An Economist's Perspective of Fiduciary Monitoring of Investments

I am delighted to share my recent article with readers of this pension blog. Entitled "An Economist's Perspective of Fiduciary Monitoring of Investments" (by Dr. Susan Mangiero and published in Bloomberg BNA Pensions & Benefits Daily, May 26, 2015), I wrote this article in the aftermath of the May 18 Tibble v. Edison decision by the U.S. Supreme Court.

A central thesis is that "ongoing oversight is an exercise in risk management" and that "[r]isk management is a never ending process." The article emphasizes the importance of (a) examining multiple risk factors and not relying on performance numbers alone (b) understanding the presence of financial leverage (should it exist) (c) clarifying the role of a service provider when an outside party is used and (d) letting participants know about the type of monitoring being done by an investment committee.

The topic of this article readily lends itself to at least one lengthy book as there is a considerable amount to say. I am co-writing a sequel article with fellow economist, Dr. Lee Heavner.

If you are interested in discussing investment fiduciary monitoring as relates to trustee training, compliance or dispute resolution, please email contact@fiduciaryleadership.com.

Derivatives, De-Risking and Disclosures

According to survey results provided in "Pension Plan De-Risking, North America 2015" (published by Clear Path Analysis and sponsored by Prudential Retirement), "pension risk management remains a principal concern for many plan sponsors." This should come as no surprise. Low interest rates, longer lifespans and anemic funding levels are a few of the concerns cited by the fifty-one senior professionals who answered questions. Half of the respondents agree that implementing a risk management strategy sooner than later makes sense, with one out of four individuals indicating an intent to transfer risk to an outside insurance company in 2015. Three out of four survey-takers "believe that movement in interest rates will impact their decisions to implement a liability driven investment strategy, or to execute a bulk annuity transaction." When asked about the use of alternatives such as hedge funds, fourteen percent replied that they currently use and seek to increase. One third currently allocates to alternatives and two percent look to introduce. Assuming that a respondent can only answer this question once and that there is one survey-taker per pension fund, this means that there is roughly a fifty-fifty split when it comes to including alternatives as part of a defined benefit plan investment portfolio.

If true that lower interest rates may discourage some plan sponsors from fully transferring risk to a third party insurer via a buy-out but they nevertheless seek to more actively manage pension risks, one could logically expect a greater use of a strategy such as Liability-Driven Investing ("LDI"). To the extent that LDI frequently entails the use of derivatives, those plan sponsors in favor of LDI may want to take note of a recent move by the U.S. Securities and Exchange Commission ("SEC"). As I just posted to my investment risk governance blog, certain registered funds could soon be asked to publish a considerable bounty of data about how they price securities, characteristics of trading counterparties and the specific use of derivative instruments. See "SEC and Asset Manager Disclosures About Use of Derivatives" (May 21, 2015). Sometimes an LDI strategy can include an allocation to alternatives. Post Dodd-Frank, lots of alternative fund managers are registering with the SEC. Connecting the dots, plan sponsors that use LDI and/or invest in alternatives are likely to benefit from enhanced disclosures made by asset managers.

Even those sponsors that decide on a risk transfer of some type other than LDI will soon be impacted by reporting mandates. In "Employers must disclose pension de-risking efforts to PBGC," Business Insurance contributor Jerry Geisel explains that data regarding lump sump arrangements will have to include answers to questions such as those listed below:

  • How many plan participants "not in pay status" were offered a chance to switch from a monthly annuity to the lump sum payout?
  • How many plan participants "in pay status" were given a choice?
  • What was the number of participants who made the choice to take a lump sum?

In its filing with the Office of Management and Budget ("OMB"), the Pension Benefit Guaranty Corporation ("PBGC") writes that "de-risking" or "risk transfer" events "deserve PBGC's attention because (among other things) they lower the participant count and thus reduce the flat-rate premium and potentially the variable rate premium." Fewer dollars being paid for this last-resort insurance "have the potential to degrade PBGC's ability to carry out its mandate..."

Given the complexities of managing pension risks and the regulatory changes underway, you may want to attend the May 27, 2015 educational webinar entitled "Pension De-Risking for Employee Benefit Sponsors: Avoiding Litigation and Enforcement Action." I hope you can join us for a lively and topical event.

Free Continuing Legal Education - Pension De-Risking Webinar

There are seven complimentary passes left for anyone who is interested in attending "Pension De-Risking for Employee Benefit Sponsors: Avoiding Litigation and Enforcement Action." This educational webinar is sponsored by Strafford Publications, Inc. and will take place on May 27, 2015 from 1:00 pm to 2:30 pm EST. Speakers include:

  • Maureen J. Gorman - Partner with Mayer Brown;
  • David Hartman - Vice President and General Counsel with General Motors Asset Management; and
  • Dr. Susan Mangiero - Managing Director with Fiduciary Leadership, LLC.

