Transcript Fiduciary Conflicts:

Fiduciary Conflicts:
What (or Where) are they now??
Clint Lackey
Director of Compliance Oversight,
Fiduciary and Insurance Activities
Wells Fargo Bank, N.A.
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Disclaimer
• The views expressed today are my own
and do not necessarily reflect the views of
Wells Fargo Bank, N.A.
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Topical Objectives
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Review “conflicts” and “self-dealing”
Risk and regulatory concerns
Where might we find conflicts now?
How do we prevent or address conflicts?
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Starting Point – Common Law Duty
of Loyalty
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The Duty of Loyalty
…the most fundamental duty owed by
the trustee to the beneficiaries of a trust.
• Not imposed by the terms of the trust, but
by the nature of the “relationship” which
arises from the creation of the trust.
• The trustee must administer the trust
solely in the interest of the beneficiaries.
• The trustee must not put himself in a
position where it would be for his own
benefit to violate his duty.
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Duty of Loyalty (Cont.)
Chief Judge Cardozo in his opinion rendered
in Meinhard v. Salmon, 249 N.Y. 458, 164
N.E. 545, 546 (1928), described a fiduciary's
duty of loyalty as follows:
"Many forms of conduct permissible in a workaday world for those
acting at arm's-length, are forbidden to those bound by fiduciary
ties. A trustee is held to something stricter than the morals of the
market place. Not honesty alone, but the punctilio of an honor the
most sensitive, is then the standard of behavior. As to this there
has developed a tradition that is unbending and inveterate.
Uncompromising rigidity has been the attitude of courts of equity
when petitioned to undermine the rule of undivided loyalty by the
'disintegrating erosion' of particular exceptions. Only thus has
the level of conduct for fiduciaries been kept at a level higher than
that trodden by the crowd."
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What is Self-Dealing? (Cont.)
A clear statement of law regarding selfdealing was expressed by the U.S. Supreme
Court in Michoud v. Girod, 11 L.Ed. 1076,
1099:
"The general rule stands upon our great moral obligation to refrain
from placing ourselves in relations which ordinarily excite a
conflict between self-interest and integrity. . . . It therefore
prohibits a party from purchasing on his own account that which
his duty or trust requires him to sell on account of another, and
from purchasing on account of another that which he sells on his
own account. In effect, he is not allowed to unite the two opposite
characters of buyer and seller, because his interests, when he is
the seller or buyer on his own account, are directly conflicting
with those of the person on whose account he buys or sells."
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Conflicts of Interest & Self-Dealing
• Duty of Loyalty – the interest of your client
is paramount.
• Statutory/Regulatory citations of interest:
– 12 USC 92a(h)
– ERISA
– State statutes
– 12 CFR 9
• Contrast with “conflicts” under the fiduciary
standards for others in financial industry.
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Permissive Exceptions to
Duty of Loyalty
• The duty of undivided loyalty can only be
waived if:
– Authorized by applicable law
• Governing Instrument
• State Law
• Federal Law
• Court Order
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Permissive Exceptions to
Duty of Loyalty
– Beneficiary Approval
• Must fully disclose the conflict.
• Must not be in contravention to local
law.
– Revocable Trust Grantor Approval
• Written direction of the grantor
required.
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Regulatory Perspectives
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Common Law
Federal Law (US Code)
State Statutes (Uniform Trust Act?)
Federal Regulation
Policy and Procedure
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Federal Laws
• 12 USC 92a(h) - Loans of Trust Funds to
Officers and Employees Prohibited; Penalties
– National bank is strictly prohibited from lending funds from the fiduciary accounts
it administers to the bank’s officers, directors, or employees.
– If any bank officer, director, or employee makes or receives any such loan, that
person may be fined up to $5,000, imprisoned, or both.
– The regulators may bring enforcement actions against the bank and its officers,
directors, and employees, including the imposition of civil money penalties.
– No exceptions to this prohibition are allowed under 12 USC 92a(h). The statute
prevails over any instrument authority, beneficiary consent, or court order
purporting to authorize the transaction.
– The strict statutory prohibition (carrying criminal sanctions) against lending trust
assets to bank employees and insiders does not extend to their related interests
or to bank affiliates.
– Obligations of directors, officers, or employees received in kind are not prohibited
by 12 USC 92a(h) unless they are renewed or carried past due at the bank’s
discretion.
– Demand loans of directors, officers, or employees received in kind should be
paid within a reasonable time.
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Federal Laws (Cont.)
• 29 USC Ch. 18 - Employee Retirement
Income Security Act (ERISA)
– The primary objective of ERISA is to protect the rights and interests of employee
benefit plan participants and their beneficiaries.
