Make Every Day Count

Posted on July 29, 2008 by Susan Mangiero

I'd like to depart from the usual commentary about financial issues and devote this blog post to the celebration of people who err on the side of kindness and integrity, especially when faced with adverse circumstances. Putting a face on otherwise abstract notions makes a difference and so it is that I talk about computer science professor Randy Pausch.

In case you missed it, this Carnegie Mellon University favorite died a few days ago of pancreatic cancer, at the age of 47. His death was anticipated and highly publicized as part of  "The Last Lecture" or "Really Achieving Your Childhood Dreams." If you haven't seen it, I highly recommend at least one viewing. You can also buy the book version of The Last Lecture, co-authored by Pausch and Wall Street Journal reporter, Jeffrey Zaslow.

While I was originally interested in watching the video of this hour long talk because of the large amount of press it received, awe and inspiration took over as I saw Dr. Pausch interviewed on several television programs thereafter. Despite his pain and the tragic knowledge of an imminent demise, he always seemed upbeat and considerate. His sense of humor no doubt continues to help others cope with their loss of a son, father, husband, friend, colleague and "citizen of the world."

While Professor Pausch will be remembered by many, it is good to know that his optimism and courage are not unique. How many people have we met in our lives who have received "more than their fair share of problems" yet greet you with a smile or handshake? I thank my lucky stars for knowing such individuals.

So how does this relate to a pension blog? Well, for one thing, it's good to remember that money is only one of many currencies. While it's critical to have the financial wherewithal to retire comfortably, perhaps just as important is to possess the ability to enjoy the things that money cannot buy.

On a professional note, integrity and courage are paramount when we talk about solidifying the three-legged post-employment stool. At a time when fiduciaries are seldom applauded for their hard work, let's look for ways to improve the reward system for good players (and penalties for those who are sloppy or impervious to their duties). 

Though I acknowledge my propensity as a Cassandra (or Dr. No as some have suggested), I'm much happier helping folks put productive solutions in place. To those fiduciaries who share that view and work tirelessly on behalf of millions of individuals, bravo! Take a bow.

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New Blog About California Municipal Employees

Posted on July 26, 2008 by Susan Mangiero

Welcome to new blogger, Jon Ortiz. A seasoned reporter for the Sacramento Bee, Ortiz is the creator of The State Worker and plans to update and debate issues relating to "state pay, benefits, pensions, contracts and jobs."

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Class Action Certification and 401(k) Fees

Posted on July 26, 2008 by Susan Mangiero

According to Class Action Litigation Report ("Court Certifies Class Action Alleging Fiduciary Breach in Charging Excessive Fees, July 25, 2008), a U.S. federal court has granted class action status to a claim by 401(k) plan participants that they were forced to pay "unreasonable" fees to service providers. Alleging that Kraft Foods Global Inc. plan fiduciaries failed to keep a lid on costs related to recordkeeping and asset management, this case may raise the stakes for Corporate America, with at least a dozen other "excess fee" cases awaiting adjudication.

Filed in October 2006, the original complaint describes the four individual members of the Benefits Investment Committee ("BIC") as having "the authority and discretion to control and manage the investment operations of the Plan," thereby rendering the BIC a named fiduciary according to ERISA. Click to read the original complaint and the order on class certification.

On a related note, the U.S. Department of Labor ("DOL") proposed its new "Fiduciary Requirements for Disclosure in Participant-Directed Individual Account Plans," (published in the Federal Register, July 23, 2008). Written comments will be received by the DOL on or before September 8, 2008. If approved, 401(k) plan sponsors will have to report details about fees and expenses to participants. Interestingly, the U.S. House of Representatives deferred a decision on requiring enhanced 401(k) plan disclosures. Interested persons may want to watch Bloomberg's video entitled "The Truth Behind Hidden Fees in 401(k) Plans" (June 19, 2008) in which 17 separate fees are cited as eroding investment returns.

As countless employers switch to defined contribution plans, putting more responsibility on individuals as to how their monies are deployed, the economic impact of fees becomes arguably even more important than before.

 

 

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SEC Issues Compliance Alert About Sloppy Valuation Process

Posted on July 25, 2008 by Susan Mangiero

Hat tip to fellow blogger gal Wendy Fried for news about the recent release of an important ComplianceAlert, issued by the U.S. Securities and Exchange Commission. Click to read "Sloppy subprime valuations on Wall Street?..." (footnoted.org, July 25, 2008)

According to the SEC website, a ComplianceAlert letter highlights results of examiners' audits in an attempt to "encourage" institutions to better their current compliance and supervisory efforts. In its July 2008 letter that starts "Dear Chief Compliance Officer," the SEC staff provides a laundry list of concerns, including, but not limited to:

  • Inadequate monitoring of personal trading by advisory staff
  • Weak oversight of mutual fund boards to "confirm that the proxy service providers' recommendations were consistent with funds' policies and procedures"
  • Stale valuations of high yield municipal bond fund holdings
  • Poor or no disclosure of the increased valuation and liquidity risk when "the percentage of illiquid securities held by a fund dramatically increased"
  • Questionable quality of price verifications of collateral held by certain broker-dealers
  • Inexperienced staff who were nevertheless tasked to validate model prices
  • Lack of documentation as to valuation standards relied upon by some broker-dealers.

