The nation’s two largest public pension funds, CalPERS and CalSTRS, are stepping up their drive to reform corporate boards of directors at a time when others are proposing reforms of pension boards.

A new listing of potential directors announced by the pension funds last week is aimed at increasing the “diversity” of corporate boards. The pension funds say the change can alter “group think” and improve corporate performance, boosting shareholder value.

Gov. Brown and the Little Hoover Commission want more public member(s) on pension boards dominated by labor and management representatives, who presumably have a self-interest in raising pensions and cutting employer contributions.

Much of the motivation for both reform movements comes from the financial crisis. Corporate missteps contributed to the market crash, and huge pension fund investment losses are driving up government pension costs.

The pension funds announced the Diverse Director DataSource (3D) shortly before a hearing last week on a suit filed by business groups to block a new law making it easier for pension funds and other shareholders to put directors on corporate boards.

A “proxy access” provision pushed by CalPERS and CalSTRS in a financial regulatory reform bill last year, the Dodd-Frank Act, allows shareowners with 3 percent of company stock for three years to put board candidates on corporate ballots.

Without access to the ballot, shareholders who back board candidates not nominated by management have to distribute the proxy material themselves to other shareholders, a costly and seldom-used method of ousting directors.

Dodd-Frank has a provision intended to make “proxy access” litigation proof. But the U.S. Chamber of Commerce and Business Roundtable filed a lawsuit to overturn a proxy access rule issued by the Securities and Exchange Commission.

“The SEC’s proxy access rule empowers unions and other special interests at the expense of the vast majority of retail shareholders,” David Hirschmann, a U.S. Chamber official, said in a news release last September.

The new ballot access and director database have business groups suspecting potential takeover attempts by the labor-friendly pension funds, which already use shareholder clout to push corporations on environmental, social and governance issues.

Anne Sheehan, CalSTRS corporate governance director, told her board in February that the Chamber has suggested that the database was being created to supply candidates nominated under the new proxy rule.

“They have wanted to sort of link the two issues together,” said Sheehan. “We have seen it in some of the media reports, some of the inquiries and I think actually in some of the comments to the SEC.”

The database, guided by an 18-member panel, will be owned and operated by the Corporate Library, a research firm with an existing database of 130,000 corporate directors. Individuals and groups can submit names for the new diversity database.

Then corporations, shareowners and other subscribers looking for a board candidate can check the list. The pension funds spent $120,000 to develop the database and expect to be repaid as the operator creates a fee-based business plan.

Diversity is broadly defined by the pension funds, going beyond ethnicity, gender and age to include things like skill and experience. The goal is to add a different point of view to like-minded boards often selected by management.

“We see this as in part our response to improving board quality after the financial crisis,” Anne Simpson, CalPERS corporate governance manager, said this week as she briefed the board on the database.

“The IMF (International Monetary Fund) in its post-mortem said that group think was the single most dangerous feature of the system in board rooms, policy making and regulatory circles, too,” Simpson said.

A review of academic studies found “the effect of board diversity on firm performance is inconclusive,” a diversity conference sponsored by CalPERS and CalSTRS was told in 2009. The financial crisis is giving diversity new momentum.

“I think one of the lessons we learned out of the financial crisis, as we try to explain to people, was that group think on those boards was detrimental to us as shareholders,” Sheehan told the CalSTRS board last week.

“So getting people with diverse backgrounds and sort of really asking some of the tough questions would be beneficial to some of those boards,” Sheehan said, ” and this (the new database) gives us the ability to identify candidates and put them forward.”

Even without proxy access, the pension funds have been seeking board changes. For example, CalSTRS and Relational Investors put forward a candidate, Peggy Foran, elected to the Occidental Petroleum board last December.

Both pension funds urge corporations to require a majority vote election of unopposed board candidates, rather than a plurality. A “say on pay” provision in the Dodd-Frank Act is giving shareholders a non-binding vote on executive compensation.

Shaking up management to improve performance is at the heart of pension fund corporate governance programs.

CalPERS has been announcing an annual “focus list” of several underperforming companies targeted for board changes such as requiring say on pay and ending staggered terms, supermajority vote requirements, and combined chairman and executive roles.

After a Wilshire study found that firms engaged privately outperformed the focus list, CalPERS announced last November that it was dropping the “name and shame” tactic of publicly identifying its annual focus list.

CalPERS also has more than $5 billion in a Corporate Governance Investment program. Activist managers “engage the portfolio companies to unlock value through governance, operational, strategic, and/or board changes.”

Now in a turnabout, the boards of the pension funds are the target of reform proposals. CalPERS and CalSTRS are both underfunded after massive investment losses during the economic downturn and stock market crash.

CalPERS is criticized for sponsoring legislation, SB 400 in 1999, that touched off a round of statewide pension increases said to be “unsustainable” by critics. A pay-to-play investment scandal at CalPERS involving former board members is still unfolding.

All three state pension funds (CalPERS, CalSTRS and UC Retirement) have been hurt by what in hindsight looks like mismanagement. When a booming stock market gave the funds surpluses a decade ago, contributions were lowered and pensions increased.

Among the watchdog Little Hoover Commission recommendations in February for a sweeping pension overhaul is restructuring labor-management pension boards “to add a majority or a substantial minority of independent, public members to ensure greater representation of taxpayer interests.”

Two of the eight points in a pension reform proposed by Gov. Brown during his campaign last year were that pension board members receive special training and be held accountable for investment decisions.

One of the 12 points in a new pension plan issued by Brown last month is “improve retirement board governance.” In failed state budget talks, Republicans said Brown proposed adding two public members to the pension boards.

As pension boards are targeted for reform, it may be worth noting that what is by far the most diverse of the boards, the 26-member UC regents, made what is in hindsight one of the biggest blunders.

The regents allowed UC Retirement to go a remarkable two decades without contributions from employers or employees, getting by on investment earnings before resuming contributions at a low rate a year ago.

Now to close a huge funding gap, UC faces years of escalating pension costs that will divert money from other programs already in a financial squeeze. “This is a breath-taking cost to our campuses,” UCLA Chancellor Gene Block told the regents.

A staff report last September said that if normal contributions had been made during the two decades, the UC Retirement system “would be approximately 120 percent funded today.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 15 Apr 11