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The Responsible Fiduciary

To guide decisions, institutional investors can tap into the wisdom of American Indian tribal leaders.

By Donald B. Trone

“The world is composed of persons, not things; some persons, including some human beings, are powerful; some are not; some persons act in caring, respectful, and nurturing ways; many do not. In brief, all people have responsibilities toward others, whether or not they act accordingly.”
—Duane Champagne, Native America: Portrait of the Peoples

Breach of fiduciary responsibility is among the most damaging charges that can be leveled against anyone placed in a special relationship of trust, confidence, or legal responsibility. In the case of an academic institution, the concept of fiduciary responsibility extends in every direction—to the conduct and activities of the officers, administrators, faculty, directors, and investment committees. While the idea of proper fiduciary conduct is something that all who hold such positions should understand, headlines continue to report breaches. In a recent study conducted by Oversight Systems (“The 2007 Oversight Systems Report on Corporate Fraud,” www.oversightsystems.com), three out of four examiners said that overall institutional fraud is more prevalent today than in 2002, the year that the Sarbanes-Oxley Act took effect. According to the study: “When asked to identify the measure most effective in preventing institutional fraud, 43 percent of the professional examiners identified the need for a strong tone from the top of the organization.”

Even well-informed and well-intentioned investment fiduciaries struggle with the juxtaposition of their responsibilities against an increasingly complex and conflicted world. Questions inevitably arise. Should the endowed assets of a higher education institution that are earmarked for scholarships and for bricks and mortar also be employed to further a particular social cause? Should the hiring of a particular money manager be based solely on the manager’s capacity to make additional donations to the institution?

This article focuses on the fiduciary practices that define a prudent process for higher education investment decision makers—trustees and investment committees responsible for foundations, endowments, or retirement plan assets. A typical approach is to substantiate fiduciary practices with relevant legislation, case law, and regulatory opinions. For this article, I have set the practices required of fiduciaries against the backdrop of the moral wisdom of American Indian tribal leaders. [Note: Most American Indian writers prefer the term American Indian to Native American. While I am aware of the sensitivity of some American Indians to the use of tribal writings for commercial exploitation, my motivation for these citations is to illustrate how investment fiduciaries can benefit and learn from this indigenous wisdom. Also, I gratefully acknowledge assistance from participants in a fiduciary training class of American Indian tribal leaders and their staffs held in April 2007.]

The DNA of Stewardship

The Fiduciary Circle

Fiduciary responsibility may be formed by legislation, case law, and regulatory opinion letters. But, the law will never adequately define the moral roles and responsibilities of the fiduciary. What brings the subject of fiduciary responsibility to life are the same ideas that we associate with leadership, stewardship, covenants, and ethics. These moral concepts inform individual behavior. They also guide the appropriate conduct for relationships among all those the institution entrusts with its fiduciary activities and with all institutional stakeholders and beyond.

“The Plains Indians arranged their knowledge in a circular format_which is to say, there were no ultimate terms or constituents of their universe, only sets of relationships that sought to describe phenomena.... The purpose of such an arrangement was to be certain that all known aspects of something would be included in the information that people possessed and considered when making decisions and reaching conclusions.”
—Vine Deloria, Spirit and Reason

“The circle has healing power. In the circle we are all equal. When in the circle, no one is in front of you. No one is behind you. No one is below you. The Sacred Circle is designed to create unity.
The Hoop of Life is also a circle. On this hoop there is a place for every species, every race, every tree, and every plant. It is this completeness of life that must be respected in order to bring about health on this planet. To understand each other, as the ripples when a stone is tossed into the waters, the circle starts small and grows until it fills the whole lake.”
—Dekawidah, Cherokee

The concepts of stewardship and covenant—which are the cornerstones for the term fiduciary—are global and as old as written and spoken language. Whether one studies the ancient writings of the Abramic religions (Judaism, Christianity, and Islam each use the covenant between God and Noah to illustrate stewardship); philosophies of Greece and Rome; or the indigenous wisdom of American Indian tribal leaders, the concepts remain the same. It could be said that their meanings are part of our human genetic makeup, a DNA that all people have in common.

