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

According to TechCrunch ("Canopy Financial Turns Into Sad, Comical Game of Hot Potato" by Michael Arrington), nearly $90 million in venture capital money may have done little to thwart alleged fraud at Canopy Financial. If true that this company has been reporting incorrect numbers, why has it taken so long to uncover?

Here is what I've been able to uncover from a quick search of the web (with no guarantees that these website links will remain live much longer, if they even exist now):

• Canopy Financial was listed #12 on Inc. Magazine's 2009 list of fast-growing companies with reported growth of nearly 8,000%, 84 employees and 2008 revenue of $19.8 million. Click to read more.
• Important website links for Canopy Financial except for a single Contact Us page (About Canopy, Learning Center, Solutions, Press Releases, Clients) are broken.
• Red Herring reported that Canopy Financial raised $15 million in a "funding round led by Granite Global Ventures," allowing this health insurance-related service company to "develop and market some of its new products and services." Read "Canopy Financial Banks $15M" by Cassimir Medford (January 10, 2008).
• Healthcare Finance News reported on an acquisition by Canopy Financial about a year ago. See "Canopy Financial buys CareGain" (October 20, 2008).
• PE Hub writes that Canopy Financial's CEO claims "no prior knowledge whatsoever of any fraud..." Click to read "Statement from Canopy Financial's Ex-CEO" by Dan Primack (November 24, 2009).
• The link to Perkins Coie is likewise broken though Google shows text that reads "Represented Canopy Financial in its Series A and Series B Preferred stock financings."
• Crunchbase.com lists financing for Canopy Financial in the amounts of $15 million Series A funding (January 2008), $8 million Series B funding (August 2008), $4 million in debt funding (2009) and $62.5 million in Series C funding (October 2009). Click to read more.
• Health Care IT News reports a partnership between Canopy Financial and Wolters Kluwer Financial Services to "make Canopy's healthcare banking platform available to all banks and credit unions." See "Financial providers integrate HSAs for banks" by Molly Merrill (February 14, 2008).
• Canopy Financial reports the release of its "Mobile Consumer Directed Healthcare (CDH) Software Application." Read the May 13, 2009 press release.
• Canopy Financial sought to recruit a product analyst as recently as November 9, 2009.
• Canopy Financial's November 3, 2009 press release describes a partnership witih A.D.A.M., a "leading provider of healthcare information technology." Click to read more.
• Canopy Financial sends out a March 2009 press release that lauds its successful completion of the "Statement on Auditing Standards No. 70 (SAS 70) Type II audit, which assesses the operational effectiveness of internal controls within service organizations." Read "Canopy Financial Achieves SAS 70 Type II Certification."

The list continues. If true, yet another fraud perpetuated on investors would be shocking. Questions abound, some of which are listed below.

• Who was conducting the due diligence for each funding round?
• What due diligence was done on Canopy as relates to several acquisitions and partnerships?
• What was the role of the auditor?
• What questions were asked of the management team by the Canopy Financial board of directors? 
• Did institutional investor limited partners utilize finder firms or contract with the venture capital general partners directly?
• Did any of the investors review the SAS 70 audit report and find it wanting?

Until more facts are uncovered, everyone deserves their day in court and we can't make hasty judgments.

On a general note, the hope is that lessons are learned along the way about who is tasked to do what, on what basis and with what rigor. While I truly believe that there are many, many good players who do their work thoroughly and with high integrity, one is compelled to reflect on why the stigma and shame of dishonesty is discarded by those who rightfully deserve a place in the Financial Hall of Ignominy.

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According to Wall Street Journal reporter Pui-Wing Tam, hedge funds are not alone in reducing their fees to entice investors. As laid out in "Venture Funds Sweetening the Terms," fund-raising is down 65% from $58.2 billion in 2008 to $20.4 billion as of the beginning of November 2009. To offset a difficult economic environment, allay concerns about longer times to exit and diminished returns reported by some managers, performance-linked fees are being put on the table.

