That’s exactly the thing to do when you’re behind, isn’t it? Double your bet so that you can “make it all back.” Right.

Having fallen into the hole to the tune of fourteen billion dollars, the Federal Government’s own Pension Benefit Guaranty Corporation has doubled its bet in an effort to “make it all back.”

Reuters has reported that on February 18, a National Holiday “when all the (media) children were asleep,” the PBGC “has adopted a new investment policy designed to increase chances the government pension guarantor will be fully-funded within 10 years.” PBGC Director Charles Millard was quoted as saying that “The new investment policy adopted by the PBGC Board of Directors will better manage our invested assets,” and added that although it should generate higher returns, it also offers lower risk through broader diversification.

Whereas the Board’s previous investment policy was to allocate 15% to 25% of assets to “diversified equity investment,” the new number is 45%.

So, nearly half of the PBGC’s total assets will now be deployed “Long” in the stock market. To a contrarian, this is just about the most powerful bearish signal imaginable: the Government itself investing in the stock market – the Ultimate Committee, always reacting to past events, always behind the curve, now about to arrive late at the tables after the party is over.

This is a sure-fire recipe for disaster. Who will be invited to pay for it? Guess.

“Diversified equity investment,” indeed. That’s not diversification; that’s concentration within a single asset class. It implies that some truly bad dogs of the market will be aggressively sought out for purchase; and in a declining market within a recessionary environment even the best of the best will suffer, and will be dragged down even further by the worst of the worst.

An argument can be made that the Directors of the PBGC are in a fiduciary relationship with the actual and potential beneficiaries of the guaranty program. If so, who is the guardian of that trust?

The “Prudent Investor Rule” may come into play. The Rule has been enacted by most, if not all, of the States in fairly uniform text as a reversal and quite spectacular liberalization of the former rules which for a long time governed the responsibilities of a fiduciary and the limitations of the categories of investments which he was permitted to choose for his beneficiary. The new Rule, as quite recently enacted by the States, was put in place as the capstone of a victorious effort by proponents of the “Efficient Market Hypothesis” to have it enshrined as law, whereby fiduciaries would now be given far greater latitude in their choice of investments – almost to the point of “anything goes.”

The text of the Prudent Investor Act (as enacted in Florida, but likely nearly identical wherever enacted) is not long. I’d like to show you the pertinent parts. Please note the prevalence of the word duty.

(Sec. 518.11) “Investments by fiduciaries; prudent investor rule.
(1) A fiduciary has a duty to invest and manage investment assets as follows:

(a) The fiduciary has a duty to invest and manage investment assets as a prudent investor would considering the purposes, terms, distribution requirements, and other circumstances of the trust. This standard requires the exercise of reasonable care and caution and is to be applied to investments not in isolation, but in the context of the investment portfolio as a whole and as a part of an overall investment strategy that should incorporate risk and return objectives reasonably suitable to the trust, guardianship, or probate estate. If the fiduciary has special skills or is named fiduciary on the basis of representations of special skills or expertise, the fiduciary is under a duty to use those skills.

(b) No specific investment or course of action is, taken alone, prudent or
imprudent. The fiduciary may invest in every kind of property and type of investment, subject to this section. The fiduciary’s investment decisions and actions are to be judged in terms of the fiduciary’s reasonable business judgment regarding the anticipated effect on the investment portfolio as a whole under the facts and circumstances prevailing at the time of the decision or action. The prudent investor rule is a test of conduct and not of resulting performance.

(c) The fiduciary has a duty to diversify the investments unless, under the circumstances, the fiduciary believes reasonably it is in the interests of the beneficiaries and furthers the purposes of the trust, guardianship, or estate not to diversify.

(d)———

(e) The fiduciary has a duty to pursue an investment strategy that considers both
the reasonable production of income and safety of capital, consistent with the fiduciary’s duty of impartiality and the purposes of the trust, estate, or guardianship. Whether investments are underproductive or overproductive of income shall be judged by the portfolio as a whole and not as to any particular asset.

——-
——-

(3) Nothing in this section abrogates or restricts the power of an appropriate court in proper cases:

(a) To direct or permit the trustee to deviate from the terms of the governing
instrument; or

(b) To direct or permit the fiduciary to take, or to restrain the fiduciary from
taking, any action regarding the making or retention of investments.”

- - - - - - - - - - - - - - - - - - - - - - - - -
(Whatever were “legal investments” before are still “legal investments” now).
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

It is clear that the fiduciary has a duty to diversify the investments. The statute does not define “diversify.” It does not distinguish between diversifying with a generally rising market in mind on the one hand, and diversifying with a generally declining market in mind on the other.

The writer posits that the Prudent Investor Act mandates a duty upon fiduciaries to diversify to the downside in the likelihood of a declining market, and that a failure to do so equates to violation of law and dereliction of duty. Is anyone ready to place a cap on personal liability in such a situation?

Such heretical thinking probably is anathema to proponents of the Efficient Market Hypothesis. Possibly, this is a whole new twist on the Prudent Investor Rule, and one which was never contemplated by proponents of the EMH. However, we are obliged to go by the plain meaning of the words. As the sage Dane, Victor Borge, said within my hearing, about American English: “Well, it’s your language.”

With respect to the Pension Benefit Guaranty Corporation, maybe the Directors will be held personally liable if the fund goes broke, and maybe they won’t. I simply posit the possibility. Nice questions arise with respect to sovereignty, application of State statutes to a Federally-chartered corporation and to its Directors and Officers, and Federal pre-emption. Almost certainly, there are more. Months, and maybe years, will pass as the disaster unfolds, the plot thickens, and recriminations fly. The pit orchestra has just begun to play the Overture. The show being presented on stage tonight must not be “Oklahoma!,” because the piece they’re playing is something other than “Oh, What a Beautiful Mornin’.”

William G. Kurtz Jr. March 2, 2008 http://www.candlewave.com