Pension Risk Matters : Pension Risk News & Analysis : Investment Governance, Inc. : Pension Risk & Investment

The new financial reforms that have recently been signed into law mandate further transparency and changes in how derivatives are traded and settled. With over-the-counter financial instruments now a mainstay for most corporate and government treasury departments, pensions, endowments and foundations, an understanding of what the new law does and does not address is critical for anyone involved in derivatives reporting, valuation, hedging, capital-raising, credit risk assessment and risk management advisory.  The impact of these sweeping changes could greatly affect the use of derivatives by institutional investors and their counterparty banks. The changing role of the fiduciary promises increased liability across the board. At the same time, questions about clearing, counterparty risk and collateral management become more important than ever.

If you are affected by these changes, you will want to join AICPA and Investment Governance, Inc. on July 29th, 2010 from 2:00pm – 3:30pm EST for this timely discussion about the new challenges as these unprecedented financial reforms become reality. This Infocast will address service provider due diligence, collateral management, transacting derivatives hedges and enhanced disclosure. 

John Hudson of Hudson Consulting Group LLC leads this important discussion with Attorney Matthew Kerfoot (Counsel, Dechert LLP), Mr. David Boberski (Head of OTC Research and New Product Development, CME Group) and Dr. Susan Mangiero (founder of Investment Governance, Inc.) to address:

• How an exchanged cleared trade will differ from the current status quo with respect to collateral management and counterparty risk
• Who is responsible for making sure that fiduciary obligations are properly discharged as relates to risk management activities by the buy side and their asset managers, respectively
• Best practices imperatives when hiring, reviewing and possibly firing funds of funds and consultancies.

Click here to register for this timely and educational event. AICPA members will pay $65.

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In a new study by the Tellus Institute, wealthy college and university endowments are described as being over zealous with respect to investment risk-taking in recent years. Related losses during the financial crisis arguably account for school staff layoffs, major budget cuts and postponed construction projects. Local businesses have been hard hit too as part of the trickle-down argument against allocating to "large illiquid investments" by academic money pools, courtesy of successful graduates.

In its examination of a few of the U.S. ivory tower giants, authors had some harsh words for those who may have turned from protecting principal and "generating reliance income" to instead rely on "radical diversification" into venture capital, private equity, hedge funds and real assets. They question the existence of possible conflicts of interest when Wall Streeters serve as trustees. Compensation levels for professional endowment investing teams are likewise called into question. 

I plan to spend more time reviewing the 104-page publication as it includes many statistical tables that describe individual endowment holdings as well as the financial strength (or lack thereof) of certain schools. I am also curious to get this take on the endowment model. The flip side of course is that experienced financial professionals (whether trustees or part of a school's investment team) can add more value than someone with little or no asset management knowledge and, in a competitive world, they can command a handsome compensation package. Then there is the issue of being an alternatives wet blanket. I've long maintained that no investment is good or bad on its face and must absolutely consider a variety of facts and circumstances.

One wonders if there will be a renewed call for a study about whether to tax wealthy college endowments as proposed by the Massachusetts House a few years ago? See "Should huge college endowments pay tax?" (Christian Science Monitor, May 20, 2008).

This 104-page publication entitled "Educational Endowments And The Financial Crisis: Social Costs and Systemic Risks In The Shadow Banking System: A Study Of Six New England Schools" (May 27, 2010) is available for no charge.

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Click here to join Investment Governance, Inc. for a timely discussion about the challenges of being a functional or de facto fiduciary for a pension plan, endowment or foundation. Learn how insurance, legal and governance experts are scrutinizing investment decision-makers and their service providers to understand if proper due diligence is being conducted. Good process can result in lower premiums and help to mitigate litigation, regulatory enforcement and reputation risk. Bad process is a recipe for disaster. Mr. Gerry Czarnecki, governance expert and member of the board of directors of State Farm Fire & Casualty, will be joined by Attorney John Horak, founder of the Nonprofit Organizations Practice Group for Reid and Riege, P.C., and Ms. Rhonda Prussack, EVP and Product Manager of Fiduciary Liability for AIG Executive Liability. Dr. Susan Mangiero, CEO of Investment Governance, Inc. will moderate this expert panel in a lively and timely discussion about:

1. Role of board members with respect to investment best practices
2. Managing the cost of liability insurance
3. Vetting service providers with respect to their internal controls
4. How to contain liability and D&O insurance premiums
5. Lessons learned from the 2008-2010 financial crisis.

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When I am not traveling for business, I drive the back roads from my house to our company office in Shelton, CT. For those who don't know, Shelton is south of New Haven and north of New York City. While true that either city is relatively close by, I live in a somewhat rural area. Our town boasts about 20,000 people with one McDonald's, a few gas stations, some sheep, lots of deer and five cows.  I know this because I pass by a corner house on what is, for local denizens, a main road.

Ordinarily, I just scoot by, anticipating my morning expresso. However, since warm weather began, I've noticed that a handful of friendly bovines are out and about each morning, chewing, mooing and looking generally happy. Since this house is not a farm, I've been pondering of late why someone would own five cows. Do they make for good pets? Can you sell milk on the side and, if so, is the money worth the fuss? What the heck do you do with a few furry friends who are bigger than a breadbox and seldom house trained?

One of these days, I ought to stop my car and politely ask the man or woman of the house why they collect cows. Until then, I've concluded that this may be the small town version of the theater of the absurd.

