Legislature(1995 - 1996)
03/21/1996 08:00 AM STA
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
HB 345 - PENSION INVESTMENT BOARD PROCUREMENTS The first order of business to come before the House State Affairs Committee was HB 345. CHAIR JEANNETTE JAMES called on John Walsh, Legislative Assistant to Representative Richard Foster, to present the sponsor statement. Number 0050 JOHN WALSH, Legislative Assistant to Representative Richard Foster, read the following statement into the record. "HB 345; An Act Relating to the Procurement of Investment and Brokerage Services by the Alaska State Pension Investment Board. "House Bill 345 simply requires that the Alaska Pension Investment Board `increase the utilization of brokerage and investment services provided by persons located in the state to at least seven percent of the brokerage services procured by the board.' Additionally, there is a provision to allow the board to `opt' out upon a written finding that the seven percent goal is unattainable. "In support of the bill, I would merely reiterate the findings section of the legislation wherein the case is made for a healthy, competitive private sector; the need to review state procurement practices and support a local procurement process; and most importantly, the need for all state agencies and state resources to be directed toward improving the statewide economy. "For the record, it is not the intent of the sponsor to jeopardize in any way the integrity of these investment funds." MR. WALSH said he would be available for any questions. CHAIR JAMES called on the first witness in Juneau, Jim Crawford. Number 0341 JIM CRAWFORD, President and Chief Executive Officer, City Commerce Corporation, referred the committee members to a graph titled, "Alaska's Economy since Statehood - Employment." He explained employment was the best way to judge an economy on a statewide basis. There were many misconceptions about Alaska's economy, therefore, affecting the stability of instate investments. The graph indicated employment was a continual plot for Alaska. MR. CRAWFORD further referred the committee members to a graph titled, "Employment - Trendlines: 1978 - 1994 (Alaska, Texas, California and New York.)" The trend line for Alaska was more positive compared to the other states. MR. CRAWFORD further referred the committee members to a graph titled, "Employment - Actual: 1978 - 1994 (Alaska, Texas, California and New York.)" The graph indicated a cyclical economy for all the states. This was contrary to popular belief that Alaska's economy was more cyclical than other states. MR. CRAWFORD further referred the committee members to a graph titled, "Housing - Trendlines: 1985 - 1994 (Anchorage, Dallas, Los Angeles and New York.)" The graph indicated a greater housing risk in the other cities compared to Anchorage. MR. CRAWFORD further referred the committee members to a graph titled, "State of Alaska Permanent Fund - Income and State Oil Revenues." MR. CRAWFORD referred to a handout titled, "State of Washington - State Investment Board Real Estate Investment Plan." He explained Washington cut back their allocation of real estate from 78 percent to 44 percent. The state of Washington invested in its own state and region. The state of Oregon put mortgage money into the state alone. The state of Texas put 50 percent of its entire fund into real estate instate. There was a pattern in other states to support the local economy with an excellent return. MR. CRAWFORD further referred to a handout titled, "Apartment Financing Comparison." He suggested reducing apartment rates by 15 percent to connect Alaska to long-term money. Alaska's apartments and commercial buildings were financed on short-term loans with short amortization and higher interest rates, by 2.5 percent. MR. CRAWFORD asked the committee members to pass the bill forward to the House Finance Committee for further consideration. He called the bill a critical component to expand the local economy. CHAIR JAMES called on the next witness in Juneau, David Schwantes. Number 0695 DAVID SCHWANTES expressed his opposition to HB 345. He said currently, if a person wanted to make a presentation to the board, he was allowed. Furthermore, to require a 7 percent investment was a disservice. The board was elected to do the best job that it could do. Therefore, if a presentation was made and the board felt it was good for the people, it would be adopted. MR. SCHWANTES referred the committee members to page 2, lines 30 - 31; and page 3, lines 1 - 2, and read, "unless the board makes a written finding that the board is unable to meet this goal because there is insufficient number of persons with the requisite skill in the state to perform the service." He said there were many people in Alaska that had the skill, but he wondered if they provided the best quality. He reiterated the board would accept a presentation if it was the best quality for the people that it served. The bill, however, would require the use of that investment, even if there was a better one. Therefore, he reiterated, he was opposed to HB 345. Number 0860 CHAIR JAMES stated she was surprised to hear testimony against HB 345 because the public expressed dissatisfaction that funds were not being invested in the state. She wondered, if Mr. Schwantes had any confidence in the state, according to his testimony regarding the requisite skills. She commented 7 percent was not very much. Number 0896 MR. SCHWANTES replied he did have confidence in the board that was elected to invest the funds. Therefore, if the board made a decision to invest in the state, that was fine. The board had the skills to determine if a presentation was of quality and best represented the people. CHAIR JAMES called on the next witness in Juneau, Dennis