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February 18, 2011
Concepts of Fiduciary Duty Face Revision for Retail and Institutional Investors
    by Robert Kropp

Both the Department of Labor and the Securities and Exchange Commission have proposed updates to the definition of fiduciary duty to broaden the number of those considered fiduciaries.

Concepts of fiduciary duty that have been exposed as antiquated in the wake of the financial crisis and subsequent global recession are finally being addressed on a number of fronts, as both the Department of Labor (DoL) and the Securities and Exchange Commission (SEC) have proposed updates for which they are seeking comments from interested parties.

Last year, the SEC issued a concept release that proposed to update, for the first time in more than 30 years, the proxy system in order to increase accountability and transparency. The Commission followed with the publication last month of staff study recommending a uniform fiduciary standard for broker-dealers and investment advisers to ensure the integrity of investment advice provided to retail investors.

Meanwhile, the Employee Benefits Security Administration (EBSA) of the DoL issued a proposed rule seeking to update the definition of fiduciary, to "protect beneficiaries of pension plans and individual retirement accounts by more broadly defining the circumstances under which a person is considered to be a fiduciary."

As Stephen Davis, Executive Director at the Millstein Center for Corporate Governance and Performance, told, "Fiduciary duty is suddenly the buzzword in the corporate governance community, for investors, intermediaries, and corporate boards. Long-held assumptions about fiduciary duty are now open for discussion."

"Up until now, we have harbored principles that encourage short-term thinking and a narrow version of what funds and companies should strive for," Davis continued. "The financial crisis and recession have exposed shortfalls in the way boards of both corporations and funds play their roles in the capital markets. In short, they failed. The issue is to whom are boards accountable, both on the investment side and the corporate side. If you can get accountability right, then improvements will follow."

Davis is a member of the Shareholder Responsibilities Committee of the International Corporate Governance Network (ICGN), a global organization of institutional and private investors with $12 trillion in assets under management. ICGN submitted a comments letter to EBSA in response to its proposed rule.

"We generally feel that increasing the notion of fiduciary responsibility throughout the investment chain will have a positive impact, not only for pension plan participants, but on the broader US financial system as well," ICGN stated. "However, since ERISA (the Employee Retirement Income Security Act) was enacted, an expansive industry of consultants and advisors has developed that now effectively exerts a strong influence over many pension fund decisions."

"Many of those consultants and advisors are not treated as fiduciaries, though trustees increasingly defer to their judgment," ICGN continued. "We would anticipate these expanded criteria will extend to include several parties not currently covered by the existing regulation, such as certain types of investment advisors, consultants, and proxy advisory firms."

Calls for considering proxy advisory firms as fiduciaries are being heard by the SEC as well. In March, 2010, the Shareholder Communications Coalition issued a discussion draft recommending that proxy advisory firms be required to register with the Commission as investment advisors.

Davis told, "EBSA is trying to answer the question of what constitutes fiduciary duty for all the players in the investment chain. The inclusion of proxy advisors is a new concept for EBSA. It's proposing to update an antiquated notion that voting is simply a compliance exercise and is not related to value. But especially in the wake of the crisis, alert shareholders are critical to the performance of boards."

However, "What really needs examination is the governance of ERISA funds," Davis continued. "You can adjust the standard for fiduciary duty, but if you don't have a governance structure that is accountable to the ultimate beneficiaries then it's always possible to make decisions that fail to optimize those interests."

"The fiduciary of most ERISA funds is a corporate board," Davis said. "Often a single executive is the sole fiduciary for a fund. This differs from many other countries where members of the fund are represented on a governing body."

Davis pointed out that ICGN has a Statement of Principles on Institutional Shareholder Responsibilities, that, he said, "Makes it very clear that in the event a fund is controlled by a corporation, there should be representation of members."

"Addressing fiduciary duty is a positive step," Davis said. "But whether decisions are taken in the interest of beneficiaries should rest not only on the fiduciary standards, but also on the question of who decides."

ICGN's comments letter to EBSA addresses other aspects of its Statement of Principles, stating, "Fiduciary duty includes use of the full range of shareholder rights to manage shareholder value risks and opportunities at companies in which they invest."

"As progress continues towards codes of best practice for institutional investors in Canada, South Africa, the Netherlands and the EU, among other markets," ICGN continued, "There is an increasing risk that pension fund participants in the United States could become disadvantaged."

Davis also addressed a 2008 interpretive bulletin issued by DoL that barred economically targeted investment (ETI) by corporate pension funds. ETI includes the incorporation of environmental, social, and corporate governance (ESG) considerations in investment decision-making.

"The Department of Labor still has interpretive advice out there that is both out of date and in conflict with current understanding of risk, and that is guidance on fund voting for extra-financial issues," he said. "Clearly, it's low-hanging fruit, but after two years of the new administration it has not been touched. The inaction makes even less sense given the renewed attention to fiduciary duty."


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