– Two government agencies are primarily responsible for administration and
enforcement of ERISA.
• The Department of Labor is responsible for interpreting and enforcing fiduciary
provisions of ERISA and also interprets those sections of the Internal Revenue Code
dealing with fiduciary requirements for employee benefit plans.
• The IRS is responsible for IRAs, Keogh accounts that cover only the
individual/employer, and various tax-related provisions of the Internal Revenue Code.
– Commonly referenced sections of ERISA
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Section 1104 - Fiduciary duties
Section 1105 - Liability for breach of co-fiduciary
Section 1106 - Prohibited transactions
Section 1107 - Limitations on acquisition and holding of employer securities
Section 1108 - Exemptions from prohibited transactions
Section 1109 - Liability for breach of fiduciary duty
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Federal Regulations
• 12 CFR 9.5 – Policies and Procedures
– Must adopt and follow written policies and procedures addressing
• Brokerage placement practices – 12 CFR 9.5(a)
• Methods for ensuring that officers and employees do not use material inside information
in connection with any decision or recommendation to purchase or sell any security –
12 CFR 9.5(b)
• Methods for preventing self-dealing and conflicts of interest – 12 CFR 9.5(c)
• Selection and retention of legal counsel to advise the bank and its officers and
employees on fiduciary matters – 12 CFR 9.5(d)
• Investment of funds held as fiduciary and the treatment of fiduciary funds awaiting
investment or distribution – 12 CFR 9.5(e)
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Federal Regulations (Cont.)
• 12 CFR 9.10 – Fiduciary Funds Awaiting
Investment or Distribution
– Funds awaiting investment or distribution in discretionary accounts shall not
remain uninvested and undistributed for an unreasonable amount of time and
should be invested at a rate consistent with applicable law – 12 CFR 9.10 (a)
– Funds of a fiduciary account awaiting investment or distribution can be placed in
an interest bearing account in the fiduciary bank, unless prohibited by applicable
law – 12 CFR 9.10(b)(1)
– Funds of a fiduciary account awaiting investment or distribution can be placed in
an interest bearing account in affiliated bank, unless prohibited by applicable law
– 12 CFR 9.10(b)(1)
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Federal Regulations (Cont.)
• 12 CFR 9.12 – Self-Dealing and Conflicts of
Interest
– Discretionary investments in the stock or obligations of the bank or an affiliate
(including their respective directors, officers and employees) are only permitted if
authorized by applicable law – 12 CFR 9.12(a)(1)
– Discretionary loans, sales or transfers of assets from fiduciary accounts to the
bank or an affiliate (including their respective directors, officers and employees)
are only permitted if authorized by applicable law – 12 CFR 9.12(b)(1)
– Loans from fiduciary accounts to bank directors, officers, or employees are
strictly prohibited – 12 CFR 9.12(b)(1)
– Loans from the bank to fiduciary accounts are permitted if the transaction is fair
to the account and not prohibited by applicable law – 12 CFR 9.12(c)
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Federal Regulations (Cont.)
• 12 CFR 9.15 – Fiduciary Compensation
– Fiduciary may charge a reasonable fee for its services if not set or governed by
applicable law – 12 CFR 9.15(a)
– Fiduciary may not permit officers or employees to earn compensation for acting
as a co-fiduciary, except with approval of the board of directors 12 CFR 9.15(b)
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Consider the Cimex Lectularius
• Commonly known as the Bed bug!
• Thought to have been significantly
eradicated in the early 1900’s. Started
seeing a resurgence after 1995.
• Resurgence is generally attributed to a
change in habits of the primary hosts.
• More foreign travel, exchange of bedding
materials, focusing on other pests and
ignoring them!
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Bed bugs and conflicts
• Can’t readily see them coming so you
have them before you know it.
• When they bite, they hurt!
• Embarrassing to acknowledge and
address.
• Requiring a re-focus in order to eliminate.
• New tools available to look for them!
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Where are we today?
• Law and regulation – much the same.
• Fundamental nature of conflicts – still the
same.
• Basic transaction types that cause
concern - still the same.
• Perhaps there is more complacency
toward potential conflict situations?
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Where are we today?(Cont.)
• Size and complexity of our financial
institutions; responsibility is the same.
• Technical knowledge and depth of
understanding about conflicts of interest.
• The primary change in perspectives has
occurred in how, where, and why we see
conflicts of interest emerging. They come
at us in some different ways!
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Sources of Emerging Conflicts
Investments
Affiliated Products
And Services
Revenue
Sources of
Potential Conflicts
Personal Interests
Cash Management
Third Party
Services
Indirect Conflicts
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Investments
• New and increasingly complex investment
vehicles provide opportunity – both for
benefitting the client and for additional
underlying conflicts.
