AVOIDING CONFLICTS OF INTEREST LESSONS FROM CALIFORNIA’S FAULT LINES Presentation to the Board of...

AVOIDING CONFLICTS OF INTERESTLESSONS FROM

CALIFORNIA’S FAULT LINES

Presentation to the

Board of Retirement of the Fresno County Employees’ Retirement Association

October 19, 2006

Jeffrey R. Rieger, Esq.

Reed Smith, LLP

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Why Conflict-Of-Interest Rules?

“A person cannot serve two masters simultaneously. . . The duties of public office demand the absolute loyalty and undivided, uncompromised allegiance of the individual that holds the office.”

People v. Honig 48 Cal.App.4th 289 (1996)

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Conflict of Interest Laws Affecting Public Officials

Common Law

State Constitution

Uniform Prudent Investor Act

State Statutes

Case Law

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Common Law

“The most fundamental duty owed by the trustee to the beneficiaries of the trust is the duty of loyalty. This duty is imposed on the trustee not because of any provision in the terms of the trust, but because of the relationship that arises from the creation of the trust. A trustee is in a fiduciary relation to the beneficiaries of the trust....In some relations the fiduciary element is more intense than in others; it is peculiarly intense in the case of a trust. It is the duty of a trustee to administer the trust solely in the interest of the beneficiaries. He is not permitted to place himself in a position where it would be for his own benefit to violate his duty to the beneficiaries.”

Source: I. W. Fratcher, Scott on Trusts, § 170 (4th ed. 1987).

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California Constitution Exclusive Benefit Rule “The assets of the retirement system are trust

funds and shall be held for the exclusive purposes of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the system.”

Primary Duty Rule “Retirement Board has sole, exclusive fiduciary responsibility over the assets and administration of the retirement system…board’s duty to its participants and their beneficiaries shall take precedence over any other duty.”

Prudent Person Rule “Members of the retirement board shall discharge their duties…with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in like capacity and familiar with these matters would use in the conduct of an enterprise of a like character and with like aims.”

Source: CA Constitution, Article XVI, Section 17

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Uniform Prudent Investor Act

Duty of Loyalty. Establishes trustee’s duty of loyalty, to administer the trust solely in the interest of the beneficiaries.

Conflicts of Interest. Establishes rule against self-dealing. Trustee has duty not to use or deal with trust property for the trustee’s own profit or for any other purpose unconnected with the trust, or take part in any transaction in which the trustee has an interest adverse to the beneficiary.

Source: California Probate Code Section 16045 et seq.

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Case Law

A trustee’s duties include the duty of loyalty, the duty to avoid conflicts of interest, the duty to preserve trust property, the duty to make trust property productive, the duty to dispose of improper investments, and the duty to report and account.

City of Atascadero v. Merrill Lynch, Pierce, Fenner & Smith, Inc. 68 Cal. App. 4th 787 (1996).

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CA Statutes Political Reform Act of 1974

“No public official may make, participate in making or in any way use or attempt to use his/her official position to influence a governmental decision in which he/she knows or has reason to know he/she has a disqualifying conflict of interest. A public official has a conflict of interest if the decision will have a reasonably foreseeable material financial effect on one or more of his/her economic interests, unless that interest is indistinguishable from the public generally.”

Source: Fair Political Practices Commission Regulation 18700

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Consequences of a Conflict of Interest Under the Political Reform Act

You are disqualified from participating, influencing and voting.

If you are disqualified, you announce your potential conflict of interest and leave the room when the agenda item is up for discussion.

In limited circumstances, however, you may speak as a member of the public.

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CA Statutes Government Code Section 1090

Officials “shall not be financially interested in any contract made by them in their official capacity, or by any body or board of which they are members.”

Limited to public contracts – narrower than the Political Reform Act treatment of “governmental decisions.”

The term “contract” is interpreted broadly to include “the negotiations, discussions, reasoning, planning and give and take that go beforehand in the making of a decision” on a contract. Chapman v. Superior Court 130 Cal.App.4th 261 (2005).

There are circumstances where disqualification of an official is not required by the Political Reform Act, but the contract is prohibited under Section 1090.

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Consequences Of A Section 1090 Violation

Civil and criminal sanctions against an interested official for willful violations may include a fine, imprisonment in state prison, restitution of any financial gain obtained from the contract, and disqualification from holding public office.

