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Communications Workers of America, AFL-CIO v. Rousseau

SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION


August 22, 2008

COMMUNICATIONS WORKERS OF AMERICA, AFL-CIO, CATHERINE DANATOS, AN ACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, JOSEPH GOLOWSKI, A RETIRED MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, CHARLOTTE GORMAN, AN INACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, LAWRENCE GUSTIN, AN ACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, NANCY HOLLERAN, AN ACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, RODERICK LEWIS, AN ACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, THOMAS MILLER, AN ACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, SUSAN NORRIS, AN ACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, THOMAS PALERMO, AN INACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, JOHN POLK, AN INACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, DENNIS REITER, A RETIRED MEMBER OF THE TEACHERS' PENSION AND ANNUITY FUND, RAE C. ROEDER, AN ACTIVE MEMBER OF THE TEACHERS' PENSION AND ANNUITY FUND, JOHN ROSE, AN INACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, AND MICHELE VICKERS, AN INACTIVE MEMBER OF THE PUBLIC EMPLOYEES' RETIREMENT SYSTEM, APPELLANTS,
v.
DAVID ROUSSEAU,*FN1 TREASURER OF THE STATE OF NEW JERSEY, THE STATE INVESTMENT COUNCIL OF THE STATE OF NEW JERSEY AND THE DIVISION OF INVESTMENT, OF THE STATE OF NEW JERSEY, RESPONDENTS, AND BLACKSTONE CAPITAL PARTNERS, V, L.P., BCP V-S, L.P., OAK HILL CAPITAL PARTNERS, II, L.P., QUADRANGLE CAPITAL PARTNERS II, L.P., AND WARBURG PINCUS IX, LLC, INTERVENORS-RESPONDENTS.
NEW JERSEY EDUCATION ASSOCIATION, JACK O'BRIEN, A TAXPAYER AND A PENSIONER IN THE TEACHERS' PENSION AND ANNUITY FUND, AND ELLEN WILLOUGHBY, A TAXPAYER AND AN ACTIVE MEMBER OF THE TEACHERS' PENSION AND ANNUITY FUND, APPELLANTS,
v.
DAVID ROUSSEAU, TREASURER OF THE STATE OF NEW JERSEY, THE STATE INVESTMENT COUNCIL OF THE STATE OF NEW JERSEY AND THE DIVISION OF INVESTMENT, OF THE STATE OF NEW JERSEY, RESPONDENTS, AND BLACKSTONE CAPITAL PARTNERS, V, L.P., BCP V-S, L.P., OAK HILL CAPITAL PARTNERS, II, L.P., QUADRANGLE CAPITAL PARTNERS II, L.P., AND WARBURG PINCUS IX, LLC, INTERVENORS-RESPONDENTS.
NEW JERSEY EDUCATION ASSOCIATION, JACK O'BRIEN, A TAXPAYER AND A PENSIONER IN THE TEACHERS' PENSION AND ANNUITY FUND, AND ELLEN WILLOUGHBY, A TAXPAYER AND AN ACTIVE MEMBER OF THE TEACHERS' PENSION AND ANNUITY FUND, APPELLANTS,
v.
DAVID ROUSSEAU, TREASURER OF THE STATE OF NEW JERSEY, THE STATE INVESTMENT COUNCIL OF THE STATE OF NEW JERSEY AND THE DIVISION OF INVESTMENT, OF THE STATE OF NEW JERSEY, RESPONDENTS, AND BLACKSTONE CAPITAL PARTNERS, V, L.P., BCP V-S, L.P., OAK HILL CAPITAL PARTNERS, II, L.P., QUADRANGLE CAPITAL PARTNERS II, L.P., AND WARBURG PINCUS IX, LLC, INTERVENORS-RESPONDENTS.

On appeal from the Final Administrative Actions of the Treasurer, the State Investment Council and the Division of Investment.

Per curiam.

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

Argued: March 12, 2008

Before Judges Cuff, Lihotz and Simonelli.

In these consolidated appeals, we review two sets of regulations adopted by the Division of Investment (Division) of the Department of Treasury. One set authorizes the Director of the Division to invest pension funds in alternative investments such as private equity funds and hedge funds. The other set authorizes the Director to engage external investment managers to manage pension fund investments. The issue is not the wisdom of either set of regulations but whether the course adopted by the Division is authorized by statute. In addition, the Communications Workers of America (CWA) and the New Jersey Education Association (NJEA), collectively referred to as "the unions," challenge four investments made by the Director in private equity funds. The unions requested a copy of the contracts relating to those investments, and the Director and representatives of the private equity funds claimed that the contracts are confidential and refused to produce them. The unions ask this court to order production of these documents; the Director and the private equity funds seeks a protective order. We hold that the regulations authorizing and governing the engagement of external investment managers, N.J.A.C. 17:16- 2.1 to -2.4, are invalid. The regulations authorizing investments in private equity funds and hedge funds, N.J.A.C. 17:16-90.1 to -90.4 and 17:16-100.1 to -100.4, are valid subject to the standard of care set forth in N.J.S.A. 52:18A-89b.

