Transcript www2.co.fresno.ca.us

AVOIDING CONFLICTS OF INTEREST
LESSONS FROM
CALIFORNIA’S FAULT LINES
Presentation to the
Board of Retirement of the Fresno County
Employees’ Retirement Association
October 19, 2006
Jeffrey R. Rieger, Esq.
Reed Smith, LLP
Why Conflict-Of-Interest Rules?
“A person cannot serve two masters simultaneously. . . The
duties of public office demand the absolute loyalty and
undivided, uncompromised allegiance of the individual that
holds the office.”
People v. Honig 48 Cal.App.4th 289 (1996)
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Conflict of Interest Laws
Affecting Public Officials
Common Law
State Constitution
Uniform Prudent Investor Act
State Statutes
Case Law
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Common Law
“The most fundamental duty owed by the trustee to the
beneficiaries of the trust is the duty of loyalty. This duty
is imposed on the trustee not because of any provision
in the terms of the trust, but because of the relationship
that arises from the creation of the trust. A trustee is in
a fiduciary relation to the beneficiaries of the trust....In
some relations the fiduciary element is more intense
than in others; it is peculiarly intense in the case of a
trust. It is the duty of a trustee to administer the trust
solely in the interest of the beneficiaries. He is not
permitted to place himself in a position where it
would be for his own benefit to violate his duty to
the beneficiaries.”
Source: I. W. Fratcher, Scott on Trusts, § 170 (4th ed. 1987).
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California Constitution
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Exclusive Benefit Rule “The assets of the retirement system are trust
funds and shall be held for the exclusive purposes of providing benefits
to participants and their beneficiaries and defraying reasonable
expenses of administering the system.”
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Primary Duty Rule “Retirement Board has sole, exclusive fiduciary
responsibility over the assets and administration of the retirement
system…board’s duty to its participants and their beneficiaries shall take
precedence over any other duty.”
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Prudent Person Rule “Members of the retirement board shall
discharge their duties…with the care, skill, prudence and diligence under
the circumstances then prevailing that a prudent person acting in like
capacity and familiar with these matters would use in the conduct of an
enterprise of a like character and with like aims.”
Source: CA Constitution, Article XVI, Section 17
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Uniform Prudent Investor Act
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Duty of Loyalty. Establishes trustee’s duty of loyalty, to
administer the trust solely in the interest of the beneficiaries.
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Conflicts of Interest. Establishes rule against self-dealing.
Trustee has duty not to use or deal with trust property for the
trustee’s own profit or for any other purpose unconnected with
the trust, or take part in any transaction in which the trustee has
an interest adverse to the beneficiary.
Source: California Probate Code Section 16045 et seq.
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Case Law

A trustee’s duties include the duty of loyalty, the duty to avoid
conflicts of interest, the duty to preserve trust property, the duty to
make trust property productive, the duty to dispose of improper
investments, and the duty to report and account.
City of Atascadero v. Merrill Lynch, Pierce, Fenner &
Smith, Inc. 68 Cal. App. 4th 787 (1996).
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CA Statutes
Political Reform Act of 1974
“No public official may make, participate in making or in
any way use or attempt to use his/her official position to
influence a governmental decision in which he/she knows
or has reason to know he/she has a disqualifying conflict
of interest. A public official has a conflict of interest if the
decision will have a reasonably foreseeable material
financial effect on one or more of his/her economic
interests, unless that interest is indistinguishable from the
public generally.”
Source: Fair Political Practices Commission Regulation 18700
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Consequences of a Conflict of Interest
Under the Political Reform Act
 You are disqualified from participating, influencing and
voting.
 If you are disqualified, you announce your potential
conflict of interest and leave the room when the
agenda item is up for discussion.
 In limited circumstances, however, you may speak as a
member of the public.
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CA Statutes
Government Code Section 1090
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
Officials “shall not be financially interested in any contract made by
them in their official capacity, or by any body or board of which they
are members.”
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Limited to public contracts – narrower than the Political Reform Act
treatment of “governmental decisions.”

The term “contract” is interpreted broadly to include “the negotiations,
discussions, reasoning, planning and give and take that go beforehand
in the making of a decision” on a contract. Chapman v. Superior Court
130 Cal.App.4th 261 (2005).

