Corporate America’s New Stealth Raiders

Corporate America’s New Stealth Raiders

City Journal
Nicole Gelinas
Winter 2005

There are no Winn-Dixies in New York City. But geographical inconvenience didn’t stop seven of New York’s elected officials from asserting jurisdiction over the Florida-based supermarket chain’s corporate policies in July. As trustees of the New York City Employees’ Retirement System (Nycers), city comptroller William Thompson and Public Advocate Betsy Gotbaum, along with Gotham’s five borough presidents, persuaded Winn-Dixie’s board to prohibit discrimination against workers on the basis of sexual orientation. “This is great news for the gay, bisexual, lesbian, and transgender community,” Gotbaum told reporters. “Corporate America needs to ensure that all people are treated equally and humanely.”

Winn-Dixie was just the latest triumph in the push by Nycers and its companion fund, the New York City Teachers’ Retirement System (Nyctrs), to persuade corporate America to “ensure a respectful and supportive atmosphere for all employees.” Within the past two years, 20 Fortune 500 companies—including Duke Energy, El Paso Corporation, and JCPenney—have adopted the same sex-discrimination policy proposed by Thompson, Gotbaum, and the other pols and union activists who sit on the Nycers and Nyctrs boards. And this isn’t the New York funds’ only issue. As Thompson told the New York Society of Security Analysts in November 2003: “We targeted 88 different companies with shareholder resolutions and other initiatives on a wide range of crucial issues, including executive compensation, director elections, and the impact of corporate behavior on the environment and human rights.”

No longer content merely to change corporate America from the outside, public-pension funds are now taking advantage of a chastened and weakened post-Enron corporate America to shift the focus of their political and economic power to the inside of the corporate boardroom. Their resolve to change the world one shareholder resolution, press release, and board election at a time spells trouble for taxpayers, U.S. corporations, and the national economy.

These public-sector funds are uniquely powerful for two reasons. First, they are huge, accounting for an ever-greater share of the 20 to 25 percent of investments in the U.S. equity markets that pension funds—both public and private—constitute. Public pension assets have grown sevenfold in 20 years, to $2.3 trillion, while corporate assets have crept up more slowly, to $4.2 trillion—only about twice as big as the public funds, compared with three times as big two decades ago. The reason, of course, is that private-sector America largely ceased to offer its employees traditional, corporate-controlled, “defined-benefit” pension plans. Instead, employers started to make “defined contributions” to each individual employee’s retirement account, his 401(k), which immediately became his property—and his responsibility for investing wisely. But public-sector America, as a result of the political power of its unions, retained defined-benefit plans, which state and local politicos made ever more lavish.


Moreover, nearly one-fourth of these public pension-fund assets are concentrated in just two intensely Blue states: some $300 billion in California’s Public Employees’ Retirement and State Teachers’ Retirement Systems (Calpers and Calstrs), $85 billion in New York City’s funds, and $200 billion in New York State’s funds. This more than half-trillion, under the control of leftist politicians and union honchos, is the largest single special-interest bloc of money in the American capital markets.

Second, while private-sector mutual-fund managers focus on picking lucrative investments, because that’s how they get paid, these left-leaning public fund trustees have different incentives. Sure, they want their funds to perform well, but if they don’t, their public-employee clients don’t get hurt, because the defined pensions of those workers are guaranteed by the taxpayers, who must make up any shortfall if the pension funds perform poorly. So unlike a private fund manager, who only wants to see the value of his investment rise and who will sell it if he loses confidence in the company or its managers, highly political public pension trustees are free to pursue political as well as economic objectives.

New York City’s funds first discovered their political heft when they teamed up with Ivy League and church endowments in the mid-1980s to pressure companies with business in South Africa either to lobby against apartheid or to withdraw from that nation. Nycers submitted dozens of apartheid-related shareholder resolutions to corporate boards, and met with success after success. When apartheid collapsed, the funds took much credit. The New York City funds, along with the same church groups and endowments, then successfully lobbied corporations with business ties to Northern Ireland to fight employer discrimination against Catholics in that region.

