investments within his or her allocated portion of the plan's portfolio.429 Yet,
425. Reich v. Rylands, 1994 Daily Labor Rep. 38, at d30 (Feb. 28, 1994).
426. See Donovan v. Guar. Nat'! Bank, 4 Employee Benefits Cas. (BNA) 1686 (S.D.
W.Va. 1983); Brock v. Citizens Bank of Clovis, 841 F.2d 344 (1Oth Cir. 1988), cert. denied,
488 U.S. 829 (1988).
427. See Marshall v. Carr, Civ. Action No. A-81-017 Civ. (D. Ala., Jan. 19, 1981).
The consent order agreed to by the parties required reduction of plan holdings of Alaska
real estate to 56%.
428. Chadwick and Hass, DiversifICation of Pension Fund Real Estate Investments,
PENSION BRIEFINGS 2 (Federal Publications, Inc.), No. 86-6 (June 1986).
429. CoNF. REP., supra note 241, at 305, reprinted in 1974 U.S.C.CAN. 5038, 5085.
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diversification is measured based on all plan assets, not merely the
assets of particular subaccounts.430 For example, a diversified portfolio
might include stocks, bonds, certificates of deposits, treasury bills,
pooled real estate funds, mortgages, and commercial loans. A diversified real estate portfolio might include direct equity investments, mortgages, construction loans, and pooled real estate funds. Investments
should also be diversified as to class: i.e., hotels, office buildings, shopping centers, commercial and industrial parts, and residential property.
LEVELS OF ENTRY:
Investments should be staggered to ensure a maximum return to
the plan and to provide sufficient liquidity. For example, certificates of
deposit and treasury bills should be purchased so that they mature on
staggered dates. 431 Similarly, leases should expire on various dates in
order to avoid the risk of simultaneous loss of many tenants. In GIW
Industries, Inc. v. Trevor, Stewart, Burton & Jacobsen, Inc.,432 the court
held that the trustees violated ERISA by investing seventy percent of
the plan's assets in government bonds with a single maturity date and
fifteen percent in zero coupon bonds with a different maturity date,
since these investments would expose the plan to large risks if the fund
was required to liquidate investments. 433
NUMBER OF INVESTMENTS:
The number of investments is directly related to diversification. A
plan which maintains a large number and variety of investments is
likely to be considered to be diversified by a court. Generally, all plan
assets should not be allocated to one investment.
RETURN CHARACTERISTICS:
Because pension funds are tax-exempt investors,434 trustees generally focus on total return which includes cash flow and appreciation.
Investments should be diversified among properties with different cash
flow and appreciation characteristics.
WRITTEN GUIDELINES:
Trustees should develop and adhere to written investment policy
statements. Even an inadvertent violation of a maximum percentage in
a policy statement may be held to violate the plan document rule. 435 For
example, in Reich v. Rylands,436 the Department alleged that plan trus430. Sandoval v. Simmons, 622 F. Supp. 1174, 1211 (C.D. fil. 1985).
431. See Whitfield v. Tomasso, 682 F. Supp. 1287 (E.D. N.Y. 1988).
432. 10 Employee Benefits Cas. (BNA) 2290 (S.D. Ga. 1989), affd, 895 F.2d 729
(llth Cir. 1990).
cb433. Id.
434. Under certain circumstances, the plan may be subject to unrelated business
income tax.
435. 29 U.S.C. § 1104(a)(1)(D) (1994).
436. Supra note 416.
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tees failed to monitor and enforce an investment management agreement in violation of ERISA.437 In several cases, trustees have violated
the plan document rule by exceeding maximum allocations set forth in
plan documents. 438
6. Compile a Thorough Paper Trail
Closely related to the duty to act prudently is the obligation to
maintain records which will support the trustees' action in the event of
a challenge by the Department of Labor. Trustees and fund professionals should carefully record the decisions of the trustees in the minutes
and include a detailed description of the facts upon which the trustees
based their decision.
All aspects of the proposed transaction should be thoroughly
discussed with the Fund's advisors and experts. The trustees should
carefully consider all of the risks involved and alternatives available.
The minutes of the trust fund meeting relating to a decision to make an
investment should include a detailed description of: (1) the investment; (2) the anticipated rate of return; (3) the risk involved; (4) the
liquidity needs of the fund and the liquidity of the investment; (5) the
role the investment will play within the portfolio; (6) the effect of the
investment on diversification; (7) the funding needs of the plan; (8) the
advice of investment advisors, consultants, and attorneys; (9) any
potential prohibited transactions; (10) the duration or maturity of the
investment; and, (11) other investments considered by the trustees.
The Department of Labor has suggested:
[TJrustees should take great care to document adequately all meetings where actions are taken with respect to management and
control of plan assets. Written minutes of all actions should be kept
describing the action taken, and stating how each trustee voted on
each matter. If trustees object to a proposed action on the grounds
of possible violation of the fiduciary responsibility provisions of the
Act, the trustees so objecting should insist that their objections and
the responses to such objections be included in the record of the
meeting. It should be noted that, where a trustee believes that a cotrustee has already committed a breach, resignation by the trustee
as a protest against such breach will not generally be considered
sufficient to discharge the trustee's positive duty under section
405(a)(3) to make reasonable efforts under the circumstances to
remedy the breach. 439
437.Id.
cb438. See e.g., Dardaganis v. Grace Capital Inc., 664 F. Supp. 105,107 (S.D.N.Y.
1987); Marshall v. Teamsters Local 282 Pension Trust Fund, 458 F. Supp. 986, 991
(E.D.N.Y. 1978).
cb439. "Questions and Answers Relating to Fiduciary Responsibility," ERISA I.B.
75-5, § 2509. 75-5(FR-10) (1975). The question raised was:
An employee benefit plan is considering the construction of a building to
house the administration of the plan. One trustee has proposed that the building be constructed on a cost plus basis by a particular contractor without
competitive bidding. When the trustee was questioned by another trustee as to
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Certain types of investments, such as real estate, require further
analysis. For example, when the Operating Engineers Local 675
Pension Fund in South Florida purchased unimproved land and
constructed an office building on the property to house the fund and
union offices, the trustees carefully documented all oftheir actions. The
trustees:
(a) appointed a building and planning committee to evaluate the
fund's investment program; (b) performed deliberate research and
analysis with the assistance of retained independent consultants
before deciding to invest in real estate; (c) obtained independent
studies which revealed that the rental market for and the potential
capital return on the project were very promising; (d) continually
sought the advice of their attorneys; (e) employed professional engineers to undertake core borings; (0 obtained two expert appraisals
before purchasing the property; (g) engaged in competitive bidding
activities before contracting with the architect and contractor; (h)
obtained an independent review of the project's economic viability,
an expert feasibility study and an evaluation of these studies; (i)
retained an independent real estate investment manager to negotiate the union's lease with the fund; (j) met frequently with their
consultants; and (k) when the project appeared over budget,
eliminated certain aspects or demanded new, cheaper designs.440
All of these actions were carefully recorded in the trustees' minutes.
The Department of Labor sued the Florida Operating Engineers
Pension Fund with respect to this investment. However, based on the
trustees' well-documented actions, the court held that the trustees did
not breach their fiduciary duties. 441 One commentator reflected on the
court's decision: "What can we learn from the .... [court's] opinion
about the trustees' successful defense of their actions?,,442 The answer
was:
There is no substitute for the fiduciary exercising informed and
reasoned judgment in addition to his corresponding documentation
of the decision-making process. He must pursue each alternative
the basis of choice of the contractor, the impact of the building on the plan's
administrative costs, whether a cost plus contract would yield a better price to
the plan than a fixed price basis, and why a negotiated contract would be better
than letting the contract for competitive bidding, no satisfactory answers were
provided. Several of the trustees have argued that letting such a contract would
be in violation of their general fiduciary responsibilities. Despite their arguments, a majority of the trustees appear to be ready to vote to construct the
building as proposed. What should the minority trustees do to protect themselves from liability under section 409(a) of the Act and section 409(b)(1)(A) of
the Act?
ERISA LB. 75-5, § 2509.75-5(FR-10) (1975).
440. Eugene Burroughs, Donovan v. Walton Opinion Provides Guidelines for Fiduciaries, PEN. WORLD, Oct. 1985, at 58-59.
441. Donovan v. Walton, 609 F. Supp. 1221 (S.D. Fla. 1985), affd sub nom., Brock
v. Walton, 794 F.2d 586 (11th Cir. 1986).
442. Burroughs, Donovan v. Walton Opinion Provides Guidelines for Fiduciaries,
supra note 440, at 58.
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until he gets to the heart of the matter, examining all the facts which
are available to him prior to making the decision. In addition to
performing resourceful due diligence, there appears to be unanimous
agreement among legal counselors of the necessity for the preparation of resourceful documentation on the part of all fiduciaries. 443
One of the best insurance policies trustees have against a challenge
by the Department of Labor is a thorough paper trail which clearly
shows the due diligence undertaken by the trustees and their advisors.
Fiduciaries should retain as much expert assistance as they need, and
must carefully research and evaluate all aspects ofthe proposed transaction and record this analysis in the minutes.
7. Act for the Exclusive Benefit of Plan Participants and
Beneficiaries
First and foremost, the fiduciary must apply the "all things being
equal test": do not accept a below market rate of return. Trustees
should consider whether the proposed investment meets ERISA's fiduciary standards. If not, the proposal should be rejected regardless of
political pressure. If the proposed investment meets the "all things
being equal test" and also produces collateral benefits such as job creation or affordable housing, the trustees may consider the investment.
ERISA requires fiduciaries to act exclusively in the interests of plan
participants and beneficiaries "with an eye single" to their interests. 444
8. Avoid Conflicts of Interest
ERISA section 406(b) prohibits a fiduciary from:
dealing with the assets of the plan in his own interest or for his
own account,
(2) in his individual or any other capacity act[ing] in any transaction
involving the plan on behalf of a party (or represent[ing] a party)
whose interests are adverse to the interests of the plan or the
interests of its participants or beneficiaries, or
(3) receiv[ing] any consideration for his own personal account from
any party dealing with such plan in connection with a transaction involving the assets of the plan. 445
(1)
No regulations have been issued under section 406(b), but regulations promulgated under section 408(b)(2) provide guidance. According
to these regulations, ERISA section 406 imposes on parties in interest
who are fiduciaries a duty of undivided loyalty to the plans for which
they act. These prohibitions are imposed upon fiduciaries to deter them
from exercising their authority, control or responsibility as fiduciaries
when they have interests which may conflict with the interests of the
plan. 446 Under these circumstances, the fiduciary has an interest in the
443. [d. at 60.
444. Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982), cert. denied, 459 U.S.
1069 (1982).
445. ERISA § 406(b)(1)-(3), 29 U.S.C. § 1l06(b)(l)-(3) (1994).
446. Statutory Exemption for Services or Office Space, 29 C.F.R. § 2550A08b2(e)(1) (1990).
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transaction which may affect the exercise of her best judgment as a
fiduciary. Thus. the fiduciary may not use the authority. control or
responsibility which makes her a fiduciary to cause a plan to pay an
additional service fee to her or to a person in whom the fiduciary has an
interest which may affect the exercise of the fiduciary's judgment.447
Furthermore. a fiduciary may not use such authority. control or responsibility to cause a plan to enter into a transaction involving plan assets
through which such fiduciary or interested person will receive consideration from a third party in connection with such transaction. 448
A fiduciary will not violate section 406(b)( 1) if she does not use any
of her authority. control or responsibility to cause the plan to pay additional fees for a service furnished by her or the interested person. Thus.
where one fiduciary retains another fiduciary to provide services for an
additional fee. no violation will occur if no authority. control or responsibility is exercised.449 Where the fiduciary provides services to the plan
without compensation other than reimbursement ofexpenses. no violation will occur.450
These conflict of interest prohibitions were designed to keep "a
fiduciary from being put in a position where he has dual loyalties. and
[which]. therefore. [prevent him from acting] exclusively for the benefit
of a plan's participants and beneficiaries."451 In Donovan v. Daugherty.452 the court stated that ERISA section 406(b) is "specifically
directed at the problem of fiduciary self-dealing and absolutely prohibits a fiduciary from acting in a conflict of interest situation where his
loyalties to the plan may be compromised or divided."453 In Leigh v.
