But all that has been changing. The Americans have long distinguished between the private (participatory) and public (regulatory) actions of the state. American courts have recognized the choice of law implications of this division, treating participatory activity as a subject of private law, and regulatory activity as a matter of public law (to which, for example, the limitations on state power contained in the 14th Amendment of the American federal Constitution apply). For a recent case in which these issues were discussed and refined, see Dept of Revenue of Kentucky v. Davis, No. 06–666, argued November 5, 2007, decided May 19, 2008, slip op. at 7-10. The Europeans appear to be taking the opposite tack. Through a jurisprudence developed from out of their “golden share” cases, the European Court of Justice appears to be embracing the position that state activity is presumptively public in character, at least when directed at domestic entities, and that such activity might contravene either the prohibitions on interference with the free movement of capital (Art, 56 EC Treaty) or with the regulation of state aid under the Competition provisions of the ECT Treaty (Art. 87 EC). (For a preliminary discussion of the cases and the development of a European conception of state activity in the market form a choice of law perspective, see Larry Catá Backer, "The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign Wealth Funds, and the Public Law Element in Private Choice of Law," Tulane Law Review, Vol. 82, 2008).
Moreover, at the supra-national level, two things have helped changed the legal framework within which an analysis of the legal character fo state activity is taking place. First, globalization has limited the reach of state regulatory activity. Notwithstanding the great efforts of dominant states to project their law outward, and irrespective of what one thinks of this development, the current legal regime is seeing the construction of regulatory systems above and to some extent beyond the state. (Larry Catá Backer, "Economic Globalization and the Rise of Efficient Systems of Global Private Lawmaking: Wal-Mart as Global Legislator," University of Connecticut Law Review, Vol. 39, No. 4, 2007). Second, states have increasingly embraced the notion, sometimes partially and sometimes grudgingly, that there may be a higher law above that of political states. Whether grounded in formal international instruments, or international common law (customary international law or jus cogens), states are getting used to the idea that their sovereign activities are not unlimited--not as a practical matter but as a formal matter. (Larry Catá Backer, "Economic Globalization Ascendant: Four Perspectives on the Emerging Ideology of the State in the New Global Order," University of California, Berkeley La Raza Law Journal, Vol. 17, No. 1, 2006) In this changing legal context, it is more likely that a space can be reserved for the possibility of states to cease acting as a sovereign (especially where they cannot and will not) and to act as something else. The legal response to this possibility has produced a great problem of modern legal regulation with its own complexities.
It is one thing when a state seeks to invest in economic activity within the territory over which it has regulatory authority. In that case one might more forcefully (and effectively make a variant of a “form over substance” argument. Because states always control the legislative environment in which economic entities operate, any purported investment by states in private entities (or even the purported participation of states in the market by appearing to act like a private investor) might well retain a public character. States, in that context, are not in the same position as private investors. The state can always legislate its way around impediments—others must satisfy themselves with exit or participation within the entity. Moreover, states do not act under the same economic constraints as private individuals. Private individuals are said to seek to maximize economic value; states might be deemed to seek to maximize political capital. Assuming that those are different things, a state might not, in that context, be capable of participating in the market like a private individual. Consequently, all state activity is both regulatory and public in character. This form of reasoning is in line with the development of European thinking. But its appeal is offset by another compelling reality. First, the assumption that that states are incapable of acting like other economic actors may be misguided. If the point of economic theory is welfare maximization, and if welfare maximization is, to some extent contextual and subjective—then the facts the some entities (states) value outcomes in a way that may be different from one’s grandmother, may make no real difference. Second, the Americans have rejected the presumptions of this “form over substance” approach in favor of a more formalist approach with its own presumptions. States are presumed to act in accordance with the form of their actions; they are also deemed to be capable of welfare maximizing behavior compatible with private law. Only where it can be shown that the participation is disguised regulation, will public law apply. Otherwise, state activity in the market, including aberrational activity, is to be guided by private law. Thus, for example, state abuse of its position as shareholder will be judged by the same standards applied to shareholder abuse generally.