Paradoxically, Nycers’s first big activist failure set going a chain of events that ended by radically expanding the scope for such shareholder activism. In 1991, the Cracker Barrel restaurant chain banned gay employees—and fired nearly a dozen of them for “failing to demonstrate normal heterosexual values.” Nycers, sensing its chance to drill down to corporate micromanagement, submitted a shareholder resolution to Cracker Barrel’s corporate parent, CBRL Group, in 1992, targeting the chain’s discriminatory policy. The Securities and Exchange Commission (SEC), which determines which proposals reach corporate ballots for shareholder votes, ruled against Nycers, declaring that the decision to exclude gays was an “ordinary” business decision, not subject to shareholder review. The SEC said that the line between corporate governance and micromanagement was becoming blurred—but its decision proved that it still believed that there was a line and that corporate honchos were free to make their own management decisions, good or bad.

But in 1998, in response to sustained lobbying by the public-sector pension funds, the SEC announced that it would reverse its Cracker Barrel rule and force corporations to include shareholder proposals on some employment-related issues on a case-by-case basis. Shareholders should have a chance “to express their views to company management on employment-related proposals that raise sufficiently significant social issues,” the SEC said. So here was the green light to the public-sector funds, which had been trying to force “fair-labor”—that is, pro-union—practices on corporate America for years.

In the wake of the corporate scandals of the past three years, Congress, the SEC, and the New York Stock Exchange have enacted the most sweeping corporate-governance changes since the Securities Acts of 1933 and 1934—changes that public-sector shareholders took as an all-out, let-’er-rip license for activism. The Sarbanes-Oxley law, in addition to making corporate executives personally liable for the accuracy of their financial statements, also mandates that a company be governed by a board of directors mostly independent of management, to prevent cronyism from nurturing the systemic fraud that sank Enron and WorldCom. Since Sarbanes-Oxley became law two years ago, Nycers and Calpers have rolled out dozens of shareholder proposals targeting hundreds of companies. These resolutions cost corporate America $91 million annually just to process, estimates UCLA law professor Stephen M. Bainbridge—all in the name of shareholder democracy.

“Shareholders should start acting like the owners they are,” California treasurer and Calpers board member Phil Angelides said in 2002. “The age of investor complacency must be replaced by a new era of investor democracy.” New York comptroller Thompson made clear just how expansive he takes this mandate to be: “We must recognize that a company’s conduct with regard to areas such as the environment and human rights is just as significant in evaluating overall corporate governance as the independence of board audit committees and executive compensation.”

It’s no mystery what “area” public pension-fund trustees, most of them unionists or politicians beholden to unions, deem most “significant.” Nycers, for example, with board members from the Teamsters, the Transport Workers Union, and the DC 37 Local that represents government employees, has renewed its push for strong workers’-rights standards, this time with a global gloss. It is trying to force 21 American companies—including ExxonMobil, Home Depot, Wal-Mart, and Hasbro—to adopt the UN International Labor Organization (ILO) standards, which mandate doing business only with suppliers who allow workers to form and join unions, prohibit child labor and forced labor, and bar discrimination and intimidation. The ILO also pushes for an “adequate living wage” globally, just as unions and public officials do on the local level, and it mandates that a certain number of its own staffers be women.

The ILO standards may be a nice idea—but in real life, they may hurt those they’re meant to help. The New York Times’s Nicholas Kristof, no right-winger, said as much in an April 2004 column about a ten-year-old African boy who spent his day foraging for wood to sell to support his family. “If child labor hawks manage to keep Abakr from working, without giving him a school to attend, he and his family will simply be poorer than ever,” Kristof wrote. At a Bangladeshi garment factory forced to lay off 50,000 children ahead of a proposed U.S. regulation on imports, Kristof noted, “Many ended up in worse jobs, like prostitution.” But further, the ILO proposal, and a Calpers human rights–based investment ban in countries like China, Pakistan, and Indonesia, pose a larger question: Why should municipal politicians have a hand in setting American foreign policy?

The pension funds have also tried to direct U.S. tax policy. In California, Treasurer Angelides has teamed up with the state’s major labor unions to fight corporate tax expatriation, targeting Tyco and Ingersoll-Rand (each incorporated in Bermuda). But it is the U.S. Treasury’s job, not that of a union-based pension fund, to ensure that corporations don’t use shell companies to avoid or evade taxes. And if the California and New York pension funds disapprove of Tyco for its alleged aggressive tax avoidance, why do they continue to invest in the company? Lots of other institutional investors have made the opposite decision: Tyco traded at around $60 a share during the era of Dennis Kozlowski’s compulsive scheming, and has plummeted to around $35 a share today.