Engle,454 the court held that section 406(b)(l) "should be read broadly in
light of Congress' concern with the welfare of plan beneficiaries. We
read those provisions dealing with the use of plan assets for the benefit
of 'parties in interest' and plan fiduciaries as 'a gloss on the duty of
loyalty required by [ERISA] section 404....455 A fiduciary must act "with
an eye single to the interests of the participants and beneficiaries"456
and cannot serve dualloyalties. 457
447. [d.
448. [d.
449. [d. at (e)(2).
450. [d. at (e)(3). See also Advisory Opinion 81·90A (Mar. 25, 1981).
451. H.R. REP. No. 1280, 93rd Cong., 2d Sess. 309 (1974), reprinted in 1974
U.S.C.CAN. 5038, 5089.
452. 550 F. Supp. 390 (S.D. Ala. 1982).
453. [d. at 403.
454. 727 F.2d 113 (7th Cir. 1984).
455. [d. at 126.
456. Donovan v. Bierwirth, 538 F. Supp. 463 (E.D.N.Y. 1981), modified, 680 F.2d
263 (2d Cir. 1982), cert. denied, 459 U.S. 1069 (1982).
457. CoNF. REP. supra note 452, at 309. See also NLRB v. Amax Coal, 453 U.S.
322 (1981).
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The duty ofloyalty under ERISA is based on common law. According to a leading authority on trusts,
[r]easons behind the establishment of the loyalty rule by equity are
that it is generally, if not always, humanly impossible for the same
person to act fairly in two capacities and on behalf of two interests
in the same transaction. Consciously or unconsciously he will favor
one side as against the other, where there is or may be a conflict of
interest. If one of the interests involved is that of the trustee personally, selfishness is apt to lead him to give himself an advantage. If
permitted to represent antagonistic interests the trustee is placed
under temptation and is apt in many cases to yield to the natural
prompting to give himself the benefit of all doubts. 458
One court explained that "this rule against divided loyalties is
designed '[t]o deter the trustee from all temptation and to prevent any
possible injury to the beneficiary' and 'must be enforced with uncompromising rigidity.' "459
Not only is it unlawful for a fiduciary to become directly involved in
a transaction from which he might personally benefit, but he also must
not allow "himself to be placed in a position where his personal interest
might conflict with the interest of the beneficiary."460 In Fulton
National Bank v. Tate,461 the Fifth Circuit explained:
[T]he beneficiary need only show that the fiduciary allowed himself
to be placed in a position where his personal interest might conflict
with the interest of the beneficiary. It is unnecessary to show that
the fiduciary succumbed to this temptation, that he acted in bad
faith, that he gained an advantage, fair or unfair, that the beneficiary was harmed.
. . . . [The] sole purpose and effect [of the rule] is prophylactic: the
fiduciary is punished for allowing himself to be placed in a position
of conflicting interests in order to discourage such conduct in the
future.'62
In Leigh v. Engle,463 the Seventh Circuit provided guidance for
trustees who are faced with serious conflicts of interest. The court
recommended that "[w]here it might be possible to question the fiduciaries' loyalty, they are obliged at a minimum to engage in an intensive
and scrupulous independent investigation of their options to insure
that they act in the best interests of the plan beneficiaries."464 The court
further cautioned that "[w]here the potential for conflicts is substan458. G. BOGERT, TRUSTS AND TRUSTEES § 543, at 475·76 (2d ed. 1960).
459. Brock v. Ardito, 8 Employee Benefits Cas. (BNA) 2303, 2307 (E.D.N.Y. 1987)
(citing NLRB v. Amax Coal Co., 453 U.S. 322,329-330 (1981».
460. Fulton Nat'l Bank v. Tate, 363 F.2d 562, 571 (5th Cir. 1966).
461. 363 F.2d 562.
462. [d. at 571-72.
463. 727 F.2d 113 (7th Cir. 1984), cert. denied sub nom., Estate of Johnson v. Engle,
489 U.S. 1078 (1989).
464. [d. at 125-26. (citations omitted).
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tial, .... the fiduciaries may need to step aside, at least temporarily,
from the management of assets."465 Similarly, in Lowen v. Tower Asset
Management, Inc.,466 the Second Circuit noted that section 406(b) "gives
notice to fiduciaries that they must either avoid the transactions
described in section 406(b) or cease serving in their capacity as fiduciaries, no matter how sincerely they may believe that such transactions
will benefit the plan."467
In Schwartz v. Interfaith Medical Center,46B the court scrutinized
the conduct of an employer who sponsored a self-administered medical
plan and, when faced with financial problems, failed to make claim
payments. The court noted that the corporate officers
cannot both satisfy their duty to keep the Hospital afloat and
perform their fiduciary responsibilities to the plan participants with
the single-mindedness mandated by §404. The Hospital does not
have enough cash to meet its current obligations. Its officers have
no choice but to defer payments to as many creditors as possible. It
is too much to expect of mere mortals that they will be able to reconcile that need with their duty under ERISA to act solely for the
benefit of plan participants. ERISA therefore requires the appointment of someone above the fray who is not charged simultaneously
with the irreconcilable responsibility of keeping the Hospital out of
hock. 469
InAvakelian v. National Western Life Ins. Co. ,470 the court held that
National Western, the sponsor of a master pension plan, violated
ERISA section 406(b) when it engaged in a transaction involving the
Plan in which National Western had interests which were irreconcilable with the interests of the Plan:
National Western's interest in the transaction involving the
Plan's purchase of group annuity contracts was to maximize
National Western's profits by paying the lowest permissible return
on the Plan's investment and by charging the maximum permissible
surrender charge, while the beneficiaries' interest in the transaction
was to maximize the sum of their investment by receiving the highest permissible rate of return and by minimizing-Qr eliminatingany surrender charges. National Western, therefore, violated
§ [406(b)].471
In Sandoval v. Simmons,472 the court noted with respect to section
406(b)(2), "[t]he term 'adverse' does not require that the interests be
465.
466.
467.
468.
469.
470.
471.
472.
[d. at 125.
829 F.2d 1209 (2d Cir. 1987).
[d. at 1213.
715 F. Supp. 1190 (E.D. N.Y. 1989).
[d. at 1196.
680 F. Supp. 400 (D.C. Cir. 1987).
[d. at 407.
622 F. Supp. 1174 (C.D. ill. 1985).
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antithetical, but only that they are different."473 In Davidson v. COOk,474
the court recognized that "[b]orrowers and lenders constitute a paradigm instance of parties whose interests are adverse. 'Fiduciaries
acting on both sides of a loan transaction cannot negotiate the best
terms for either [party].' "475
In Marshall v. Davis,476 the court held that "there is a per se adverse
transaction involved when .... trustees attempt to 'balance the interests' involved"477 by deducting union dues from contributions paid to the
funds on a monthly basis where benefits are paid to the plan participants on an annual basis. The court noted that
Section 406(b)(2) speaks of the interests of the Plan or beneficiaries not "some" or "many" or "most" of the participants. While the
trustees may have operated with the best of intentions to accommodate all the parties involved, provision for the monthly distribution of Plan assets to the Union dilutes the economic viability of the
Holiday and Vacation Fund. Until the funds are available to the
participants, the trustees may not disburse Plan assets to a party
in interest. 478
Trustees must take care to avoid being placed in a position where
they are required to act on both sides of a transaction.
9. Avoid Transactions with Parties in Interest
ERISA section 406(a) prohibits fiduciaries from causing the plan to
engage in a direct or indirect:
(A) sale or exchange, or leasing, of any property between the plan
and a party in interest;479
(B) lending of money or other extension of credit between the plan
and a party in interest;480
(C) furnishing of goods, services, or facilities between the plan and
a party in interest;481
473. [d. at 1213.
474. 567 F. Supp. 225 (E.D. Va. 1983), affd sub nom., Accardi v. McGuire, Woods,
and Battle, 734 F.2d 10 (4th Cir. 1984), cert denied sub nom., Accardi v. Davidson, 469
U.S. 899 (1984).
475. [d. at 237 (citing Cutaiar v. Marshall, 590 F.2d 523, 530 (3d Cir. 1979».
476. 517 F. Supp. 551 (W.D. Mich. 1981).
477. [d. at 553.
478. [d. at 554.
479. In Eaves v. Penn, the court held that a purchase of employer stock from a
party in interest violated ERISA § 406(aXIXA). 587 F.2d 453 (10th Cir. 1978). See also
Donovan v. Cunningham, 541 F. Supp. 276 (S.D. Tex. 1982), affd in part, rev'd in part,
and vac'd in part, 716 F.2d 1455 (5th Cir. 1983), cert. denied, 467 UB. 1251 (1984).
480. Brock v. Citizens Bank of Clovis, 841 F.2d 344 (1Oth Cir. 1988), cert. denied,
488 U.S. 829 (1988); Zanditon v. Feinstein, 7 Employee Benefits Cas. (BNA) 1896 (D.
Mass. 1986), affd in part, rev'd in part, 849 F.2d 692 (1st Cir. 1988); Donovan v. Bryans,
566 F. Supp. 1258 (E.D. Pa. 1983); Donovan v. Campbell, 4 Employee Benefits Cas.
(BNA) 1732 (W.D. Ky. 1983); M & R Inv. Co. v. Fitzsimmons, 685 F.2d 283 (9th Cir.
1982); Freund v. Marshall & Usley Bank, 485 F. Supp. 629 (W.D. Wis. 1979); Marshall
v. Kelly, 465 F. Supp. 341 (W.D. Okla. 1978).
481. Kim v. Fujikawa, 871 F.2d 1427 (9th Cir. 1989); Gilliam v. Edwards, 492 F.
Supp. 1255 (D.N.J. 1980); Marshall v. Snyder, 572 F.2d 894 (2d Cir. 1978).
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CD) transfer to, or use by or for the benefit of, a party in interest, of
any assets of the plan;482
(E) acquisition, on behalf of the plan, of any employer security or
employer real property in violation of section 407(a).483
These prohibited transaction rules are "absolute, structural
constraints"484-the good faith of the trustee and the reasonableness or
fairness of the transaction are irrelevant.485 In Ziegler v. Connecticut
General Life Ins. CO.,486 the Ninth Circuit noted that "plaintiffs need not
allege actual injuries to prosecute certain ERISA violations. Congress
intended to make fiduciaries culpable for certain ERISA violations even
in the absence of actual injury to a plan or participant."487 ERISA
creates a per se prohibition against certain transactions with parties in
interest.
