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Local Government Financial Advisers Must Have No Conflicts
Saturday, August 7th, 2010
Robert Wechsler
It's important not to have pension board members with serious conflicts
of
interest, such as a personal interest in the board's investments,
or acting as providers of investment products (see my
blog
post on California reforms prohibiting such conflicts).
But it is equally important for a pension board not to work with others who have conflicts. This issue has arisen with respect to the Denver board of education's catastrophic decision to get involved in a complex investment vehicle — pension certificates with a derivative attached — according to an article in yesterday's New York Times.
At the center of this decision was, of course, a conflict of interest. The board of ed's independent financial adviser in this transaction, Royal Bank of Canada, also participated in the debt transaction. School officials signed a conflict waiver with the bank. That was a big mistake.
Governmental bodies need to have truly independent financial advisers, even when they're dealing with relatively traditional financial transactions. There are issues such as whether to sell callable bonds or not, which absolutely cannot be left to anyone who might profit from one approach more than another.
The general rule is, the more complex the transaction, the more the underwriters and insurers profit. These firms must be held completely at arm's length. Local governments need someone who understands what the underwriters are saying and, especially, knows what they are not saying (in this case, the risks of the downside, which turned out to be huge and of great benefit to the underwriters). This someone must be absolutely loyal to the governmental body. Any board members or other officials who refuse to hire a truly independent adviser should be held, as fiduciaries, personally liable for losses to the government.
The Denver waiver of the Royal Bank of Canada's conflict was at least as destructive to the citizens of Denver as it would have been had the school board members each had a conflict themselves, and given each other a waiver.
Robert Wechsler
Director of Research-Retired, City Ethics
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But it is equally important for a pension board not to work with others who have conflicts. This issue has arisen with respect to the Denver board of education's catastrophic decision to get involved in a complex investment vehicle — pension certificates with a derivative attached — according to an article in yesterday's New York Times.
At the center of this decision was, of course, a conflict of interest. The board of ed's independent financial adviser in this transaction, Royal Bank of Canada, also participated in the debt transaction. School officials signed a conflict waiver with the bank. That was a big mistake.
Governmental bodies need to have truly independent financial advisers, even when they're dealing with relatively traditional financial transactions. There are issues such as whether to sell callable bonds or not, which absolutely cannot be left to anyone who might profit from one approach more than another.
The general rule is, the more complex the transaction, the more the underwriters and insurers profit. These firms must be held completely at arm's length. Local governments need someone who understands what the underwriters are saying and, especially, knows what they are not saying (in this case, the risks of the downside, which turned out to be huge and of great benefit to the underwriters). This someone must be absolutely loyal to the governmental body. Any board members or other officials who refuse to hire a truly independent adviser should be held, as fiduciaries, personally liable for losses to the government.
The Denver waiver of the Royal Bank of Canada's conflict was at least as destructive to the citizens of Denver as it would have been had the school board members each had a conflict themselves, and given each other a waiver.
Robert Wechsler
Director of Research-Retired, City Ethics
---
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