FIDUCIARY LIABILITY—PUBLIC SECTOR
Hard Choices, Real Protection
October 10, 2009
Daniel Aronowitz
Ullico Casualty
President
Christine A. Dart
Chubb & Son
Vice President
Robert D. Klausner
Klausner & Kaufman, P.A.
Esquire
Brian L. Smith
The Segal Company
Senior Vice President
Agenda
 Indemnity protection
 Common misconceptions v. reality
 Fiduciary “Standard of Care”
 Fiduciary liability exposures
 Operational
 Statutory
 Other
 Claim Examples
 Fiduciary liability insurance
 Is it permitted?
 What does it cover?
Common Misconceptions
Trustees are not bound to fiduciary rules
 Plans are exempt from ERISA
Trustees are exempt from liability
 Sovereign immunity
 Statutory indemnification
 Governmental policy
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The Reality
Trustees are subject to significant fiduciary obligations
Existing protections may be
 Very limited
 Non-existent
3
Possible “Gaps” in Your Liability Protection
“Good faith” standard
 Who determines?
– The attorney general, the board of trustees, or the courts
Indemnity contingent upon an evaluation of the underlying conduct
Liable for bad faith, willful, wanton or grossly negligent conduct
“Ultra virus” standard
 Indemnity not available for actions taken outside “the scope of employment”
 Conduct must be consistent with “statutory duties” or “applicable standard of care”
– “Breaches of fiduciary duty” may not be covered
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Potential “Gaps” continued
No uniformity
Statues vary by state for indemnification of defense costs,
judgments, penalties, and other expenses
“Triggers” also vary
No indemnity
At least eleven appear to limit indemnification to trustees
 No indemnity is available to other officers, agents or employees
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Immunity
State “agent” immunity may be qualified
 Acts involving skill or judgment (Discretionary Acts) may not be eligible for
immunity
 Non-qualifying acts may include:
– Acts “inconsistent” with statutory duty
– “Ultra Virus” acts
– “Willful and wanton” negligence
The “independence” of Public Sector plans may void sovereign
immunity protection
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Indemnity/Immunity
Other Observations
State statutory law may mirror ERISA’s section
412 [or 410?]
Any indemnity agreement for a breach of fiduciary duty is void
State statutory law may specifically grant immunity
BE AWARE OF THE CAVEAT
 “That do not involve malicious or wanton misconduct…”
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Critical Questions
Do you know your state’s statutory and other applicable laws that
define your responsibilities and liabilities?
Do you have written opinions from legal counsel identifying the
scope of any indemnification or immunity protections?
Do you understand the caveat language that may exist within these
protections? For example, is indemnity available for:
 “Gross negligence” or “willful or wanton failure?”
 Any alleged criminal activity?
Are you protected if the Plan or a regulatory agency (e.g., the state
attorney general) sues you for an alleged wrongdoing?
Will the indemnity or immunity be provided if the alleged wrongdoing
has become a political “hot potato” or “public scandal”?
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Fiduciary Standard of Care
The fiduciary standard adopted in most states is the ERISA standard
applicable to most private sector plans.
Federal
Standard
=
Expert
Prudent Man
State
Standard
= or ~
Expert
Prudent Man
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Fiduciary Standard of Care continued
The fiduciary…may owe affirmative duties…beyond those found in
an ordinary case of fraud.
