More Columns
BENEFITS BEAT
Courts Put Fiduciaries on the Hook
Two recent judicial decisions sharpen ‘duty of care’ and ‘duty of loyalty.’
Questions, success stories or anecdotes about benefit issues in government? Girard Miller wants to hear from you.
E-mail him
Two eye-opening court decisions last month sent retirement plan trustees turning to their attorneys for guidance on their fiduciary duties. In one case, the U.S. Supreme Court held that a participant in a defined contribution plan could sue a fiduciary for individual losses incurred as a result of administrative errors. In the other, a California appeals court held that public pension fund trustees could be criminally liable if they approve a contract that provides them a personal benefit. The first case addresses the fiduciary's "duty of care," and the second case indirectly addresses that responsibility as well as the "duty of loyalty."
In fiduciary law, the "duty of care" holds a trustee responsible for taking reasonable care to ensure the proper administration of the trust for the sole protection of the beneficiaries. This means "crossing the t's and dotting the i's" at every step. Not only must the trustee take as much care in the administration of the trust properties as she would for her own money, she must be able to prove it and demonstrate prudence, procedures, caution and focus. Under the "duty of loyalty," a trustee cannot serve two masters. The trustee must act in the sole interest of the plan's beneficiaries and never put her own interests or those of another party ahead of the beneficiaries. Conflicts of interest are therefore intolerable.
The U.S. case, LaRue v DeWolff, Boberg, was brought against the administrator of a defined contribution plan and alleged that the plaintiff lost money because the plan administrator failed to properly follow investment instructions that resulted in a loss of $150,000 in his defined contribution account. Heretofore, the lower courts had denied individuals the right to sue for personal investment losses under the Employee Retirement Income Security Act, so the majority opinion written by Justice John Paul Stevens establishes important precedent that will heighten trustees' oversight of their plan administrators' actions.
In the governmental context, it should be noted that ERISA does not apply directly to state and local governments, but many lawyers observe that once a principle such as this becomes embedded in the expectations of fiduciaries, it eventually filters into the municipal arena. Of course, there is nothing to prevent the trustees of a deferred compensation plan or a defined contribution system from requiring their contractual plan administrator to indemnify them for all errors made by the contracting vendor. However, if a plan official or employee makes the mistake, the trustees may be on the hook without a third party's deep pockets to protect them — and unable to rely on the trust property to pay for damages.
In California, the Lexin decision in San Diego held that criminal liability is possible if trustees take actions in a pension board meeting that results in their own personal financial benefit. This could involve increases in payment formulas, cost-of-living allowances, or as alleged in the San Diego case, a decision by the board to allow the city to imprudently underpay its contributions while increasing the benefits formula. Municipal leaders are deeply concerned about this case. In addition to this state case, some of the defendants were indicted in federal court on a related charge.
One of the inherent structural problems with most public-employee retirement systems is that their boards of trustees are composed of members and retirees who are themselves individual beneficiaries. This structural conflict of interest has generally survived the test of time, with pension attorneys constantly reminding trustees that they sit on the board for the interest of all beneficiaries and not just the constituency that elected them. But it is not uncommon to hear trustees make reference to the employee or retiree groups they "represent" on the board, even as their attorneys shudder and cringe when they hear those words. The Lexin decision, if upheld in the California Supreme Court, will bring this issue front and center.
In coming months, don't be surprised to see public pension fund trustees abstain or even walk out of meetings when key votes are taken that could benefit them directly — at the advice of their board attorneys or their own personal counsel. In Marin County, California, one trustee has resigned over this issue. Which raises a question of how public pension boards will function in the future if they cannot muster a quorum on benefits issues because of these potential conflicts. One possibility is that pension boards will need more independent public trustees without personal interests in the fund — or fewer employee members.
Stay tuned for continuing developments in the courts, as these often-neglected aspects of fiduciary law finally begin to hit home.
In the meantime, I strongly encourage every public retirement system board to ask its administrator and attorney to re-brief it on its responsibilities under the Duty of Loyalty and the Duty of Care, as well as on recent court decisions that could impact the board's decision-making. While they are at it, trustees should revisit divestment policies and how those may conflict with these fiduciary responsibilities.
Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net. His general market observations and institutional investment strategies are his own and should not be construed as investment advice or recommendations concerning specific securities. More biographical information.