Fiduciary responsibility also calls for a personal commitment to do the right thing—to formulate decisions that are just and right for the common good. The indigenous wisdom of American Indian tribal leaders can serve as a means to encourage and inculcate standards of care in investment fiduciaries—and motivate individuals to operate at a higher level than what is required by law. Indigenous wisdom can serve as a working guide for investigating and distinguishing right from wrong and can enable investment fiduciaries to enter each decision-making situation fully armed with maxims that serve as illuminators. Such age-old guidance likewise can form the basis of an intelligible prudent investment process that brings fiduciary and ethical imperatives into practical application.

At the Foundation for Fiduciary Studies, we have identified 22 practices that help define a prudent process for investment fiduciaries. The practices are organized using a four-step investment management process.

1. Organize—foster a culture of fiduciary responsibility.

2. Formalize—demonstrate understanding of risk and return.

3. Implement—establish asset allocation parameters and due diligence selection criteria.

4. Monitor—examine all investment policies and procedures as well as performance.

These 22 practices, which follow in checklist fashion, can help facilitate a self-assessment conformance with defined fiduciary practices. Obviously, these activities cannot be reduced to a simple checklist; they also must become a state of mind and an attitude. Therefore, appearing with the practices are selected passages that illuminate these subjective standards. Together, practice and wisdom provide a continuum of methodology and knowledge for enhancing fiduciary responsibility.

Foster a Culture of Responsibility

Oftentimes when a fiduciary audit is conducted to analyze surfacing problems, the results reveal numerous breaches not only with regard to investment committee members but to their investment decisions. Chances are good that if conflicts of interest exist with investment committee members, the committee, in turn, has hired investment consultants or money managers who likewise pose conflicts of interest.

A key challenge for institutional fiduciaries is to work to foster a pervasive culture of responsibility defined by reliable, fixed standards. Investment fiduciaries who do not promote such a culture may lack the sensitivity and awareness to identify fiduciary breaches.

Practices

1. Organize
1.1:
Manage investments in accordance with all applicable laws, trust documents, and written investment policy statements.
1.2: Define, document, and acknowledge the roles and responsibilities of all involved parties (fiduciaries and nonfiduciaries).
1.3: Ensure that fiduciaries and parties in interest are not involved in self-dealing.
1.4: Put service agreements and contracts in writing, and do not include provisions that conflict with fiduciary standards of care.
1.5: Make certain that assets are within the jurisdiction of appropriate courts and are protected from theft and embezzlement.


Understand Risk and Return

Fiduciary audits often reveal that an investment committee has abandoned its well-defined investment procedures to pursue an allocation into alternative investments or hedge funds. Such a decision to invest in nontraditional asset classes and investment strategies should trigger greater—not less—sensitivity for the application of fiduciary practices. True, there is no requirement or expectation that the investment fiduciary forecast future returns. Rather, the fiduciary is required to demonstrate an understanding of the risk and return presumptions used to model the probable outcomes of a given investment strategy.

The investment fiduciary is also required to manage investment decisions with a reasonable level of detail. By reducing that detail to writing (i.e., preparing a written investment policy statement), the investment fiduciary can avoid unnecessary differences of opinion and resulting conflicts; minimize the possibility of missteps due to a lack of clear guidelines; establish a reasoned basis for measuring compliance; and establish and communicate reasonable and clear expectations with beneficiaries and sponsors (donors).

Practices

2. Formalize
2.1: Identify an investment time horizon.
2.2: Determine a risk level.
2.3: Develop an expected, modeled return to meet investment objectives.
2.4: Select asset classes consistent with the identified risk, return, and time horizon.
2.5: Select asset classes consistent with implementation and monitoring constraints.
2.6: Ensure that investment policy statements contain the detail to define, implement, and manage a specific investment strategy.
2.7: When applicable, make certain that investment policy statements define appropriately structured, socially responsible investment strategies.