For all their global and national posturing, these pension-fund trustees have a basic agenda that’s really much closer to home and much more self-interested. Take Calpers, for instance, whose board of directors was until December 31 headed by one Sean Harrigan, who moonlights as the regional executive director of one of California’s most powerful private-sector unions: the United Food and Commercial Workers Union. This tie got Calpers enmeshed in a hopeless fiduciary tangle last year, when the fund mounted a corporate proxy fight against the Safeway supermarket chain right after Safeway had resolved a four-month strike by Harrigan’s union at its California supermarkets.

Calpers, coincidentally enough, decided that this was an auspicious time to take up the cause of “shareholder value” against Safeway’s board of directors, so the fund mounted an unsuccessful campaign in mid-2004 to vote down Safeway’s chairman and CEO in the service, purportedly, of safeguarding the pension fund’s shareholder interests.

It’s true that Safeway stock is a dog—but that’s because the company must compete with low-cost upstarts like Wal-Mart while burdened by an outdated, and untenable, labor-cost structure, thanks to Harrigan’s union members. A rational investor with no confidence in Safeway’s board ahead of a cutthroat fight with looming food giant Wal-Mart would simply have sold Safeway stock (and a graph of Safeway’s downward price trajectory over the past few years shows that they have sold in droves). But if Calpers didn’t own Safeway, Harrigan (who says he recused himself from the fight) wouldn’t have had a platform to stand and fight management on. Who bears the risk of Calpers’s continued investment in the dismally performing Safeway? California’s long-suffering taxpayers do, of course.

California taxpayers shouldn’t view Harrigan’s ouster from the Calpers board as a sign that the fund is stepping back from pro-union activism, however. Trustee Rob Feckner, his likely successor, is no less incestuously involved with California Big Labor and seems determined to bar the fund from future lucrative private-equity investments in companies specializing in the privatization of public-sector jobs and services.

When the duly elected Lucia Mar school board decided—quite legally—to privatize its school-bus operations in 2000 to save taxpayers money, it laid off nearly 50 drivers, represented by the California School Employees Association (CSEA) union, who mounted an aggressive campaign to get their jobs back. Calpers’s Feckner is on the CSEA board. The CSEA and the Service Employees International Union (SEIU) pressed Calpers to divest itself of shares in companies that take over formerly public-sector jobs—and in November 2003, Calpers’s investment committee voted to reduce its investments in such companies. Calpers has also avoided new investments in companies that build or staff charter schools. “The policy [will] pave the way for other public pension funds to take similar action and send a strong anti-privatization signal to companies that try to make profits off of public services,” then–CSEA president J. J. Jelincic said after the union’s partial victory.

In New York, Nycers adopted a flat prohibition on similar investments in 2003: “Nycers will not entertain proposals that have the potential of eliminating public-sector jobs,” the fund declared. Nycers and the American Federation of State, County, and Municipal Employees (AFSCME) also teamed up last year to push Waste Management, a private sanitation firm active in New York, to “report on the effect on the company’s business strategy of measures to oppose privatization of the provision of waste collection, disposal, transfer and recycling services.” This is not corporate governance, of course, but naked special-interest activism. And let’s remember that Nycers is funded largely by the taxpayers—who have their own interest in keeping government costs down, sometimes through privatization of services.

As pro-union advocates, the public pension-fund boards have a central, irreducible conflict of interest: for them, workers always come first, rather than the success of the corporations in which they invest. And it is not only union officials on the funds’ boards who push this agenda, but also the ambitious left-leaning politicians on the boards, who are hopelessly beholden—financially and politically—to union labor. Ten of Calpers’s 13 board members are union members, union officers, or current and former politicians who depend or depended on union support and endorsement.

Board member Angelides, for example, is California’s treasurer—a statewide elected office. But he is already looking toward the next big thing: the Dem has announced that he’ll run against Governor Arnold Schwarzenegger in 2006. To win a Democratic primary, he’ll need the unions and the Democratic Party’s leftist wing behind him—and what better way to accomplish that than to use pension-fund investments as a prop?

