Dogs Get the Blame



Pension risk is serious stuff so this author has been reluctant to post anything "cute" or "funny", instead opting to write about topics that resonate with our readers. From the feedback and tremendous growth in visits, we seem to be on the right track. In fact, the list of topics we want, and plan, to address is huge and continues to grow.

As a humble thank you to this blog's readers, please permit a bit of whimsey as a quick diversion. The inspiration? Almost everyone in pension land (hedge fund land too) seems to be insanely busy this summer. Instead of thoughts about languorous vacation days stretching into balmy nights, it's more about taking an expresso break as a way to get a few minutes in the sunshine, walking to and from the office.

So perhaps it is not surprising that quirky facts and bits of knowledge make for a welcome respite. Talking about the hot, muggy weather with a colleague, we spent several minutes debating the genesis of the expression "dog days of summer". In taking yet another minute or two to research (in lieu of that aforementioned expresso break), the conclusion was that more than a few popular idioms involve dogs.

Here are some examples.

1. We're going to the dogs.

2. This is a dog-eat-dog world.

3. You'll end up in the doghouse.

4. He is sick as a dog.

5. This investment is a dog.

6. He leads a dog's life.

7. I've been working like a dog.

8. It's raining cats and dogs.

9. Every dog has its day.

10. Her bark is worse than her bite.

11. Let sleeping dogs lie.

12. You can't teach an old dog new tricks.

To dog lovers everywhere, hang in there. We don't mean any harm. We're in search of a quick smile.

Now back to work ...
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Backdating Executive Stock Options: The Role of Volatility, Part I

Executive stock options continue to grab headlines. In late 2004, after a parade of protests, the Financial Accounting Standards Board issued the "Summary of Statement No. 123 (revised 2004): Share-Based Payment". Intending to promote transparency, FASB's rule requires public companies "to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award" and to recognize the cost "over the period during which an employee is required to provide service in exchange for the award-the requisite service period (usually the vesting period)."

Following suit, on July 26, 2006, the U.S. Securities and Exchange Commission announced news about additional (and arguably more comprehensive) disclosure rules for all sorts of executive compensation vehicles, including stock options. The SEC plans to provide "additional guidance regarding disclosure of company programs, plans and practices relating to the granting of options, including in particular the timing of option grants in coordination with the release of material nonpublic information and the selection of exercise prices that differ from the underlying stock's price on the grant date."

(Click here and here for recent posts on this topic.)

Now, backdating takes a bow. The Corporate Library describes this practice as "awarding stock options on one date, and then backdating the grant or award date to a time when the stock price was lower."

Experts say that backdating per se is not illegal. So why the hullabaloo? Several reasons account for the recent news flurry. For one thing, there may be tax consequences. CNNMoney.com reports that "companies and individuals could face hundreds of millions of dollars from civil penalties, unpaid taxes and interest payments if widespread wrongdoing is found." One law firm, McDermott Will & Emery writes that "failure to disclose this practice could possibly constitute securities fraud" and give rise to accounting misrepresentation as well.

Concerned about alleged misdeeds and an adverse impact on stock price, pension funds are lining up to bring suit. Institutional Shareholder Services writes that "an international group of 14 institutional investors led by the U.K.'s Universities Superannuation Scheme and the Australian Reward Investment Alliance asked the SEC to increase disclosure requirements for option grants. The group includes five U.S. state pension funds and institutions from Canada, Norway, and the Netherlands."

To be clear, it is impossible to tackle the merits of any one situation without sufficient information to evaluate a problem, if one exists, and assess economic damages to anyone found to have been harmed by backdating.

However, even in the absence of case-specific information, a discussion about the valuation of executive stock options is nevertheless worthwhile. Saying that this topic is broad is like saying that Lake Michigan is a little body of water. That's why this topic will show up again in subsequent posts to www.pensionriskmatters.com and why it will continue to resurface as the topic du jour in court, regulatory proceedings, auditors' roundtables and board meetings everywhere.

