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Risky Business

Connecting Illinois Investments and Terrorism


On September 20, 2001, with a nation suddenly thrown into a different kind of war, President Bush gave a clear ultimatum: "Either you are with us, or you are with the terrorists," he said. "From this day forward, any nation that continues to harbor or support terrorism will be regarded by the United States as a hostile regime."

Bush's ultimatum, a concept that seems so black-and-white to many Americans, becomes hazy once you venture down the money trail that supports terrorists. Their radical operations only survive day-to-day through money-money that can be traced back to our pockets here in Illinois, as well as across the country. Anyone who has a pension plan, a mutual fund or a 401(k) has money invested in companies that do business with countries that the federal government has identified as sponsors of terrorism. Countries such as Iran, Syria, Libya, North Korea and Iraq (though it may come off the list soon), include what's come to be known as "the Axis of Evil." With these hundreds of well-known companies embedded in the economies of "rogue" states-many of them prominent in our stock portfolios-some people are saying we're setting ourselves up for disaster.

"These companies that do business in rogue countries form the economic backbone of terrorist-sponsoring states," says Adam Pener, chief operating officer of Conflict Securities Advisory Group (CSAG), a Washington-based research firm that has identified 400 companies that do business with terrorist-sponsoring states. "Iran, for example, relies heavily on public companies to strengthen its energy sector."

There are two critical ways to look into U.S. investments in companies that do business with rogue countries: one way is from a moral dimension, and the other way is from a financial risk dimension. The moral criticism of these investments is clear. Especially in light of the heightened sense of patriotism that followed September 11, most Americans probably don't want a cent of their money passed along to terrorist cells. It's not uncommon for people to have their investment portfolios reflect their moral beliefs. For example, some choose not to invest in tobacco giants because of their beliefs in the detriments of smoking.

"Would any U.S. company have done business with Germany during World War II?" Pener asks. "We may not be at war with some of these countries, but the U.S. is fighting a war on terror."

The risk dimension of this issue sets aside morals and argues that these aren't stable investments because they put the finances of Americans at risk. "There is a proven track record that corporate ties to terrorist states can negatively affect investors," Pener says. "We're talking about a possible catastrophic, real-time risk. If I could have told you before the collapse of Enron that there was a financial risk for investors, would you have done something about it?"

What the risk entails, Pener and others say, is the fact that these companies exchange information, hard money and advanced technology with terrorist-sponsoring nations that have weapons of mass destruction programs. An example is the case of Talisman Energy. When it became public that the company did business with the Islamic Republic of Sudan, its stock price dropped more than 20 percent. In the event of a terrorist attack-which we often hear is imminent from our own government-what if a component of weapons of mass destruction were linked back to an outside company? Hypothetically, that company could soon find itself in financial despair and all of its stockholders would be at a loss. And when the investments are in the public pension plans, state employees who've devoted their lives to public service could be without the money they thought they'd earned.

A situation the company Siemens AG encountered could have evolved into such a catastrophe. Along with having subsidiaries in Iran, building a diesel power station in Sudan and having a license to provide wireless systems in Syria, Siemens AG did business with Iraq. The company sold more than 100 high-powered electrical switches to the former government of Saddam Hussein. The switches are used in a kidney stone-smashing machine, of which Iraq only had about six. Technically, Iraq should have only needed about six to 12 replacement switches, if the originals were to ever burn out. But, the switches have a dual-use-when strung together, they can serve as a nuclear detonator.

What may seem farfetched now is the investment risk of the future, many argue. "If you think back 40 years, people thought environmental risk sounded crazy," says Tony Malaj, chief of staff to Arizona Treasurer David Petersen, who has spearheaded an initiative to diminish the risk in the Arizona state pension plan. One of the only states to do so, Petersen has drafted legislation that would force his state's asset managers to assess this risk and identify companies who do business with rogue states. "After the Exxon and Chernobyl disasters, environment risk was a given, so now it's avoided."

Malaj served in the Gulf War, and his son fought in Afghanistan. The service he and his family have provided to this country makes the situation all the more distressing. "This undermines the patriotic works of others," he says.

