Enterprise Risk Management, Board Governance and the Art of Cleaning Dirty Dishes

Old habits sometimes die hard. In my husband's case, he insists on soaking the dishes before putting them into the dishwasher. I prefer to scrub them with a sponge, rinse and put them aside until the current load is finished, the machine is emptied and there is room to add the next set. After twenty-two years of otherwise marital bliss, you would think that we would have the whole kitchen clean-up dance choreographed and down to a science. Yet, here we are on a Sunday night, talking about the best way to clean the dishes...again. The good news is that we have squeaky clean dishes. The less than good news is that it would be better in my view to discuss the issue thoroughly, agree on a process and then allocate work accordingly instead of each of us spending time on a basic task that should be easy enough to master without repeatedly going over the same thing.

Now if talking about cleaning dishes is the extent of disagreement in any relationship (marriage or otherwise), life is good. It does get you thinking however about interpersonal dynamics, leadership and how to accomplish a goal, especially when things are more complicated.

Managing enterprise risk management ("ERM") is a good example of a task that requires care and coordination and is arguably more complex than pulling out a scrub brush. According to a recent McKinsey & Company survey about improving board governance, others concur. In their August 2013 write-up of results, authors Chinta Bhagat, Martin Hirt and Conor Kehoe write that "...most boards need to devote more attention to risk than they currently do. One way to get started is by embedding structured risk discussions into management processes throughout the organization."

In "Risk Management and the Board of Directors" by Martin Lipton et al (Bank and Corporate Governance Law Reporter, February 2011), the role of oversight is distinguished from "day-to-day" risk management. The authors write "Through its oversight role, the board can send a message to the company's management and employees that comprehensive risk management is neither an impediment to the conduct of business nor a mere supplement to a firm's overall compliance program, but is instead an integral component of the firm's corporate strategy, culture and business operations."

According to a 2009 publication entitled "Effective Enterprise Risk Oversight: The Role of the Board of Directors" by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"), board oversight entails several important actions. These include the following:

  • Comprehend an organization's philosophy about risk and "concur with the entity's risk appetite," otherwise defined as its risk tolerance for alternative ways to create shareholder wealth;
  • Assess whether management has put effective risk management processes in place in order to identify, measure and manage key sources of uncertainty;
  • Regularly carry out a study of an organization's portfolio of risks in the context of stated risk tolerance goals; and
  • Evaluate whether management is "responding appropriately" to factors that could seriously erode enterprise value.

Hopefully, readers agree that the topic of risk management oversight should be important to pension plans and other types of institutional investors that invest in companies directly or by purchasing corporate stocks and bonds. Looking askance or ignoring the topic altogether is ill-advised.

In a recent conference call about vendor selection for a relatively large ERISA plan, I was surprised when one of the callers admitted to not having yet vetted the risk management controls in place for a candidate service provider. Worse yet, he thought doing so was a bad idea since "the numbers spoke for themselves."

Certainly insurance underwriters are taking a further look at their exposure. Professors David Pooser and Kathleen McCullough, on behalf of the Professional Liability Underwriting Society ("PLUS") Foundation, explain that more attention is being paid to the oversight role of directors in the aftermath of recent financial crises. In "How is Enterprise Risk Management Affecting the Directors' and Officers' Liability Exposure?" (September 1, 2013), they write that "Better governance control through ERM should make a firm a more appealing risk for D&O insurers to write. ERM becomes especially important if it signals that the corporation is less risky and better controlled than others, and therefore may be a useful tool to D&O insurers, regulators, and other monitors."

Understanding Directors and Officers ("D&O") oversight of a firm's enterprise risk management activities is not exactly the same thing as settling on how best to get the dishes clean. However, both activities are important, require that collaborative discussions take place and actions ensue.

Financial Executives Address De-Risking and ERISA Benefit Programs

According to "Balancing Costs, Risks, and Rewards: The Retirement and Employee Benefits Landscape in 2013" (CFO Research and Prudential Financial, Inc. - July 2013), numerous changes are underway. The opinions of senior financial executive survey takers validate the continued twin interest in expanding defined contribution plan offerings and managing the liability risk of existing defined benefit ("DB") plans. The strategic import of benefits as a way to attract and retain talent is recognized by "nearly all respondents in this year's survey." Regarding the restructuring of traditional pension plans, this report states that nearly four out of every ten leaders have frozen one or more DB plans yet recognize the need to manage risk for those plans as well as for active plans. Liability-driven investing ("LDI") programs are being adopted by "many companies". Transfer solutions are being "seriously" considered by roughly forty percent of companies represented in the survey. Almost one half of respondents agree that a return to managing its core business could be enhanced by doing something to address pension risk.

None of these results are particularly surprising but it always helpful to take the pulse of corporate America with respect to ERISA and employee benefit programs. I have long maintained that the role of treasury staff will accelerate. There are numerous corporate finance implications associated with the offering of non-wage compensation. As I have added in various speeches and articles echoing what numerous ERISA attorneys cite (and I am not an attorney), plan sponsors must carefully weigh their fiduciary responsibilities to participants against those of shareholders in arriving at a particular decision.

For a copy of the study, click here.

Interested readers may also want to check out the reference items listed below:

If you have further comments or questions, click to email Dr. Susan Mangiero.

Hollywood and Hedge Funds

Some pension funds invest in hedge funds. Some hedge funds invest in movie companies. That's why pension fund fiduciaries may be interested in the recent comments made by Hollywood insider George Clooney. According to "George Clooney To Hedge Fund Honcho Daniel Loeb: Stop Spreading Fear At Sony" by Mike Fleming Jr. (Deadline, August 2, 2013), the actor and sometimes director and producer criticized activist hedge fund investor and head of Third Point LLC, Daniel Loeb, for what can be politely described as undue interference. The catalyst seems to be a May 14, 2013 letter written to the president and CEO of Sony, Kazuo Hirai, by Third Point's CEO in which several recommendations are made, including the public sale of a minority stake in Sony Entertainment. Although Sony rejected the IPO, documenting the importance of the entertainment business as "fundamental to Sony's success" in an August 6, 2013 letter to Third Point LLC, the conversations about company ownership and ways to enhance value are instructive.

Some of the numerous comments left on various publication websites refute the notion that a material investor has a right to make suggestions. This sentiment defies logic. For one thing, an investor (large or small) may have legitimate questions and suggestions that can potentially enhance the value of all shareholders. Second, an asset manager has a responsibility to its investors. Remaining silent about concerns could put the activist at risk for fiduciary breach. Third, an activist investor by definition has typically amassed "enough" money to transact. Unless we are talking about a jumbo lottery winner who wants a seat at the table, resources had to have come from somewhere, usually from other parties such as endowments, family offices, pensions and individuals who believe in the activist's strategy. That's not to say that an activist investor is always right or wrong but certainly deserves a hearing without impunity. For those companies that want to avoid short-term actions that they deem unattractive and antithetical to long-term performance, going private is one way to keep naysayers away from the door.

However, there are those who believe that squeaky wheels improve corporate governance and boost stock price. In "Activist investors find allies in mutual, pension funds" (Reuters, April 9, 2013), journalists Jessica Toonkel and Soyoung Kim attribute FactSet for statistics that show an increase in activist campaigns, from 187 in 2009 to 241 in 2012. They quote Hedge Fund Research as asserting that "Over the past three years, activist hedge funds have outperformed more traditional hedge funds." According to "Let's do it my way" (The Economist, May 25, 2013), activists were once given short shrift but that is no longer the case. "Indeed, some American pension funds have even placed money with activists to keep companies on their toes."

