HB 81 - PERMANENT FUND BOARD MEMBERS & STAFF The first order of business to come before the House State Affairs Standing Committee was HB 81, "An Act relating to the members of the board and staff of the Alaska Permanent Fund Corporation." CHAIR JEANNETTE JAMES called on Patrick Lounsbury, Legislative Assistant to Representative Jeannette James, to present the bill. Number 0069 PATRICK LOUNSBURY, Legislative Assistant to Representative Jeannette James, stated he was here to tell the truth about HB 81 and the Alaska Permanent Fund. He explained on January 3, 1959 Alaska became the 49th state, and the state's constitution, which was approved by a public vote three years prior to statehood, became law. In 1969, the state received $900 million in bonuses from the Prudhoe Bay oil lease sale. The total unrestricted General Fund revenue was $112 million. In 1974, construction began on the Trans Alaska Pipeline System. In 1976, the voters approved by a margin of 75,588 to 38,518 for a constitutional amendment to establish the Permanent Fund. In 1980, the legislature created the Permanent Fund Corporation and approved a $900 million special appropriation to the corpus of the fund. The legislature also passed a bill that increased from 25 percent to 50 percent the Permanent Fund share in certain mineral earnings to be deposited. The legislature also approved the first version of a Permanent Fund Dividend Program-later to be ruled unconstitutional by the United States Supreme Court-while the first billionth barrel of oil rolled through the pipeline. In 1981, the legislature made a second appropriation to the Permanent Fund of $1.8 billionth. In 1982, the first Permanent Fund Dividend Check was sent to the citizens in the amount of $1,000. Also, at the request of the Board of Trustees, inflation proofing was adopted. In 1983, the Permanent Fund made its first investment in the stock market. In 1984, the assets of the corporation reached $5 billionth. In 1986, the fifth billionth barrel of oil rolled through the pipeline. In 1987, the corporation celebrated its tenth birthday with an historical rate of return of 11.5 percent. In 1989, the Permanent Fund grew to $10 billion and the legislature allowed for the non-domestic exchange of securities. In 1991, the eighth billionth barrel of oil rolled through the pipeline. In 1993, the market value of the Permanent Fund was $15 billion. In 1995, the stock portfolio of the Permanent Fund stretched to over $7 billion. In 1996, the legislature approved another appropriation of over a billion dollars to the fund. In 1997, the Permanent Fund breached over $20 billion. MR. LOUNSBURY further stated that continuity and stability were critical and vital to the fund's existence. House Bill 81 was an act relating to the board and to the staff of the Permanent Fund Corporation. It was designed to create continuity within the board and allowed for any Governor to remove members for cause. MR. LOUNSBURY explained Sec. 1 increased the board members from six to seven. The Governor would be allowed to appoint one public member at his discretion. MR. LOUNSBURY explained Sec. 2 required that at least one member would have competence and experience in investment portfolio management. MR. LOUNSBURY explained Sec. 3 was a technical change to conform with the increase in the number of public members in order that two members did not expire in the same year. Mr. Lounsbury stated, "This provision would allow the Governor to still stack the deck in the course of his term." MR. LOUNSBURY explained Sec. 4 was the heart of the bill. It allowed the Governor to remove trustees for cause. The term "cause" was defined as incompetency, misfeasance or malfeasance. Mr. Lounsbury referred the committee members to a letter dated, January 30, 1997 from a former chairman of the board, John T. Kelsey, and read, "The problems presented to new board members in the matter of `learning the system' and becoming comfortable with making important decisions of major proportions affect almost all citizens of the State of Alaska. Further, making major decisions without proper education on the operation of such a large fund could be damaging to future earnings that might very well impact budget consideration in the twenty-first century. Removing all board members, or even a majority of them, and appointing new members is unfair to those newly seated and could well adversely affect the state." MR. LOUNSBURY explained Sec. 5 was new. It required that the Governor base his decision to appoint new members solely on the best financial interest of the fund-otherwise it was an ethical violation. MR. LOUNSBURY explained Sec. 6 provided that the executive director served at the pleasure of the board for a two year period. MR. LOUNSBURY explained Sec. 7 required that each member of the board should have a fiduciary responsibility to the fund. MR. LOUNSBURY stated, in conclusion, that identical legislation passed the Alaska State Legislature with bi-partisan support last year. It passed the Senate with a vote