Millhouse. Number 0959 DENNIS MILLHOUSE, Owner, Trend Setters School of Beauty, expressed his support of HB 345. It was time that Alaskan money was reinvested in Alaska. He explained he got caught in the economic downturn in the late 1980's and had yet to recover. He said he hoped the bill passed so that the people who lived in Alaska and made their money in Alaska could reinvest in Alaska. He did not leave Alaska when he encountered his problems because Alaska was his home. He asked the state to loosen up and to reinvest its money to make Alaska better. CHAIR JAMES called on the next witness in Juneau, Gayle Harbo. Number 1222 GAYLE HARBO stated it was important that the board be allowed to invest the money in the best way possible to get the best return. Currently, there was not anything that prevented the board from investing 7 percent, or more, in the state of Alaska. The board was the expert, so let the board decide. She expressed her opposition to HB 345. CHAIR JAMES called on the next witness in Juneau, Gary Bader. Number 1292 GARY BADER, Chairman, Alaska State Pension Investment Board (ASPIB), explained the board was comprised of eight members - four were elected by the beneficiaries and four were appointed by the Governor. Two of the current members were appointed by Governor Hickel then reappointed by Governor Knowles. The board was interested in serving the best interest of the participants in the system. The participants were: for example, retirees, potential beneficiaries, and public entities. Moreover, the returns of the system were of a vital interest to the employee's level of comfort. It was also important to the political subdivisions that were assessed based on the earnings of the fund. If the fund did not earn as it should, the contribution rates of employers tended to go up over time. Moreover, the board created a mechanism where all of the equity trades were reported to the brokers in Alaska. It was not up to the board, however, to see that the check went directly to the brokers. He said there was an interest to invest in Alaska. The board would consider an investment in Alaska that was in the best interest of the fund. Lastly, he believed there were ways that Alaska benefitted from investments in Alaska. He cited the Alaska Housing Finance Corporation that ensured investments were placed in areas of general need. Number 1435 REPRESENTATIVE BRIAN PORTER said he did not see language in the bill that indicated 7 percent of the investment should go towards improving Alaska. The language only indicated that 7 percent of the investment services the board procured should be brokeraged through the local brokerage services. Number 1453 MR. BADER stated the bill did not require investment in Alaska as Representative Porter indicated. He was responding to earlier testimony that inferred there was a linkage between investment in Alaska and HB 345. Number 1464 REPRESENTATIVE PORTER said he assumed that there was a linkage. A local investor would have better knowledge of prudent investments in Alaska compared to an investor in New York, for example. He reiterated he did not see language in the bill that indicated this would jeopardize money. Number 1481 REPRESENTATIVE JOE GREEN asked Mr. Bader how much of the Alaska State Pension Investment Board's portfolio was invested in Alaska now? Number 1485 MR. BADER replied a very small amount of the portfolio was invested in Alaska now. Number 1512 REPRESENTATIVE GREEN asked Mr. Bader if investments were not made in Alaska because they were shakier, or the return was not as good, for example? Number 1522 MR. BADER replied he did not say the ASPIB would not invest locally. He explained an investment allocation was based upon the risk characteristics of the fund. The fund had not called for an increased allocation in real estate or mortgages, therefore, the other investments tended to be stocks and bonds, which were not instate investments. Number 1550 REPRESENTATIVE SCOTT OGAN agreed with the remarks of Representative Porter. The bill simply increased the board's utilization of brokerage and investment firms that were based in Alaska or Alaskan owned. The board could still make the calls to invest wherever it wanted. He wondered how good the investors were in Alaska. He asked, are they capable and competent enough to invest properly? Number 1593 MR. BADER stated that question would be better put to the Chief Investment Officer, Robert Storer, who would testify shortly. Number 1601 CHAIR JAMES asked Mr. Bader, what brokerage firms did the board normally use when looking to invest? Number 1608 MR. BADER replied a brokerage firm was normally selected in terms of stocks by the investment manager engaged. Furthermore, the pension fund had directed a mechanism to recapture some of the commissions back to the fund as opposed to the investment manager, for example. Number 1635 CHAIR JAMES wondered if the fund was its own broker. Number 1638 MR. BADER responded the fund was using another broker, but there was an arrangement for discounts. That did not cover the entire fund, however. CHAIR JAMES asked if that was a local broker or a broker outside of the state? MR. BADER replied that was a broker outside of the state. Number 1651 CHAIR JAMES asserted herein lied the problem. If Alaska could keep the money instate, it would not be having the financial dilemma now. She never failed to hear the people wonder why the state did not invest its own money in Alaska. She reiterated the 7 percent brokerage requirement in the bill was not an unreasonable request. CHAIR JAMES called on the next in Juneau, Michael J. Kirk. Number 1717 MICHAEL J. KIRK said he was here today on behalf of retired teachers, state employees, municipal employees and the people. He said, "If I told you how to invest