ERISA prohibits a plan from entering into the transactions
described above with a "party in interest." Under ERISA section 3(14),
party in interest includes fiduciaries (such as administrators, trustees,
custodians and officers),488 counsel,489 plan eml?loyees,490 service providers,491 contributing employers and the employer association,492 the
union,493 or a fifty percent owner (direct or indirect) of a contributing
482. Pension Benefit Guar. Corp. v. Fletcher, 750 F. Supp. 233 (M.D. Tex. 1990);
Leigh v. Engle, 727 F.2d 113 (7th Cir. 1984), cert. denied sub nom., Estate of Johnson
v. Engle, 489 U.S. 1078 (1989); Whitfield v. Tomasso, 682 F. Supp. 1287 (E.D.N.Y. 1988);
James A. Dooley Assoc. Employees Ret. Plan v. Reynolds, 654 F. Supp. 457 (E.D. Mo.
1987); Brock v. Ardito, 8 Employee Benefits Cas. (BNA) 2303 (E.D.N.Y. 1987); Sandoval
v. Simmons, 622 F. Supp. 1174 (C.D. lli. 1985); Marshall v. Mercer, 4 Employee Benefits
Cas. (BNA) 1523 (N.D. Tex. 1983), rev'd on other grounds, 747 F.2d 304 (5th Cir. 1984);
Marshall v. Cuevas, 1 Employee Benefits Cas. (BNA) 1580 (D.P.R. 1979); Marshall v.
Kelly, 465 F. Supp. 341 (W.D. Okla. 1978).
483. 29 U.S.C. § 1l06(a)(I)(A)-(E).
484. Marc Gertner, Legal Considerations of Employment-Generating Investments
at 92, Address at the Investment Inst., Las Vegas, Nev., sponsored by the Int'l Found.
of Employee Benefit Plans (March 29, 1989). ERISA § 406 "per se prohibits certain
transactions, whether or not the transactions actually lead to unfair self-dealing." Arakelian v. National Western Life Ins. Co., 680 F. Supp. 400, 407 (D.C. Cir. 1987). See also
McDougall v. Donovan, 552 F. Supp. 1206 (N.D. lli. 1982); Gilliam v. Edwards, 492 F.
Supp. 1255 (D.N.J. 1980).
485. Cutaiar v. Marshall, 590 F.2d 523, 530 (3d Cir. 1979). In Rutland v. Commissioner, 89 T.C. 1137 (1987), the U.S. Tax Court held that:
The language and legislative history of ERISA indicate a congressional
intention to create, in Section 4975(c)(l), a blanket prohibition against certain
transactions, regardless of whether the transaction was entered into prudently
or in good faith or whether the plan benefited as a result. "Good intentions and
a pure heart are no defense" to liability under section 4975(a). Leib v. Commissioner, 88 T.C. 1474,1481 (1987).
ld. at 1146.
486. 916 F.2d 548 (9th Cir. 1990).
487. ld. at 551.
488. 29 U.S.C. § 1002(14)(A).
489. ld.
490. ld.
491. 29 U.S.C. § 1002(14)(B).
492. 29 U.S.C. § 1002(14)(C).
493. 29 U.S.C. § 1002(14)(D).
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employer or the union. 494 The term "party in interest" also includes the
spouse and certain other relatives495 of a fiduciary, counsel, plan
employee, service provider, or contributing employer. 496 ERISA defines
"party in interest" to include several other persons. 497
A fiduciary is forbidden from entering into any transaction which
he knows or should know involves a party in interest. 498 A trustee is
required to scrutinize proposed transactions to determine whether a
party in interest is involved in the transaction. 499 Actual knowledge
need not be shown in order to prove a violation of the prohibited trans494. 29 U.S.C. § 1002(14)(E). This section defmes a party in interest as an owner
of 50% or more of:
(i) the combined voting power of all classes of stock entitled to vote or the
total value of shares of all classes of stock or a corporation,
(ii) the capital interest or the profits interest of a partnership, or
(iii) the beneficial interest of a trust or unincorporated enterprise which is an
employer or employee organization.
495. A "relative" is a spouse, ancestor, lineal descendant, or spouse of a lineal
descendant. 29 U.S.C. § 1002(15).
496. 29 U.S.C. § 1002(14)(F).
497. The defmition of party in interest also includes a corporation, partnership,
trust or estate of which 50% or more of the:
(i) combined voting power of all classes of stock entitled to vote or the total
value of shares of all classes of stock of such corporation,
(ii) the capital interest or profits interest of such partnership, or
(iii) the beneficial interest of such trust or estate, is owned directly or indirectly, or held by a fiduciary, counsel, plan employee, service provider,
contributing employer, union or 50% owner of a contributing employer or
the union.
29 U.S.C. § 1002(14)(G).
A party in interest also includes "an employee, officer, director (or an individual
having powers or responsibilities similar to those of officers or directors), or a 10 percent
or more shareholder directly or indirectly, of" a service provider, contributing employer,
the union, a 50% owner of a contributing employer or the union, or a corporation or
other entity of which 50% is owned by certain parties in interest. 29 U.S.C.
§ 1002(14)(H). Finally, "a 10 percent or more (directly or indirectly in capital or profits)
partner or joint venturer" of certain parties in interest is also a party in interest. 29
U.S.C. § 1002(14)(1). Note that two or more multiemployer plans are not parties in
interest with respect to each other merely because they are maintained by the same
plan sponsor. However, they may be parties in interest for other reasons, for example,
if one plan provides services to the other. Prohibited Transaction Exemption C 76-l.
498. Marshall v. Kelly, 465 F. Supp. 341, 351 (W.D. Okla. 1978). See also Donovan
v. Schmoutey, 592 F. Supp. 1361, 1392 (D. Nev. 1984); Marshall v. Mercer, 4 Employee
Benefits Cas. (BNA) 1523 (N.D. Tex. 1983), rev'd on other grounds, 747 F.2d 304 (5th
Cir. 1984); Freund v. Marshall & Osley Bank, 485 F. Supp. 629, 637 (W.D. Wis. 1979).
499. The ERISA Conference Report states that:
Under the labor provisions a fiduciary will be liable for losses to a plan
from a prohibited transaction in which he is engaged if he would have known
the transaction involving the particular party-in-interest was prohibited if he
had acted as a prudent man. The type of investigation that will be needed to
satisfy the test of prudence will depend upon the particular facts and circumstances of the case. In the case of a significant transaction, generally for a
fiduciary to be prudent he must make a thorough investigation of the other
party's relationship to the plan to determine if he is party-in-interest. In the
case of a normal and insubstantial day-to-day transaction, it may be sufficient
to check the identity of the other party against a roster of parties-in-interest
that is periodically updated.
BNA, ERISA SELECTED LEGISLATIVE HISTORY, 1974-1985, at 43 (1986).
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action rules if the fiduciary should have known of the forbidden relationship.5°O In Marshall v. Mercer,50l the court observed that where "a
fiduciary is intimately involved with the operations of the party in
interest, he will be presumed to have knowledge of prohibited
transactions. "502
Some courts have held that a transaction remains prohibited even
after the party in interest relationship has been severed. In M & R
Investment Co. v. Fitzsimmons/,(J3 the court held that a loan was a
prohibited transaction because, at the time the loan commitment was
made, the borrower was a party in interest. The status and legal relationships are frozen as of the date of the transaction. One court held
that "[i]n overview, the purpose of ERISA would not be served by allowing an otherwise disqualified person to avoid liability by merely changing his legal status after he has engaged in the prohibited
transaction."504 After the party in interest relationship terminates, the
transaction is still prohibited. In Brock v. Gerace,505 a district court held
that the Department of Labor stated a legal cause of action when it
alleged that a renewal of a contract with a service provider, which was
a party in interest solely because it provided services to the plan, was a
prohibited transaction unless it was covered by an exemption. This
tortured interpretation of the rule would preclude a plan from renewing
contracts with service providers,506 or from using the same service
provider twice, unless the transaction falls within an exemption. 507
Numerous prohibited transaction exemptions exist. It is outside
the scope of this article to describe the statutory and class exemptions. 508 However, if a prohibited transaction cannot be avoided, the
trustees should determine whether the transaction is exempt under
existing exemptions or whether the trustees should apply for an individual prohibited transaction exemption. The Internal Revenue Service
500. ld. See Dimond v. Retirement Plan, 4 Employee Benefits Cas. (BNA) 1457
(W.D. Pa. 1983).
501. 4 Employee Benefits Cas. (BNA) 1523 (N.D. Tex. 1983), rev'd on other grounds,
747 F.2d 304 (5th Cir. 1984).
502. ld. at 1533 (citing Marshall v. Carroll, 2 Employee Benefits Cas. (BNA) 2491
(N.D. Cal. 1980)).
503. 685 F.2d 283 (9th Cir. 1982).
504. Rutland v. Commissioner, 89 T.C. 1137,1145,9 Employee Benefits Cas. (BNA)
1147, 1153 (1987).
505. 7 Employee Benefits Cas. (BNA) 1713 (D.N.J. 1986).
506. In Brock v. Gerace, the court recognized that its decision may result in "unrealistic and uneconomic consequences" but stated that the remedy for such result "lies
with Congress, not with this court." 7 Employee Benefits Cas. (BNA) 1713, 1716. See
Kroll & Tauber, Fiduciary Responsibility and Prohibited Transactions Under ERISA,
14 REAL PROP., PROB. & TR. J. 657, 672-74 (1979) for discussion of multiple services.
507. Certain providers such as attorneys and accountants fall within the exemption
afforded by ERISA § 408(b)(2).
508. See SoLELY IN OUR INTEREST, supra note 6, at Chapter 8 for a detailed description of exemptions.
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imposes a tax on prohibited transactions with pension funds and the
Department imposes a similar tax for transactions with welfare funds
and so it is best to avoid prohibited transactions or apply for an
exemption. 509
E. Conclusion
Most ETI programs that have suffered bad publicity failed to meet
procedural prudence. Most often, trustees succumb to political pressure
and make imprudent economically targeted investments. This happens
when trustees or States focus on what is in their self-interest: How can
we encourage business development in our State? How can we protect
our participants from losing their jobs when ABC Corporation decides
to shut down? How can we increase affordable housing for our plan
participants? These questions invite problems.
By taking a broader focus, trustees can avoid falling prey to political pressure. ETIs programs should stimulate economic growth
throughout the United States, not necessarily stimulate growth in the
plan's backyard. Pooled ETIs not only offer diversification and liquidity,
but also allow trustees to invest in ETIs that are independent of their
self-interest. For example, a plan that wishes to loan money to a startup business could reduce its potential liability by proposing the
investment to a venture capital firm who would independently investigate the transaction without regard to political interests. Most objections to ETIs are related to the problem of self-interest.
In light of the Department's renewed interest in economically
targeted investments, and hopefully, with the guidance of the ETI
Clearinghouse, more fiduciaries should feel comfortable investing in
economically targeted investments, especially through national pools.
By following the above steps to procedural prudence, fiduciaries can
implement a prudent ETI program that complies with ERISA.510
Part II. Institutional Shareholder Activism and
High Performance Investing
A. Introduction
Institutional shareholder activism and high performance investments are essentially a form ofeconomically targeted investment. Trus509. I.R.C. § 4975 imposes a two-tier excise tax on pension funds for prohibited
transactions and ERISA § 502(i) authorizes a similar excise tax for welfare funds. 29
U.S.C. § 1132(i) (1994). Initially, an annual five percent excise tax is imposed. If the
transaction is not corrected within ninety days, the IRS will impose an excise tax equal
to 100% of the amount involved. The tax is imposed on the disqualified person.
510. A fiduciary who violates his or her fiduciary duty will "be personally liable to
make good to such plan any losses to the plan resulting from each such breach, and to
restore to such plan any profits of such fiduciary which have been made through the
use of assets of the plan by the fiduciary ...." 29 U.S.C. § 1109(a). A detailed discussion
of fiduciary liability is beyond the scope of this article. See SOLELY IN OUR INTEREST,
supra note 6, Chapters 5 and 6 for a more detailed analysis.