An added twist exists when activist investors gain exposure indirectly versus buying shares for cash. In "CSX Battles Hedge Funds - A Cautionary Tale for Pensions?" by Susan Mangiero (July 5, 2008), I wrote about a legal challenge to The Children's Investment Management (UK) LLP by CSX Corporation over the hedge fund's then prevailing cash-settled swap position as a way to gain equity exposure and a path to control. (The court ultimately decided not to opine on whether a total return swap holder is a beneficial owner. Click to access the July 18, 2011 CSX Corp. v. The Children's Inv. Fund Mgmt. opinion issued by the United States Court of Appeals For the Second Circuit.") According to "Sony Holdings Blurred by Third Point Swaps, Goldman Bonds" (Bloomberg, June 11, 2013), Mariko Yasu and Takako Taniguchi suggest that Third Point's direct equity stake could be less than five percent since it "doesn't show up in regulatory filings" and "[s]hareholdings of more than 5 percent of a company have to be reported to Japan's Ministry of Finance." Its "exposure" to an estimated 64 million Sony shares could be "clouded" due to its "use of cash-settled swaps and convertible bonds." A key question for investors in Third Point LLC and other activist hedge funds that use equity swaps is whether voting rights will be enhanced or impeded when derivatives are used.

Whatever you think about George Clooney or Daniel Loeb, the role of activists and the way they finance their positions is critically important to understand.

Fiduciary Duty is More Than Numbers

As a published author, I am constantly assessing what has appeal to readers. I try to write about topics that are relevant and timely and welcome feedback. Click here to send an email with your suggestions. As a financial expert, I continuously seek to stay on top of what is being adjudicated. As a risk manager, I regularly evaluate what might have been done differently when things go seriously awry.

What I have noticed is that enumeration seems to offer comfort. Lists of this or that are common to many best-selling books and widely read articles. A trip to the Inc. Magazine website today illustrates the point. Consider this excerpted list of lists:

The popularity of laying out "to do" items extends to the retirement industry as well. For example, Attorney Mark E. Bokert provides insights in his article entitled "Top 10 ERISA Fiduciary Duty Exposures - And What to Do About Them" (Human Resources - Winter Edition, Thomson Publishing Group, 2007). His list of vulnerabilities - and prescriptive steps to try to avoid liability - includes the following:

  • Identify who is a fiduciary and making sure that they are properly trained;
  • Create a proper process by which investments are selected and monitored;
  • Monitor company stock in a 401(k) plan and consider whether to appoint an independent fiduciary;
  • Assess the reasonableness of "like" mutual funds versus existing plan choices;
  • Ensure that communications with plan participants are adequate;
  • Undertake a thorough assessment of vendors and review their performance thereafter;
  • Assess whether 401(k) deferrals and loan repayments are being made in a timely fashion;
  • Identify the extent to which service providers enjoy a float and whether they are entitled;
  • Understand what is allowed in terms of providing investment advice to participants and abide by the rules accordingly; and
  • Critically evaluate whether auto enrollment makes sense and the nature of any default investment selection.

One could easily break out each of the aforementioned items into sub-tasks and create appropriate benchmarks to ascertain whether fiduciaries are doing a good job. Indeed, ERISA attorneys are the first to invoke the mantra of "procedural process" as a cornerstone of this U.S. federal pension law. Importantly however, relying only on numbers is not sufficient. Increasingly legal professionals and regulators are asking that process be demonstrated and discussed. Expect more of the same in 2013. Analyses and expert reports may be deemed incomplete if they do not include a deep dive of the fiduciary decision-making process that took place (or not as the case may be).

Pensions and Corporate Finance: How to Avoid Buyer's Remorse

Ever since the PBGC’s 2007 opinion that a private equity fund with a controlling interest can be liable for a portfolio company’s pension problems, there is increased evidence that corporate transactions can go seriously awry if ERISA benefit plans are not properly addressed. Legal issues are not the only risk factor that could cause a merger, acquisition, spin-off or carve-out to fail to materialize. Low interest rates, investment lock-ups, participant longevity and complex vendor contracts are a few of the challenges that must be confronted by the legal and finance team in charge of due diligence. And with virtually every defined benefit plan facing funding issues in light of these circumstances, the PBGC is extremely proactive in seeking concessions to not interfere with corporate transactions yet hold parties who may have responsibility for unfunded liabilities accountable. Headlines are replete with articles about deals that were stalled or failed because ERISA due diligence was given short shrift. In 2010, the acquisition of a major chemical company took less than six months but coordinating the relationships with defined contribution managers took nearly two years to wrap up. Talks between a large manufacturing company and a potential target company are currently focused on how best to tackle the acquiree’s multi-billion dollar pension fund gap. In the aftermath of the settlement of a recent case, private equity firms and limited partners continue to be jittery about joint and several liability for pension plan funding gaps, making it harder to take a portfolio company public or sell. Taken together, the most important thing that a potential corporate buyer and its counsel can do is to acknowledge the importance of proper due diligence. These problems are not going away and arguably could get much worse.

Join Dr. Susan Mangiero, CFA, certified Financial Risk Manager and Accredited Investment Fiduciary Analyst and senior ERISA attorney Lawrence K. Cagney to talk about ways to keep a deal from derailing and to avoid buyer’s remorse due to an incomplete assessment of pension plan economics on enterprise value.

Join us to hear speakers talk about critical steps and lessons learned from their experience, to include the following:

  • How to revise investment and/or hedging strategy and policy statement(s) when organizations merge;
  • Elements of an ERISA service provider due diligence analysis when plans are combined;
  • Red flags for an institutional investor to consider when seeking to allocate to private equity portfolios with “pension-heavy” companies that may be hard to exit without costly restructuring;
  • Assuring that participant communication is comprehensive;
  • Role of the corporate finance attorney versus ERISA counsel; and
  • Installing knowledgeable fiduciaries for the new and/or merged employee benefit arrangements

Click to register for "Pensions and Corporate Finance: How to Avoid Buyer's Remorse," sponsored by the Practising Law Institute on November 15, 2012 from 1:00 pm to 2:00 pm EDT.

Pension Risk, Governance and CFO Liability

My November 2011 presentation about pension risk, governance and liability to financial executives struck a chord. Part of a Chief Financial Officer ("CFO") conference held at the New York Stock Exchange, attendees alternatively listened with interest while adding their insights from the front lines here and there. It is no wonder.

With ERISA litigation on the rise and 401(k) and defined benefit plan decisions often driving enterprise value in a material way, CFOs and treasurers have accepted the obvious. Corporate governance and pension governance are inextricably linked. Make a bad decision about an employee benefit plan and participants and shareholders alike may suffer. As a result, the CFO is exposed to fiduciary liability, career risk and the economic consequences of an outcome with broad impact.

Rather than rely on luck, there is no better time to apply discipline and rigor to employee benefit plan management for those companies that have not already done so. With trillions of dollars at stake, properly identifying, measuring and mitigating pension risks continues to be a critical element of fiduciary governance.