That brings me to the topic of financial reform. Oh boy, where does one start? Those who pushed for strong reform are disappointed. Critics think the impending bill goes too far. According to writer Alain Sherter in "Funny Business: Why the Financial Reform Bill Has Become a Joke" (BNET.com, June 30, 2010), taxpayers are left holding the bag in more ways than one. Let us count the ways: 

• Regulatory consensus is needed to address systemic risk
• Behemoth financial institutions are free from arduous capital reserve requirements
• Credit rating agencies will be studied but not immediately reformed.

Worse yet, "its passage would create a false sense of security, a hollow complacency" while it "entrenches Wall Street's control over the financial system."

Only time will tell if this sweeping "reform," destined to become the nation's law, will thwart future meltdowns. I'd much prefer to see capital market participants taking steps towards a robust risk management culture (if not in place already) and then providing transparency to interested parties about their risk mitigation (not the same as minimization) policies and procedures.

Animals and supposed strict mandates may seem warm and inviting but might end up costing a lot, generating few benefits and urging rational thinkers to ask why.

P.S. A future post will address the issue of derivatives and financial reform.

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Please join ERISA attorney Linda Ursin and Ms. Jamie Greenleaf, Senior Partner with Cafaro Greenleaf on June 29 from Noon to 1:00 PM EST to learn more about assessing management fees for reasonableness, new Form 5500 rules and fiduciary liability for failure of oversight of service providers. To register, visit https://www2.gotomeeting.com/register/671138658.

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Many thanks to Ms. Marlys Appleton, governance expert and financial professional. Her comments are provided below. Click to read the original blog post entitled "BP Investments - The Role of Ethics and Risk Management" (June 19, 2010). The governance storm clouds are dark indeed.

<< I believe what happened in this case is connected to internal governance issues at BP. One only has to look at their safety violation record relative to peers such as Exxon and Conoco over the last few years (as reported recently by Bloomberg News) to see that BP accepted hundreds of safety violations as a "cost of doing business". Institutional investors' failure to pay attention to safety violation records at BP reflects their lack of understanding of the need to price in poor governance. BP's safety record was known for years and now the market is forced to acknowledge and price such behavior, with devastating results.

I also think of the Massey coal mine disaster - another company whose safety record was well know. Both boards need a paradigm shift to acknowledge past failures, but for one, it may be too late. Some damages cannot be remedied by compensation alone. The fund is a good start and may reduce the need for litigation though there are likely to be lawsuits. I believe such a devastating social and environmental disaster such as this event should not be mediated through the courts, but that's another topic. Add upon this, the additional layer of inept government regulation, another example of 'poor governance' as a contributing factor.

It is my hope that institutional investors, boards and executive management embark upon a real understanding of what can happen when governance and ethical behavior break down. In the world of emerging risks, acknowledgement of "fat tail" catatrophic events needs to be stepped up with the implementation of a good Enterprise Risk Management ("ERM") process. This information must then be socialized with boards, management, and investors. >>

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Signed on June 25, 2010 by President Obama, the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act (H.R. 3692) allows plan sponsors to amortize funding gaps over a longer period of time than is currently allowed. In addition, this legislation enables funding relief for up to two years.

While the financial markets have not been kind to more than a few defined benefit plans, new rules are going to make it even more difficult for financial statement users to assess the true economic health of any given retirement arrangement. This is not a good thing. Beneficiaries and shareholders alike deserve user-friendly information, especially if a plan is in trouble. The new law will make things even more challenging in terms of deciphering reported numbers and that's saying something.

As I wrote in "The Plan That Didn't Bark" (CFA Magazine, March-April 2008), financial analysts and other interested parties must learn to think like detectives. The current state of pension accounting is far from perfect. Taking into account the likely impact of H.R. 3692, published funding information is going to be clear as mud.

Click here to access the full legislation. Clear to read "The Plan That Didn't Bark" by Dr. Susan Mangiero. (Editor's Note: Pension Governance, LLC is now part of Investment Governance, Inc.)

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Investment Governance, Inc. posts information about our free June 21, 2010 webinar about BP, money manager due diligence and metrics for risk management. This current issue also links to commentary about actuarial numbers versus economic funding status, courtesy of Mr. Ryan McGlothin (head of U.S. operations for P-Solve). ERISA Attorney Andrew Oringer provides insights about the prudent expert standard of care and procedural process.

Click here to read the June 20, 2010 issue of Investment Best Practices Matters^SM.

Click here to sign up for Investment Best Practices Matters, our complimentary ezine about investment governance, due diligence and so much more.

If you would like a complimentary subscription to www.FiduciaryX.com, an investment best practices portal created and operated by Investment Governance, Inc., click here, call (203) 929-0011 or email our team today.

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Click here to join us for a free webinar on June 21 from Noon to 1:00 PM EST. Sponsored by Cenario Capital, this educational event will include a case study about the BP spill in terms of investment implications and money manager due diligence.

Besides the immediate and delayed impact on sector and individual company risks, webinar speakers focus on the numerous signals that pensions, endowments, foundation and other institutional investors should be assessing on a regular basis - either directly or via their money managers. A discussion about how portfolio holdings can be vetted on an ongoing basis includes commentary about correlations, earnings forecasts, volatility, dividend yields, factor risk and valuation.

Join us for this timely convening with experts - Mr. Steve Van Beisen (Managing Director, Cenario Capital) and Dr. Petter Kolm (Director, Mathematics in Finance, NYU Courant Institute).

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