the money in the piggy bank of your children, you'd be outraged." The tradition in this country was a free economy. There were no special privileges in the investment game. There was, however, in the Alaska State Constitution a prudent investor clause, of which you, the legislators, had sworn to uphold. Furthermore, he explained he had followed approximately 250 to 300 corruption pension fund cases of which the same type of pleading was heard today. He said he would love to see the money invested in the state, but not somebody else's money. "You invest your own money, they invest their own money, and I'll be darned if they tell me how to invest my savings." He referred the committee members to his handout on the Robin E. Ward's opinion column in the Anchorage Daily News and urged them to read it. He reiterated, until the prudent investor clause was changed in the Alaska State Constitution, the committee members would be violating their loyalty to it. Number 1852 REPRESENTATIVE PORTER stated he understood the position of Mr. Kirk. However, as a retired municipal employee, he felt Mr. Kirk was not talking on behalf of every retiree. Furthermore, the state put more than 50 percent of the money into the trust fund. Moreover, the investment procedures were well within state policy and guidelines. Imprudent investment was not an issue, and there was nothing in this bill that indicated anyone should make an imprudent investment. Number 1891 MR. KIRK responded the market would find its own sense of gravity. He would not object, if 100 percent were invested in the fund, for example. He reiterated the bill violated the law, and the market. REPRESENTATIVE PORTER replied, "I respectfully disagree with you." CHAIR JAMES called on the next witness in Juneau, Robert Storer, Department of Revenue (DOR). Number 1920 ROBERT STORER, Chief Investment Officer, Treasury Division, Department of Revenue, explained the DOR provided staff for the Alaska State Pension Investment Board. He said he was here primarily to answer any questions, but he did have a few observations to comment on. He referred the committee members to page 2, line 10, and read "increase the board's utilization of brokerage and investment services provided by persons located in the state to at least seven percent of the brokerage and investment services that the board procures by contract, unless the board makes a written finding that the board is unable to meet this goal because there is an insufficient number of persons with the requisite skill in the state to perform the services." He explained brokerage services were not procured by contracts in Alaska. Therefore, given the intent of this bill, he suggested changing the language. Furthermore, the ASPIB accepted fiduciary responsibility on July 1, 1993 for the retirement funds. The contract stated that they must consider the status of the funds' investments and liabilities, determine appropriate investment objectives, establish investment policies to achieve these objectives, and act only in regard to the best interests of the system's plan and beneficiaries. Moreover, the pension board was held to the prudent expert rule standard. He said he could not quiver with the intent of the bill. However, legislation that defined investment criteria, in effect, defined investment policy. Therein was his problem with the bill. Moreover, a policy did try to address the commitment that brokerage firms had made in Alaska. He explained the board balanced the Alaskan entities and the best executions through information. Information was provided on a quarterly basis by the Department of Revenue. He explained there were two different entities within a brokerage firm - retail and institutional. The DOR used the institutional entity. The institutional market was in jeopardy of downsizing, however. Furthermore, he explained 30 percent of all equity trades were through firms that had offices located in Alaska which equated to about $764,000 in commission. "Did all of that money come back to Alaska," he asked? The answer was, "no." How much? He did not know as well. "It would not be all, however." Number 2187 REPRESENTATIVE GREEN asked Mr. Storer, if the board were to use a local broker to contact an institutional broker, could the fee be shared? Number 2206 MR. STORER replied the board had committed to a commission recapture program which brought dollars back into the plan. It was intentional to not include the Alaskan firms otherwise all the commissions would come back to the department. "By excluding them, we are advantaging them in this process," he stated. REPRESENTATIVE GREEN wondered if this was double talk. MR. STORER replied, this was a "trust me" scenario. It was done intentionally so that the maximum dollars were available to firms that had offices located in Alaska. Number 2266 REPRESENTATIVE GREEN asked Mr. Storer if it was possible through institutional brokerage to direct the money? He wondered if there were additional ways to direct the money through the state. Number 2279 MR. STORER replied, "yes, you can direct money." There were implications, however. There were market impacts, for example. When directing money, it had to be in the best interest of the beneficiaries. It also had to be in the best interest of Alaska's financial community. He reiterated the institutional desks were distinctly different than the offices in Alaska. Number 2319 REPRESENTATIVE PORTER asked Mr. Storer what the current percentage the board was using for local investment brokers? Number 2324 MR. STORER replied about 30 percent of the commission dollars were executed through firms that had offices located in Alaska. The execution was not made directly through the offices in Alaska, however. REPRESENTATIVE PORTER stated that would not mean the