Gov. Arnold Schwarzenegger’s controversial proposal to privatize California’s two giant pension funds is designed to help reduce the state’s $9.1 billion budget deficit without raising new taxes by cutting benefits and shifting liability for investment decisions to risk-averse state employees.
Last week, the board of the California Public Employees’ Retirement System, the largest pension fund in the U.S., rejected the governor’s plan to move public workers into individual investment accounts beginning in July 2007. Earlier this month, Schwarzenegger fired four appointees to the California State Teachers Retirement System who had voted against his privatization plan for that pension fund.
This year, the governor faces $2.6 billion in required payments to the two pension funds, up from $160 million in 2000. But neither Calpers, with 1.2 million members and $182 billion in assets, nor CalStrs, with 1.4 million members and $126 billion in assets, are in a financial crunch. The payments represent the unfunded liability of the systems based on a formula; the potential shortages they represent wouldn’t occur for years.
The issue is further muddled because none of CalStrs’ members and only one-third of Calpers’ members pay into Social Security.
Many supporters of privatization blame the situation on Democratic legislators and former Gov. Gray Davis, who approved a slew of bills in 1999 and 2000 that increased retirement benefits for public employees and gave more control over payouts to localities.
The cities of Oakland and San Diego, along with Contra Costa County, face huge unfunded pension liabilities because they approved benefit increases at the height of the stock market.
Orange County Supervisor Lou Correa, a former Democratic Assemblyman from Santa Ana who authored one of the bills, said its original goal was to give local authorities the ability to negotiate with unions. “This is about a major public policy shift where you place the risk of retirement back onto the workers,” he said.
Steve Frates, a senior fellow at the Rose Institute at Claremont McKenna College, supports privatization. “What are the priorities for the citizens of California a wealth transfer to public employees or providing goods and services to citizens?” he said.
Schwarzenegger wants the state Legislature to propose a constitutional amendment that would place public employees hired after July 2007 into individual retirement accounts, with local school districts contributing matching funds. The changes would not affect retirees. Existing employees would be “allowed” to shift into defined-contribution plans, according to language in the bill proposed by Assemblyman Keith Richman, R-Granada Hills.
In the absence of legislative action, the governor plans to use the initiative process to bypass the Legislature and get citizens to vote directly on the issue.
Both Calpers and CalStrs are legally limited in their ability to mobilize their members against a ballot initiative because they act solely at the discretion of their board members.
Sanford Jacoby, a management professor at UCLA, said privatizing public pensions would create massive personnel problems for the state and have a radical impact on the education system. State-funded pensions were created in the 1930s to entice highly-educated employees into low-paying public sector jobs, he said.
“These white-collar employees are supposed to get a pension to make up for the fact that pay in the public sector is not as high as pay in the private sector,” he said. “This might be a short-term solution that creates long-term personnel problems.”
Kate Berry
New Scandal
The NASD complaint filed last week against mutual fund giant American Funds Distributors Inc. is expected to spark additional probes and possibly class-action claims against the mutual fund industry, with a renewed focus on rules that govern relationships with brokerage firms.
The allegations against American Funds, a unit of Capital Group Cos., depend in part on details the company gave NASD investigators as part of a review of a practice known as “directed brokerage,” which was banned late last year to prevent mutual funds from using brokerage commissions to pay for the distribution of their shares.
The NASD claims American Funds paid $100 million in commissions to 50 brokerage firms over a three-year period starting in 2001. At issue is whether the mutual fund firm steered a percentage of stock market trades to brokerage firms that were top sellers of its own funds.
American Funds plans to challenge the complaint on the grounds that paying commissions to brokerage firms constitutes a “non-binding” agreement, according Capital Group spokesman Chuck Freadhoff. The NASD alleges the relationships are a “quid pro quo” arrangement in which brokerage firms are paid commissions to tout some mutual funds over others. The NASD has had an anti-reciprocal rule in place since 1972.
Perrie Weiner, national co-chairman of the securities group at law firm DLA Piper Rudnick Gray Cary, said the NASD complaint has no merit.
“This is an indictment of the entire mutual fund industry,” Weiner said. “There is no rule that I’m aware of that prohibits members of the NASD from considering sales of shares as a factor in the selection of broker-dealers to execute stock trades.”
The complaint sheds new light on the NASD investigation process and on the practice of kickbacks in the mutual fund industry.
Unlike Securities and Exchange Commission investigations into “market timing” and illegal after-hour mutual trades, the NASD complaint does not accuse American Funds of failing to execute the best trades for its customers. NASD has jurisdiction over American Funds but not over its parent company, Capital Group, the financial advisor that determines which brokerage firms will execute trades.
“What they’re alleging is that a broker or financial advisor may have had an incentive to put a client in an American fund because the broker’s firm expected to gain brokerage business,” said Freadhoff. “There was never a quid pro quo.”
The complaint alleges that American Funds arranged for Capital Group to direct $71 million in commissions to 20 of its top-selling brokerage firms with commissions ranging from $490,000 to $11 million. In addition, the company paid $29 million in “step out” trades to a third-party broker even though the commission ultimately was steered to reward another firm. Those commissions ranged from $112,000 to $5.4 million.
In December, American Funds was one of seven mutual fund firms named by brokerage firm Edward Jones & Co. as part of its $75 million settlement agreement with the SEC.
Edward Jones claimed it received $27.2 million in fees from American Funds in the first 11 months of 2004 to recommend its funds over others. American Funds accounted for more than half of Edward Jones’ mutual fund sales last year.
Kate Berry