The Division is an agency within the Department of Treasury, N.J.S.A. 52:18A-79, that manages State-employee pension funds, N.J.S.A. 52:18A-88.1, in accordance with policies and procedures established by the Securities Investment Council (SIC), N.J.S.A. 52:18A-91. The Director has the "authority to invest and reinvest the moneys" of the pension funds, to "acquire [assets] for or on behalf of" the pension funds, N.J.S.A. 52:18A-88.1, and "to sell or exchange any such investments." N.J.S.A. 52:18A-89a.

In August 2004, the SIC issued a Request for Qualifications (RFQ) for Real Estate Investment Consulting Services for the Division. The RFQ sought a real estate investment consulting firm that would (1) "assist and advise . . . [the State Treasurer, the Director and the SIC] in making prudent real estate investment management decisions, implementing such decisions, and evaluating current and proposed investment strategies, structure and design"; and (2) "assist in conducting searches for real estate investment managers," including interviewing candidates and "providing analyses and information" on reasonable fees. According to the State Treasurer, the Director and the SIC, the SIC issued the RFQ as the first step in implementing an alternative investment program (AIP) to expand the types of investments that the Director could make to include real estate equity, private equity funds and hedge funds. Until that time, regulations only authorized the Director to invest in "traditional investments."

The SIC initiated the AIP in response to recommendations made by Independent Fiduciary Services, Inc. (IFS) in its September 2003 report. IFS had examined the structure of the Division and its investment practices to determine ways in which it could improve operational efficiency and the rate of return on investments. IFS reported that the Division employed a unique management and investment practice inconsistent with industry best practices. Unlike other public employee pension funds, the Division actively managed all of its investments without the aid of external investment managers and invested only in "traditional, publicly-traded securities." IFS recommended the Division retain external investment managers to assist in managing some of its investments and more broadly diversify its investment portfolio by using nontraditional asset classes and strategies, such as real estate equity, private equity, appropriate hedge fund strategies and greater use of high yield bonds. The SIC accepted these recommendations and initiated the AIP. The first step in the AIP process was issuance of the RFQ.

The SIC adopted a Resolution Regarding Investment in Alternative Asset Classes on November 8, 2004. The resolution designated real estate, private equity, absolute return strategies, and hedge funds as alternative classes. The resolution did not define private equity fund or hedge fund.

An excerpt from an article concerning private equity fund disclosures provides a useful definition of private equity funds. The author states:

Private equity funds are investment vehicles. Primarily accessible only to the wealthy and large institutions, they invest in a nondiversified portfolio of businesses to provide both investment capital and managerial expertise. . . . [T]hey provide both high returns - an estimated 23.5 percent in 2004 - and an opportunity for diversification not possible with other mainstream investments.

Frequently, private equity funds are set up as limited partnerships or limited liability corporations. In this arrangement, the private equity firm acts as the general partner or manager, and the investors in the fund, usually 'a limited number of sophisticated investors,' act as limited partners or members. To augment the capital contributions of these investors, the private equity firms make some kind of financial commitment to the fund, usually 1 percent of the total capital raised. The total capital raised in any particular fund can exceed a billion dollars; this is almost always invested in a portfolio of private companies with the intent to take the companies public, sell them, or liquidate them at a later date. Because the general partner manages the day-to-day investing, the distribution of profits is usually 20 percent to the general partner (after management fees and expenses) and 80 percent to the limited partners. Due to the work involved in managing the investment and advising portfolio companies, most private equity firms raise only a few funds. The investments are not designed to be held indefinitely - most have a horizon of seven to thirteen years, with the investments liquidated or distributed to investors before the end of the fund's life. [Steven E. Hurdle, Jr., Comment, A Blow to Public Investing: Reforming the System of Private Equity Fund Disclosures, 53 UCLA L. Rev. 239, 241-42 (2005) (footnotes omitted).]

An official from the Securities and Exchange Commission (SEC) offered the following definition of hedge funds and their differences from private equity funds during testimony before a Congressional committee:

Hedge funds are pools of investment capital that are managed by professional investment advisers and that are not offered generally to the public. They are operated so that they are not subject to the same regulatory requirements of mutual funds, which are governed by the Investment Company Act of 1940 which contains many safeguards for retail investors. [Testimony Concerning Hedge Funds: Hearing Before the Subcomm. on Sec. and Inv. of the U.S. Senate Comm. on Banking, Hous., and Urban Affairs, 109th Cong. (May 16, 2006) (Statement of Susan Ferris Wyderko, Dir., Office of Investor Educ. and Assistance U.S. Sec. and Exch. Comm'n), http://www.sec.gov/news/testimony/ts051606sf w.htm).]