The letter concludes with a variety of recommendations, including but not limited to:

  • Improvement of price verification and assessment of "modeled inputs and the calibration of valuations against trades or trade information inferred from activity in similar securities and or the derivative markets"
  • Retention of records "used in determining value"
  • Getting independent product control groups involved in "monitoring collateral valuations"
  • Creating and maintaining a database that "serves as the internal repository for security position information, including periodic valuations, in order to ensure consistency amongst various inventory trading accounts and collateral valuations."

I hate to say "we told you so" but this blog has been on a tear about proper valuation process for a long time. Check out a few of our many past posts. 

With FAS 157 and international equivalent accounting rules forcing change, pension fiduciaries need to take a hard look at their external service providers' trading controls and valuation policies and procedures, if not already. Check with legal counsel but likely they will remind plan sponsors that delegation does not absolve one of the fiduciary duty to properly select and oversee vendors.

What is your biggest concern about how "hard to value" instruments are currently being assessed by banks and broker-dealers? Send us an email with your opinions.

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Pensions Lose Key Players

Posted on July 24, 2008 by Susan Mangiero

According to "Public funds taking long view" by Raquel Pichardo (Pensions & Investments, July 23, 2008), pension decision-makers are retiring in droves. At a time of great uncertainty and a fast-changing operating environment (new accounting rules, market volatility and increased transaction complexity) it may not be easy to quickly replace experienced professionals. Add the fact that public plans are not always in a position to match industry wages and real concerns emerge.

Succession planning is likewise important when it comes to vetting the riskiness of external money managers. When pensions allocate monies to various hedge fund and/or private equity partnerships, they are essentially making a bet on whether existing management can turn in a "good" risk-adjusted performance on a regular basis.

  • What happens if any or all of the key persons leave for greener pastures as superstar traders are wont to do?
  • What happens if a general partner gets divorced and, absent a plan to protect partnership assets, the spouse becomes the new owner? What happens if that spouse knows little about running a financial partnership)?
  • What happens if a senior partner or managing member (in the case of a Limited Liability Company) is in an accident and rendered unable to make important decisions about strategy?

If not already part of the RFP and/or periodic reviews of external money managers, pension fiduciaries should add questions about key persons, key person insurance and whether a succession plan exists. Ex-ante investigations can potentially save plan sponsors a lot of grief later on.

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SEC Short Selling Rules - Fallout for 130/30 and Hedge Funds?

Posted on July 21, 2008 by Susan Mangiero

Trading today may be wild as Wall Street back office staff and short sellers scramble to comply with new rules, imposed via emergency order by the U.S. Securities and Exchange Commission ("SEC"). By way of background, on July 15, 2008, the SEC issued "Securities Exchange Act of 1934, Release No. 58166/July 15, 2008," prohibiting naked short sales for 19 identified financial company stocks. (The company names and ticker symbols are shown below.)

The official stated goal is to avoid panic selling as a result of outright short trading and discourage false rumors. (A naked short contrasts with the situation whereby an individual borrows shares and then sells them at the prevailing market price. The short can be closed at a profit when the trader buys shares back at a lower price, assuming that prices do eventually fall).

Only a few days later, the SEC issued "Securities Exchange Act of 1934, Release No. 58190/July 18, 2008," amending its earlier emergency order and exempting certain parties such as "registered market makers, block positioners, or other market makers obligated to quote in the over-the-counter market, that are selling short as part of bona fide market making and hedging activities related directly to" the identified securities and related derivative instruments and exchange traded funds. The order is set to terminate at 11:59 p.m. EDT on July 29, 2008 "unless further extended by the Commission."

According to "SEC Short-Sale Rule Gets Negative Reviews," Wall Street Journal reporter Kara Scannell (July 19-20, 2008) reports that certain companies did not make the list but have nevertheless seen their stocks come under recent "selling pressure." Some firms complain that SEC list inclusion will add to jitters and thereby exacerbate woes for existing shareholders, big and small.

Important questions remain unanswered, notably the impact on non-exempted parties and their institutional investors. Take 130/30 managers. By their very nature, they short stocks they deem "over-valued." How will this SEC mandate impact quarterly 130/30 fund performance and beyond, especially if trading costs mount as a result of compliance? What about those pension plans that have allocated monies to 130/30 managers who are adversely impacted by the SEC order? Could their funding status be in jeopardy? The same concerns extend to hedge fund managers whose specified strategy requires short-selling in any or all of the SEC "specified" stocks. Additionally, will the regulatory effect be materially different if shorted shares already represent a large percentage of outstanding common equity?

Will the SEC emergency order solve one problem but create others?

Financial Services Firm Name (Ticker Symbols) Covered by the Order and Amendment:

  • BNP Paribas Securities Corp. (BNPQF or BNPQY)
  • Bank of America Corporation (BAC)
  • Barclays PLC (BCS)
  • Citigroup Inc. (C)
  • Credit Suisse Group (CS)
  • Daiwa Securities Group Inc. (DSECY)
  • Deutsche Bank Group AG (DB)
  • Allianz SE (AZ)
  • Goldman, Sachs Group Inc (GS)
  • Royal Bank ADS (RBS)
  • HSBC Holdings PLC ADS (HBC and HSI)
  • J. P. Morgan Chase & Co. (JPM)
  • Lehman Brothers Holdings Inc. (LEH)
  • Merrill Lynch & Co., Inc. (MER)
  • Mizuho Financial Group, Inc. (MFG)
  • Morgan Stanley (MS)
  • UBS AG (UBS)
  • Freddie Mac (FRE)
  • Fannie Mae (FNM)
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Dr. Susan Mangiero Will Give Hedge Fund Conference Keynote

Posted on July 21, 2008 by Susan Mangiero

Join me at the 6th Hedge Fund Accounting & Administration Forum 2008 on July 22, 2008 at the Harvard Club. I will be giving the second day keynote presentation entitled "Hedge Fund Risk Management and Valuation - No Time for Shrinking Violets."