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tees make a fiduciary decision to invest plan assets in certain stocks,
then actively monitor corporate performance and communicate with
management to improve corporate performance and enhance investment returns. The trustees receive a collateral benefit: high performance workplaces that respond to the concerns of their shareholders and
employees. Secretary of Labor Robert Reich recently described the relation between corporate performance and workplace practices: "Responsible shareholder activism by pension plan managers can improve
long-term company performance. [Corporate performance is] tightly
linked to how companies treat their most important assets-their
workers."511
Pension funds have been described as "a sleeping giant [whose]
awakening may leave the corporate landscape forever changed."512
Pension funds currently own about twenty-five percent of the stock of
U.S. public corporations513 and the Department of Labor predicts that
by the year 2000, pension funds will own forty percent of corporate
stock. 514 Institutional investors own fifty percent ofthe stock ofthe largest U.S. public corporations. 515 For example, institutional owners own
more than eighty percent of Chiquita Brands, Storage Technology and
Owens-Corning Fiberglass and more than seventy-five percent of
Deere, Gannett, Hercules, Whirlpool, Xerox, Armstrong World Industries, and Pitney Bowes. 516
In recent years, pension funds have become more actively involved
in monitoring corporate performance and exercising their shareholder
communication rights. 517 The Department of Labor has encouraged
pension funds to exercise their shareholder rights. In July 1994, the
Department issued an interpretive bulletin on voting proxies, monitoring corporate performance, and communicating with management.51B In
511. Labor Department Moues to Increase Shareholder Activism by Pension Plans,
26 Sec. Reg. & Law Rep. (BNA) 1057 (July 29, 1994).
512. Judith Crosson, Study Shows U.S. Shareholders Second Class Citizens
Abroad, REUTER Bus. RPT. (May 10, 1989) (In a report by the Investory Responsibility
Research Center).
513. David Walker, Corporate Governance Issues and Their Fiduciary Implications,
EMPLOYEE BENEFITS DIGEST (Int'l Found. of Empl. Benefit Plans), Vol. 26, No.9, at 3
(Sept. 1989). See also Davis, Pension Funds and Financial Markets, EMPLOYEE BENEFIT
RESEARCH INST., Issue Brief, No. 91, at 6 (June 1989).
514. U.S. DEP'T OF LABOR, PENSION AND WELFARE BENEFITS ADMIN., PROXY
PROJECT, at 1 (1989).
515. CoLUMBIA INSTITUTIONAL INVESTOR PROJECT, INSTITUTIONAL INVESTORS AND
CAPITAL MARKETs: 1992 UPDATE, at Table 19 (1991).
516. The Top 100 U.S. Companies Ranked by Stock Market Value, Bus. WK., 1992
Special Bonus Issue, at 118.
517. I have previously addressed this subject at length in Jayne Zanglein, Who's
Minding Your Business?, 10 HOFSTRA LAB. L.J. 23 (1992) and Jayne Zanglein, Pensions,
Proxies and Power, 7 LAB. LAw. 771 (1991).
518. Pension and Welfare Benefits Administration Interpretive Bulletin 94-2
(July 29, 1994), reprinted in 59 Fed. Reg. 38,860 (July 29, 1994), codified at 29 C.F.R
2509.94-2.
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the interpretive bulletin the Department reaffIrmed its view that the
plan trustee has the exclusive right to vote proxies unless the trustee is
subject to the directions of a named trustee or the power to manage plan
assets has been delegated to investment managers. 519 If proxy voting
authority has been delegated to the investment manager then only the
investment manager can vote the proxies unless the named fiduciary has
reserved the right to direct the trustee with respect to proxy voting. 52O
The Department clarified that "a named fiduciary, in delegating investment management authority to an investment manager, could reserve to
itself the right to direct a trustee with respect to the voting of all proxies
or reserve to itself the right to direct a trustee as to the voting of only
those proxies relating to specified assets or issues."521 Thus, it appears
that the board of trustees could delegate proxy voting authority to its
investment manager but single out certain corporate stocks or certain
proxy issues for which it reserves the right to vote proxies.
In its interpretive bulletin, the Department emphasized that in
voting proxies, a fiduciary should "consider those factors that may
affect the value of the plan's investment and not subordinate the interests of the participants and beneficiaries in their retirement income to
unrelated objectives."522 The fiduciary must also act solely in the interest of the plan participants and beneficiaries and its vote cannot be
influenced by its relationship with the plan sponsor. 523
The interpretive bulletin consolidates the Department's position,
as stated in previous advisory opinions,524 that plan fiduciaries have a
fiduciary duty to vote proxies appurtenant to shares of stock held as
plan assets. 525 The bulletin clarifies that a named fiduciary who
appoints an investment manager may require investment managers to
vote proxies according to investment policy guidelines adopted by the
named fiduciary.526 The bulletin also encourages active monitoring of
corporate management by plan fiduciaries. 527
519. [d.
520. [d.
521. [d. Where the plan document says that the investment manager is not
required to vote proxies but does not forbid the investment manager to vote proxies,
the manager retains the exclusive right to vote proxies. [d.
522. Interpretive Bulletin, 94-2 supra note 518.
523. [d.
524. See Letter from Department to Helmulth Fandl, Chairman of the Retirement
Board of Avon Products (Feb. 23, 1988), reprinted in 15 Pens. Rep. (BNA) 391 (Feb. 29,
1988) (Avon Letter); Letter from Department to Robert A.G. Monks of Institutional
Shareholder Services, Inc. (Jan. 23, 1990), reprinted in 17 Pens. Rep. (BNA) 244, 245
(Jan. 29, 1990) (Monks Letter).
525. Interpretive Bulletin 94-2, supra note 518.
526. [d.
527. [d.
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B. Avon Letter
The bulletin summarizes the Department's two previous opinion
letters on proxy voting. In the Avon Letter,528 the Department stated
that "the fiduciary act of managing plan assets which are shares of
corporate stock would include the voting of proxies appurtenant to
those shares of stock."529 The Department stated that "[t]o act prudently
in the voting of proxies (as well as in all other fiduciary matters), a plan
fiduciary must consider those factors which would affect the value of
the plan's investment.''530 The Department gave examples of proxy
issues that may affect the value of stock held by the plan and consequently are subject to the fiduciary provisions of ERISA These issues
include
[a] proposal to change the state of incorporation of a corporation in
which a plan owned shares (thereby possibly affecting shareholders'
rights to participate in the decision making process of the corporation which, in turn, affects the value of their investment) and a
proposal to rescind "poison pill" arrangements with regard to various
corporations in which a plan is invested. 531
In the Avon Letter, the Department also discussed circumstances
under which the duty to vote proxies may be delegated. ERISA section
403(a) requires plan assets to be held in trust by one or more trustees. 532
Trustees have the exclusive authority and discretion to manage plan
assets unless such authority is delegated to an investment manager,533
or unless the plan provides that the trustees are subject to proper direction by a named fiduciary.534
Pursuant to ERISA section 402(c)(3), trustees may delegate
authority to an investment manager to manage and control plan
assets. 535 In the Avon Letter, the Department of Labor stated that if
plan documents authorize an investment manager to act with complete
discretionary authority, the named fiduciary or trustees cannot vote
proxies without violating ERISA's plan document rule. 536 A violation
528. See supra note 524.
529. [d.
530. [d. at n.4. This discussion of the Avon and Monks letters is adapted from
SoLELY IN OUR INTEREST, supra note 6, at Chapter 9.
531. [d. at 392. For an extensive discussion of the types of proxy issues that affect
stock value, see Who's Minding Your Business?, supra note 5, at 52-70. Examples
include reincorporation, poison pills, supermajority voting requirements, authorization
of blank-eheck preferred stock, dual class voting, greenmail, and classified boards. [d.
at 69.
532. 29 U.S.C. § 1l03(a).
533. 29 U.S.C. § 1l03(a)(2).
534. 29 U.S.C. § 1l03(a)(1). A named fiduciary is a person designated as a fiduciary
in accordance with plan procedures. 29 U.S.C. § 1l05(c)(l). Named fiduciaries may be
named in plan documents or may be chosen by the plan sponsor through a procedure
which is specified in the plan. 29 U.S.C. § l103(a)(1); Avon Letter, supra note 524, at 2.
535. 29 U.S.C. § 1l02(c)(3).
536. Avon Letter, supra note 524, at 392.
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will occur if any person other than the investment manager (or person
under the investment manager's supervision) votes the proxies. Once
the named fiduciary delegates its investment authority, the fiduciary
"no longer [has] .... the authority to decide how the investment
manager votes proxies and would be engaging in a section 404(a)(l)(D)
violation in doing so unless, in delegating such management responsibility to the investment manager it reserves to itself the right to vote
proxies."537
The Department of Labor also cautioned trustees to periodically
monitor the activities of the investment manager and review proxy
votes:
[I]t is the opinion of the Department that Section 404(a)(1)(B)
requires proper documentation of the activities of the investment
manager and of the named fiduciary of the plan in monitoring the
activities of the investment manager. Specifically, with respect to
proxy voting, this would require the investment manager or other
responsible fiduciary to keep accurate records as to the voting of
proxies. 538
In public speeches after the Avon Letter was issued, David Walker,
then Assistant Secretary of Labor, advised investment managers or
other fiduciaries who vote proxies to establish a general policy on recurrent voting issues. 539 A 1992 survey oflarge pension funds found that
eighty-nine percent of public funds have proxy voting guidelines and
seventy-seven percent of union funds have adopted voting guidelines. 540
Ninety-seven percent of investment managers reported that they have
adopted guidelines. 54 !
C. Monks Letter
One year after the Department ofLabor issued the Avon Letter, the
Department further delineated its position on proxy voting in the
Monks Letter. In announcing the letter to Robert A.G. Monks, then
president of Institutional Shareholder Services, Inc., David George
Ball, the head of the Pension and Welfare Benefits Administration
537. Id.
538. Id. at n.3.
539. Pension Investments: Public Hearing Before the New York State Pension
Investment Task Foree 202 (1989) (testimony of David Walker, Assistant Secretary of
Labor for Pension and Welfare Benefits, U.S. Department of Labor). Walker further
advised trustees to consider the following factors when voting on proxies:
Number one, the nature of the issue and whether or not the issue itself is
likely to have an effect on the underlying value of the stock;
Secondly, what your investment philosophy and strategy is, how long do
you plan to hold this investment and how does that play into the issue;
And, thirdly, quite candidly, your confidence in management.
Id. at 203.
540. Who's Minding Your Business?, supra note 5, at 76.
541. Id.
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stated, "Privilege bears responsibility.''542 [W]cbhen institutional investors don't vote, or vote without paying close attention to the implications of their vote for the ultimate value of their holdings, they are
hurting not only themselves but also the beneficiaries of the funds they
hold in trust.''543
The Department responded to several questions raised by Monks.
