670600© 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved. 1 Understanding Your Fiduciary Duty: Selecting and Monitoring Vendors Presented by Katherine A. Hesse June 5, 2012

Fiduciary Duty The definition of fiduciary and the duties applicable to fiduciaries in M.G.L. c. 32 were modeled after the requirements for fiduciaries under the Employee Retirement Income Security Act of 1974 (“ERISA”). ERISA was adopted in 1974, while the fiduciary definition and fiduciary duty sections of c. 32 were adopted in © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.2

Fiduciary Duty M.G.L. c. 32, Sec. 1 provides: “‘Fiduciary’, any person who exercises any discretionary authority or discretionary control respecting management of the funds of any retirement system or exercises any authority or control respecting management or disposition of its assets.” This language is taken almost exactly from ERISA Sec. 2(21)(a)(i) © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.3

Fiduciary Duty M.G.L. c. 32, Sec. 23(3) provides: “Fiduciary Standards. — A fiduciary as defined in section one shall discharge his duties for the exclusive purpose of providing benefits to members and their beneficiaries with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims and by diversifying the investments of the system so as to minimize the risk of large losses unless under the circumstances it is clearly prudent not to do so.” © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.4

Fiduciary Duty The fiduciary standard contained in c. 32 is taken almost directly from ERISA Sec. 404(a). The main duty of a fiduciary is to act prudently in managing the assets of the system in the best interests of the members. By acting prudently within the standard of care, fiduciaries may limit liability © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.5

Fiduciary Duty Fiduciaries are responsible for: Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them; Carrying out their duties prudently; Acting within the limits of c. 32; Diversifying plan investments; and Paying only reasonable plan expenses © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.6

Selecting Vendors Part of acting prudently and only paying reasonable expenses includes performing your due diligence in selecting and monitoring vendors. Ch. 176 of the Acts of 2011 included a new procurement process for the selection of accounting, actuarial, investment or legal vendors. (M.G.L. c. 32, Sec. 23B) Fiduciaries should be aware that they have a duty to perform due diligence in selecting any vendor © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.7

Selecting Vendors The new procurement process is similar to that required of other public entities under M.G.L. c. 30B. The procurement process is a road map to fulfilling your fiduciary duties, as following the process will ensure that you are performing due diligence and documenting your efforts in selecting vendors © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.8

Selecting Vendors Retirement systems must procure these services through a competitive process, using a request for proposals. The required RFP process includes: Providing public notice of the RFP through posting at the retirement system offices, posting in a newspaper of general circulation in your area, posting in a publication of interest to practitioners in the area for which services are sought, and posting with the Secretary of State © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.9

Selecting Vendors Providing reasonable time for responses. Reasonable time is at least 2 weeks but may be more © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.10

Selecting Vendors The RFP must include all terms and conditions applicable to the procurement – non-mandatory terms may be negotiated with the selected vendor. Retirement Boards may have their consultant or designated procurement officer perform the initial evaluation of respondents to the RFP. The Retirement Board selects the most advantageous proposal, taking into consideration price and the evaluation criteria set forth in the RFP © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.11

Selecting Vendors All contracts falling under c. 32, Sec. 23B must be in writing. Such contracts must be for a term of no more than 5 years, including any renewals, extensions or options. Exception: contracts for illiquid investments with required terms of more than 5 years © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.12

Selecting Vendors RFPs for investment service providers, which include “managers, partnerships, trusts, custodians, consultants, as well as those providing proxy services, services related to the financial information (cash books, pooled fund statements, Annual Statements) retirement boards must file with PERAC, securities litigation services and other services which are investment related,” must include certain mandatory contract terms. See PERAC Memo #27 of © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.13

Selecting Vendors Provision that the vendor is a fiduciary Provision that the Retirement Board will not indemnify the vendor Provision that the vendor will annually inform PERAC and the board of any arrangements in oral or in writing, for compensation or other benefit received or expected to be received or paid or expected to be paid by the vendor or a related person in connection with the contractor’s services to the retirement board or any other client; © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.14

