DISCUSSION
Will Hutton, Charlie King and Anne Simpson
Accountable insiders?
Reforming the pension funds

The pension funds hold our collective savings. Reforming them might improve our private investment record as well as supporting us better in old age. But can greater accountability be combined with more effective investment?
From Soundings Issue 4 Autumn 1996

Pension funds are the conduit for the savings of a community, either a community of workers in a company or a community of workers in a local authority area, and the money is by and large channelled into shares on the stock market. Their current collective value is in excess of five hundred billion pounds. Pension funds own over a third of the UK stock market.
Anne Simpson, who is talking here, is an executive director of PIRC - Pensions and Investment Research Consultants. PIRC are registered professional investment advisors, but unusual ones. Their origins lie in a consortium of public sector pension funds who got together in the 1980s to discuss how they could become more responsible owners of company shares.
If you look only thirty years ago, around 1963, around a fifth of company shares were owned by institutions, and the four fifths was almost entirely owned by individuals. Capitalism in those days had real capitalists, individuals with money who owned shares. Now two thirds of shares are owned by institutional investors: pension funds and the insurance companies.
For Anne Simpson, these are public institutions: 'They're private in theory, but they're holding the public's money. When I say they are public institutions I mean they are intermediaries who ought to be accountable to those on whose behalf they invest. In that sense they have a public role, and there's a requirement for public accountability which is lacking at the moment.'

A lack of accountability
Early organising around accountability in the 1980s focused on ethics and employees' rights. Charlie King was a trustee on the British Gas pension fund for eleven years. At the same time he was a senior shop steward in the company.
I wanted to try and change the world a bit. I thought, it's our money so we ought to have some say in it. South Africa was an early issue when I was there. We agreed that we didn't invest in South Africa because it was a political risk. Not because we didn't like their politics. So that got everybody off the hook.
The 'hook' in question is the fiduciary duty of trustees, their duty to seek the best returns for the pension fund members. This duty can be interpreted to exclude ethical considerations from investment decisions, as Charlie King remembered.
Another issue was privatisation of water. I said, 'There are a number of issues about water: environmental issues, complying with European directives. I'm not sure water would be a good investment. And also, as a public sort of company and pension scheme, do we think it's right?' So we met with the other trustees, and they put forward the counter-arguments, and their last point was, 'OK Mr King, if you're not going to allow us to invest in water, you tell us where else we can invest to get the same return. And if you can't, then you're breaking your fiduciary duty.' That's the problem you're up against. You can't brush it off.
Anne Simpson argues that there is no conflict between good financial returns to fund pensioners' incomes and an ethical investment strategy.
Competitiveness is the foundation upon which responsibility is built. But these two dimensions are integral rather than in competition. A company over the long term, in our view, will not survive and thrive financially unless it understands that it's a social organisation with responsibilities. If companies over the last twenty or thirty years had been monitoring their environmental impact, controlling it, reducing emissions, many of them would not now be facing bills for cleaning up contaminated land. Companies like Shell and ICI are putting aside up to a billion pounds apiece to protect themselves against claims in the future. We can see an immediate financial consequence of an issue which five or ten years ago would have been considered an ethical rather than a corporate issue.
Can the pension funds, then, as owners of companies, play a role in a developing a more responsible capitalism? Will Hutton, the editor of the Observer, is also author of a best selling book, The State We're In. In the book, he refers to pension funds as 'absentee landlords'. He explains:
An absentee landlord is somebody who enjoys unearned rent from property: whilst they own it, they're not engaged with the management of it. It's power without responsibility, it's income without engagement, it's property rights without parallel obligations. And my sense of institutional share ownership in Britain in the 1990s is that it's much closer to that than is desirable.

