AVOIDING%20CONFLICTS%20OF%20INTEREST%20LESSONS%20FROM%20CALIFORNIA

1
AVOIDING CONFLICTS OF INTERESTLESSONS FROM
CALIFORNIAS 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

2
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)

3
Conflict of Interest Laws Affecting Public
Officials

• Common Law
• State Constitution
• Uniform Prudent Investor Act
• State Statutes
• Case Law

4
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).

5
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
  systemboards 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 dutieswith 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 trustees 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 trustees 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.

7
Case Law

• A trustees 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).

8
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.

10
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.

12
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/offic
  ers, competitively bid contracts, childrens
  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

13
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.

14
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 Citys former
• Human Resources Director
• Treasurer
• Assistant Auditor
• Management Analyst
• President of the Municipal Employees Association
• President of the Firefighters Association

15
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.

16
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 Managers Proposal Two, as in the
  state criminal charges.

17
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 firefighters
  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.

18
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 officials public
  position for personal gain, calling into question
  impartiality of performance and breach of the
  publics 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.

19
Recent Inductees into the Honest Services Fraud
Hall of Shame

• Randy Duke Cunningham (R-San Diego)
• Jack Abramoff

20
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.
• Agencys 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 Chiefs Severance Pay Probed by
  Virginia Legislative Panel, The Washington Post,
  July 9, 2005
• Teachers 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

22
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.

23
Predictable Fault Lines for Pension Officials

• Wearing two or three hats
• Negotiating for benefit increases
• Increasing ones 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

24
TAKEAWAY LESSON

• UNCOMMON GAIN
• LEADS TO
• UNCOMMON PAIN!

25
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.

26
How High on the Richter Scale?

• 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.

27
How High on the Richter Scale?

• 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.

28
How High on the Richter Scale?

• 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
  sponsors agency? Or a prior member?
• A Not for that reason alone.

29
How High on the Richter Scale?

• 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? 
• A Not for that reason alone.

30
How High on the Richter Scale?

• Q As a Trustee or administrative staff member,
  may I participate in meet confer over benefits
  as a member of either the employers or the
  unions negotiating team? Any different if I
  participated before becoming a trustee?
• A Troublesome. Lets talk more.

31
How High on the Richter Scale?

• Q Do I have an impermissible conflict of
  interest if I am a member of a Taxpayer
  Association or similar group?
• A Not for that reason alone.

32
How High on the Richter Scale?

• Q What if the Taxpayers Associations official
  position includes statements of intent or goals
  inimical to the mission of the retirement system?
  
• A Unlikely, but tell me more.

33
How High on the Richter Scale?

• 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 Yesbut!

34
How High on the Richter Scale?

• 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 Yesbut!

35
How High on the Richter Scale?

• 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.

36
How High on the Richter Scale?

• 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 dont 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.

37
How High on the Richter Scale?

• 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?