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

I am delighted to have been invited to join the faculty of the Master’s Track at the annual fi360 investment fiduciary conference, held this year in Scottsdale, Arizona. Speakers include: (1) ERISA attorney Charles Humphrey (2) Edward Lynch, AIFA, RF, GFS with Fiduciary Plan Governance, LLC (3) Dr. Susan Mangiero, AIFA, CFA, FRM with Fiduciary Leadership, LLC and (4) pension auditor Michelle Sullivan, CPA with Freed Maxick CPAs

The fi360 Master’s Track offerings are created especially for those with a knowledge of fiduciary standards and how that standard applies to the topics being presented.

Our session is entitled "Due Diligence for Alternative Investments." Our panel will focus both on the legal issues and the internal control compliance issues that cannot be ignored by anyone with a fiduciary responsibility to prudently select and monitor. This session will describe the impact of Dodd-Frank on investing in alternatives, various court cases and regulatory enforcement actions as well as the DOL/IRS regulatory guidance on alternative investment allocations. Click to read more about this session and the other sessions to be presented at this conference of investment fiduciary professionals from April 17 to April 19.

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In recent discussions with asset managers, pension trustees and consultants, investment fraud continues to attract attention. It is no surprise that people want to know more about what constitutes bad practice versus crossing the line, especially in the aftermath of a devastating few years of economic losses. New disclosure regulations are another catalyst for learning more about how to avoid trouble. Email your request if you want more information about what can be done to detect fraud and/or would like to receive research and thought leadership on the topic of investment fraud.

Impending changes to fiduciary standards and allegations of fiduciary breach likewise continue to create a stir.

In "The EBSA Cracks Down on Retirement Plan Advisors," AdvisorOne's Melanie Waddell (March 26, 2012) describes a material increase in enforcement actions brought by the U.S. Department of Labor ("DOL"), Employee Benefits Security Administration ("EBSA"). Besides effecting nearly 3,500 civil cases in 2011, EBSA closed 302 criminal cases with "129 individuals being indicted," "75 cases being closed with guilty pleas or convictions" and an excess of $1.3 billion in monetary damages collected. Quoting Andy Larson with the Retirement Learning Center, the article mentions fiduciary negligence as a key concern of regulation and a driving force behind a proposed expansion of ERISA fiduciary duties to numerous professionals who work with retirement plans in an advisory capacity.

ERISA Attorney David Pickle points out that fraud and embezzlement of 401(k) plan money have been investigated for years by the DOL and U.S. Department of Justice ("DOJ") but recent investigations are being done now as part of the formal Contributory Plans Criminal Project ("CPCP"). He observes that "the DOL is conducting an increasing number of investigations of financial service providers, including registered advisers, banks and trust companies (both as trustees or custodians but also as asset managers), and consultants. For other insights about ERISA pain points, read "An Excerpt From: K&L Global Government Solutions (R) 2012: Annual Outlook."

According to the ERISA enforcement manual, civil violations include:

• Failure to operate a plan prudently and for the exclusive benefit of participants
• Use of plan assets to benefit the plan administrator, sponsor and other related parties
• Failure to properly value plan assets at the current fair market value
• Failure to adhere to the terms of a plan (assuming that those terms are compatible with ERISA)
• Failure to properly select and monitor service providers
• Unlawfully taking action against a plan participant who seeks to exercise his or her rights.

Criminal violations include:

• Embezzlement of monies
• Accepting kickbacks
• Making false statements.

The "oops - I didn't know" strategy is unlikely to serve those who work with or for pension plans. The spotlight continues to focus on ways to improve the management of $17+ trillion U.S. retirement system and rightly so. There is so much at stake for millions of people.

George Washington said that "In executing the duties of my present important station, I can promise nothing but purity of intentions, and, in carrying these into effect, fidelity and diligence.

ERISA and public pension trustees are likewise tasked to be faithful and diligent, among other things. For those who choose a different path, the outcome can be dire indeed. Jail time and stiff penalties as well as legal costs are a few of the potential costs associated with a fraud conviction, not to mention shame and the loss of income.

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Join me on May 1, 2012 for a timely and interesting program about alternative investment fund due diligence and other considerations for ERISA plan sponsors, their counsel and consultants. Click here for more information.

This CLE webinar will provide ERISA and asset management counsel with a review of effective due diligence practices by institutional investors. Best practices will be offered to mitigate government scrutiny and suits by plan participants.

