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Are institutional investors taking over the world? Maybe not, but their importance in the public policy arena is growing, enough for the Federalist Society -- you know, the conservative legal cabal of which liberals speak in hushed tones -- to notice. It's a good thing they did. A recent Federalist Society panel took up this question, "Unions as Shareholders: Doing Their Duty or Misusing Pension Fund Influence?" <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />
Before answering this question, we need to answer another: What is an institutional investment manager's fiduciary duty? Fortunately, it was addressed at this forum.
Moderator Eugene Scalia, an attorney at the firm Gibson, Dunn & Crutcher and former Solicitor at the Department of Labor, led off the panel by setting the historical context: In the United States, unions are in trouble. Union membership has been declining for years. Strikes are less effective as bargaining weapons. And several major unions recently disaffiliated from the AFL-CIO, signaling the largest split in organized labor since the 1930s, when several unions left the American Federation of Labor to form the Congress of Industrial Organizations.
Yet despite these troubles, Scalia pointed out, union power has been ascendant in other ways: 1) through their control of pension funds and 2) by finding "common ground" with other institutional investors, such as public employee pension funds. This has allowed unions and their political allies to introduce resolutions at public company shareholder meetings to advance a variety of goals, from changes in corporate governance to stands on public policy issues.
Unions have engaged in shareholder activism for several years, but only recently have others begun to question the practice. In fact, this was one of the rare public forums in which advocates of shareholder activism have stepped forward to defend it. Representatives from the AFL-CIO and the Council of Institutional Investors made the case for it, but their answers were unsatisfactory.
Professor Jarol Manheim of <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />George Washington University, who has written extensively on the sophisticated strategies used by modern activists, outlined the evolution of shareholder resolutions as a tactic, summing up in a quote by AFL-CIO Secretary-Treasurer Richard Trumka: "[W]e decided to organize our money the way we organize workers." The result, says Manheim, is that, "On the one hand, while [union membership] has been declining, another base of power has been increasing," through the leveraging of $3 trillion in assets in public employee and multi-employer pension funds run by boards that include union representatives.
Unions' Working Capital
A key development in unions leveraging these assets was the establishment of the AFL-CIO Center for Working Capital in 1995, the year John Sweeney became president of the federation. Before heading the AFL-CIO, Sweeney headed the stridently activist Service Employees International Union (SEIU), which perfected the strategy of the corporate campaign. Corporate campaigns are sophisticated, multi-faceted efforts waged by unions and allied groups against an employer the union seeks to organize. Tactics include feeding allegations of company wrongdoing to the news media, filing complaints with regulatory agencies, and plain old-fashioned picketing. They also include applying pressure through shareholders, including contacting stockholders to deride management and the company's financial health and leveraging the union's investment power to introduce resolutions at shareholder meetings advancing union goals. In his 1995 AFL-CIO inaugural address Sweeney proclaimed, "We will use old-fashioned mass demonstrations, as well as sophisticated corporate campaigns, to make worker rights the civil rights issue of the 1990s." Shareholder resolutions have been an important tool in this effort.
Sweeney's strategy got a huge boost in 1998, when the Securities and Exchange Commission, during the Clinton administration, revised its Rule 14a-8, to allow shareholders who meet certain floor criteria to submit resolutions and have them included in the company's proxy materials. Before 1998, companies could exclude proposals that dealt with social issues such as the environment and human rights, but in May 1998 the SEC changed the rule to allow some social policy resolutions to go before shareholders over management objections. In his book, Biz-War and the Out-of-Power Elite: The Progressive-Left Attack on the Corporation , Manheim notes that one of the driving forces behind this change were 2,000 letters to the SEC from activists.
Since 1998, leveraging union assets to assist in organizing campaigns has become a major union tactic. Indicative of the importance that it has acquired is the establishment earlier this year of SEIU Capital Strategies -- an organization with parallel functions to the AFL-CIO Center for Working Capital -- which Manheim described as a clear signal of the Service Employees' then-impending disaffiliation from the AFL-CIO.
We can expect SEIU Capital Strategies to be active in introducing resolutions. SEIU President Andrew Stern led the exodus of several dissident unions out of the AFL-CIO, including Stern's own union, the Teamsters, United Food and Commercial Workers, and the textile and hospitality union UNITE-HERE. These unions have now formed a new federation, Change to Win. And as Manheim noted, prior to leaving the AFL-CIO, the Change to Win unions introduced more than half of all shareholder resolutions in 2004, which numbered more than 200. Interestingly, a large plurality of these dealt with executive compensation -- while only four dealt with labor rights.