Resources

The 22 practices referenced in this article are contained in Prudent Practices for Investment Stewards, part of a fiduciary handbook series developed by the Foundation for Fiduciary Studies, published by Fiduciary360 (www.fi360.com), and available through the NACUBO bookstore at www.nacubo.org/x3509.xml. Concepts and quotations for this article were taken from a number of books and Web site resources:

  1. Custer Died for Your Sins: An Indian Manifesto, by Vine Deloria (University of Oklahoma Press, 1988)
  2. Native America: Portrait of the Peoples, by Duane Champagne (Visible Ink Press, 1994)
  3. Spirit and Reason, edited by Vine Deloria (Fulcrum Publishing, 1999)
  4. The Wisdom of the Native Americans, edited by Kent Nerburn (New World Library, 1999)
  5. 365 Days of Walking the Red Road: The Native American Path to Leading a Spiritual Life Every Day, by Terri Jean (Adams Media, 2003)
  6. www.greatdreams.com/wisdom.htm
  7. http://thewildwest.org
  8. www.sapphyr.net/natam/quotes-nativeamerican.htm

Establish Parameters and Criteria

Investment fiduciaries must avoid the temptation to chase the latest top-performing asset class or hottest money manager. By establishing specific, asset-allocation parameters and money-manager or mutual-fund, due-diligence selection criteria, it is much easier to determine whether a prospective manager fits into the approved investment program.

Fiduciary responsibility also calls for investigating the qualities, characteristics, and merits of each money manager and identifying the role each plays in the implementation of the investment strategy. The investment policy statement should reflect the due-diligence criteria defined by the fiduciary and be the same criteria used to evaluate and monitor the money manager on an ongoing basis.

Practices

3. Implement
3.1: Implement the investment strategy in compliance with the required level of prudence.
3.2: Follow applicable safe harbor provisions, when elected.
3.3: Ensure that investment vehicles are appropriate for the portfolio size.
3.4: Follow a due-diligence process in selecting service providers, including the custodian.

Monitor Policies and Procedures

The investment fiduciary’s monitoring function extends beyond a strict examination of performance; it occurs across all policy and procedural issues. When investment fiduciaries are taken to task it is often for what the fiduciary failed to do, rather than for what he or she actually did.

The failure of the fiduciary to properly monitor investment expenses provides an excellent example of the layers of required analysis. The fiduciary has a duty to:           

1. Control and account for all investment-related fees and expenses.
2. Identify every party that has been compensated from portfolio assets.
3. Demonstrate that a determination was made that the fees and expenses paid to each party were appropriate and reasonable, given the level of services rendered.

Practices

4. Monitor
4.1: Establish periodic reports to compare investment performance against appropriate index, peer group, and investment policy statement objectives.
4.2: Conduct periodic reviews of qualitative and organizational changes of investment decision makers.
4.3: Put control procedures in place to periodically review policies for best execution, soft dollars, and proxy voting.
4.4: Ensure that investment management fees are consistent with agreements and with all applicable laws.
4.5: Appropriately apply, utilize, and document finder’s fees or other forms of compensation that may have been paid for asset placement.
4.6: Develop a process to periodically review the organization’s effectiveness in meeting its fiduciary responsibilities.

Law and Moral Order

“Out of the Indian approach to life there comes a great freedom, an intense and absorbing love for nature; a respect for life; enriching faith in a Supreme Power; and principles of truth, honesty, generosity, equity, and brotherhood as a guide to mundane relations.”
—Luther Standing Bear (1868–1939), Oglala

“Among the Indians there have been no written laws. Customs handed down from generation to generation have been the only laws to guide them. Every one might act different[ly] from what was considered right did he choose to do so, but such acts would bring upon him the censure of the Nation.... This fear of the Nation's censure acted as a mighty band, binding all in one social, honorable compact.”
—George Copway (1818–1863), Ojibwa Chief

It would seem that almost every decision that could be made by a fiduciary comes with a set of rules and regulations. Yet, they alone will never fully inform investment fiduciaries of their duties and responsibilities. While responsibility may be defined by law, it is shaped by moral imperatives. The moral fundamentals that commit institutional fiduciaries to abide by their covenants and to be faithful stewards are eloquently defined by indigenous wisdom—a wisdom that provides a mentoring spirit.

The fiduciary practices identified in this article prescribe a flexible process for the effective management of investment decisions. The indigenous wisdom provides a timeless philosophy on the importance of stewardship and the preservation of covenants. The intelligent and prudent management of investment decisions requires the fiduciary to balance those two elements to maintain a rational, responsible, and disciplined investment program.

DONALD B. TRONE is president, Foundation for Fiduciary Studies, Sewickley, Pennsylvania.