There are circumstances where disqualification of an official is not
required by the Political Reform Act, but the contract is prohibited
under Section 1090.
Consequences Of
A Section 1090 Violation
 Civil and criminal sanctions against an interested official
for willful violations may include a fine, imprisonment in
state prison, restitution of any financial gain obtained from
the contract, and disqualification from holding public office.
Finnegan v. Schrader 91 Cal. App.4th 572 (2001) (member of
sanitary district board later hired as district manager was
required to return all of the over $70,000 he received in
compensation under the illegal contract).
 The challenged contract is void, from the date it was
entered into.
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Exceptions for
“Remote” and “Non-Interests”
 The prohibition of Section 1090 does not extend to an official who
has only a “remote interest” or a “non-interest” in the contract.
 Exempt “remote interests” are specified in the statute

E.g., employment by non-profit entities, small holdings in large
companies by non-directors/officers, competitively bid contracts,
children’s interests, compensation from a government entity, etc.)
 Where only a “remote interest” exists, the public entity is not
prohibited from entering into the contract, so long as
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the interested member discloses his or her interest
the interest is noted in the public record
the interested member does not participate in the process or vote
on the contract
Exception for “Non-Interests”
 The prohibition of Section 1090 also does not extend to an
official who has a “non- interest” in the contract.
 Exempt “non-interests” are defined in Section 1091.5,
including “that of a recipient of public services generally
provided by the public body or board of which he or she is a
member, on the same terms and conditions as if he or she
were not a member of the board.”
 It is also a “non-interest” if your only interest comes from
your government salary, per diem or expense
reimbursement.
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The San Diego Quake –
State Criminal Charges
Six former board members of SDCERS are charged with three
counts of felony conflict of interest. The six defendants are the
City’s former
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Human Resources Director
Treasurer
Assistant Auditor
Management Analyst
President of the Municipal Employees’ Association
President of the Firefighters’ Association
The San Diego Quake –
State Criminal Charges
The core allegations are:
 In 2002, the City, the employees’ unions and the City retirement
system entered into a triangle deal to boost benefits for active
employees, contingent upon relieving the City from (1) an
immediate balloon payment due to the retirement system and
(2) paying the true actuarial cost of the increased benefits. As a
consequence, the retirement system became severely underfunded.
 Each of the six defendants participated in designing and
negotiating the deal and as retirement board members voted in
favor of under-funding the pension system.
 Each of the six defendants personally benefited from the deal.
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The San Diego Quake –
Federal Criminal Indictments

Three former retirement board members and its former Administrator
and General Counsel are charged with a total of 20 counts of felony
conspiracy to commit wire and mail fraud and to deprive the
retirement system, its members and the citizens of San Diego of the
“honest services of their public officials,” causing “significant harm to
the financial integrity of SDCERS.”

