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Froelich on “The Dual Nature of Fiduciary Duties for Public Authorities”

August 5, 2011

A recent paper by Reannon Froehlich, The Dual Nature of Fiduciary Duties for Public Authorities, explores some of the tricky issues related to the fiduciary obligations of public authority board members. As the paper explains, the meaning and extent of board members’ fiduciary duties remains somewhat unclear under the Public Authorities Reform Act of 2009 (PARA). “Principles of corporate law, the Public Authorities Law, and the Public Officers Law all play a part in defining the duties owed by board members to the authority and the public,” Froehlich states. “But what happens when the authority’s interest and the public’s interest are in conflict? To whom does the board member owe a greater duty? And what entity should decide these issues when conflict arises?”

Froelich raises a number of important issues in this paper, including the sources and requirements of board members’ fiduciary duties, the application of the business judgment rule, and the appropriate beneficiaries of board members’ fiduciary duties. After the jump I’ll provide a more detailed look at Froelich’s analysis regarding these issues.

The Public Authorities Reform Act of 2009

The Public Authorities Reform Act of 2009 (PARA) established beyond question that public authority board members have fiduciary duties. Froehlich explains that:

As directed in PARA, board members must sign an Acknowledgement of Fiduciary Duty, which provides notice of each member’s legal obligations, facilitates understanding of their duties, and ensures that official action will be in accordance with the mission of the authority. The language of the Acknowledgement is clear; by signing, the board member acknowledges “his or her role and fiduciary responsibilities” and the “duty of loyalty and care to the organization and commitment to the authority’s mission and the public interest.” The Acknowledgement sets forth the mission of each authority to achieve a public purpose on behalf of the state. Also included is an agreement to maintain a duty of care and a duty of loyalty by exercising independent judgment on all matters before the board, even when interested parties come before the board in an attempt to influence decision making. Board members agree to attend board and committee meetings, and engage fully in the decision-making process…. The Acknowledgement also contains a confidentiality provision and disclosure requirements in the event of any actual or perceived conflicts of personal, financial, ethical or professional interests. Furthermore, each board member must agree, in writing, that he or she does not have “any interest, financial or otherwise, direct or indirect, or engage in any business or transaction or professional activity or incur any obligation of any nature, which is in substantial conflict with the proper discharge of my duties in the public interest.”

Fiduciary duties in the context of private corporations and public authorities

To help clarify the meaning of public authority board members’ fiduciary responsibilities, Froehlich provides an informative discussion of the origin of fiduciary principles and their more common application in other areas of the law, explaining that

Fiduciary duty governs the relationship between different corporate actors and is derived from the law of trusts. The duty has different meanings depending on the context of the person or entity with the duty, and to whom the duty is owed. Two types of fiduciary duties are recognized by corporate law—the duty of loyalty and the duty of care—and both are evaluated within the context of the business judgment rule. By the basic tenets of business law, corporations are to be organized and managed primarily for the profit of stockholders. Public benefits—if any—are to be limited as incidental to that primary purpose.

The fiduciary duties of public authority board members, on the other hand, must have their own definition and paraments given the governmental character of public authorities.

Public authorities and the duty of loyalty

The duty of loyalty owed by public authority board members, Froehlich explains, centers around their ability to remain disinterested—i.e., to refrain from having a stake in a business deal or standing to derive personal gain from authority decisions—as this disinterest is necessary to avoid conflicts of interest. Froehlich notes that one obvious safeguard to prevent such conflicts is PARA’s provision that allows a board member to serve as both the CEO and Chair, but prohibits a CEO/Chair from participating in discussions regarding the CEO’s compensation. And “to further ensure that the duty of loyalty is honored, every state authority is required to maintain a contemporaneous record of all lobbying contacts made with any member, officer or employee of the authority…. This rule is important to determine whether a board member acted with independent judgment or was improperly influenced by a third party representing interests other than those of the authority and the public.”

Public authorities and the duty of care

“The duty of care involves good faith efforts of management,” Froehlich states. “Specifically, board members must take reasonable efforts to be attentive and prudent in making business decisions, and must apply diligence to the ‘ordinary and extraordinary needs of the corporation.’ This includes taking reasonable care in discharging their responsibilities, rather than ‘rubber- stamping’ a decision without properly considering it.” The duty of care also functions to ensure that uninformed board members can’t escape responsibility simply because they weren’t aware of conflicts of interest, mismanagement, or other problems.

Unfortunately, Froehlich notes that there have been numerous reported incidents of public authority board members breaching their duty of care:

The Comptroller’s March 2004 audit of the Rochester-Genesee Regional Transportation Authority (RGRTA) revealed that the authority made significant decisions regarding the proposed Rochester Central Station without sufficient study or documentation to support such choices….. In similar cases, the New York Power Authority’s poor planning and reliance on questionable cost estimates in constructing the Poletti Power Plant in New York City inflated the expected cost of the project by 73% ($275 million), and the board of Nassau Health Care Corporation failed to authorize or ratify decisions made by its officers, including pay raises and a proposed severance package for the former CEO.

Public authorities and the business judgement rule

Froehlich explains that the business judgment rule is a general defense to breach of duty claims. “The rule preserves the discretion of directors to manage the authority without undue interference from outside parties, and protects directors when well-meaning decisions result in failure. Generally, when a reasonable purpose for a decision can be found, objecting parties must defer to the judgment of the board members.” Were there no business judgment rule, Froelich contends that “authorities would become inefficient and overburdened” under the pressure of justifying each and every decision as the best possible choice.

Who benefits from board members’ fiduciary duties?

Deciding how to apply commercial law fiduciary duties to public authorities is relatively easy when compared to determining just who the beneficiaries of those duties should be. Froehlich states that there are three potential categories of such beneficiaries:

  • the public official or entity which appointed the board member;
  • the general public served by the authority; and
  • the authority itself.

