Public pension funds provide retirement benefits for government employees, such as firefighters, teachers, and police officers. In the United States, the pension funds of state employees are typically managed by a board of trustees that is generally comprised of investment professionals, beneficiary representatives, and individuals appointed by state elected officials. (Fund governance structures vary somewhat from state to state.) These trustees then exert tremendous influence over the allocation of pension assets to different investment vehicles, such as private equity and hedge funds. While individual pension funds vary in size, the total amount of money involved is enormous: Public pension fund managers in the United States are responsible for allocating over $5.5 trillion in assets across different investment vehicles.
How pension managers select among different investment opportunities remains a largely opaque process. This lack of transparency—coupled with broad investment discretion—fosters a substantial risk of corruption. Such corruption can take several different forms:
- First, pension managers have been known to accept bribes in exchange for directing pension assets into certain external investment managers. In one particularly notorious example, while Navnoor Kang was serving as a manager for the New York State Common Retirement Fund, he channeled billions of state pension fund assets into two broker-dealers in exchange for “cocaine, prostitutes, event tickets, travel and luxury items, as well as cash to pay for strippers and other personal expenses.”
- Second, pension managers can influence the allocation of assets into investments in which the managers have a pre-existing financial interest. For example, an ongoing SEC and FBI probe into alleged misconduct by managers of the Pennsylvania’s Public School Employees’ Retirement System (PSERS) is investigating, among other things, PSERS’ $1.6 million acquisition of a Pennsylvania property managed by a real estate company in which the PSERS’ CIO and two staff members sit on the board of directors. While the PSERS’ managers received no direct compensation for the sale, they presumably receive salaries for their service on the board.
- Third, state pension investment decisions are susceptible to unsavory political influence. As noted above, state elected officials typically appoint individuals to serve on the pension fund’s board of trustees. While such political appointments can serve the interest in democratic accountability, political influence over funds can open the door to other forms of corruption, or, at the very least, the appearance of corruption. For example, in 2013, associates of a venture capital firm called EnCap Investments made financial contributions to the election campaigns of officials in Texas, Indiana, and Wisconsin who had influence over the composition of public pension fund governing boards in those states. Between 2004 and 2015, Texas public pension funds collectively invested $2.27 billion in EnCap, while the Indiana Public Retirement System and the State of Wisconsin Investment Board also invested $363 million and $212.5 million in EnCap, respectively. More generally, a quantitative analysis of state pension fund equity holdings has found evidence that state pension funds tend to overinvest in firms that make contributions to state politicians. While not conclusive evidence of corruption, this finding is at the very least troubling indirect evidence of improper influence over fund management.
In short, state pension funds are susceptible to unscrupulous actors reaping private gains at the expense of state employee pension beneficiaries. The stakes here are significant: Many pension funds are already facing looming funding shortfalls, and poor investment decisions by fund managers could wipe billions from state employees’ retirement plans. It is therefore vital that the US federal and state governments take more aggressive steps to ensure that the management of these funds is free from bribery, self-dealing, and improper political influence, so that all investment decisions are made so as to promote the best interest of the funds’ beneficiaries.
Reforms to improve the integrity and transparency of state public pension funds’ governance can and should include the following measures:
- The federal government should engage in greater oversight of state-governed pension funds, for example by imposing a blanket prohibition on pension managers engaging in transactions where they have a conflict of interest (a requirement that federal law already imposes on private pension funds) and making the exchange of goods and services in breach of fiduciary duties a federal criminal offense. (Right now, though the federal government does sometimes prosecute egregious cases of bribery of state pension fund managers, the government must rely on other laws and legal theories. In the case of Navnoor Kang, for example, DOJ prosecutors charged him with securities fraud and wire fraud—in essence, prosecuting him for failing to disclose the bribes he had received, rather than the bribery itself.) A federal regulatory scheme for public pensions would broaden the arsenal of tools for regulators to ensure adequate oversight.
- State pension funds should also be subject to a uniform set of transparency requirements that would mandate, among other things, disclosure of the source and size of investment expenses. Such transparency would make it easier for beneficiaries to identify cases in which a pension fund manager may have been unduly influenced by factors unrelated to the beneficiaries’ best interests.
- States should also reform their pension funds’ governance structures, specifically addressing the risk of excessive political influence on the selection of pension managers and trustees. The selection of these fiduciaries should be based on factors that will promote the fund’s investment objectives and serve the best interests of pension beneficiaries. For example, appointment criteria should prioritize candidates’ investment experience and proven track records, rather than political ties. States should also consider imposing a hard cap on the number of political appointments by state-elected officials to the board. These measures would not only mitigate corruption risk but would also likely bolster investment performance.
U.S. public pension funds face a variety of challenges in light of recent market volatility, rising inflation, and a growing number of retiring plan beneficiaries. While many of the risks facing public pensions are unavoidable, the risks associated with corruption can be controlled and mitigated, so long as federal and state regulators take proactive steps. Doing so is imperative if the government is to keep the promise it has made to its employees.
Thanks for drawing attention to the risks of corruption in public pension funds. Given the amount of money at stake, the corruption risks seem real. I did wonder how big the corruption problem is in the industry. That said, your suggestions of greater federal oversight, transparency, and improved governance would go a long way to ensuring the integrity of public pension plans. Even if the worst offenses are limited, these reforms would still address softer forms of corruption/conflicts of interest that can nonetheless have real negative consequences for pension plans’ performance.
Wonderful post. One thing that caught my attention was your final suggestion that states take steps to curb the risk of political influence in the selection of pension managers. You say that appointment criteria should prioritize the investment experience of appointees, which certainly seems fair. However, I wonder if this might not create an interesting dilemma: it could be that experienced investors with proven track records are the ones who are financially equipped to exert political influence (e.g., through donations), and so when it comes time to select pension managers, the most experienced candidates are precisely the ones who were able to donate in the first place. I don’t think this undermines your suggestion, but I do wonder how you might respond to the possibility that, with investment managers, experience/success and the ability to wield political influence frequently overlap.
Hi Logan, thanks for the thoughtful reply! There is a risk that a pension manager receives their appointment as a political favor from an elected official that they have previously donated to (which would like you said be more feasible to the extent they had more money from prior work experience). However, I have not come across much evidence of this so far. Additionally, the consequences of this appointment, granted that the individual does have a strong track record, may not be as severe as other forms of corruption that more directly impact the flow of pension funds assets.
Great piece and should be of interest to everyone. I think you’re right that transparency will help; you can count on whistle blowers to sound the alarm . . .