of 16 to 4, and it passed the House of Representative with a vote of 35 to 1. In addition, the Board of Trustees urged the Governor not to veto the bill. Mr. Lounsbury stated, "Madame Chair, if this Administration continues to oppose this particular legislation, I would maintain that this Administration is open and ready for business, as usual." Number 0637 REPRESENTATIVE KIM ELTON commented he was confused about the term "cause." He assumed that a trustee who missed two out of every three meetings, for example, could be removed for cause. He asked Mr. Lounsbury what were the standards applied towards cause? MR. LOUNSBURY replied a past chairman of the board also mentioned what Representative Elton described-missed meetings. The term "cause" meant in HB 81 incompetency, intentional or unintentional failure to perform ones duties. Number 0720 REPRESENTATIVE ELTON stated he did not have a problem maintaining the integrity of the board, if the trustees were doing their expected duties. He wondered, however, if the Governor determined the cause or if the chairman of the board determined the cause. He assumed from the language in the bill that the Governor determined the cause. Number 0753 MR. LOUNSBURY replied, "Madame Chair, that's correct." The Governor would determine the cause. The Hickel Administration and the Knowles Administration wiped out the entire board except for one person. He declared, "It's just not good business to wipe out the board, put the burden on the new members, and maybe the one other member to keep this machine rolling." Number 0783 REPRESENTATIVE ELTON wondered if it would be a case of cause if the board was wiped out entirely. He reiterated there was a loose determination of cause, which was the only part of the bill that bothered him. Number 0819 CHAIR JAMES asked Representative Elton what was loose? Governor Knowles' excuse for cause could have been that Governor Hickel filled the board with political appointees, for example. House Bill 81 would preclude either Hickel or the current Governor from removing them all. The law specifically addressed cause as intentional or unintentional failure to perform one's duties. In addition, it would be up to the Governor to define the failure and to pursue a legal challenge. Number 0892 REPRESENTATIVE ELTON replied the final determination would be made by a judge who was not involved with the system. This created a situation where the best judgement of the trustees and the best judgement of the Governor would be second guessed by the best judgement of a judge. Number 0987 CHAIR JAMES wondered if Representative Elton would choose to not have the provision "for cause," therefore, creating the potential for the two situations to repeat themselves again. She asked Representative Elton which was the best way to protect the Permanent Fund? Number 1003 REPRESENTATIVE ELTON replied he would want the Governor to be responsible for making the decision because he answered directly to the people of the state of Alaska. Number 1029 MR. LOUNSBURY stated he found that the board usually took action unanimously. Last year, the board unanimously urged the Governor not to veto the bill. He had also spoken to six other prior trustees who all felt that this bill was in the best interest of the state. Number 1068 REPRESENTATIVE ETHAN BERKOWITZ explained the term "for cause" was a legal bone of contention, therefore, there was a lot of legal history and precedence attached to the term. Number 1088 CHAIR JAMES stated there were other provisions in statute that addressed the removal of the board members for cause as opposed to serving at the pleasure of the Governor. The question was whether or not it was a rational and prudent decision for it to be that way. Number 1115 REPRESENTATIVE BERKOWITZ asked Mr. Lounsbury to distinguish the term "best interest" from the term "financial best interest." Number 1138 MR. LOUNSBURY replied an interesting example was brought up during the tobacco tax hearing in the House State Affairs Standing Committee, whereby, it was stated that the Permanent Fund had about $65 million worth of Phillip Morris stock. He said, "We can all have our thoughts on how and where and why to invest our money-- turns out those are good stocks and that would be in the best financial interest of the fund." Number 1184 REPRESENTATIVE BERKOWITZ asked Mr. Lounsbury to distinguish the term "financial best interest" from the term "fiduciary duty." Number 1191 MR. LOUNSBURY replied the terms "fiduciary duty" and "financial best interest" went hand in hand. It was like a realtor's fiduciary responsibility to his clients and to the lending institutions. The trustees, therefore, had a fiduciary responsibility to the Permanent Fund, to the corporation and in turn to the state of Alaska. Number 1219 REPRESENTATIVE BERKOWITZ commented that the evolution of the term "fiduciary duty" was related to investment in South Africa during the 70's and 80's where the concept got away from a strict return on investment and began to incorporate broader