Transcript Fiduciary Fundamentals for Public Retirement System Trustees

Fiduciary Fundamentals for
Public Retirement System Trustees
Presentation to the SACRS Educational Symposium
Sacramento Convention Center
March 20, 2009
Ashley K. Dunning
Manatt, Phelps & Phillips, LLP
Overview of Topics




2
Fiduciary Duty of care
Fiduciary Duty of loyalty
Legal standards used to review Boards’ actions
Processes to demonstrate fiduciary compliance
manatt
Fiduciary Duty of Care

Prudent Expert Rule
“The members of the retirement board . . . shall
discharge their duties with respect to the system with the
care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person
acting in a like capacity and familiar with these matters
would use in the conduct of an enterprise of a like
character and with like aims.”
Cal. Const., art. XVI, § 17(c) (emphasis added).
3
manatt
Fiduciary Duty of Care (cont.)

Duty to Assure Competency of Retirement System
Assets
“The retirement board of a retirement system . . .
consistent with the exclusive fiduciary responsibilities
vested in it, shall have the sole and exclusive power to
provide for actuarial services in order to assure the
competency of the assets of the . . . retirement system.”
Cal. Const., art. XVI, § 17(e) (emphasis added).
4
manatt
Fiduciary Duty of Care (cont.)

Duty to Monitor

5
The duty to monitor and to take corrective action when
reasonably appropriate is fundamental to a trustee’s exercise of
the duty of care. Rest. 3d Trusts, § 227, p. 14 (1992), comment
d (“The duty of care requires the trustee to exercise reasonable
effort and diligence in making and monitoring investments for the
trust, with attention to the trust’s objectives”).
manatt
Fiduciary Duty of Care (cont.)

6
Duty to Monitor (cont.)

In Public Service Co. of Colorado v. Chase Manhattan Bank, 577
F.Supp. 92 (S.D.N.Y. 1983), the trustee bank was held liable for a loss
to the trust from a multi-million dollar mortgage on a large apartment
complex because the court found that the trustee made inadequate
efforts to monitor the investment and should have known of information
that would have revealed that the investment had become imprudent
such that it should have disposed of the mortgage.

In Citizens and Southern National Bank v. Haskins, 254 Ga. 131,
327 S.E.2d 192, 197 (1985), the court noted that a trustee’s duty
to analyze investments “is a continuing one and although it does
not require a trustee to ‘watch the ticker as a speculator would’ it
does require review and the exercise of the necessary care and
skill.”
manatt
Fiduciary Duty of Care (cont.)

Duty to Consult with Experts


7
“To the extent necessary or appropriate to the making of
informed investment judgments by the particular trustee, care
also involves securing and considering the advice of others
[such as legal, actuarial and investment counsel] on a
reasonable basis.” Rest. 3d Trusts, supra, § 227, p. 15,
comment d.
The implicit corollary to that proposition is that if a fiduciary fails
to follow the advice of its professional consultants, it must
demonstrate an informed, reasonable, and prudent rationale for
failing to do so.
manatt
Fiduciary Duty of Care (cont.)

8
Duty of care = Duty of prudence

Prudence requires asking questions and understanding rationale
for actions before taking them

Prudence requires analyzing advice and recommendations
received from experts, not acting as a “rubber stamp”

Prudence requires following the Plan Document and other
applicable law governing the retirement system
manatt
Fiduciary Duty of Loyalty

Exclusive Benefit Rule
“The retirement board of a . . . retirement system shall have the
sole and exclusive fiduciary responsibility over the assets of the
. . . retirement system . . . to administer the system in a manner
that will assure prompt delivery of benefits and related services
to the participants and their beneficiaries. The assets of the . . .
retirement system are trust funds and shall be held for the
exclusive purposes of providing benefits to participants in the . . .
retirement system and their beneficiaries and defraying
reasonable expenses of administering the system.”
Cal. Const., art. XVI, § 17(a) (emphasis added).
9
manatt
Fiduciary Duty of Loyalty (cont.)

Primary Duty Rule
“The members of the retirement board . . . shall discharge their
duties with respect to the system solely in the interest of, and for the
exclusive purposes of providing benefits to, participants and their
beneficiaries, minimizing employer contributions thereto, and
defraying reasonable expenses of administering the system. A
retirement board’s duty to the system’s participants and their
beneficiaries shall take precedence over any other duty.”
Cal. Const., art. XVI, § 17(b) (emphasis added).
10
manatt
Fiduciary Duty of Loyalty (cont.)

Loyalties of Board Members

11
No “dual loyalties,” as would occur if a Board member acted as
an “agent” for the party that appointed or elected him or her to
the Board. See generally National Labor Relations Board v.
Amax Coal Co., 453 U.S. 322, 101 S. Ct. 2789, 69 L. Ed. 2d 672
(1981)
manatt
Fiduciary Duty of Loyalty (cont.)