board had exceeded the 7 percent goal. MR. STORER replied, according to the language and intent of HB 345, the answer would be 0 percent, because the commissions were not executed in Alaska. Number 2349 CHAIR JAMES stated if a firm such as Merrill Lynch, for example, had an office in Alaska, but the dealings were with the office in New York, she wondered how the money would come back to Alaska. Number 2365 MR. STORER stated money did come back to Alaska. How much, however, he could not measure. It was called the "intermurals" of Merrill Lynch. He explained as much information was provided to the local firms to receive as much commission dollars as possible in the process. It depended on the relationship of the firms, however. Number 2393 CHAIR JAMES stated she was embarrassed and disappointed that the intent of HB 345 was even an issue. Testimony today indicated to her why it was an issue, however. She said, "the public doesn't understand." She wondered if organizations were willing to tell the people why there were not willing to invest in Alaska. It was hard for her to believe there was not prudent investment available in Alaska. She reiterated her frustration with the process. MR. STORER replied, "I understand, Madame Chair." CHAIR JAMES called on the next witness in Juneau, John Cyr. Number 2460 JOHN CYR, Vice President, National Education Association - Alaska (NEA - Alaska), said the NEA - Alaska was opposed to HB 345. TAPE 96-38, SIDE B Number 0000 MR. CYR further said the board was obligated to get the best return that was possible for the fund for the state. House Bill 345 was the antithesis of faith in Alaska. If there was faith in Alaskan businesses, brokerage firms, and Alaskans, legislation would not be needed. Let the free market economy determine the best process. Number 0046 CHAIR JAMES stated she agreed with Mr. Cyr. However, there were at least eight people today that were concerned about the prudent decisions of the board. She agreed the market should set the process. There was bias, however. Furthermore, legislators had a fiduciary responsibility as well. She reiterated, if this was not an issue, the bill would not be before the committee today. CHAIR JAMES called on the first witness via teleconference in Anchorage, Ray J. Ellis. Number 0095 RAY J. ELLIS, Certified Public Accountant, Raymond J. Ellis, said he had been practicing in Alaska for over 30 years and during this time he had seen many ups and downs in the economy. He also worked with many clients to obtain financing. He explained it had become very difficult to obtain financing in Alaska. He mentioned his investment in real estate in the 1980's and the problems associated with the banks. He expressed his support of HB 345 for more opportunities for financing projects. CHAIR JAMES called on the next witness via teleconference in Anchorage, Scott Johannes. Number 0223 SCOTT JOHANNES, President, Criterion General Inc., explained as a general contractor he practiced business all over the state. He said the financing process was unique due to the rural communities in Alaska. It was hard to have comparable pricing for the banks to use for loans, therefore, the banks required stringent cash requirements. It was frustrating because the state put a lot of money into the rural communities as state funded projects, but it could not make funds accessible for private development. There were many individuals that wanted to develop but could not find the financing to get started. CHAIR JAMES called on the next witness via teleconference in Anchorage, David Gottstein. Number 0290 DAVID GOTTSTEIN, President, Dynamic Capital Management Inc., read the following statement into the record. "My name is David Gottstein. I am the president of Dynamic Capital Management, an Alaskan based investment Advisory firm specializing in large capitalization equities. I am in the market to manage other peoples' money for a fee. This includes government pension assets. On the surface, because I might gain materially from its passage, you might assume that I would favor HB 345 as it is currently written. You would be very wrong. I am also a life-long Alaskan, and I do not think the bill as written serves the residents of Alaska or would accomplish the goals intended. "Even though the intent of the proposed legislation should gain wide approval within the state, the mechanism used is fundamentally flawed on a number of issues. With more focused analysis, a much better formula could be devised. "As members of the legislature, you are charged with the difficult task of balancing your fiduciary obligations to grow and to protect the pension and other assets of state government with your obligations, as citizens charged with the general welfare of you constituencies, to seek the growth of employment opportunities for Alaska's residents. I believe the solution would be to adopt a legitimate prejudice to hire firms that can show that the bulk of their human resources, wherever possible, are located in Alaska, and that services are provided without materially sacrificing competency, performance,or competitiveness in the area of fees, charges or commissions. There are several reasons why a quota system would not establish a system of checks and balances to accomplish the goal of having a legitimate prejudice to hire such Alaskan firms. For example: "1. The legislation, currently written establishing a quota system, could result in disaster. It is important that the decision makers assigning contracts feel ownership in the outcome and performance of their decisions. By focusing the decision making process on a mandate to hire Alaskans, state decision makers are forced to abdicate their primary responsibility as fund protectors to become job creators. If a bad performance ensues from