The following opinion is presented on-line for informational use only and does not replace the official version. (Mich Dept of Attorney General Web Site -
www.ag.state.mi.us) STATE OF MICHIGAN
MIKE COX, ATTORNEY GENERAL
STATE OF MICHIGAN
Authorized investment under Public Employee Retirement System Investment Act
The Bay City Police and Fire Pension Plan and Retirement System Board of Trustees' investment of 20% of the system's total assets in the Advanced Investment Management Enhanced Equity Index Commingled Fund LP was not an authorized investment under the Public Employee Retirement System Investment Act.
Opinion No. 7144
November 5, 2003
Honorable Jim Barcia
You have asked whether the Bay City Police and Fire Pension Plan and Retirement System Board of Trustees' investment of 20% of the system's assets in the Advanced Investment Management Enhanced Equity Index Commingled Fund was an authorized investment under the Public Employee Retirement System Investment Act.
Information supplied with your request indicates that in 2002, the Bay City Police and Fire Pension Plan and Retirement System Board of Trustees (Retirement Board) invested $10 million, or approximately 20%, of the system's assets in the Advanced Investment Management Enhanced Equity Index Commingled Fund LP (AIM Commingled Fund).1 The AIM Commingled Fund is a limited partnership designed to function as an enhanced index fund with a goal of providing investors with a return that tracks and outperforms the Standard and Poor's 500 Composite Stock Index (commonly referred to as the "S & P 500").2 The Retirement Board divested the system of its holdings in the AIM Commingled Fund, but not before incurring a loss of approximately $3 million.3 For the fiscal year ending June 30, 2002, the system had total assets of approximately $45 million.
The Public Employee Retirement System Investment Act (PERSI Act), MCL 38.1132 et seq, codifies the investment authority of public employee retirement systems. OAG, 1995-1996, No 6893, p 143 (March 21, 1996). The PERSI Act defines and limits the amount and type of investments that may be made by those acting as investment fiduciaries on behalf of public employee retirement systems. A public employee retirement system investment that does not conform to the PERSI Act is precluded and constitutes an unauthorized investment.
Section 12c(1) defines an "investment fiduciary" as a person who:
(a) Exercises any discretionary authority or control in the investment of a system's assets.
(b) Renders investment advice for a system for a fee or other direct or indirect compensation. [MCL 38.1132c(1).]
Accordingly, the Retirement Board serves as an investment fiduciary.4 As an investment fiduciary, the Retirement Board must comply with the PERSI Act and exercise the required standard of care. Section 13(3) identifies this standard of care as follows:
An investment fiduciary shall discharge his or her duties solely in the interest of the participants and the beneficiaries, and shall do all of the following:
(a) Act with the same care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a similar capacity and familiar with those matters would use in the conduct of a similar enterprise with similar aims.
(b) Act with due regard for the management, reputation, and stability of the issuer and the character of the particular investments being considered.
(c) Make investments for the exclusive purposes of providing benefits to participants and participants' beneficiaries, and of defraying reasonable expenses of investing the assets of the system.
(d) Give appropriate consideration to those facts and circumstances that the investment fiduciary knows or should know are relevant to the particular investment or investment course of action involved, including the role the investment or investment course of action plays in that portion of the system's investments for which the investment fiduciary has responsibility; and act accordingly. For purposes of this subsection, "appropriate consideration" includes, but is not limited to, a determination by the investment fiduciary that a particular investment or investment course of action is reasonably designed, as part of the investments of the system, to further the purposes of the system, taking into consideration the risk of loss and the opportunity for gain or other return associated with the investment or investment course of action; and consideration of the following factors as they relate to the investment or investment course of action:
(i) The diversification of the investments of the system.
(ii) The liquidity and current return of the investments of the system relative to the anticipated cash flow requirements of the system.
(iii) The projected return of the investments of the system relative to the funding objectives of the system.
(e) Give appropriate consideration to investments that would enhance the general welfare of this state and its citizens if those investments offer the safety and rate of return comparable to other investments permitted under this act and available to the investment fiduciary at the time the investment decision is made.
(f) Prepare and maintain written objectives, policies, and strategies with clearly defined accountability and responsibility for implementing and executing the system's investments.
(g) Monitor the investment of the system's assets with regard to the limitations on those investments pursuant to this act. Upon discovery that an investment causes the system to exceed a limitation prescribed in this act, the investment fiduciary shall reallocate assets in a prudent manner in order to comply with the prescribed limitation. [MCL 38.1133(3).]
To analyze the issue presented, it is necessary to consider if the Retirement Board's investment in the AIM Commingled Fund was a qualified investment. While not defined in the PERSI Act, the term "qualified investment" was considered in OAG, 1989-1990, No 6597, pp 198, 203 (August 24, 1989), which concluded that a "qualified investment" is one that is specifically authorized by the PERSI Act. To the extent that an investment is not specifically qualified, it may otherwise be an authorized investment under the "basket clause" provisions of the PERSI Act, as discussed later in this opinion.
According to the information supplied to this office, the AIM Commingled Fund held itself out as a limited partnership organized under the laws of the State of Delaware. Prospective investors were required to sign and agree to the terms of a limited partnership agreement. The PERSI Act includes limited partnerships within the definition of an "equity interest" in section 12b(3) as follows:
"Equity interests" means limited partnership interests and other interests in which the liability of the investor is limited to the amount of the investment, but does not mean general partnership interests or other interests involving general liability of the investor. [MCL 38.1132b(3).]