Description

With the DOL's and SEC's new disclosure rules and heightened concerns about compliance and valuation, corporate pension plans that invest in alternatives must focus on properly vetting asset managers more than ever before or risk being sued for poor governance and excessive risk-taking.

The urgencies are real. The use of private funds by asset managers is crucial for 401(k) and defined benefit plan decision makers. Understanding the obligations of private funds is essential to any retirement funds with limited partnership interests.

In addition, suits and enforcement actions against asset managers make it incumbent on counsel to hedge fund and private equity fund managers to fully grasp and advise on full compliance with the duties of ERISA fiduciaries to plan participants.

Listen as our ERISA-experienced panel provides a guide to the legal and investment landmines that can destroy portfolio values and expose institutional investors and fund managers to liability risks. The panel will outline best practices for implementing effective due diligence procedures.

Outline

• ERISA fiduciary duties for institutional investors
  1. Hedge funds and private equity funds compared to traditional investments
• Regulatory developments
  1. Disclosure
  2. Compliance
  3. Valuation
• Developments in private litigation involving pension plan fiduciaries and alternative fund managers
• Best practices for developing due diligence plans

Benefits

The panel will review these and other key questions:

Following the speaker presentations, you'll have an opportunity to get answers to your specific questions during the interactive Q&A.

• Regulatory developments
  1. Disclosure
  2. Compliance
  3. Valuation
• Developments in private litigation involving pension plan fiduciaries and alternative fund managers
• Best practices for developing due diligence plans
• What are the regulatory concerns for ERISA pension plans that allocate assets to hedge funds and private equity funds?
• What are the potential consequences for service providers that fail to comply with new fee, valuation and service provider due diligence regulations?
• What can counsel to pension plans and asset managers learn from recent private fund suits relating to collateral, risk-taking, pricing, insider trading and much more?
• How should ERISA plans and asset managers prepare to comply with expanded fiduciary standards?

Following the speaker presentations, you'll have an opportunity to get answers to your specific questions during the interactive Q&A.

Faculty

Susan Mangiero, Managing Director
FTI Consulting, New York

She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors as well as offered expert testimony and behind-the-scenes forensic analysis, calculation of damages and rebuttal report commentary for various investment governance, investment performance, fiduciary breach, prudence, risk and valuation matters.

Alexandra Poe, Partner
Reed Smith, New York

She has over 25 years of experience in investment management practice counseling managers of hedge funds, private equity funds, institutional accounts, mutual funds and broker-dealer advised programs. She counsels hedge and private equity fund advisers in all stages of their business and due diligence matters.

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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.

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Since I launched my second blog in early 2011 to discuss risk management and investment best practices for a wider institutional audience beyond pension plans alone, I've seldom posted items in both places. Instead, I've tried to provide unique insights for employee benefit plan decision-makers on www.PensionRiskMatters.com and address broader regulatory, litigation and compliance issues on www.GoodRiskGovernancePays.com.

Today is an exception. I am reprinting my comments about risk management on both blogs because I believe so strongly in the importance of effective risk management as an integral component of investment governance. I hope you enjoy reading my comments, originally published on The Glass Hammer website. For those who are not familiar with the group, check out www.TheGlassHammer.com to learn about this award-winning blog and online community created for women executives in finance, law, technology and big business. See below or click on "Thought Leaders: Prioritizing Risk Management" to read the full text of this commentary about the benefits of risk mitigation well done and the costly consequences of inattention or sloppy practices.

Full Text:

Thought Leaders: Prioritizing Risk Management, July 14, 2011, 1:00 pm

Contributed by Susan Mangiero, PhD, Investment Risk Governance Consultant and Author

For those financial institutions which have yet to grasp the importance of identifying, measuring, managing, and monitoring risks on a comprehensive basis, time may not be on their side. Regulators and litigators alike are forcing change.

There are countless individuals who want better information from their service providers about risk and are prepared to vote with their feet if they don’t get good answers. After all, these institutional investors themselves are confronted with a bevy of new mandates that require transparency. The good news is that change opens the door to business opportunities. Enlightened organizations that have good processes in place and have nothing to hide can differentiate themselves from competitors. Providing clients with education and data tools offers yet another way for asset managers, consultants, banks, and advisors to forge stronger relationships with their pension, endowment, foundation and family office clients. On the flip side, those who are reluctant to explain how they manage their financial, operational and legal risks may lose clients or worse yet, could end up as defendants in a lawsuit.