More about this presentation is excerpted below.

"Explore key questions and challenges facing hedge fund professionals in these turbulent times. Join appraiser and risk manager, Susan Mangiero, for a topical discussion about the fast changing operating environment for buyers and sellers alike. Always important topics, portfolio valuation and operational controls are front and center as fund managers, and their service
providers, deal with new rules and regulations and the continuing fallout of credit-related problems. Dr. Mangiero will share her insights about:

  • Regulatory enforcement hot buttons
  •  Valuation and risk management litigation trends
  • Best practices for evaluating key risks and managing exposure
  • Institutional investor impact as pensions/endowments/foundations allocate more money to alternatives.

To learn more about this FRA, LLC sponsored two-day conference (July 21-22, 2008), download the flyer.

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Comments from Readers About Financial Tumult

Posted on July 19, 2008 by Susan Mangiero

In response to our July 19, 2008 post ("Doris Day, Scarlett O'Hara and Financial Market Tumult"), a reader with thefinance_section adds "Freedom certainly isn't free. I think you are only truly free once you can live off your passive income, i.e. income from investments."

In response to general market volatility, the chief actuary of a major retirement services firm writes the following:

"The market will continue to find instruments to dampen the losses from the large bubble of speculative loans created over the past three years. Government will also act to smooth the market. Congress & the Executive Branch cannot allow the full chaos that comes from destroying the equity of so many lenders by forcing them to write off the bad loans quickly. This is similar in scope to the issues of the S&L crisis of a prior generation, and the market should be watching closely to see how the industry and govt will follow the old pattern or try another approach.

In some respects, this crisis follows the prior bubble problem with tech stocks. A large number of people who get paid for activity (commissioned stockbrokers) were guilty of pushing "POS" investments in the late 90's. A large number of people (mortgage brokers and bank loan officers) were guilty of pushing more loans through the system in this decade. Both were speculative bubbles in the classic Holland Tulip style of the 1700's but both also had regulators to punish the truly criminal operators. Who will emerge as winners?

However, the sharper investment managers will try to find the higher performing assets of firms that are less exposed to the losses. Are there enough quality investments for those who are running to quality? Will this create another surge to buy from the banks least affected by the loan crisis? Who will seize the initiative? Who will be able to make timely value-style investment choices? The swift and the brightest will continue to prosper, and may even pick up some bargains along the way.

What will be the new "due diligence" rules for pension trustees?" 

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Doris Day, Scarlett O'Hara and Financial Market Tumult

Posted on July 19, 2008 by Susan Mangiero

Remember the 1939 epic classic "Gone with the Wind" wherein Scarlett O'Hara protests serious conversation? Interrupted by news of an imminent Civil War, this party gal (with the famous 17-inch waist) complains. "Fiddle-dee-dee. War, war, war: this war talk's spoiling all the fun at every party this spring. I get so bored I could scream." 

As I read "Why No Outrage" by James Grant (Wall Street Journal, July 19, 2008), I wonder if this southern belle might now be heard to say "Loss, loss, loss: this loss talk is spoiling all the fun..." About structural reforms (a 2007-2008 equivalent of losing Tara, the family homestead), Scarlett might encourage delayed action. "After all...tomorrow is another day." Why fuss now?

Well, as we all know, Main Street and Wall Street are inextricably linked. Unlike Las Vegas, what happens in the financial markets,  does not "stay here." (Read "Slogan's run" by Newt Briggs, Las Vegas Mercury, April 8, 2004.) When huge losses roil capital markets (not just in the U.S. but around the world), real people can get hurt:

  • Employees lose jobs
  • Shareholders see their portfolios plummet in value
  • Pension plans that allocate big money to equities and bonds scramble to improve funding
  • Retirees who depend on the financial health of plan sponsors pinch their pennies further
  • Vendors who do business with financial institutions tighten their belts and/or layoff staff
  • Businesses, seeking to grow, borrow at higher rates, if they can borrow at all...

It is therefore a mystery to the editor of Grant's Interest Rate Observer that relatively few bad players are taken to task "in the wake of the 'greatest failure of ratings and risk management ever,' to quote the considered judgment of the mortgage-research department of UBS." Grant conjectures that high gas prices and an election-focused Congress may be to blame or that "old populists" have hoisted themselves by their own petard, having pushed for paper money, federal insurance subsidization of higher risks and government intervention with respect to credit decision-making. From the tone of this long, yet fascinating, commentary, Grant rants about big government at the same time that, ironically, big government seeks to become even bigger in the form of new financial market regulations.

For my two cents as an advocate of free markets (not faux capitalism as exists around the world), a return to the gold standard merits serious consideration. Improperly priced federal insurance of bank deposits and pension liabilities (and much more) induces adverse selection and moral hazard. Riskier organizations get subsidized by more prudent market participants and have little incentive (arguably no incentive) to get their risk management house in order. Regarding government intervention as to how credit is allocated, plenty of empirical studies quantify the economic "bad" that results from information asymmetry. When buyers and sellers are not fully informed, supply and demand cannot intersect at the"correct" price of money or the optimal level of borrowing/lending.