To begin, pricing model choice and determination of inputs are integral to option valuation. While myriad factors contribute to a final assessment, one variable, volatility, is often described as dominant.

What exactly is volatility and how is it measured? Given different types of volatility, which one makes sense to use? Historical volatility is frequently measured as the standard deviation of returns for the underlying asset and can serve as a proxy for uncertain future asset price movement. This technique assumes that past price behavior is a bellwether for the future. Sometimes this is not an appropriate conclusion. An industry and its constituent members may have undergone radical change in the form of deregulation or technological innovation, completely changing the profitability landscape thereafter. In contrast, implied volatility is derived by examining market prices of an option (characterized by time to maturity, exercise price and other relevant factors) and backing into an estimate of investors' beliefs.

As demonstrated in "Model Risk and Valuation" by this blog's author, Dr. Susan M. Mangiero, the volatility number can have a dramatic impact on the computed value of an option. Moreover, the relationship between volatility and option value is not proportional. Consider that an increase of ten percent in volatility does not necessarily translate into a ten percent rise in the value of the option. (This is a simplistic statement since option value does not depend on volatility alone.)

Business Week reporters Jane Sasseen and Greg Hafkin correctly make the point that "options for volatile stocks carry higher expenses". Citing a report by Credit Suisse Group analyst David Zion, they describe a precipitous drop in the value of options granted by S&P 500 member companies, from "$104 billion in 2000 to $30 billion in 2005", adding that "implied numbers have been lower than the historical ones" but that "volatilities are heading up."

One thing is certain. Estimating volatility should amount to more than a mere number crunching exercise. The process should reflect an assessment of economic performance going forward. A mistake in volatility choice can be costly and lead to a slew of unwelcome events.

There is a lot (!) more to say on this topic.

Survey Shows That Institutional Investors Are Worried




In a survey co-sponsored by Pension Governance, the RiskMetrics Group and Ulysses Partners, institutional investors expressed concern about a variety of issues, including:

1. Fiduciary breach litigation
2. Underfunding
3. Asset allocation mix
4. Investment return assumptions
5. Realized investment returns
6. Investment risk
7. Valuation
8. Regulation

In excess of fifty percent of respondents said they would like to know more about risk measurement and risk management. That makes sense, given survey results that point to beta, duration and, in the case of derivatives, notional principal amount, as favored ways to track position limits. As explained in great detail in Risk Management for Pensions, Endowments and Foundations, care must be taken to properly interpret these numbers, understand their strengths and limitations and undertake a comprehensive analysis of risk. Only twelve percent of respondents declared Value of Risk as a way to track position limits. Seventy-nine percent of respondents said that they do not currently use risk budgeting.

Interestingly, forty-six percent of respondents affirmed the use of more than ten money managers. No one answered "yes" to the question: "Do you use zero money managers?" The message? Institutional investors must make sure that the risk and valuation dialogue with external managers is comprehensive and clear. Outsourcing does not absolve fiduciaries of their oversight duties.

Seventy-five percent of respondents answered that the primary responsibility for making strategic risk management decisions rests with a committee. Only two percent answered that consultants or external money managers play this role. Arguably fiduciary education is critical for all committee members who collectively decide on all things risk. (As an aside, committee decisions should reflect analysis by all members rather than having some individuals passively accept the recommendations of one or two "leaders". The author is not an attorney. Fiduciaries should seek legal counsel for advice regarding relevant duties.)

Several results merit special comment.

More than ninety percent of institutional investors with assets in excess of $1 billion said that they know the amount of leverage being used by external money managers. At the same time, they expressed concern about risk management and admitted to using only a handful of risk measurements. Additional research is required to get behind these seemingly contradictory answers.