In a related article in the same paper, the Initial Public Offering ("IPO") thaw is described as imminent. According to "Issuers Look to 2010" by Lynn Cowan (November 23, 2009), underwriters prepare to help private businesses make their public debut. Notably, nearly 40 companies have "filed paperwork to start the IPO process, compared with eight during the same period of 2008."

It will be interesting to watch whether IPO-related liquidity leads to any retraction of performance-linked venture capital fees currently being offered to limited partners.

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According to an October 2009 study entitled "Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds" by researcher Samuel Sender, regulations discourage European retirement plan managers from focusing on long-term risk management objectives. The study further suggests that risk management is far superior to risk measurement if a focus on funding ratios steals resources better spent on ensuring the long-term viability of the plan. The 142 respondents cite a fear of tighter accounting rules and concern that regulators need to "provide incentives" to build internal models. Nearly eighty percent of survey-takers "report that dynamic strategies are difficult to implement because management agreement is needed to rebalance a portfolio." Click here to access the study.

In contrast, a new poll conducted by SEI suggests that pension risk management is a top priority for executives in Canada, Netherlands, UK and the United States. According to the November 18, 2009 press release released by SEI, "the percentage of pensions employing a Liability Driven Investing strategy has nearly triped over the past three years from 20 percents in 2007 to 54 percent in 2009. Queries about pension benchmarks sugges that decision-makers are veering away from absolute return in favor of "improved funded status." Click to read "SEI Global Poll: 3rd Annual Liability Driven Investing Poll Finds A Significant Increase in Adoption" (November 18, 2009).

A 2008 survey created by Pension Governance, Incorporated (now rebranded as Investment Governance, Inc.) supports the notion that more work remains to be done, by far. Click to read "Pension Risk Management: Derivatives, Fiduciary Duty and Process."

Each survey-taker was asked to self-identify as a USER if he/she works for a plan that trades derivatives in its own name. A NON-USER works for a plan that does not trade derivatives directly but may nevertheless be exposed indirectly if any of the plan's asset managers trade derivatives.

• Plan size seems to be one factor that distinguishes USERS from NON-USERS, with 39% of USERS managing plans in excess of $5 billion versus 14% of NON-USERS associated with plans larger than $5 billion.
• Pension decision-making appears to vary considerably by job function, with 48% (37%) of USERS (NON-USERS) choosing "Other" rather than selecting from given titles such as Actuary, Benefits Committee Member, CFO or Human Resources Officer.
• Time allocation varies considerably with 64% (40%) of USERS (NON-USERS) saying they devote 75 to 100 percent of their work week on pension issues. In contrast, 37% of NON-USERS say they spend 0 to 24% of their work week on pension issues.
• A majority of USERS (64%) and NON-USERS (48%) have had discussions about the concept of a fiduciary duty to hedge asset-related risks. A smaller number say they have discussed the concept of a fiduciary duty to hedge liability-related risks.
• Few plans currently embrace an enterprise risk management approach with 59% (57%) of USERS (NON-USERS) responding that their organization does not use a risk budget. When asked if their organization has or is planning to hire a Chief Risk Officer, 57% (64%) of USERS (NON-USERS) answered "No."
• NON-USERS cite numerous reasons for not using derivatives directly, including, but not limited to, "Lack of Fiduciary Understanding" (25%), "Perception of Excess Risk" (31%), "Considered Too Complex" (23%), "Prohibition Against Possible Leverage" (19%) and/or "Defined Benefit Plan Risk Not Considered Significant" (28%).
• A query about whether survey-takers review external money managers' risk management policies results in 70% (58%) of USERS (NON-USERS) responding "Yes." Fifty-two percent (57%) of USERS (NON-USERS) say they review external money managers' valuation policies. This survey did not drill down with respect to the rigor of questions being asked.
• Survey respondents seem to rely mainly on elementary tools to measure risk. Eighty-three percent (64%) of USERS (NON-USERS) rank Standard Deviation first in importance. Seventy-nine percent (63%) of USERS (NON-USERS) rank Correlation second. Only one-third (38%) of NON-USERS cite Stress Testing (Simulation). Four out of 10 USERS cite Value at Risk in contrast to 23% of NON-USERS who do the same.
• Survey respondents worry about the future with 58% (60%) of USERS (NON-USERS) ranking "Accounting Impact" as a concern. Other concerns were also noted to include "Regulation," "Longevity of Plan Participants" and "Fiduciary Pressure."

