Wednesday, March 24, 2010

What is State Investment Fund Reform?


By Sen. Timothy M. Keller

Almost 10 years ago, our country was coping with a series of corporate accountability crises in the wake of Enron, World Com and other breakdowns in organizational governance. Widespread public outcry led to responses through our legal system and in Congress. Hundreds of lawsuits were filed in an effort to retrieve squandered funds and lawmakers responded by passing the Sarbanes Oxley Act. It’s now time for New Mexico to act.

Currently, a similar crisis faces state pension and investment funds across the country and at home in New Mexico. Our State Investment Council (SIC) has been drained by scandal costing over $5 million in legal fees. State funds finished 2009 in the very bottom 1 percent of performance nationwide, down a whopping $2 billion. Like those affected by Enron, our citizens and state should push legal actions to get our money back. We must also address the state investment fund’s inherent structural flaws much like Congress did with Sarbanes Oxley to prevent further deterioration of investor confidence and improve performance.

A central tenet of good governance is to have any board of directors be as diverse in experience as possible. Much attention has been given to ideas directed at diluting the Governor’s influence on our SIC. This idea is warranted, however, it’s only the tip of the iceberg. Our state has numerous structural conflicts of interest built into statute.

In January, an independent review of New Mexico fund governance reported 40 plus recommendations for structural change issued to the Governor and Legislature. The report noted that the State Investment Officer (SIO) has sole control of decision making during the SIC, while the state investment board acts, in reality, as an “advisory” board. Herein lies the root cause of systemic conflicts of interest built into the statutes for our state investment funds.

Right now, all contractor agreements, including financial advisors and legal counsel – which amount to about 85 percent of the $35 million SIC budget -- are at the sole discretion of one person, the SIO. The SIO also has a seat on the SIC so that if they (voluntarily) decide to bring an issue to the SIC, they get to vote on the same issue they are recommending. This structure creates potential for a serious conflict of interest. Considering our state funds manage $30 billion plus dollars, it is crucial that we build into law real accountability and transparency into our state funds.

Further, our investment fund board lacks basic qualification requirements. In Senate hearings we have heard testimony from top state fund officials who declared that their board “recently learned how to read a prospectus,” and “have E*TRADE accounts,” and “used to work at local bank;” as examples of “expertise.” In the professional investment world, these kinds of statements show an embarrassing lack of understanding.

Successful modern investing translates into a keen understanding of “alternative investments.” These are not traditional stocks and bonds; they are private equity, venture capital, derivatives, hedge funds, commercial backed mortgage securities, etc. In the private sector, individuals are not permitted to invest in most of these unless they are a “qualified investor” nor have various certifications, yet we allow or state funds to be invested in them by a board that has almost zero experience in these areas. Faced with the choices of not investing in these types of assets or hiring in house the requisite talent, we rely on almost 40 different advisors to make decisions for us.

Lastly, basic governance concepts such as quorum rules, transparency rules, vice chairman requirements, attendance requirements, designee rules, government conduct act provisions and fiduciary requirements are all virtually non-existent in our state laws.

A proposal, which is now making its way through our state Senate, includes many provisions to specifically address these glaring weaknesses. These changes are imperative in order to ensure best practices in investment bodies. In doing so, this will improve and protect objectivity and independence in investments, foster greater public confidence, establish structural and institutional confidence and promote honest and ethical conduct.

Our state funds, in addition to tax revenue, are the basis for our annual budget and are the $30 billion endowment for our state’s educational services. I hope New Mexico can lead the way in enacting comprehensive investment fund reform.
Keller (D-Bernalillo-17) is a state senator who previously worked in private equity, investment banking and corporate governance.
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