The Emerging Role of the Independent Fiduciary for Non-Traditional Real Estate Investments

Article excerpt

A recently published survey of pension plan sponsors [1] attempted to make big news of the fact that a number of the plans intended to reduce their respective allocations to real estate investments in the future. What is surprising about the survey to the authors, was the fact that only some 13 percent of those responding indicated that they would reduce their allocations. The authors do not consider the results to be particularly significant, especially when a number of pension plans, including CalPERS, CalSTRS, and New York State Teachers, have recently announced substantial allocation increases to the asset class.

These increases can be rationalized, in part, by pension plans' redefinition of the role of real estate in a multi-asset portfolio. Real estate investments may now include technology-related investments and higher return/higher risk vehicles such as opportunity funds, joint-ventures, development programs, foreign investment, and the like. Pension plan sponsors have recently discovered the value of an independent fiduciary in evaluating these non-traditional real estate investment opportunities.

In most cases, investments of this type are sponsored by firms that are not registered investment advisors. Seeking to provide some assurance that these investments meet minimum fiduciary standards, pension funds are turning to independent fiduciaries to perform due diligence, identify risks, suggest mitigation as necessary, and render overall advice on the desirability of the investment. The independent fiduciary performs the front-end analytical functions that would be undertaken by an investment advisor in a more traditional core real estate investment, and also gives the pension plan sponsor an investment recommendation based on its analysis. The recommendation is possible, and depended upon, because by law the independent fiduciary must be a registered advisor.

EVOLUTION OF THE FIDUCIARY STANDARD OF CARE

The role of the pension fund investment fiduciary was first described in the Employee Retirement Income Security Act (ERISA) of 1974. Under ERISA, a person or firm is deemed to be an investment fiduciary if they make recommendations as to the advisability of investing in, purchasing, or selling securities or other property, pursuant to a mutual agreement between the parties.

This fiduciary standard of care was subsequently refined to establish who would be considered an investment advisor and the level of prudence under which they were expected to act. Initially, investment advisors were required to be commercial banks, insurance companies, or Registered Investment Advisors under the Security and Exchange Commission. This was subsequently modified to allow smaller firms to register with state regulatory authorities. For pension funds desiring additional protection, the Qualified Plan Asset Manager (QPAM) designation was established by the Department of Labor (DOL), requiring certain levels of financial size and assets under management.

TRADITIONAL ROLE OF THE INDEPENDENT FIDUCIARY

ERISA contemplated that the occasion might arise when the DOL, acting through the courts, would be faced with the necessity of replacing the fiduciaries responsible for a pension plan's assets. Since this might take some time, the role of the independent fiduciary was established by the DOL to be responsible for the assets of the plan and its operation until such time as new fiduciaries could be secured.

In recent years, several plans have utilized independent fiduciaries to evaluate situations in which a significant modification was being proposed in the structure of existing investment vehicles. Examples include the sale of plan assets, the rollup of portfolios to create a public company, asset transactions between related plans, and other situations where an independent opinion was required. Investment advisors also have proposed the use of independent fiduciaries in situations where a conflict of interest existed or was perceived to be a possibility. …

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