Resolved for the New Year – Get Your Ethics, Compliance and Fiduciary House in Order

Shareholder Advocate Winter 2020

February 10, 2020

A Checklist for 2020

Ask public pension plan trustees or counsel what keeps them up at night, and you’re likely to hear about ethics, compliance and fiduciary issues. Resolve to address these issues in 2020. Here’s a checklist to help you achieve your New Year’s resolution.

Tone at the Top: “Tone at the top” is not just a cliché—it has a significant effect on an organization and its people, and shapes the culture of ethics, compliance and risk management. Several organizational studies have shown that, when presented with a hypothetical ethical quandary, only a small percentage of individuals in an organization are likely to always do the right thing or the wrong thing. For the vast majority—90 percent, according to these studies—their choice of actions will depend upon the organization’s culture and the individuals’ access to guidance.

These studies confirm that when faced with a moral choice, most people act based upon environmental circumstances. For that reason, it is essential to set the correct tone and focus on core values. Communicate the message throughout the organization, speaking frequently on it, and integrating the message throughout. Articulate the mission and the values of the organization. Don’t just pay them lip service. When an organization’s ethical culture is weak you can wind up with headlines like those we’ve seen over the years—pay to play scandals, improper disability awards, pension spiking, nepotism, lack of oversight, and misrepresentation—which have led to ethics investigations, criminal convictions, regulatory enforcement actions, and reputational damage. Don’t let that happen to your organization.

A Resource for Guidance: The organizational studies cited above also found that access to information and guidance were key factors in determining ethics and compliance issues. Make sure your organization has a resource where people can comfortably go get the answers to ethical questions. The person tasked with responding to questions from trustees and staff must be knowledgeable, approachable and able to address sensitive questions. Importantly, that person must be given enough resources to respond quickly.

A Reporting Mechanism: Ethical cultures create an atmosphere in which individuals are comfortable coming forward to report wrongdoing. Be sure you have an appropriate resource where people can report allegations without fear of retaliation and with a belief that the issue will be taken seriously, together with a mechanism for investigating such allegations.

Codes of Ethics: An important element of the vigorous and robust ethics program needed to create an ethical culture or maintain an existing ethical culture is a code of ethics that sets forth permissible and impermissible conduct. Such codes must be workable and clearly written, preferably with examples of actual conflicts of interest or situations that create the appearance of a conflict. Many public pension plans have separate codes for trustees and employees, although sometimes both appear in the same document. At a minimum, codes must be consistent with the state or local ethics laws, but public pension systems often wish to adopt customized codes that are directly applicable to the work and mission of pension plans.

Training Program: Clearly communicating rules is essential to compliance. Put in place a comprehensive training program to educate trustees and staff. Remember the 90 percent of the population cited in the studies above—the overwhelming majority of trustees and employees are trying to do the right thing and need access to resources to help them do so. Among the elements of an effective training program are annual fiduciary training for trustees and appropriate staff, and regular ethics and compliance training for trustees and all staff. Attendees say they often prefer shorter, more frequent training sessions on tightly focused topics. Use a variety of speakers to keep the material fresh. For example, while a staff member is likely in the best position to train on the organization’s code of ethics, you may wish to invite a trainer from your jurisdiction’s commission on open meetings/open records to speak on those requirements for a subsequent session.

Governance: It is hard to overstate the importance of good governance in public pension plan management and success. Among the most critical questions in this area is whether the board has delegated appropriately and, having delegated, is careful to exercise appropriate oversight without micromanaging day-to-day operations. While trustees should not be substituting their judgment for that of staff who have been delegated authority, trustees are responsible for carefully monitoring and overseeing those operations and for regularly reviewing the performance of direct reports (the Executive Director and sometimes the Chief Investment Officer).

Policies and Procedures: Policies and procedures are at the heart of the public pension plan and can provide a strong system of internal controls. Many plans organize their policies in a Board Governance Manual that sets forth committee charters and contains such policies as a Communication Policy, Gifts Policy, Travel Policy, Placement Agent and Political Contribution Policy, Whistleblower Policy, and Discrimination, Harassment and Retaliation Policy, among others. In addition to having the right internal controls in place, policies and procedures must be regularly revisited and revised so that they remain relevant and robust.

Chief among policies is the Investment Policy Statement (IPS), which is at the core of good governance. The IPS should clearly set forth investment objectives; roles and responsibilities among trustees, staff, consultants and advisers; long-term strategic asset allocation; operational guidelines for carrying out the asset allocation; and rules for monitoring and reviewing the investment strategy.

Process: Remember that fiduciaries are judged by the process by which they reach their decisions. Establishing a reasonable decision-making process and adhering to that process helps to demonstrate prudence. Documenting the process is an important part of demonstrating prudence. Be sure that your review process has been sufficiently memorialized in order to demonstrate such prudence.

Happy New Year!