More than sixty percent of institutional investors with assets in excess of $5 billion cite the use of custodians as providers of "independent" valuation numbers. Only forty percent of investors with assets between $1 and $5 billion use custodians for this job. As institutions gravitate towards assets for which there is no ready public market or for which public market trading occurs infrequently, contacting qualified appraisers is worth investigating. Valuation disputes often end up in arbitration, litigation or regulatory enforcement actions and more than a few experts have been disqualified for lack of specialized training. Forty-eight percent of respondents claimed a concern about how hedge fund assets are valued.

For interested readers, click here to read "Hedge Fund Valuation: What Pension Fiduciaries Need to Know". Click here to read "Asset Valuation: Not a Trivial Pursuit."

Sixty-two percent of respondents confirmed that derivatives are permitted. Worry about the risk associated with derivative use, inadequate systems to monitor and manage risk and lack of familiarity or experience with derivatives showed up most often as the reasons for prohibiting their use. Seventy percent of users cited the use of equity and fixed income derivatives. When asked about instrument categories, sixty-three percent cited the use of futures contracts, fifty percent cited the use of interest rate swaps and forty some percent checked off credit derivatives and currency swaps. About thirty percent of respondents cited the use of options, both exchange-traded and over-the-counter.

Seventy-seven percent of people who completed the survey said that they "feel that institutional investor fiduciaries are more vulnerable to being sued in the aftermath of recent corporate, government and non-profit scandals."

This begs some important questions.

1. What are fiduciaries doing to better protect themselves from allegations of breach of duty?

2. Are investment committee members being recruited, retained and compensated on the basis of their investment knowledge and experience? If not, do they plan to introduce educational and experiential requirements soon? If not, why not?

3. Do fiduciaries respond best to the carrot or the stick approach? If the latter, will an increase in litigation result in better governance? If not, what will prompt organizations in need of improvement to do a better job?

4. How will pension reform and new accounting rules affect the investment risk strategies adopted by public and private funds? (The expectation is that derivatives and related risk management strategies will climb to the top of the MUST DO list in response to anticipated reforms and new rules.)

5. How are fiduciaries carrying out their duties with respect to properly analyzing non-traditional instruments and strategies?

The development of follow-up surveys is underway. Contact Dr. Susan M. Mangiero, CFA, Accredited Valuation Analyst and certified Financial Risk Manager (FRM) for more information.

Tea Party Redux: State Pensions in Turmoil



Is a modern Boston Tea Party soon to come? Will taxpayers say "enough" to what they perceive as generous municipal pensions while they struggle to save?

The Associated Press reports on July 21, 2006 that "Oregon's state pension board plans to ask about 1,900 retired government employees to repay an average of nearly $28,000 each. They are among 125,000 workers and retirees whose benefits will be cut as a result of a successful lawsuit filed by local governments who argued that the pension board put too much money in benefit accounts in 1999." Apparently, state employees will bear the brunt if retirees are loath to return the funds (though taxpayers ultimately finance salaries and benefits of existing and retired workers).

Moving east, a July 20, 2006 announcement from Albany has New York Governor George Pataki vetoing a bill "that would have allowed teachers and other government workers with 25 years of experience to retire at 55 with the benefits now available at 62", costing taxpayers more than $195 million over the next seventeen years.

Whether municipal benefits are excessive is hard to say. To be fair, many government workers accept lower than market salaries in exchange for better benefits. That being said, times are tough and it will become increasingly difficult for state, county and city employees to get much sympathy from individuals who have their own retirement crisis to solve.

Instigator of the now famous tea toss, Samuel Adams offered: "It does not require a majority to prevail, but rather an irate, tireless minority keen to set brush fires in people's minds." On the opposing side, British Admiral Montague countered: "You have got to pay the fiddler yet!"

Nothing is ever free. Someone, somewhere, somehow, pays the bill. How will politicians respond? After all, grumpy taxpayers tend to vote.
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More About Executive Compensation

A few thoughts come to mind regarding the new SEC executive compensation disclosure requirements.

1. Will it be hard for analysts to interpret information about executive pensions if they are reported on an accumulated benefit basis but FASB requires the use of a projected benefit approach?