Expanding Fiduciary Duty
Manheim pointed out that the AFL-CIO has tried to justify shareholder activism on fiduciary duty grounds by putting the federation on record as supporting a broad definition of fiduciary duty. And this is where the definition of a pension fund manager's fiduciary duty becomes crucial.
Council of Institutional Investors (CII) Executive Director Ann Yerger gave a brief history of the rise of institutional investors. She said that, "Union funds have been remarkably successful," and that union resolutions "have been successful because they are supported by the market at large." But that still leaves open the issue of the goal of these resolutions -- to increase investors' value or advance some other goal?
AFL-CIO Associate General Counsel Damon Silvers sought to define union pension fund managers' fiduciary responsibility broadly. First he pointed out that, "There's a big difference between union and pension funds," because pension funds have one function, while unions have several functions, and that the AFL-CIO, its affiliates, and "ex-affiliates" -- the unions who bolted the old federation and formed Change to Win -- seek to maintain that distinction. By this definition, unions' fiduciary responsibility for their investments does not just address the return on those investments, but how they can advance the unions' greater goals. As Silvers said, union fund managers must ask the question, "Are these assets being managed in our interest?"
Unions' answer to this question encompasses how companies are run beyond labor-management relations. Silvers pointed out that, while a decade ago union shareholder resolutions addressed mechanisms for companies to prevent hostile takeovers, over the past decade, there has been "a shift from takeover-related work to long-term governance" -- mainly executive compensation. What does this have to do with improving investment performance? Most might say not much -- but a lot under unions' broad definition of fiduciary responsibility. As Silvers noted, the AFL-CIO's view of good corporate governance is "different" from that of a hedge fund manager, since the labor federation sees companies as "collaborative" arrangements, as more than "a bundle of contracts."
In this context, such labor-management "collaboration" can extend to a lot of things -- including expanding union membership or winning a dispute with an employer. For example, unions and allied institutional investors have used resolutions in campaigns to unionize Wal-Mart and gain a new union contract from Safeway. Said Silvers, "Wal-Mart's labor practices are of great interest to the labor movement and we care a great deal about them."
Michael Collins, like Scalia, an attorney at the firm Gibson, Dunn & Crutcher, provided a better definition of fiduciary duty. And it just happens to be codified in law. The 1974 Employee Retirement Income Security Act (ERISA) , which regulates private pension and health plans, defines fund managers' fiduciary duties  along two principles:
1) Prudence, which Collins described as a "prudent man acting in a like capacity." According to the Department of Labor website, under ERISA, "Fiduciaries must act prudently and must diversify the plan's investments in order to minimize the risks of large losses."
2) Exclusive benefit of the participants; by this criterion, fund managers cannot subordinate the interests of plan participants in their retirement income to unrelated objectives.
Collins pointed out that social investing may be acceptable under ERISA, but should be subject to ERISA fiduciary standards -- that is, the value of the investments should not be subordinated to unrelated objectives. Shareholder activism -- such as, for example, divestiture from companies that do business in certain countries -- can be consistent with fiduciary duties if the responsible fiduciary concludes that there is a reasonable expectation that the action is likely to enhance the value of the plan's investments after taking into account the costs involved, argues Collins.
This sounds generally agreeable to most people. Indeed, said the AFL-CIO's Silvers, "In general, management trustees, like union trustees, are concerned about the prudence of the investments that they make." But it's when we get down to specifics that the issue of what constitutes a proper shareholder action becomes contentious.
During the discussion section of the panel, moderator Scalia cited a chapter from Working Capital: The Power of Labor's Pensions , in which author Marleen O'Connor argues that shareholder activism can aid union negotiations with management by pushing resolutions on "wedge issues," and, if negotiations proceed as the union wants, the resolutions may be withdrawn.
Manheim, concurs, seeing a close relationship between labor negotiations and union shareholder resolutions, which function as part of a broader corporate campaigns to identify pressure points that can be leveraged against the company.
Again, the AFL-CIO's Silvers seemed to broaden the definition of fiduciary duty. "One may disagree with our analysis of what constitutes healthy corporate governance," he said, but the federation's aim, he said, is to benefit employees as well as shareholders.
