One of the biggest financial frauds in generations, the false and misleading sale of securitized subprime and other instruments, is creating havoc with the concept of fiduciary duty.
Fiduciaries at pension funds and other of large institutions are apparently failing dreadfully in their responsibilities to oversee and protect assets entrusted to them because of their acceptance of these instruments.
Fiduciary duty is clear, not only to protect assets but also to protect elated claims associated with assets entrusted to them.
Fiduciaries have to ask a basic question — what does their fund own? To be sure, literally trillions of dollars of these securities, many with bogus triple-A ratings, were marketed and sold to pension funds, endowments and other institutions of all sizes during the untroubled, yield-chasing days of 2005 to 2008. A report last November put the issuance at nearly $2 trillion, with estimated losses amounting to $700 billion for investors. The extent of the missing documentation and fraudulent disclosures made in connection with the creation and sale of these instruments is becoming clear. The fraud is so obvious, in fact, that a compelling case for potential recovery can be made against firms that packaged and sold the instruments.
It might be understandable that there would be reluctance by investment fund trustees to bring cases and thus avoid embarrassment. Bringing such actions may very well reveal the fund manager's carelessness in buying such junk in the first place. Equally distressing is the situation in which the fund officials simply don't know they own such securities. These officials either get incorrect or incomplete information from portfolio managers, or fail to even ask the question. Either way, fiduciary duty requires more.
Any senior staff person or board member worth their fiduciary salt should be asking for a full accounting on the amounts bought, currently held or sold, and any losses attributable to these instruments. In addition, the duty to maximize the value of assets on behalf of beneficiaries would call for consulting proficient legal counsel to assess prospects for successful fraud claims and recovery. If for any reason the pension fund officials are unwilling to pursue or even ask the question, perhaps a group of the underlying beneficiaries might call the question.
Of the estimated pool of securities sold under false and misleading statements on the quality of underlying loan collateral, claims representing only a tiny fraction of the securities issued have been brought, whatever the circumstances of the allegations. At a time when pension underfunding and state deficits are of particular concern, it is even more important for fiduciaries to investigate every available means of recovery, even if it gets embarrassing.
Even the newest trustee, put in charge of pension or endowment or other entrusted assets, is given a basic primer in fiduciary duty upon assuming such a role. For those even more seasoned, the triple duties of prudence, loyalty and care roll off the tongue as though it were native language. My own grounding in fiduciary responsibility comes from many years as legal counsel in the public pension fund and registered investment adviser sectors. I know from experience that there are many opportunities to be reminded of one's obligations. It is a conviction to fiduciary duty that is critical to doing business in the financial services industry, underpinning the concepts of diligence and integrity. It is what gives markets and investors confidence and underpins the integrity of pension funds. n
Kurt N. Schacht is managing director of the standards and financial market integrity division of CFA Institute, Charlottesville, Va.