Then there is the shame factor. In an era of reality shows, can we expect honor and accountability? Grant has few kind words for market behemoths (current and now extinct) who watch(ed) the Titanic sink "under the studiously averted gaze of the Street's risk managers." Will today's villains of excess rise, Phoenix-like, as have infamous names of yore, now reincarnated as media superstars? (Nick Leeson of Baring's fame has his own website and earns a living as a consultant and speaker. Henry Blodget pens "Internet Outsider" and e-newsletter, Silicon Alley Insider - a fun read for this bloggerette.)

Related to Grant's provocative piece, a recent article about voluntary standards caught my eye with its suggestion that industry attempts may be more show than reality. In its "agenda-setting column on business and financial topics," the Financial Times' Lex states that such guidelines receive little scrutiny and are put in place as a way to attract risk-averse institutional investors and/or to avoid the harsh spotlight of global regulators. (See ""Funds of hedge funds," Financial Times, July 17, 2008.) An easy way to check is simply ask each hedge fund manager about his/her reliance on published guidelines. Inquire how traders are compensated. Are they encouraged to take pure risks or are they instead benchmarked on the basis of risk-adjusted returns (with "risk" referring to the holistic assessment of uncertainties)? Don't stop with hedge funds. Ask any service provider or trader about their controls and how they monitor the quality of their processes.

The creation of an effective reward system and "best practices" are favorite topics of this blog. Our team (Pension Governance, LLC) and fiduciary community colleagues decry the status quo that makes it difficult to reward good players, at the same time that questionable practices are frequently left untouched. Poor quality disclosure is just one factor that inhibits the design of a better mousetrap.

Two hours into this post, I'm going to conclude with the notion that "freedom is not free" (anonymous). To enjoy flexibility and regulatory latitude, people of great courage must buck the existing system and both demand and assume accountability. At a minimum, interested parties (retirees, shareholders, taxpayers) want to better understand what went wrong and how internal controls will be strengthened post-haste as a result of introspection. Leaders at troubled institutions do a great service by informing the public about corrective actions underway.

For pension fiduciaries, a critical lesson learned is this. If you are not already doing so, waste no time in getting an operational review. This extends to tough and detailed interviews with your external money managers and service providers about all things risk management. Communicating your process to plan participants (for all types of plans) and shareholders/taxpayers gets you brownie points and helps to raise the "best practices" bar. 

Doris Day's sentiment may be great for meditation class but has no place in a discussion about financial system reform and governance of individual organizations, plan sponsors included. "What will be, will be" is the wrong answer (though "Que Sera, Sera" is a favorite tune).

The power of one keeps us in awe. Who will step up to the podium and say - "The buck stops here?"

Please email us with examples of pension and financial service leaders whom you believe inspire and lead the way in terms of governance. Let us know if we may attribute your comments or should post them anonymously.

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New Pension Investment Disclosure Rules a Reality

Posted on July 17, 2008 by Susan Mangiero

Unhappy auditors and plan sponsors may be roaring in response to the outcome of yesterday's FASB board meeting. In case you missed it, Norwalk-based accounting rulemakers opine in favor of enhanced asset risk disclosures. Despite industry arguments to the counter, FASB concludes that benefits outweigh costs, citing credit-related large losses as a factor in their decision to enhance plan transparency.

As stated in our July 15, 2008 post ("FASB Meets to Unlock Pension Investment Risk Information"), critics offer that FAS 132(R) compliance entails time-consuming data collection and analysis, across asset categories and fund managers and, in some cases, for multiple corporate entities. According to CFO.com reporter Marie Leone, FASB chairman Bob Herz (himself a former pension fiduciary) favors layers of information. A plan that allocates four out of every ten dollars to equities would be asked to disclose industry and sector concentrations as follows:

  • 40% in equities
  • 25% of that 40% in pharma
  • 50% of that 25% in high-growth pharma stocks.

Leone adds that FASB board members unanimously dismissed the need for a materiality guidance rule, also concluding that "drilling down to the underlying assets that make up mutual funds, trusts, and fund of funds was not necessary" as long as qualitative text is provided to financial statement users. Click to read "One Step Forward on Pension Disclosures" by Marie Leone (CFO.com, July 16, 2008).

Click to access the FASB audio file for "Disclosures about plan assets" (July 16, 2008 FASB board meeting). Noteworthy is the discussion about what constitutes an "optimal" level of granularity, while acknowledging that some fund managers are VERY reluctant to say too much about how they invest.

Call me circumspect but one wonders whether point in time qualitative information would be better replaced with a description (even if somewhat broad) of risk management and valuation policies and procedures for (a) the plan sponsor and (b) external money managers, respectively.

Process is extremely important. An investment may not return much over a given period(s). However, if financial statement users know that a plan sponsor (and/or asset managers, in the case of outsourcing the investment function) is regularly measuring and managing risk, there may be less angst on the part of nervous beneficiaries and shareholders.

What an interested party does not know (and can't control or influence as a result) is a sure way to lose sleep.