Earlier this year, national Democrats were blowing the Abu Ghraib prison scandal way out of proportion, and Angelides used his Calpers leverage to gain precious on-air time. Calpers invests in defense contractor CACI—and CACI came under fire in the spring because an employee allegedly supervised military police at Abu Ghraib when torture allegedly took place. Angelides seized the opportunity to badger CACI president Kenneth Johnson at a public press conference. “The meeting at times resembled a hostile interrogation itself, as Angelides repeatedly interrupted Johnson,” reported the San Francisco Examiner. “You’ve been in the wrong place at the wrong time,” Angelides lashed. “Either CACI needs to get out of this line of business, or our pension funds need to get out of this company.” This was political preening in the first degree—and it also showed that fiduciary duty toward fund beneficiaries often takes a backseat to activist politicking

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New York state comptroller Alan Hevesi isn’t in quite the same league as Angelides when it comes to publicity-mongering—but he isn’t shy about twisting his own “investment concerns” to meet political ends. Back in October, Hevesi jumped headfirst into the election controversy over conservative-run Sinclair Broadcast Group, which had proposed to preempt regular programming on its television stations to show a documentary critical of candidate John Kerry. Fellow Democrat Hevesi fired off a letter to Sinclair executives to warn that running the documentary could mean lost profits from commercials—and that “bad news” reports about the broadcast could affect Sinclair’s “already poor performance.”


Hevesi fretted aloud that “Sinclair [could be] more interested in advancing its partisan political views than in protecting shareholder value”—which raises the question: Why not sell, rather than waste time writing letters and adding to “bad news”? But, of course, Hevesi’s letter won him a few days of publicity—and points for his party, when Sinclair backed off.

Despite these obvious conflicts of interest, the pension officials insist that all their efforts toward increasing shareholder democracy are in the service of that singular goal: to make sure that American companies are doing the best that they can to increase market value for all shareholders. The essential problem with this argument is that democracy, while great for governments, doesn’t belong in the corporate boardroom. Corporations are not partnerships or sole proprietorships—they are not meant to be run directly, or even indirectly, by the shareholders.

“Contrary to the democratic rhetoric of today’s shareholder activists,” writes UCLA’s Bainbridge, “limitations on shareholder voting rights are . . . as old as the corporate form itself. Separating ownership and control by vesting decision-making authority in a centralized entity distinct from the shareholders . . . is what makes the large public corporation feasible.” Investors don’t buy shares in a company’s stock because they think they can run the company better than the current management; they buy shares in a company’s stock because they believe that the current management is doing a good job and they want to get in on the profits.

Nevertheless, the SEC, trying to make up for being as asleep through the 1990s as the CIA and the FBI, has unveiled a stunning new “shareholder-access” plan that would give the public-pension funds even more power to advance their special interests within corporate America. It proposes to allow activist minority shareholders—that is, the funds—to nominate directors to a corporate board.

Currently, boards appoint their own internal nominating committees. Shareholders can’t vote against a particular nominee, but they can withhold votes from that candidate as a show of no confidence. As a last resort, if they are disgruntled (and rich) enough, they can mount, and pay for, proxy fights to encourage fellow shareholders to propose an alternative director or slate of directors, a process that has ousted entrenched and dysfunctional boards.

Now, the SEC proposes to let unhappy minority shareholders nominate their own directors—at the targeted company’s expense—if 35 percent of shareholders withhold their votes for an existing or board-nominated director as a display of no confidence. Only one group has the ability and willingness to nominate its own dissident directors: public pension funds.

The public sector can already taste the awesome potential of this new power and has been ferociously lobbying for it, with full-page ads in the Wall Street Journal and a heavyweight letter to SEC chairman William Donaldson. Signers, including Calpers’s Angelides, Nycers’s Thompson, and New York state comptroller Hevesi, as usual, hold up Enron, WorldCom, and their fallen brethren as poster children for corporate reform—conveniently ignoring the vast majority of Fortune 500 companies that haven’t failed. In truth, the SEC’s plan will force corporations to fend off a costly plague of frivolous proxy fights just as they fend off frivolous lawsuits.