The complexity and ongoing nature of the risk management process is sometimes overlooked as less important than realizing a particular rate of return. Recent market volatility, large funding deficits and pressures from creditors, shareholders, rating agencies and plan participants make it harder for pension fiduciaries to avoid the adoption of some type of pro-active risk control strategy that effectively integrates asset and liability economics.

In "Pension risk, governance and CFO liability" by Susan Mangiero (Journal of Corporate Treasury Management, Henry Stewart Publications, Vol 4, 4, 2012, pages 311 to 323), the issues relating to a panoply of risks such as actuarial, fiduciary, investment, legal, operational and valuation uncertainties are discussed within a corporate treasury framework. Article sections include:

  • Enterprise risk management, employee benefit plans and the role of the CFO;
  • Conflicts of interest and pension plan management;
  • Risk management principles and 401(k) plans;
  • Pension liability and mergers, acquisitions and spinoffs;
  • Prudent process;
  • Pension risks; and
  • Benchmarking success.

Click to download "Pension risk, governance and CFO liability" by Dr. Susan Mangiero, CFA, FRM.

Pensions and Washington Mutual Class Action Lawsuit

According to "Washington Mutual settles class-action suit for $208.5 million," Associated Press, July 1, 2011, pension plans that include the Ontario Teachers' Pension Plan Board (as lead) will benefit as shareholders of the failed bank (if and once the Bankruptcy Court approves the terms).

On a related note, Judge Mary F. Walrath of the U.S. Bankruptcy Court for the District of Delaware tells certain Washington Mutual ("WaMu") employees that they are "entitled only to general unsecured claims because they do not have a right to the funds that is superior to the rights of the other general unsecured creditors." She added that "Because the plans were unfunded, and the funds were identified as property of WaMu," it was not possible to "impose a constructive trust because the money allegedly owed to the participants can no longer be clearly traced to funds or property in their possession." See "WaMu wins bankruptcy fight over employee retirement funds," Thomson Reuters News & Insight, June 20, 2011.

The two articles caught this blogger's attention as a timely example that financial distress can impact multiple constituencies in completely different ways.

Risk Management and Valuation Blog Launches

Recognizing the continued need for actionable information about institutional investment best practices, Dr. Susan Mangiero offers analysis of critical issues affecting the $30+ trillion global buy side industry. This unique investment risk management and valuation blog at www.goodriskgovernancepays.com serves as a resource for trustees, board members, attorneys, money managers and financial advisors with asset allocation, governance, risk management and fiduciary oversight responsibilities.

According to Dr. Mangiero, “Investment risk governance is more important than ever before. As billion dollar losses continue to make headlines, fiduciaries and their counsel continue to be challenged with volatile markets, a slew of new mandates and investment complexity that requires rigorous due diligence. Litigation is increasing at a fast clip and investment professionals must absolutely embrace and demonstrate an understanding of risk management and valuation issues. Post-Madoff and the credit crisis, there is no room for complacency.”

Click here to read the February 10, 2011 press release about GoodRiskGovernancePays.com.

Note to Readers: PensionRiskMatters.com, soon to celebrate its fifth year anniversary, focuses on the many challenges confronting retirement plan decision-makers. GoodRiskGovernancePays.com takes a broader view of the industry and includes commentary, insights and analysis about important issues for pension funds and other types of institutional investment industry participants such as endowments, hedge funds, mutual funds, private equity funds and sovereign wealth funds. The coverage is slightly different and the access is complimentary. Readers are encouraged to get email updates for each of these two unique websites. Visit GoodRiskGovernancePays.com and type your email into the box by the green GO button or click here to add GoodRiskGovernancePays.com to your RSS feeder.

BP, Fat Tails and Risk Management

Many thanks to Ms. Marlys Appleton, governance expert and financial professional. Her comments are provided below. Click to read the original blog post entitled "BP Investments - The Role of Ethics and Risk Management" (June 19, 2010). The governance storm clouds are dark indeed.

<< I believe what happened in this case is connected to internal governance issues at BP. One only has to look at their safety violation record relative to peers such as Exxon and Conoco over the last few years (as reported recently by Bloomberg News) to see that BP accepted hundreds of safety violations as a "cost of doing business". Institutional investors' failure to pay attention to safety violation records at BP reflects their lack of understanding of the need to price in poor governance. BP's safety record was known for years and now the market is forced to acknowledge and price such behavior, with devastating results.

I also think of the Massey coal mine disaster - another company whose safety record was well know. Both boards need a paradigm shift to acknowledge past failures, but for one, it may be too late. Some damages cannot be remedied by compensation alone. The fund is a good start and may reduce the need for litigation though there are likely to be lawsuits. I believe such a devastating social and environmental disaster such as this event should not be mediated through the courts, but that's another topic. Add upon this, the additional layer of inept government regulation, another example of 'poor governance' as a contributing factor.

It is my hope that institutional investors, boards and executive management embark upon a real understanding of what can happen when governance and ethical behavior break down. In the world of emerging risks, acknowledgement of "fat tail" catatrophic events needs to be stepped up with the implementation of a good Enterprise Risk Management ("ERM") process. This information must then be socialized with boards, management, and investors. >>

Governance of Venture Capital Fund(s)

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this fifth question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about how venture capital firms govern themselves. Click here to read Mr. Levensohn's impressive bio.

SUSAN: How are venture capital ("VC") funds governed differently from the governance standards they apply to their portfolio companies?

PASCAL: This is a very important question. It starts with recognizing that VC funds, as partnerships, are governed quite differently from their portfolio companies which are typically set up as corporations. The VC fund may have one managing partner that sets the tone and controls the entire firm or it may have a collegial distribution of governance among several senior partners.  The best way to understand how a VC fund is governed begins with an analysis of the fund’s investment committee, its deal due diligence process, and the specific allocation of the fund’s investment capital among the individual partners.  An important question to ask is whether the partners evaluate themselves and each other on an annual basis, if at all. You might be surprised to learn that many VC funds lack an internal feedback loop, that the partners may not communicate openly among each other, and that the partners themselves may lack a formal measure of accountability among each other, even though the economics are laid out formally in the management company agreement.

Turning to portfolio companies, the board of directors is responsible for the governance of the company, and here we have a very interesting dynamic which often leads to board dysfunction. The VC directors have inherent conflicts of interest as representatives of their funds and as fiduciaries who must act in the best interests of all of the shareholders.  In addition there is a major tension and conflict between the management team and the VC directors. The management wants more share ownership. The common equity is at the bottom of the seniority stack behind the various series of preferred equity rounds. The VCs want capital efficiency, which means they want management to do more with less. Compounding the complexity is the fact that most VC-backed companies replace their CEOs twice between the founding and the liquidity event. So you can imagine that the VC boardroom governance equation is very complex and rife with opportunities for problems.

Do Institutional Investors Have More Clout Now?

 

This week has been an eye opener in terms of customer service. As I've been signing off on more than a few big purchases related to the opening of a new office, I've noticed that some companies are definitely better than others when it comes to the care and feeding of those who fund their paycheck.

Take Company A for example. Since certain of their models are forced into obsolescence by top management (though still functional), they no longer sell spare parts so one has no choice but to toss otherwise viable products in the trashbin. It seems wasteful to this budget-focused gal but the vendor leaves me little room to maneuver. 

