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!

Not Everyone Gets a Pot of Gold at the End of the Rainbow

On March 17, the Irish and "Irish-at-heart" happily celebrate St. Patrick's Day, wear the green and look forward to a productive twelve months, after which the festivities can begin anew. Yet March 17 this year brought gloomy headlines for some individuals. In "New pension scheme will see teachers work to 68 in Northern Ireland," Belfast Telegraph journalist Rebecca Black writes that critics of a newly approved plan to increase employee contributions and push back when an educator can retire will make life difficult for new entrants to the job market. For the one out of five teacher graduates who are able to secure employment, they will be asked to pay "9.6%, well above the rate for a civil service pension, and with employer contributions of 13%, well below the rate for a civil service pension." Beyond changes to benefit terms, there are some who offer that teachers burn out by their late 50's and that's why "Most teachers retire by 60." Being asked to work for almost a decade more could be a real hardship.

In the United States, multiple public employee retirement plans have been or are in the process of being examined, restructured, reduced or otherwise reformed. Kentucky State legislators just voted to create a task force to investigate how best to close a funding deficit. As of mid-year, the gap "stood at $14 billion." This step came in the aftermath of a decision not to issue $3.3 billion in pension obligation bonds. See "Senate passes bill to study state's underfunded teacher pension plan" (KY Forward, March 11, 2015).

The State of New Jersey had similarly set up a task force to provide insights into current funding woes and recommend how to move forward. In "A Roadmap to Resolution" (February 24, 2015), the New Jersey Pension and Health Benefit Study Commission urges the freezing of existing retirement plans, the creation of a cash balance plan instead and a unification of benefit plan management to encompass both state and local municipal obligations.

Accounting changes will likely accelerate a further in-depth examination of other retirement and health care plans. According to "Why Some Public Pensions Could Soon Look Much Worse" (Governing, March 17, 2015), recent accounting rule changes - promulgated by the Governmental Accounting Standards Board ("GASB") - force dozens of plans to report "dramatic changes" that reveal significantly larger deficits. Using 2013 and 2014 data, magazine researchers examined 80 public plans in an effort to quantify the impact of using GASB 25 versus GASB 67. The results are telling. Click here to see for yourself how much of a difference ensues due to the now prevailing reporting regime.

As state and municipal plans seek to close serious funding gaps, participants may gasp if they are asked to pay more or receive less or both, making the proverbial gold at the end of the retirement rainbow a challenge.

Calvin Ball and ESOP Governance

Calvin and Hobbes has long been a favorite treat of mine. (I don't have permission to embed a likeness but you can click here for a peek.) This long-running cartoon strip ceased in 1995, ten years after the creation of a mischievous six-year old and his furry feline friend. The brainchild of cartoonist Bill Watterson, Calvin entertained and moralized at the same time, charming a global audience of adults and children alike. In a rare interview, Washington Post reporter Michael Cavna (March 10, 2015) learned from the somewhat reclusive Mr. Watterson that "fantasies are drawn more realistically than reality, since that says a lot about what's going on in Calvin's head." In "America's Most Profound Comic Strip" (Wall Street Journal, March 6, 2015), senior editor at the Weekly Standard, Christopher Caldwell, adds that "...Calvin keeps running into evidence that the world isn't built to his ... specifications" and that his "favorite sport is 'Calvinball,' in which he is entitled to make up the rules as he goes along."

I thought of Calvin and his world views yesterday as I listened to ERISA attorney Ted Becker talk about Employee Stock Ownership Plan ("ESOP") governance. As the lead speaker for an NCEO-sponsored webinar entitled "What the DOL v. GreatBanc Trust Co. ESOP Court Settlement Means for ESOPs," this Drinker Biddle & Reath LLP partner gave some nuts and bolts recommendations that are concrete and therefore radically different from the actions of ERISA trustee "Calvins" who comfort themselves that sloppy work is okay.

