Alert September 02, 2008

Appeals Court Strikes Down New Jersey’s Ability to Hire External Investment Managers for State Pension Fund Investments

A New Jersey appellate court (the “Court”) struck down as invalid a group of regulations adopted by the Division of Investment of the New Jersey Department of Treasury (the “Division”), authorizing the Director of the Division to engage external investment managers to manage pension fund investments.  The unpublished opinion in Communications Workers of America v. Rousseau, Nos. A-5198-04T1, A-5378-04T1, A-6126-04T1, 2008 WL 3876032 (N.J. Super. App. Div. Aug. 22, 2008), found that the Division lacks the statutory authority from the Legislature to delegate its investment responsibilities to external managers.  The Court, citing case law from environmental and water cases, bases its conclusion that the regulations exceed statutory authority on the applicable standard of care, which the court found did not allow for delegation of management duties.  Although the State argued that the Division’s staff lacked the expertise to make prudent investment decisions in certain areas and thus needed external managers, the Court was not persuaded.  The Court did distinguish between external professionals providing investment advisory services, as opposed to managers with discretion to invest state pension funds, noting that there was authorization to seek the former, but not the latter.

The Court left intact another set of challenged regulations authorizing the Director of the Division to invest state pension funds in alternative investments such as private equity funds and hedge funds.  The appellant unions also challenged particular investments made by the Division, charged with managing state employee pension funds, because those investments included certain private equity fund and other alternative investments.  The Court rejected that challenge and found the private equity and hedge fund investments to be within the Division’s authority. 

At stake is whether the decision requires New Jersey to unwind contemplated or actual arrangements with external managers, as is the delegation by state fiduciaries of such management duties.  Regardless of whether the state officials believe the external managers to be better qualified to manage state pension funds in particular investment strategies, for now, short of action by the New Jersey Legislature or a ruling from a higher court, the Division has no authority to delegate management services.