Tuesday, April 19, 2011

The Appearance of Reality: Trustees

This is the fourth post in my effort to clarify corporate governance terms that now seem misleading to me. We all know what these words mean in a literal sense but in the context of governance, of business and of our post-crash world do they still mean the same thing?
I look forward to your comments.
It’s likely that a majority of the voting shares of all publicly traded companies are held by “trustees” – legal creatures with the obligation to responsibly manage trust property for “the exclusive benefit [ERISA terminology]” of “plan participants”. The ancient, unchanging and inveterate requirement of trust law and practice is that the trustee is not permitted to serve its own objectives when they are in conflict with those of trust beneficiaries.
With a few rare and honorable exceptions, trustees – including universities, foundations and even the most enlightened corporations’ pension funds – deliberately decline to take steps as activist shareholders. There is no recorded judicial effort to enforce trust principles; there has been no action by regulators; there has not been any derivative litigation on behalf of the beneficiaries.
What this means is that mutual funds, employee benefit plans and other relationships styled as trusts are trusts in name only, and not in substance. A trustee who actively pursues the interests of their beneficiaries is in a precarious position. Good guys can’t be good because they’re at a competitive disadvantage. So we’re left with layers of conflicts. Among them:
  • When the trustee is a member of a conglomerate group, pursuing beneficiary interest could put them into conflict with their parent company. If the fiduciary portfolios include tradable shares from other parts of the conglomerate, how do you proceed? On behalf of the beneficiary or the parent company?
  • When university or foundation trustees also represent companies in the trust portfolio, which interest takes priority? Engaging such a company raises questions of comity and collegiality within the board and can make for difficult relationships.
  • There has long been a rumored “Golden Rule” for ERISA plans: “You leave my company alone and our pension plan will leave your company alone.” Whether or not this is hyperbole, there has never been a recorded case of activism by an ERISA plan. When a trustee is serving as fiduciary for a company employee benefit plan, he might well be acting contrary to the commercial interest of the sponsor company (company whose employees join the plan) by raising questions about the management of companies in the pension portfolio. 
So long as these important institutional investors can ignore legal fiduciary obligation with respect to portfolio companies, this significant block of shares is effectively sterilized. And, because entire categories of investors decide not to participate, they succeed in trivializing those who do.  As a result, critics of shareholder involvement can claim that only a limited group of shareholders are active and that their perspective is skewed.
Here are my questions:
  1. Is the involvement of informed, motivated and empowered owners essential for the protection of the ultimate beneficiaries?
  2. Should trustees be permitted – because of lack of enforcement – to ignore their legal duties of management and acquiesce in management conduct?
  3. Should the obligation of trustees to act be enforced? And, if so, how should they be enforced?
    1. By the judicial system
    2. By regulatory authorities – the FSA in the UK, the SEC, DOL in the US
    3. By private litigation.
April 19, 2011 in accountability , fiduciary duty , institutional investors , Pension , trustees , Disinformation  |  6 comments  | 

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Posted by Bob Monks on Apr 27, 2011 at 10:07 PM
Jim-- Thanks for being in touch.

The outrage is that Foundation trustees, along with university fiduciaries, charged solemnly with fiduciary obligations, should feel free not to act as stewards of portfolio companies. Alan Greenspan represented the conventional wisdom: The extent of the problem was glaringly evident in a 2002 speech Alan Greenspan delivered at NYU's Stern School of Business. "After considerable soul-searching and many congressional hearings, the current CEO-dominant paradigm, with all its
faults, will likely continue to be viewed as the most viable form of corporate governance for today's world. The only credible alternative is for large - primarily institutional - shareholders to exert far more control over corporate affairs than they appear to be willing to exercise."28 The emphasis is mine, added to demonstrate Greenspan's
confusion of a legal obligation with something a trustee can freely choose not to do. That one of the nation's most respected and powerful economists is seemingly content to allow fiduciaries to shirk their inveterate obligations clearly states the current level of neglect. In the absence of shame, a judicial or agency enforcement action will be
necessary to require fiduciary involvement in corporate governance.
Posted by Jim McRitchie on Apr 26, 2011 at 5:03 PM
Enforcement should come from all quarters. You point to a difficult problem, especially at mutual funds, which can have clear conflicts of interest when it comes to criticizing management and hoping to administer 401(k) plans.

More difficult to understand are foundations, many of which at least appear to not need additional contributions or outside support. American foundations have endowments of more than $600 billion. Yet most are only utilizing 5% of their assets as they determine who gets their grants. The other 95% remains underutilized.

Foundations should be taking the lead in aligning values through mission-related investment, shareowner advocacy and proxy voting. I see little hope in the mainstream until foundations, whose trustees have clear unconflicted missions, can't even see there way clear to values alignment.
Posted by Bob Monks on Apr 22, 2011 at 10:06 AM
Scott --

My way of dealing with "human nature" is to assure the existence and functioning of informed, motivated and empower shareholders to counterbalance the power of management.
Posted by Bob Monks on Apr 22, 2011 at 10:06 AM
Catherine --

I am not discouraged a full twenty six years after attempting, as the official in charge (now Assistant Secretary, to get the Department of Labor to bring the suit (against Carter Hawley Hale) that would have settled once and for all the transcending obligation of ERISA fiduciaries to manage plan assets "for the exclusive benefit" of plan
participants. {My superiors in the White House would not approve the suit !) What is needed is a clear and plain court holding that "fiduciary" in the context of owning half of the outstanding shares of publicly traded companies in the US and UK means the same thing as "trustee" under the
inveterate and unchanging common law.
Posted by Scott Hamann on Apr 20, 2011 at 7:57 PM
Corruption is inherent to human nature, at least in enough of the population to make oversight necessary.

It would be too expensive to litigate on a uniform basis, and there are so many cases that it'd clog up the judicial system to go that route.

Regulation (sensible regulation, that is) seems to be the only financially viable "speed limit" to impose. Conversely, deregulation has the opposite effect...there's a reason Montana has speed limits again.
Posted by Catherine Neal on Apr 20, 2011 at 7:02 PM
Clearly, trustees owe a fiduciary duty to the participants in and beneficiaries of the plans for which they agree to serve as trustees. Should this obligation be enforced? Yes. Absolutely. But realistically, plan participants and beneficiaries are uninvolved, apathetic, and uninformed, which makes it easy for trustees to engage in conflicts of interest; to serve multiple masters. Regulatory agencies are busy addressing "squeaky wheels." If no one is complaining, trustees can nuture relationships and make decisions that are not in the best interest of those to whom they owe a duty. Because of the vast number of institutional and beneficial shareholders, incestuous relationships and conflicts of interest have become the norm, so much so that perhaps it is now simply a "hidden fee" in all of our retirement accounts and portfolios. Traditional notions of fiduciary duties have been diluted or perhaps they have evolved. How should trustees' duties be enforced? All of the above: through the judicial system, by regulatory authorities, and through private litigation. But maybe most importantly, by educating the investing public and the participants in and beneficiaries of benefit plans. Shareholders can't enforce their rights until they understand them. Keep up the good work, Mr. Monks. What you're doing in this area is very important.
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