2. How do company compensation committees determine who gets what and why? Understanding the process by having access to meeting notes would be particularly helpful.

3. What volatility numbers will be used to determine the value of executive stock options?

4. How are D&O insurance costs likely to change in response to disclosures about the timing of option grants to executives?

5. How are pensions determined for non-executives and does the Compensation Committee interface with the company's benefits team?

Shedding Light on Executive Compensation



SEC Chairman Christopher Cox announces new disclosure rules about executive compensation by stating that "With more than 20,000 comments, and counting, it is now official that no issue in the 72 years of the Commission's history has generated such interest." (Read the announcement online.)

Besides wages, options and other types of compensation, the investing public will now have access to a Pension Benefits Table which, among other things, will include "disclosure of the actuarial present value of each named executive officer's accumulated benefit under each pension plan, computed using the same assumptions (except for the normal retirement age) and measurement period as used for financial reporting purposes under generally accepted accounting principles".

This comes as good news, especially as Wall Street Journal reporters Ellen E. Schultz and Theo Francis highlighted the "hidden burden" for shareholders in the form of executive pensions. According to their June 23, 2006 article, "As Workers' Pensions Wither, Those for Executives Flourish", "Compensation committees often aim for a pension that replaces 60% to 100% of a top executive's compensation" versus "20% to 35% for lower-level employees." Their research revealed that "executive benefits are playing a large and hidden role in the declining health of America's pensions."

Talk about a morale buster for everyone below C-level!

Pension Accounting Going Global



Global Pensions Magazine reports that the International Accounting Standards Board (IASB) has added pension accounting to its work plan. Smoothing and cash balance plans are two of the topics to make their way under the microscope. Executed in two stages, the goal is for IASB and Financial Accounting Standards Board (FASB) rules to converge by end of Phase Two.

According to its website, the International Accounting Standards Board is an "independent, privately-funded accounting standard-setter based in London, UK. The Board members come from nine countries and have a variety of functional backgrounds." Similarly, the FASB is self-described as "the designated organization in the private sector for establishing standards of financial accounting and reporting." (Click here to download Facts About FASB.)

Accounting harmonization is the wave of the future as more and more companies go global and investors seek ease of financial statement use. What will be interesting to know (and only time will tell) is whether:

1. The business community outside the U.S. is likely to push back

2. Disagreement will focus on the same issues (In the US, liability calculation methodology has taken center stage.)

3. Shareholders will demand the same level of transparency as in the U.S. (or more)

4. The extent to which common accounting standards will facilitate capital market development with respect to cost, availability and liquidity.

Bye Bye Equities



The Star Ledger reports that New Jersey state officials "adopted a plan to shift billions of dollars in state pension money to private investment managers and set a course to reduce the funds' heavy reliance on the stock market." Journalist Dunstan McNichol describes a $16 billion reallocation from stock "in favor of larger holdings in toll roads, hedge funds and international stocks."

A harbinger of things to come?

Many experts agree that pending regulations and increased focus on pension obligations will move asset allocation to center stage, resulting in a variety of questions that demand good answers. (Asset allocation is oft-cited as the most important determinant of performance.)

1. How will an increased emphasis on alternative investments change the expected return-risk tradeoff of the pension portfolio (particularly as relates to estimating pairwise correlations of returns that vary over time)?

2. What are the liquidity implications of investing in public works projects, hedge funds, international stocks, commodities, private equities and so on?

3. How should pension plan decision-makers proceed in selecting alternative investment consultants (especially with respect to their ability to thoroughly analyze the impact of performance fees on net returns)?

4. How do alternative fund managers value their holdings, if at all?

5. How will overseers evaluate performance in the event of diminished transparency of returns and risk drivers that influence returns?

6. Will fiduciary liability change for funds that invest outside the traditional mix of equities and debt?

7. Do fiduciaries need additional training to feel comfortable asking the right questions about alternatives (and interpreting the answers with confidence)?

