Passed in 1974, ERISA curtailed the investment activities of pension funds by establishing a federal prudence standard that, among other things, discouraged speculation and investment in early stage companies. Almost immediately following its passage, financiers advocated for the ERISA prudence standard be restated to allow pension fund investment in venture capital through an adoption of modern portfolio theory (MPT). MPT re-conceptualized risk as an investment characteristic to be read across the full portfolio and in the context of the market as a whole. Prior to this, “risk” was considered a thing to be avoided in the contexts of trusts. In 1979, Labor issued a restatement of the ERISA prudence standard, bringing it into accordance with MPT. The impact on the venture capital industry was significant. Over the following decade, pension fund participation in venture capital funds skyrocketed. The ERISA prudence clarification was followed in 1990 by the revision of the prudent man rule as generally applied to trusts, effectively completing the financialization of “risk” as applied to trusts.
The impact of the ERISA prudence clarification on investment is recognized, but the debates leading to this policy shift are not well understood. These debates occurred within the Department of Labor itself, but also in the pages of professional publications like law review journals, in the business press, and in the halls of Congress. This paper traces these debates as they occurred in print, in hearings, and in committee meetings at the Department of Labor. These debates show how contentious the restatement of the ERISA prudence standard was. Though Labor claimed that the 1979 restatement was merely intended to bring clarity, it is clear from tracing the debate that the restatement represented a massive shift in the basic meaning of prudence, and that this was understood at the time in the legal, financial, and policy spheres. By undertaking this debate, we can better understand the process of financialization in the second half of the twentieth century.