Pay to play conflicts, questions about hidden fees, state and federal legislation and new accounting rules are a few of the forces at work to ensure that trillions of institutional dollars are in good hands. Effective investment stewardship is no longer a luxury. Recent surveys confirm that buy side decision-makers continue to emphasize governance and risk management for their organizations as well as providers of products and services. Institutional investors can ill afford to lose money after a tumultuous few years. Investment committee members who give short shrift to fiduciary duties could end up being investigated by regulators or sued. According to federal court data, the number of ERISA lawsuits is going up. Factor in investment arbitrations, enforcement actions and “piggyback” securities litigation allegations and it is clear that unhappy investors are not going to accept the status quo.

1. Fiduciary Focus

Besides efforts underway by the U.S. Securities and Exchange Commission (SEC), the U.S. Department of Labor (DOL) has proposed an expanded definition of who should serve as a fiduciary to ERISA employee benefit plans. If adopted, countless more professionals will be tasked with demonstrating procedural prudence when it comes to the investment of over $30 trillion in money from corporate retirement plan sponsors. States are likewise seeking change in the form of trust law reforms that tighten accountability for the investment of monies held by endowments, foundations and charities. The questions now being addressed by judges and arbitration panels relate to “excessive” risk-taking, insufficient diversification, absence of independent assessments of hard-to-value instruments and oversight failures that have led to large losses that might have been highly preventable.

One asset management firm recently settled with the SEC for $242 million over a mistake with one of its risk management models. Another firm just settled with the SEC for $200 million due to problems in the way subprime securities were marked. A few years ago, a Northeast pension plan was sanctioned by the DOL for not having thoroughly vetted valuation numbers provided by one of its hedge fund managers.

When I testified before the ERISA Advisory Council in 2008, I emphasized that having good valuation policies and procedures is essential because it impacts so many decisions having to do with asset allocation, hedging and fees paid.

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Five years ago, valuation and risk management professional Dr. Susan Mangiero launched the first blog devoted exclusively to the topic of retirement plan governance and investment best practices. This unique blog, www.PensionRiskMatters.com, continues to serve as a resource for ERISA and public plan trustees, board members, actuaries, advisers, attorneys, auditors, consultants, money managers and regulators who want to explore important ideas about pension risk issues within a fiduciary framework.

Since the inception of www.PensionRiskMatters.com, the challenges that confront retirement plan decision-makers continue to mount. The U.S. Department of Labor (“DOL”) and U.S. Securities and Exchange Commission (“SEC”) each seek to expand the definition and scope of investment fiduciary duties. Pension litigation is on the rise with some lawsuits being certified as class actions and resulting in multi-million dollar settlements. Liability insurance underwriters and federal, state and international regulators are asking tough questions about risk-taking and due diligence. Lawmakers actively examine issues relating to 401(k) fees. Taxpayers worry that more than $3 trillion of unfunded IOUs will strain local budgets. Pay-to-play and other types of conflict of interest investigations grab headlines. Investors worry that bad employee benefit plan economics could roil share prices or thwart corporate mergers.

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Dr. Susan Mangiero, CFA, FRM is pleased to join a panel entitled "Manager Monitoring & Ongoing Due Diligence" on March 30, 2011 in New York City. Part of IMN's "Real Estate Investment & Search Consultants Congress: Meet the Gatekeepers" event, Dr. Mangiero will participate in a discussion about the following topics:

• Factors used to evaluate fund managers;
• Asset manager - client communication best practices;
• Organization and strategies as relates to style shifts;
• When to consider replacing a manager;
• Duties of a limited partner;
• Benchmarking against the agreed upon scope of work; and
• Performance reporting pitfalls.

According to statistics published by the Pension Real Estate Association ("PREA"), real estate equity accounts for an average of roughly 4.6 percent of surveyed plans that control about $5 trillion in assets (including single-employer public and corporate pensions, endowments, foundations and Taft-Hartley plans). About 90 percent of surveyed institutional investors state that they expect no change in allocation to this asset class. Given the size of monies being deployed to real estate and the various mechanisms used (including but not limited to commingled funds, direct investments, real estate investment trusts, joint ventures), a detailed discussion about manager due diligence is timely and helpful.

Use online registration code SP10 if you plan to attend this conference in the Big Apple on March 30.

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Today's blog post is provided, courtesy of Mr. Phil Chiricotti, President of the Center for Due Diligence. Since the topic of contract review as an important element of proper due diligence is one which I have addressed elsewhere on www.pensionriskmatters.com and in my articles and speeches, I asked Phil for permission to reprint his article and he kindly agreed.         