Loyalties of Board Members (cont.)

12
NLRB v. AMAX incorporated traditional fiduciary duties into the
employee benefit trust provision of the pre-ERISA LaborManagement Relations Act (LMRA), holding that although the
statute: “requires an equal balance between trustees appointed
by the union and those appointed by the employer, nothing in
the language of [the provision] reveals any congressional intent
that a trustee should or may administer a trust fund in the
interest of the party that appointed him, or that an employer may
direct or supervise the decisions of a trustee he has appointed.”
453 U.S. at 331 (emphasis added).
manatt
Fiduciary Duty of Loyalty (cont.)

Loyalties of Board Members (cont.)

NLRB v. AMAX also noted that the
“The management-appointed trustee ‘represents’ the employer
only in the sense that he ensures that the union-appointed
trustee does not abuse his trust with respect to the funds
contributed by the employer. Nowhere in the debates over [the
LMRA trust provision regarding board composition] did any
Member of either House of Congress suggest that the employer
‘representative’ as a trustee of a benefit fund created under this
statute could or should advance the interest of the employer in
administering the fund.” 453 U.S. at 330, n.13.
13
manatt
Fiduciary Duty of Loyalty (cont.)

14
Loyalties of Board Members (cont.)

California law applicable to public pension funds also does not permit
trustees to administer the retirement system as an “agent” for the party
that appointed, or subgroup of members that elected, that individual to
the Board. On the contrary, the California Constitution (Prop. 162)
seeks to prevent such political “meddling” or “interference” by others
and mandates loyalty to the overall best interest of members and
beneficiaries.

California cases confirm that many traditional fiduciary duties apply to
public retirement system trustees. Hittle v. Santa Barbara County
Employees’ Retirement Association, 39 Cal. 3d 374 (1985); Claypool v.
Wilson, 4 Cal.App.4th 646, 676-7 (1992) (stating that Article XVI,
Section 17 of the Constitution imports the existing law of trusts).
manatt
Fiduciary Duty of Loyalty (cont.)

Loyalties of Board Members (cont.)

California authorities have, however, permitted public retirement system
fiduciaries to take actions that result in reduction in employer
contributions so long as



those actions do not compromise competency of assets of the
retirement system to pay promised benefits;
no conflict of interest arises in doing so; and
the action is in the overall best interest of members and
beneficiaries.
See generally Bandt v. Board of Retirement (2006) 136 Cal.App.4th
140; see also Claypool v. Wilson (1992) 4 Cal.App.4th 646.
15
manatt
Fiduciary Duty of Loyalty (cont.)

Collateral interests of Board members?

The strict duty of loyalty in trust law ordinarily prohibits the
trustee from . . . investing in a manner that is intended to serve
interests other than those of the beneficiaries or the purposes of
the settlor. Thus, for example, in managing the investments of a
trust, the trustee’s decisions ordinarily must not be motivated by
a purpose of advancing or expressing the trustee’s personal
views concerning social or political issues or causes.
Rest. 3d Trusts, supra, § 227, p. 12, comment c (emphasis
added).
16
manatt
Fiduciary Duty of Loyalty (cont.)

17
Collateral interests of Board members? (cont.)

Common thread in case law and academic publications regarding duty of
loyalty with regard to “collateral” interests: social interests may be
advanced through investments by fiduciaries only so long as the interests of
trust beneficiaries (e.g., risk-adjusted returns provided to members and
beneficiaries) are not compromised thereby.

See generally DOL Advisory Opinion 2007-07A regarding proxy voting
under ERISA: “as the Department has indicated in other contexts, plan
fiduciaries may not increase expenses, sacrifice investment returns, or
reduce the security of plan benefits to support or promote goals not directly
related to the plan”; and

DOL Advisory Opinion 98-04A regarding socially responsible investing: “A
decision to make an investment, or to designate an investment alternative,
may not be influenced by non-economic factors unless the investment
ultimately chosen for the plan, when judged solely on the basis of its
economic value, would be equal to or superior to alternate investments.”
manatt
Fiduciary Duty of Loyalty (cont.)

18
Conflicting interests among members and beneficiaries?

Can be complex and crosscutting.

Determinations of priorities among members and beneficiaries
must serve the overall best interest of members and
beneficiaries of the retirement system.

Appropriate balance may not be obvious when the interests
within the member and beneficiary groups are not the same.
manatt
Fiduciary Duty of Loyalty (cont.)

19
Conflicting interests among members and beneficiaries?
(cont.)

Dissimilar interests among beneficiaries are built into most trusts.

