Because of the growing size, complexity and influence of pension funds, the SEC in recent years has given higher priority to investigating potential violations of the federal securities violations by such funds. In January 2010, the SEC established the Municipal Securities and Public Pension Unit to identify market activities that pose the greatest risk of harm to investors and to investigate aggressively possible violations. The unit's initial priorities were offering and disclosure fraud; tax or arbitrage-driven fraud; pay to play and public corruption violations; public pension accounting and disclosure violations; and valuation and pricing fraud. Now, with the enactment of the whistle-blower provisions of the Dodd-Frank act, the SEC has a powerful new tool for detecting securities violations.
Accordingly, sophisticated funds should carefully review their operations and those of the companies in which they hold an ownership interest.
Historically, pension funds have been the subject of relatively few enforcement actions. Notwithstanding this fact, as significant investors in the capital markets, all funds should be aware of the potential for the Dodd-Frank whistle-blower provisions to affect their portfolios and should take steps to minimize that risk.
Many pension funds have been strong proponents of good corporate governance and at the forefront of corporate governance reform. Now, it will be doubly important for pension funds to examine closely the governance practices of the companies they are investing in, paying particular attention to the effectiveness of the internal compliance programs and the tone set at the top with respect to such programs. In other words, enhancing the due-diligence process for examining potential or current pension fund investments will help minimize the chances that a portfolio company will be the subject of a whistle-blower complaint and related regulatory or criminal activity.
The same logic holds true for choosing external investment managers or consultants. In order to remain ahead of the curve, forward-thinking pension funds will conduct more extensive due diligence regarding compliance issues before establishing new vendor relationships and closely monitor compliance programs of their existing business partners. Doing so will avoid potential harm to the pension fund's investments, as well as possible reputational harm from being associated with an individual or organization engaged in securities violations.
For the foregoing reasons, pension funds and their trustees should review their own compliance programs to ensure a robust monitoring process is in place to detect and prevent possible securities law violations. Internal reporting systems should be examined and tweaked to encourage potential whistle-blowers to report internally. An action plan should be crafted and “put on the shelf” to be broken out in the event that a possible securities violation is reported internally or with the SEC. If pension funds fail to take compliance issues seriously, particularly responding appropriately to internal reports of violations, potential whistle-blowers will contact the SEC or law firms that represent whistle-blowers concerning those violations.
In the past, some organizations that discovered securities violations considered the probability of detection by law enforcement authorities in deciding whether to self-report to the SEC. Now, for the first time, individuals have significant new protections and incentives to report possible securities violations. Accordingly, the probability of detection has increased dramatically and pension funds must plan accordingly. They and their trustees need to look at external manager, consultant or vendor relationships to ensure that appropriate due diligence is conducted before agreements are entered into and to remain vigilant for the duration of the relationship. Current and possible future investments also will need to be examined through the compliance/corporate governance lens to ensure that possible securities law violations are identified early. Perhaps most importantly, the fund and its trustees should conduct a regular self-assessment to ensure that a culture of integrity is maintained at the fund.
