Jay Youngdahl — IC in the Relationship Between Pension and Benefit Fund Trustees and their Investment Advisors

The March 6, 2013 Lab seminar was led by Jay Youngdahl, Senior Fellow in the Initiative for Responsible Investing (IRI) at Harvard's Hauser Center, and Network Fellow at the Edmond J. Safra Center for Ethics. Since 2007, Youngdahl has served as independent Trustee of the Middletown Works Hourly and Salaried Union Health Care Fund (VEBA). Based on his experience as a Trustee and his studies at Harvard, Youngdahl has written a number of pieces on the issue of responsible investment and the role of trustees in such efforts. During his fellowship, Youngdahl intends to study the distorting effects of institutional corruption in the relationships of employee benefit fund trustees and their service providers.

Youngdahl began his presentation with a general overview of the structure of public and private pension funds and an explanation of the types of responsibilities and relationships that exist between trustees of funds and consultants and managers of funds. Since trustees are liable with the fiduciary duty of the funds they oversee, Youngdahl explained that his research would hone in on the activities and responsibilities of investment managers and consultants who actually administer funds and who are exempt from fiduciary liability in a fund of a fund system. When asked how institutions can mitigate corruption from arising in the public pension fund system, Youngdahl stated that redefining ambiguous ERISA statues would be a good starting point. For example, Section 404 (a) of ERISA, which enumerates the laws and regulations governing public pension fund trustees, simply states that trustees should administer funds "with the care, skill, prudence, and diligence under the circumstances then prevailing . . ." Coupled with the increasingly complex nature of public pension funding in the United States, Youngdahl argued that this type of ambiguity will only give rise to more instances of institutional corruption.

At this point in the discussion, one participant of the seminar asked why traditional contracting principles between trustees and consultants would not solve issues of ambiguity in the administration and investment of funds. Youngdahl agreed that amending contract language and clearly setting forth portfolio investment intentions can solve some instances of corruption in the industry. However, Youngdahl argued that instances of corruption are likely to get worse, because in his opinion, modern portfolio theory, understood as the ability of a portfolio to be diversified adequately to shield itself from external market pressures, has failed. To support this argument, Youngdahl pointed to the heavy losses sustained during financial meltdown of 2008-2009 as evidence that diversified portfolios were not all that they claimed to be. At this point in the discussion, one Lab participant disputed Youngdahl's position that diversified portfolio theory had been thrown into doubt. He argued that toxic assets had been injected into the financial system by corrupt institutions, but that the mere presence of these assets and institutions did not mean that the underlying framework of the system itself was flawed. He also went on to argue that modern portfolio theory never promised absolute protection from market fluctuations and externalities. There was respectful disagreement and the discussion soon carried on to the topic of corrupting relationships that develop between trustees and investment managers. Finally, Lab participants discussed the integrity of rating agencies and notions of short-termism in the stock market.