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FASB Meets to Unlock Pension Investment Risk Information

Posted on July 15, 2008 by Susan Mangiero

The Financial Accounting Standards Board ("FASB") meets on July 16, 2008 to discuss how much investment-related information pension plans should disclose to the public. Following the "exposure" of Statement 132(R) on March 18, 2008, industry participants weigh in about the feasibility of compliance. In its 17-page summary of comment letters, FASB notes disagreement among respondents with respect to the need for asset categorization. Some suggest the use of Form 5500 as a guide to the proper delineation of asset investment risks. (As mentioned elsewhere in this blog, we take issue with the Form 5500 as a meaningful guide for economic risk assessment purposes.) 

Surprising to this blogger, only one other organization (Eli Lilly) besides Pension Governance, LLC comment on the need to better understand a reporting entity's process. In our May 2, 2008 letter, we suggest  that accounting rules "require plan sponsors to describe how it decided on a particular concentration, who monitors the concentrations, what triggers a breach, and what happens when a concentration is exceeded."

Regarding fair value, several companies aver that such disclosures would "provide little information to users because annual postretirement benefit cost is based on the expected return on plan assets rather than the actual return." In stark contrast, note that the U.S. Department of Labor is holding hearings today about "hard to value" assets held by ERISA plans.

More than a few respondents claim that the costs of gathering, and then analyzing, requisite information will outweigh the benefits, especially for those companies with geographically dispersed benefit plans. Others cite problems related to assets held by "multiple trustees in pooled asset accounts" whereby the "look through" process cannot be done by a "trustee with partial information, and the employer may not have the skills or proper information to do so."

A key question remains - If something like FAS 132(R) is not adopted, what do critics propose in its place? At a time when more and more plans allocate monies to complex securities and/or funds with less than full transparency, is it sufficient for fiduciaries to simply say "trust me" and assume that disclosure of investment risk is unwarranted? That may be a lot to ask of plan participants who are already nervous about their financial futures.

Editor's Notes: Click to read "Postretirement Benefit Plan Asset Disclosures - Comment Letter Summary" (FASB). Click to access comment letters submitted by various organizations (including Pension Governance, LLC) about "Employers' Disclosures about Postretirement Benefit Plan Assets."

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New Accounting Rules for Public Pension Funds

Posted on July 11, 2008 by Susan Mangiero

According to "Government Rule Makers Looking at Pensions," New York Times reporter Mary Walsh (July 11, 2008) describes a new initiative, sure to create headaches for troubled state and city pension plan auditors. Announced at its July 10, 2008 public meeting, the Government Accounting Standards Board plans to "force state and local governments to issue better numbers and reveal the true cost of their pension promises." Walsh describes a GASB report that is frightening at best. (I am trying to get a copy of the report to upload to this blog.) Questionable practices include:

  • Award of retroactive employee benefits without recognizing the incremental costs
  • Use of "skim funds" which diverts some investment income dollars away from the pension plan for other uses
  • Amortization of expenses over 50 or 100 years (versus the customary 30 years)
  • Use of a 30-year amortization period with an annual reset back to Year 1.

Additionally, on June 30, 2008, GASB issued Statement No. 53, Accounting and Financial Reporting for Derivative Instruments in order to promote transparency about the use of derivatives by public entities. In its news release, GASB describes the need to determine "whether a derivative instrument results in an effective hedge." Unclear is whether GASB 53 applies to public pensions that employ derivative instruments for hedging, return enhancement or a variety of other applications. Also unclear is whether embedded derivatives must be accounted for. (I am researching these questions.)

Having been on the front lines of FAS 133 implementation (the corporate equivalent of GASB 53), challenges await auditors and pension finance managers alike. Click to read "FAS 133 Effectiveness Assessment Issues" by Dr. Susan Mangiero (GT News, June 15, 2001) or "Is correlation coefficient the standard for FAS 133 hedge effectiveness?" by Dr. Susan Mangiero and Dr. George Mangiero  (GARP Risk Review, May 2001).

Notably, a survey soon to be released by Pension Governance, LLC and the Society of Actuaries suggests that public and corporate pension plans worry about accounting representation. A large pool of U.S. and Canadian respondents rank compliance with new accounting rules as their number one concern. The survey, entitled "Pension Risk Management: Derivatives, Fiduciary Duty and Process" is tentatively scheduled for release during the week of July 21, 2008.

Editor's Notes:

  • You may have to register in order to read articles online by New York Times reporters.
  • Check out "The $3 Trillion Challenge" by Katherine Barrett and Richard Greene (Governing, October 2007) and the related "Q&As With the Experts" - Gary Findlay, Susan Mangiero and Richard Koppes.
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Emotional Intelligence and Pension Fiduciaries

Posted on July 10, 2008 by Susan Mangiero

In early 2006, I published an article entitled "Do Fiduciaries Need Better Incentives to Make the Retirement System Work?" with pension professional, Mr. Wayne Miller (Executive Decision, January - February 2006). The major premise is that the work of the investment fiduciary (for both defined benefit and defined contribution plans) is challenging at best. Do something right and few people pay attention. Violate a rule or make a decision that results in an economic loss and there is "you know what" to pay. Fiduciaries seldom earn anything extra for their work at the same time that they assume sometimes signficant personal and professional liability exposure.

You may ask - Why does anyone choose to be an investment fiduciary when the payoff is so lopsided? For some individuals, their voluntary service is a badge of honor. By assisting plan participants, these folks believe they can make a true difference. For others, retirement plan work is part of the job. Their boss says "you take care of this" and they have no choice, unless they quit that position or the company or both. A third category - pension finance managers or independent fiduciaries, external to a plan - represents a full-time job commitment to handling retirement benefit plans and nothing else. (Interestingly, results of a survey soon to be released by Pension Governance, LLC and the Society of Actuaries suggest that someone either spends very little of their work week or almost all of their work week in handling retirement plan financial decision-making. The survey, entitled "Pension Risk Management: Derivatives, Fiduciary Duty and Process" is tentatively scheduled for release during the week of July 21, 2008.)