Then there is Company B. A purveyor of premium communication accessories, their service representative took down copious details about shipping location and what products we wanted to order. However, to pay for the merchandise, we were directed to a separate billing clerk who had us repeat all the gory details because the two departments had systems that did not talk to one another.

Company C has limited customer service hours and no "Contact Us" email address posted on their website. Hence, we were forced to take precious time during the next work day to call the vendor after we missed reaching them during a limited client care window. It would have been so much nicer to be able to call during extended hours or send a quick email.

The list goes on. I'm sure readers have their own tales to tell.

Anyhow, this repeated angst got me to thinking about client service in buyside land, fiduciary asymmetries and balance of power when it comes to large-scale purchasing. We've conducted enough market research studies to know that things are definitely changing in favor of institutional investors for a bunch of reasons.

Yet, and somewhat puzzling to some (though not to us), there still seems to be a disconnect between how certain products and services are sold to buy side executives. Some transactions that should make immediate sense are not necessarily causing the cash register to kaching for vendors.

Take risk management information technology or due diligence audits for example. Arguably a no-brainer to buy a product or service that helps one better identify, measure and manage risk, whether monies are being managed internally or not, some areas of IT and consulting spending have dipped according to recently published industry reports. While this may change (risk control is the new cool and budgets are being relaxed a bit), a reasonable person logically asks about barriers that currently inhibit sales. VERY importantly, part of the conundrum is the proper identification as to who makes for a logical buyer - Asset Manager? Consultant? Institutional Investor? All of the Above? None of the Above? Other?

When we've dug deep with organizations on both sides of the fence, we've heard variations of the following (with a gigantic caveat that there are some terrific companies in the vanguard when it comes to infrastructure that explicitly embraces their sensitivity to the fiduciary duties for which their institutional investor clients are responsible to discharge):

  • From a hypothetical service provider - "We aren't going to implement best practices X, Y and Z until the institutional investor requires us to do so. Otherwise, we're spending money we don't have to spend." 
  • From a hypothetical consulting firm - "We couldn't possibly engage in all of the best practices you recommend because of the costs to implement. We can't charge our clients enough to recoup our outlays."
  • From a hypothetical institutional investment executive - "We just assumed that our vendors are doing what they need to do in order to vet qualitative and quantitative risks appropriately.

No doubt lasting changes are underway with respect to industry participants, pricing structure and investment governance policies and procedures. With turmoil, there is tremendous opportunity to do well by doing good. We are excited about what the future holds in terms of investment best practices.

Risk Management for Corporate Counsel

I am pleased to announce my participation as part of the February 26, 2009 Lexis Nexis Corporate Counsel Series. According to the official program site, the 60-minute Webcast will focus on critical corporate governance and risk assessment issues that pertain to in-house company attorneys. Click here to register for what promises to be an interesting and timely event.

I've excerpted information about panelists below. I hope you can join us.

  • Susan Mangiero, Financial Analyst, Risk Assessment and Valuation Expert -  Susan has over 20 years of experience in capital markets, global treasury, asset-liability management, portfolio management, economic and investment analysis, derivatives, financial risk control and valuation. She has worked for organizations such as the General Electric Company, PricewaterhouseCoopers LLP, Bank of America, and Bankers Trust.
  • Lynn Brewer, Ethics Expert and Author of Confessions of an Enron Executive: A Whistleblower's Story - Lynn was responsible for Risk Management in Energy Operations at Enron, worked in forensic accounting, and spent 18 years as a legal professional in private practice until she joined Ralston Purina, where she worked in Corporated Development for the General Counsel and Chief Financial Officer.
  • Jason Greenblatt, Executive Vice President and General Counsel. The Trump Organization - Jason is involved in a large number of transactions worldwide, including deals with major financial institutions, Fortune 500 companies, governmental agencies, and joint venture partners.

Risk Oversight and the Boardroom

Ms. Alexandra Reed Lajoux, with the National Association of Corporate Directors ("NACD"), responds to "Pension Funds Ask - "Who is Responsible for Risk Oversight? " as follows:

"New appointees face a steep learning curve that exposes a company to risk of another kind. Excellent point, well made. Director education is the key!"

I will be speaking at the 2008 NACD Corporate Governance Conference in just a few weeks. The panel is entitled "What Directors Must Know About the Company's Pension Plan." A session description follows.

"In light of the unanimous U.S. Supreme Court LaRue decisions, panelists look at the board's oversight responsibilities of ERISA plans to assure they are well managed. Historically, many boards have been uninvolved in the plans and have not exercised adequate oversight. From a governance and risk management perspective, we look at salient issues and core elements of oversight that should be addressed at the board level."

Click to read more about the 2008 NACD Corporate Governance Conference.

Dutch and US Lawmakers React to Hedge Fund Activists

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."

CSX Battles Hedge Funds - A Cautionary Tale for Pensions?

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.

Pension Power in the Boardroom

On April 7, 2008, this blogger wrote about unhappy pension campers, seeking to rid troubled companies of certain board members. (See "Three Public Pension Plans Say No Thanks.") At the time, the general consensus seemed to be "good luck but don't count on being able to oust anyone" in part because experts suggest that boards may be limited in their oversight capabilities. In what appears to be a win for protesting pensions, director Mary Pugh has resigned from Washington Mutual. According to The Street.com, CtW Investment Group had asked shareholders to draw support for Pugh (chairwoman of the bank's finance committee) and a second director, James Stever (chairman of the human resources committee). In a slide presentation and on its website, CtW blames this duo for failing "to recognize and act in a timely manner on the risks to shareholder value presented by the housing bubble" and for not reducing executive bonuses as a result of "this risk management failure." Note that she was re-elected with "50.4 percent of the shareholder vote" according to the Associated Press ("WaMu directors narrowly re-elected in shareholder vote, April 16, 2007), notwithstanding a Q1-2008 reported loss of $1.1 billion.

Click to read "WaMu Director Resigns Under Pressure" by Laurie Kulikowski (TheStreet.com, April 15, 2008).

Three Public Pension Plans Say "No Thanks"

Related to our April 6, 2008 post about risk management oversight (asking who is in charge is a logical query), Wall Street Journal reporter Jed Horowitz writes about unhappy pension campers.  Three plans are now on record as opposing the re-election of various Morgan Stanley directors, including Chairman and CEO John Mack. They include: (a) California State Teachers' Retirement System (b) State Universities Retirement System of Illinois and the State of Connecticut Retirement Plans & Trust Funds. Citing "failure to generate returns consistent with the broad stock market," inter alia, they decry an adverse impact of the company's risk-taking on the value of their Morgan Stanley shares. See "Morgan Stanley Board Feels Heat Over Loss" (April 7, 2008).

Pension Funds Ask - "Who is Responsible for Risk Oversight?"

In "Bear's board was busy elsewhere," Financial News reporter Jeff Nash (March 31, 2008) writes that the investment bank's board has been busy, with three individuals doing work for "at least four other public companies" and two "of those three extremely busy directors" doing double duty as members of the risk committee. Corporate governance pundits add that outside distractions do little to help business fiduciaries carry out critical risk oversight duties.

Wall Street Journal reporter George Anders likewise addresses the question of where the buck stops, or if it arrived at all. In "Wall Street Housecleaning May Bypass Boardroom," the executive director of the $12 billion Illinois State Board of Investment, William R. Atwood puzzles over the involvement of directors as relates to sub-prime losses, wondering if "directors at big banks and Wall Street firms share some responsibility for what has gone wrong." Others quoted in the April 2, 2008 article counter that it may be ill-advised to unseat veteran directors. New appointees face a steep learning curve that exposes a company to risk of another kind.