But what ought to be the governing law when one state seeks to invest in the economy of another state? This question has become particularly acute since the rise, over the last decade of a number of large funds controlled by states, the purpose of which is to invest in economic entities wherever they may be domesticated. On the surface, this might suggest the best case for the equal treatment of states with private entities. In this case, unlike that in which the state always has the potential to legislate changes to its corporate law, the state stands in the same shoes as a private investor. On the other hand, the state, even as a private investor, has the power to reach deeply into the economic affairs of other states by implementing its legislative program through shareholder activism.
It may be most useful to consider the problem by way of an example from contemporary practice. Consider for the purpose the current role of Norway as an increasingly important private shareholder within the European Union, and worldwide. Norway has twice rejected the opportunity to join the European Union, once in 1972 and the last time in 1994. (See Eur. Comm’n, External Relations, Norway). Norway, however, is heavily integrated with the European Union through its participation in the European Economic Area, the terms of which are governed by the Agreement on the European Economic Area (EEA). (Id.). The EEA has been in force since January 1, 1994 “and extends the Single Market legislation, with the exception of Agriculture and Fisheries, from the EU Member States to Norway, Iceland, and Liechtenstein.” (Id.). The EEA permits Norway to participate in many of the programs of the European Union, but membership in the EEA carries no voting rights in shaping European Union policy. (Id.). Norway thus is burdened with policy over which it has no direct control. “Norway also, along with its EEA/EFTA partners, contributes financially to social and economic cohesion in the EU/EEA. Norway is as integrated in European policy and economy as any non-Member State can be, and the close EU-Norway relations generally run smoothly.” (Id.).
But control can come in a variety of forms in an age in which the state can assert sovereign power using the mechanics of private action. The Norwegian Government Pension Fund (Folketrygdfondet) is the second largest sovereign wealth fund (SWF) in the world, and the largest in Europe. (Pension Funds Online, Top 100 Global Pension Funds). “Folketrygdfondet has been investing in the stock market since 1991, and its role as a financial investor is well entrenched.” (See Folketrygdfondet, Ownership Report 2007). It is currently estimated to be valued at 375 billion U.S. dollars. (Foreign Government Investment in the U.S. Economy and Financial Sector: Hearing Before the H. Subcomm. on Domestic and Int’l Monetary Policy and the Subcomm. on Capital Markets, Insurance, and Government Sponsored Enterprises of the H. Comm. on Fin. Servs., 110th Cong. 2 (Mar. 5, 2008) (Statement of Martin Skancke, Director General, Asset Management Department, Ministry of Finance, Norway).
The name “pension fund” is something of a misnomer, as Folketrygdfondet is funded from Norway’s considerable petroleum revenues. (Id.). In 2006, the Government Pension Fund—Global was merged with Norway’s National Insurance Scheme to form Folketrygdfondet by an act of the Legislative Assembly. (Id., at 111). The new entity has the long-term goals of management of petroleum revenues and the financing of Norway’s pension scheme, and it has become a model for transparency and ethical management among SWFs. (Norwegian Ministry of Finance, Report No. 24 (2006-07) to the Storting: On the Management of the Government Pension Fund in 2006, 6-7 (2006), [hereinafter Pension Fund Management Report No. 24].) This goal remained unchanged. See Norwegian Ministry of Finance Report No. 16 (2007-08) to the Sorting on the Management of the Government Pension Fund.