If you would like to attend (whether you need continuing legal education or not), please email contact@fiduciaryleadership.com. The remaining passes will be distributed on a "first come, first serve" basis.

Public Pension Funds and Municipal Bond Issuance

On June 1, 2015, I will be talking about pension risk management with several other invited co-speakers. Part of the annual meeting of the Government Finance Officers Association ("GFOA"), this panel will address topics that include (a) what risk management means to public pension fiduciaries (b) different board oversight models (c) the role of strategic asset allocation and (d) reasons why numerous government plans are experiencing deficits. Just as important, we will discuss what risk management means when capital-raising solutions or plan design decisions are denied by lawmakers or courts.

Nowadays, it is nearly impossible to pick up a newspaper without reading an article about pension obligation bonds, bond ratings and legislative pressures to create a fix. As Thomas A. Corfman points out in "Weighing higher taxes against the pension deficit" (Crain's Chicago Business, May 16, 2015), Illinois Governor, Bruce Rauner, has to consider fiscal reform in the aftermath of the State Supreme Court decision that prevents a cut in promised benefits. Increasing income taxes and taxing retirement income are two paths with economic potential to address the nearly $105 billion shortfall but likely to upset voters. Notably, Moody's Investors Service announced on May 1, 2015 that "...Chicago's unfunded pension liabilities and ongoing pension costs will grow significantly, forcing city officials to make difficult decisions for years to come." Its related downgrades of certain city-issued debt will increase expenses and widen the gap between inflows and obligations.

Elsewhere, an attempt to issue fixed income securities as a way to lower "the $23 billion unfunded liability of Colorado's Public Employees Retirement Association" did not gain approval by a requisite State Senate committee. Monica Mendoza with the Denver Business Journal wrote on May 5, 2015 that complex covenants were partly to blame. In Pennsylvania, pension obligation bonds may go forward but that has not curtailed Governor Tom Wolf from issuing a vow to "stop excessive fees to Wall Street managers." With approximately $77 billion in assets in 2014 and $50 billion in unfunded retirement plan commitments, the Keystone State has a heavy load to bear.

New Jersey is another state where heated protests focus on pension deficits. According to "Union bashes Christie on pension cuts in new ad" by Samantha Marcus (NJ.com, May 15, 2015), the Governor has cut almost $1.6 billion "from this year's pension payment to balance the budget." Earlier this month, the Garden State highest court heard arguments about whether such cuts are valid under the law.

The list of beleaguered plan sponsors is long as is the set of issues relating to risk management. For example, absent a green light to issue pension obligation bonds and populist disinterest in seeing benefits cut or taxes raised, can a public pension plan asset-allocate its way to better funding? If a focus on investments is the goal, won't that mean that a grossly underfunded plan will end up assuming a lot more risk? Supposing that the answer is "yes," can a cost-effective infrastructure be established to mitigate risks such as less liquidity without sacrificing expected performance?

No doubt our panel discussion will be lively and timely. I hope you can join us on June 1 for the pension risk management panel.

ERISA Litigation Webinar Transcript Now Available

Seeking to accomplish a goal without having the right tools can result in frustration and possible failure. One solution is to get outside help when needed as long as the party being hired is knowledgeable and independent. Otherwise, what looks like a solution could quickly become a problem. Applied to ERISA plans, trouble might take the form of costly and time-consuming enforcement and/or litigation. Over the last few years, that reality has set in for more than a few employers.

Recognizing the importance of abiding by good governance principles, several of us agreed to speak as part of an educational webinar on April 8, 2015 about fiduciary tools, pitfalls and lessons learned. Sponsored by fi360 and entitled "ERISA Litigation and Enforcement: The Role of the Independent Fiduciary and Best Practices for Financial Advisors," this webinar joined Attorney Tom Clark (Counsel with the Wagner Law Group), Dr. Susan Mangiero (Managing Director with Fiduciary Leadership, LLC) and Mitchell Shames, Esquire (Partner with the Harrison Fiduciary Group) to address the (a) use of an independent fiduciary (b) clarifying what an outside vendor should be doing and (c) avoiding legal and economic landmines that have revealed themselves in prominent court cases and regulatory examinations.