The first question was whether an investment manager can effectively
avoid responsibility for voting proxies by including a disclaimer in the
investment management contract. The Department clarified that "[i]f
the plan expressly reserves to the named fiduciary the authority to
direct the trustee with respect to proxy voting, the trustee must follow
such directions so long as the directions are proper, in accordance with
the terms of the plan and not contrary to the provisions of ERISA."544
The Department noted that "[a]n ERISA violation will occur if the
investment manager is explicitly or implicitly assigned the authority to
vote proxies .... and the named fiduciary, trustee, or any person other
than the investment manager makes the decision how to vote those
same proxies."545 Even if the investment management agreement
provides that the manager is not required to vote proxies, "a delegation
of authority to the investment manager to vote such proxies will have
occurred and the investment manager must vote the proxies."546
However, if the trust agreement does not grant the trustees the authority to delegate the voting of proxies, or if the trust agreement requires
any investment manager who is appointed to assume the duty to vote
proxies, any investment management agreement which provides to the
contrary would be void to the extent inconsistent with plan documents. 547 If the plan documents prohibit the investment manager from
voting proxies, the trustees have the exclusive responsibility to vote the
proxies. Where the plan requires the trustees to act subject to the direction ofa named fiduciary, then the trustees must vote the proxies at the
direction of the named fiduciary.546
542. Ball Signals Continued Commitment to Proxy Voting Issues at Department, 17
Pens. Rep. (BNA) 207 (Jan. 29, 1990).
543.Id.
544. Labor Department Opinion Letter on Proxy Voting (Jan. 23, 1990), reprinted
in 17 Pens Rep. (BNA) 244, 245 (Jan. 29, 1990).
545. [d.
546. [d.
547. The Department noted that "[t]he interpretation of any particular plan provision or investment management contract is, however, inherently factual in nature." Id.
548. Morton Klevan, an official of the Department of Labor provides the following
example of the complexity of proxy delegation rules:
Assume that there is a chief rmancial officer, "CFO," of Company A. She
directs Bank X, the trustee of A's pension plan, to vote in favor of Company
A's proposals, which include super majority voting provisions and the creation
of a new class of stock for the management group which carries ten times the
votes of regular shares of stock. Under ERISA, the fIrst question to ask is
whether the plan expressly provides for directed trustees. The trustees have
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Monks also inquired whether an investment manager has a fiduciary obligation to reconcile proxies with holdings on a record date. The
Department responded that "the fiduciary who has the authority to
vote proxies has an obligation under ERISA to take reasonable steps
under the particular circumstances to ensure that the proxies for which
it is responsible are received.''549 Reasonableness is determined on the
basis ofrelevant facts and circumstances. The Department warned that
an investment manager who has made no effort to reconcile proxies
would be acting in violation of ERISA. 550
In the Monks Letter, the Department also described the information that a plan fiduciary must review in carrying out its responsibility
to monitor the activities of the investment manager relating to proxy
voting. Records must be kept on the voting of proxies, the voting procedure pursuant to which the investment manager votes the proxies, and
individual votes. This information is necessary for the fiduciaries to
monitor the investment manager to ensure that he is "fulfilling his fiduciary obligations in a manner which justified the continuation of the
management appointment.''551
D. Interpretive Bulletin 94-2
1. Voting Proxies of Foreign Corporations
In its recent interpretive bulletin, the Department stressed that it
was reiterating and supplementing the Avon and Monks letters, rather
than superseding them. 552 The Department noted that although the
previous letters did not address the voting of proxies on shares of
the exclusive authority to manage and dispose of plan assets unless the plan
provides for directions by a narned fiduciary and they get proper directions from
the named fiduciary. It is then necessary to consider whether the plan contemplates directions to be given as to these sorts of issues, and if so, whether the
CFO is the person described in the plan as the one to give the directions. If
not, the directions should be ignored by the trustee because the plan has not
properly provided direction for the trustees. If the plan specifies that the trustees should be subject to the CFO's directions with respect to the voting of
proxies on all issues except routine matters, the trustees are still not insulated.
They must decide whether these directions .... may violate Title I of ERISA,
particularly the solely in the interest provision of section 404(a), the "exclusive
purpose" provisions of sections 404(a), and the prohibited transaction provisions of section 406. If the directions contravene these provisions, the trustees
would be duty bound to ignore them.
Klevan, Fiduciary Duty and Proxy Voting, 7 ANN. REV. BANKING L. 229, 233-34(988),
reprinted in KRIKORIAN, FIDUCIARY STANDARDS IN PENSION AND TRUST MANAGEMENT
230 (989).
549. Labor Department Letter on Proxy Voting, supra note 544.
550. A 1992 survey found that 70% of investment managers reconcile proxies, 8%
cannot reconcile, and 22% do not attempt to reconcile. Who's Minding Your Business?,
supra note 6, at 94-95.
551. Labor Department Letter on Proxy Voting, supra note 544, at 246. A 1989 survey
by the Department found that almost 40% of investment managers surveyed did not keep
proxy voting records. Joel Chernoff, Washington Working to Change System, PENS. & INV.
AGE, Apr. 16, 1990, at 19.
552. Interpretive Bulletin 94-2, supra note 518.
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foreign corporations, the same principles apply: "[P]lan fiduciaries
have a responsibility to vote proxies on issues that may affect the value
of the shares in the plan's portfolio."553 However, the Department noted
that the exercise of voting shares of foreign corporations may entail
additional costs to the plan. Where the costs of voting on a particular
proposal might "exceed any benefit the plan could expect to gain in
voting on the proposal,"554 the plan fiduciary must "weigh the costs and
benefits of voting on [the] proxy proposal .... and make an informed
decision with respect to whether voting a given proxy proposal is
prudent and solely in the interest of the plan's participants and beneficiaries."555 The Department advised that a fiduciary, when making this
decision must "take into account the effect that the plan's vote, either by
itselfor together with other votes, is expected to have on the value ofthe
plan's investment and whether this expected effect would outweigh the
cost of voting."556 The fiduciary should also consider whether the difficulty and expense ofvoting the shares is reflected in the market price of
the shares. 557
2. Investment Policy Statements
The interpretive bulletin also addressed the role of investment
policy statements in governing the conduct of investment managers. 55B
The Department stated that a named fiduciary has authority under
ERISA section 402(c)(3)559 to appoint an investment manager. Inherent
in this authority is the fiduciary's power to issue investment policy
statements which will govern the conduct of investment managers.560
Investment policy statements are plan documents 561 and investment
managers are required to follow a policy statement to the extent the
document is consistent with ERISA.562
553.
554.
555.
556.
557.
558.
[d.
[d.
[d.
[d.
Interpretive Bulletin 94-2, supra note 518.
For a description of investment policy statements and sample guidelines see
SoLELY IN OUR INTEREST, supra note 6, at Chapter 15, and Appendix C. The Department defines an investment policy statement as a "written statement that provides the
fiduciaries who are responsible for plan investments with guidelines or general instructions concerning various types of categories of investment management decisions, which
may include proxy voting decisions." Interpretive Bulletin 94-2, supra note 518. The
term does not include specific directions given to an investment manager with respect
to the purchase or sale of a specific security at a designated time or the voting of a
particular proxy. [d.
559. 29 U.S.C. § 1l02(c)(3).
560. Interpretive Bulletin 94-2, supra note 518.
561. [d.
562. [d. The Department states that "a trustee to whom a statement of investment
policy applies would be required to comply with such policy unless, for example, it would
be imprudent to do so in a given instance." [d.
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The Department took care to distinguish investment policy statements from directions given by a named fiduciary to a trustee under
ERISA section 403(a)(l).563 The Department considers an investment
policy statement to be general guidelines. Examples include the
identification of acceptable classes or types of investments, limitations on investment categories as a percentage of the plan's portfolio,
or generally applicable guidelines regarding voting positions in
proxy contests (for example, criteria regarding the support of or
opposition to recurring issues, such as proposals to create classified
boards of directors or to provide for cumulative voting for board
members).
The Department does not consider specific instructions as to the
purchase or sale of a specific security at a designated time or instructions to vote certain proxies in a specific manner to be investment policy
statements.564
Although ERISA does not require investment policy statements to
be adopted by fiduciaries, the Department "believes that such statements serve a legitimate purpose in many plans by helping to assure
that investments are made in a rational manner and are designed to
further the purposes of the plan."565 The Department noted that proxy
voting guidelines may be particularly helpful where a fund employs
numerous investment managers because the guidelines might prevent
investment managers from taking conflicting positions on the same
proxy issue. 566 The Department encouraged the adoption of investment
policy statements and noted that such statements are consistent with
the prudence rule. When drafting investment guidelines and proxy
voting guidelines, fiduciaries must follow the prudence rule and "take
into account factors such as the plan's funding policy and its liquidity
needs as well as issues of prudence and diversification."567
The named fiduciary must monitor the investment manager,568 and
the investment manager must maintain sufficient records for the fiduciary to monitor the manager's activities. The manager's records must
include the voting procedure with respect to each plan-held stock and
the vote on each corporate stock held by the plan.
The Department observed that managers of pooled accounts who
are governed by multiple proxy voting guidelines must, to the extent
possible, comply with each policy.569 Where the policies conflict, the
563. Section 403(a)(l) provides that if a plan expressly provides that the trustee is
subject to the direction of a named fiduciary who is not a trustee, the trustee shall be
subject to proper directions which are made in accordance with the terms of the plan
which are not contrary to ERISA
564. Interpretive Bulletin 94·2, supra note 518.
565. [d.
566. [d.
567. Interpretive Bulletin 94·2, supra note 518.
568. [d.
569. [d.
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investment manager should vote the proxies "to reflect each policy in
proportion to the respective plan's interest in the pooled account."570 If
an investment manager cannot feasibly vote proxies according to each
individual proxy voting guideline, then the manager may require all
clients to agree to the manager's master proxy voting guidelines. 571
3. Shareholder Activism
In the bulletin, the Department also addressed institutional shareholder activism. The Department noted that "where proxy voting decisions may have an effect on the value ofa plan's underlying investment,
plan fiduciaries should make proxy voting decisions with a view to
enhancing the value of the shares of stock, taking into account the
period over which the plan expects to hold such shares."572 The Department also endorsed the monitoring or influencing of corporate management where the fiduciary expects that the acts of monitoring or
influencing corporate management either alone, or in conjunction with
other shareholders, are likely to enhance the value of plan-held stock.573
The Department suggested that shareholder activism is appropriate
where a stock portfolio such as an index fund is being held on a long
term basis or where the plan cannot easily dispose of the stock without
affecting the stock's value. 574 The Department further suggested that
shareholder communication might be proper on issues such as board
independence, candidates' qualifications, executive compensation,
board policies on mergers and acquisitions, the company's long-term
business plans, the extent of debt financing, the company's investment
in work force training and other workplace practices, and financial and
non-financial measures of corporate performance. 575 Monitoring and
communication can be accomplished through correspondence, meetings
with management, and exercising legal shareholder rights. 576
The interpretive bulletin signals the Department's encouragement
of "relationship investing.''577 John Wilcox, managing director of Georgeson & Company, a proxy solicitation firm, says: ''This adds a regula570. [d. A 1992 survey found that 88% of investment managers surveyed have
sufficient staff and resources to vote proxies according to proxy voting guidelines of
individual pension fund clients. Who's Minding Your Business?, supra note 5 at 96-97.
Six percent of investment managers do not have sufficient resources to provide individualized proxy voting, and 6% said they would do it only under certain circumstances
and for certain types of fund. Id.
571. Interpretive Bulletin 94-2, supra note 518. The master policy then would
become the plan document and the manager would be required to follow the document.
572. [d.
573. Interpretive Bulletin 94-2, supra note 518.
574. [d.
575. [d.
576. [d.
577. Ken Silverstein, Clinton Administration Official Advocates Relationship
Investing; Pension Funds, PENSION WORLD, July 1994, at 6.
