As If We Didn’t Already Have Enough to Worry About, We Have to Talk About Board Governance NOW? Presentation by Christopher W. Waddell Senior Attorney,

As If We Didn’t Already Have Enough to Worry About, We Have to Talk About Board

Governance NOW?

Presentation by Christopher W. WaddellSenior Attorney, Olson Hagel & Fishburn, Sacramento, CA

Corporate Governance Fellow, Stanford Law School

CALAPRS Trustee’s RoundtableOctober 16, 2009

OVERVIEW• A little background, please—Who am I and why

am I here today?• An overview of the Arthur and Toni Rembe Rock

Center for Corporate Governance at the Stanford Law School and its programs

• The Clapman Report and Clapman 2.0• Other pension fund governance challenges:

– SEC Rulemaking– A.B. 1584

Who Am I And Why Am I Here Today?

• Former General Counsel for CalSTRS and SDCERS– CalSTRS governance initiatives– SDCERS reform efforts– Now in private practice

• Corporate Governance Fellow at the Arthur and Toni Rembe Rock Center for Corporate Governance at Stanford Law School.

The Rock Center at Stanford Law School

• Funded by a gift from venture capitalist Arthur Rock and his wife Toni Rembe Rock with three objectives:– Bridge the gap between governance theory and

practice– Advance intellectual understanding of the governance

process– Strengthen corporate governance as an independent

area of teaching and scholarship

The Rock Center at Stanford Law School

• Rock Center Programs of Benefit to Public Retirement Systems (To Date):– Stanford Securities Class Action Clearinghouse– Recent conference: “Diversity on Corporate Boards:

When Difference Makes a Difference”– Fiduciary College– Stanford Institutional Investors Forum

Fiduciary College

• A two-day program for trustees and senior managers of public, corporate and union funds as well as endowments and foundations on topics such as fiduciary duties and liabilities, board governance, ethical issues, staff accountability, and relationships with sponsors.

• Presentations from experts in the field in a not-for-profit, academic atmosphere geared toward experienced trustees and staff.

Fiduciary College

• March 25-26, 2010• Overlap with CALAPRS New Trustee Training is

Deliberate– Opportunity for joint lunch session with Kirk O.

Hanson, Executive Director of the Markkula Center for Applied Ethics at the University of Santa Clara

– Expose new trustees to future educational opportunities

Stanford Institutional Investors’ Forum

• The Stanford Institutional Investors Forum provides an opportunity for many of the nation’s largest and most sophisticated institutional investors to meet in a confidential setting, closed to the press and public, to discuss current policy issues of concern to the institutional investor community.

Stanford Institutional Investors’ Forum

• More than just talk• Stanford Fund Governance Initiative (SFGI)

– Identify principles of best practice that promote better governance of pension funds.

– Develop tools that assist pension fund leaders to implement those principles.

– In May, 2007, SFGI released the “Clapman Report,” which set forth best practice principles in five key areas.

Clapman Report

• Transparency of a fund’s rules and governance structure

• Fund leadership• Trustee attributes and core competencies• Addressing conflicts of interest and related

disclosure issues• Delegation of duties and allocation of

responsibilities

Transparency of a Fund’s Rules and Governance Structure

• A fund should clearly define and make publicly available its governance rules– Gathered in one location that is clearly accessible to

persons involved in the governance process and the public

– Ideally posted on the System’s website– Annual affirmation of understanding and compliance

by board members

Fund Leadership

• Identify and disclose its leadership structure• Governing body should consist of qualified,

experienced individuals dedicated to fulfilling their fiduciary duties to fund beneficiaries– Doesn’t mean that board members have to come in

as experts, but that they must take reasonable steps to acquire the skills to serve appropriately as a fiduciary.

Fund Leadership-Continued

• Board should promote policies that strengthen fiduciary principles in the selection and monitoring of trustees

• System should establish clear lines of authority between its governing body and staff

• Board should have authority to select or dismiss key staff and have access to unconflicted, qualified external counsel and consultants

Trustee Attributes and Core Competencies

• Board members should have a thorough understanding of the fund’s obligations to its beneficiaries, the fund’s economic position and strategy, and its relevant governing principles.