The PERSI Act authorizes an investment in an equity interest or limited partnership in two circumstances, neither of which would permit the AIM Commingled Fund investment in question. Section 19(2) applies to systems that have assets in excess of $100 million and subsection 19(2)(c) provides, in pertinent part, that an investment fiduciary of such a system may "[f]orm 1 or more limited partnerships . . . to hold title to, improve, lease, manage, develop, maintain, or operate real or personal property . . . ." MCL 38.1139(2)(c). The AIM Commingled Fund was not formed for such real or personal property purposes, and the system does not have assets in excess of $100 million, so this provision cannot be the basis for the investment in question.
Section 20a(1) allows an investment fiduciary to invest not more than 2% of a system's assets in a "debt, warrant, or equity interest in a small business having more than 1/2 of the small business's assets or employees within this state." (MCL 38.1140a(1); emphasis added.) Based on information provided to this office, the AIM Commingled Fund does not qualify as a small business with more than one-half of its assets or employees within Michigan. Further, section 20a limits this form of investment to systems that have assets in excess of $250 million, which is well beyond the reported asset level of the Bay City Police and Fire Pension Plan and Retirement System, so this provision cannot be the basis for the investment in question.
A review of the Confidential Offering Memorandum and other related materials submitted to this office leads to consideration of section 20c of the PERSI Act, which relates to financial institutions, trust companies, or management companies retained as investment fiduciaries. Section 20c(1), in pertinent part, provides that:
A financial institution, a trust company, a management company qualified under section 15, or any affiliate of a person described in this section if that affiliate qualifies as an investment fiduciary under section 13(8)(a), retained to act as an investment fiduciary may invest the assets of a system in any collective investment fund, common trust fund, or pooled fund that is established and maintained for investment of those assets by the financial institution, trust company, or management company under federal or state statutes or rules or regulations. [MCL 38.1140c(1); emphasis added.]
Section 20c(1) recognizes three separate entities that could be retained as an investment fiduciary. Clearly, the AIM Commingled Fund is not established as either a financial institution or trust company. While the Retirement Board entered into a contractual relationship with the AIM Commingled Fund, a review of investment materials provided to this office does not document that the AIM Commingled Fund was a management company retained by the Board to act as an investment fiduciary as set forth in section 20c(1). Therefore, section 20c cannot serve as the basis for the investment in this matter.
A review of other sections of the PERSI Act leads to the conclusion that the Retirement Board's investment in the AIM Commingled Fund does not have a specific qualifying provision. Section 20d, MCL 38.1140d, provides limited authority to invest in investments not otherwise specifically qualified under the PERSI Act. Often referred to as the "basket clause,"5 section 20d states, in pertinent part, that:
(1) An investment fiduciary of a system having assets of less than $250,000,000.00 may invest not more than 5% of the system's assets in investments not otherwise qualified under this act, whether the investments are similar or dissimilar to those specified in this act.
* * *
(5) If an investment described in subsection (1) is subsequently determined to be permitted under another section of this act, then the investment shall no longer be included under this section.
Since the AIM Commingled Fund investment is not otherwise qualified under the PERSI Act, section 20d(1) provides statutory authority for the investment, provided this investment, together with any other basket clause investments, is limited to no more than 5% of the system's total assets. See OAG No 6893 at p 144. Since the investment in the AIM Commingled Fund exceeded 5% of the system's total assets, section 20d(1) cannot be the basis for the investment at issue.
It is my opinion, therefore, that the Bay City Police and Fire Pension Plan and Retirement System Board of Trustees' investment of 20% of the system's total assets in the Advanced Investment Management Enhanced Equity Index Commingled Fund LP was not an authorized investment under the Public Employee Retirement System Investment Act.
1Investment documentation for the AIM Commingled Fund provided to
this office includes a Confidential Offering Memorandum, a draft Limited
Partnership Agreement, and a draft Subscription Agreement. In addition, we
received various opinion letters from counsel representing Bay City and the Bay
City Police and Fire Pension Plan and Retirement System.
2Materials provided to this office include an opinion that analyzes this transaction and concludes that the Retirement Board's investment was an investment in the AIM Commingled Fund's underlying portfolio of investments, which includes equities, fixed income instruments, and other types of investments. The AIM Commingled Fund is, however, a separate legal entity from the retirement system, and the underlying portfolio of investments was legally that of the AIM Commingled Fund and not its investors. Thus, as discussed later, the Retirement Board's investment resulted in its acquisition of a limited partnership interest in the AIM Commingled Fund.
3Based on information provided to this office, the investment was entered into on March 28, 2002, and the Retirement Board divested the system of the investment on September 30, 2002.
4Other individuals and firms may also serve as investment fiduciaries for the Bay City Police and Fire Pension Plan and Retirement System. Consistent with Michigan Beer & Wine Wholesalers Ass'n v Attorney General, 142 Mich App 294, 301; 370 NW2d 328 (1985), this opinion addresses only the legal question presented by your request and does not address the more fact-intensive question of whether a breach of fiduciary duty may have occurred in connection with the investment at issue.
5"Basket clause" is a term of art used to designate section 20d investments under the PERSI Act. The "basket clause" provides investors flexibility by authorizing investment in certain new or hybrid investment vehicles as they are introduced to the market.