The courts will surely play a prominent role in determining who pays (if at all) as shareholders and pension plan participants file lawsuits aplenty.

Hedge Funds - Boardroom Friends or Foe?

As hedge funds around the world take a seat in the boardroom, new rules of engagement apply. In response, the Conference Board Governance Center Research Working Group on Hedge Fund Activism issues draft guidelines for companies under attack from alternative capital pools.

According to its March 18, 2008 press release, the Conference Board prioritizes five areas, as excerpted below.

  • What corporations can do to better monitor securities holdings and learn about those accumulations of stock or extraordinary trading patterns that may reveal a hedge fund's activism tactic.
  • What measures corporations can adopt to avoid becoming a target.
  • How boards and senior executives can react to an activism campaign and how they should respond to requests for change made by hedge funds.
  • How companies and large institutional investors can ensure integrity of the voting process in those situations where hedge funds borrow shares for the sole purpose of influencing a shareholders' vote.
  • What considerations institutional investors should be mindful of when allocating some of their assets to hedge funds pursuing activism strategies.

Pension plan fiduciaries are urged to "pursue their beneficiaries' long-term interest" when allocating monies to hedge funds that are likely to buy shares in public companies. Does this imply that hedge fund activists may be motivated by short-term gains only? The authors provoke with an intriguing question. What are institutional investors obliged to do so as not to reduce "shareholder value for companies that may be held elsewhere in their portfolio?" This is a valid query for several reasons. First, a pension plan may be working against itself if it invests in both an activist hedge fund and a particular company, each with divergent interests. Second, a plan sponsor may think it is getting diversification when in fact it is doubling up (or more) on a particular equity issuer. The economic consequences could be profound.

Members of the public are invited to comment before April 30, 2008. A final report is planned for June 2008. Click to download "Report of the Conference Board Research Working Group on Hedge Fund Activism: Findings and Recommendations for Corporations and Investors."

Adopting a similar stance that hedge fund activism is a "must know" topic, the National Association of Corporate Directors hosts an afternoon program in New York City on April 17. Entitled "Activist Hedge Funds: What Public Company Directors Need to Know," the esteemed speakers will address the reality that "hedge funds now account for as much as 30% of total U.S. equity trading." Click here to register.

New IRS Form Mandates Governance Disclosures for Non Profits - What About Pensions?

Little noticed inside the pension community is a provision of the Pension Protection Act of 2006 that directly impacts reporting by tax-exempt organizations. What's interesting is that required changes mandate important governance disclosures for churches and foundations and other non-profits. According to Guidestar.org, "Form 990-T was considered a tax return and was not open to public inspection. The Pension Protection Act of 2006, however, mandates that any IRS Form 990-T filed by a 501(c)(3) organization after August 17, 2006, is now a public document. The exception is a Form 990-T filed solely to request a refund of the telephone excise tax."

Too bad the same disclosures are out of reach for anyone interested in understanding the nature of fiduciary risk attached to pension plans. As we pointed out in "Searching for Hidden Treasure" (April 17, 2006), even seemingly "mundane" information such as who makes primary decisions about defined benefit and defined contribution plans is often out of reach. As I wrote then, other than the names of the plan sponsor and plan administrator (found on Form 5500), no one knows much about who is in charge. (Some databases provide this information for a fee and various plan sponsors voluntarily provide this information online or in writing.)

Wouldn't it be grand to know more about who is making critical decisions regarding the $10 trillion pension industry? After all, how can we reward "good players" and hold "bad" or "careless" fiduciaries accountable if they operate in the shadows?

At a time when the SEC is asking for additional information (executive compensation decisions, audit committees, etc) and FASB wants to know more (having just announced plans to promote pension investment risk disclosure) where is the upset about pension fiduciaries - who they are, how they are selected and whether they are qualified for the tasks put upon them?

Editor's Note:

Part III questions of the newly revised form 990 are shown below. The IRS website provides detailed instructions and commentary.

  • Enter the number of members of the governing body
  • Did the organization make any significant changes to its organizing or governing documents?
  • Does the organization have a written conflict of interest policy?
  • Does the organization have a written whistleblower policy?
  • Does the organization contemporaneously document the meetings of the governing body and related committees through the preparation of minutes or other similar documentation?
  • Enter the number of independent members of the governing body
  • If “Yes,” how many transactions did the organization review under this policy and related
    procedures during the year?
  • Does the organization have a written document retention and destruction policy?
  • Does the organization have local chapters, branches or affiliates?
  • If yes, does the organization have written policies and procedures governing the activities of such chapters, affiliates and branches to ensure their operations are consistent with the organization’s?
  • Does an officer, director, trustee, employee or volunteer prepare the organization’s financial statements?
  • Does the organization have an audit committee?
  • How do you make the following available to the public?

Is Pension Governance a Stretch or a Rewarding Practice?

I love the challenge of an intermediate/advanced yoga class and attend as often as my schedule permits. Executing splits and flips like Gumby (am I dating myself here?) comes easy to me so the appeal is likely due to my comfort level in taking stretches to the limit.  Not surprisingly, many of us indulge in hobbies and sports that exploit an existing aptitude or strength. Is this a coincidence?

Do we adopt activities that help us enhance what we already do relatively well ("preaching to the choir")? If true, does that mean that companies with anemic corporate governance policies and practices are unlikely to "walk the pension governance walk" because it's too hard or different from the comfortable status quo?

It's a provocative idea.

At a time when new accounting rules and regulations have the potential to materially impact share price, it would be nice to know if corporate governance precedes pension governance or if the two activities are independent of each other. Indeed, quantifying how much companies care about their stewardship responsibilities is an attention-grabber.

Mounting evidence suggests that a solid reputation matters to the bottom line. According to a July 9, 2007 Business Week article, corporate reputation that is "able to deliver growth, attract top talent, and avoid ethical mishaps" may explain "much of the 30%-to-70% gap between the book value of most companies and their market capitalizations." This statement ignores some of the measurement issues that determine the book value - market value gap but merits review. Click here to access the article. (Registration may be required.)

  • How much is a good name worth and what exact governance policies and procedures tend to drive up stock prices?
  • Do investors care more about compliance or do they reward going beyond what is minimally required by law?
  • Is the relationship symmetric in the sense that stock issued by corporate baddies should be avoided at all costs while "hero equity" makes for good buys?

Wall Street Journal reporter Phred Dvorak quotes CEO of GovernanceMetrics International, Howard Sherman, as saying that "Good governance translates into trust, and trust determines what you're willing to pay for a company's shares." That makes sense but a further read of the July 2, 2007 article informs readers that ratings can and do vary. Audit Integrity and other rivals end up with a different "you go gal" list, in part because they employ alternative measures. Click here to read "Finding the Best Measure Of 'Corporate Citizenship' Governance Trackers Use Various Rating Criteria, Leaving Users Confused." (Registration may be required.)

One thing is certain. The business of governance is far from trivial. In a July 2, 2007 press release, Ethan Berman, chief executive officer of RiskMetrics explains the rationale for its announced acquisition of the Center for Research & Analysis ("CFRA"). Proud owner of proxy advisory firm Institutional Shareholder Services ("ISS"), RiskMetrics will name CFRA CEO Rich Leggett as head of ISS. Click here to read the full text announcement.