The first potential beneficiary of board members’ fiduciary obligations—the entity or official who appointed the board member—is not officially recognized as deserving any measure of fiduciary duty. Nevertheless, “board members are susceptible to the interests of the appointing or designating party since their service beyond their initial term of appointment depends on performing a satisfactory job from the perspective of the appointer or designator.” While the fiduciary obligation to remain independent prohibits board members from being beholden to their political sponsors, the duty of care requires them to consider a broad variety of policy standpoints and can support their consideration of the interests of the entity or official who appointed them. In this context, Froelich notes that:

a fine line exists between input and influence. The influence by a public official over a board member may manifest in facially neutral ways—such as implied expectations of the appointer or displays of gratitude by the board member—but nonetheless compromise the integrity of the board member and breach the public’s trust in government. This [influence] is exacerbated by the appointing party’s removal power of any appointed board member for inefficiency, breach of fiduciary duty, neglect of duty or misconduct in office.

The potential danger of improper influence is limited somewhat by ethics provisions in the Public Officers Law, as well as by the Authorities Budget Office, which oversees both board members and appointing officers.

Examining the fiduciary duty owed by board members to the public raises an entirely different problem, namely, figuring out how to define the relevent portion of the general public. “After all,” Froelich explains, “every characterization of ‘the public’—whether local, state-wide or national—includes a variety of conflicting interests…. For example, when a board decides to sell authority-owned assets below market value, its motive might be to encourage economic development in disadvantaged communities…. Conversely, selling the land at or above market value would better serve the financial interests of the authority and potentially lessen its reliance on tax-based financing.”

Regarding the last potential beneficiary—the authority itself—Froelich notes that while the fiduciary duty owed to the authority will often overlap with the fiduciary duty owed to the public, situations will still arise where these interests will conflict with one another. As an example, Froelich recounts that

the Comptroller’s July 2004 audit of the Metropolitan Transportation Authority (“MTA”) concentrated on the MTA’s consideration of a price hike for MetroCards and service cuts to close a $540 million budget deficit, just fourteen months after the largest fare hike in the history of New York City. An additional fare increase would over burden the public and thereby work against its interest. However, the authority’s budget was overstretched and needed additional financing. Since the public interest should be served first, and the authority’s mission should be that of the public interest, a solution keeping with the board’s fiduciary duty would be focused on increasing efficiency, scaling back on costs, and improving operations with less cost.

Derivative suits and public authorities

Another potential problem that Froelich identifies with trying to impose traditional corporate fiduciary duties on public authorities is that there is no equivalent of a derivative suit available to the public. Whereas shareholders can make a claim on behalf of the corporation to enforce its fiduciary duties, members of the public do not have taxpayer standing to challenge the actions of public authorities and board members are additionally shielded by their status as unelected officials. Nevertheless, Froelich contends that if citizens were permitted to challenge authorities’ actions, the public might actually be harmed by the costs of defending such suits or incidents of “strike suits.” Moreover, Froelich suggests that as long as the Authorities Budget Office, the Comptroller, and other state oversight entities are performing their duties, there is little need for citizen suits.

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4 Comments leave one →
  1. Bill Licata permalink
    October 19, 2011 8:32 am

    Amy, Andrew Jackson said in his veto message of the Second National Bank, “It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes.” I can’t help but think this has some application with public authorities, when the oversight agency, the ABO, from all appearances and comparisons with similar agencies is grossly underfunded.

    While it is true, I am no expert, perhaps it doesn’t take one to see that the playing field is not level when former Senator Alfonse D’Amato receives $500,000 for placing a single phone call on a matter involving the MTA and an interim executive for LIPA receives $580,000 for a 14 months’ work. These two examples of compensation are almost equivalent to the entire budget of the ABO, which is $1.3 million dollars.

    In short, I would take issue with Froelich, the expert in your posting who, “suggests that as long as the Authorities Budget Office, the Comptroller, and other state oversight entities are performing their duties, there is little need for citizen suits.” How does an oversight agency efficiently and effectively perform its duties of a $130 billion dollar financial sector with 11 members and $1.3 million? I don’t mean this as a criticism of the ABO, instead I believe sensible and reasonable regulation requires commensurate funding and staffing. Do you agree or is my concern misplaced?

    Sincerely,
    Bill

    • October 19, 2011 9:22 am

      I would agree that the ABO is underfunded and understaffed, particularly when you consider the breadth of its duties under the Public Authorities Accountability Act and the Public Authorities Reform Act. And as you note, this is especially glaring when you consider some of the more exorbitant salaries paid to public authority executives. Compensation is a very big issue…

      I also agree with you that oversight from the ABO and the Comptroller can’t replace the need for citizen suits. (There are a number of points in the Froelich article that I don’t agree with completely – this post wasn’t meant so much as a critique but rather as a summary.) Amending State Finance Law section 123-b to allow taxpayer suits against public authorities would result in much more accountability, giving the public a way to challenge their actions when government oversight (for whatever reason) fails. Personally, I don’t understand why taxpayers should have standing against state agencies, but not public authorities, regarding “a wrongful expenditure, misappropriation, misapplication, or any other illegal or unconstitutional disbursement of state funds or state property….” This all goes back to some dubious (in my mind) legal precedents that hold that public authority funds aren’t “state funds,” particularly Schulz v. State, 84 N.Y.2d 231 (1994) (available here: http://bit.ly/pFr0bg). Taxpayer and common law standing were more recently raised in Montgomery v. MTA, 2009 Slip Op. 52539U. If you’re interested in the issue, the ruling and all of the legal papers are available here: http://dddb.net/MTAsuit/index.php.

Trackbacks

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