Setting a Gold Standard for Pensions

The Government Finance Officers Association has issued a list of best practices for public pensions. These measures should be adopted nationwide.
by | April 8, 2010

Last year, CalPERS, California's public-employee retirement savings plan and the nation's largest pension fund, suffered an embarrassing governance crisis: Marketeers and placement agents had reportedly paid their way into positions of undue influence. Not surprisingly, this caused many pension critics and commentators to cry out for reforms -- myself included. My previous column urged trustees to strip voting rights from censured board members who accept payments from marketeers and to prohibit peddlers from meeting with trustees when staff and investment consultants can perform the screening to ensure objectivity. In my view, there is no need for third-party "placement agents" in the first place. But if they are to exist, their role must be tightly controlled and limited.

The national professional associations have now looked at this issue and a new gold standard for governance practices has emerged. The Government Finance Officers Association (GFOA), whose membership includes public pension plan officers as well as thousands of CFOs for public employers and plan sponsors, has issued recommended governance practices that provide clear guidance to pension trustees and administrators on how to manage their business affairs. It is by far the most comprehensive and thoughtful document now available to pension managers and fiduciaries and should be reviewed by every board in the country at least annually. Every new-trustee orientation session should include explicit review and discussion of these recommendations.

The GFOA document starts with three key concepts which every pension board attorney should review with trustees every year:

Duty of Loyalty: Here, GFOA has provided the most important guidance in the field by making explicit the obligation of trustees to represent the interests of all beneficiaries and the overall plan, and not the special interests of whatever groups might have elected or selected them. Trustees are not instructed delegates, like legislators. They are fiduciaries. Accepting campaign contributions, gifts or gratuities from potential service providers should be a clear violation of the Duty of Loyalty.

Duty of Care: GFOA has included the key concept of financial sustainability in the responsibilities of trustees. It's not sufficient for trustees to simply blame structural funding problems on the plan sponsor. If trustees sleep at the switch and allow an unsustainable benefit plan to jeopardize retiree benefits, they are violating their Duty of Care and should be held legally responsible as fiduciaries. If the law or their charter precludes them from changing the system, they must formally admonish those in power to do so.

Duty of Prudence: Many pension plans have adopted a prudent person rule (which requires investments to be made with the judgment and care that an informed person would make with their own money for investment and not for speculation), even if they operate in states with a "legal list" for investments. But prudence goes beyond portfolio construction, and the GFOA language provides a thoughtful basis for consideration of fiscal considerations as well.

Board composition is then addressed, to include the important concept of including enough independent directors free of influence from employee and retiree groups, as well as public employers, to assure balanced decision-making. Pension plans that have become dominated by labor interests should take heed, and plan sponsors and legislatures should take corrective actions to insert sufficient independent trustees on their boards to assure the public's interests. Personally, I would prefer to follow the mutual fund requirement of a majority of independent trustees, but I would settle for a controlling bloc that keeps the self-interested parties in check.

GFOA's language on codes of conduct and codes of ethics is also the strongest of all the policy documents now offered by professional organizations and pension associations. The activities of third-party marketers and the control of campaign contributions and paid influence are addressed directly. Finder fees are discussed explicitly in this document. Trustees and pension-plan managers looking for more concrete language should also study the proposed code of conduct published by the New York attorney general.

The GFOA committee on retirement and benefits administration deserves high praise for its thoughtful work and leadership in this problematic realm of retirement-plan finance. Other national associations in the public pension field would serve their members well by adopting equally informative and detailed guidance on governance practices, instead of general platitudes that fail to instruct trustees on the difficult decisions they need to make in the high-stakes world of pension finance. State legislatures and oversight bodies would likewise do well to adopt and codify the key principles embodied in GFOA's recommendations concerning board composition, trustees' fiduciary obligations, campaign finance and activities of marketers.

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