8. How should the Investment Policy Statement change to accommodate the use of alternatives?

Get ready pension fiduciaries! There is a lot of work to be done in moving the money around.

Air Miles to Fund Pension Shortfall



The Independent reports that "British Airways is mulling the sale of its Air Miles customer loyalty scheme to help fill a pensions deficit that could be twice as big as first thought".

A novel concept, perhaps U.S. carriers will follow suit. How it will work specifically is not yet publicly known. It is reported that British Airways would receive up to 200 million British pounds "and provide flights in return" as part of a "complex transaction".

How the deal is priced will be of particular interest to many. Since airlines often employ discriminatory pricing, what exact flights should be bartered (in terms of revenue generation possibilities)? What are the tax implications? Is this the best way to finance the pension shortfall? What is the likely shareholder reaction? How will frequent fliers be impacted?

If it works for the airlines, what about the credit card companies and other industries that regularly employ reward programs to augment market share and plump up the bottom line?

Pension Haiku




Haiku, a type of Japanese poetry, consists of three sentences, each one containing five, seven and five syllables, respectively. The goal is to convey a message in simple terms. Here are a few tries.

Pensions are crucial
People are not saving much
Will we always work?

Governance is key
Bad decisions cost money
Who will take the blame?

The point is this. Clear and simple communication is a precursor to change. Solving the retirement benefits problem is far from easy and a cacophony of dissident opinions, without some unifying end goal, spells disaster.

Wouldn't it be nice to simplify, clarify and streamline? Answering questions such as those shown below is a good start towards implementing meaningful reform.

1. What is the problem that needs to be solved?
2. Who currently bears the cost(s) of not having a solution in place?
3. What are the alternative solutions?
4. How do they compare/contrast in terms of costs and benefits?
5. Who should make the decisions about what benefits to offer?
6. How much responsibility should employees enjoy with respect to pensions?
7. Who currently "owns" the pension "problem"?
8. Who can effect change?
9. Who should be able to effect change?
10. What lessons can be learned from past mistakes with respect to pension funding?

We'd love to publish your poems, musings or anecdotes. Write to pension@bvallc.com
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Do As I Say, Not As I Do



Mr. Jerry Kalish provides a novel suggestion in response to a July 13, 2006 post about legislative attempts to curb dividend payouts for underfunded pension plans. (See "Dividends, Pensions and California Chaos".)

Creator of Retirement Plan Blog, Jerry writes the following:

"The proposed bill - and the politics behind it - conveniently ignores the massive unfunded pension liabilities in California, e.g, the California State Teachers' Retirement System faces a $24 billion unfunded pension liability.

But we got them beat in my home state of Illinois which at $35 billion has the largest unfunded pension obligation in the country. The Fitch Rating service released a "negative outlook" for Illinois finances - one of only three negative outlooks issued by the rating service in its review of the states. The other two? Louisiana dealing with the aftermath of Hurricanes Katrina and Rita and Michigan dealing with massive problems in the automobile industry.

Um! Should there should be a law that says no more salary increases for state legislators until pension liabilities are met?"

Give the man a bow for an astute observation.

Others have provided novel solutions to the ubiquitous problem of do as I say, not as I do. In 1993, then Michigan state representative Greg Kaza proposed that legislators' pensions be taxed at the state income tax rate, similar to what they required of others. The result? A few months later, the state ceased taxing private pensions. Greg continues to dazzle as executive director of the Arkansas Policy Foundation.

Ode to Valuation



According to Oscar Wilde, a cynic is "a man who knows the price of everything and the value of nothing." In today's world, that could be a label that some pension fiduciaries end up wearing with regret. At a time when pension funds are allocating more and more money to alternative investments, assessing their value and understanding why (and how) the value is likely to change is paramount.

Could hedge fund regulation help to shed light on valuation practices? We may never know.