Mr. Becker and co-speaker Loren Rodgers (Executive Director of the National Center for Employee Ownership) explained that changing regulatory emphasis on employer security valuation led to what is known as the Fiduciary Process Agreement. Described as a "playbook," the U.S. Department of Labor ("DOL") and "GreatBanc Trust Company agreed that it could be used for future transactions by an ESOP fiduciary in which the ESOP purchases or sells employer securities that are not publicly traded." Engaging an independent and qualified valuation advisor and then adequately reviewing (and understanding) the resulting information used to carry out the valuation are two of the recommendations for trustees.

In the official source file ("Agreement Concerning Fiduciary Engagements And Process Requirements For Employer Stock Transactions" dated June 2, 2014), readers are reminded of the importance of process for multiple tasks. Among other things, this roadmap details what should be documented by the ESOP Trustee when choosing a valuation advisor, to include:

  • "The reason for selecting the particular valuation advisor;
  • A list of all the valuation advisors that the Trustee considered;
  • A discussion of the qualifications of the valuation advisors that the Trustee considered;
  • A list of references checked and discussion of the references' views on the vauation advisors;
  • Whether the valuation advisor was the subject of prior criminal or civil proceedings; and
  • A full explanation of the bases for concluding that the Trustee's selection of the valuation advisor was prudent."

This guiding document likewise lays out suggestions about process regarding the fiduciary review of any potential transaction such as buying or selling employer securities that are not publicly traded, the reliance on the valuation report and much more. As independent fiduciary Mitch Shames writes in "Once Again, Strong Process and Substance Matters" (September 11, 2014), "... DOL requires that the fiduciary be an active participant in an ESOP transaction...far from a passive role."

Having been trained as an appraiser and someone who has (a) rendered opinions of value (b) reviewed others' valuations (c) critiqued valuation models (d) taught valuation courses and (e) served as an expert witness, I know firsthand that inappropriate assumptions, bad data and short cuts are likely to create headaches. Quality of valuations that are used for statutory and commercial reasons can and do vary - sometimes materially so. A "quickie" appraisal that ignores fundamentals about an industry let's say or proceeds from grossly inflated management projections are two potential vulnerabilities. The danger is that an inadequate valuation report potentially creates a domino effect of unwanted outcomes because it is used as a driver to make subsequent decisions. For example, ESOP trustees with multiple suitors may select the "wrong" buyer or approve a recapitalization that would not otherwise occur had a better valuation assessment been used. Valuation numbers are frequently inputs as opposed to the end goal.

Big numbers are involved so it's no surprise that ESOP governance is garnering close scrutiny. According to "The Current State of ESOPs," 2012 ESOP assets exceeded $1.059 trillion with 13.824 million participants in 6,908 plans.

On a separate note, I am speaking at the annual conference of the National Center for Employee Ownership, to be held this year in Denver from April 20, 2015 to April 23, 2015. Entitled "Effective Boards of Directors: Obligations, Recruitment and Compensation," my panel will "cover the standards and responsibilities of directors in the board room, how committees function, building a sustainable board structure and standards and surveys for establishing and measuring compensation to reward the performance of directors." Attorney Kevin G. Long (Shareholder with Chang Ruthenberg & Long PC) and Ms. Nancy Wiefek (Research Project Director with NCEO) will co-present.

ERISA Litigation and Enforcement: Role of Independent Fiduciary and Financial Advisor Best Practices

Mark your calendars to attend an educational webinar entitled "ERISA Litigation and Enforcement: The Role of the Independent Fiduciary and Best Practices for Financial Advisors." Sponsored by fi360 and eligible for continuing education credit, this April 8, 2015 event will take place between 3:00 pm and 4:00 pm EST and address important and timely issues for plan sponsors and their advisors. Details are provided below.