Folketrygdfondet is administered by Norges Bank Investment Management (NBIM), a division of the Norwegian Central Bank. (Id.). Norges Bank is also responsible for the publication of quarterly and annual reports on the fund, which are made public. (Id., at 21, Fig. 2.5). These reports include lists of all companies and commodities in which the fund is invested, rates of return, absolute and relative risk, and a strategic plan for the future. (Id., at 107). The Folketrygdfondet board of directors consists of nine members, who are appointed by the King to four-year terms. (Id., at 103). Investment regulations are set by the government. (Id., at 103-104). Up to 50% of the fund’s assets may be invested in shares, primary capital certificates, bonds, commercial paper, and deposits in commercial and savings banks. (Id., at 103). The fund is also subject to regional investment restrictions, with the majority of both fixed income and equity investments confined to Europe. (Id., at 101-102). Additionally, the fund is not permitted to own more than 5% of the equity shares, or exercise voting rights in excess of 5% of total voting rights in a single company. (Id., at 102). In 2008, the Fund reported that "[w]hile there are also plans to increase the limit on ownership stakes from 5 pct to 10 pct, this does not alter the Fund’s role as a financial investor. At the same time, the Minister is emphasizing the ethical obligations of the Fund, says Finance Minister Kristin Halvorsen." Norweigian Ministry of Finance, Prudent and Long Term Asset Management, Press release, published 04.04.2008, No.: 16/2008.
Investments are made by the Folketrygdfondet in accordance with a set of “Fundamental Ownership Guidelines.” (Folketrygdfondet, Ownership Report 2007, at 3). Among them is an obligation to “attend to its ownership interests on the basis of a set of qualitative investment criteria within the areas of ethics and corporate governance. Evaluation against such criteria shall form an integral part of the investment methodology of Folketrygdfondet, and of its ongoing asset management effort.” (Id.). The Folketrygdfondet is also required to assume a shareholder activist role:
The financial interests of Folketrygdfondet shall be attended to by way of management monitoring, on an ongoing basis, financial developments on the part of the companies in which Folketrygdfondet is invested, hereunder by attending investor presentations held by the companies and by meeting with management representatives of the companies when deemed desirable. (Id.).
The Norwegian finance minister has publicly acknowledged her intention to incorporate a social agenda into Norway’s investment strategies by, for instance, paying careful attention to companies that emit greenhouse gasses. As she has explained, “[i]n a global economy, ownership of companies is the most important way to have influence.” (Mark Landler, Norway Backs Its Ethics with Its Cash, N.Y. Times, May 4, 2007, at C1.).
The Folketrygdfondet is not subject to the usual rules applicable to private or state pension funds. “Folketrygdfondet is not subject to restrictions in the form of ongoing return or capital adequacy requirements. This means that Folketrygdfondet enjoys a special position as far as asset management is concerned, and is well placed to adopt a long investment horizon.” ((Folketrygdfondet, Ownership Report 2007, at 2). Fund ownership must be geared to fostering “good corporate governance.” (Id.). The Norwegian fund explains this approach:
The corporate governance principles adopted by Folketrygdfondet are premised on the Norwegian Code of Practise for Corporate Governance and the OECD Principles of Corporate Governance. Good corporate governance shall attend to the rights of the owners and other stakeholders in relation to the companies, and ensure that the management mechanisms of the companies work appropriately. (Id.).For its 2007 report, the Folketrygdfondet targeted corporate officer remuneration models (Id., at 6-7). It also focused on activities relating to the issuance of shares, noting that “[w]e are of the view that a general authority to issue shares should normally not exceed ten percent of the share capital.” (id., at 5). It sought to take the position that “a general authority to issue shares should normally not exceed ten percent of the share capital.” (Id.). Lastly, it also targeted and on the creation of elections committees on boards of directors. “The role of the Election Committees is to ensure a good process for the appointment of Directors, with the proposed candidates enjoying the support of the main shareholders, and to ensure that the interests of the shareholders as a whole are attended to.” (Id., at 5).
On November 19, 2004, an Ethics Council was established by Royal Decree. (Council on Ethics, Norwegian Government Pension Fund-Global). The Council’s primary function is to evaluate companies in which the fund might invest to determine whether those companies meet certain ethical standards. The fund justifies this focus on ethics in both conventional and behavior modification terms.