Just a few weeks ago, the D.C. Circuit Court of Appeals vacated a rule that required hedge fund managers to register, pursuant to the Investment Advisors Act of 1940. Wall Street Journal reporter Kara Scannell describes that, in the aftermath, "10 managers have filed papers to withdraw from registration." Whether this is good or bad depends on a host of factors. However, critics are likely to cite registration shyness as a step backward with respect to better understanding how hedge funds value their positions. While some funds report net asset values on a daily basis, others don't because they trade instruments for which there is no ready market or trading occurs infrequently.

As written before, this creates its own set of problems. (See the June 18, 2006 posting about hedge fund valuation.)

This blog's author, an Accredited Valuation Analyst, CFA charterholder and certified Financial Risk Manager, writes about the topic of hedge fund valuation, and the fiduciary implications, in two new articles.

Write to pension@bvallc.com if you would like a copy of either or both articles:

1. "Hedge Fund Valuation: What Pension Fiduciaries Need to Know" (Journal of Compensation and Benefits, July/August 2006)

2. "a growing necessity for hedge fund valuation" (HFMWeek.com, June 29-July 5, 2006).

Incidentally, any concerns about transparency and valuation can rightfully be said to apply to private equity and venture capital funds as well. Future blog postings will look at these other types of alternatives.
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Taking the Pension Pulse



Take a five question quiz and see if others agree with you about the state of the pension system.

Hi Ho Hi Ho - It's Off to Work We Go






Do you have happy workers? Productive workers? Loyal workers? So many news stories address the financial dimensions of THE pension issue. While important, ultimately the story is about the employees, isn't it? Ignoring tax considerations, companies provide benefits to protect human capital. Though this asset shows up nowhere on a company's balance sheet, it is nonetheless vital to profitability and growth. This is especially true for countries and industries where intellectual prowess determines success or failure.

According to a recent article in FORTUNE, the new paradigm urges managers to "hire passionate people". Citing research done by Christopher Bartlett of Harvard Business School, employees "want a sense of purpose". (See "Tearing Up the Jack Welch playbook" by Betsy Morris.)

In their best-selling book, First, Break All the Rules: What the World's Greatest Managers Do Differently, Marcus Buckingham and Curt Coffman regale the reader with countless suggestions as to how to manage people more effectively, including the need to keep people motivated.

Ironically, at a time when identifying and cultivating human potential is paramount, some leaders are still missing the mark. In today's Wall Street Journal, Erin White describes the disconnect between what companies say their performance reviews are supposed to measure versus what employees describe as their perceived opportunity set to advance and contribute. (See "For Relevance, Firms Revamp Worker Reviews".)

With so many companies shifting away from defined benefit plans, will there be a concomitant change in worker happiness? Do employees really choose a work situation based on benefits? Could plan sponsors be taking a short-term view without acknowledging long-term consequences? Do employees favor a parental approach or is individual empowerment the touchstone (in which case 401K and other choice-focused plans make perfect sense)?

There are no easy answers. People genuinely disagree about the role that benefits (quality, quantity, form) play in attracting and keeping good people.

One thing is certain, however. Corporations everywhere (U.S. and abroad) will be affected by changing demographics (recently described elsewhere in this blog). An oft-discussed dearth of skilled workers compels companies to think long and hard about the link between benefits and the bottom line.

Dividends, Pensions and California Chaos



According to CFO.com, the State of California may soon prohibit a company from paying out dividends or buying back shares until all required defined benefit plan payments have been made. AB 2122, introduced by Democrat Johan Klehs, could impact corporate leaders individually as well since it "would make directors and officers of a corporation jointly and severally liable for improper distributions", even if they had no knowledge of the impropriety.

Needless to say that if this bill becomes law, other states would likely follow, creating a cascade of new challenges for chief financial officers everywhere.

Think about it.

Capital structure, securities issuance and debt rating assignments would necessarily change as a function of a company's mix of employee benefits. Modeling a defined benefit plan liability (and related liquidity obligations) would take center stage. Shareholders seeking current dividend income may get an unpleasant surprise if dividend payouts become more volatile, even if a company enjoys steady growth in economic earnings.