The short-termism problem
The funds' disengagement, Will Hutton argues, cannot be justified:
Their savings, the dividends that they are enjoying, don't actually come out of clear blue air. They are the results of the endeavours of men and women in work places. These funds are owners of people's livelihoods. Now it may be extremely boring for this to be said, but there are obligations upon you to respect that, even whilst you're trying to maximise the money under your management, under your stewardship.
Anne Simpson identifies a 'curious irony'.
Britain is in the fortunate position of having capital markets dominated by long term investors. Who are - for a variety of historical and circumstantial reasons, and a lack of forward thinking and proper analysis - behaving like short term investors, not all of them but a large number of them...
The first responsibility for a pension fund is to make sure that it can fund its pensions when they fall due. That obviously gives pension funds a responsibility to ensure that the long term investment returns are matched with those liabilities. Simply in order to pay pensions in thirty years a trustee has got to be concerned about issues like capital investment in manufacturing, training, research and development and so forth.' Insurance companies too have long term liabilities...
During a recession, companies haven't made as much money as normal, but they are expected to continue paying out a steady stream of dividends to shareholders. If they cut their dividend or hold their dividend at last year's level, their shares will be marked down. Which is an obvious sign of failure but it also, then, makes the company vulnerable to a take-over bid.
What companies therefore do is pay out a proportion as dividends, salt some away to reserves, and when times get bad they raid their reserves, but the suspicion is that they also cut back on other budget heads to put shareholders first. Now unfortunately we do not have accounting standards which give a clear statement about things like research and development spending, advertising, training. But if they're cutting back on training their staff, on investment, capital expenditure, research and development, advertising, then what they're doing is sacrificing their long term prospects for their short term survival.
The companies in turn say 'Well the reason we're doing this is because our shareholders want us to.' So why do pension funds demand this? An immediate problem, says Charlie King, is the short time horizons over which pension fund managers are judged. 'The investment manager is measured every year. There are league tables, and if my manager was below the mean he was in trouble.' And, Anne says, it's getting worse. 'Fund managers are increasingly paid performance-related salaries, which mean that their bonuses will be affected if they decide sometimes to take a long term view, and for example say no to a particular take-over bid.' PIRC aims to alter this pattern, by increasing the role of trustees in investment decisions.
I think that the chain of accountability from trustees through to companies is going to be an important part of having an investment strategy geared up to the needs of industry. It's not that we haven't got money to spend, but that we're probably spending it on the wrong things. As pension funds with liabilities over a thirty to forty year period, the sort of frothy returns on the stock market in the mid-eighties would mean nothing compared with funding capital growth over a thirty year period. So the issue is how to invest in companies that will grow over the long term. How do we provide a critical voice during the wave of take-overs and mergers, and as owners how do we support companies making an investment plan?

Creating long termism
Can this be done? Will Hutton sees the pension funds as just one part of the problem constituted by an interlocking network of British financial institutions which undermine long term growth and which need reform.
I believe that take-over is too easy in Britain. There should be a public- interest defence for companies. I think competition law should be applied very aggressively, so that when certain thresholds of market share are passed, the take-over just fails. I think that some of the incentives for take-over, which are to do with the easy way that accounts can be bent, to demonstrate profits when in fact profits aren't too great, should be disallowed.
There are problems at the level of the firm too. Anne Simpson cites economist Paul Marsh. 'For him, the problem is that managers of companies don't consider that they ought to be looking for long term investment opportunities, or perhaps even consider that they don't exist.'
Legislation is one key to change. Will Hutton argues for tax changes: I believe that, instead of giving pension funds tax exempt status completely, they should have to earn their tax exempt status through long-termist behaviour. The more they dispose shares in the near term, the higher the capital gains tax they pay, and the longer they hold equity then the lower the capital gains tax.
Anne Simpson worries about the incentives implied in such proposals, being wary about undermining the right to sell if necessary. In her view,
reforms are needed on two sides. First, the Companies Act needs a complete overhaul. We need minimum standards governing the rules by which companies are run, model Articles of Association which govern the rights that shareholders have and how decisions are taken. We also need to look at the duties of directors which currently are not codified in the Act. And we need to greatly enhance the level of disclosure because at the moment, for example, there's no requirement for a director to even disclose what his or her other directorships are, or past faults and failings.
The other side is reform of the role of the institutional shareholder. Pension funds would have a duty to exercise their voting rights in the interests of the beneficiaries. We also think that the rule which allows one third of trustees to be elected by the members isn't enough, it ought to be at least half. In the insurance industry, policy holders ought to be entitled to know what shares are held in the portfolio and what happens to voting.
Shareholder reform and company reform come together at events like the Annual General Meeting. Currently there's no duty on shareholders to disclose how they voted, and there's no duty on the company to say what votes they've received. Both sides are currently governed by Victorian thinking and the legislation clearly needs a complete overhaul.
Hutton would also constrain the optimistic valuations actuaries put upon pension funds.
I often laughingly say that the two bodies in Britain where there's an unambiguous case for nationalisation are the accountancy profession and the actuary profession. If we nationalised the actuaries, and made auditors responsible to the national audit commission, you'd get standard accounts and you'd get public interest valuations of pension funds' assets and performance, which put a lower value upon short term gains.
The aim, says Hutton, is a series of legislative changes which together sustain institutional reform.
Essentially what you're saying to British companies is, building corporate empires to inflate the ego of the Chairman, or the short term share price, is not actually congruent with the public interest. And we're going to build in a series of small measures which taken together really do hold the Leviathan down.