• Banks and affiliates are assuming
additional duties relative to financial
instruments.
• Management of fiduciary cash –
remember the fundamentals.
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Potential Conflicts - Investments
• Roles related to investment vehicles
(sales, service, underwriting)
• Fees and other financial benefits
associated with investing
• Underlying purpose of the investment
• Failure to take actions on behalf of client
interests (contrary interests)
• Proxy voting (must vote clients’ interest;
not that of the bank)
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Potential Conflicts - Investments
• Soft dollar arrangements not meeting
requirements of Section 28(e).
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Potential Conflicts - Investments
Private Equity Fund Proposal
• Investment opportunity for “select”
fiduciary accounts
• New fund for company; “incubation”
• Bank affiliate to manage
• Executive employees are investing
partners
• Fiduciary accounts – limited partners
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Potential Conflicts - Investments
• Proprietary Investment Managers (who are
also investors) – get “gain sharing”,
incentive compensation, and management
fees
• Fund allowed to incur debt from own bank
• Management team indemnified for
financial loss
• Shared Counsel with waiver of conflict
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Potential Conflicts - Investments
• Bank may act as investor, investment
banker, investment manager, advisor,
agent and principal in the deal.
• Bank to have multiple relationships with
portfolio companies and other parties –
lender, advisor, servicer, shareholder,
underwriter, or trustee.
• Officers of bank may be directors of
portfolio companies.
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Potential Conflicts - Investments
• Fund cash may be invested in bank
instruments.
• Warehoused investments to be transferred
from bank balance sheet to the fund.
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Revenue
• Structure of fees and fee schedules
• Layers of fees (performance fees,
enhanced services fees, etc.)
• Unfair or unreasonable fees
– Extra fees for routine, traditional fiduciary
services
• Additional revenue received due to
fiduciary appointment
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Revenue (Cont.)
• Revenue from serving in multiple
capacities
– Placement fees
– Sweep fees
– Sales incentives (internal and external)
– Revenue share (internal and external)
– Commissions
– Account or Transactional fees
– Service fees
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Affiliated Products and Services
Everyone wants their
piece of the (very
“proverbial”) pie!
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Affiliated Products and Services
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Lending relationships
Insurance products and services
Brokerage services
RE Sales/Servicing
Investment vehicles (Alternatives and
other internal investment products)
• Deposit and cash management
instruments
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Third Party Services
• Goods, services, and other benefits that
may be made available by vendors to the
bank (or DOE’s) in return for:
– Investing money
– Using account or professional services
• Potential for interlocking relationships
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Indirect Conflicts
• An action taken with respect to a fiduciary
account that could indirectly benefit the
bank or any of its DOE’s.
• Corporate benefits from service
arrangements.
– Price breaks or gratuities in return for full retail
pricing (or more) for servicing fiduciary
accounts.
• A fiduciary can’t do anything indirectly that
he is prohibited from doing directly.
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Cash Management
• OCC Bulletin 2010-37
• Deposits or Investment of Cash Balances
– Don’t leave cash uninvested
– May deposit in own bank if properly
pledged
– Don’t “invest” cash in own-bank deposits
– Consider the rates of return available
• Sweep vehicles – basis of selection
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Potential concerns involving
personal interests
• Transactions involving DOE or affiliated
business interests
• Bequests and gifts to DOE’s
• Family accounts – transactions and
decisions by DOE’s
• “Benefits” in return for services from
clients OR 3rd parties
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Leveraging Consent
• Must get informed consent – both the
specifics of the transaction and the conflict
itself must be disclosed.
• Consent is not direction
• Full beneficiary consent
• Negative consent does not fully mitigate a
conflict
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Risk Perspectives
• Regulatory Risk – punitive action by
regulators can include formal agreements,
civil money penalties, and potential loss of
fiduciary powers.
• Financial Risk – conlfict transactions are
voidable; loss of revenue and potential
damages
• Reputation Risk- significant public risk for
the professional fiduciary
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Recommended strategies
• Education programs
• Strong Policies and Procedures at multiple
levels
• Effective preventive AND detective
controls
• Leverage technology and accounting
system capabilities; encourage
development of additional tools
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Recommended strategies
• Effective Risk Analysis
– Refocus and identify areas of potential
problems; consult with legal counsel
• Limit mitigation of conflicts through
“papering” the account.
• Consider using screening processes or
checklists designed to identify potential
conflicts in new accounts, new products,
and in relevant transactions.
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Recommended strategies
• Consider language that will protect the
bank in transactional contracts.
• Include conflicts screening in all vendor
due diligence programs.
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Final wish…
Good night,
sleep tight,
and don’t let the
bed bugs bite!
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