In his just published statement to the House Committee on Ways and Means, Miller addresses what he calls a "dysfunctional retirement plan system" in the context of Emotional Intelligence ("EI"). He bemoans the "governance nightmare" that ensues when "responsibility exists without individual accountability." In his view, emotional influences include, but are not limited to:

  • "the avoidance of blame,
  • promoting the illusion of competency,
  • the need for approval,
  • the lack of self acceptance of making mistakes,
  • the desire to look good,
  • the willingness to acquiesce to the status quo rather than live out one's own values and last but not least...
  • the lack of personal courage to speak out."

Wow. This man packs a one-two punch and certainly says what he thinks. Whether you agree or not, his statement is worth a read. Click to access "Statement of Wayne H. Miller, Denali Fiduciary Management, Vashon, Washington."

This blogger gal likes to think she is more upbeat with respect to good intentions on the part of investment fiduciaries (though legal counsel will likely urge that intentions are not enough to evidence the discharge of fiduciary duties). Unlike Miller who asserts that "the problem isn't technical," I am a strong proponent of a systematic, disciplined approach, with lots of common sense and "roll up the shirt sleeves" due diligence thrown into the mix.

What do you think? Send us an email and let us know.

Editor's Notes:

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Dutch and US Lawmakers React to Hedge Fund Activists

Posted on July 6, 2008 by Susan Mangiero

Far from the halcyon image of a young boy admiring Dutch tulips, hedge fund activism has some lawmakers seeing red.

In response to our July 5, 2008 post about CSX ("CSX Battles Hedge Funds - A Cautionary Tale for Pensions"), Peter at riskfriends.net writes the following:

<< TCI also played a major role in the take over of ABNAMRO and benefited with an incredible return on investment (almost 100 percent). In the Netherlands legislation is being prepared to reduce impact of these activist inveztors that immediately profit by simply sending a warning letter to the board of a company. >>

Credit to Peter for directing us to the Governance Focus blog post entitled "Dutch taskforce wants to tighten corporate governance" (June 7, 2008). According to the cited June 5,2008 Reuters article with the same title, Dutch lawmakers seek to equalize what they perceive as an unlevel playing field across shareholders. In "Dutch corporate governance review mulls over M&A 'put up or shut up' clause" (Thomson Financial News, June 4, 2008), the head of the Corporate Governance Code Monitoring Commission, Mr. Jean Frijins, posits the need for more transparency as relates to corporate takeover attempts.

Stateside, TheDeal.com reports on US Senator Chuck Schumer's letter to SEC Chairman Cox, asking why the court failed to penalize either The Children's Investment Fund or 3G Capital, having concluded that the "group" violated securities laws by not disclosing their partnership, pursuant to Schedule 13D rules.  Jurists did however allow TCI and 3G to vote their shares (direct and indirect via equity swaps). See "Schumer may propose bill concerning CSX ruling" by Ron Orol, June 18, 2008. Oral is the author of Extreme Value Hedging: How Activist Hedge Fund Managers Are Taking on the World (John Wiley & Sons, 2007).

As I wrote yesterday, this case is noteworthy for numerous reasons, not the least of which is the fact that derivatives (equity swaps here) are clearly changing the corporate governance landscape. Significant questions remain about what constitutes "appropriate" transparency (already a hot button issue for pensions, endowments and foundations that invest in hedge funds, not all of which provide "enough" detail about their holdings). Just as important, what is the proper role of activist money managers? Are they doing existing shareholders a favor by shaking up things, urging existing managers to improve performance (however "performance" is defined) or creating chaos? While each situation differs, their clout is far from non-trivial.

This blogger does not have sufficient information to make a judgment about the CSX case. On a more general note, however, it would be enlightening to understand how pension plan fiduciaries (defined benefit or defined contribution) vet corporate governance risk before allocating monies to a particular stock, bond or hedge (private equity) fund. Unless the plan's corporate governance policies are made available (if they exist at all), we learn only from reading headlines and court filings, after the fact.

Wouldn't it better for investment fiduciaries to ex-ante publish how they monitor and manage "beneficial ownership" issues, especially in the event of a takeover?

Editor's Note: Click to read the "Final Judgment, CSX v. The Children's Investment Fund."

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CSX Battles Hedge Funds - A Cautionary Tale for Pensions?

Posted on July 5, 2008 by Susan Mangiero

In case you missed it, possible trend-setting legal parries are commanding attention from New York jurists, institutional investors and proxy specialists. According to corporate governance expert Jay Brown, "The CSX case is the first decision to find that shareholders must sometimes disclose the shares acquired by investors as part of equity swap transactions. This holding makes it harder for activist shareholders - trying to acquire or influence control of a public company - to keep their holdings secret." Brown should know. As a securities law professor (University of Denver Sturm College of Law) and lead contributor to The Race to the Bottom (a widely read legal blog), he and colleagues have penned no fewer than 16 posts about the ongoing litigation between CSX Corporation ("CSX") and several CSX investors - 3G Capital Partners ("3G" or "3G Capital") and The Children's Investment Master Fund ("TCI").

