Statement of the Honorable Maureen M. Baronian,
Vice President, Investors Services of Hartford, Inc.
(forner State Representative, Connecticut General Assembly,
and former Trustee, Investment Advisory Council, State of Connecticut)

Testimony Before the Subcommittee on Social Security
of the House Committee on Ways and Means

Hearing on Social Security's Trust Funds in the Stock Market

March 3, 1999

Chairman Shaw, Ranking Member Matsui and Members of the Subcommittee, thank you for inviting me to be here today. As a member of the Investment Advisory Council (IAC) for the State of Connecticut from 1987 to 1995, I have seen first hand the results of allowing governments to invest directly in private equity markets. I can only hope that my experiences will help enlighten this Committee as it considers President Clinton's proposal to invest a portion of the federal Social Security surplus in private markets.

Almost 10 years ago, on March 22, 1990, the State of Connecticut Retirement and Trust Funds joined with members of the United Auto Workers, some existing members of Colt management, and a few other private investors to complete a buyout of the Colt Firearms Division of Colt Industries, Inc. In all, the State placed $25 million in State pension funds into this buyout ($17.5 million in CF Holding and $7.5 million in CF Intellectual Properties -- which owns the Colt trademark). This investment gave the State of Connecticut a 47 percent share of Colt Manufacturing.

Unfortunately, in less than two years, on March 18, 1992, CF Holding Corporation filed for Chapter 11 Bankruptcy. Fortunately, the State Pension's loss was "limited" to "only" $21 million -- after the Colt trademark was sold to the Economic Development Authority of Connecticut two years later. While it is not uncommon for Pension funds to lose money on the investments they make, the case of Connecticut's investment in Colt is an example where politics, not prudence led to the failed investment.

For months leading up to this investment, Connecticut newspapers were filled with editorials and news reports on the financial crisis facing Colt Manufacturing -- a company that employed 950 people. Colt finances were in disarray, it lacked positive cash flow, it had low reserves, and it was suffering from a bitter four-year strike by its labor union which had resulted in a $10 million fine by the National Labor Relations Board (NLRB).

Not only was Colt in trouble, industry analysts pointed to a shrinking market for firearms, growing international competition and an increasing threat of liability claims against firearms manufacturers. Colt was clearly a failing company in a shrinking industry -- not exactly the type of company a pension manager would normally seek to invest $25 million.

Colt's financial problems were well known to the State and to the Investment Advisory Council. In fact, the State Economic Development Authority had been trying to find a buyer or investor for Colt Manufacturing for years. Unfortunately, no venture capitalists or private money managers would touch Colt Manufacturing with a ten-foot pole. So why did a majority (7 of 10) of the Investment Advisory Council vote in favor of investing in Colt Manufacturing? Politics.

While the supporters in the IAC and the State Treasurer wrapped this investment in the rhetoric of "prudence," "due diligence," and "careful consideration," there was no question that the primary reason for this investment was political -- i.e., to save 950 UAW workers from certain unemployment.

Shortly after the State buyout of Colt, the Hartford Courant ran an editorial noting that the State Treasurer, Francisco Borges, had told the editors that the Colt investment was not "to make money for the state but to save jobs." Upon announcement of Colt's bankruptcy Mr. Borges issued a press release that bemoaned the bankruptcy of Colt "despite our best efforts in saving the company from demise or dismantling two years ago." These two statements are very enlightening -- the States investment in Colt was not about higher returns for state pension funds, it was not about sound investment practices, it was about saving a company from certain "demise." Like I said, it was politics over prudence.

As a former member of the State of Connecticut's House of Representatives and as a first hand witness of the hearings and deliberations of the Investment Advisory Council, I am well aware of the difficulty in shielding state investment funds from political influence. The failed investment in Colt is only the starkest and most dramatic example of the effect of politics on investment decisions. During my tenure on the IAC, our investment decisions were limited by legislative action by the State of Connecticut limiting our investment in companies located in Northern Ireland and South Africa, and by rules requiring us to consider the "environmental records" of the companies in which we invest.

Even more troubling, the influence of state investment funds is not limited to the investment decisions of the State, but also is effected by the active role of the State in the governance of the companies in which the State invests. In fact, the State used to have a person in charge of voting the States proxies at shareholder meetings, thus ensuring that the States restrictions on investing in various foreign countries or the States concerns over environmental matters were heard at such meetings.

My experience with the State of Connecticut pales in comparison to the meddling politics could ultimately play were the federal government to invest Social Security surpluses in private markets. Connecticut's pension was equal to approximately $8 billion at the time we invested in Colt -- a paltry sum compared to the trillions that could ultimately be invested by the federal government.

Would the federal government be able to resist the temptation to invest in suffering steel companies to save jobs? Would the government be able to resist the temptation to limit its investment to "union-friendly" companies? Would the government be tempted to meddle in the pay scales of the companies it invests in to lower wage disparities between management and labor? Would the federal government be able to add weight to its anti-trust cases by threatening to divest in companies it files cases against? Or worse yet, would the federal government pursue anti-trust cases against companies it owns shares of? I fear not, and for that reason, I strongly oppose allowing the federal government to invest surplus funds in private markets.

Mr. Chairman, the United States has been a shining example of the benefits of the free enterprise system to the rest of the world. As a result of the success of our system, countries around the world have divested their government's ownership in private companies: France is exiting Renault, England has sold British Airways, and Germany is divesting in Lufthansa. I am baffled that the President would now move our government in the opposite direction and follow the disastrous and discredited example of foreign governments by buying shares of private corporations.