The reason why we want ethics to form a key aspect of our company assessments is that we believe that a conscious and responsible attitude to ethical issues will over time contribute to enhanced value creation. This will again contribute to safeguarding our shareholder value, as entrusted to companies. Folketrygdfondet has therefore defined a set of investment principles for ethical investment assessments, and these are incorporated into our investment methodology and ongoing asset management efforts.
(Folketrygdfondet, Ownership Report 2007, at 8). The Council makes recommendations to the Ministry of Finance, which then has the power to exclude companies from the fund’s portfolio. (Ethical Guidelines, Norwegian Government Pension Fund—Global § 4.1, ). Subsequently, the Council is obligated to periodically evaluate excluded companies in the event that a company has ceased to engage in actions which are contrary to the ethical guidelines. (Id. § 4.6). In December 2005, the Council released ethical guidelines by which companies are to be evaluated. (Id. § 1). The guidelines state two principal aims. First, because the fund is concerned with long-term stability and solvency, it should seek to invest in companies who promote sustainability in the “economic, environmental and social sense.” (Id.). Second, the fund should abstain from investments that might contribute to violations of “fundamental humanitarian principles, serious violations of human rights, gross corruption or severe environmental damages.” (Id.).
The Council has recommended the exclusion of companies who manufacture or aid in the manufacture of nuclear weapons or cluster munitions. (Pension Fund Management Report No. 24, supra, at 75-77). Such companies include Northrop Grumman Corp., Lockheed Martin, and GenCorp, Inc. (Id. at 77 tbl. 4.1). The Council has also excluded Freeport McMoRan Copper & Gold, Inc., and DRD Gold Limited for environmental abuses, as well as Wal-Mart Stores, Inc., for labor rights violations. (Id. at tbl. 4.2). The Council has even shown its willingness to exclude companies that deal with governments which have poor human rights records, as evinced in its exclusion of Total SA, for doing business with the ruling military junta in Burma. (Ministry of Fin., Recommendation of 14 November 2005 (Unofficial English translation)).
Some of these decisions have had political consequences, especially from the Americans. When the Folketrygdfondet put Wal-Mart on its “no-invest” list of companies because of its alleged difficulties in keeping its supply chain relationships within ethical bounds, the Americans reacted. “The ministry said the council had found ‘an extensive body of material’ that indicated Wal-Mart had broken norms, including employing minors against international rules, allowing hazardous working conditions at many of its suppliers and blocking workers’ efforts to form unions.” (John Acher, Norway Dumps Wal-Mart from $240 Billion Investment Fund, USA Today.com, June 6, 2006). In response, American officials publicly criticized the Norwegians both for their conclusions and for their actions, which for the Americans had a flavor of indirect regulation. “[T]he American ambassador to Norway, Benson K. Whitney, . . . “accused the government of a sloppy screening process that unfairly singled out American companies. ‘An accusation of bad ethics is not an abstract thing,’ Mr. Whitney said. ‘They’re alleging serious misconduct. It is essentially a national judgment of the ethics of these companies.’” (Mark Landler, Norway Backs Its Ethics with Its Cash, N.Y. Times, May 4, 2007, at C1.).
Were the Folketrygdfondet merely a private actor, there is little question that it would pose no particular problem in private law regimes. It would be clear that the rules applicable to all private investors would apply (as would whatever rules generally govern investment funds of the type created). The fund purchases stock on the market, does not take a majority position, has negotiated no special regulatory regime within the host states, and seeks ultimately to maximize the value of its investments in a way that is precisely articulated and approved by its holders.
But the result might be different under the emerging European jurisprudence. First, it is not clear that the investments are made like ordinary investments. The Norwegian legislature has conferred special rights on the fund to act more flexibly than equivalent private funds. Moreover, a significant objective of the investment might be deemed regulatory—the Folketrygdfondet means to be an active shareholder, both in its purchase decisions, and its relationship with entities in which it has taken a position. To the extent that such entities also have operations in Norway, the result would be little different than if the state had invested in a domestic entity; Norway has a privileged position with respect to its private investment.