Note: In the spirit of full disclosure, Pension Governance, LLC currently resells CFRA products, including its PPM (Pension Portfolio Monitor) product. Click here to learn more. We are also developing a three-day in-person workshop about pension risk management with RiskMetrics. Click here to get more details about the debut September program.

Please Welcome an Interesting Corporate Governance Blog

As we've said before and will continue to say, the link between corporate governance and pension governance is strong and growing. We welcome the ISS (Institutional Shareholder Services) Corporate Governance Blog to our Links.

Pension Investors, Corporate Governance and Financial Reporting



According to the New York Stock Exchange Fact Book, pension ownership now accounts for nearly twenty-five cents of every equity dollar. No surprise then that the governance movement is alive and well and ensuring that forthcoming talks about proxy reform receive wide attention.

Part of the SEC's roundtable discussions about voting reform, various institutional investors, attorneys and governance experts will meet on May 7 to talk about topics such as shareholder rights under state law, whether investors should be able to exert more influence over corporate management and the role of the SEC in overseeing the proxy process. Click here to access the full agenda and list (and bios) of speakers. Subsequent meetings will take place later this month.

At a time when large shareholders crave more power over issues such as executive pay, corporate social responsibility and proper financial disclosure, a meaningful conversation is welcome.

On a related note, the PCAOB (Public Company Accounting Oversight Board) concluded its first International Auditor Regulatory Institute on May 4, 2007. With representatives from over forty countries assembling to discuss how the PCAOB handles Sarbanes-Oxley Act of 2002 compliance, chairman Mark Olson extols the notion of global oversight.

Also in the news, BDO Seidman's "Financial Reporting" letter (dated May 2007) is replete with question lists for shareholders. Organized by topic such as board composition, audit committees, preparation of financial statements, management's strategic plans and business ethics, the publication is easy to understand and serves as a useful guide.  The sub-list on risk management emphasizes company-wide issues, including, but not limited to, topics such as the role of the board in developing a risk management system and the choice of risk management techniques to evaluate "the adequacy and cost effectiveness of insured risks." Questions related to derivatives and financial risk are shown below (excerpted verbatim from the BDO document). Click here for the full text publication.

1. Does the company use enterprise risk management?
2. What is the company's attitude towards financial risk?
3. Were there any significant foreign currency exchange gains or losses in 2006 and in interim 2007 operations?
4. What is the company doing to minimize the impact of changes in foreign currency rates?
5. Does the company hedge its foreign currency exposures?
6. What types of financial instruments and derivatives does the company use?
7. What are the major risks from the company's use of financial instruments or derivatives (e.g. options, futures, forwards, caps, collars, interest rate swaps)?
8. Does the company have written guidelines and policies on the use of financial instruments and derivative instruments?
9. Who formulated those policies?
10. Did the board of directors approve those policies?
11. Do management and the board of directors monitor the company's financial instruments and derivatives exposures?
12. Is there a limit system in place (i.e. a system that sets the maximum amount of loss the company would tolerate before liquidating a position)?

PG Editor's Note: We are (and will continue to) address many of these issues online. Visit www.pensiongovernance.com. Also watch for our soon-to-be published newsletter about the use of derivatives, investment fiduciary risk, financial statement analysis and so much more. Pension Risk AlertSM will examine risk and valuation issues from a "how-to" perspective. Email us if you want to be notified about the availability of this informative newsletter.

Pension Plan Plaintiffs Cost Corporate Defendants With Opt-Outs

A recent trend in class action litigation circles is the pension plan opt-out. Choosing not to settle with the rest of the "class," several large institutional investors are getting recompense that reflects multiples of what they could otherwise receive.

Pension Governance contributing editor, attorney Kevin Lacroix talks about this significant shift in class action outcomes, citing a sea change in the cost of litigation. Click here for more information about Kevin's interesting article and here to read more about our first class team of contributing editors.

PG Editor's Note: We have just posted an interesting and complementary item to www.pensiongovernance.com. In "Predicting Corporate Governance Risk: Evidence from the Directors' & Officers' Liability Insurance Market," authors Tom Baker and Sean J. Griffith examine how liability insurance underwriters assess corporate governance behavior - and related expectations of risk - when pricing coverage. The authors also examine whether corporations are deterred by the cost of liability insurance, especially since "virtually all corporations purchase D&O insurance to cover the risk of shareholder litigation, and because virtually all shareholder litigation settles within the D&O insurance limits, the D&O insurance premium represents the insurer’s best guess of the insured’s expected liability costs." The authors conclude that governance factors such as culture and character are taken into account by insurance underwriters. Click here for more information.

Pension Governance, LLC Sponsors Research Sites

Pension Governance, LLC is pleased to announce the sponsorship of two sections of the Social Science Research Network. Check them out and see for yourself. You'll find interesting research papers and announcements about forthcoming events in the areas of employee benefits law and corporate governance, respectively.  At a time when so much is happening in these two areas, we're delighted to encourage cutting edge analysis by top scholars. Click here to learn more.

Section One: Employee Benefits, Compensation & Pension Law
Edited by Pamela Perun with the Urban Institute, "Employee Benefits, Compensation and Pension Law Abstracts is a forum for the exchange of ideas by policy makers, practitioners and researchers on current employee benefits issues. It publishes abstracts of working papers and recently published and forthcoming articles on the full spectrum of employee benefits, both in the U.S. and abroad, such as healthcare, pension and savings arrangements, cash and equity compensation, and Social Security."

Section Two: Corporate Governance Law
Edited by Bernard S. Black with the University of Texas at Austin Law School, "Corporate Governance Law publishes abstracts of working papers as well as articles accepted for publication in corporate governance law, and related fields of scholarship.."

Union Pension Power

In response to a request from the United Brotherhood of Carpenters and Joiners of America, American Express Co. is slicing retirement benefits for top executives by more than ten percent. According to Wall Street Journal reporter Robin Sidel, the changes "come amid shareholder criticism over supplemental executive retirement plans, or SERPS, that award big pay packages to departing executives." (See "Top Executives at American Express Will See Retirement Benefits Shrink" - January 27-28, 2007).

This is not the first time that unions have taken an activist stance nor will it likely be the last. Check out the long list of Annual Group Meeting (AGM) resolutions brought by union pension plans, courtesy of Ms. Jackie Cook, a researcher on director interlocks and corporate social responsibility. Click here to access the list.

Now that new, and arguably more rigorous, SEC executive compensation disclosure rules are in effect, it will be interesting to observe union response. Will juicy corporate pay packages encourage even more attempts at reform? Will rank-and-file workers find it difficult to lobby for cuts in executive perks while asking for personal hikes? How will the dual role of employee and shareholder affect union clout?

"Workers unite" could start to take on an altogether different meaning.

Who is Responsible for the Benefits Issue?



A question that arises again and again centers on who "owns" the benefits issue at a particular organization. There is increasing evidence that board members and C-level executives are becoming more involved, if not so already. One gentleman told me that his board has met four times this year about pension issues alone.

This comports with the notion that pension, health care and other types of deferred compensation benefit programs can significantly impact a corporate or government employer's financial health, lower debt ratings, diminish (or enhance) employee productivity and influence the ability to attract and retain skilled workers, already in short supply.

