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Defining state investment fund reform

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By The Staff

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. There were hundreds of lawsuits in an effort to retrieve squandered funds, and lawmakers responded by passing the Sarbanes-Oxley act. The time for New Mexico to pass similar legislation is now.

Currently, a similar crisis faces state pension and investment funds across the country and here 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 one percent of performance nationwide, down a whopping $2 billion. Like those affected by Enron, our citizens and state should press 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 tenant 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, but 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 lays the root cause of systematic 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 (out of $35 million) of the SIC budget – is 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 serious conflicts of interest. Considering our state funds manage $30 billion-plus dollars, it is crucial that we build into law real accountability and transparency in our state funds.

Further, our investment fund boards lack basic qualification requirements. In Senate hearings we have heard testimony from top state fund officials who state 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 and commercial backed mortgage securities, etc. In the private sector, individuals are not permitted to invest in most of these unless they are “qualified investors” or have various certifications, yet we allow our 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 the requisite talent in-house, 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 and fiduciary requirements are all virtually non-existent in our state laws.

Legislation, which is now making its way through the 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 passing comprehensive investment fund reform, the first of what will likely follow in other states facing similar crises.

 

Senator Tim Keller, D-Alb., spent many years working in private equity, investment banking and corporate governance and is the sponsor of SB 18 for comprehensive investment fund reform.