Hedge funds differ from private equity funds in that they are not characterized by a single dominant investment strategy, although many seek to obtain returns that are not correlated to market returns and instead seek to obtain an "absolute return" in a variety of market environments. Some adopt a "multi-strategy" approach that permits the adviser to determine, at any given time, what investment strategy to follow to pursue returns for the investors. Hedge funds also do not have a single risk profile. Some utilize leveraging techniques that expose investors to substantial risks, while others adopt investment strategies more similar to mutual funds. [Ibid.]

On January 20, 2005, the SIC adopted an Alternative Investments Policy (the Policy) and an AIP. The Policy explains that "[t]he AIP calls for the establishment of a new common trust fund to be known as 'Common Pension Fund E,'" in which funds from CWA and NJEA pension funds could participate for the purpose of investing in "Alternative Investments in order to provide enhanced returns for the Pension Funds, at an acceptable level of risk." Alternative investments include real estate and assets, private equity, and hedge funds. The Policy further provides guidelines and standards for the investments and a procedure for selecting investment managers to manage the alternative investments.

At the time the SIC adopted the Policy and procedures, the State Treasurer, the Director and the SIC solicited and obtained advice from several private equity advisors and fund-to-fund managers for their views on the state of the private equity market and how it might influence the investment strategy for pension funds. Based on this advice, the State Treasurer, the Director and the SIC decided to commit $1.5 billion to $2 billion dollars in the first year to private equity investments.

To that end, the State Treasurer, the Director and the SIC entered into partnership agreements that created interests in two private equity funds, Oak Hill Capitol Partners II, L.P. (Oak Hill) and Quadrangle Capital Partners II, L.P. (Quadrangle). The former was executed in December 2004, the latter in March 2005. During this period, Common Pension Fund E was created by regulation. This fund was named as a limited partner in the Oak Hill, Quadrangle and a third private equity fund formed in June 2005, Warburg Pinkus IX, L.L.C. (Warburg). In June 2005, the SIC took another step in implementing an AIP by adopting three sets of regulations: one set, N.J.A.C. 17:16-69.1 to -69.10, created Common Pension Fund E; the second set, N.J.A.C. 17:16-90.1 to -90.4, allows investment in private equity funds; and a third set, N.J.A.C. 17:16-100.1 to 100.4, authorizes absolute return strategy or hedge fund investments.

The regulations authorizing investment in private equity funds provides that the Director may invest and reinvest the moneys of any eligible fund in private equity through separate accounts, funds-of-funds, limited partnerships, direct investments, co-investments and joint ventures in any of the following ways:

1. Buyout Investments: Purchase of a control position (primarily majority positions, with some minority positions) in established companies, with or without leverage.

2. Venture Capital Investments: Purchase of an equity position in small, privately-owned, high-growth companies.

3. Debt-related Investments: Purchase of investments which combine a debt instrument with equity participation. [N.J.A.C. 17:16-90.2.]

"Private equity" is defined as "investments in businesses made through means other than through publicly traded securities. Private equity may consist of buyout funds, venture capital funds and debt-related investments." N.J.A.C. 17:16-90.1. The remaining private equity regulations list the funds that could invest in private equity, N.J.A.C. 17:16-90.3, and the limitations on the Director's ability to invest in private equity. N.J.A.C. 17:16-90.4.

The regulation authorizing investment in absolute return strategy investments, or hedge funds, provides: the Director may invest and reinvest the moneys of any eligible fund in absolute return strategy investments through funds-of-funds, separate accounts and direct investments in individual funds (all generally through limited partnerships) in any of the following ways:

1. Participation in low volatility funds.

2. Participation in equity long/short funds.

3. Participation in opportunistic funds.

[N.J.A.C. 17:16-100.2.]

"Absolute return strategy" is defined in the regulation as "an investment strategy with the goal of achieving positive returns with less correlation than long-only strategies to traditional performance benchmarks." N.J.A.C. 17:16-100.1. The remaining regulations in this set list the public employee pension funds that can invest in private equity investments, N.J.A.C. 17:16-100.3, and the limitations on the Director's ability to invest in them. N.J.A.C. 17:16-100.4. None of the AIP regulations directly relate to or govern the use of external investment managers.

Soon after adoption of the regulations, Common Pension Fund E funded the Oak Hill, Quadrangle and Warburg private equity investment agreements. Common Pension Fund E committed $75 million to Oak Hill, $50 million to Quadrangle, and $200 million to Warburg. In October 2005, Common Pension Fund E entered another partnership and investment agreement and committed $100 million to a fourth private equity fund, Blackstone Capital Partners V, L.P. (Blackstone).

Then, in July 2006, the SIC approved the Fiscal Year 2007 Investment Plan. This plan included not only alternative investments but also proposed management of traditional asset classes in whole or in part by external investment managers. In September 2006, the SIC adopted a policy and procedures for the engagement of external investment managers to manage investments in publicly-traded securities. Up until this time, this function had been performed exclusively by Division personnel.