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tory seal ofapproval to what had been a maverick activity .... [P]ension
plans have profoundly changed Corporate America and this is another
part of that change."578 Assistant Secretary of Labor, Olena Berg,
recently endorsed this concept, defining "relationship investing" as a
long-term approach in which pension fund investors "own larger stakes
in fewer companies, giving them more leverage [to negotiate issues of
concern] with corporate management and the board of directors."579
Assistant Secretary Berg suggested that pension investors monitor the
corporate performance of the companies in which they invest, assign
"incentive pay for corporate executives, and influenc[e] rule changes for
those who serve on the boards."580
Secretary ofLabor Robert Reich recently encouraged pension funds
to "[g]et out the vote." He noted that because oftheir size, many pension
funds cannot sell corporate stock without "disrupting trading and
lowering share prices."581 He encouraged large pension fund shareholders to "stick it out-and this means using the voting power that comes
with ownership to keep managers' minds concentrated on sound, longterm strategies.''582
Secretary of Labor Reich stated that "exercising the corporate vote
can help the bottom line."583 He referred to a study by Wilshire Associates which tracked forty-two companies during five years that the California Public Employee Retirement System (CaIPERS) was actively
involved in corporate governance. According to the study, these fortytwo companies "beat the S. & P. 500 by 41 percent-while in the prior
five years the same companies underperformed the S&P 500 by 66
percent."584 As Samuel Johnson said, "Depend upon it, sir, when a man
knows he is about to be hanged in a fortnight, it concentrates his mind
wonderfully."585
578. Leslie Wayne, U.S. Prodding Companies to Activism on Portfolios, N.Y TIMES,
July 29, 1994, at Dl.
579. Clinton Administration Official Advocates Relationship Investing, supra note
577.
580. Id.
581. Robert B. Reich, A Moral Workout for Big Money, N.Y. TIMES, Sept. 11, 1994;
§ 3, at 9. See also Leslie Wayne, Seeking Investment with Principle, N.Y. TIMES, Aug. 10,
1993 (quoting Assistant Secretary of Labor Olena Berg as saying: "Given the size of
funds, it doesn't make sense to try to beat the market for a quarter .... when you are
the market, as funds are, you can't beat it. The goal should be an overall lifting of the
economic boats by investing in ways that are economically productive and create more
and better jobs."
582. A Moral Workout for Big Money, supra note 581.
583. Id.
584. Id. Contra Robert C. Pozen, Institutional Investors: The Reluctant Activists,
HARV. Bus. REV., Jan./Feb. 1994, at 140. See also Ken Silverstein, Pension Funds
Increase Presence in Corporate Boardrooms, PENSION WORLD, May 1994, at 4.
585. The 1990s spin on this phrase was coined by Secretary Reich: "Nothing
concentrates the mind of a corporate executive quite so sharply as a pointed inquiry
from a large investor or outside director." See Patrick S. McGurn, DOL Issues New
Guidelines on Proxy Voting, Active Investing, IRRC CORP. Gov. BULL., July/Aug. 1994,
at 1, 4.
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Corporations and analysts recognize that pension funds represent
a threat to the autocratic control exercised by most corporate boards:
"Relational investing" is emerging as a new "buzzword" for this
era of rejuvenated investor activity. In its mildest form, it incorporates little more than improved communications between management and shareholders. At its extreme, relational investing
anticipates that "institutions will acquire large ownership positions,
voluntarily commit to hold stock for the long term, occupy seats on
boards of directors, participate in corporate decision making, and act
like 'owners' rather than investors."586
Advocates of relationship investing point to its benefits:
First, it helps solve a problem executives have complained of for
years: short-term investing. By creating a class of enlightened investors who give companies patient capital, relationship investing
should free management to focus on the long term. Over time, that
should lift profits, productivity, and prospects. And that would boost
U.S. competitiveness.
Second, the very existence of a new breed of active capitalists
fixes another failing of U.S. corporations: the imperial CEO,
unchecked by a pliant board of directors. . .. Investors who actively
monitor their holdings would introduce a badly needed measure of
management accountability.587
586. Karl A. Groskaufmanis, Proxy Reform and the Brave New World of Investor
Relatwns: Ten Rules of Thumb for the 1990s, INSIGHTS, Dec. 1993, at 18 (quoting John
G. Wilcox, Relational Investing: Can It Really Work?, N.Y.L.J., May 6, 1993, at 5). See
also John C. Wilcox, Managing the Proxy Process, INSIGHTS, Dec. 1993, at 3; Robert C.
Pozen, Institutional Investors: The Reluctant Activists, lIARv. Bus. REV., Jan./Feb. 1994,
at 140; Norma M. Sharara and Anne E. Hoke-Witherspoon, The Evolutwn of the 1992
Shareholder Communication Proxy Rules and Their Impact on Corporate Governance,
49 Bus. LAw. 327 (1993); Dennis J. Block and Jonathan M. Hoff, Corporate Governance
Reform and Directors' Duty of Care, N.Y.L.J., May 20, 1993, at 5; John Wilcox and
Richard Wines, Investor Targeting: A Quantitative Approach to Reaching Institutions,
INSIGHTS, May, 1993, at 14; Judith H. Dobrzynski, Relationship Investing, Bus. WK.
Mar. 15, 1993, at 68; The New Governance Paradigm: CE Roundtable, CHIEF ExEcuTIVE, Apr. 1994, at 40; Mary McCue, Matching Perceptwns to Reality: Communicating
Effectively with Shareholders, INSIGHTS, Dec. 1994, at 22; Ethan Stone, Must We Teach
Abstinence? Pensions' Relationship Investments and the Lessons of Fiduciary Duty, 94
COL. L. REV. 2222 (1994); Robert Kleiman, Kevin Nathan, and Joel Shulman, Are There
Payoffs for "Patient" Corporate Investors?, MERGERS & ACQUISITIONS, MarJApr. 1994,
at 34; Mark J. Roe, The Modern Corporation and Private Pensions, 41 UCLA L. REV.
75 (1993); John H. Matheson and Brent A. Olson, Corporate Cooperatwn, Relationship
Management, and the TrialogicalImperative for Corporate Law, 78 MiNN. L. REV. 1443
(1994); Bernard S. Black and John C. Coffee, Hail Britannica?: Institutional Investor
Behavwr Under Limited Regulation, 92 MICH. L. REV. 1997 (1994); Edward B. Rock,
Controlling the Dark Side of Relational Investing, 15 CARDOZO L. REV. 987 (1994); Ian
Ayres and Peter Cramton, Relational Investing and Agency Theory, 15 CARDOZO L. REV.
1033 (1994); Jill E. Fisch, Relationship Investing: Will It Happen? Will It Work?, 55
OHIO ST. L.J. 1009 (1994).
587. Judith H. Dobrzynski, Relationship Investing, Bus. WK., Mar. 15, 1993, at 68.
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The tactics used by institutional investors are working. 588 In 1993,
pension fund investors complained to management when James Robinson III announced his intention to resign as CEO but remain as chairman of the board ofAmerican Express. 589 The funds wanted Robinson to
resign from both positions. Less than a week after the funds complained,
Robinson announced his intention to resign from both positions.590
Pension funds were also the impetus behind the firing or resignation of
other corporate chieftains including John F. Akers ofInternational Business Machines, Paul Lego of Westinghouse Electric Corporation, Kay B.
Whitmore of Eastman Kodak Company, Anthony D'Amato of Borden,
Inc.,591 and Robert Stempl ofGeneral Motors Corporation. 592 Nell Minow,
co-founder of LENS, Inc., has dubbed this phenomenon the "Queen of
Hearts theory of activism: 'Offwith their heads!' "593
This demand for corporate accountability has CEOs listening.
James E. Preston, chairman and CEO ofAvon Products, recalls:
Five years ago when I became chairman and CEO of Avon Products, I learned an important lesson about communication. The
company had been under intense scrutiny by a number of shareholder activist groups because of dismal performance for about a
decade. During my first year, I discovered that open communication
with your larger shareholders and shareholder rights groups can go
a long way toward weathering the storm. Through the years, we've
built on that lesson. We recently invited between 70 and 80 institutional investors to two meetings, one in New York and the other
in California .... The feedback from those meetings was terrific. 594
Pension funds have exercised their power in other ways. Last
summer, the City of New York pension funds demanded that Philip
Morris justify their decision to split off its food company from the cigarette company.595 Jon Lukomnik, deputy comptroller for the New York
City pension funds issued a veiled threat: "We will get a meeting [with
588. For a more detailed description of the history of shareholder activism, see
Jayne Zanglein, Pensions, Proxies, and Power, supra note 6. See also Gerald F. Davis
and Tracy A. Thompson, A Social Movement Perspective on Corporate Control, 39
ADMIN.. SCIENCE Q., Mar. 1994, at 141; Thomas A Stewart, The King is Dead, FORTUNE,
Jan. 11, 1993, at 34.
589. Vidya N. Root, Marking a "Sea Change" in Corporate Life: The Boards Bite
Back, THE BUFFALO NEWS, Jan. 23, 1994, Supplement-Prospectus '94.
590. [d.
591. [d.
592. Nell Minow, Turning Back the Queen ofHearts, THE RECORDER, Mar. 30, 1994,
at 7. Minow notes that studies have shown that stock price increases significantly when
the CEO is fired. However, she believes that firing the CEO is not always the best
response. [d.
593. [d.
594. The New Governance Paradigm: CE Roundtable, CHIEF EXECUTIVE, Apr. 1994,
at 40.
595. Vinetta Anand and Paul G. Barr, Shareholders Take on Management, Philip
Morris, K-Mart, UAL Under Fire, PENSIONS & INV., June 13, 1994, at 3. See also Judith
Dobrzynski, Call for Philip Morris: Don't Stonewall the Shareholders, Bus. WK., Oct. 10,
1994, at 44.
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management. If not,] other things will happen."596 Six other pension
.
funds joined in the demand for justification.597
When K-Mart announced its plans to sell stock tied to the earnings
of its specialty retail stores, pension funds, including the Wisconsin
Investment Board, requested that the company propose an alternative
restructuring plan. The pension funds refused to support the restructuring plan and the plan failed to pass at the company's annual meeting. Pension funds and other shareholders abstained from voting nearly
twenty-eight percent of the shares. 598 After the proposal failed, a
company spokesperson was forced to accede to the shareholders'
demands. 599
Pension funds take varying approaches to corporate governance:
sending a written demand for justification to the board of directors;
meeting with corporate boards; filing shareholder resolutions; instituting proxy campaigns against management proposals; and possibly
engaging in a proxy fight for control. Most funds take the CalPERS
approach-"buy low, talk loud. Or more precisely, [CalPERS] buys
passively, sells never and agitates to improve performance.''600 Others
engage in quiet diplomacy.
CaIPERS' approach is the most well-known, since CalPERS has
been setting the trend for years. CalPERS indexes its pension fund.
Each year it targets the corporations which are the poorest performers
in its portfolio.
A CalPERS spokesperson describes the goal of its program: "to get
companies to recognize that they are being observed by a major shareholder.''601 This proxy season, CalPERS is using five-year total shareholder returns to rank the corporations in its index portfolio.602 Tier-one
companies, also called the "Focus 10," were sent a letter requesting a
meeting with management.603 If management does not agree to meet,
CalPERS will either fIle a shareholder proposal or withhold its votes
from directors.604 Tier-two companies were sent a letter requesting a
written explanation for their poor performance.605 The performance of
companies in the final tier is simply being monitored.
The State of Wisconsin Board (SWIB) also screens its portfolio for
corporations in which the fund owns five to ten percent of the shares
596. Shareholders Take on Management, supra note 595.
597. [d.
598. [d.
599. [d. See also Judith Dobrzynski,Attention, K-Mart Shoppers: Victory, Bus. WK.,
Sept. 5, 1994, at 8.
