FIDUCIARY LIABILITY—PUBLIC SECTOR

1. FIDUCIARY LIABILITY—PUBLIC SECTOR Hard Choices, Real Protection October 10, 2009 Christine A. Dart Chubb & Son Vice President Robert D. Klausner Klausner & Kaufman, P.A. Esquire Brian L. Smith The Segal CompanySenior Vice President Daniel Aronowitz Ullico Casualty President

2. Agenda Indemnity protection • Common misconceptions v. reality Fiduciary “Standard of Care” Fiduciary liability exposures • Operational • Statutory • Other Claim Examples Fiduciary liability insurance • Is it permitted? • What does it cover?

3. Common Misconceptions • Trustees are not bound to fiduciary rules • Plans are exempt from ERISA • Trustees are exempt from liability • Sovereign immunity • Statutory indemnification • Governmental policy

4. The Reality • Trustees are subject to significant fiduciary obligations • Existing protections may be • Very limited • Non-existent

5. Possible “Gaps” in Your Liability Protection • “Good faith” standard • Who determines? • The attorney general, the board of trustees, or the courts • Indemnity contingent upon an evaluation of the underlying conduct • Liable for bad faith, willful, wanton or grossly negligent conduct • “Ultra virus” standard • Indemnity not available for actions taken outside “the scope of employment” • Conduct must be consistent with “statutory duties” or “applicable standard of care” • “Breaches of fiduciary duty” may not be covered

6. Potential “Gaps” continued No uniformity • Statues vary by state for indemnification of defense costs, judgments, penalties, and other expenses • “Triggers” also vary No indemnity • At least eleven appear to limit indemnification to trustees • No indemnity is available to other officers, agents or employees

7. Immunity • State “agent” immunity may be qualified • Acts involving skill or judgment (Discretionary Acts) may not be eligible for immunity • Non-qualifying acts may include: • Acts “inconsistent” with statutory duty • “Ultra Virus” acts • “Willful and wanton” negligence • The “independence” of Public Sector plans may void sovereign immunity protection

8. Indemnity/ImmunityOther Observations State statutory law may mirror ERISA’s section 412 [or 410?] • Any indemnity agreement for a breach of fiduciary duty is void State statutory law may specifically grant immunity • BE AWARE OF THE CAVEAT • “That do not involve malicious or wanton misconduct…”

9. Critical Questions • Do you know your state’s statutory and other applicable laws that define your responsibilities and liabilities? • Do you have written opinions from legal counsel identifying the scope of any indemnification or immunity protections? • Do you understand the caveat language that may exist within these protections? For example, is indemnity available for: • “Gross negligence” or “willful or wanton failure?” • Any alleged criminal activity? • Are you protected if the Plan or a regulatory agency (e.g., the state attorney general) sues you for an alleged wrongdoing? • Will the indemnity or immunity be provided if the alleged wrongdoing has become a political “hot potato” or “public scandal”?

10. Fiduciary Standard of Care The fiduciary standard adopted in most states is the ERISA standard applicable to most private sector plans. Federal Standard = Expert Prudent Man State Standard = or ~ Expert Prudent Man

11. Fiduciary Standard of Care continued • The fiduciary…may owe affirmative duties…beyond those found in an ordinary case of fraud. • See Jersey City v. Hague, 18 N.J. 584, 589-90 (1995) • A fiduciary agent is presumed to be acting with “absolute devotion”… • See Jaclyn, Inc. v. Edison Bros. Stores, Inc., 1970 N.J. Super. 334, 369 (1979) • The public official may be considered a “constructive trustee” of assets gained through misconduct…or impose an “equitable lien”… • The public employer may demand not only what was lost, but also gains… • See Dobbs, Law of Remedies • RICO provisions and remedies may also be available

12. Public versus Private Sector Plans • ERISA preempts state law and creates a uniform statutory standard • Public sector plans are not so protected • Numerous statutory and common law standards may apply ERISA = Uniform Statutory Standard Public Sector = No Uniform Statutory Standard

