Professor Bainbridge...on law, politics, religion, culture & food

Labor Pension Fund Activism

Eugene Scalia opines in the WSJ:

A recent University of Chicago study showed that union-affiliated funds do indeed systematically exercise their proxies to support labor objectives rather than simply to increase shareholder value. This was already evident in unions’ statements about their shareholder power, in corporate campaigns such as the attempted ouster of Safeway’s leadership during its 2004 labor dispute, and the refusal of some union health and welfare plans to do business with Wal-Mart, despite its low prescription drug prices.

That’s a problem because:

… “union pension funds” do not belong to unions. The funds are managed by trustees—half appointed by the union and half by the companies that contribute to the fund pursuant to their collective-bargaining agreements. Under the federal employee benefits law (ERISA), which is administered by the Department of Labor, these trustees are to act “solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of paying benefits and defraying reasonable administrative expenses,” as the Department reiterated in an advisory opinion last month.

The Labor Department letter addressed a reported AFL-CIO plan to promote shareholder proposals that press companies to offer more generous employee health-care benefits, and that would require companies to disclose political contributions so shareholders could see if support was being given to candidates who don’t share labor’s views on health care.

Before undertaking “to monitor or influence the management of corporations,” the department said, fiduciaries “must first take into account the cost of such action and the role of the investment in the plan’s portfolio, and cannot act unless they conclude that the action is reasonably likely to enhance the value of the plan’s investments.”

Scalia’s op-ed reinforces my argument that institutional investor activism does not solve the principal-agent problem but rather merely relocates it locus.

Like all other large institutional investors, union funds manage the pooled savings of small individual investors. From a governance perspective, there is little to distinguish such institutions from corporations. The holders of investment company shares, for example, have no more control over the election of company trustees than they do over the election of corporate directors. Accordingly, fund shareholders exhibit the same rational apathy as corporate shareholders. As amusing illustration was provided by a 1994 Wall Street Journal article, which reported that Kathryn McGrath, a former SEC mutual fund regulator, had admitted that a “lot of shareholders take ye olde proxy and throw it in the trash.” The proxy system thus “costs shareholders money for rights they don’t seem interested in exercising.” Indeed, McGrath herself conceded that she “often tosses a proxy for a personal investment onto a ‘to-do pile’ where ‘I don’t get around to reading it, or when I do, the deadline has passed.’” Nor do the holders of such shares have any greater access to information about their holdings, or ability to monitor those who manage their holdings, than do corporate shareholders. Worse yet, although an individual investor can always abide by the Wall Street Rule with respect to corporate stock, he cannot do so with respect to such investments as an involuntary, contributory pension plan.

For beneficiaries of union and state and local government employee pension funds, the problem is particularly pronounced. As Scalia illustrates, those who manage such funds may often put their personal or political agendas ahead of the interests of the fund’s beneficiaries.

Labor Department ERISA enforcement at least offers a bandaid, but assuming a Democratic win in the 2008 Presidential campaign, even that constraint is likely to be lost.