600. Buy Low, Talk Loud, PENSIONS & 00., July 11, 1994, at 10.
601. James E. Heard & Jill Lyons, Labor Unions and Public Funds Set Active
Shareholders Agenda for 1995, INSIGHTS, Dec. 1994, at 3.
602. [d.
603. [d.
604. [d.
605. [d.
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and which are chronic underperfonners.606 SWIB negotiates with these
corporations on poison pills and compensation practices.607 Where negotiations fail, SWIB will submit shareholder proposals.60B For the 1995
proxy season, SWIB is negotiating with four companies on poison pills
and seven corporations on compensation packages.6oo
The New York State Common Retirement Fund also targets
companies:610
In Phase One, the fund will screen its stock portfolio to identify
long-term corporate underperformers on the basis of 17 performance
indicators which include stock returns, valuation ratios, accounting
data and capital spending. These variables will be calculated for oneand five-year periods adjusted for risk and grouped by industry. The
boards of those companies that fail all performance measures will
receive a letter from the fund requesting an explanation of the steps
being undertaken to improve performance. In Phase Two, each of
these companies will be reviewed to narrow the focus to the most
poorly performing companies. Companies that fail both phases of
review will be the subject of other governance initiatives which may
include correspondence, meetings with the board, and attendance at
annual shareholder meetings. As a last resort, the fund may [have]
meetings with management. 6ll
Several commercial funds have developed to help pensions engage
in relationship investing. One cynic notes: "Relationship investing is a
hot subject, and whenever the money-management business sees a
trend, they immediately try to design products to cash in on it."612 The
LENS Fund has been around for several years and was started by
Robert Monks (of the Monks Letter) and Nell Minow. The LENS Fund
invests in poorly performing companies and negotiates with management to change corporate strategy.613 Corporate Partners, an independent affiliate of Lazard Freres, has been around since 1989 and invests
heavily in corporations that need capital and in return demands a
board seat.614 Allied Investment Partners, a newer fund created by
Dillon, Read & Co., buys "friendly stakes in companies that have
started to change for the better but need time to do it."615 The fund plans
to demand a seat on the board of directors of the corporations in which
it invests.
606. Heard & Lyons, supra note 601.
607.Id.
608.Id.
609.Id.
610. Heard & Lyons, supra note 601.
611. Id. See also Patrick McGurn, New York State Fund: Back to Activism, IRRC
CORP. Gov. BULL., SeptJOct. 1994, at 4.
612. Judith H. Dobrzynski, Relationship Investing, Bus. WK., Mar. 15,1993, at 68.
613. Id.
614. Dobrzynski, supra note 612. See Are There Payoffs for "Patient" Corporate
Investors?, supra note 586 at Table 4.
615. Id.
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E. High-Performance Workplaces
In 1994, the U.S. Department of Labor's Office of the American
Workplace, a new government agency founded by President Bill Clinton and Secretary of Labor Robert Reich, published a guidebook entitled Road to High-Performance Workplaces: A Guide to Better Jobs and
Better Business Results.GlG The book promotes high-performance workplaces, which Secretary Reich describes in explaining the difference
between high-performance workplaces and conventional corporations:
[T]here are really two different kinds of workplaces. There are those
workplaces that treat their workers as assets to be developed, train
their workers, bring their workers in as partners, make their workers intrinsic to the innovation of that business. And then there's a
second kind of business .... that treat their workers as costs to be
cut, not as assets to be developed. 617
Secretary Reich explains:
Sixty years ago, the challenge was how to achieve and maintain
labor peace, how to divide up the pie between, on the one hand,
workers, on the other hand, managers and owners, and how to do
so peacefully. Today there are new questions, questions having to do
with how to bake a bigger pie. Workers and management working
together constructively, it is shown, and the [Dunlop] [C]omission
[on the Future of WorkerlManagement Relations] shows again and
again, can bake a bigger pie, can cause much, much larger productivity, higher profits, higher wages.
But the commission also shows just the opposite, that if workers
are not working collaboratively, if they are not working cooperatively, the pie actually shrinks. There is greater distrust, disloyalty,
there is a greater degree of litigation, huge amounts of litigation.
And so the issue today is not simply how to divide up a pie .... The
issue today is whether there is going to be genuine collaboration or
not ....618
The book is based on three basic premises. The first premise is:
High performance companies view their workers as valuable
assets and make investments accordingly .... Training is viewed as
continuous, with a commitment to life-long learning.
With this kind of knowledge base, workers gain the opportunity
to make informed decisions that will affect the service or product
616. U.S. DEP'T OF LABoR, RoAD TO HIGH-PERFORMANCE WORKPLACES:
TO BE'ITER JOBS AND BETTER BUSINESS RESULTS (1994).
A
GUIDE
617. News Conference with Robert Reich, Secretary of Labor, Ron Brown, Secretary of Commerce, John Dunlop, Chairman of Commission on Future of WorkerManagement Relations on Future of Worker Management Relations, (Jan. 9, 1995),
reprinted in Fed. News Service (Jan. 9, 1995). The Commission found overwhelming
evidence "that employee participation and labor-management partnerships are good for
workers, fmns, and the national economy." Executive Summary of Report and Recommendations of the Commission of the Future of Worker-Management Relations Issued
January 9, 1995, Daily Rep. for Executives (BNA) at M-6 (Jan. 10, 1995).
618. Press Conference on the Dunlop Commission Report on the Future of Worker/
Management Relations, reprinted in Federal News Service (June 2,1994).
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they offer. When combined with information sharing, the result is
greater job satisfaction and an employee commitment to high quality
and increased customer satisfaction.619
Preliminary evidence shows that finns that introduce fonnal training programs into the workplace have experienced a productivity
increase of nineteen percent or more over a three year period. 620 Training programs also reduce waste: one study found that doubling
employee training for the initial average of fifteen hours resulted in a
seven percent reduction in scrap.621
New United Motor Manufacturing Inc. (NUMMI) offers an example of the effects ofjob training on the corporate bottom line. Employees
receive extensive training in problem-solving skills before they start on
the production line. Each employee trains on ten to fifteen projects.
Once trained, employees work in teams of four to six, and most workers
rotate among all of the jobs on a team. The team is responsible for all
aspects of the job, from safety to quality control and cost.622
NUMMI recently entered into a joint-venture with Toyota, General
Motors, and the United Auto Workers. In preparation for the joint
venture
several hundred employees traveled to Japan for 3 weeks of intensive instruction on production-line and interpersonal practices.
When they returned to the U.S., those who had been to Japan
formed a central core of trainers for newly hired workers .... Every
new employee was given 8 days of classroom instruction before
moving to on-the-job, production line training. 623
The result was a dramatic decrease in defects per vehicle sold. In
1992, NUMMI averaged 83 defects per 100 cars compared to the U.S.
average of 125 defects per 100 cars and the Asian average of 105.624
In addition to providing job-training, high-performance companies
also share information with employees, including financial information.
An open-book strategy gives employees access to "[sJtrategic plans,
organizational priorities, budget constraints, operating results by business unit, competitors' relative perfonnance, and plans for new technology.''625 While it is difficult to measure the effects of information-sharing
619. RoAD TO HIGH PERFORMANCE WORKPLACES, supra note 616, at 2.
620. Id. (citing Ann Bartlel, Productivity Gains from the Implementation of
Employee Training Programs, INDUS. REL. (forthcoming 1995)).
621. Id. (citing Harry Holzer, et al., Are Training Subsidies for Firms Effective?
The Michigan Experience, INDUS. & LAB. REL. REV. (forthcoming 1995)).
622. RoAD TO HIGH-PERFORMANCE WORKPLACES, supra note 616, at 3.
623. Id.
624. Id.
625. Id. at 4. A recent study by Princeton Survey Research Associates found that
63% of employees would like to participate more in decision-making, and 76% said their
employers would be more competitive if employees made more decisions about production and operations. Louis Uchitelle, Workers Seek Executive Role, Study Says, N.Y.
TIMES, Dec. 5, 1994, C1, at CtS.
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on productivity, there appears to be a positive correlation between this
practice and corporate returns and sales.626
For example, when workers at Springfield Remanufacturing
purchased the plant to save their jobs through an employee buyout, all
workers were trained to read quarterly financial statements:G27
As workers began to realize how the business worked, they saw
ways in which they could have a direct impact on product quality
and on profits. As a result, sales and service to the customer ....
have improved dramatically. So have earnings. According to the
Wall Street Journal, in December of 1993 on a pre-split basis (the
stock had split three times), each share was valued at $18.60 up
from 10 cents when the buyout occurred. The employees' stock fund
has climbed to $5.5 million from $6,000 in the same period. Revenues climbed from about $18 million in 1983 to $73 million in
1992.628
The second premise presented in the Department's guidebook is
that high performance workplaces encourage workers to accept multiple new roles as problem-solvers, self managers, and entrepreneurs.629
Management invites workers to participate in the day-to-day management of the company:
HigWy successful companies avoid program failure by assembling employees into teams that perform entire processes-like product assembly-rather than having a worker repeat one task over and
over. In many cases, teams of workers have authority usually
reserved for managers: They hire and fire; they plan work flows and
design or adopt more efficient production methods; and they ensure
high levels of safety and quality.630
A 1990 report found that "employee participation is more effective
when workers are encouraged to make suggestions and have authority
to implement workplace improvements."631 The report reviewed
twenty-nine studies of conventional firms and found that in fourteen
studies worker participation had a positive effect on productivity, in
two studies, worker participation had a negative effect on productivity,
and the remaining thirteen studies had mixed results. 632 The degree of
worker participation was a key factor: "Participation was more likely
to have a positive long-term effect when it involved substantive decision-making rights rather than purely consultive arrangements.''633
626. [d. (citing Daniel Denison, CORPORATE CULTURE AND ORGANIZATIONAL
EFFECTIVENESS (1990».
627. RoAD TO HIGH PERFORMANCE WORKPLACES, supra note 616, at 5.
628. [d.
629. [d. at 6.
630. [d.
631. [d. (citing David Levine and Laura D'Andrea Tyson, Participation, Productivity, and the Firm's Environment, reprinted in ALAN BLINDER, ED., PAYING FOR PRODUCTIVITY 183-225 (1990)).
632. [d. at 7.
633. RoAD TO HIGH PERFORMANCE WORKPLACES, supra note 616, at 8.
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Studies have shown that companies that use a teamwork approach
are more productive than conventional fIrms. One study found that
automotive "plants that used flexible production systems (including
extensive training, contingent compensation, cross-functional work
teams, problem-solving groups, and decentralized responsibility for
quality control) manufactured vehicles in an average of 22 hours with
0.5 defects per vehicle. In contrast, more traditional plants took 30
hours and had 0.8 defects per vehicle.''634
Edy's Grand Ice Cream is an example of a business that has
adopted a cross-functional approach. 635 Each team is responsible for
"quality, individual business goals, internal scheduling and discipline, .... training, hiring, pay scales, and career development.''636
This approach has contributed to a 67% reduction in cycle time, a 66%
reduction in inventory, a 57% increase in productivity, and a 830%
increase in sales.637
Numerous studies have been conducted on the impact of employee
participation on productivity. A Gallup Chamber of Commerce study
found that eighty-four percent of the population would work harder and
do a better job if they were involved in decisions relating to their work. 638
In another report, psychologist Raymond Katzell reviewed 103 studies
and concluded that in eighty-five percent of the studies, an improved
incentive system including both monetary rewards and greater control
over work led to higher productivity.639 A 1982 New York Stock Exchange
survey concluded that eighty-two percent of those surveyed in corporations with 500 or more employees considered participative management
to be a promising approach for business enterprises.640
Other studies have shown the effects of employee ownership on
productivity. A 1986 study by the National Center for Employee Ownership found that employee-owned companies that encourage employee
participation grow eight to eleven percent faster annually than nonemployee owned fIrms that encourage worker participation.641 Another
study found that companies with ESOPs are 1.5 times more profItable
than comparable conventional frrms. 642 This ratio increases as the
amount of employee ownership increases. Managers surveyed noticed a
634. [d. (citing John Paul MacDuffie, Human Resource Bundles and Manufacturing
Performance (June 1993) (unpublished manuscript.)