If you missed the event, email contact@fiduciaryleadership.com for a copy of the slides. Click here to download the written transcript. Edited for clarity (and because the audio file is spotty in some places), this fourteen page document lays out cornerstone concepts and includes suggestions for plan sponsors and the advisers who serve them. These include, but are not limited to, the following:

  • The outsourced fiduciary market is growing in the United States and elsewhere.
  • When an outside party is hired by a plan sponsor, it is critical to specify responsibilities and contract accordingly. When an "expectations gap" exists, some critical tasks may be left wanting or not addressed at all.
  • When multiple fiduciaries are in place, a plan sponsor must ensure that a central person or team is adequately coordinating the efforts of all fiduciaries.
  • The newly proposed Conflict of Interest rule is predicted to materially change the landscape of fiduciary relationships between plan participants and retirement advisers.
  • A fiduciary status may exist due to either a contractual agreement or by virtue of the functions assumed by an individual or organization.
  • ERISA litigation is getting more attention these days, with a particular focus on fees, use of proprietary funds, revenue-sharing and disclosure of compensation paid to investment consultants, advisers and asset managers.
  • Demonstrating procedural prudence in part depends on what others in the industry are doing (or not doing as the case may be) and whether actions make sense for a given plan.
  • A renewed focus on disclosure and transparency is in the works according to comments made by the U.S. Department of Labor.
  • An independent fiduciary can be engaged for a singular transaction or for a task that continues over a long period of time.
  • An independent fiduciary can be engaged by either a defined contribution plan or defined benefit plan or both.
  • When there is a perception or reality of a conflict of interest, it may be prudent for an independent fiduciary to be engaged. The participants pay for said party because the independent fiduciary works on behalf of the participants.
  • The concept of co-fiduciary status is important and should be paid heed by any adviser who has an ERISA plan as a client.
  • Before delegating duties (to the extent allowed) to a third party, a plan sponsor should decide what financial issues should be vetted. Liquidity, the use of leverage by asset managers and asset allocation are a few of the many topics that a delegated fiduciary could be asked to measure, monitor and manage.
  • A fiduciary audit can be extremely helpful as a tool for identifying areas of improvement for an ERISA plan sponsor.

It may be no surprise that over 500 people registered for this educational webinar about fiduciary foibles. After forty years since its inception, ERISA remains a force that cannot be ignored.

Employee Ownership and ERISA Litigation

I had the pleasure of speaking at the sold-out National Center of Employee Ownership ("NCEO") conference on April 21 about board education, compensation metrics and procedural prudence. Consonant with NCEO's commitment to providing trustee and director education about Employee Stock Ownership Plan ("ESOP") administration and governance, my co-speakers and I fielded lots of questions from the audience relating to insurance coverage, selection of directors, board composition, training, governance red flags to avoid and long-term versus short-term strategy.

In conversing with some of the ESOP company CEOs and independent trustees who traveled to Denver for this annual convening (last held in Atlanta), the message was clear. Employee ownership is working for their respective companies. The sentiment struck me as quite different from what I heard last week when I attended the American Conference Institute meeting about ERISA litigation. Post Dudenhoeffer (courtesy of the U.S. Supreme Court), there seems to be a lot of caution on the part of large company counsel about how much equity should be in the hands of employees.

Clearly, facts and circumstances will determine the appropriateness of any particular structure. That said, results of a recent survey reflect a growth in employee power, at least as of several years ago. According to NCEO's research project director, Nancy Wiefek, the tabulated results show that 214 Employee Stock Ownership Plans commenced between 2001 and 2012, a rise of 44 percent from earlier periods. Out of 502 ESOP company responses, 317 were reported as fully owned at 100 percent. Click here to read more about the complete survey.

Whether the 2014 Dudenhoeffer decision will have an impact on the mostly private businesses that consider ESOP implementation remains to be seen. For now, it is important that venues exist to allow for an exchange of ideas about what works and what to avoid, should a company's management decide to embark on putting company stock in the hands of employees.

ERISA Litigation Predicted To Rise

I have just returned from Chicago where I spent two days listening to transaction attorneys, litigators and insurance company executives talk about trends in ERISA enforcement and legal disputes. Sponsored by the American Conference Institute, this assembly about ERISA litigation included sessions on class actions, Employer Stock Ownership Plan ("ESOP") problem areas, the role of economic experts in litigation, challenges to the church plan exemption, questions about excessive fees, de-risking, stock drop defense strategies, health care reform, how much ERISA fiduciary liability insurance to purchase and much more.

I took a lot of notes and intend to write about implications for plan sponsors and their service providers through an economic and governance lens.

It may be coincidental but certainly not trivial that the United States Department of Labor released its fiduciary proposed rule about conflicts of interest on the second day of this important ERISA litigation convening, i.e. on April 14, 2015. The thinking is that the adoption of a more rigorous rule could open the door wide to a multitude of further disputes and heightened examinations. Click here to access the language of the proposed rule and supporting documents.

It sounds like many will be even busier in the coming months.