Finnegan v. Schrader 91 Cal. App.4th 572 (2001) (member of sanitary district board later hired as district manager was required to return all of the over $70,000 he received in compensation under the illegal contract).

The challenged contract is void, from the date it was entered into.

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Exceptions for “Remote” and “Non-Interests”

The prohibition of Section 1090 does not extend to an official who has only a “remote interest” or a “non-interest” in the contract.

Exempt “remote interests” are specified in the statute E.g., employment by non-profit entities, small holdings in large

companies by non-directors/officers, competitively bid contracts, children’s interests, compensation from a government entity, etc.)

Where only a “remote interest” exists, the public entity is not prohibited from entering into the contract, so long as the interested member discloses his or her interest the interest is noted in the public record the interested member does not participate in the process or vote

on the contract

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Exception for “Non-Interests”

The prohibition of Section 1090 also does not extend to an official who has a “non- interest” in the contract.

Exempt “non-interests” are defined in Section 1091.5, including “that of a recipient of public services generally provided by the public body or board of which he or she is a member, on the same terms and conditions as if he or she were not a member of the board.”

It is also a “non-interest” if your only interest comes from your government salary, per diem or expense reimbursement.

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The San Diego Quake –State Criminal Charges

Six former board members of SDCERS are charged with three counts of felony conflict of interest. The six defendants are the City’s former

Human Resources Director Treasurer Assistant Auditor Management Analyst President of the Municipal Employees’ Association President of the Firefighters’ Association

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The San Diego Quake –State Criminal Charges

The core allegations are:

In 2002, the City, the employees’ unions and the City retirement system entered into a triangle deal to boost benefits for active employees, contingent upon relieving the City from (1) an immediate balloon payment due to the retirement system and (2) paying the true actuarial cost of the increased benefits. As a consequence, the retirement system became severely under-funded.

Each of the six defendants participated in designing and negotiating the deal and as retirement board members voted in favor of under-funding the pension system.

Each of the six defendants personally benefited from the deal.

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The San Diego Quake – Federal Criminal Indictments

Three former retirement board members and its former Administrator

and General Counsel are charged with a total of 20 counts of felony

conspiracy to commit wire and mail fraud and to deprive the

retirement system, its members and the citizens of San Diego of the

“honest services of their public officials,” causing “significant harm to

the financial integrity of SDCERS.”

The allegations concern the same 2002 “deal,” known as “Manager’s

Proposal Two”, as in the state criminal charges.

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The San Diego Quake – Federal Criminal Indictments

The core allegations are:

Defendants conspired to under-fund the system, boost their own personal retirement benefits and employment security and conceal the true facts from other board members.

The key material fact alleged: The firefighter’s union president, a retirement board member, increased his own personal benefits.

The key wrong alleged: Defendants deprived the system and citizens of “the honest services of their public officials to be performed free from corruption, fraud, undue influence, conflict of interest, and deceit.”

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The San Diego Quake –Federal Criminal Indictments

“Honest Services Fraud” -- 18 U.S.C. §§ 1341 and 1346

“For the purposes of this chapter [i.e., mail and wire fraud statutes], the term, “scheme or artifice to defraud” includes a scheme or artifice to deprive another of the intangible right of honest services.”

Typically involves misuse of an official’s public position for personal gain, calling into question impartiality of performance and breach of the public’s trust

The Government says “honest services” means “conscientious, loyal, faithful, disinterested, unbiased service, to be performed free of deceit, undue influence, conflict of interest, self-enrichment, self-dealing, concealment, bribery, fraud and corruption.”

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Recent Inductees into the “Honest Services Fraud” Hall of Shame

Randy “Duke” Cunningham (R-San Diego)

Jack Abramoff

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Shock Waves Outside of California, Too

“ING Units Are Hit by New Hampshire Complaint,” Wall Street Journal, June 9, 2006

“Clueless in Billerica,” The Boston Globe, January 13, 2006 “Pension Trustee Voted for Firm Linked to Ally; Millions Invested with

Company Tied to GOP Powerbroker,” Chicago Sun-Times, September 6, 2005

“Theobold Free-Rent Arrangement Revealed,” New Hampshire Business Review, November 11, 2005.