635. [d. at 8.
636. [d. at 8-9.
637. RoAD TO HIGH PERFORMANCE WORKPLACES, supra note 616, at 9.
638. 129 U.S. CONGo REC. 11643 (May 10,1983).
639. [d.
640. [d.
641. Employee Ownership Makes Sense; Employee Stock Ownership Plans, 108
IMPLEMENT & TRACTOR 20 (Aug. 1993).
642. 129 U.S. CONGo REc. 11644 (May 10,1983).
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significant improvement in work attitudes and a positive effect on
productivity.643 One employee described the difference:
You have everyone more united and you have a better outlook
on coming to work. It seems as if you're working for yourself. You
just don't come in and put in your eight hours. It's kind of a psychological thing.644
Employee participation and ownership often reduces waste. One
employee describes the decrease in corporate waste:
Everyone is not so willing to throw a part away anymore which
was one of the first signs they cared about the company. Scrap is
held to a minimum. A ten minute break is now a 15 minute break
where it used to be a half hour or 45 minute break. They're a little
more conscious of a lot of small thingso 645
Researchers have concluded that when managers "humanize" the
workplace by giving employees more autonomy and involvement in the
work process, workers are more satisfied and productivity increases.
One worker comments on the effects of efforts to humanize the
workplace:
They listen to our problems more readily. The people on the floor
have to work with certain problems all day, week in and week out,
year in and year out, and managment is beginning to realize
that .... It's good employee-employer relationships because if you
know someone will listen to your problems, you feel more like a
human and .... there's more productivity. You're more responsible,
you're more willing to work overtime, and [there's] less tension, and
it's a pretty good deal all around. 646
Another study found that workplaces with "innovative relationships had 75 percent fewer worker hours lost to scrap, 42 percent fewer
defects per worker, and 17 percent higher labor productivity.''Il47
The Department's final premise in its guidebook is that "[hHghperformance companies gain long-term worker commitment by creating compensation systems tying pay to individual, team, and corporate
performance. Such companies also seek to make executives more
responsive to shareholder concerns by linking executive compensation
to longer term corporate goals."648 The Department encourages the use
of gainsharing, profit-sharing, employee stock ownership, team-based
pay, and skilled-based pay to reward workers. 649
643. Michael Conte and Arnold Tannenbaum, Employee Ownership: A Report to the
Economic Development Administration 19 (1978).
644. 129 U.S. CONGo REC. 41 (Nov. 17,1983).
645. Ido at 43.
646. Ido at 44.
647. RoAD TO HIGH PERFORMANCE WORKPLACES, supra note 616, at 10 (citing Joel
Cutcher-Gershenfeld, The Impact on Economic Performance of a Transformation in
Workplace Relations, 44 INDUS. & LABOR REL. REV. 241 (1991)).
648. Id. at 12.
649. Id.
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A recent study by Hewitt Associates of 437 publicly traded companies compared the productivity of companies with programs that focus
on and reward employee job performance and those without such
programs.650 The study concluded that the companies with performance
management programs "posted higher profits, better cash flows,
stronger stock market performance, and higher stock value; produced
significant gains in productivity; and showed higher sales growth per
employee and lower real growth in number ofemployees.''651 The survey
compared company performance for 1990 through 1992. During those
years, companies with performance management programs had a
median return on equity of 10.2% while companies without performance incentives had a 4.4% return. 652 Statistics for "turnaround" companies were even more astounding: these companies boasted a 19.7 %
return. 653 Sales increased from $126,000 per employee in companies
without performance management to $170,000 per employee in companies with performance incentives.654
Quality of worklife is important as well, the Department
recognizes:
In today's tight economic environment, companies initiating
family-supportive and other qualify-of-life policies gain a competitive
advantage by attracting and retaining a more talented, committed,
and productive pool of workers. These firms typically adopt policies
and programs to promote fitness, health, and safety. They initiate
flexible work hours and days, make accommodations for disabled
employees, and provide for child care. Other worker commitments
may include the elimination of "glass ceiling" barriers for women and
minorities and implementation of antidiscrimination policies and
practices.655
Studies have supported this conclusion. A survey of sixty Fortune
100 companies found that "where employees perceived a high level of
company concern with employee welfare and work conditions, the
company tended to show a higher profitability.''656 A 1994 study
concluded that "companies with well-respected employee practices
scored highest on critical measures oflong-term corporate performance,
including the utilization of capital and total returns to investors.''657
650. Study Analyzes Employee Performance Programs, 22 Pens. & Benefits Rep.
(BNA) 20 (Jan. 2, 1995).
651. Id.
652.Id.
653.Id.
654.Id.
655. RoAD TO HIGH PERFORMANCE WORKPLACES, supra note 616, at 16.
656. Id. (citing Gary S. Hansen and Birger Wernerfelt, Determinants of Firm
Performance: Relative Importance of Economic and Organizational Factors, 10 STRATEGIC J. MGMT 399-411 (l989)).
657. Id. at 19 (citing Gordon Group, Inc., High-Performance Workplaces: Implications for Investment Research and Active Investing Strategies. Report to the California
Public Employees Retirement System (May 30, 1994)}.
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This study was commissioned by the California Public Employee
Retirement System and found that between 1990 and 1994, "companies
with 'high performance' workplace practices outperformed the S. & P.
500 by an average of 16 percent each year and beat their industry
averages by 7.5 percent.''658 The report cautiously concluded that
"[clompanies with poor workplace practices .... had substandard
financial results.''659
Secretary of Labor Reich is a strong advocate of high-performance
workplaces. He stresses that pension fund investors should "watch the
workplace.''66O He notes that balance sheets don't tell everything about
a workplace:
Hard-to-measure data about the work force and workplace practices-the quality and loyalty of employees, investment in training
and retraining, and health and safety strategies-are especially
likely to elude standard accounting. Yet these factors can matter
enormously-especially for long-term players like pension funds. 66t
Secretary Reich has stated that "[s]ince this should enhance their
net investment returns, pension fund investors may want to encourage
such practices. [Research shows there isl a striking positive correlation
between good workplace employee practices and the bottom line.''662
Assistant Secretary Olena Berg agrees. She notes that the Department will undertake research to "verify what 'seems intuitively correct,'
namely that a company that invests heavily in its employees should,
658. Robert B. Reich, A Moral Workout for Big Money, N.Y. TIMES, Sept. 11, 1994,
3, 9.
659. Id. See also Buy Low, Talk Loud, supra note 600. The report concluded:
There is no discernible difference between the stock performance of companies recognized for their workplace practices and their industry peers in the
period after their workplace practices have become well-known in the market.
High-performance workplace companies appear to have higher price-to-book
valuation ratios than their industry peers, while firms with substandard reputations on workplace issues have lower valuations.
The stock performance of companies with substandard workplace reputations that remain independent in the period after such practices have become
well-known does not differ systematically from the stock performance of fIrms
that are highly regarded for their workplace practices. However, a large portion
of frrms with the worst reputations on workplace issues are either taken over
or experience bankruptcy.
There is a strong correlation between corporate policy in the area of workplace practices and the general quality and effectiveness of management. This
suggests that workplace practices are one part of a broad spectrum of management practices that determine superior performance, and that the best-run
companies are those that are managed successfully along a number of
dimensions.
Fred McCarthy, GalPERS to Focus on Workplace Performance, IRRC CORP. Gov. BULL.,
July/Aug. 1994, at 15-16. See also Jinny St. Goar, GalPERS Weighs in, PLAN SPONSOR,
Sept. 1994, at 40 (noting that the report is very cautious).
660. A Moral Workout for Big Money, supra note 659.
661. Id.
662. Patrick McGurn, DOL Issues New Guidelines on Proxy Voting, Active Investing, IRRC CORP. Gov. BULL. July/Aug. 1994, at 1, 4.
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over the long term, perform better than its competitors, and that this
superior performance will be reflected in the growth of its stock
price.''663
F. Conclusion
Most people would agree with the Department's intuitive premise:
companies that invite employee participation and treat their employees
well are more profitable. Research proves this, but not very clearly.664
The difficulty in conducting research on these issues is that it is impossible to isolate the effects on productivity of a wide-range of determinants from employee participation, workplace training, compensation
·systems, workplace cooperation, and other variables. Another difficulty
is that the same workplace practices implemented at two companies
may have strikingly different results. And yet, intuitively, most people
agree that workplace practices have some effect on the corporate
bottom line.
Another concern involves how much money pension funds should
invest in pursuing corporate performance issues such as high-performance workplaces or shareholder activism when the exact payoff is
unknown. Certainly, pension funds should act as long-term investors.
But most pension funds have neither the assets nor the personnel to
monitor corporate performance to the same extent as public funds like
CalPERS and SWIB.
However, pension funds don't have to expend huge amounts of time
and resources monitoring corporate performance. They also can adopt
proxy voting guidelines and delegate the job to investment managers.
They don't have to directly monitor workplace practices; again, this can
be delegated to investment managers. Not every pension fund will have
the ability to influence corporate management like CalPERS but collectively, pension funds can make this statement.
As investment managers start to take Interpretive Bulletin 94-2
seriously, new products and commercial funds are likely to develop to
assist pension funds in monitoring corporate performance and shareholder activism. Some groups already exist: the Council for Institutional Investors, the Investors Rights Association of America, the
LongView Fund, and the LENS Fund. Other intermediaries will jump
to the fore now that the Department has clarified its position on proxy
voting and shareholder activism.
663. Pat Griffith, AFL-CIO Pension Money May Fund City Housing, PITrSBURGH
POST-GAZETrE, Jan. 16, 1994, at A-6. See also, Berg Advises Pension Fund Managers to
Invest in Firms that Develop Skills, 20 Pens. & Benefits Rep. (BNA) 1915 (Sept. 13,
1993).
664. Even Secretary Reich concedes that "much of this informative is qualitative.
It is hard sometimes to be terribly precise about these workplace practices." Reich
Encourages States to Eye Workplace Practices When Investing, 22 Pens. & Benefits Rep.
477 (Feb. 20, 1995).
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11 THE LABOR LAWYER 59 (1995)
Although the Department's pronouncements in its interpretive
bulletins are useful, the Department must continue to give direction to
trustees on how to approach these issues. Otherwise, most funds will
not change their investment policies and the few trend-setting funds
will continue at full speed.
During congressional hearings on Pension Investments and
Economic Growth, Senator Barbara Boxer (D-Cal) summed up economically targeted investments and high-performance investing by saying,
"What could be better than doing well financially by doing good?''666
This article shows that pension funds can do well by doing good by
investing in prudent economically targeted investments and through
shareholder activism. Pension funds should rise to meet the expectation ofthe Department ofLabor that pension funds will be strong, effective, informed, and prudent long-term investors which will promote
national economic growth and workplace integrity.
665. Hearings on Pension Investments and Economic Growth, supra note 10 (statement of Senator Barbara Boxer, Chair of Joint Economic Committee Hearing).
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