social concerns. He asked Mr. Lounsbury if he would incorporate any of those developments into this definition? Number 1239 MR. LOUNSBURY replied, "Madame Chair, not being a member of the Board of Trustees, I would have a tough time answering that." Number 1267 JAMES BALDWIN, Assistant Attorney General, Governmental Affairs, Section, Civil Division, Department of Law, explained that the Governor vetoed an identical bill last year. Therefore, he wanted to review some of the points raised last year. "I thought I had you going with me on some of them, but the bill moved out of committee and received a very favorable vote on the House," he said. The most important point was the removal for "cause." "If you want to do this, it may require a constitutional amendment and the reason that I arrive at that conclusion is by looking at Article III, Sec. 26 which talks about the appointment of boards and commissions." It was the only place that provided the ability of the legislature to remove for cause. He explained that the Permanent Fund Board was created by statute to administer a constitutionally established fund. Thus, there was a strong argument to be made that the only way to provide removal for cause would be through a constitutional amendment. The power of appointment was an executive power unless given to the legislature. He cited the confirmation process as an example. The Permanent Fund Board was not a quasi-regulatory or judicial body, therefore, there was no provision for confirmation in the constitution or for removal for cause. He cited the court case of Bradner v. Hammond where, the Alaska Supreme Court ruled that unless there was a specific provision in the constitution allowing the legislature to encroach upon the power of appointment, it would not be authorized; it was not within the state's constitutional framework. "It's a hard thing to hear about the limitations on legislative power, but I think I need to convey that to you today." Number 1464 MR. BALDWIN further explained that the Administration had problems removing a board member for cause. When a board member received a salary or a property right, it was very, very difficult to remove him. "It can be so difficult that it is nearly impossible," he declared. It required a trial like proceeding, usually in front of an independent fact finder. It was also a protracted and an expensive process. It was not as simple as writing a letter as HB 81 indicated. In addition, the board members received a per diem payment of around $300. He was not conceding here on the record, however, that the per diem was a property right. Number 1566 MR. BALDWIN further stated that the Governor answered to all of the people for his appointments because he stood for election. "He's the one that has to pay the price if he makes a bad decision." That was how the system was set up and he did not want the Governor's executive powers further eroded by the bill. Number 1601 MR. BALDWIN further stated that the standards for cause were vague. The statutes under the Board of Game, the Board of Fish and other regulatory boards were fairly specific in regards to the grounds for cause. Whereas, HB 81 was very broad. He referred the committee members to page 2, lines 17-20, and read, "(2) misfeasance or malfeasance in office, which included the failure of the trustee to exercise prudent judgement in the affairs of the corporation or intentionally taking action for reasons other than the financial best interest of the corporation." MR. BALDWIN further stated that the term "financial best interest" had yet to be defined. And, it probably would not be known until it went through a few court decisions. "I don't know if that's going to service the best interest of the fund or not. Lawyers and judges attempting to define this when perhaps that should be done in the legislature." Number 1650 MR. BALDWIN referred to Sec. 6 and explained it was designed to solve a problem when there was difficulty removing a high level person due to a philosophical difference during the change from one Administration to the next. MR. BALDWIN further stated that the employees of the board were exempt. Therefore, it was difficult to remove them if not done correctly. "That's just a fact of life in employment law. It's a rapidly changing area of our law, and one where the courts are inclined to recognize the rights the people have in their job even though they may be in the exempt service." The attempt in HB 81 was to allow for the removal "at pleasure," which was the Administration's understanding of what it meant to be an exempt employee. He also said, "I think the intent here is to say it doesn't matter what. You can be out the door at 4:00 and I'm here to say that it just isn't that simple. It isn't going to do away with litigation and courts protecting the rights of people." Number 1729 MR. BALDWIN further addressed the issue of investment responsibility. He explained there were a lot of people at the corporation who did things in connection with investment. There were three or four