While serving as a trustee, you will have many different responsibilities—some that you are probably aware of and others that you are not. Ultimately as a trustee your primary responsibility rests with ensuring the best interests of the organization and/or stakeholders. Depending on the organization, these stakeholders will vary.

For example, if you sit on a hospital board there may be multiple pools of assets, each with their own stakeholders. One set of stakeholders may be the participants in the hospital’s pension plan, while the operating fund may have an entirely different set of interests. Alternatively, you could be on a local university board where an endowment was established to provide students with financial aid, which consequently makes future and present students the beneficiaries. Or perhaps you serve a foundation working with children, whereby as a board member you have to ensure the wellbeing of the children (the ultimate beneficiaries). As a board member, you will ensure the interests of the stakeholders (beneficiaries), whoever they may be, and bear a fiduciary responsibility to the organization, entity, or trust.

Because you have been placed in a position of trust, you have a duty to administer the assets with care and prudence, a duty to exercise reasonable diligence and skill, and a duty to maintain loyalty to the organization. These five duties share some characteristics in common and oftentimes are all lumped into a single responsibility called “prudence.” However you decide to slice and dice them, they all exist and are all a requirement of the job.

Loyalty

Your first and perhaps most important duty is loyalty. Loyalty to the organization and its stakeholders takes precedence over any other job, concern, or business. The reason for this is to prevent self-dealing and to keep one constituency from benefiting over another. While it may seem obvious to place loyalty to others over all else, regrettably, this duty is the most often violated. Even though it is not always done purposefully, and in many instances it is inadvertent, a breach of your duty of loyalty is a serious offense, regardless of intent. Loyalty snuggles up close to ethics, as well—you really can’t be loyal and unethical at the same time. As challenging as it may seem, you really need to know yourself and whether the decisions you are about to make are in fact for the benefit of the fund or for some other reason.

Loyalty, or the lack thereof, could be as simple as how you view your advisor. Being unhappy with your advisor for a reason unrelated to their responsibilities toward your organization isn’t necessarily justification to find a replacement. Being comfortable with an old friend when their performance is inferior, is not being loyal to your fund if you continue to employ that person. Maintaining an advisor simply because they make large donations to your organization is not being loyal to your fund, even if they would be difficult to replace as a donor. In each of these scenarios, and the many variations on this theme you must ensure that the organization takes precedence over all else. The situations you will likely encounter will differ from these examples, but at some point during your time as a board member, a loyalty issue will certainly rear its ugly head. How you and your fellow board members respond will dictate the ultimate success or failure of your organization. Loyalty is not a difficult concept to grasp, but each situation will be unique. Here are some real life examples of fiduciary loyalty misconduct:

Example 1:

A group of retired pension fund members elects a new trustee. The newly elected trustee feels indebted and seeks enhanced health care benefits for his retired “constituents,” knowing full well that the enhanced health benefits will lower the fund’s coverage ratio, which would be detrimental to the non-retired members. The trustee pushes for the benefits and ultimately wins.

Example 2:

Trustee number two was recently appointed to sit on the board of the defined benefit plan of their employer. In their new role, the trustee sees their only duty as that of reducing the employer contribution rates for the general benefit of the employer, even though the plan is underfunded.

In both instances, the trustees were fundamentally wrong. As a trustee, you owe your loyalty and duty to all stakeholders, not to the constituents who elected or appointed you. In the first example, the newly elected trustee violated the loyalty responsibility by harming the defined benefit plan for future beneficiaries. In the second example, the trustee violated her duty of loyalty because her allegiances were with the employer and not the plan as a whole.

Example 3:

An individual who sits on a foundation’s board has a personal relationship with a consultant at a large broker-dealer. The large broker-dealer is willing to remunerate the trustee if he is able to convince other members that the consultant should oversee the foundation’s funds. The broker-dealer has subpar performance and there are a handful of better alternatives available to the foundation. The trustee ultimately wins the debate, and the consultant is hired.

Although Example 3 is a bit more blatant and observable, these types of deals occur throughout the industry. Pay-to-play is not uncommon and works in both directions. Unfortunately, we only hear about the ones who get caught.

Example 4:

A new member convinces the committee that their current advisor, one who has successfully built the foundation’s assets significantly, should be replaced. The new member believes the foundation needs a “brand name” advisor to match the foundation’s importance and asset size. A brand name advisor is hired, even though their historical performance is lackluster.

This breach is much more subtle and may be a variation on Example 2, with the pay part being a non-monetary benefit; either the new member is personally unhappy with the old advisor, wants to exert power, wants to advantage an old friend, or is Procrustes’ heir and wants to be like everyone else.

Skill

The second duty you must exhibit is skill. “A pure heart and empty head will not do.” For that reason, you must develop and use skills necessary to manage these funds, or you must delegate those tasks that you don’t have the time or expertise to do yourself. The level of skill required is different for different types of funds. Your decisions in governance will determine which standard of skill you will be held to. In some cases, like ERISA (Employee Retirement Income Security Act), you have little choice and will be held to the more stringent prudent expert rule.

