The Private Equity Conundrum

A recent article in the Wall Street Journal notes the apparent conflict of public pension fund investments in private equity. The article points to the fact that certain labor unions, including the Service Employees International Union (SEIU), have criticized private equity funds while their members sit on boards which authorize investments in such funds. A specific example citied is the Ohio Public Employees Retirement System, which includes a representative of SEIU among its Board members, having increased its targeted private equity holdings. The article goes on to point out TV spots funded by the American Federation of State, County and Municipal Employees (AFSCME) which criticize Republican presidential candidate Mitt Romney regarding his tenure at Bain Consulting.

The piece touches on two issues of particular interest. First, public funds were clearly late to the private equity party. The article states that public funds missed the 1980s private equity boon “fearing the unknown.” While this may have been true in some cases, it ignores the fact that many state and local funds operated under enabling legislation that did not authorize private equity investment and, in some cases, actually prohibited such investments. (By contrast, while there are some limitations on private equity investment under ERISA, it has never been prohibited for private pension funds.)

A second, more pressing issue is the nature of a “representative” trustee’s duty. The article suggests that if a trustee is the representative of a specific group, e.g. bargaining unit, police officers, retirees, etc., then that trustee should adhere to the positions of that group in the exercise of his or her fiduciary duties. This is a plainly incorrect. In our fiduciary training sessions, we stress that each trustee, regardless of the origins of appointment, has an overriding duty to act “solely in the interests of participants and beneficiaries,” commonly known as the “duty of loyalty.” While a representative trustee may consider the impact of a decision on his or her “constituents,” such consideration must be subordinate to the prudent exercise of fiduciary duty to the fund membership as a whole. In both the public fund and ERISA context, this duty is clear. See Sec. 7 of the Model Rules for Public Employee Retirement Systems Act and Sec. 404(a)(1) of ERISA. Viewed from this perspective, this apparent “conflict” can, and in fact does, go away.