Last year, the California Public Employees' Retirement System (CalPERS), the nation's largest pension fund, suffered an embarrassing governance crisis: Marketeers and "placement agents" reportedly paid their way into positions of undue influence. Its board has censured one member, and legislation was introduced to regulate placement agents.

California wasn't the only state to deal with such unseemly conduct on the part of its governing body. In New York, the attorney general received complaints of similar abuses and recently entered into settlement agreements with several implicated firms.

The apparent conflicts of interest--and media coverage of them--are shining a spotlight on the little-known world of pension governance. The attention may be unwelcome, but it has led to a call for sweeping reforms in the way public pension plans are run.

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 and thousands of chief financial officers for public employers and plan sponsors, has issued recommended governance practices that provide clear guidance to pension trustees and administrators on how to govern their plans:

It is by far the most comprehensive and thoughtful document now available to pension managers and fiduciaries, and it should be reviewed by every board in the country at least annually. Every new trustee orientation session should include explicit discussion of these recommendations.

The GFOA document starts with three key concepts: duty of loyalty, duty of care and duty of prudence.

The duty of loyalty concept states that trustees must represent the interests of all beneficiaries and the overall plan. They should not represent 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.

The modernized duty of care concept now says that assuring financial sustainability must become a trustees' responsibility. 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.

The duty of prudence concept maintains that many pension plans require 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--the prudent person rule. But prudence goes beyond portfolio construction and should also include fiscal considerations.

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 now 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 industry requirement of a majority of independent trustees; the bare minimum would be a controlling bloc of independents that keeps the self-interested parties in check.

The GFOA's language on codes of conduct 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 finders' fees are addressed directly. 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.

Other national associations in the public pension field would serve their members well by adopting equally informative and detailed guidance on governance practices. State legislatures and oversight bodies would likewise do well to adopt and codify these key principles.