who directly make investment policy and a lot of other people who implemented the policies. He wondered if the bill was discussing those who made policies or those who implemented them. It was broad enough to cover both. He reiterated the intent was unclear. He did not have a solution to the problem at this point, however. Number 1771 MR. BALDWIN further addressed the philosophical problem of fiduciary responsibility to the fund. He referred the committee members to page 3, lines 12-14, and read, "Each board member has a fiduciary duty to the fund, and each member shall perform official actions solely in accordance with that duty." He stated it sounded good and mirrored the language in Title 37 and Title 14 regarding the responsibilities of the pension investment board. It was also very similar to the responsibilities of the employees in the Department of Revenue in regard to the General Fund. However, there were a few concepts being mixed together. Fiduciary responsibility not only included the fund, but the beneficiaries as well. And, in this case the board members would be responsible to the state while the bill indicated that the board members were responsible to the fund. "It seems a little confusing. Who is the beneficiary here. Who do you owe your duty to. Is it just to continue the Permanent Fund, or is your fiduciary responsibility owed to the state." He reiterated, "Maybe, what you want to accomplish here would best be accomplished in a constitutional amendment that would tackle some of those issues as well. If you want to establish the Permanent Fund as a trust, which seems to be the underlying theme here, by bringing in all these references to fiduciary obligations, then it seems to me that would be a better approach in the form of a constitutional amendment with a constitutionally established board with a constitutionally established for cause removal or confirmation or for whatever the legislature wants." Number 1915 CHAIR JAMES stated that she was willing to work with the Administration to solve some of the concerns raised by Mr. Baldwin today. She did not want the Administration to follow and argue the bill again. She would look at the constitutional issue further. She did not recall that issue being discussed last year. CHAIR JAMES further stated that the Permanent Fund was the biggest and most important asset of the state. Therefore, continuity was needed for the board and removal for no particular reason should not be allowed. She also believed that at least one person on the board should have extensive knowledge regarding investment portfolio management. She also believed it was important to run the board in a smooth and efficient way. "Pulling people out for various reason can be harmful." She also believed, however, that the process to remove someone could also be destructive. She asked Mr. Baldwin what his real intent was on the bill? Number 2055 MR. BALDWIN replied the Administration did not support the bill, in its current form. The Administration was willing to work on the fringe provisions and was willing to try to find common ground surrounding the for cause issue. In addition, the Governor stated in his veto message that the constitution presented a major problem which was the main reason for the veto. Number 2113 CHAIR JAMES commented she did not understand why "for cause" was such a problem. She asked Mr. Baldwin if it was a personal thing? Did he not want to remove people and replace them? Or, Was it a constitutional problem? "We certainly can put forth a resolution to make a constitutional amendment. That's not out of the question, if that's what's required." Number 2145 MR. BALDWIN replied there were two levels of discomfort surrounding the issue of for cause. The first level was the constitutional concern. And, the second level was the near impossibility of removing someone from a board. He reiterated, "It becomes a quasi- judicial proceeding. It becomes one in which the individual is entitled to due process of law, a public hearing, a record and it's long and protracted." It would appear that if a board member was found for malfeasance, he or she should be removed immediately. TAPE 97-19, SIDE B Number 0001 CHAIR JAMES replied she found it hard to believe that the state would have such a terrible person ever serving on the board in the first place. This was a very prestigious board and she did not expect the same types of problems as other boards faced, such as, the Board of Fisheries. "This is not so political as that. In fact, this ought not to be as political as that. This ought not be political at all." Number 0042 MR. BALDWIN agreed that the people currently serving on the Board of Trustees and those that had served in the past were of the highest caliber. He was concerned about the future, however. Number 0105 REPRESENTATIVE BERKOWITZ stated the Governor should be flattered of the confidence shown for his appointments today. It appeared "for cause" was at one end of the spectrum of dismissal and "at will" was at the other end of the