So it is with great pleasure that I will be part of a panel that addresses the ownership issue, enterprise risk management and "pension tensions" (though the issues extend to other benefit programs as well).

Entitled "Strategies for Managing Diverse Constituencies: Shareholders, Employees, Beneficiaries and Management" and part of an exciting risk management conference, sponsored by Pensions & Investments, the panel plans to address a host of important governance and financial issues.

Ms. Fern Jones, CFA is the conference moderator. Managing Partner of FJ Corp/THS Ltd, Jones will lead the following panelists in what is sure to be a lively discussion. Speakers include:

Mr. James H. Norman
Managing Director
Deutsche Asset Management

Dr. Susan M. Mangiero, CFA, AVA, FRM and Accredited Investment Fiduciary Analyst
Managing Member
BVA, LLC and Pension Governance, LLC

Mr. Jim M. Voytko
President & COO
R.V. Kuhns & Associates, Inc.

Compliance and Litigation Remain Hot Button Issues



According to Fulbright & Jaworski partner and global chair of the Litigation Department, Stephen C. Dillard, fear may be appropriate with respect to all things litigation. In "Litigation Nation" (Wall Street Journal, November 25, 2006), Dillard describes results from their third Litigation Trend Survey, emphasizing an increasing upward trend in lawsuits here and abroad. "Even we were surprised by the volume and scope of legal actions across all major industries and regardless of company size."

Besides finding that "Some 89% of companies report being hit with at least one new lawsuit in the past year," companies stateside "face an average of 305 lawsuits pending world-wide." At the same time, "companies with sales of $1 billion or more" face an average of 556 cases, "with 50 fresh suits emerging each year for nearly half of these firms."

The cost of litigation is far from trivial. The survey cites corporate legal expenditures averaging $12 million, up from $8 million last year and with some industries - engineering and insurance - spending over $35 million.

Given the nature of this blog, www.pensionriskmatters.com, what caught my eye were the assertions that "more than half of the in-house counsel cited employment as their top litigation concern" and that "disputes over wages and hours can be brought as class actions in many jurisdictions, creating more waves of litigation."

Other press accounts about corporate lawsuits are similarly engaging.

According to the Chief Legal Officer Survey 2006, compliance and litigation are huge concerns. Conducted by Altman Weil, Inc. and LexisNexis Martindale-Hubbell, respondents lament that time and money used to fight and/or prevent lawsuits could not be otherwise used to grow the company.

New York Times reporter Paul B. Brown describes the concept of litigation funding companies in "What's Offline: Next, a Lawsuit Futures Exchange?" Citing Joshua Lipton in "Litigation 2006," Brown informs that hedge funds are researching the possibilities of investing now in anticipation of enjoying hefty case outcomes later on. That same supplement to the American Lawyer & Corporate Counsel includes a piece by Alison Frankel that offers insight about the globalization of litigation.

Lest you need more of a reminder that a sea change is upon us, consider the U.S. Appeals Court decision that found a fiduciary personally liable for nearly $180,000 due to losses realized by the International Brotherhood of Industrial Workers Health and Welfare Fund. In "Ruling highlights fiduciary need for hindsight", Reid and Riege attorneys David M.S. Shaiken and Eileen M. Marks describe the serious fallout from Chao v. Merino, 452 F.3d 174 (2d Cir. 2006), stating that the individual in question "was permanently prohibited from serving as a fiduciary or service provider to any employee benefit plan."

Other excerpts from the November 2006 Employee Benefit News article merit attention.

1. "The Court of Appeals' holding underscores how important it is for new plan fiduciaries to inform themselves thoroughly about a plan's operations, consultants and service providers with whom the plan has contracted. New fiduciaries should raise with co-fiduciaries any concerns about existing relationships after conducting their review.

2. The mere fact that an imprudent relationship predates a fiduciary's tenure does not shield the fiduciary from liability. The duties to be informed about plan business and to act prudently include a duty to be informed about, raise objections to, and protect the fund from any imprudent relationships that are in place with consultants and service providers when a fiduciary's term begins.

3. Plan fiduciaries may wish to review their and their plan's insurance coverage. ERISA plan fiduciary liability insurance covers claims against current and former plan trustees and, if they are named in the policy, plan administrators who have fiduciary duties. In case of a claim of breach of fiduciary duty, within the insurance policy's limits the insurer provides and pays for defense counsel, and indemnifies the plan fiduciary from liability, provided that the claim is not excluded from the policy's coverage."

Given the tsunami of litigation (with all indications that more is on its way), pension fiduciaries need to assess their personal and professional risk.

It's scary stuff indeed. Email us if you want to know more about our fiduciary and board training programs. If you are an attorney, ask to receive our complimentary pension governance kit.

Milton Friedman, Free Markets and Ethics in Business



While November 16, 2006 marks the passing of famed economist, Dr. Milton Friedman, his ideas will no doubt live on for years to come. Economists in the U.S. and abroad embrace his work for its clarity, originality and impact. Recipient of the 1976 Nobel Prize for Economic Science, Friedman was a staunch advocate of free markets, something that put him at odds with the big government crowd. Author of Capitalism and Freedom and co-author (with his wife Rose) of Free to Choose (book and television show), Friedman wrote about the "tyranny of controls" in 1979, adding that "restrictions on economic freedom inevitably affect freedom in general, even such areas as freedom of speech and press." Taking a page from Adam Smith's Wealth of Nations, this well-respected Ph.D. wrote that "it is in the self-interest of the businessman to serve the consumer" and by doing so, everyone wins.

Post-mortem tributes that review Friedman's work as part of a general discussion about free markets versus regulation come at a time when laws such as the Sarbanes-Oxley Act of 2002 are being critically examined. In early September of this year, the Committee on Capital Markets Regulation, "a newly formed independent group of U.S. business, financial, investor and corporate governance, legal, accounting and academic leaders" announced its intent to study ways to "improve the competitiveness of the U.S. public capital markets."

A critical question? How much regulation is enough?

In "Businesses Seek New Protection on Legal Front," journalist Stephen Labaton (New York Times, October 29, 2006) writes that the Committee on Capital Markets Regulation and a parallel group "aim to limit the liability of accounting firms for the work they do on behalf of clients, to force prosecutors to target individual wrongdoers rather than entire companies, and to scale back shareholder lawsuits."

Dr. Friedman was not only prescient but correct to observe that "there is no such thing as a free lunch." Someone, somewhere, somehow pays.

What is an appropriate cost to pay for a relaxation of current rules? More self-policing at the industry level? At the individual company level? At the shareholder level?

With regard to pension funds, should we abandon ERISA and ask company sponsors to provide more transparency and financial backing on their own? How do we reward companies that do that already and without prodding from government watchdogs? Will the aftermath of the Pension Protection Act of 2006 reflect the law of unintended consequences, i.e. outcomes that are antithetical to the original intent of legislators?

Only time will tell but, until then, thank you Dr. Friedman. Your legacy of thought-provoking ideas is a rich one indeed.

Bad Boy Syndrome and Governance



Ever have a sleepless night? You find yourself watching late night television and pondering whether to call overseas clients in their time zone as a way to score points. If so, you may have come across a police reality show known simply as COPS. According to the Fox Television website, COPS is "still one of the most popular television shows on the air," leading one to wonder about the national fascination with crime and disgrace.