Then there is the philosophical issue about the role of government with respect to corporate management. Does the state have the right to micromanage this way? Would shareholders shy away from investing in companies with defined benefit plans, knowing that the state has the right to prevent dividend distributions? Would companies rush to shed defined benefit plans, possibly exacerbating an already pronounced trend towards defined contribution plans? Would companies lobby more aggressively for exemptions from the dividend rule? Would that worsen campaign finance problems? Would D&O insurance costs skyrocket as a result of increased liability exposure for board members? Would federal lawmakers seek to follow suit?

The little bill that could ...

What's in a Promise?



In a current National Law Journal article, Pamela A. MacLean provides a fascinating overview of unanswered questions regarding employee benefit-related promises. She points out that federal courts are being "pulled into the wrangling over how promises of lifetime benefits can be broken, or whether they existed at all", adding that "the courts have not been uniform in their answers". According to MacLean, there are three particular areas of contention that include:

1. Method and timing of benefit recission

2. Bankruptcy impact on the provision of post-retirement medical benefits

3. Health care benefits for individuals over 65 versus younger retirees

With the contemporaneous effort underway to reform pension accounting, any legal decisions that permit companies to expunge their retirement obligations without penalty may accelerate what many experts believe is the ultimate nail in the coffin for traditional offerings.

For additional reading, see "CPAs Debate FASB's Pension Draft", AccountingWeb.com and "FASB Pension Rule Could Spur Loan Woes" by David M. Katz, CFO.com.

Will Hedge Funds Displace Pension Plans in Court?



There is no doubt that hedge funds are here to stay, especially with respect to their increasing clout in the boardroom. According to editor and associate publisher of Directors & Boards, Jim Kristie, "Corporate America is owned by hedge funds". He points out that institutions, including hedge funds, own more than sixty percent of equity issued by top U.S. corporations. Moreover, he cites research that "the average institutional holding period is about 12 months" and possibly even shorter.

In the same issue, William G. McBride warns that activist hedge fund investors "rely on negative media to keep the pressure on boards of directors", highlighting bad practices, sluggish earnings and/or vague communication about strategy.

For some institutional investors, seeking redress by going to court as lead plaintiff is another type of activism. (See the recent post about this topic.) Given their significant ownership stake, is it possible therefore that hedge funds could displace pension funds as key players in litigation against company boards?

In a recent speech, U.S. SEC Commissioner Paul Atkins cites a concern about "complicity between short sellers, namely hedge funds, and plaintiff's lawyers". He adds: "As the story goes -- and I have personally seen instances of this before I came to the Commission -- the two groups can act in concert to systematically drive down the price of a company's stock, to their mutual gain and the company's and its shareholders' loss."

Institutional investors that use the legal system to ferret out wrong-doing serve society well. Their actions arguably help to promote capital market transparency and thereby facilitate economic growth.

Regarding activist hedge funds and their role in litigation as plaintiff, lead or otherwise, it is impossible to generalize anything from a few anecdotes. Moreover, the selection of lead plaintiff depends on many factors.

We welcome hearing about research that directly examines the role of hedge funds as lead plaintiffs and will keep you posted as our investigation ensues.

Governance Update: Personal Liability on the Rise?

Voltaire once wrote "No snowflake in an avalanche ever feels responsible". In the aftermath of some of the more "infamous" corporate scandals, one wonders if this is what the french philosopher had in mind. Unfortunately, for the directors seeking refuge in the opinions of others, hiding may become more difficult.

A recent article in Canadian Underwriter describes several trends that seem to be gaining ground: (a) plaintiffs' demand that directors personally contribute in the event of litigation-related payouts and (b) attempts by insurance underwriters to rescind Directors & Officers coverage "upon learning of fraudulently-reported financial statements".