 See Jersey City v. Hague, 18 N.J. 584, 589-90 (1995)
A fiduciary agent is presumed to be acting with “absolute
devotion”…
 See Jaclyn, Inc. v. Edison Bros. Stores, Inc., 1970 N.J. Super. 334, 369 (1979)
The public official may be considered a “constructive trustee” of
assets gained through misconduct…or impose an “equitable lien”…
 The public employer may demand not only what was lost, but also gains…
– See Dobbs, Law of Remedies
RICO provisions and remedies may also be available
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Public versus Private Sector Plans
ERISA preempts state law and creates a uniform statutory standard
Public sector plans are not so protected
 Numerous statutory and common
law standards may apply
ERISA
=
Uniform Statutory
Standard
Public Sector
=
No Uniform
Statutory Standard
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Delegation of Fiduciary Duty
ERISA permits the
avoidance of fiduciary
liability by delegation
 Trustees’ exposure is
essentially limited to
monitoring
Government plan
fiduciaries do not
transfer their liability
by delegation of their
duties to service
providers
ERISA Delegation
Permitted
Public Sector
Delegation Permitted
Liability
Transferred
Liability
Not Transferred
 Trustees’ exposure
includes investment
decision, performance,
and monitoring
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Trustee and Administrative (Operational) Exposures
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Trustee and Administrative (Operational) Exposures
Asset/Liability Valuations
 Actuarial assumptions
– Investment return assumption
– Liability valuation
» LTM or level-cost vs. MVL
 GASB and OPEB
Asset/allocation choices
 Traditional v. non-traditional
– Complexity of non-traditional
» Research, evaluating, explaining, and
monitoring
 Statutory constraints or mandates
– Green, “politically correct,” “community
development”
 “Prudent investor” rule
Benchmarking
 By whom, how and what comparatives
 Investment monitoring arrangements
Benefits
 Formulas
– 1 – 3 – X final year salaries
– Overtime impact
– “Cash balance” type formula
 Statutory anti-cutback provisions
 Alternatives/Supplemental
– Lump sum
– DROP
– LTD
Corporate governance
 Sophistication or non-sophistication
 Agenda
Expectations
 Participants
 Contributing employer
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Trustee and Administrative
(Operational) Exposures continued
Fees
 Reasonableness
 Transparency
Funding levels
 Long term
 Short term
– Cash flows
Knowledge/Experience
 Trustees
 Investment committee members
 Staff, especially investment staff
Market issues
 Access, especially private sector
 Volatility
 Rate of return
Public bond funding
 Contributing employer implications
Scandals
 Ponzi schemes
– Madoff and Stanford Financial Group
 LTD percentages
Sponsor contributions
 Budget/tax implications
Staffing
 Expertise
 Retention
 Resources
Strategic partnerships
 Investment consultants
 Investment managers
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DOL 401(K) Enforcement Actions—A Partial List
 Labor Department Sues to Appoint Independent Fiduciary for 401k Plan Abandoned by Employer
 DOL Sues Health Care Provider to Recover 401k Assets
 Company Agrees to Restore 401k Funds Following DOL Investigation
 DOL Sues Defunct Company for Abandoning 401k Plan
 DOL Sues to Restore Losses to Tampa 401k Plan
 DOL Sues Company President to Recover 401k Assets
 DOL Sues Company to Protect 401k Plan Participants
 DOL Sues Company and Owners Over Delinquent 401k Contributions
 DOL Sues Fiduciary to Recover 401k Assets
 Owner Pleads Guilty to Embezzlement of 401k Assets
 Labor Sues to Recover 401k Assets from California Company
 Labor Appoints Independent Fiduciary for Abandoned Georgia 401k
401Khelpcenter.com
 Labor Department Recovers $8.6 Million Involving Agway 401k Plan
 Labor Department Obtains Judgment Over Misuse of 401k Assets
 Company and Officers Ordered to Restore Misused 401k Funds
 DOL Takes Legal Action Against 401k Plan Trustee
 Labor Department Sues Fiduciary to Recover 401k Assets
 Labor Department Obtains Settlement with Business Owner to Restore 401k Funds
 DOL Sues Defunct Company Over Abandoned Retirement Plan
 Labor Department Sues to Appoint Independent Fiduciary for Abandoned 401k
 Labor Department Seeks to Recover Employee Contributions to 401k Plan
 Labor Sues to Protect Retirement Assets of Reno, Nevada, Workers
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Specific Examples
Asset allocation choices
Mostly debt
Statutory
limitations
Debt to Equity Shift
Statutory limitations
eliminated
Heavy equity
and Alternative
investments
Possibly
ALM
~1950’s
~1970’s – 1990’s
Today
Future
Funding Issues
 NJ—Considers bill deferring ½ of municipalities annual pension funding
requirements.
 PA—Employer contributions may increase from 4% of payroll to 28% in 2012.
 MI—Employer contributions for Detroit’s police and fire pension plans may
increase to 50% of payroll in 2011.