The traditional level of skill, or “prudent man rule” as it’s more informally known, is based on the concept that each Board member has the skills and knowledge of a typical person (businessman, doctor, fireman, or whatever profession that board member may be). The prudent man rule, which is a relatively less -stringent standard, is often used by foundations and endowments. On the other hand, the ERISA “prudent expert” rule requires a skill level of “one knowledgeable in like and similar matters,” in other words, an “expert” or professional. If you choose to use the older definition (prudent man) you can either manage the portfolio yourself or hire professionals, but if you use the prudent expert standard you’d better get well-educated or hire some professional help. This decision (prudent man vs. prudent expert) is largely dependent upon the legality of the organization’s situation. ERISA plans must obey the prudent expert rule, while other entities have a bit more flexibility.

Example: One university’s investment committee chairman is at the pinnacle of a narrow part of the investment world. He is incredibly knowledgeable and skilled in that narrow sub-sector. However, he has an inadequate understanding of multi-asset portfolios. This can be seen in the university’s performance, which is near the bottom of all universities for many years. However, the university’s investment committee fails to hire someone with the necessary skill set to manage the portfolio because the chairman’s stature within this narrow space is so high that they relied heavily on his opinion when discussing “investments”—particularly investments within the university’s portfolio. It isn’t until a blogger posts about the top ten worst performing university endowments before a change is made. Even though the chairman has an esteemed investment background, he does not have the necessary skill set to ­manage a multi-asset portfolio. They are two entirely different animals.

As the famed management consultant Peter Drucker once said, “do what you do best, and outsource the rest.” If the investment committee or board doesn’t have the necessary skills to accomplish the tasks at hand (and ­obviously this chairman didn’t), they need to obtain the skills or to hire someone with the necessary skills, or seek outside professional help.

Care

The next duty you must exhibit is care. Care is the responsibility of ensuring the collection of funds and monies due to the sponsor (such as the plan, foundation, or endowment) are received. This includes interest, fees for money lent, employer/employee contributions, dividends, brokerage dollars from commission recapture, soft dollars, security litigation proceeds, etc. Care also ensures that beneficiaries are informed about the financial standing and financial security of the fund. Care also requires the board to evaluate both implicit and explicit costs associated with brokerage, manager soft dollars, potential shareholder litigation proceeds, or custodial arrangement.

Example: A large state employees plan was buying securities that were sold net (fees, markups, and commissions included) but were also being charged a commission in addition.

The trustees at this particular employee plan were not exhibiting duty of care, as their broker was charging them twice on their commissions.

Prudence

The fourth duty—prudence—is often the most discussed, but in practice it is hard to detect its abuse. Essentially, when you act with prudence, you act in good judgment, with knowledge and deal advisably toward all fund matters. You monitor and manage the actions of staff and outside professionals, as well as assess the skill levels of both. The questions to ask yourself are: 1) “Have I used reason, or emotion?” 2) “Is this advisable?” and 3) “Does it make sense, or am I just following the lead of others?” Particular care must be taken because Procrustes lives here. It is too easy to force yourself into someone else’s practice and think you are being prudent. Some gather several fiduciary duties under the rubric of prudence, and a failure of one can therefore also be a failure of prudence. See Example 4 under Loyalty. Is it prudent to fire a well-known and productive advisor just to look like others with a brand name advisor? Most often failure of prudence is directed at decisions that were not well thought through, or decisions that did not take into account foreseeable issues and knock-on effects. Is it prudent to sell all equities after a market crash? Is it prudent to insist on five years of firm history? What about the person who just stepped out of a large firm to start their own? Is it wise to buy long bonds when the foundation has a short-term need for cash? Where is the common sense when you hire a manager who has never had anything but massive returns without investigation just because your friend uses him? (Madoff, anyone?)

Failure of prudence is easy to see after the fact. The difficulty arises beforehand, when you must control yourself and others as well. The only solution is a detailed discussion and investigation of all the risks, the costs of failure and a brake on enthusiasm.

Diligence

Diligence is the last of the five duties and is relatively straightforward. Diligence implies that adequate attention is being delivered. To fulfill the diligence responsibility, you must be doing trustee and not just being trustee. But what is adequate? Is it enough to just show up once per quarter? Should you read and understand the entire suite of reports? Is it enough to read outside of the meeting reports? Unlike Justice Potter Stewart’s pronouncement on pornography, this is one you notice when you don’t see it.

Example: A committee member shows up late, did not preview the report, and then asks questions already answered by the report.

A committee member who is not prepared for meetings is not only being disrespectful to their fellow committee members, but is also likely making decisions on a whim instead of diligently—a complete failure by the trustee.

Taken as a whole, these five duties, and prudence in particular, are inherently conservative in that they favor the status quo and eschew change, even if it is advantageous change. Investing by its very nature means working with risk, and a decision to make no change is the same as a decision to change. Board and investment committee members that use the prudential rule as a decision rule rather than an element of decision making, rule out innovation when ­warranted, sway stakeholders away from risks they would or should otherwise take, and inhibit opportunities they would otherwise embrace. On the other side of that same coin, bad decisions or no decision can be sold as good governance if prudence is the decision rule.

Executing your duties as a fiduciary is the implementation of governance. Governance is the process and implementation of decision-making as a fiduciary.