Developing active ownership
Many constraints affect active participation by trustees in companies' affairs. According to Charlie King: 'In the past we'd been absolutely passive. The only time we ever met to discuss anything was when a problem occurred and it was usually too late then. One exception was the Pilkington take-over. We did have a special meeting over that and we agreed not to sell' His pension fund developed policies on corporate governance, for example on political donations, 'but there was definitely one of the management trustees who thought that was none of our business, providing the company was being run properly and we had an adequate return.'
So strengthening pension funds' role in companies' investment policy involves major cultural change, and here collective organisation through PIRC helps.
We've been getting our pension funds clients to vote at Annual General Meetings. They vote according to a set of detailed critical guidelines which have been sent to the companies in advance, covering everything from receiving the report and accounts to accepting the dividend, the directors, the auditors. They raise issues like the making of corporate political donations, environmental policy; and as more funds begin to exercise their votes on an independent and informed basis so an important mechanism of corporate accountability is being put into place...
Last year we ran the campaign at British Gas [on executive pay] which put the whole issue of shareholder voting onto the front page of not just the Financial Times but of the tabloids. To have brought the issue of shareholder voting onto the front page of the Sun I think is pretty good. We aim to get this recognised as an important issue for the next century, and to give the public that sense of ownership; to instil in them the view that this money belongs to them and therefore they have the right to demand accountability from institutions.
Similarly last year we ran a director for the board of Yorkshire Water, Diana Scott, who got 20 per cent of the vote which is a very reasonable showing for a shareholder candidate, and certainly that put on the agenda what the deficiencies were with the Yorkshire Water board. And everything that's happened since then has shown that they need input from somebody with consumer interests and environmental concerns at the forefront of their mind. So I think a lot of shareholders would now look at Yorkshire Water and think yes we should have backed her.
Better company disclosure rules could strengthen the hand of trustees seeking to change company policy. 'Any government ought to be thinking about accounting standards, whether it's environmental liability, research and development or simply making sure that the financial information is transparent to outsiders'. Hutton wants to see more direct participation of funds in decision making: 'representatives of groups of pension funds should sit as non-executive directors on company boards, I think that's absolutely an imperative.' Pension funds as owners should, Anne Simpson argues, get involved in 'things like dividend policy, research and development, training, all sorts of issues relating to investment.' PIRC also wants pension fund money to support small and growing companies, seeing the lack of a thriving medium sized corporate sector as partly down to the lack of 'long term patient equity capital' which the funds could in principle supply - but don't.

Individualism and class divisions
Making this work, however, needs co-operation among institutions, which is hard to establish in the individualistic British financial system. Charlie King learned how difficult it was to collaborate with other pension fund trustees.
It isn't easy. British Gas bought up a power station, and I wrote to every one of its pension fund trustees and said I would be willing to meet them. There were a number of common issues. But the message came back, 'you're twenty times the size they are and they don't want you interfering in their life.'
Charlie King thinks that a better way would be to have industry wide-type pension schemes with independent trustees. 'It would be a separate scheme altogether, not administered by companies like British Gas, and people who work in the industry could nominate the trustees and bring in advisors, so in some ways it would work like a trade union pension scheme.'
Will Hutton thinks that individualism and unwillingness to co-operate is deeply embedded in Britain, making us very bad at institutional reform.
I think the big reason we're bad at it is that the institutions that we currently have do benefit a particular vested interest, hugely. So institutional change creates losers, who in the current institutional framework in Britain tend to be conservatives. It's very rare to find a Labour-voting member of a board of directors in Britain. It defines your middle-classness, almost, and your membership of the upper caste, that you vote Conservative. That's the first point. The second point is, this is validated by bad theory: a complete debauching of a kind of nineteenth century liberalism, so that all outcomes in free societies are portrayed as the results of individual choice. Therefore people like me, who want to build institutions, are criticised as people who want to meddle with free decisions, who are going to construct a bureaucratic layer of government or quasi-government, and who also take away power and status from conservatives. You put those two things together, and, the opposition to change is fierce. That's why I argue for political change so ferociously, because I think that it's only the act of changing the House of Commons or the House of Lords or the judiciary, and demonstrating that creative thinking in this way is possible, that allows it to inform institution building in the private sector.
This theme of class division runs like a thread through all the stories. As a shop steward, Charlie King was first drawn in to pension fund affairs by efforts to get a decent pension scheme for manual employees, one which matched the staff scheme. 'A lot of companies still have staff-only schemes. So we started from that issue, and then I got more involved.'
He remembers the feel of the early meetings.
It's quite intimidating in a way. You sit round a big table, and there's us three at this end, and three from management who had the right of the chair. You then had several investment managers, in-house at British Gas. Then people servicing the committee, and somebody from the British Gas financial department, and a lawyer. Then we had two outsider advisers, and internal and external property advisers. So it's you on your own against all this lot, who knew the business inside out. After a bit of experience I knew what to look for. But that takes time. I frequently raised things that I knew would never go anywhere but it's worth raising them in front of the outside advisers, because they would go back and say, 'Yes there's a bit of a problem with this, you know.' Because it's all a matter of influence. If we had a problem we would sometimes have a trustees meeting, with our internal investment officer or the lawyers.
It is hard for employee trustees to develop the knowledge and confidence to cope. 'And they can soon wreck it for you. It's, 'Come on, this is a multi-million pound decision and I need an answer by three o'clock.' And you're trying to work on a building site at the same time, and talk on the phone.' Nevertheless British Gas was ahead of many other pension funds. 'The good thing about it was, it was a democratic structure. You elected people off the shop floor to sit there, and they sat there at the highest level. I could go out and ring up the pensions manager and say "Can I come in/1 don't understand this? What is a bloody derivative?"
Trade union support, training and networking helped. 'The TUC and GMB do some really good courses, but it's trying to get the trustees in the frame of mind to know that they need it! Because the company's very supportive, and it's guiding you through, but it's guiding you through in their sort of way. So it can cut you off a bit from behind if you're not careful'
Charlie echoes Anne's experience of the scale of the education - or persuasion - to be done. 'It comes back to why you're there in the first place. Do you actually want to change it? I used to do these couple of sides of A4 every year, saying what our policy was. I used to send it to loads of people. I think in eleven years I got about three questions. It was, "No, you're doing a good job, that's fine." "I know it interests you but it's really boring.'"

