FIDUCIARY DUTIES OF TRUSTEES WHO ARE PUBLIC OFFICIALS Fiduciary Education Program for the CalSTRS Board of Administration September 15, 2016 Harvey L. Leiderman ReedSmith LLP
OVERVIEW Fundamental fiduciary duties Why do fiduciaries get sued? The deliberative process ESG, in three dimensions Harmonizing the dual roles of plan fiduciaries and public officials 2
FUNDAMENTAL FIDUCIARY DUTIES 1. Exclusive Benefit Rule To use plan assets solely for the purpose of paying the members promised benefits and reasonable administrative expenses 2. Primary Loyalty Rule To act in the best interests of all members and beneficiaries, not to promote personal or others interests 3. Prudent Expert Standard To act under the circumstances then prevailing as would a prudent person in a like capacity and familiar with these matters in the conduct of an enterprise of like character and with like aims 3
FUNDAMENTAL FIDUCIARY DUTIES 4. Duty to Diversify To diversify the investments so as to minimize risk and maximize return, unless clearly not prudent to do so 5. Act Lawfully To administer the Plan in accordance with the Plan Documents including the Constitution, the Teachers Retirement Law, IRC and regs, CalSTRS regulations and Board policies 4
BREACH OF FIDUCIARY DUTY CLAIMS Not imprudent to lend to a distressed plan sponsor - Withers v. Teachers Retirement System You can be prudent and still lose money - Pfeil v. State Street Bank Liability of co-fiduciaries for others breaches - In re Spring Corporation ERISA Litigation Unreasonable reliance on experts - Gregg v. Transportation Workers of America Immunity for exercising judgment, investing prudently - Nasrawi v. Buck Consultants; San Mateo HS Dist. V. County Don t set and forget -Tibble v. Edison International 5 No pay-to-play or conflicting loyalties - U.S. v. Buenrostro; Lexin v. U.S.
SO: IT S YOUR PROCESS THAT REALLY MATTERS 6 More about the prudent expert standard: Familiar with these matters means up to the standard of a prudent expert, not just a good person Follow a strong, deliberative process that considers all known factors, avoids conflicting interests and document it A prudent expert may delegate to others, but must monitor their performance Under the circumstances then prevailing means to review decisions and their prudence over time, in light of changing circumstances Like capacity and like aims means it s ok to look to comparable funds performance A prudent fiduciary is expected to employ a sound decision-making process, not guarantee the outcome
A W - M AL M L 7 7
W A W 8 8
9 SO NOW, LET S TALK ABOUT ESG
ENVIRONMENTAL, SOCIAL & GOVERNANCE ISSUES Ancillary benefits Economic consequences Legacy DoL approaches DoL 2015 guidance for ERISA plans Economic impact or Tie-breaker between two = risk/return alternatives
CALSTRS THIRD DIMENSION 1. CalSTRS Board members owe Constitutional fiduciary duties to the members of the retirement system, to maximize risk-adjusted returns. You may not sacrifice returns solely to benefit other causes or interests. 2. CalSTRS Board members are also public officials, who take an oath of office to uphold the CA Constitution. CalSTRS is a state agency, and the state is obligated under the Constitution to provide for the health, safety and welfare of its People. 3. The Constitution also gives the Legislature the authority to prohibit the Board from making certain investments where it is in the public interest to do so, and where the prohibition satisfies the standards of care and loyalty required of the Board. This allows the trustees to harmonize considerations of the public welfare with their duties to members. 4. These dual Constitutional roles do not exist in the private fund, ERISA sector. Dept. of Labor guidance does not consider or reconcile the additional duties of public officials.
CALSTRS THIRD DIMENSION 5. In making investment decisions, therefore, the Board may consider not only how to fund its members benefits, but how it might do so in a way that avoids harm to, or promotes, the public welfare. 6. Economic, social and governance factors that are intended to avoid harm, or promote health, safety and welfare, are proper for trustees to consider, particularly where alternative investment options are available that can be integrated into a diversified portfolio without detracting from the overall expected risk/return of the portfolio. 7. The fact that, in hindsight, for a while, an investment decision ultimately added to or detracted from returns is irrelevant, if it was motivated by reasonable and prudent considerations at the time it was made. 8. Similarly, the Board need not consider abandoning an investment decision simply because, in hindsight, more money might have been earned had the Board not made the decision in the first place.
EXAMPLE: TOBACCO DIVESTMENT The Board does not violate its fiduciary duty if it decides that it will not invest in an industry that kills and maims tens of thousands of people annually. If the Board makes such a determination, its charge is then to find reasonable alternative investment opportunities, so it can harmonize its duty as fiduciaries to members with its duty as public officials to the People. Rather than reevaluating its tobacco divestment policy in light of the past financial performance of that isolated industry, the Board may first determine to continue divestment, and then focus instead on finding a substitute investment alternative that fits within the risk/return design of its overall portfolio. In this way the Board can successfully harmonize its multiple Constitutional duties.
MEANINGFUL ALTERNATIVES ARE INCREASINGLY AVAILABLE SHE Index 12 MSCI ESG indices Custom indices, as exemplified by Goldman Sachs presentation 5+ S&P ESG & climate change indices Green bonds Thematic public and private funds
HARMONIZING YOUR RESPONSIBILITIES Consider ESG risks and rewards and whether they impact economic expectations Use ESG attributes to break ties between equivalent investments Use diversification to integrate opportunities for alternatives that optimize return AND either mitigate public harm or improve public welfare In all cases, use a prudent deliberative process to assure the best exercise of judgment
A FINAL WORD OF CAUTION RE: FUNDED STATUS The duty to minimize employer contributions is a Constitutional caution to avoid gambling in the markets Set priorities: We have limited resources available to pursue hundreds of global investment opportunities While funded status improves, keep your eye on proven sources of long-term gain Part of the push and pull of fiduciary prudence
THE TAKE-AWAY You can harmonize your dual roles as plan fiduciaries and public officials if you prudently pursue investment opportunities that meet appropriate risk/return expectations and promote public welfare.