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California's New "Thermal Coal" Divestment Law Forces Fiduciary Duty Question

Public pension funds exist to provide retirement benefits to public employees.  Cal. Const. Art. XVI, § 17(a).  In 1992, the voters of California tried to eliminate political interference with the state's retirement funds by enacting Proposition 162, the California Pension Protection Act of 1992.  One of the express purposes of the Pension Protection Act was to "to ensure that the assets of public pension systems are used exclusively for the purpose of efficiently and promptly providing benefits and services to participants of these systems, and not for other purposes."  Act, § 2 (emphasis added).  However, the Act also amended the Constitution to provide "The Legislature may by statute continue to prohibit certain investments by a retirement board where it is in the public interest to do so, and provided that the prohibition satisfies the standards of fiduciary care and loyalty required of a retirement board pursuant to this section."  Cal. Const. Art. XVI, § 17(g).

A bill, SB 185 (De León), signed by Governor Brown last week directs CalPERS and CalSTRS to liquidate their holdings in publicly traded "thermal coal" companies by July 1, 2017.  The new law also (not surprisingly) prohibits new investments in those companies. The legislature, however, included a significant exception.  The statute provides that it does not require a fund's board of administration to take action unless it determines in good faith that the action is "consistent with the fiduciary responsibilities of the board described in Section 17 of Article XVI of the California Constitution".

If CalPERS addresses the statute with intellectual honesty, it should consider the following conclusion of its own investment adviser with respect to CalPERS' previous divestment activities:

Wilshire Associates concludes that the generally accepted academic argument is that limiting the opportunity set for investments has a deleterious impact on performance over long periods of time. For example, over a market cycle, a portfolio that can choose from all 500 stocks in the S&P 500 should outperform one that can only select from 450 stocks. The analyses contained in this report generally confirm this argument, with a few exceptions.

CalPERS apparently already agrees with this conclusion as its existing divestment policy provides:

Divesting appears to almost invariably harm investment performance, such as by causing transaction costs (e.g., the cost of selling assets and reinvesting the proceeds) and compromising investment strategies.

Despite these cautionary notes, CalPERS' staff may have prejudged the question in favor of divestment.  A proposed timeline included in the agenda for next week's Investment Committee meeting provides for "CalPERS Board approval to liquidate applicable securities pursuant to fiduciary responsibility" by July 1, 2017.


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30172DBAB0084D3A8F39D7AF0A8E79BC.ashx Keith Paul Bishop
Partner at Allen Matkins
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