The panelists discussed the example of the grocery store chain Safeway. Safeway faced a strike in Southern California a year ago over health care benefits. Silvers claimed that, "Safeway had a series of governance problems;" but given the resolutions' timing and context, pushing the employer toward an agreement favorable to the union seems a more likely motive. The resolutions in this campaign, in which Yerger acknowledged CII played a major role, centered around alleged conflicts of interest stemming from some Safeway directors' ties to the buyout firm Kohlberg Kravis Roberts & Company, which took Safeway private during the 1980s. The resolutions were introduced by public employee pension fund managers -- union funds' best allies today -- from 10 states.
"Virtually No Limit" to Resolutions
The tone of the discussion remained civil throughout, so any strong language was noticeable. This came when the AFL-CIO's Silvers dismissed a letter that the federation received from the Department of Labor that said that efforts to leverage union pension funds to push companies to not support President Bush's Social Security reform plan were not appropriate. The letter, he said, had "no basis at all." Why the strong reaction?
Earlier this year, the AFL-CIO successfully pressured some banks and brokerage firms to distance themselves from organizations supportive of the Bush Social Security plan to create private accounts. In a letter to AFL-CIO General Counsel Jonathan Hiatt dated May 3, 2005, Department of Labor Deputy Assistant Secretary for Program Operations Alan Lebowitz stated that, "The Department reiterates its view that plan fiduciaries may not increase expenses, sacrifice investment returns or reduce the security of plan benefits in order to promote collateral goals." According to The New York Times, the unions' anti-Social Security reform campaign also involved protest rallies in New York, Washington, San Francisco, and 70 other cities.
Rep. John Boehner (R-OH), chairman of the House Education and the Workforce Committee, supported the DOL position that union pension fund managers would be in violation of the law if they threatened to withdraw funds from a firm "simply because it has a differing view on the importance of reforming Social Security."
At the time, Silvers said that the Labor Department had acknowledged the AFL-CIO's position that it could take a company's stance on Social Security reform when choosing between those that were "better than or equal to" alternative fund managers, and called the letter "an effort to enlist the Department of Labor in a punitive expedition designed to prevent workers and their unions from exercising their First Amendment rights."
But the DOL letter's main concern was over the AFL-CIO "using pension plan assets to pay for communications to plan participants on options to reform Social Security," which would constitute a violation of fund managers' fiduciary responsibility to "act solely in the interest of participants and beneficiaries and for the exclusive purpose of paying benefits and defraying reasonable administrative expenses."
The AFL-CIO claimed that Social Security reform could impact pension funds. While that may be the case, Lebowitz rightly points out that:
"If a fiduciary could characterize an 'educational' expense as 'plan management' merely by positing some connection between the particular policy at issue and the broad economic interests of ERISA-covered plans, there would be virtually no limit to the range of such expenses that would be permissible. Federal policies concerning public debt, trade, exchange rates, interest rates, housing, the environment, labor, tax law, antitrust law, bankruptcy law, criminal law, civil rights, and myriad other matters have important effects on the economy and economic actors such as ERISA- covered benefit plans."
Lebowitz notes that it is appropriate to communicate the effects of specific policies to plan participants, since these affect their investments' value directly. "Giving plan participants information directly relevant to particular plan choices, however, is very different from expressing views or providing information concerning broad issues of public policy like Social Security reform."
And what about the First Amendment rights of union members who support the President's plan? For those in the 28 states that do not prohibit union membership as a precondition for employment, this is a case of forced speech for a position they do not hold.
Politicizing Public Companies
But back to the core issue of fiduciary duty: It is questionable that wholesale use of funds to pressure companies on public policy issues would not eventually subordinate shareholder value to secondary goals.
Naturally, the question of whether union pension funds are fulfilling or flouting their fiduciary duty by engaging in shareholder activism was not resolved at this forum. But one thing became clear: Institutional investors may not be taking over the world, but their growing influence will make the definition of fiduciary duty an important issue in social policy for the foreseeable future. No matter what definition of fiduciary duty fund managers come to accept, unions will likely continue to play by their own broad definition, one that is likely to politicize public companies. That would be a bad deal for investors, managers, and employees.
Thanks to John Berlau and Katie Frohmann for their assistance in research for this article.