Beyond economically targeted investments: redefining the legal framework of pension fund investments in low-to-moderate income residential real estate.

Author:Sauchik, Alec

The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function. (1)


The greatest reservoir of our nation's wealth, pension funds, have long been recognized as a potential source of funds for economic development. It proved extremely difficult, however, to devise a strategy that while providing the influx of capital to various social programs would also guarantee the safety of retirees' assets. Economically targeted investing, an innovative approach based on a concept that, at the time of its development, contradicted mainstream investment ideology, in theory has overcome this potentially insurmountable obstacle. From the beginning, though, this promising yet controversial strategy has met with criticism, which, perhaps more than any other factor, accounted for the fact that economically targeted investments ("ETIs") have never gained wide acceptance among pension fund trustees.

Economically targeted investments are most commonly defined as investments designed to produce a competitive rate of return commensurate with the risk, as well as to create collateral economic benefits for a targeted geographic area, group of people, or sector of the economy. (2) Mindful of the significant economic impact that pension fund investments can have on local development, pension fund trustees find the general concept of investing in their respective states and municipalities attractive. (3) Thus, although the goal of economic development is indeed wisely believed to be a laudable one, the means of achieving it through economically targeted investments by pension funds has always been the subject of heated debate because of concerns that such investments would constitute a wasting of pension assets and hence a violation of trustees' fiduciary duties. (4)

As is often the case with issues related to pensions and retirement benefits, the debate over the legality of economically targeted investments has become extensively politicized. At stake are the gigantic assets of the pension funds in the United States, which in the year 2000 amounted to more than $8 trillion. (5) According to Rich Ferlauto, Associate Director of Constituent Development for the Center for Policy Alternatives, "The largest pool of investment capital available for any type of economic development stimulus now rests in the hands of pension funds...." (6) Taking into account the sensitive nature of the topic, the propriety of investing pension money in infrastructure, affordable housing, and inner-city neighborhoods is understandably a controversial issue. (7)

The concept of ETIs has venerable roots; (8) however, it was not until the Clinton Administration (the "Administration") put it high on its domestic policy agenda that ETIs attracted substantial attention. (9) Former Secretary of Labor Robert Reich, and Assistant Secretary of Labor, Pension and Welfare Benefits Administration Olena Berg, actively promoted economically targeted investments, taking their case to Congress on several occasions (10) and establishing, under the auspices of the Department of Labor, the Clearinghouse of Economically Targeted Investment Opportunities. (11) This activity resonated with liberal voters across the country who intensified pressure on pension funds to assume a more proactive role in developing affordable housing, funding real estate mortgages, and providing venture capital for local businesses. (12) In turn, these attempts to exert pressure on pension fund trustees met with sharp criticism from conservative legislators led by Representative Jim Saxton (R-N.J.), who criticized the Administration for jeopardizing the safety of private and public pension systems. (13)

It was in this context that the trustees of many pension funds in the United States sighed with relief when in the summer of 1994 the Department of Labor released Interpretive Bulletin 94-1 ("the Bulletin" or "I.B. 94-1"), (14) specifically addressing the issue of ETIs. The Bulletin, which was intended to clarify the Department's position on the legality of ETIs, (15) in effect placed the Administration's imprimatur on economically targeted investments. In the fall of 1995, however, the House of Representatives passed the Pension Protection Act of 1995 ("H.R. 1594"), prohibiting the Administration from promoting economically targeted investments and voiding I.B. 94-1. (16) Although the companion resolution died in the Senate, (17) H.R. 1594 succeeded in effectively nullifying whatever successes the Administration had achieved in popularizing ETIs.

Conservative organizations and the media immediately responded to Congress' shift in attitude toward ETIs. The Institute for Policy Innovation and the Lexington Institute, for example, named Interpretive Bulletin 94-1 one of the ten worst regulations requiring immediate repeal or correction by the 107th Congress. (18) As often occurs in the realm of public policy, what many once considered an ingenious solution to a number of social challenges ranging from homelessness to unemployment has become synonymous with the worst-case abuse by Washington's "regulatory monster." Once the subject of national attention, (19) the topic of economically targeted investment programs has since acquired a negative connotation. (20)

Setting politics aside, two basic issues are at the heart of the debate over economically targeted investments: first, whether such investments represent sensible economic and social policy; second, whether ETIs are consistent with the fiduciary obligations of pension fund trustees. (21) Supporters of ETIs advocate using pension money as a source of funds for affordable housing, venture capital, infrastructure, and job creation by putting money in geographical areas and sectors of the economy overlooked by other investors. (22) Opponents of economically targeted investments typically point to the lack of empirical data supporting the economic theories underlying the concept of ETIs, (23) potential political pressures on pension fund sponsors to engage in this type of investments, (24) and the perceived lack of accountability of trustees engaging in the abuse-prone activity of using pensions for public purposes. (25) Critics also argue that targeted investments often produce lower returns compared to non-targeted investments. (26) Invariably, however, critics tie these arguments to the larger question of the consistency of ETIs with fiduciary obligations of pension fund trustees. (27)

This Note contrasts two conflicting views on the legality of economically targeted investments. Examining the concept of ETI from the perspective of targeted investments in low-to-moderate income residential real estate, the Note identifies various shortcomings of the traditional ETI model. The Note demonstrates how recent developments in pension fund fiduciary laws can revive the interest of pension fund trustees in targeted investments in low-to-moderate income residential real estate, and proposes several policy approaches aimed at increasing pension fund investments in this sector.

Part I presents the socioeconomic theory underlying the concept of ETIs and outlines the scope of trustees' fiduciary obligations to plan participants when making investments in residential real estate. This Part also analyzes relevant case law pertaining to fiduciary duties of pension fund trustees. Part II compares two conflicting views on the legality of economically targeted investments. Part III argues that although the legal framework applicable to the fiduciary obligations of pension fund trustees is inadequate to fully address all challenges to the legality of ETIs, pension fund investments in low-to-moderate income residential real estate can be reconciled with the duties of plan fiduciaries to plan participants and their beneficiaries. It examines several potential strategies aimed at popularizing targeted pension investments in low and moderate income residential real estate. This Note concludes that targeted investments in low and moderate income residential real estate are a valid social objective that pension funds can and should cautiously pursue.


    Although the subject of economically targeted investments has been publicized widely, this subject still creates significant confusion for pension fund trustees. (28) This Part discusses socioeconomic and legal issues relevant to economically targeted investments in low-to-moderate income residential real estate. First, it demonstrates the critical need for non-traditional sources of affordable housing financing. Second, it analyzes pension fund investments in various real estate vehicles, and examines pension funds as the source for financing low-to-moderate income residential real estate. Third, it summarizes the fiduciary obligations of pension fund trustees when making real estate investments.

    1. Affordable Housing

      The need for affordable housing in the United States is at a record high. According to the latest report from the Department of Housing and Urban Development, 5.3 million low-income Americans now suffer "worst case housing needs," paying more than fifty percent of their gross income for rent or living in severely substandard housing. (29) The dramatic increase in rent prices in the 1990s, particularly in large cities, (30) led to a housing shortage of unprecedented proportions, with the fastest growth in worst-case households among working families, which increased twenty-four percent between 1991 and 1995. (31) Although home ownership rates are at an all-time high, (32) affordable housing is scarcer than ever, with five million families paying half their income in rent. (33)

      According to the report, the crisis is attributable in part to the continuing decline in the affordable housing stock over the past twenty years. (34)...

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