By way of background (and this is a summary only), a letter was sent to CSX by TCI on February 7, 2008, stating its intentions to acquire effective control. In response, CSX filed a lawsuit against the two funds. The Q1-2008 quarterly SEC filing for CSX states:

<< On March 17, 2008, the Company filed a lawsuit against The Children’s Investment Master Fund (together with certain of its affiliates, “TCI”), 3G Capital Partners Ltd. (together with certain of its affiliates, “3G”) and certain of their affiliates (collectively, the “TCI Group”) in the United States District Court for the Southern District of New York alleging violations of federal securities laws, including violations of Sections 13(d) and 14(a) of the Securities Exchange Act of 1934. The lawsuit alleges, among other things, that TCI and 3G have undisclosed plans with respect of CSX. The lawsuit further alleges that TCI and 3G have employed swap agreements in order to evade the filing requirements of Section 13(d) and that their Section 14(a) and Section 13(d) filings concerning their collective 12.3 percent swap position in CSX shares are materially misleading. The lawsuit further alleges that TCI’s and 3G’s disclosures in their Section 14(a) and Section 13(d) filings concerning their formation of a Section 13(d) group are false and misleading. >>

Click to access the CSX 10-Q, filed on 4/16/08. Click to read the complaint for "CSX Corporation v. The Children's Investment Management (UK) LLP et al," filed with the U.S. District Court, Southern District of New York.

Following various motions (in limine, opposition and so on), the two funds (owning about 20 percent in direct form and via equity derivative contracts) sent a letter to other CSX shareholders on June 20, 2008 in which they explain why five nominees should be elected to the CSX board. Citing support for their slate from RiskMetrics Group - ISS Governance Services, they write:

<< If you believe CSX cannot afford to rest on its laurels in favorable pricing and market environments, if you believe that CSX should strive to achieve its full operating potential, if you believe that CSX can and should be the best railroad in America and, finally, if you believe the board of CSX will benefit from the railroad experience of our nominees, along with the perspectives of large shareholders who are engaged because they have made a significant investment in CSX stock using their own money, we urge you to join with us in electing our five nominees to the board of directors of CSX by voting on the BLUE TCI/3G proxy card today. >>

On June 20, 2008, Judges Hall, Livingston and McMahon opine that TCI and 3G Capital Partners can vote their shares, additionally setting up a briefing schedule to include a July 25, 2008 date by which reply briefs in each appeal must be filed. Click to read the ruling.

The "TCI and 3G Comment on Circuit Court Ruling" (dated June 20, 2008) is short and sweet, expressing confidence in the then future June 25, 2008 vote to elect "five highly qualified director nominees." Following that vote, CSX declares the June 25, 2008 board vote "too close to call." In its June 25, 2008 press release, CSX states that the "annual meeting will reconvene at 10 am ET on Friday, July 25, 2008.

Courtesy of Knowledge Mosaic, we know that many large pension funds likewise invest in CSX (at least as of the end of Q1-2008). Regardless of the election results, the corporate governance impact is real. A partial list of funds is included below.

  • CALIFORNIA PUBLIC EMPLOYEES RETIREMENT SYSTEM
  • CALIFORNIA STATE TEACHERS RETIREMENT SYSTEM
  • CANADA PENSION PLAN INVESTMENT BOARD
  • ELCA BOARD OF PENSIONS
  • EMPLOYEES RETIREMENT SYSTEM OF TEXAS
  • IBM RETIREMENT FUND
  • NEW MEXICO EDUCATIONAL RETIREMENT BOARD
  • NEW YORK STATE COMMON RETIREMENT FUND
  • NEW YORK STATE TEACHERS RETIREMENT SYSTEM
  • ONTARIO TEACHERS PENSION PLAN BOARD
  • PUBLIC EMPLOYEES RETIREMENT ASSOCIATION OF COLORADO
  • PUBLIC EMPLOYEES RETIREMENT SYSTEM OF OHIO
  • PUBLIC SECTOR PENSION INVESTMENT BOARD
  • STATE BOARD OF ADMINISTRATION OF FLORIDA RETIREMENT SYSTEM
  • TEACHER RETIREMENT SYSTEM OF TEXAS
  • VIRGINIA RETIREMENT SYSTEMS ET AL

Not being an attorney, this case caught my eye because of the numerous and complex investment and governance implications, including the concept of"beneficial ownership" and use of financial derivative instruments. Several things come to mind.

  • When a defined benefit invests in a particular stock (or selects such stock for its defined contribution plan participants), are plan fiduciaries doing sufficient homework with respect to identifying "large" ownership stakes and assessing possible corporate governance implications?
  • For those defined benefit plans allocating monies to activist hedge funds, are investment fiduciaries taking into account a potential diversification "offset" that could occur if the plan invests directly in the same stock that represents a concentrated hedge fund position? (This is predicated on the notion that many pensions invest in alternatives for portfolio diversification reasons.)
  • Are pensions (endowments and foundations too) asking enough questions about their external money managers' use of derivatives? Always a critical exercise, this case illustrates that equity exposure can be material through both direct buys and indirect trades, i.e. equity swaps. Though not germane to this case, equity futures or options facilitate exposure to an individual stock and/or a particular sector of the equity markets. Will their use connote "beneficial ownership" and is the exposure deemed significant? (Note that in their June 2, 2008 amici curiae brief, the International Swaps and Derivatives Association, Inc. and Securities Industry and Financial Markets Association argue against the notion that equity swaps evidence "beneficial ownership," adding that to conclude otherwise would disrupt derivative market activity.  In an unrelated case, "Securities and Exchange Commission v. Larry P. Langford et al" (filed with the U.S. District Court for the Northern District of Alabama, Southern Division, on April 30, 2008), the issue as to whether swaps (interest rate) are securities appears again. See "SEC Plan for Swaps 'Securities' Gets Alabama Rebuff" by Bloomberg reporter Joe Mysak (July 3, 2008).
  • In the event that a fund manager is known to use equity derivatives (because the pension fund or consultant inquires), should plan fiduciaries be carefully tracking whether the derivatives represent a hedge, a cross-hedge or an anticipatory price/volatility trade? In the case of a hedge, yet another question goes to how best to measure effectiveness.