                                          Advisor Service Agreements: The Weak Link

Enormous attention has been centered on retirement plan fees in recent years, including the new 408(b)(2)disclosure requirements. The liability has also increased for those who fail to comply. Lost in this shuffle is the fact that fees are only one piece of the puzzle.

While a well drafted, reviewed and understood service agreement can help preclude errors and claims, the service agreement is also the primary defense against liability caused by service provider mistakes and negligence. In spite of this important role, many plan sponsors - particularly small plan sponsors - sign standard service agreements without adequate review or counsel.

In addition to agreeing to vague service agreements, some sponsors engage advisors without a service agreement or verification of insurance coverage and bonding. As noted many times, most small plan sponsors also lack first party fiduciary liability insurance. A combination of the aforementioned is nothing less than a nuclear accident waiting to happen.

The DOL's new regulations provide an increase in both fee disclosure and clarity for comparative shopping, but 408(b)(2) does not preclude the need for an equitable service agreement. In our minds, the service agreement remains a weak link in the advisor vetting process, particularly in the small plan market. Indeed, the service agreement may not even reflect what was discussed and/or negotiated during the vetting process.

As noted by many attorneys, ERISA's primary focus has been on regulating the relationship between plan sponsors and participants. Beyond prohibited transactions and prior to the DOL's new disclosure regulations, little guidance was provided on how to manage the relationship between sponsors and service providers, including those assuming a fiduciary role.

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According to "State workers face privatization" by Jason Stein (Milwaukee Journal Sentinel, January 6, 2011), over 300 Wisconsin State Department of Commerce employees may soon be classified differently. The stated goal is to better deploy its $183 million budget to try to create jobs. (Whether you believe that governments are the engine of jobs creation is a post for another day.)

Questions remain about the benefits for identified employees and whether they will be covered by the state's retirement system. A related question is whether the general public will have a true assessment of Wisconsin's retirement plan IOUs if these privatized workers are counted as "public" for some purposes but not for others. In reading the many comments posted for the aforementioned article, emotions are running high about the real costs associated with this decision. Clearly, more information would go a long way to quelling any concerns.

The topic of financial disclosures may soon create real problems for public plans and, by extension, ERISA plans that are sponsored by companies that issue stocks and/or bonds. In today's New York Times, Mary Williams Walsh reports that the U.S. Securities and Exchange Commission ("SEC") may be investigating the large California pension plan known as CalPERS. It's premature and inappropriate to speculate but the inference is that bond buyers may have been in the dark about the "true" risks associated with this $200+ billion defined benefit plan. If true, California could pick up an even bigger than expected tab and municipal security investors could be in a position of having paid too much to own state debt. See "U.S. Inquiry Said to Focus on California Pension Fund."

As recently as 2009, then Special Advisor to California Governor Arnold Schwarzenegger, David Crane, referred to public pension plan reporting as "Alice-in-Wonderland" accounting. He added that "state and local governments are understating pension liabilities by $2.5 trillion, according to the Center for Retirement Research at Boston College." Since these are legal contracts that bind the state, city or municipal sponsor, they are on the hook for bad results, with large cash infusions likely.

It's not rocket science to conclude that other states and municipalities could face the same type of securities regulation inquiry. Indeed, even ERISA plans are vulnerable to allegations of fraud or sloppy reporting if their risk disclosures are incomplete, inaccurate, misleading or all of the above. See "Testimony for Securities and Exchange Commission Field Hearing re: Disclosure of Pension Liability" (September 21, 2010). Investors want to know whether they have a striped horse or a zebra in their stable. They need and deserve a solid understanding of investment risks to which they are exposing themselves. That can only occur if accurate and complete information is provided. To its credit, CalPERS seems to be emphasizing risk-adjusted performance as paramount. A December 13, 2010 press release describes the adoption of a "landmark" asset allocation that emphasizes "key drivers of risk and return."

Email Dr. Susan Mangiero, CFA and certified Financial Risk Manager if you would like information about what a risk disclosure assessment entails for your organization or on behalf of a client(s). You may likewise be interested in one of our workshops for directors, trustees and/or members of the investment committee about performance reporting within a fiduciary and financial risk management framework.

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Please join Investment Governance, Inc. CEO - Dr. Susan Mangiero - for a one hour discussion with ERISA attorney, Linda Ursin, and Ms. Jamie Greenleaf, Senior Partner with Cafaro Greenleaf on June 29 from Noon to 1:00 PM EST.

Attendees will learn more about:

1. Assessing management fees for reasonableness
2. Form 5500 compliance rules
3. Fiduciary liability for failiure of oversight of service providers

And much more!

Click here to register for this free educational webinar.

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