Pension Risk Management For Public Plans

Dr. Susan Mangiero will speak about pension risk management on June 1, 2015. Part of the annual conference for the Government Finance Officers Association ("GFOA"), this session will examine changing rules and economics that go beyond traditional asset-liability management. Dr. Mangiero, CFA, certified Financial Risk Manager, Accredited Investment Financial Analyst and Professional Plan Consultant will be joined at the podium by Mr. Rick Funston.

According to the GFOA website, this 100-minute program is worth 2 continuing education credits. The course description is shown below. Join city, state and county government executives in Philadelphia for this timely and important session.

Pension Risk Management Course Description:

The goal of public pension fund asset allocation can no longer be focused solely on outperforming the plan’s return on assets. Recent changes to GASB and rating agency liability calculation methodologies have brought renewed focus to managing funding volatility and developing a plan to reduce the unfunded pension liability. This session will provide case study examples and effective strategies for identifying and implementing the appropriate risk management strategy for public pension plans.

Investment Committee Teamwork

Watching the Rockettes dancing in sync to foot-stomping music this weekend was a good reminder that team work requires attention and commitment. My guess is that these ladies can't miss a step and expect to stay employed for too long. It's amazing to see such synchronized movements, one leg kick after another.

Teamwork is important elsewhere too, notably in managing institutional money pools. Healthy deliberations can promote a thorough vetting of important decisions such as what asset manager to hire or whether to embark on a new strategy. In contrast, repeated squabbles and misunderstandings about core objectives can be disruptive and expensive.

Exits of key persons at the San Diego County Employee Retirement Association illustrate what happens when teams don't run smoothly. According to "San Diego County pension fund suffers new shock" by Arleen Jacobius (Pensions & Investments, March 23, 2015), this $10+ billion pension plan is keeping recruiters busy with searches for a Chief Investment Officer ("CIO"), Chief Financial Officer ("CFO"), General Counsel and now a permanent Chief Executive Officer ("CEO"), following the resignation of Mr. Brian White. As readers may recall, this public pension plan has been in the news for a derivatives-based strategy that some felt was too risky. In "San Diego Pension Dials Up the Risk to Combat a Shortfall" (August 13, 2014), Wall Street Journal reporter Dan Fitzpatrick referred to its "new approach" as "comparatively complex at a time when some big pension plans are moving in the opposite direction. See "Decision Making When You Don't Like Your Colleagues" (Pension Risk Matters, September 9, 2014) for further commentary.

On March 9, 2015, the not-for-profit organization, the Greenwich Roundtable, tackled the issue of investment committee dynamics with the release of a 60-page white paper. Contributors to "Best Governance Practices for Investment Committees" address items to consider for implementation as well as those to avoid. At the top of the list of recommendations is an urging to crystallize long-term organizational objectives and identify "unique needs." Establishing a "target for investment success that is both realistic and consistent" with fund resources is likewise mentioned. Both make sense.

An institutional investment committee needs to decide where it must go in order to create a road map process. Acknowledging that the end game could change as new circumstances arise is another factor. Setting up an actionable plan to assess how "success" will be determined is paramount. Without such, it is difficult at best to benchmark any or all decisions made by members of the investment committee.

The Rockettes may not be everyone's cup of tea when it comes to entertainment. Nevertheless their efforts in working together to deliver a seamless outcome provide a good example to follow.

Pension Risk Governance Blog Still Going Strong After Nine Years

Nine years today marked the debut of www.pensionriskmatters.com. Since then, I am proud to say that traffic has steadily grown, with continued feedback and suggestions about all sorts of topics. I am deeply grateful to visitors to this independent website for their time and encouragement. While the specific feedback tends to vary by issue or job function, a central theme is clear. Ongoing education about topics such as due diligence, fees, risk management, asset allocation, hedge funds, liquidity and valuation is both needed and desired. In 2015, this award-winning blog will continue its focus on providing objective and helpful information about important subjects that challenge investment stewards and their advisors, attorneys and regulators who oversee the management of more than $30 trillion.

As I point out in "Financial Expert Susan Mangiero Celebrates Ninth Year as Lead Contributor to Pension Risk Governance Blog" (Business Wire, March 25, 2015), "There is never a shortage of subjects to discuss, thanks to ongoing suggestions and contributions from readers and the significant realities of changing demographics, market volatility and new accounting rules."

To date, there are over 900 published analyses, research updates and guest interviews that can be readily accessed by category and keyword. Simply click on the Archives section of www.pensionriskmatters.com. For a complimentary subscription to this blog, as posts are published, click here to sign up. Click here to read our Privacy Policy. If you are interested in contributing an educational essay or letting us know about a relevant news item or rule change, please email contact@fiduciaryleadership.com.

Until the next blog post, thank you for your interest!