In January 2007, the SIC proposed regulations on the engagement of external investment managers and in February 2007, the Division issued a Request for Qualifications for Emerging Markets Investment Managers. The SIC adopted these regulations in July 2007. N.J.A.C. 17:16-2.1 to -2.4. These regulations define external investment manager, N.J.A.C. 17:16-2.1, delineate the types of engagements that the Director may make with external investment managers, N.J.A.C. 17:16-2.2, the funds which the investment manager may manage, N.J.A.C. 17:16-2.2, and the limitations on the Director's ability to engage external investment managers. N.J.A.C. 17:16-2.4. An external investment manager may make investment decisions. N.J.A.C. 17:16-2.1. The State Treasurer, the Division and the SIC contend they have not but intend to engage external investment managers. The unions contend that the investment arrangements with the four private equity partnerships are tantamount to retention of external investment managers.

I.

Although the appeals filed by the unions implicate three issues, we deal with only two in this opinion, i.e., whether the State Treasurer, the Director and the SIC are authorized to retain external investment managers, and whether private equity funds and alternative investment strategies, such as hedge funds, are authorized investments. The unions also challenge the refusal of the State Treasurer, the Director, the SIC and the private equity fund managers to turn over the four partnership agreements. The unions commenced a separate action in the Law Division pursuant to the Open Public Records Act (OPRA). On March 5, 2008, Judge Feinberg ruled that the agreements were confidential and not subject to disclosure under OPRA. Appeals from this order are pending in this court. The issue of disclosure will be addressed in a separate appeal. We commence our discussion with the regulations authorizing retention of external investment managers.

The unions contend that the Division lacks the authority to delegate its investment responsibilities to external fund managers. Therefore, the regulations establishing the practice and describing the manner in which external fund managers may be retained, and the funds which may be managed by these retained experts, are invalid.

There is a suggestion in their briefs that the unions include in this argument not only the external manger regulations, N.J.A.C. 17:16-2.1 to -2.4, but also the Alternative Investment Policy regulations, N.J.A.C. 17:16-90.1 to -90.4 and 17:16-100.1 to -100.4. In doing so, the unions seem to consider the authority to retain external managers and investment policy as interchangeable. We perceive a difference. Although the basic issue is one of authority, one set of regulations concerns who may give investment advice and make investment decisions while the other set of regulations concerns the type of investments that may be made. These are two different issues governed by different statutory authority.

Our review of both sets of regulations, those governing who may invest public employee pension funds and those governing what investments are permissible, is governed by common principles of agency decisions and the regulations adopted in the performance of their authority.

Courts generally defer to agency decisions and presume that the regulations they pass are valid because "agencies have the specialized expertise necessary to enact regulations dealing with technical matters and are 'particularly well equipped to read and understand the massive documents and to evaluate the factual and technical issues that . . . rulemaking would invite.'" N.J. State League of Municipalities v. Dep't of Cmty. Affairs, 158 N.J. 211, 222 (1999) (quoting Bergen Pines County Hosp. v. N.J. Dep't of Human Servs., 96 N.J. 456, 474 (1984)). An exception to that rule exists when a party challenges a regulation as contrary to the agency's statutory authority. N.J. State League of Municipalities, supra, 158 N.J. at 222.

In this case the issue turns on statutory construction.

"When construing a statute, courts initially consider the statute's plain meaning." National Waste Recycling, Inc. v. Middlesex County Improvement Auth., 150 N.J. 209, 223 (1997). If the plain language of a statute creates uncertainties or ambiguities, a reviewing court must examine the legislative intent underlying the statute and "construe the statute in a way that will best effectuate [that] intent." Ibid. (quoting State v. Szemple, 135 N.J. 406, 422 (1994)). The general legislative intent influences the interpretation of a statute's component parts. Ibid. To that end, courts must read statutes "sensibly rather than literally." Roig v. Kelsey, 135 N.J. 500, 515 (1994) (quoting Schierstead v. City of Brigantine, 29 N.J. 220, 230, (1959)). [N.J. State League of Municipalities, supra, 158 N.J. at 224-25.]

Two statutes, N.J.S.A. 52:18A-88.1 and N.J.S.A. 52:18A-89, address the authority of the Director and delineate the limitations on his ability to invest. In relevant part, N.J.S.A. 52:18A-88.1 provides:

The Director of the Division of Investment, in addition to other investments, presently or from time to time hereafter authorized by law, shall have authority to invest and reinvest the moneys in, and to acquire for or on behalf of the funds of the following enumerated agencies:

The Public Employees' Retirement System of New Jersey;

The Teachers' Pension and Annuity Fund; . . . . and all other funds in the custody of the State Treasurer, unless otherwise provided by law; such investments which shall be authorized or approved for investment by regulation of the State Investment Council.