At the same time, KPMG's Integrity Survey 2005-2006 suggest that things are improving. "Although the level of observed misconduct has remained constant, employees reported that
the conditions that facilitate management's ability to prevent, detect, and respond to fraud and misconduct have improved since 2000. For example, pressure to engage in misconduct is down, and confidence in reporting concerns to management is up."

In a related article, attendance at Directors College was way up this year, with a star-studded roster of speakers addressing many topics including several sessions about D&O insurance.

Financial Independence Day




Americans will celebrate Independence Day on July 4 with patriotic tributes, picnics and parades. Wouldn't it be wonderful if some time was spent ruminating about financial self-sufficiency as well?

According to the national debt clock website, U.S. IOUs are growing by roughly two billion dollars each day. (Keep hitting the Refresh key for the full effect.)

Personal debt levels are staggering. In a report to Congress, the Federal Reserve cites credit card outstandings in 2004 at $644.8 billion. UK statistics are no less sobering with an estimated fifty-two percent rise in indebtedness over the last five years.

Eilene Zimmerman describes the adverse impact of debt load for Workforce Management, stating that "debt problems cause stress and anxiety that sap workers' productivity, cause health problems and increase the likelihood they will leave a job in search of better pay". Moreover, employees may tap into their 401k accounts prematurely just to stay even with bills.

What role do employers play? Besides plan design, educating employees about retirement choices and personal finance overall can boost morale and enhance a company's return on benefits spending. However, doing so puts companies between Scylla and Charybdis. In its survey about corporate-sponsored financial education programs, Ernst & Young reports that some employers worry about the liability of providing financial education while those that abstain do so for the exact same reason, fear of increased liability.

According to the U.S. Department of Labor "Some plans, such as most 401(k) or profit-sharing plans, can be set up to give participants control over the investments in their accounts. For participants to have control, they must be given the opportunity to choose from a broad range of investment alternatives" and "must be given sufficient information to make informed decisions about the options offered under the plan."

Whether an employer provides broad-based financial training or not, employees still bear the responsibility of paying their bills on time and arguably planning for their own future.

So enjoy the fireworks and picnic today. The debt diet follows.

Is Sixty the New Thirty?



Many experts agree with Betty Friedan that "Aging is not 'lost youth' but a new stage of opportunity and strength." Unprecendented advances in healthcare technology and amassed wealth make life a happy lot for countless seniors.

Gray power is here to stay.

According to a report from the National Institute of Aging, "the U.S. population age 65 and over is expected to double in size within the next 25 years. By 2030, almost 1-out-of-5 Americans - some 72 million people - will be 65 years or older. The age group 85 and older is now the fastest growing segment of the U.S. population."

The U.S. is not alone. The AARP website includes an Associated Press story that ranks Japan as the "most elderly" country, pushing Italy to second place, with the elderly making up "almost 27 million of Japan's total population of nearly 128 million". Brandchannel.com reports that UK seniors account for eighty percent of the nation's wealth and forty percent of consumer spending. The financial services industry is gearing up for the nearby demographic tidal wave of seniors in need of estate planning and retirement services.

On the jobs front, countless numbers of seniors are taking suits and briefcases out of the closet and returning to work. To help combat the ill-effects of the silver ceiling, the AARP has created a National Employer Team to bring together various companies and older workers in search of work.

It's easy to understand why hiring the 65-plus set has appeal. A company enjoys ready access to well-trained workers, offsetting an otherwise scarce supply of labor. Rehiring employees might also mean that millions of dollars of retirement benefit payments are deferred until a later date. State and federal governments realize higher tax revenues. Seniors who want to work avoid the pressure of being forced into an unwanted, premature retirement.

All in all, a good thing!

As writer Lisa Belkin aptly states in the July 2, 2006 New York Times: "The Best Part Comes in the Third Act".

So does this mean that sixty is the new thirty and that being fifty makes one a veritable youngster?



Note: The photo, taken by Jud Burkett with the Spectrum, accompanies a story about Senior Olympics.