On that basis its very investment is public rather than private in character and could impede the free movement of capital. That is to say, because of the regulatory effect, the fund would be treated as a state actor operating in its sovereign capacity (though indirectly so) rather than in a private capacity. By its own admission, the fund is seeking not merely to maximize its financial position, but also to advance a specific regulatory program. While that program is not specifically Norwegian, that does not change the regulatory—though indirectly regulatory—character of the investment project. From this perspective, Norway appears to be engaging in a bit of extra-territorial regulation through its control of key economic actors.
Yet, this would bean odd result if one examined the question from an institutional perspective. Norway is seeking to do little more than any other private investor could do. Its activism is limited by the regulatory framework within which it operates. It, like a publicly traded corporation with a large shareholding base, must be sensitive to those actions which its “shareholders” deem to be welfare maximizing. Ignoring these sentiments is not only anti-democratic from a corporate governance perspective (as well as from a public law perspective, of course), but might result in a reduction of the value of the concern. It has not sought to change the rules of corporate governance—clearly a sovereign activity. Rather it means to use them the way any other investor with a large stake might. That its motivations spring from the public policy of Norway should not distinguish it from, say a corporation whose investment strategy is grounded in a founder’s deeply held religious beliefs. (See, e.g., Cynthia L. Cooper, Religious Right Discovers Investment Activism, CorpWatch, Aug. 3, 2005, (discussing the growing popularity of Christian investment funds)). In either case, as long as the ultimate goal is stakeholder wealth maximization—however plausibly defined—then that should be the end of the story. The difference can only be supported by a presumption that states are different, and that the fiction of private action by public entities is just that.
It is in this context that Brazil adds another wrinkle. “Brazil will create a sovereign wealth fund with the primary aim of intervening in foreign exchange markets to counter the appreciation of Brazil's currency, according to finance minister, Guido Mantega.” (Jonathan Wheatley, Brazil Plans Sovereign Welfare Fund to Counter Rising Currency, Financial Times, Dec. 9, 2007). According to another report, the fund would start fairly modestly. ““A sovereign wealth fund to be established by Brazil’s government will begin with at least $10 billion in assets and will likely invest in securities issued by the BNDES Brazilian National Development Bank, among others, Brazilian Finance Minister Guido Mantega said Thursday.”” Brazil Min: Sovereign Fund To Start At $10B, Invest In BNDES, Dow Jones Newswire, Nov. 22, 2007 .
This takes the Norwegian fund practice one step farther from traditional investment objectives of privately held funds. “His statement adds to controversy surrounding the fund, first announced by Mr Mantega in October. Since then, funding plans and objectives have undergone several revisions. The uncertainty has caused concern among investors and officials at the country’s central bank. The SWF appears to differ substantially from funds operated by other countries.” (Id.). As the media has reported, “About two-thirds of sovereign funds are capitalized with cash from exports of oil or gas. The Abu Dhabi Investment Council, for example, is the largest sovereign wealth fund, with $875 billion of assets, according to the Sovereign Wealth Fund Institute. Other funds, like the $60 billion Australian Government Future Fund, are financed from budget surpluses.” (Isabel Versiani, In plan for sovereign wealth fund, Brazil charts a different course, The International Herald Tribune, May 14, 2008). Still, from a slightly different perspective, it might be argued that what separates Brazil from Norway is the sophistication of description of programs. I have suggested that Norway's investment might also be deemed to be public in some respect--it has chosen to express public policy goals through an aggressive program of investment that is expressed in the traditional language of finance, risk management, diversification, wealth production and the like. Even the choices of investment vehicle, so well grounded in policy, and limiting, are expressed in value maximizing terms. Brazil has not yet learned the use of the language of investment as an overlay of its investment strategies. Clearly, that is possible.