Description: ERISA litigation and enforcement increasingly involves allegations of conflicts of interest and imprudent decision-making on the part of advisors, consultants, banks and asset managers. In several recent matters, regulators and judges have made it clear that the use of an independent fiduciary would be interpreted as a reflection of procedural prudence and the absence of an independent fiduciary could hasten a decision of fiduciary breach.

Learning objectives:

  • Learn about relevant cases and regulatory actions that involve third parties such as financial advisors;
  • Hear a discussion about how advisors, consultants, banks and asset managers can work effectively to demonstrate procedural prudence; and
  • Better understand what state trust law and ERISA oversight activity means for advisors and consultants who work with non-ERISA trusts.

Speakers:

  • Thomas Clark, Esquire (Counsel - The Wagner Law Group)
  • Susan Mangiero, PhD, AIFA, CFA, FRM, PPC (Managing Director - Fiduciary Leadership, LLC)
  • Mitchell Shames, Esquire (Partner - Harrison Fiduciary Group) 

Please join as your schedule permits. Click here to register.

Fiduciary Outsourcing Considerations

I try hard to avoid duplication when contributing to this retirement plan blog (www.pensionriskmatters.com) versus writing about investment compliance on a broader scale (www.goodriskgovernancepays.com). However, there are times when I believe a topic has equal appeal to both plan sponsors and their advisers, attorneys, asset managers and other types of vendors.

With that in mind, I invite you to read "Fiduciary Outsourcing Considerations." As I have said both in private conversations and in public speeches, my work as a forensic economist (and sometimes testifying expert witness) leads me to predict that disputes between institutional investors and service providers are unlikely to disappear any time soon. The good news is that those who take governance seriously have a wonderful opportunity to develop and maintain business with risk management focused pension funds, endowments, foundations and other types of buyers.

ERISA Litigation Costs

After having just blogged about the April 13-14, 2015 American Conference Institute program about ERISA litigation in Chicago, it was somewhat coincidental that an article on the same topic crossed my desk today, painting a grim picture of what could happen to a plan sponsor in the event of a lawsuit.

While only two pages long, "An Ounce of Prevention: Top Ten Reasons to Have an ERISA Litigator on Speed Dial" invites readers to consider the advantages of staying abreast of increasingly complex rules and regulations as part of a holistic prescription for mitigating legal risk. Authors Nancy Ross and Brian Netter (both partners with Mayer Brown) cite "heightened interest" in ERISA by U.S. Supreme Court justices, a rise in U.S. Department of Labor enforcement and court decisions about the importance of having a prudent process. They add that de-risking compliance, disclosure requirements, conflicts of interest, large settlements and attorney-client privilege restrictions are other potential landmines for a public or private company that offers retirement benefits.

Elsewhere, Employee Benefit Adviser contributor, Paula Aven Gladych, predicts that the U.S. Supreme Court review of Tibble v. Edison International ("Tibble") could increase ERISA litigation risk for plan sponsors, regardless of its decision. In "Edison decision could be 'slippery slope' for plan fiduciaries" (February 26, 2015), she writes that "the court focused its attention on duty to monitor fees and investments, generally by investment committees and plan administrators of 401(k) plans." Interested readers can download the February 24 2015 Tibble hearing transcript.

Recent events reflect multi-million dollar resolutions, even when an ERISA litigation defendant feels strongly that it is in the right. In "Settlements offer lessons in breach suits" (Pensions & Investments, February 23, 2015), Robert Steyer reports that publicly available documents can shed light about what types of disputes are being settled, the dollar amounts involved and any non-monetary requests made by the plaintiffs. Competitive bidding as part of selecting a vendor is one example. He goes on to say that regulatory opinions are thought to be particularly helpful when they are viewed by the retirement industry as de facto guidance.

I will report back after attending the ERISA litigation conference in a few weeks although I suspect that judges, litigators and corporate counsel who speak will convey a similar message with respect to fiduciary scrutiny. As Bob Dylan sang, "the times they are a-changing."