spectrum. He asked Mr. Baldwin what was in between? Number 0120 MR. BALDWIN replied what existed now was in between. The Governor could remove at will. The removal was done publicly and in writing. It was the middle ground reached when the corporation was created. Number 0140 CHAIR JAMES commented that the Governor did not have to say "why," however. Number 0145 MR. BALDWIN replied, according to existing law, the Governor had to state the reason for the removal in writing. MR. BALDWIN also explained that the Governor knew his appointments would be protected by the removal of the for cause provision, but it did not affect his view about the bill. Number 0168 REPRESENTATIVE BERKOWITZ asked Mr. Baldwin how the removal of the board members by Governors Hickel and Knowles affected the return on the investments? Number 0179 MR. BALDWIN replied, "I don't think it affected it at all. The Permanent Fund operated under the theory that the best people were hired. The board ultimately made the policy, and the policies were implemented by advisors, employees, and account managers. "I think you'd see the permanent fund return going steady up." Number 0211 REPRESENTATIVE BERKOWITZ asked Mr. Baldwin, if there was a conflict of investment strategy between a board and an incoming Governor, for example, would that conflict rise to a level of cause based on financial best interest? Number 0223 MR. BALDWIN replied, "I don't know." The statute did not say; it was too vague. Number 0237 REPRESENTATIVE ELTON said that Mr. Baldwin commented the additional language in Sec. 6 clouded the issue of exempt service, and he also questioned the language added in Sec. 7. He wondered if Mr. Baldwin suggested that Sec. 6 and Sec. 7 were not necessary. He saw the sections as fringe elements. Number 0292 MR. BALDWIN replied it was a policy decision to interpret the service "at pleasure" concept. It was at odds with and was redundant to a two year duration. The bottom line was that one served at the pleasure of the board, and left when the board said so. The bill implied a covenant that went along with employment and good faith dealings. Therefore, there would be legal problems. Number 0394 CHAIR JAMES stated that serving at the pleasure of a board was a deterrent to hiring the best person. Whereas, a two year contract would allow for the hiring of a good person. Furthermore, the language in the bill said that the board "may" enter into a two year contract. CHAIR JAMES further stated now that the fund was at $20 billion, it should be run more like a business than a political entity. She declared, "That's my whole problem with this issue." Number 0499 MR. LOUNSBURY stated that the fringe elements were in line with the board's philosophy-to remain objective to the safety of its principle and to maximize the total return on its investment. The board also believed that the corporation should always act to assure the level of investment risk was prudent and that it did not jeopardize the primary objective which related to the fiduciary responsibilities. He further stated any Governor that decimated a board was the person acting irresponsibly. He also believed that the state constitution wanted a strong Governor. The conversation today was an erosion of power. That was the bottom line. The bill was to prevent any Governor from jeopardizing the Permanent Fund. Number 0570 REPRESENTATIVE BERKOWITZ stated that something more sweeping was needed to be done to protect the interest of the Permanent Fund by making sure that every board members was truly the best available candidate. "Perhaps we should contemplate an entirely different scheme for selecting them." Number 0597 CHAIR JAMES asked Mr. Baldwin if he would get back to her in a few days with some suggestions. She reiterated she would look further at the constitutional issue discussed today. There was public support for continuity on the board. So, let's work together. "I don't want to face another veto," she stated. Number 0734 REPRESENTATIVE ELTON suggested taking a careful look at Sec. 6 and Sec. 7. He was concerned about the delineation of investment responsibilities addressed in Sec. 6. He was also concerned that adding a layer that had not been tried before would complicate the exempt service factor. In addition, the new language in Sec. 7 also added confusion. He reiterated that Chair James look further at Sec. 6 and Sec. 7 because they created unnecessary baggage and questions. Number 0801 CHAIR JAMES replied that Sec. 6 was extremely important to secure the type of person that the board would want to hire. Number 0819 REPRESENTATIVE ELTON suggested taking out the first part of the sentence only. CHAIR JAMES replied she would consider his suggestion. Number 0829 MR. BALDWIN explained the board was in town now. He would take these issues back to the board. Number 0838 CHAIR JAMES stated she would yield to their concerns, as well, and take their suggestions. CHAIR JAMES announced for the record that Representatives Berkowitz and Elton had to leave due to another meeting.