Source: Pension Bills to Surge Nationwide (WSJ, March 16, 2009)
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Specific Examples continued
Favorable benefit provisions
 For example, in at least one municipal plan
– The minimum retirement age = 50
– 100% benefits after 25 years of service
Performance disclosure
 13 states have secrecy laws
Real estate investments—risk adjusted performance
 In 2007, one large fund held $213 billion in commercial real estate equity,
leveraged 70% on average.
– Rarely do internal rates of return account for leverage.
– In a down market, leverage turns average performance into a disaster.
Source: The Next Meltdown, Forbes, July 21, 2008
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Other Statutory Exposures
Federal
ERISA’s “exclusive benefit” rule
 Tax exempt status is subject to plan assets not being used for or diverted to nonparticipants
– Does this indirectly impose ERISA’s “fiduciary standards”?
» See H.R. Conf. Rep. No. 93-1280
ADEA, PPA’06, and WRERA
 Crediting interest in cash balance plans
– What is a market rate?
 Non-spousal rollovers
 Temporary waiver of required minimum distributions
 Self-funded plans eligible for special tax exclusion
See Segal’s
April, 2009 Bulletin
for details
IRS
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Other Statutory Exposures continued
State and local laws
“Mirror” ERISA’s fiduciary standards
Statutory “prudent investor” rules
 Investment analysis “per investment” versus “overall portfolio”
Trust law
Common law
Duty of loyalty and “prudent investment” rule may create additional
liability
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Claim Examples and Allegations
Pay to
Play
Theft
Churning
Investment
Protocols
Pension
Benefits
Cuts
Portfolio
Allocations
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Allegations versus Final Impact
ALLEGATION
FINAL IMPACT
 Fee increases for poor performance
 Reduced benefits
 Churning—unusually high number
of transactions
 New benefit “tiers”
 Inappropriate investments—
insufficient liquidity
 Theft of funds
 Increased taxes
 Greater contributions
 Insolvency
 Pay to play
22
Public Scandals are Not New
History repeats itself
Ancient Roman writing
tablets suggest public
officials were involved
in expenses scandals
2,000 years ago.
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Fiduciary Liability Insurance
At least one state mandates its purchase
Approximately twenty states expressly authorize its purchase
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Fiduciary Liability Insurance Protection
Coverage
 Defense costs, settlements and judgments
Named insured
 The plan, its trustees and employees
Wrongful act
 Any actual or alleged breach of fiduciary duty or administrative error or omission
even if it is proven frivolous or without merit
Exclusions
 Willful, deliberate and dishonest acts
– Defense coverage may be available until a final adjudication is established
Severability
 Each insured individually protected
This is an extremely limited “oversight”
description. Consult legal counsel.
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Fiduciary Liability Insurance Protection continued
It is a legal, insurance contract with a third party, professional
insurance company
The insurance carrier will either provide or pay for independent legal
counsel
A qualified insurance carrier knows public sector claims
The insurance carrier has an objective, financial rather than
emotional investment
The insurance carrier has been paid to be on your side
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Conclusion
Recent economic events:
 Spotlight trustees’ actions and responsibilities
 Are potentially redefining trustees’ standard
of care
Historical experience is not an indicator
of future experience
Relying on indemnification and
immunity may be a false security
Fiduciary liability insurance is an
established, proven “safety net”
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Contacts
1625 Eye Street, NW
Washington, DC 20006
Bus: 202-682-4992
Mobile: (415) 254-4031
Bus Fax: 202-962-8853
Daniel Aronowitz
President
daronowitz@ullico.com
10059 Northwest 1st Court
Plantation, Florida
33324
Robert D. Klausner
Esquire
bob@robertklausner.com100
82 Hopmeadow Street
Simsbury, CT 06070-7683
Phone: 203-222-9625
Mobile: 203-451-3431
Christine Dart
Vice President
cdart@chubb.com
Bus: 954-916-1202
Bus Fax: 954-916-1232
One Park Avenue
New York, NY 10016-5895
www.segalco.com
Bus: (212) 251-5333
Mobile: (347) 423-3452
Bus Fax: (212) 726-5518
Brian L. Smith
Senior Vice President
email: bsmith@segalco.com
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