Which Companies Are Involved and How They Do It

The Conflict Securities Advisory Group has compiled a database of 400 companies that do business with terrorist-sponsoring countries. The group says each company has a profile, based on public sources, newspaper articles and company reports, that details their relations with rogue states. Each profile is sent to its respective company, and if the company chooses to respond, CSAG will publish their response in the report. Only about 25 percent of the companies respond, according to Pener. He says there is little chance of misinformation in their program.

"The main risk with doing business with rogue countries is that people will say you're an evil company because you do business there. Then pensions divest, and stock values decline."

Seventy-five percent of the 400 identified companies are foreign-Siemens, Alcatel and Total Fina Elf being examples. Alcatel, a French company, built a multimillion-dollar fiber optic communication system for Iraq. The system could enhance air defense-which would essentially advance the capability to shoot down U.S. aircrafts. Some of the 100 U.S. companies in the database bypass U.S. law, which bans nearly all commerce with Iran, Libya and other rogue nations, by setting up foreign or off-shore subsidiaries. Some Fortune 500 companies, like General Electric and Halliburton-where Vice President Dick Cheney served as CEO-take advantage of this loophole. In an expos? aired on January 25, 2004, 60 Minutes found that the Halliburton subsidiary in the Cayman Islands was basically nonexistent. Mail to the Cayman Island address gets rerouted to the Halliburton headquarters in Houston. Halliburton currently sells about $40 million a year worth of oil field services to the Iranian government.

"It is lawful to do business through subsidiaries," says William Reinsch, chairman of the National Foreign Trade Council. "U.S. companies take the position that it's lawful. I suppose one can challenge that on any case, although I haven't seen the government prosecute on that lately. There is an adverse public relations risk. The main risk with doing business with rogue countries is that people will say you're an evil company because you do business there. Then pensions divest, and stock values decline. But those aren't risks that have actually been created by the rogue country."

Thirty of the 400 companies are in technical violation of the Iran-Libya Sanctions Act, which states that if you do energy business in Iran or in Libya in excess of $40 million a year, you can be sanctioned by the U.S. government. However, there is a national interest waiver, which has been used in the past. From an investment perspective, the risk is that the government can at any moment go after these companies, which could also put the stockholders in jeopardy. In 2001, President Bush re-signed the Iran-Libya Sanctions Act, extending it for another five years.

"If I told you that you're invested in a company that's in technical violation of U.S. law, would you call that a risk?" Pener asks. "Remember, we all own these companies. If something goes wrong, it's really the fault of investors for not being vigilant."

Whose Responsibility Is It?

The federal government has acknowledged that investments in companies that do business in rogue states are at an increased risk. President Bush signed a bill to establish an Office of Global Security Risk at the Securities and Exchange Commission. The office would ensure that companies properly disclose their business activities that intersect with global security concerns. Interestingly, Reinsch offers a different perspective.

"When Bush signed that bill, the [Office of Global Security Risk] provision was buried among many other provisions," Reinsch says. "If you asked this administration if they supported that particular provision, they'd say no. They haven't been in favor of that in the past. But corporations are now going to have to deal with it, no doubt."

Whatever the rationale behind Bush's signature-in conjunction with the creation of the Office of Global Security Risk-on November 7, 2003 SEC Chairman William Donaldson wrote a letter to Frank Wolf, chairman of the Subcommittee on Commerce, Justice, State and Judiciary, outlining the risk.

"Thank you for your letter concerning actions by the Securities and Exchange Commission relating to companies that may directly or indirectly do business in countries that have been identified as sponsors of terrorism," Donaldson writes. "Like you, I believe this is a crucial issue for investors and appreciate this opportunity to brief you on a number of the SEC's efforts in the area."

Though they legitimize there is a risk, the federal government currently leaves much of the responsibility to the states to do something about protecting their investments. According to a source who asked to remain anonymous, the federal government plans to send out letters to each state's pension system this summer notifying them to account for so-called "global security risk." However, many people say the states already know about this issue and are simply neglecting to do anything about it.