The allegations concern the same 2002 “deal,” known as “Manager’s
Proposal Two”, as in the state criminal charges.
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The San Diego Quake –
Federal Criminal Indictments
The core allegations are:
 Defendants conspired to under-fund the system, boost
their own personal retirement benefits and employment
security and conceal the true facts from other board
members.
 The key material fact alleged: The firefighter’s union
president, a retirement board member, increased his own
personal benefits.
 The key wrong alleged: Defendants deprived the system
and citizens of “the honest services of their public officials
to be performed free from corruption, fraud, undue
influence, conflict of interest, and deceit.”
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The San Diego Quake –
Federal Criminal Indictments
 “Honest Services Fraud” -- 18 U.S.C. §§ 1341 and 1346
“For the purposes of this chapter [i.e., mail and wire fraud
statutes], the term, “scheme or artifice to defraud” includes
a scheme or artifice to deprive another of the intangible
right of honest services.”
 Typically involves misuse of an official’s public position for
personal gain, calling into question impartiality of performance
and breach of the public’s trust
 The Government says “honest services” means
“conscientious, loyal, faithful, disinterested, unbiased service,
to be performed free of deceit, undue influence, conflict of
interest, self-enrichment, self-dealing, concealment, bribery,
fraud and corruption.”
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Recent Inductees into the “Honest
Services Fraud” Hall of Shame
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Randy “Duke” Cunningham (R-San Diego)
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Jack Abramoff
Shock Waves Outside
of California, Too
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“ING Units Are Hit by New Hampshire Complaint,” Wall Street Journal,
June 9, 2006
“Clueless in Billerica,” The Boston Globe, January 13, 2006
“Pension Trustee Voted for Firm Linked to Ally; Millions Invested with
Company Tied to GOP Powerbroker,” Chicago Sun-Times,
September 6, 2005
“Theobold Free-Rent Arrangement Revealed,” New Hampshire
Business Review, November 11, 2005.
“Agency’s Ex-Chief Charged in Gift Probe; Food, Travel among Items
Man who Led Retirement Fund is Now Accused of Accepting,”
Columbus Dispatch, August 4, 2005
“Ex-Pension Chief’s Severance Pay Probed by Virginia Legislative
Panel,” The Washington Post, July 9, 2005
“Teacher’s Retirement Deal under Scrutiny,” The Charleston (W. VA)
Gazette, February 20, 2005
Can We Predict When the
Next Big One Will Hit?
No.
(But we can try to help with some practical, everyday concerns you may have.)
HOWEVER:
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BIG DISCLAIMER!!
THE FOLLOWING IS NOT LEGAL ADVICE AS TO ANY SPECIFIC FACT
SITUATION. THIS IS ONLY GENERAL GUIDANCE AS TO THE LIKELY
STATE OF THE LAW GENERALLY ON THESE SUBJECTS. IN MAKING
ANY DECISIONS AFFECTING YOUR LEGAL RIGHTS, YOU SHOULD
NOT RELY UPON ANYTHING SAID IN THIS PROGRAM, BUT INSTEAD
SHOULD SEEK INDEPENDENT LEGAL COUNSEL TO ADVISE ON
SPECIFIC SITUATIONS.
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Predictable Fault Lines for
Pension Officials
 Wearing two or three hats
 Negotiating for benefit increases
 Increasing one’s personal benefits
 Communicating with the plan sponsor, unions, and retirees over
actuarial funding, contribution rates, quid pro quos
 Not disclosing everything
 “Pay to play,” “soft dollars,” “kickbacks,” etc. among consultants,
administrators and investment managers
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TAKEAWAY LESSON
UNCOMMON GAIN
LEADS TO
UNCOMMON PAIN!
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How High on the Richter Scale?
Q: As an elected Trustee or system Administrator, do I have
an impermissible conflict of interest making decisions
affecting contributions or benefits, because I make
contributions and receive the benefits available to all
members of the pension system?
A:
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Not for that reason alone.
How High on the Richter Scale?
Q: If the Board is considering plan changes (e.g. assumption
rate, interest crediting rate, amortization periods) that have
an impact on all members, and I am a member of the
system, do I have an impermissible conflict of interest as a
Trustee?
A: No, not for that reason alone.
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How High on the Richter Scale?
Q: What if the change affects only a category of members
(e.g. DROP participants) and I am a member of that
particular category?
A: Unlikely to create a conflict unless the category is as
small as a single grade/class, management, or small
department.
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How High on the Richter Scale?
Q: Do I have an impermissible conflict of interest as a
Trustee if I am a member of a union or employee
organization within the plan sponsor’s agency? Or a prior
member?
A: Not for that reason alone.
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How High on the Richter Scale?
Q: As a Trustee or administrative staff member, do I have an
impermissible conflict of interest if I am an officer of a union
in the plan sponsor's agency? Or a prior officer?
A: Not for that reason alone.
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How High on the Richter Scale?
Q: As a Trustee or administrative staff member, may I
participate in meet & confer over benefits as a member of
either the employer’s or the union’s negotiating team?
Any different if I participated before becoming a trustee?
A: Troublesome. Let’s talk more.
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How High on the Richter Scale?
Q: Do I have an impermissible conflict of interest if I am a
member of a Taxpayer Association or similar group?
A: Not for that reason alone.
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How High on the Richter Scale?
Q: What if the Taxpayer’s Association’s official position
includes statements of intent or goals inimical to the
mission of the retirement system?
A: Unlikely, but tell me more.
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How High on the Richter Scale?
Q: Can the Board and/or staff enter into any kind of
discussions with plan sponsors re: benefits, plan design,
actuary assumptions, retiree health coverage, etc.?
A: Yes…but!
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How High on the Richter Scale?
Q: Can board members/staff, or any of their professionals,
give advice on actuarial projections and calculations, tax
qualification questions, investments, etc. to the plan
sponsor or to other political entities?
A: Yes…but!
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How High on the Richter Scale?
Q: One of the vendors doing business with the system has
indicated interest in employing me after I am no longer
associated with the system. To what extent would I have
an impermissible conflict of interest in continuing to serve
the system?
A: Very problematic, unless you expressly disclaim any
interest in a future job. You should avoid any activity
relating to that vendor and make full disclosure of the
situation.
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How High on the Richter Scale?
Q: I have an outside business interest that will benefit
indirectly from my serving the system – e.g., I will make
good business contacts, enhance my reputation or gain
access to helpful business leads. As long as I don’t use my
office to directly benefit that business interest, do I have an
impermissible conflict of interest?
A: A judgment call. See specific state regulations.
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How High on the Richter Scale?
Q: I am often invited to speak at pension fund conferences. The
system pays for all my travel and lodging costs, because the
meetings are educational or otherwise directly related to our
business. I also receive my regular pay (if I am a staff
member or an elected trustee) while in attendance. Deep
down, however, my primary motivation in going to these
programs is to enhance my own personal marketability,
rather than any knowledge I might gain. Does this create an
impermissible conflict of interest?
A: This is a close call. At some point, you are taking public
funds to promote personal interests. Is it worth the risk?
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