N.J.S.A. 52:18A-89a and b provide:

a. Limitations, conditions and restrictions contained in any law concerning the kind or nature of investment of any of the moneys of any of the funds or accounts referred to herein shall continue in full force and effect; provided, however, that subject to any acceptance required, or limitation or restriction contained herein: the Director of the Division of Investment shall at all times have authority to invest and reinvest any such moneys in investments as defined in subsection c. of this section and, for or on behalf of any such fund or account, to sell or exchange any such investments.

b. In investing and reinvesting any and all money and property committed to the director's investment discretion from any source whatsoever, and in acquiring, retaining, selling, exchanging and managing investments, the Director of the Division of Investment shall exercise the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. In making each investment, the director may, depending on the nature and objectives of the portfolio, consider the whole portfolio, provided that, in making each investment, the director shall act with the reasonable expectation that the return on each investment shall be commensurate with the risk associated with each investment. The director shall be under a duty to manage and invest the portfolio solely in the interests of the beneficiaries of the portfolio and for the exclusive purpose of providing financial benefits to the beneficiaries of the portfolio.

N.J.S.A. 52:18A-89c defines "investments":

c. For the purposes of this section, "investments" means and includes property of every nature, real, personal and mixed, tangible and intangible, and specifically includes, solely by way of description and not by way of limitation, bonds, debentures and other corporate obligations, direct and indirect investments in equity real estate, mortgages and other direct or indirect interests in real estate or investments secured by real estate, capital stocks, common stocks, preferred stocks, diversified pools of venture capital which otherwise could be made consistent with the standard of care required by subsection b. of this section, common trust funds as defined in and regulated by sections 36 through 46 of P.L.1948, c.67 (C.17:9A-36 through 17:9A-46), repurchase agreements, securities loan transactions secured by cash, securities issued by the United States government or its agencies, or irrevocable bank letters of credit, whether directly or through a bank or similar financial institution acting as agent or trustee, mutual funds, and any other security issued by an investment company or investment trust, whether managed or not by third parties, registered under the "Investment Company Act of 1940," 15 U.S.C.[A.] § 80a-1 et seq. No investment that is otherwise permissible under this subsection shall be considered to be unlawful solely because the investment is made indirectly or through a partnership, trust, or other legal entity.

In addition, N.J.S.A. 52:18A-91b requires the SIC to report annually to the Governor, the Legislature and the State Treasurer regarding its work and the work of the Division. The report must include whether the investments were made by Division personnel or by external managers. Section 91d requires an external investment manager to file a certification before retention and annually thereafter that discloses political contributions made by the manager or the manager's firm, or a political committee on which the manager or investment firm was active.

The unions contend that these statutes do not authorize retention of external investment managers to invest public employee pension funds because these provisions speak only in terms of the Director's authority to make investment decisions and do not even suggest that the Director may delegate that authority to a third party. The State Treasurer, the Director and the SIC do not dispute that retention of an external investment manager is a delegation of the authority of the Director to make investment decisions on behalf of the State. They also do not dispute that N.J.S.A. 52:18A-91b and 91d do not authorize the retention of external investment managers but rather reflect the regulatory change allowing retention of such managers. They also agree that there is no express legislative authority to retain external investment managers; they do argue that sections 88.1 and 89 grant the Director broad discretion that extends to the persons or entities that he may retain to make authorized investments.

"The general rule is that a power or duty delegated by statute to an administrative agency cannot be subdelegated in the absence of any indication that the Legislature so intends."

Mutschler v. N.J. Dep't of Envtl. Prot., 337 N.J. Super. 1, 12-13 (App. Div.) (quoting Mercer Council # 4, N.J. Civil Serv. Ass'n v. Alloway, 119 N.J. Super. 94, 99 (App. Div.), aff'd o.b., 61 N.J. 516 (1972)), certif. denied, 168 N.J. 292 (2001). "This is especially true when the agency attempts to subdelegate to a private person or entity, since such person or entity is not subject to public accountability." In re Applications of N. Jersey Dist. Water Supply Comm'n, 175 N.J. Super. 167, 206 (App. Div.) (citing N.J. Dep't of Transp. v. Brzoska, 139 N.J. Super. 510 (App. Div. 1976)), certif. denied, 85 N.J. 460 (1980).

The plain language of N.J.S.A. 52:18A-88.1 and N.J.S.A. 52:18A-89 reveals that the Legislature has not authorized the Director to delegate his investment-decision-making authority to external investment managers. These provisions speak only in terms of the Director's authority to invest; they do not provide that the Director may delegate that power to a third party. Thus the plain language of the statutes shows that the Director has no ability to delegate his decision-making authority to a third party.