But Brazil has made no pretense of private objective—the purpose of the Brazilian effort is to maximize the welfare of Brazil by using its investment to build its wealth by preventing a rise in the value of its currency. “On Friday, Mantega revealed a few details on the source of the cash, saying it would come from the federal government's primary budget surplus of more than 4 percent of gross domestic product. He did not say how much of the surplus would be earmarked. The fund also will be fed by dollars purchased by the government to keep the dollar from falling even more, Mantega said.” Brazil Puts Final Touches On Bill Creating Sovereign Wealth Fund, The International Herald Tribune, May 24, 2008.
But. . . isn’t that sort of thought and action precisely we would expect from any private investor—to invest and vote their shares in a way that maximizes their personal (rather than the value of the target corporate) wealth. Why should the state be forbidden what a non-sovereign private participant is encouraged to do? The answer is, because Brazil is a state. But Microsoft is not a person born of a woman. Yet there is little difficulty treating as equivalent the investment behavior of natural and juridical individuals. If the state is different, it is because it can regulate. The large multinational enterprise, or the private wealth fund, can only threaten to withdraw an investment. States can regulate and affect the fortunes of its investment. Yet, that is not what Brazil intends. It merely tends to act privately to protect its public interest. Is that private in character or public. Or both?
And, indeed, the market has begun to react to Brazil’s strategy in the same way that it would value the worth of a large multinational corporation or publicly traded investment fund. This is no surprise. While people worry about the nature of private activity by sovereigns, the global economy has already decided—states acting in a non sovereign capacity (borrowing money, engaging in common transactions) will be treated like other private entities—although with a few quirks. See, Larry Catá Backer, "Ideologies of Globalization and Sovereign Debt: Cuba and the IMF, 24 Penn State International Law Review (2006).
In this case, the reactions have not been positive. Morgan Stanley recently downgraded Brazil from equal weight to underweight. Jonathan Garner, GEMS Equity Strategy, Country Model Update: Going Underweight Brazil, Morgan Stanley Global Strategy Bulletin, December 18, 2007 (reducing ranking from 12 to 17). The rationale is ironic: “In our view the “virtuous circle” of exchange rate appreciation, commodity price strength, sovereign risk premium reduction, and equity valuation convergence has now run its course in Brazil. Forward P/E has essentially reached parity with the rest of EM and is also now well above the 5-year historically observed fit level to the sovereign spread. In absolute terms it has only been higher 10% of the time in the last 10 years.” (Id.). Others have reported that “analysts say this plan could jeopardize Brazil's fiscal position because it would have to buy BNDES bonds in U.S. dollars to finance business abroad. The government might also have to subsidize the loans to make them attractive to businesses. As if that were not enough, the focus on national companies is atypical of sovereign wealth funds, which tend to diversify investments internationally to minimize risk.” (Isabel Versiani, In plan for sovereign wealth fund, Brazil charts a different course, The International Herald Tribune, May 14, 2008).
And, indeed, the media has not taken the fund seriously either—principally because it is coming from Brazil. It has been characterized as “a symbol of Brazil's emergence as a leading investment-grade economic power than a significant investor or earner of income.” (Isabel Versiani, In plan for sovereign wealth fund, Brazil charts a different course, The International Herald Tribune, May 14, 2008). And it has been dismissed as a gimmick. “Sovereign wealth funds have become popular with governments as emerging-market countries, in particular, seek to manage their newfound wealth as the world economy grapples with a credit crisis.” Id.
But the fear remains, a fear that haunts the development of European jurisprudence presuming states incapable of non-sovereign activity. And there is a point to this. Having gone to the trouble of getting the state—as a sovereign entity—out of markets, and then globalizing markets and economic activity, it seems odd to now permit states back into the market through the back door. If states still act as states, this might provide the states with a new method of regulation—incentive based, wealth based, and as coercive as direct positive legislation. Norway’s impulse to do good, multiplied, could substantially distort (that is redirect) the markets. And states might be tempted to use the markets for other goals—and thus threaten the integrity of the very thing that makes their private participation possible. But fears need not result in prohibition. It might instead require a new regulatory regime—a private public law. (Backer 2008, supra). Only time will tell, but the legal and economic ramifications will be profound in all legal orders.