Commentary: 6 guiding principles for developing governance policies

Pension plans currently face a variety of challenges from the effects of a global pandemic, a changing political climate and a struggling economy. Trustees, those entrusted with the life savings of millions, are expected to understand the intricate workings of finance, demography, technology and more. Are they now required to know how to navigate these uncharted waters as well?

The truth is that pension plan trustees come from a variety of backgrounds, experiences, and perspectives. Whatever a trustee's credentials and qualifications, the fiduciary responsibility remains the same. If good governance practices create the formal infrastructure that guides fiduciary decision-making, here are six guiding principles about governance that will help trustees steady the ship.

The duty of prudence is a core fiduciary principle. Though the standard of care may vary by state, most states apply a prudent expert standard that requires the fiduciary to exercise the care, skill, judgment and diligence that any prudent expert would use in a similar enterprise. The prudent expert standard is process-oriented with a focus on diligence, meaning that the development and consistent application of reasonable governance practices is key to demonstrating the absence of negligence.

Demonstrating prudence in decision-making requires complete and accurate information. An important source of guidance for trustees when evaluating and revising governance policies can be a review of peer practices, which can serve as a reference point in determining whether an action or inaction is negligent. In an ongoing effort to stay up to speed, trustees should periodically benchmark their governance practices against their peers. Peer benchmarking requires ongoing education regarding evolving practices and can be accomplished through structured board training and education programs. Peer benchmarking also requires trustees to actively seek the advice of consultants, counsel and other experts in developing and reviewing policies.

Peer practices are a data point to be considered, but trustees must remember that each fund or system is unique. Appropriate fund governance considers a variety of factors, including the size of the fund, staff capability, strategic focus, funded status, operational budget and resources, delineation of board and staff roles, complexity of the investment program, additional internal and external resources, and applicable law. These specific characteristics provide the critical context that should influence policy development.

Prudent fund governance requires both formality and accountability. Trustees should require clear policies that provide uniformity and explicit guidelines to the board and staff. Well-documented policies also ensure continuity and consistency in organizational knowledge despite any turnover.

Of course, there is no standard approach to how specific or detailed a policy should be. For some topics, the policies may be high-level, setting forth an objective while leaving tactical discretion to staff. Others may require more technical or specific guidance. The goal is to develop policies that are specific enough to provide guidance, but not so specific that the policies lack critical flexibility or raise unnecessary compliance risks.

In addition to organizational basics, like bylaws, committee charters and stand-alone policies, a prevailing practice among pension funds is to establish a governance policy framework and compile governance policies in a manual, which becomes a central repository for all the board's governance documents and an important resource. The governance manual, framework and policies within should be specific to the unique characteristics and operational realities of the fund, but the governance manual will likely include such topics as general board governance, delegation, risk and compliance, ethics, stakeholder relations, operational issues and investments.

From a fiduciary perspective, trustees are not judged in hindsight on outcomes. Rather, from a fiduciary perspective, trustees are scrutinized on the prudence of the process they followed. Well-documented policies, procedures and a robust system of compliance are all vital to demonstrating prudent processes. In fact, a lack of formal policies and compliance practices or the use of outdated practices could support a claim that a board action (or inaction) was negligent.

The consistent application of policies and procedures can help trustees avoid potential liability and other adverse outcomes. Good governance typically requires the even-handed application of policy, which can demonstrate that fiduciary decisions are not arbitrary or capricious. If the board (or staff where appropriate) determines to take an action inconsistent with policy, there should be an informed, reasoned and documented basis for doing so.

The development of governance policies should be a dynamic and ongoing process, continuing after the initial development of the governance manual. Employing the expertise of staff and professional resources, such as legal counsel or consultants, trustees should begin by reviewing foundational policies to fill any gaps or lagging areas. Then the board should consider any leading practices suggested by peer comparisons. Finally, trustees should plan ahead and draft new policies that address foreseeable issues.

Tiffany R. Reeves is a shareholder with Reinhart Boerner Van Deuren SC in the employee benefits and institutional investor services practices, based in Minneapolis. She is the former deputy executive director and chief legal counsel at the $12.1 billion Chicago Teachers' Pension Fund. Ms. Reeves is a member of the Board Smart Faculty. Board Smart is an online governance learning resource. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.