Articles

Fiduciary Issues in the New Year

Shareholder Advocate Winter 2024

January 30, 2024

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Suzanne M. Dugan

As pension funds across the country put 2023 behind them, the new year may bring additional headwinds. (Keep in mind: 2024 is a leap year, so there is one more whole day this year for complication and challenge!) Concerns about interest rates and inflation are front of mind for institutional investors, who are wondering whether the Federal Reserve will cut interest rates and how much the economy will slow. A presidential election year brings further uncertainty. Beyond those concerns, here are some key areas that public pension plan leaders have said they will be thinking about in the 366 days of 2024.

Cybersecurity

Managing cybersecurity risk will be a top priority in 2024. The U.S. recorded a 75% increase in ransomware events between July 2022 and June 2023, according to Malwarebytes, Inc. The National Conference on Public Employee Retirement Systems notes that public employee pension funds are prime targets for cyber criminals drawn by the fact that they collect large amounts of personally identifiable information, hold significant assets, and have relatively small staffs. Any doubt about this was resolved in June 2023, when the nation’s two largest US pension plans, CalPERS and CalSTRS, were involved in a worldwide data security incident that impacted one of their contracted third-party vendors. The so-called MOVEit hack, named after the popular file transfer software that was breached, demonstrates that pension plans must be cognizant of their fiduciary risk. As the U.S. Department of Labor has emphasized, plan fiduciaries have an obligation to ensure proper mitigation of cybersecurity risks. One mitigation risk tool that pension systems have begun instituting are cybersecurity tabletop exercises, which simulate real-world attacks and are designed to test the organization’s ability to respond to a cybersecurity incident.

Artificial Intelligence

The use of artificial intelligence (AI) is another hot topic in the pension plan world in 2024. The CFA Institute noted in a report issued in October 2023 that “the potential impact of AI on the pensions industry is likely to be widespread.” In a webinar hosted by the National Institute on Retirement Security, Andrew Roth, the Deputy Director of the Teacher Retirement System of Texas, observed that “tools that have AI components built into them [have] great promise for transformational technology to quickly get things done and do things faster with fewer resources” but “underlying that promise is a lot of risk.” Pension systems are exploring the use of AI in a wide variety of ways, such as plan operations, member communications, retirement planning, investment analysis, and modeling. The CFA Institute notes that as pension systems learn how to integrate AI into their processes, each decision must be considered through an ethical lens. The report finds that AI can be used in many aspects of pension systems to potentially improve returns and reduce costs, “thereby delivering a higher standard of living in retirement—a worthwhile objective for all pension systems.” But as the CFA Institute notes, “[a]ctive governance and clear accountability are essential in the development of all AI models and algorithms” and “[t]his will require experienced pension professionals to be involved, for, without that experience, judgment and oversight, there is the real risk that some outcomes will be helpful or misleading, or possibly even wrong, in the complex world of pensions.”

Governance

There are a myriad of other key challenges that pension plans face in 2024—from regulatory issues (IRS guidance on Secure 2.0) to litigation (seeking to overturn the new SEC rule requiring increased disclosure from private fund advising and prohibiting certain fee arrangements) to politicization (efforts to prohibit pension plans from making certain investments, or from doing business with certain investment managers). As the Council of Institutional Investors wrote in a recent letter, it believes “the heightened political atmosphere of U.S. elections will increase public scrutiny of members’ investment policies and practices—especially those related to sustainability.” An overarching principle that stands out when pension plans are addressing issues like these with fiduciary implications is the need for good plan governance. As noted by the Stanford Institutional Investors’ Forum Committee on Fund Governance, just as good organization governance is critical to publicly owned corporations (corporate governance), it is also critical to pension plans that own the stocks of those companies (plan governance). It cannot be said strongly enough: governance matters. It reduces the risk of conflicts of interest, abuse of authority, and misuse of plan resources. It helps ensure organizational performance, such as proper payment of benefits, and multiple studies have concluded that governance is, in fact, a key driver of strong investment performance—which is necessary to pay benefits. Good governance can also help attract and retain employees to public pension plans, which may not be able to compete with private sector salaries but can win employees’ hearts and minds through their mission to protect the retirement security of the nation’s teachers, safety officers, and other public servants. In 2024, more than ever, sound governance results in greater transparency, promotes buy-in from plan sponsors, legislators and other stakeholders, and enables trustees and administrators to fulfill their fiduciary duty to the members and beneficiaries of their pension plans.