Unfortunately, there never seems to be a shortage of bad boys and gals who flaunt the law. The temptation of easy money is too intoxicating for some, ensuring that the saga will likely continue for a long time to come.

Just recently, former Enron CEO Jeffrey Skilling was sentenced to twenty-four years over a corporate scandal that has received significant press attention and prompted a new wave of governance standards and rules. New York Times reporter Alexei Barrionuevo describes Skilling's sentence as slightly shorter than the twenty-five years metered out to Bernie J. Ebbers, former head of WorldCom "who was sentenced to 25 years last year for his role in the $11 billion fraud that led to that company's collapse." (In the spirit of full disclosure, let me confess to owning some two hundred shares of Enron common stock.)

Financial Times reporter Kevin Allison writes that David Kreinberg, former CFO of voicemail software company Converse, "became the first top executive to plead guilty to conspiracy and securities fraud in connection with options backdating." Rumour has it that others are in the hot seat and have hired criminal lawyers.

Financial wrongdoing accounts for an entire industry of specialists. Benchmark Financial Services bills itself as an expert "in investigations of pension fraud, money management abuses and wrongdoing involving securities brokerages and pension investment consultants," adding that their "investigations frequently focus upon illegal or unethical business practices that are commonplace in the securities brokerage, asset management and consulting industries, as well as hidden or poorly disclosed financial arrangements between vendors to pensions."

Another organization, Corporate Resolutions, focuses on fraud, money laundering, risk management and competitive intelligence. President Ken Springer, a Certified Fraud Examiner and former special agent of the Federal Bureau of Investigation, provides an interesting update in the company's monthly newsletter about security issues.

Notwithstanding their efforts, some interesting questions come to mind with respect to how people respond to problems in pension land and elsewhere.

1. Does news about white collar criminal punishments deter others from misdeeds?

2. What type and magnitude of loss roils people to the point of lobbying for changes in the system, with the goal of minimizing future mishaps?

3. Does the avoidance of shame play a role in keeping financial abuses to a minimum? (How many rogue traders are now making a nice living as commentators, security consultants or well-published writers?)

4. What is the fine line between fraud and unethical practices?

5. Who is responsible for early detection of fraud within an organization?

6. What can investors and/or plan beneficiaries do to protect themselves from fraud and "ethically challenged" decision-makers?

Taking a pro-active approach can go a long way to calming jitters. For pension fiduciaries, providing transparency about the investment process, including choice of money managers and related vendors, is huge.

Why then is it often difficult to get meaningful information about a plan and how it is being managed? Why do we pay attention to the bad boys and gals instead of more emphatically rewarding all the good players?

General Counsel in the Hot Seat - Who's Next?



I can't tell you how many conversations I've had on the topic of governance and what motivates behavior, good or bad. Is it the proverbial carrot or stick? What is that one event (or series of events) that changes the collective mindset and spurs organizations to take action?

The answer I get most of the time is that people will act when they are forced to do so, either because of regulation, litigation, liability insurance hikes, regulatory investigation, losses that lead to headlines and so on.

Does that imply that bad news is a harbinger of corporate governance activity (and by extension, pension governance)?

If so, then a recent article about corporate counsel liability is a must read. According to "Gatekeeper GCs Increasingly Becoming Targets for Liability" by Sheri Qualters, gatekeepers like corporate attorneys are under "escalating government scrutiny" for failing to protect shareholders' interests. As a result, "in-house counsel and their law firm advisers say they're increasingly concerned about potential liability faced by in-house lawyers, who are stepping up their documentation of advice and even taking on additional professional liability insurance as precautionary measures."

Securities litigation lawyer William Schuman with McDermott Will & Emery's Chicago office offers that "The current mindset at enforcement agencies is that general counsel need to protect the shareholders' best interests, not just do the management team's bidding."

So how does this relate to life in pension land?

Let me count the ways.

1. There is increasing recognition that ERISA and Sarbanes-Oxley go hand in hand and that anyone involved in corporate governance is necessarily on the hook for pension governance. (In case you missed it, click here to read "Can Poor Pension Governance Land You in Jail?")

2. The first of several major accounting rule changes announced last week have the potential to wreak financial havoc for companies with underfunded plans. There is some talk that even companies with "healthy" plans may find the heightened scrutiny by investors a bit tough to take. Similar to stock drop cases, one wonders if adverse financial statement impact could lead to shareholder suits.

3. In the aftermath of several hedge fund blow-ups, do some ERISA plan fiduciaries leave themselves exposed if their selection process is anything but robust?

4. Will 401(k) plan providers be accused of selecting an inappropriate default investment option (pursuant to the Pension Protection Act of 2006) and have to quell participants' concerns in court?

5. How many more complaints will be filed on the basis of fiduciary breach with respect to the payment of investment fees? (See "Employers Face Suits Over 401(k) Fees" by Arden Dale and Jilian Mincer, Dow Jones Newswires, October 3, 2006.)

These are just a few of the many outcomes we think could lead shareholders to cry foul, sue and put the general counsel, board members and other parties in the liability hot seat.

Drop us a line if you want to talk further.

Can Poor Pension Governance Land You in Jail?



In a riveting and timely article, senior Greenberg Traurig ERISA attorney Jeff Mamorsky provides a serious wake-up call to pension fiduciaries everywhere. (Click here to read "Is Today's Pension Plan Environment Cause for Concern?", CEO Magazine, August 2006.)

Mamorsky chronicles the parade of corporate horribles in the U.S. that eventually led to the Sarbanes-Oxley Act of 2002 (SOX). He points out the irony that "All this happened in the USA despite the fact that the federal pension law, the Employee Retirement Income Security Act of 1974 (ERISA), contains rules that require plan sponsors to establish internal control procedures to monitor compliance with the fiduciary responsibility requirements of ERISA."

In the spirit of the stick winning over the carrot, Mamorsky adds that "These rules were in some cases not followed since there were few real teeth in the law. It took SOX with its draconian certification penalties and ERISA's 'white collar' criminal penalty provisions to make plan sponsors take pension governance more seriously."

Emphasizing the nature of personal liability for pension fiduciaries, the article explains the critical, and undeniable, connection between SOX compliance and pension governance. In a rather ominous statement, Mamorsky warns "This liability has increased as the result of legislation such as SOX that requires a public company CEO, CFO or other responsible fiduciary to certify the establishment and adequacy of 'disclosure controls and procedures' relating to material items in the annual financial report. What companies sometimes overlook is that this SOX section 404 management assessment of the adequacy of internal control procedures requirement applies to pension and benefit expenses."

If you aren't scared at this point in the article, he goes on to describe SOX sanctions of money and jail - "$2m and up to ten years' imprisonment for non-wilful ($5m / up to 20 years' imprisonment for wilful) certification of any statement that does not comply with SOX requirements." Then there is the matter of heightened IRS scrutiny of pension plan governance (or lack thereof), a rise in litigation and general upset about the topics du jour, pension funding gaps, rescinded benefits and so on.

Mamorsky concludes that the rest of the world is starting to feel the pinch as the UK and other countries address governance as an important element of the "global pension world."

As an aside, our sister company, Pension Governance, LLC is soon to launch a pension litigation database, chock full of analyses and trends. We had planned to launch earlier but found many more cases than we originally anticipated.

A harbinger of days ahead in pension governance land?

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!

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 ...