“Agency’s Ex-Chief Charged in Gift Probe; Food, Travel among Items Man who Led Retirement Fund is Now Accused of Accepting,” Columbus Dispatch, August 4, 2005

“Ex-Pension Chief’s Severance Pay Probed by Virginia Legislative Panel,” The Washington Post, July 9, 2005

“Teacher’s Retirement Deal under Scrutiny,” The Charleston (W. VA) Gazette, February 20, 2005

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Can We Predict When theNext Big One Will Hit?

No.

(But we can try to help with some practical, everyday concerns you may have.)

HOWEVER:

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BIG DISCLAIMER!!

THE FOLLOWING IS NOT LEGAL ADVICE AS TO ANY SPECIFIC FACT

SITUATION. THIS IS ONLY GENERAL GUIDANCE AS TO THE LIKELY

STATE OF THE LAW GENERALLY ON THESE SUBJECTS. IN MAKING

ANY DECISIONS AFFECTING YOUR LEGAL RIGHTS, YOU SHOULD

NOT RELY UPON ANYTHING SAID IN THIS PROGRAM, BUT INSTEAD

SHOULD SEEK INDEPENDENT LEGAL COUNSEL TO ADVISE ON

SPECIFIC SITUATIONS.

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Predictable Fault Lines for Pension Officials

Wearing two or three hats

Negotiating for benefit increases

Increasing one’s personal benefits

Communicating with the plan sponsor, unions, and retirees over actuarial funding, contribution rates, quid pro quos

Not disclosing everything

“Pay to play,” “soft dollars,” “kickbacks,” etc. among consultants, administrators and investment managers

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TAKEAWAY LESSON

UNCOMMON GAIN

LEADS TO

UNCOMMON PAIN!

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How High on the Richter Scale?

Q: As an elected Trustee or system Administrator, do I have an impermissible conflict of interest making decisions affecting contributions or benefits, because I make contributions and receive the benefits available to all members of the pension system?

A: Not for that reason alone.

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Q: If the Board is considering plan changes (e.g. assumption rate, interest crediting rate, amortization periods) that have an impact on all members, and I am a member of the system, do I have an impermissible conflict of interest as a Trustee?

A: No, not for that reason alone.

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Q: What if the change affects only a category of members (e.g. DROP participants) and I am a member of that particular category?

A: Unlikely to create a conflict unless the category is as small as a single grade/class, management, or small department.

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Q: Do I have an impermissible conflict of interest as a Trustee if I am a member of a union or employee organization within the plan sponsor’s agency? Or a prior member?


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Q: As a Trustee or administrative staff member, do I have an impermissible conflict of interest if I am an officer of a union in the plan sponsor's agency? Or a prior officer?


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Q: As a Trustee or administrative staff member, may I participate in meet & confer over benefits as a member of either the employer’s or the union’s negotiating team? Any different if I participated before becoming a trustee?

A: Troublesome. Let’s talk more.

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Q: Do I have an impermissible conflict of interest if I am a member of a Taxpayer Association or similar group?


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Q: What if the Taxpayer’s Association’s official position includes statements of intent or goals inimical to the mission of the retirement system?

A: Unlikely, but tell me more.

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Q: Can the Board and/or staff enter into any kind of discussions with plan sponsors re: benefits, plan design, actuary assumptions, retiree health coverage, etc.?

A: Yes…but!

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Q: Can board members/staff, or any of their professionals, give advice on actuarial projections and calculations, tax qualification questions, investments, etc. to the plan sponsor or to other political entities?

A: Yes…but!

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Q: One of the vendors doing business with the system has indicated interest in employing me after I am no longer associated with the system. To what extent would I have an impermissible conflict of interest in continuing to serve the system?

A: Very problematic, unless you expressly disclaim any interest in a future job. You should avoid any activity relating to that vendor and make full disclosure of the situation.

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Q: I have an outside business interest that will benefit indirectly from my serving the system – e.g., I will make good business contacts, enhance my reputation or gain access to helpful business leads. As long as I don’t use my office to directly benefit that business interest, do I have an impermissible conflict of interest?

A: A judgment call. See specific state regulations.

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Q: I am often invited to speak at pension fund conferences. The system pays for all my travel and lodging costs, because the meetings are educational or otherwise directly related to our business. I also receive my regular pay (if I am a staff member or an elected trustee) while in attendance. Deep down, however, my primary motivation in going to these programs is to enhance my own personal marketability, rather than any knowledge I might gain. Does this create an impermissible conflict of interest?

A: This is a close call. At some point, you are taking public funds to promote personal interests. Is it worth the risk?

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