13. Delegation of Fiduciary Duty • ERISA permits the avoidance of fiduciary liability by delegation • Trustees’ exposure is essentially limited to monitoring • Government plan fiduciaries do not transfer their liability by delegation of their duties to service providers • Trustees’ exposure includes investment decision, performance, and monitoring ERISA Delegation Permitted Liability Transferred Public SectorDelegation Permitted Liability Not Transferred

14. Trustee and Administrative (Operational) Exposures

15. Asset/Liability Valuations Actuarial assumptions Investment return assumption Liability valuation LTM or level-cost vs. MVL GASB and OPEB Asset/allocation choices Traditional v. non-traditional Complexity of non-traditional Research, evaluating, explaining, and monitoring Statutory constraints or mandates Green, “politically correct,” “community development” “Prudent investor” rule Benchmarking By whom, how and what comparatives Investment monitoring arrangements Benefits Formulas 1 – 3 – X final year salaries Overtime impact “Cash balance” type formula Statutory anti-cutback provisions Alternatives/Supplemental Lump sum DROP LTD Corporate governance Sophistication or non-sophistication Agenda Expectations Participants Contributing employer Trustee and Administrative (Operational) Exposures

16. Fees Reasonableness Transparency Funding levels Long term Short term Cash flows Knowledge/Experience Trustees Investment committee members Staff, especially investment staff Market issues Access, especially private sector Volatility Rate of return Public bond funding Contributing employer implications Scandals Ponzi schemes Madoff and Stanford Financial Group LTD percentages Sponsor contributions Budget/tax implications Staffing Expertise Retention Resources Strategic partnerships Investment consultants Investment managers Trustee and Administrative (Operational) Exposures continued

17. DOL 401(K) Enforcement Actions—A Partial List • Labor Department Sues to Appoint Independent Fiduciary for 401k Plan Abandoned by Employer • DOL Sues Health Care Provider to Recover 401k Assets • Company Agrees to Restore 401k Funds Following DOL Investigation • DOL Sues Defunct Company for Abandoning 401k Plan • DOL Sues to Restore Losses to Tampa 401k Plan • DOL Sues Company President to Recover 401k Assets • DOL Sues Company to Protect 401k Plan Participants • DOL Sues Company and Owners Over Delinquent 401k Contributions • DOL Sues Fiduciary to Recover 401k Assets • Owner Pleads Guilty to Embezzlement of 401k Assets • Labor Sues to Recover 401k Assets from California Company • Labor Appoints Independent Fiduciary for Abandoned Georgia 401k • Labor Department Recovers $8.6 Million Involving Agway 401k Plan • Labor Department Obtains Judgment Over Misuse of 401k Assets • Company and Officers Ordered to Restore Misused 401k Funds • DOL Takes Legal Action Against 401k Plan Trustee • Labor Department Sues Fiduciary to Recover 401k Assets • Labor Department Obtains Settlement with Business Owner to Restore 401k Funds • DOL Sues Defunct Company Over Abandoned Retirement Plan • Labor Department Sues to Appoint Independent Fiduciary for Abandoned 401k • Labor Department Seeks to Recover Employee Contributions to 401k Plan • Labor Sues to Protect Retirement Assets of Reno, Nevada, Workers 401Khelpcenter.com

18. Specific Examples • Asset allocation choices • Funding Issues • NJ—Considers bill deferring ½ of municipalities annual pension funding requirements. • PA—Employer contributions may increase from 4% of payroll to 28% in 2012. • MI—Employer contributions for Detroit’s police and fire pension plans may increase to 50% of payroll in 2011. Mostly debt Statutory limitations Debt to Equity Shift Statutory limitationseliminated Heavy equity and Alternative investments PossiblyALM ~1950’s ~1970’s – 1990’s Today Future Source: Pension Bills to Surge Nationwide (WSJ, March 16, 2009)