The State's contention that N.J.S.A. 52:18A-89c supports the authority of the Director to engage external investment managers is misplaced. This section provides that the Director may make investments "directly or through a bank or similar financial institution acting as agent or trustee," or through a "mutual fund" or a "partnership, trust or other legal entity." This section concerns the types of investments the Director may make not who may make those investments. For example, a person choosing to invest in a mutual fund does so by examining the investment policy of the fund, its historic performance, and its anticipated performance as an investor does for an individual stock, bond or other investment vehicle. Although a mutual fund is managed by a third party, it is distinctly different from handing over a sum of State money to a third party who has the discretion to invest the State funds.

The unions also argue that the legislative history of N.J.S.A. 52:18A-88.1 and 89 and the standard of care in N.J.S.A. 52:18A-89b establish that the Legislature did not intend to authorize the Director to delegate his investment decision-making authority to a third party. Their argument is premised upon L. 1997, c. 26, which the Legislature adopted in 1997 and codified at N.J.S.A. 3B:20-11.1 to -11.12; N.J.S.A. 52:18A-88.1 and 89.

Law 1997, c. 26 did two things. One, it changed the standard of care for fiduciaries from the "prudent man rule," contained in the Prudent Investment Law, N.J.S.A. 3B:20-12 to -17 (repealed by L. 1997, c. 26), to the "prudent investor rule," contained in the Prudent Investor Act, N.J.S.A. 3B:20-11.1 to -11.12. Second, it amended N.J.S.A. 52:18A-88.1 and 89 to specify the standard of care that governs investments by the Director.

The prudent man rule provides that in investing and managing funds a fiduciary shall exercise the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. In making each investment, a fiduciary may, depending on the nature and objectives of the portfolio, consider the whole portfolio, provided that, in making each investment, a fiduciary shall act with the reasonable expectation that the return on each investment shall be commensurate with the risk associated with each investment. If the fiduciary has special skills or is named as the fiduciary on the basis of representations of special skills or expertise, he is under a duty to exercise those skills. [N.J.S.A. 3B:20-13 (repealed by L. 1997, c. 26).]

The prudent investor rule provides, in relevant part:

a. A fiduciary shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the fiduciary shall exercise reasonable care, skill, and caution.

b. A fiduciary's investment and management decisions respecting individual assets shall not be evaluated in isolation, but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.

c. Subject to the standards established in this act, a fiduciary may invest in any kind of property or type of investment. No specific investment or course of action is inherently imprudent. [N.J.S.A. 3B:20-11.3.]

The two standards differ in that the prudent man rule requires the fiduciary to base investment decisions on the risk and rate of return for each investment, while the prudent investor rule requires the fiduciary to consider the "purposes, terms, distribution requirements, and other circumstances of the trust . . . in the context of the trust portfolio as a whole and as part of an overall investment strategy having risk and return objectives reasonably suited to the trust." Senate Management, Investment and Financial Institutions Committee, Statement to S.1092 (June 6, 1996) (enacted as L. 1997, c. 26). Additionally, and more important to this appeal, the prudent investor rule allows delegation of decision-making authority, but the prudent man rule does not. Ibid. The Legislature explained:

The second major revision to current law made by the bill [1092] concerns delegation of investment responsibility. The bill allows a fiduciary to delegate investment and management functions that a prudent fiduciary of comparable skills could properly delegate under the circumstances. [Ibid.]

Accord Restatement (Second) of Trusts § 171 (1959) (discussing the prudent man rule's prohibition against delegation of authority). See also Restatement (Third) of Trusts: Prudent Investor Rule at 3-8 (1992) (summarizing the differences between the prudent man rule and the prudent investor rule). Thus, L. 1997, c. 26 changed the standard of care for fiduciaries and thereby allowed fiduciaries the ability to delegate their decision-making authority.

However, the Legislature continued to subject the Director to the prudent man rule. The Committee Statement provides:

The bill [L. 1997, c. 26] provides that the Director of the Division of Investment shall not be subject to the fiduciary standards of the new "Prudent Investor Act," and keeps the director subject to fiduciary standards identical to the standards of the current "Prudent Investment Law" (N.J.S.A. 3B:20-12 et seq.) when the director invests and manages funds in the custody of the State Treasurer. [Senate Management, Investment and Financial Institutions Committee, Statement to S.1092 (enacted as L. 1997, c. 26).]

To that end, the Legislature in L. 1997, c. 26, amended N.J.S.A. 52:18A-88.1 and N.J.S.A. 52:18A-89 to clarify the Director's duty of care. Specifically, it added section b to N.J.S.A. 52:18A-89 to define the Director's standard of care in terms of the prudent man rule, and deleted the following underscored language from N.J.S.A. 52:18A-88.1:

The Director . . . shall have authority to invest . . . moneys in . . . such investments which shall be authorized or approved for investment by regulation of the State Investment Council and in which fiduciaries of trust estates in this State may legally invest and subject to the limitations and conditions applicable thereto.