Accountable insiders?
Because of the class-ridden nature of our society, a contradiction runs through the proposals for reform. All three interviewees emphasise the importance of democracy, openness and accountability but also believe that being an 'insider' is key to influencing change. They want pension funds to become effective insiders in company decision-making, and the British financial system to become more of an 'insider' system, where companies are more insulated from immediate shifts in stock market valuations by having long term committed investors.
But can you have accountable insiders in our class-divided society? Will Hutton agrees there is a problem.
It's a dilemma. Two ways to go. You can make your pension funds insiders. Put members on the board. Not actually be very democratic. And become allies of capitalist Britain in a major investment programme. As committed owners the funds would give the stable platform from which this investment could be secured. You can go down that insider route. Or the other route you can go down is the democratic/ transparency route, which is PIRC's route. But you go down one, or you go down the other. What you're doing is trying to get engagement, and there are two routes to engagement.
Hutton's instincts are with the insider route. 'Well I have a problem with that, because I'm simultaneously, you know, a devotee of Tom Paine, and someone who recognises the power of insider networks in making capitalism work. It's a dilemma for me.' Hutton has drawn lessons from the German financial system. 'The German system is an insider system. I think I'm for an insider system where the lines of accountability are strong.'
It is hard to underestimate how difficult it will be to create such accountable insiders in Britain, where 'insider' is associated so strongly with secrecy and class privilege. Institutional reform needs both to bring far more people 'inside', and to open up decisions to public scrutiny. This partly requires reforming the pensions system itself.
Improving pensions means a mixture of compulsion, collective management of funds, better state support, and better investment strategy to provide better jobs and hence a more solid tax base. In Will Hutton's view, 'What you make compulsory is not the amount, but the fact of contributing. And for those people who are out of work or socially excluded, one of the things that their income support should entitle them to do is to pay a minimum amount into this personal pension which would become a kind of floor payment for everybody.'
These payments, he adds, could support a new kind of investment institution. You might contribute to a low-commission friendly society, established by the state with various stake-holders on the board. This friendly society would be a long term investing institution. It would be one of the sources for funds for a network of regional investment banks and regional development agencies. It would support the construction of a bank for medium sized and small business...
It itself would be a change agent, because the commissions and fees it charges would be so much lower that it would automatically be able to provide better guaranteed minimums than the private sector. And then it can do some creative things in how it invests. It would be a kind of Warren Buffet. It would be a combination of Warren Buffet and social citizen.
Warren Buffet is an American private investor, committed to long term investment and a legendary financial success. A 'combination of Warren Buffet and social citizen' is thus a really vivid image of an accountable insider. It's quite a challenge: to combine long term investor commitment with openness, and in the process to overcome the pathologies of what Charlie King calls 'the City club'.