Trust law has evolved to grant trustees a fair measure of discretion to
balance those competing beneficiary interests. See Rest. 3d Trusts, §§
50, 183 comment a, and 232; Estate of Bissinger, 212 Cal.App.2d 831,
833 (no liability where trustee bank “acted reasonably, prudently, in
good faith and in the exercise of its best judgment . . . and with the
intention of being fair to both the income and remainder beneficiaries”);
and IIIA Fratcher, Scott on Trusts, § 232, p. 7 (4th ed. 1988) (“The
trustee, however, ordinarily has considerable discretion in preserving
the balance between beneficiaries”).
manatt
Fiduciary Duty of Loyalty (cont.)

Conflicting Interests Among Members and Beneficiaries?





20
Examine purposes identified in Plan Document (’37 Act provisions,
Bylaws/Regulations and, possibly, certain existing Policies) and
determine means to serve those purposes.
Consider number of active, deferred and retired members and their
beneficiaries affected by Board action.
Consider degree of hardship created by potential curtailment or
provision of particular benefit.
Consider equities as between members/beneficiaries.
Consider whether proposed action implicates any vested rights of
members/beneficiaries, including, without limitation, actuarial
competency of retirement system assets to pay promised benefits.
manatt
Legal Standards Used to Review
Retirement Boards’ Actions

Standard of Review and Related Issues


Arbitrary and capricious standard for “quasi-legislative” acts
 Strumsky v. San Diego County Employees Ret. Ass’n (1974) 11
Cal.3d 28, 34 n.2 (different standards of review for quasi-legislative
and quasi-adjudicative acts of retirement boards).
Deference to administrative discretion
 In re Retirement Cases (2003) 110 Cal.App.4th 426, 471 (“when a
statute imposes upon an administrative body discretion to act under
certain circumstances, mandate will not lie to compel the exercise
of such discretion in a particular manner”).

21
Op. Att’y Gen. No. 06-808 (December 1, 2006), p. 7 (“As long as an
actuarial method is ‘reasonable’ and not ‘arbitrary’ or ‘irrational,’ it
may be applied even though other approaches may be equally
correct or even ‘more precise’ or ‘better.’”).
manatt
Legal Standards Used to Review
Retirement Boards’ Actions (cont.)

Deference to administrative discretion (cont.)

22
Mathews v. Ventura County Employees’ Retirement Association,
Ventura County Superior Court Case No. 220607 (Statement of
Decision, February 17, 2005) (appeal abandoned October 4, 2006) (in a
non-precedential decision, court concluded that VCERA did not violate
Cal. Constitution when it required the County to pay no or reduced
employer contributions when the system’s funded ratio was over 100%
where “There was no evidence in the record that the County controlled
or influenced the actuaries used by VCERA. Instead, the evidence
presented in this case was that VCERA’s actuaries were competent,
independent and only used accepted actuarial methodologies in
determining when and how much, if any, the County was required to
contribute to the retirement fund.”).
manatt
Legal Standards Used to Review
Retirement Boards’ Actions (cont.)

Evidentiary Issues

Legislator’s subjective motives are irrelevant.

23
County of Los Angeles v. Superior Court (1975) 13 Cal.3d 721, 727-728
(given the general rule that the validity of legislation does not turn on
legislative motive, the mental processes of individual legislators become
irrelevant and the courts do not peer into these subjective realms).

NOTE: Intent may potentially become relevant, however, if conflicts of interest
or other crimes are alleged.

FURTHER NOTE: Attorney-client privilege is held by the Board, and thus cannot
be waived by an individual trustee or staff member. Further, because the Board
holds the privilege, no individual trustee or staff member can assert the privilege
to prevent Board counsel from communicating anything said to him or her by the
individual trustee of staff member to the Board.
manatt
Processes to Demonstrate Fiduciary
Compliance

Recognize that although Courts afford Board’s broad discretion in
decision-making, “exclusive authority” is not absolute discretion

Avoid “abuse of discretion”





24
Process important – make sure record reflects that process: minutes
reflecting deliberation, written materials provided by expert consultants
Education, inquiry, disclosure of reasons for action, reflecting due
consideration to overall best interest of members and beneficiaries
Active independent actuarial oversight
Active independent investment oversight
Legal consultation and compliance with applicable statutes
manatt
Fiduciary Goal When Addressing
Actuarial and Economic Issues In
Current Environment

25
A Board of Retirement must use informed judgment and
act in the overall best interest of system
members/beneficiaries in a manner that is consistent
with applicable laws when exercising its plenary
authority over actuarial and investment determinations,
and its actions in that regard may not be “arbitrary” or
“capricious” and must be rationally related to the
evidence presented to the Board.
manatt
QUESTIONS?
Ashley K. Dunning
manatt | phelps | phillips
11355 W. Olympic Blvd., Los Angeles
One Embarcadero Center, 30th Fl., San Francisco
Direct tel: (415) 291-7453
[email protected]
www.manatt.com
26
manatt