The State does not address the legislative history that restored the prudent man standard to guide the Director's actions. Instead, they contend that the retention of external investment managers is consistent with the "prudent person standard." According to the State, the prudent person rule imposes a standard of prudence on the Director and includes "two elements that further define the standard of care." First, they contend that N.J.S.A. 52:18A-89b requires the Director to consider "the whole portfolio and the risk/return balance when making individual investment decisions." Second, they argue that N.J.S.A. 52:18A-89b requires the Director to manage the funds exclusively for the benefit of the beneficiaries. They insist that engaging external managers is consistent with that standard because the Director has determined that it is in the pension funds' best interest to do so because Division staff lack the expertise to make prudent investment decisions.

We conclude that the plain meaning of the legislation and the legislative history of the 1997 amendments make clear that the Legislature did not intend to authorize the Director to delegate investment decision-making authority to a third party. The Legislature not only said that the Director is subject to the prudent man rule, it underscored that, unlike the prudent investor rule, the prudent man rule does not allow delegation of decision-making authority. Senate Management, Investment and Financial Institutions Committee, Statement to S. 1092 (enacted as L. 1997 c. 26). Furthermore, the Legislature amended N.J.S.A. 52:18A-88.1 to delete reference to investments that other fiduciaries may lawfully make, and added section b to N.J.S.A. 52:18A-89, which defines the Director's standard of care in terms of the prudent man rule. Compare N.J.S.A. 52:18A-89(b) with N.J.S.A. 3B:20-13. The prudent man rule does not allow delegation of decision-making authority. Senate Management, Investment and Financial Institutions Committee, Statement to S. 1092 (enacted as L. 1997 c. 26).

An external investment manager is not akin to hiring additional staff. The external investment manager may be subject to a competitive and rigorous review process, but the Director is not making the investment decisions as required by statute. Moreover, unlike external investment managers, the Director and Division staff are State employees. Staff is accountable to the Director, and the Director, in turn, is accountable to the SIC, the State Treasurer, the Governor and, ultimately, the public. Indeed, the lack of public accountability is of prime importance when considering whether an agency may delegate or subdelegate its authority to a private third party. In re Applications of N. Jersey Dist. Water Supply Comm'n, supra, 175 N.J. Super. at 206; Brzoska, supra, 139 N.J. Super. at 513.

In short, we hold that the plain language of N.J.S.A. 52:18A-88.1 and 89, conferring authority on the Director to manage and invest pension funds in conjunction with the fiduciary standards imposed on the Director by the Legislature do not authorize the Director to delegate his investment decision-making authority to external investment managers. Regulations derive their validity only from the authority of the executive agency to perform the function that is the subject of the regulations. See Med. Soc. of N.J. v. N.J. Dep't of Law & Pub. Safety, 120 N.J. 18, 25 (1990) (noting validity of regulations within the authority delegated to an executive agency and not beyond the agency's power). It follows, therefore, that the regulations authorizing such action by external investment managers are invalid as are any agreements with external investment managers authorized by those regulations because the Director lacks the authority to delegate his investment authority to a third party.

This is not to say that the Director cannot retain an external investment manager to provide advisory services. We also do not suggest that the Legislature may not authorize the Director to retain external investment managers for the purposes of actively investing and managing certain State funds. The manner in which the State has handled investment of State funds may be considered out-of-step with the practice by other public entities. External investment managers may be more efficient or proficient. Ultimately, who performs investment functions for the State is a policy issue that has been addressed in the past by the Legislature. The issue is fraught with many considerations that should be addressed in the first instance by the Legislature.

II.

Many of the same concerns about who should have the authority to invest State pension funds arise in the second issue in this appeal, the type of investments that the Director may make. Once again, the wisdom of investments in private equity funds and hedge funds is not before us. Our inquiry is confined to the authority bestowed on the Director to make investments on behalf of the State.

The Director has the authority to invest and reinvest any of the moneys entrusted to him subject to the limitations established by law. N.J.S.A. 52:18A-89a-b. N.J.S.A. 52:18A-89c defines "investments" as follows:

"investments" means and includes property of every nature, real, personal and mixed, tangible and intangible, and specifically includes, solely by way of description and not by way of limitation, bonds, debentures and other corporate obligations, direct and indirect investments in equity real estate, mortgages and other direct or indirect interests in real estate or investments secured by real estate, capital stocks, common stocks, preferred stocks, diversified pools of venture capital which otherwise could be made consistent with the standard of care required by subsection b. of this section, common trust funds as defined in and regulated by sections 36 through 46 of P.L. 1948, c. 67 (C. 17:9A-36 through 17:9A-46), repurchase agreements, securities loan transactions secured by cash, securities issued by the United States government or its agencies, or irrevocable bank letters of credit, whether directly or through a bank or similar financial institution acting as agent or trustee, mutual funds, and any other security issued by an investment company or investment trust, whether managed or not by third parties, registered under the "Investment Company Act of 1940," 15 U.S.C.[A] § 80a-1 et seq. No investment that is otherwise permissible under this subsection shall be considered to be unlawful solely because the investment is made indirectly or through a partnership, trust, or other legal entity. (emphasis supplied).