• The board should include individuals with relevant investment and financial market expertise and experience

Trustee Attributes and Core Competencies--Continued

• Board members should obtain education that provides and improves core competencies

• Board members should be able to obtain intelligible explanations of recommended actions from staff, advisors or colleagues– No such thing as a “dumb” question

• Annual evaluation of trustee skills

What are the “Core Competencies”

• Loyalty to best interests of fund’s beneficiaries• Ability to disassociate personal viewpoints from

objective requirements of fiduciary obligations• Willingness and ability to dedicate the necessary

time and attention to system business• Understanding of the system’s operating

environment and underlying economic and structural relationships

Core Competencies--Continued

• Understanding of the obligations of a fiduciary relationship

• An inquisitive nature• Ability to consider and debate issues in a civil

and constructive manner• Effective communication and interpersonal skills• A substantive base of knowledge

Addressing Conflicts of Interest and Related Disclosure Issues

• Establish and publicly disclose its policy for dealing effectively with situations that raise either:– An actual conflict of interest; or– The potential for the appearance of a conflict of

interest

• Regular reporting and disclosure of actual or potential conflicts

Addressing Conflicts of Interest--Continued

• Periodic verification of compliance• No undue influence on any person to engage in

a transaction that creates an actual conflict or appearance of impropriety

• Public disclosure of information sufficient to ensure that trustees and staff are fulfilling their fiduciary duties

Delegation of Duties and Allocation of Responsibilities

• Board should be permitted to rely on the expertise and advice of appropriately selected and unconflicted consultants and staff

• Consultants should be required to comply with fund’s conflict of interest and ethics policies.

• Fund should evaluate cost/benefit evaluation of expenditures

• Effective monitoring of all service contracts

Observations

• Recognition that any set of best practices must be flexible and adaptable to the unique circumstances of each fund—not “one size fits all.”

• View recommendations as a conceptual framework to measure adequacy of existing policies and/or need for new policies

Observations-Continued

• Policy development is a hard, grueling process. Given other demands on pension funds in era of scarce resources, most systems are not going to be able to make significant progress without assistance.

Clapman 2.0

• Goal: To Provide “Off-the Shelf” tools, including model governance policies and self-assessment instruments, for consideration, easy adaptation and adoption by pension funds

• Target date for completion is June, 2010• Input from smaller systems needed and is

welcome

Why Now?

• Defined benefit pension plans are under assault as they never have been before

• “Perfect storm” of investment losses and governance scandals

• Potential pension initiative(s) in 2010• Legislative and regulatory actions already

underway

SEC “Pay-to-Play" Rulemaking

• Background– CalPERS policy banning campaign contributions

overturned by court– SEC initial rulemaking effort in 1999 – CalSTRS policy/regulations adopted in 2006/07– New York pay-to-play scandal in 2009/Investigations

by NY Attorney General and SEC

Proposed SEC Rules

• Prohibits investment advisors from providing compensated services to a public retirement system if campaign contributions were made to elected officers or candidates for office

• Prohibits investment advisors from engaging third party “placement agents” to solicit business from a public pension fund

SEC Rules--Status

• Comments were due on October 6, 2009• SEC can adopt, modify, or drop proposed rules

following receipt of comments• Quick resolution not expected

Meanwhile, Back at the Ranch

• A.B. 1584 signed by Governor Schwarzenegger on Sunday, October 4 and takes effect immediately as an urgency bill

• Key Provisions:– The special two-year “revolving door” law previously

applicable only to CalPERS and CalSTRS is now applicable to all California pension systems

A.B. 1584

• Key Provisions—Continued– All California public retirement systems are required

to develop and implement placement agent disclosure policies by June 30, 2010 following a model adopted by CalPERS

– Action not required unless Board determines, in good faith, that this is consistent with their fiduciary duties under Article 16, Section 17 of the CA Constitution.

A.B. 1584

• Key Provisions—Continued– This means that system has option NOT to adopt a

policy—for example, where the system doesn’t invest in asset classes that typically attract placement agents (i.e., private equity) and placement agents have not been involved in system investments.

– Separately, law requires placement agents to disclose gifts and campaign contributions made to any elected board member

A.B. 1584

• What should systems do?– Make an initial assessment on potential need to adopt

a policy– Wait and see re: SEC rulemaking– Absent law change, must either adopt policy or, by

vote of the Board, elect NOT to adopt a policy by June 10, 2009

QUESTIONS?