19. Specific Examples continued • Favorable benefit provisions • For example, in at least one municipal plan • The minimum retirement age = 50 • 100% benefits after 25 years of service • Performance disclosure • 13 states have secrecy laws • Real estate investments—risk adjusted performance • In 2007, one large fund held $213 billion in commercial real estate equity, leveraged 70% on average. • Rarely do internal rates of return account for leverage. • In a down market, leverage turns average performance into a disaster. Source: The Next Meltdown, Forbes, July 21, 2008

20. Other Statutory Exposures Federal • ERISA’s “exclusive benefit” rule • Tax exempt status is subject to plan assets not being used for or diverted to non-participants • Does this indirectly impose ERISA’s “fiduciary standards”? • See H.R. Conf. Rep. No. 93-1280 • ADEA, PPA’06, and WRERA • Crediting interest in cash balance plans • What is a market rate? • Non-spousal rollovers • Temporary waiver of required minimum distributions • Self-funded plans eligible for special tax exclusion • IRS See Segal’s April, 2009 Bulletin for details

21. Other Statutory Exposures continued State and local laws • “Mirror” ERISA’s fiduciary standards • Statutory “prudent investor” rules • Investment analysis “per investment” versus “overall portfolio” • Trust law Common law • Duty of loyalty and “prudent investment” rule may create additional liability

22. Claim Examples and Allegations Pay to Play Theft Churning Investment Protocols Portfolio Allocations Pension Benefits Cuts

23. Fee increases for poor performance Churning—unusually high number of transactions Inappropriate investments— insufficient liquidity Theft of funds Pay to play Reduced benefits New benefit “tiers” Increased taxes Greater contributions Insolvency Allegations versus Final Impact ALLEGATION FINAL IMPACT Benefit Plan

24. Public Scandals are Not New History repeats itself Ancient Roman writing tablets suggest public officials were involved in expenses scandals 2,000 years ago.

25. Fiduciary Liability Insurance • At least one state mandates its purchase • Approximately twenty states expressly authorize its purchase

26. Fiduciary Liability Insurance Protection • Coverage • Defense costs, settlements and judgments • Named insured • The plan, its trustees and employees • Wrongful act • Any actual or alleged breach of fiduciary duty or administrative error or omission even if it is proven frivolous or without merit • Exclusions • Willful, deliberate and dishonest acts • Defense coverage may be available until a final adjudication is established • Severability • Each insured individually protected This is an extremely limited “oversight” description. Consult legal counsel.

27. Fiduciary Liability Insurance Protection continued • It is a legal, insurance contract with a third party, professional insurance company • The insurance carrier will either provide or pay for independent legal counsel • A qualified insurance carrier knows public sector claims • The insurance carrier has an objective, financial rather than emotional investment • The insurance carrier has been paid to be on your side

28. Conclusion • Recent economic events: • Spotlight trustees’ actions and responsibilities • Are potentially redefining trustees’ standard of care • Historical experience is not an indicator of future experience • Relying on indemnification and immunity may be a false security • Fiduciary liability insurance is an established, proven “safety net”

29. Contacts 1625 Eye Street, NW Washington, DC 20006 Bus: 202-682-4992 Mobile: (415) 254-4031 Bus Fax: 202-962-8853 82 Hopmeadow Street Simsbury, CT 06070-7683 Phone: 203-222-9625 Mobile: 203-451-3431 Daniel AronowitzPresidentdaronowitz@ullico.com Christine DartVice Presidentcdart@chubb.com One Park Avenue New York, NY 10016-5895 www.segalco.com Bus: (212) 251-5333 Mobile: (347) 423-3452 Bus Fax: (212) 726-5518 10059 Northwest 1st Court Plantation, Florida 33324 Bus: 954-916-1202 Bus Fax: 954-916-1232 Brian L. SmithSenior Vice Presidentemail: bsmith@segalco.com Robert D. KlausnerEsquirebob@robertklausner.com100