The unions argue that the underscored language prohibits investment in a company that is not registered with the SEC. They read the underscored limiting language to apply to the entire universe of investment vehicles referenced in section 89c. The State defendants argue that the limiting language cited by the unions refers only to mutual funds and any other security issued by an investment company or investment trust.

The first step in construing a statute is to analyze the statute's plain language. N.J. Carpenters Apprentice Training and Educ. Fund v. Borough of Kenilworth, 147 N.J. 171, 178 (1996); Merin v. Maglaki, 126 N.J. 430, 434 (1992); Sheeran v. Nationwide Mut. Ins. Co., 80 N.J. 548, 556 (1976). When the statute's plain meaning is unambiguous, the analysis is complete and there is no need to look beyond its plain language to determine the Legislature's intent. State v. Sutton, 132 N.J. 471, 479 (1993); Phillips v. Curiale, 128 N.J. 608, 618 (1992). In construing the plain language of a statute, every effort must be made to construe the language in a manner that will avoid an absurd result. Planned Parenthood of New York City, Inc. v. State, 75 N.J. 49, 53 (1977). In addition, a construction of a statute which renders a word or a sentence meaningless must be avoided. Bergen Commercial Bank v. Sisler, 157 N.J. 188, 204 (1999).

The plain language of N.J.S.A. 52:18A-89c and the Investment Company Act of 1940 (the 1940 Act), 15 U.S.C.A. §§ 80a-1 to -52, make it readily apparent that the interpretation offered by the unions is not supportable. We observe that the 1940 Act defines "investment company" as an entity that "holds itself out as being engaged in the business of investing, reinvesting or trading securities." 15 U.S.C.A. § 80a-3(a)(1)(A). Yet the term "investment securities" does not include securities issued by the United States government or its agencies. 15 U.S.C.A. § 80a-3(a)(2). Section 89c authorizes the Director to invest in "securities issued by the United States Government or its agencies." Yet, the interpretation proffered by the unions would preclude the Director from investing in one of the investment vehicles expressly identified by the Legislature as a suitable investment because securities issued by the United States are not subject to the 1940 Act. Similarly, section 89c authorizes the Director to invest in common trust funds as defined in and regulated by N.J.S.A. 17:9A-36 to -46. This type of investment is also not an investment security subject to the 1940 Act. See 15 U.S.C.A. § 80a-3(c)(3).

Section 89c also authorizes the Director to make direct investments in real estate. This is a type of transaction not encompassed by the 1940 Act. The unions' interpretation of the limiting language would similarly preclude the Director from making a direct purchase of an apartment complex or an office building despite the express authority bestowed on the Director by the Legislature to do so.

We recognize that as a general matter private equity funds and hedge funds are investment companies that fall within one of the 1940 Act's many exemptions. See Hurdle, Jr., supra, 53 UCLA L. Rev. at 247 (explaining that most private equity funds are exempt from the 1940 Act's registration requirement); Andrew J. Donohue, Director, Division of Investment Management, U.S. Securities and Exchange Commission, Speech by SEC Staff: Remarks Before the 4th Annual Hedge Funds and Alternative Investments Conference by The Securities Industry and Financial Markets Association (May 23, 2007), http://www.sec.gov/news/speech/2007/spch052307ajd.htm (last visited Aug. 4, 2008) (explaining that hedge funds avoid registration under the 1940 Act). Usually that exemption is 15 U.S.C.A. § 80a-3(c)(1), which provides an exemption for "[a]ny issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of its securities." Yet, the Legislature has clearly indicated that the Director may acquire assets from persons or entities that are not subject to the 1940 Act.

We noted at the commencement of this opinion that the wisdom of any investment is not within the province of this court. Similarly, the issue of whether investments in hedge funds and private equity funds are consistent with the standard of care imposed on the Director by N.J.S.A. 52:18A-89b is not before us.*fn2 Our inquiry is confined simply and solely to the scope of authority bestowed on the Director by the Legislature. It is for the Legislature to determine if the risks presented by a particular investment outweigh the rewards the Director expects to achieve through these alternative investment vehicles.

In summary, we hold that N.J.S.A. 52:18A-88.1 and 89 do not authorize the Director to select external investment managers and authorize those managers to invest pension funds. Therefore, the regulations governing this practice, N.J.A.C. 17:16-2.1 to -2.4, are invalid. On the other hand, we hold that N.J.S.A. 52:18A-89c identifies a broad range of investments in which the Director may invest limited solely by the standard of care established in N.J.S.A. 52:18A-89b. We hold that the fact that private equity funds and hedge funds are not subject to the 1940 Act does not preclude investment in such vehicles. Thus, the regulations adopting the AIP, N.J.A.C. 17:16-90.1 to -90.4 and 16-100.1 to -100.4, are valid on their face.


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