The CSX case is sure to be the beginning of a lively debate among financial market participants and corporate issuers.

Editor's Note: Go to www.corpgov.net for a great collection of corporate governance sites. Directors and Boards is another valuable resource.

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Financial "Independence Day" is Not a Reality for Some

Posted on July 4, 2008 by Susan Mangiero

July 4 marks the U.S. version of Independence Day, a celebration of America's break from colonial England. Click to learn more about Independence Day in other countries.

Naturally, the question arises. How many of us are truly independent when it comes to financial resources? A recently published study, courtesy of the American Association of Retired Persons ("AARP"), suggests that a significant shift is occurring in terms of financial distress for individuals. Entitled "Generations of Struggle," authors Deborah Thorne, Elizabeth Warren and Teresa Sullivan make some worrisome observations:

  • "Americans age 55 or older have experienced the sharpest increase in bankruptcy filings.
  • The average age for filing bankruptcy has increased.
  • The rate of bankruptcy filings among those age 65 or older has more than doubled since 1991."

Factor in another weak element of the three-legged U.S. retirement stool - the huge economic drag due to ballooning post-retirement entitlements - and things look grim indeed. A soon-to-be released documentary entitled "I.O.U.S.A." sounds the bell clear and loud. This 232 year old nation is on the verge of a financial meltdown. Visit YouTube.com to hear what director Patrick Creadon says about the serious message of his movie. The expected impact on the younger generation is undeniable. (Read our April 2, 2007 post entitled "New Fiction Book Advocates Radical Solution to Pension Crisis" for a quick synopsis of Boomsday by Christopher Buckley.)

In "The State of the Union's Finances: A Citizen's Guide to the Financial Condition of the United States Government" (June 2008), the Peter G. Peterson Foundation reports that entitlement spending is on the rise, with a 213% increase in what they call "Implicit Exposures: Future Benefits," between 2000 and 2007 (i.e. $13 trillion to $40.8 trillion). Putting this in context, the "Size of the Individual Burden Imposed by Major Fiscal Exposures" is currently about $400,000 per full-time worker. Refresh the U.S. National Debt Clock site several times to see how quickly the number climbs in just a few seconds. (The reported daily average increase in the U.S. national debt is almost $2 billion.)

So while we all enjoy a hotdog while watching the fireworks, it is worth asking - How independent are we truly, when our collective debt obligations resemble a runaway train?

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CalSTRS and the Missing Billion Dollars

Posted on July 3, 2008 by Susan Mangiero

In response to our June 29, 2008 post entitled "California Pension Fund Investments in Tobacco," a consultant questioned CalSTRS' claim that the fund had suffered an opportunity loss of $1 billion by divesting itself of $238 million in tobacco stocks.

Sacramento Bee reporter Jon Ortiz sent the following text, excerpted from a CalSTRS report (page INV82, "Performance Review of the Modified Benchmarks"):

<< The performance of the modified benchmarks from inception to December 31, 2007, was
reviewed at the April 4, 2008 Investment Committee meeting. Over the seven and a half years,
since inception, it is estimated that CalSTRS has suffered slightly over a $1 billion opportunity
loss by not investing a market weighting in the tobacco industry. This calculation too is open for
debate, but it remains in Staff’s view that this is a reasonable approximation of the opportunity
loss. >>

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ERISA Attorney Blogger Comments on Tullis v. UMB Bank

Posted on July 1, 2008 by Susan Mangiero

ERISA legal blogger, otherwise known as attorney Stephen Rosenberg, comments on our June 22, 2008 post entitled "Rights of Individual Plan-Holders Expanded by Sixth Circuit" with his usual insight. See below for an excerpt of his June 30, 2008 post.

"There are two particularly interesting side notes about this. First, it illustrates a particular point I - and others - made in a number of media outlets after the Supreme Court issued its opinion in LaRue, namely that, while it may not result in an avalanche of litigation that otherwise would not have been filed, the ruling is certainly going to lead to an increase in the filing of smaller cases on behalf of a few participants in circumstances that, in the past, would not have generated suits unless a class wide action could be brought. Second, the case presages what may be the dying off, by a thousand cuts, of the long held use of standing to cut off ERISA breach of fiduciary duty suits at the earliest stages of procedural wrangling, long before any litigation over the merits of a case, something which occurred at the federal district court level in the original LaRue case itself. Roy Harmon, over at his Health Plan Law blog, has a detailed analysis of this question, one I have been thinking about since LaRue was decided but which Roy has thankfully saved me from addressing in detail at this point.

Click to read the full text version of "From Preemption to ERISA Standing, and Lots of Things In-Between."

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