"It's frustrating to see a state like Illinois that is so big, but isn't doing anything about this when the pensions of its workers are at risk," says Malaj. Beginning in February 2003 and ending in January 2004, he along with Arizona Treasurer Petersen sent three letters to every state treasurer in the country. The letters discussed how they believe investments in these companies are at risk, what they aim to do and offered any sort of assistance.

"Despite this forceful validation of global security risk, as well as recent high profile cases, most of our state pension systems and their asset managers do not currently account for global security risk," Petersen wrote in his final letter to each treasurer. "Should your asset managers or pension systems claim to conduct such due diligence-as some have falsely attested to-a simple test can be employed: ask them to provide a list of portfolio companies with links to terrorist-sponsoring countries."

Petersen heard back from only about eight of the treasurers. He never received a reply from Illinois Treasurer Judy Barr Topinka. The Claremont Institute, a political philosophy think-tank, also sent letters to each state's governor, treasurer, comptroller and party leaders from the state legislature. The letters warned of the financial risk of investing in companies that do business in rogue states. Once again, there was little response.

"The sense we have is that there is a lack of appreciation in the connection between economics and politics," says Tom Karako, director of national security programs from the Claremont Institute. "It's our security and prosperity at risk. Our political system has given us freedom in investments, but we need to be aware of the risks. No one wants to tackle this issue."

"It's our security and prosperity at risk. Our political system has given us freedom in investments, but we need to be aware of the risks. No one wants to tackle this issue."

What should be a universal need to explore this issue becomes a partisan blame game, with many legislators, pension funds and public officials shifting the responsibility to someone else. "Everyone knows the risk exists, but few are addressing it," says Pener, who describes what one state's major pension director told him. "He said he didn't want to look into this because he didn't want to have guilty knowledge if something goes wrong. But I said to him, 'If you know there's a risk, by not doing anything, you're not meeting your fiduciary responsibility.' In Illinois, pension fund officials and their asset managers may not have taken the steps to identify and assess 'at risk' companies because it would require a new layer of due diligence. It's a tough issue."

The Arizona legislation puts the responsibility to account for the risk in the hands of the state's asset managers. It would be one more risk to take into consideration when investing the state's dollars. This would involve the asset managers assessing new information-extra work they're not going to do unless they're asked to do it.

"These asset managers can tell you if a particular company is building a dam in Nigeria, but they can't tell you if a company is building a pharmaceutical plant in Iran," says Pener. "The state pension plans need to ask them to provide this information."

Whether fear or laziness play into the neglect of dealing with this issue, it is certain that the sheer complexity of the pensions and investments deter many from delving into them.

"People's eyes get glazed over when you start talking about pensions," says Malaj. "They don't get it. It's hard to get an elected official to understand this. People often don't get this unless they're 70-years-old, saying, 'Where's my money? Why didn't someone tell me?' What drives this office is knowing that there's a single-parent mom or an elderly couple out there, depending on the government to be doing the right thing with their tax dollars. They don't get the money they expect and deserve when the government does something stupid, so we're going to watch out for them. We're raising the fiduciary responsibility of those who manage our money because, right now, they're not doing their job for the single mom and the elderly couple."

Illinois Among Other States

In the United States, state-run pension investments total about $7 trillion. However, few states have initiated an investigation into the risks of investments in companies who work with rogue states. Connecticut is exploring the risk, and recently the Pennsylvania legislature unanimously passed a bill stating a need exists for a screen for these risks. New York City Comptroller William Thompson, who manages the pension funds for all city workers, is working to increase the transparency of this issue until the companies modify their practices. Thompson and other proponents of this issue argue that divestment is the last resort. The goal is to force companies to change their practices with rogue countries to ensure they are safe investments. Upon prompting from shareholders, Conoco-Phillips, once invested in rogue states, said in February that they'd no longer do such business.

"This is a perfect example of what investors can do without divesting," says Pener. "It shows investors working within the system to protect the stock. It's a good corporate governance."

Illinois has five major state pension plans, which have been under fire lately for their vast unfunded liability. The plans-The State Employees Retirement System (SERS), the State Universities Retirement System (SURS), the Teachers' Retirement System (TRS), the Judges Retirement System (JRS) and the General Assembly Retirement

System (GARS)-incorporate more than 630,000 state workers, retirees and beneficiaries. As of June, 2003, the combined pension assets amounted to $46.5 billion, with liabilities of $83.8 billion. The resulting unfunded liability was $37.3 billion. This problem, which has accumulated over some 20 years, is compounded by what some see as a pension system that hasn't adjusted to the times.