The Business Roundtable—whose members include the CEOs of 150 well-run corporations like ChevronTexaco, HP, Home Depot, and Pfizer—have pointed out the scariest defect of this scheme to the SEC: “the significant leverage [that] the rules [would] provide to special-interest organizations intent on hijacking the director election process for the explicit purpose of gaining boardroom representation of their agendas.” Guess who they mean. “Every member of the board has a fiduciary responsibility to all shareholders,” the Roundtable’s Johanna Schneider told me—not to one group of shareholders. “Board members don’t have [separate] agendas; they have a fiduciary duty.” The SEC’s proposal points the way to Germany’s failed model of mandatory board representation for workers.

Since these trustees want a direct hand in overseeing corporate America, it’s fair to ask how well they do at overseeing their own funds. The answer isn’t confidence-inspiring. They outsource the buying and selling of their investments to professional money managers, whose performance, according to a National Tax Journal study by Julia Coronado of the Federal Reserve Board, Eric Engen of the American Enterprise Institute, and Brian Knight of Brown University, was about one percentage point below that of private-sector pension funds between 1968 and 1983, and 1 to 2 percent below from 1986 and 1990 (a period during which the researchers included mutual funds in the universe of private-sector funds). A Calpers-sponsored study of 50 large municipal pension funds and 50 large corporate pension funds between 1994 and 1998 found that corporate funds returned 12.3 percent a year, while the public funds returned just 11.4 percent a year.

And the fact that the public-sector fund trustees outsource their money-management responsibilities to the private sector gives politicians a twisted excuse to meddle in the corporate affairs of the companies in which they invest. Because they stuck with the investments picked for them by the pros, public fund trustees argue, they must concentrate on ensuring that corporate executives don’t run their investments into the ground. Of course, if shareholder-resolution activism really had a positive effect on investments, the private-sector firms that actually manage the money would insist on handling that task themselves and would assign teams of people to draw up resolutions and submit them at board meetings—because the private-sector managers, not the public-sector trustees, are the ones rewarded or punished for performance.

But even if public-sector pension funds don’t perform terribly, their performance is never enough to compensate taxpayers for a massive concentrated risk that is not present in private-sector 401(k) accounts. The fact that the taxpayers guarantee to make up any pension-fund shortfalls means that in bear markets municipal governments often raise taxes or cut services to cover mushrooming pension obligations. New York City taxpayers have had to pony up nearly $2.6 billion a year since the tech bubble burst nearly four years ago, and the city’s Office of Management and Budget expects that New Yorkers will pay $4.4 billion a year to meet these obligations—nearly 9 percent of the city’s total budget—by 2008. In California, Governor Schwarzenegger is still floating “emergency” deficit bonds a year after his election to pay at least $1 billion a year in unexpected pension costs to cover chronic multibillion-dollar shortfalls. Manhattan Institute senior fellow E. J. McMahon wrote last year that the current municipal pension-fund system was “a ticking time-bomb—ready to explode again with the next market down-cycle—if it’s not reformed.”

His recipe for reform is simple and correct: New York—and other jurisdictions—should “replace [its] old-fashioned defined-benefit pension with the sort of defined-contribution plan that’s come to dominate private-sector retirement planning.” The private sector is still learning the hard way that defined-benefit pension funds are unsustainable. In November, the Pension Benefit Guaranty Corporation, a government insurance company that guarantees pensions for 44 million private-sector workers, announced that its deficit had doubled, to $23.3 billion, in just one year. The reason? Too many bankrupt firms like US Airways and LTV Corp. were unable to keep promises made long ago to employees who are retiring now.

The same thing could happen to state and local workers when the baby boomers retire in droves. Today’s municipal workers who look forward to a taxpayer-funded retirement could see benefits cut, if younger taxpayers simply refuse to shoulder double-digit tax increases to make good on luxury retirement payments promised in decades past. Defined-contribution pension plans in the public sector would protect government workers from this crisis scenario now—they’d have their retirement money safely in their own hands, not in the hands of some future politician. At the very least, cities and states could begin by offering only such plans to all new hires. Foreseeing such a possibility, Calpers in December came out unequivocally against President Bush’s proposal to allow Americans to divert a portion of their Social Security contributions into their own private accounts. After all, if Social Security is democratized through worker-owned accounts, Calpers and its East Coast counterparts will stand revealed as the unsustainable anachronisms they are.

But why should taxpayers continue to pay so that Sean Harrigan and Betsy Gotbaum can tell corporate America what to do with billions of dollars of other people’s money?