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Investment Governance, Inc. wants to hear what you think about the current state of retirement readiness. Click here to answer a short survey of six questions. The survey is identical to one we ran a few years ago with one exception. This time, we added a question about whether corporate and government leaders should receive generous pension packages during hard economic times.

I will post results to this blog in a few weeks.

To refresh your memory, the results of the original survey are shown below.

• Sixty-two (62) percent of respondents said there is a pension crisis looming.
• When asked who was responsible for the crisis, board members (32%), chief executive officers (30%), governors and other state officials (27%), pension consultants (24%), plan fiduciaries (38%), regulators (33%) and U.S. Congress (41%) took the blame.
• When asked who can fix things, 54% of respondents listed the U.S. Congress first, followed by plan fiduciaries (34%), regulators (29%), board members (28%), chief executive officers (25%) and governors and other state officials (25%).
• A whopping seventy-five (75) percent of respondents acknowledged a Social Security crisis.
• Fifty (50) percent of survey-takers strongly agreed that most people are ill-equipped to invest their own money for retirement planning purposes with thirty-two (32) percent moderately agreeing that people are literate with respect to retirement readiness.

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ERISA legal expert and Ropes & Gray LLP partner, Attorney Andrew L. Oringer provides an interesting insight into a recent case about the investment of excess assets and prudence. The case he cites can be downloaded by clicking here. Note the court's opinion on page 5 wherein it writes that the plaintiff, seeking redress over a question of fees paid by the plan, cannot "bring suit because the plan's surplus was sufficiently large that the 'investment loss did not cause actual injury to plaintiff's interests in the Plan'."

Our thanks to Attorney Oringer for his contribution, provided below.

A Scary Halloween Gift from the Eighth Circuit?

So here's a question - you're managing an overfunded defined benefit plan (remember those) and you want to let your guard down. You want to roll the dice a bit or push the limit of what you can do with ancillary (non-investment) motivations, and you figure you can do so because you're playing with house money. At least, you want to play around just with some of the excess. Or maybe you're just a touch careless, albeit unintentionally so. What's the big deal?  After all, participants and beneficiaries are going to get their money, without government help, unless the whole overfunded thing goes to heck in a hand basket and turns radically south.

Now, you'd expect that you might be on the wrong end of this one, so, as your feet get colder, you poke around a bit. And what do you find? You find that you may indeed have a friend or two in the Eighth Circuit with an ever-so-slightly delayed Halloween present for you.  In McCullough v. AEGON USA, No. 08-1952 (8th Cir. Nov. 3, 2009), which follows its earlier decision in Minnesota Mining and Manufacturing, 284 F.3d 901 (8th Cir. 2002), the Eighth Circuit in effect seems to hold that one cannot violate the prudence rules with respect to the investment of excess assets.  (Note that the widely discussed 3M case may well be wrong on both of the issues considered there.)  Assuming AEGON is not reviewed en banc and reversed on rehearing, its confirmation of the 3M decision seems like a welcome development for those seeking to limit potential liability for investment decisions under a DB plan.

My advice, however, is to be careful, real careful, even in the Eighth Circuit. The reasoning of AEGON and 3M is so suspect that, outside the Eighth Circuit you would draw comfort from these cases at your own peril, and, even within the Eighth Circuit, I think you'd have to be at least a little concerned that any given case could be reversed by the nine old and young men and women in the black robes. Having said that, the cases are certainly nice precedent if you need to use them defensively

So: "Boo" or "Boo!" depending on your perspective.

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