"The enormity of the pensions' spending pressure on the state is beyond what anyone comprehends outside the small world of people who actually understand this," says Becky Carroll, communications director for Illinois Budget Director John Filan. "It's hard to explain the pensions to rank and file people because it's so complex, but it needs to be told because this is a spending pressure unlike one in any other state government. And, it's only going to get worse. Since this governor took office, we've been saying, it's been 10 years since the retirement systems have reevaluated what their investment strategy is. It's just like what anyone managing his or her own investment portfolio would do: If things happen in the market that impact where you're investing your money, you're going to reevaluate and revise your portfolio, probably every year. On a macro level, it's the same concept, but they have not done that. Their formula hasn't changed."

The spending pressure and large amounts of unfunded liability make risky investments all the more precarious.

"Illinois is a unique state because its pensions are so spread out-it's a bit of a labyrinth," Pener says. "I know not much is being done in Illinois with regard to looking into investments in companies that do business with rogue states. I would doubt that any of Illinois' plans or their asset managers can say which companies are invested in terrorist states, let alone which are at risk."

However, upon our request, Pener did analyze the 2003 Illinois State Board of Investment portfolio. The Illinois State Board of Investment oversees the net investment assets of SERS, JRS and GARS. The assets totaled $7.8 billion at fair value at the end of fiscal year 2003. Pener found 103 companies in the portfolio that do business with rogue nations. Based on fair market value, $900 million, more than 10 percent of the fund value, is at potential risk.

"I think that is huge," Pener says about his findings. "I was surprised by that amount of money. The university and teachers plans probably have even more money than that."

Before hearing Pener's results, Illinois Treasurer Judy Barr Topinka, who sits on the Illinois State Board of Investment, insists the state is very safe with investments, especially those abroad.

"When you're talking about other areas of the world where there is instability, it would be a big risk [to invest there]," Topinka says. "And so, as a result, we're very careful about where we do that. There may be a risk."

After learning about the 103 companies, Topinka says, "I've never regarded [investments in companies that do business in countries that sponsor terrorism] as a risk. From a personal and patriotic standpoint, I would be most concerned that we always look at companies that might be involved in terrorist activities so that we don't become a part of any kind of program. That we're not going to do."

Bill Atwood, executive director of the Illinois State Board of Investment, offers his view of Pener's findings.

"I think we expect corporate managers to assess these risks," Atwood says. "One way we actively manage these risks is to not invest in companies domiciled in rogue nations. We follow what kinds of investments the government allows. Our asset managers do their job. Whether it's the best policy-it's open to questions. If a company knowingly transfers technology that's used in an attack, that company has a level of liability. Investors have to be aware of those risks."

Topinka says she will look into this situation and talk to Petersen about it, with the hope of finding some sort of resolution. "Continually, we have an interest in this issue," she says. "America has an interest in this. To the extent that we can influence that board by our presence, by our vote and so on, I think you will see that."

Atwood suggests that this risk discussion relates to a much larger problem in corporate America. " You're getting close to a timely and critical issue-the role of boards," he says, seemingly shocked to hear about Siemens AG selling the switches to Iraq (Siemens is in his investment portfolio). "What's happened in corporate America is that we've lost sight of who corporations are supposed to benefit. Corporations have a responsibility to look out for the stockholders. We expect these companies to follow certain standards, and we have a duty to take action when the portfolio is not in sync with the interests of shareholders. At the end of the day, we're fiduciaries to this portfolio. But if our asset managers don't see this as a risk, our ability is limited. To date, nothing big has happened, so our asset managers haven't done much."

Illinois has yet to see anyone really take responsibility to investigate this risk, and perhaps no one will until, as Atwood says, something happens.

"The people who really have something to lose are the public employees," says Pener. "At the end of the day, we just want to make sure the public employees don't get hurt. Plain and simple, there needs to be accountability for this risk."

Published: April 01, 2004