one of the marginally qualified Alaskan contractors, fiduciaries cannot be held accountable, because they were forced by statute to select from a limited pool. It would be better for all if competency did not have to take a back seat in the decision- making process. Can you imagine a standard so low that one is required to hire someone unless they are determined to be unqualified? Do you know what one calls the person who graduates last in his or her medical class? He or she is called Doctor. This path is laced with potential mines. "2. The second flaw lies within the language, not the intent. The language in part says "services provided by persons located in the state..." The potential problem here is that legally a "person" can mean a human or an entity. A company with an office in Alaska, with only an order taker, might qualify, even though personnel in other states were actually getting paid for the services. Brokerage services might appear to go through an Anchorage or Fairbanks office, but actually be credited to an institutional New York broker when determining commission income and bonuses. "3. There is also a human factor. It is obvious from the way the legislation is written that the drafters have given up on the state bureaucracy's ability to contract services without a prejudice against local hire. They have no incentive to do so. They would rather go to Phoenix to check up on a money manager than Anchorage. Attempting to beat them into submission by expecting them to adopt a new agenda and to perform it appropriately and with enthusiasm is, quite frankly, naive. Perhaps a better approach would be to convince the procurement officers that Alaskan employment "will" be a secondary, but a legitimate criteria in the selection process. Rather than cramming a process down their throats that they don't believe in, getting input from them on how to accomplish both goals simultaneously would yield better results. "4. I believe the main challenge here is to devise a method whereby the state does not suffer from using local hire but rather supports and fosters growth in an immature but potentially significant industry. Current requirements sometimes preclude the state from nurturing a promising financial services industry. Therefore, in part, we may have to deal with certain regulatory or policy issues that act to discriminate against local hire because of company size and age, or amount of assets under management. Nascent industries need help most in their early stages of development. Let me next suggest two different approaches that may work better than a quota system. "Instead of quota standards that set a minimum percentage as a goal, a peer review qualification test could be maintained that requires, at a minimum, above average competency. This could be done by inserting the language I used previously such as "to institute a legitimate prejudice policy to hire firms who can show that the bulk of the human resources engaged in providing purchased services are located in Alaska, and that services are provided without materially sacrificing competency, performance, or cost." This does not require Alaskan companies to be the best or the cheapest, but they would have to be competitive. Fiduciaries could then be required to manage the execution of the policy. "Another approach, not dissimilar from that which other institutions use as a matter of course, would be to craft a farm team program for investment managers with a relatively modest dollar commitment. This would require the trustees to engage local hire farm or test teams under guidelines they deem appropriate. The quota system recommendation came as a result of frustration within the industry. A better approach would be to tell fiduciaries that they must engage in an affirmative action plan without dictating to them how to do it. A quota system could result in significant performance issues with a marginally- performing service provider, discrediting the whole intent of the legislation. "These are just a few words on what might be a delicate subject. I would be happy to answer questions from the committee members." CHAIR JAMES called on the next witness via teleconference in Anchorage, Bob Bell. Number 0519 BOB BELL said he was an Anchorage Assembly Member and Engineer. He explained the Anchorage Assembly passed a resolution asking the financial officers to use the local brokerage firms as much as possible. He explained the hard times he experienced in the 1980's. The local financial institutions stood by him compared to the national financial institutions. Furthermore, the local brokers knew how to better invest in Alaska. He strongly supporting keeping the profits in Alaska. CHAIR JAMES announced HB 383 would no be heard today due to time constraints. It would be scheduled for to Saturday, March 23, 1996. House Bill 371 would be heard next. CHAIR JAMES called on the next witness via teleconference in Anchorage, Mano Frey. Number 0687 MANO FREY, Trustee, Alaska Laborers - Employers Retirement Fund, explained the fund was a joint trustee comprised of four management trustees, and four union trustees. The composition provided a balance for decision making. It was personally repugnant to him to have to be here today to testify to urge the ASPIB to invest in Alaska. It was beyond his comprehension that it did not meet that standard already. The Alaska Laborer's Fund had always provided a funding level for investments in Alaska. He cited the pension fund was about $400 million. It used investment advisors from outside, but directed them, as long as the investment was prudent, to look at the Alaskan market. He asserted there were prudent investment opportunities in the state of Alaska. In conclusion, he encouraged the ASPIB to make a direct investment in the state.