Selecting Vendors Provision requiring the vendor to annually disclose to PERAC and the retirement board in writing any conflict of interest the contractor may have with regard to the services being provided. The statute provides that other mandatory contractual terms and conditions shall address investment objectives, brokerage practices, proxy voting and tender offer exercise procedures, terms of employment and termination provisions © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.15

Selecting Vendors PERAC has developed new forms that vendors and Retirement Boards must complete during the procurement process for investment services. Forms for vendors: Vendor Certification of Good Faith Proposal; Vendor Annual Disclosure of Compensation Received Form; Vendor Annual Disclosure of Compensation Paid Form; Vendor Disclosure of Conflict of Interest Form; and Placement Agent Statement © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.16

Selecting Vendors Forms for Retirement Boards to complete: Retirement Board Procurement Compliance Certification Form; Retirement Board Member Certification Form; Retirement Board Certification of Consultant’s Reports Form; and Retirement Board Certification of Prohibited Investment Compliance Form © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.17

Selecting Vendors M.G.L. c. 32, Sec. 23B requires that all written documents required under that section be retained by the Retirement Board for at least 6 years from the date of final payment under the contract © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.18

Selecting Vendors In selecting vendors, there are some basic questions your will want to keep in mind*: What services does the retirement system need? Does each candidate possess the expertise and qualifications needed to perform the services they propose to deliver? * Adapted from Hagan, Ronald E., “The Excellent Fiduciary – Pension Vendors Must Be Prudently Selected and Monitored”, Journal of Compensation and Benefits, May/June © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.19

Selecting Vendors Are the proposed vendors completely transparent about their ownership, business affiliations, and revenue partners? Are there any potential conflicts of interest for the vendor? © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.20

Selecting Vendors How do the candidates' fees compare against other vendors of the same services? Have the vendors provided all costs and fees up front and included the costs and fees in the contract? © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.21

Monitoring Vendors By acting prudently and performing due diligence in the selection of vendors, fiduciaries have the right to rely on advice and information provided by those vendors in making decisions that affect the retirement system. However, fiduciaries have an ongoing duty to monitor all vendors to ensure that they are providing the contracted for services and acting with the proper standard of care © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.22

Monitoring Vendors THE NOVEMBER 1996 REPORT OF THE WORKING GROUP The November 1996 Report of the Working Group on Guidance in Selecting and Monitoring Service Providers identified the following issues in relation to the duty to monitor service providers: © 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved.23

670600© 2012 Murphy, Hesse, Toomey & Lehane LLP. All Rights Reserved.24 Monitoring Vendors 1.Who is responsible for monitoring the service providers? 2.What is the process to monitor the service provider?

670600© 2012 Murphy, Hesse, Toomey & Lehane LLP. All Rights Reserved.25 3.Are written reports provided by the service provider? With what frequency are the written reports provided? Monitoring Vendors

670600© 2012 Murphy, Hesse, Toomey & Lehane LLP. All Rights Reserved.26 4.Do the written reports describe the performance of the service provider as compared to the applicable written guidelines and/or contract? 5.Do the written reports provide sufficient information to adequately evaluate the performance of the service provider compared to benchmarks or industry standards? Monitoring Vendors

670600© 2012 Murphy, Hesse, Toomey & Lehane LLP. All Rights Reserved.27 6.Is there a process in place to either: (a) correct any non-conformance with guidelines/contract, benchmarks or industry standards; or (b) to terminate the service provider and retain a successor? 7.Do the written reports provide sufficient information to adequately evaluate the performance of the service provider compared to benchmarks or industry standards? Monitoring Vendors

670600© 2012 Murphy, Hesse, Toomey & Lehane LLP. All Rights Reserved.28 8.If the responsibility to monitor a service provider has been delegated, has the individual or service provider to whom the delegation has been made accepted fiduciary responsibility in writing for the monitoring? Monitoring Vendors

670600© 2012 Murphy, Hesse, Toomey & Lehane LLP. All Rights Reserved.29 Summary A.Have a clearly enunciated purpose/mission/set of guidelines B.Always utilize qualified professional help C.Follow the basic fiduciary rules of prudence D. Follow applicable law

670600© 2012 Murphy, Hesse, Toomey & Lehane, LLP. All Rights Reserved. 30 Questions?

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