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

According to "REITs By The Numbers," published by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), real estate is gaining favor with 401(k) investment committees that decide on asset allocation. They write that the last ten years has seen a rise from 5 percent to 30 percent of 401(k) plans that offer Real Estate Investment Trusts ("REITs") as an investment option. Moreover, the market is large at $1 trillion of real estate held in the form of an investment pool.

If you are a member of a 401(k) investment committee, advisor, consultant or individual participant, you will want to keep up with current guidelines and rules. Some of these are described in "Real Estate Investment Trust Valuation Guidelines Published." This blog post by Susan Mangiero includes FINRA and SEC comments about non-listed REITs as relates to items such as illiquidity, valuation and disclosures.

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An esteemed panel of experts will speak on May 14, 2013 from 1:00 PM EST to 2:40 PM EST as part of a webinar that is sponsored by Business Valuation Resources. Entitled "Valuation and ERISA Fiduciary Liability: Traps for the Unwary Appraiser," Dr. Susan Mangiero, CFA, FRM and Accredited Investment Fiduciary Analyst, will be joined by Mr. Robert Schlegel, ASA, MCBA and ERISA attorney James V. Cole II. Dr. Mangiero is a Managing Director with Fiduciary Leadership, LLC. Mr. Schlegel is a principal with Houlihan Valuation Advisors. Attorney Cole is a principal with Groom Law Group.

Why You Should Attend

As retirement, healthcare, and other employee benefits continue to grow, they are placing new stresses on firms of all sizes, whose commitments to these funds are beginning to outpace their revenues. Regulations and lawsuits are now challenging the defined responsibilities and liabilities of the financial professionals who create, manage, and even analyze these entities. This means that every appraiser now needs to assess risk, and the extent to which employee benefit plans impact enterprise value.

In this webinar, Dr. Susan Mangiero, Mr. Rob Schlegel, and ERISA attorney James Cole discuss existing, emerging, and proposed disclosure rules, an understanding of which are imperative to navigate the maze of actuarial, accounting, and regulatory numbers. Learn why estimating future expected cash requirements to service a plan(s) is imperative if an appraiser wants to opine whether a firm can realize its growth targets, and how benefit plan economics, such as withdrawal liabilities, change when derivatives or annuity transactions are in place. Appraisers need to understand emerging discussions now taking place at FASB and other regulatory agencies that will affect market participant activity relating to exchange value. Markets are waking up to this emerging area, and appraisers can no longer afford to remain asleep of these issues.

According to Mr. Blake Lyman, Professional Program Manager with Business Valuation Resources, LLC, "BVR is thrilled to be offering this program with Susan, Rob, and Jim. As the go-to resource for all professionals involved with business valuation, we always seek to present the most in-depth content on the most pressing issues for the many experts who rely on us. With Susan, Rob, and Jim's experience and expertise, this program is sure to surpass the high standards we set for ourselves and that our customers have come to expect."

To register, visit the Business Valuation Resources website.

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I am delighted to co-present on May 14, 2013 from 1:00 pm to 2:40 pm EST for Business Valuation Resources about the urgent need to properly assess pension fund economics as part of any opinion of value.This is a particularly timely topic as the U.S. Department of Labor seeks to designate appraisers as a fiduciary for an assessment they render about an ERISA plan such as an Employee Stock Ownership Plan ("ESOP"), 401(k) plan and/or defined benefit plan.

The session is entitled "Valuation and ERISA Fiduciary Liability: How to Protect Yourself." Speakers include:

• Dr. Susan Mangiero, CFA, certified Financial Risk Manager, Accredited Investment Fiduciary Analyst, trained appraiser and past president of the Connecticut chapter of the National Association of Certified Valuation Analysts (Fiduciary Leadership, LLC;
• Mr. Robert Schlegel, ASA, MCBA and past president of the Indiana chapter of the American Society of Appraisers (Houlihan Valuation Advisors); and
• Senior ERISA attorney James V. Cole II, with the Groom Law Group.

Click here to register for this ERISA valuation program.

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I am delighted to announce our seventh year as an educational resource for the $30+ trillion global retirement plan industry. With over a million visitors to www.pensionriskmatters.com, I appreciate the ongoing feedback and encouragement from financial and legal readers. This blog began as a labor of love and continues to be personally rewarding as a way to help guide the discussions about pension risk, governance and fiduciary duties.

Here is a link to the March 25, 2013 Business Wire press release about www.pensionriskmatters.com, an educational pension risk governance blog for ERISA, public and non-U.S. pension plan trustees and their advisors.

As always, your input is important. Click to send an email with your comments and suggestions.

Thank you!

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Speedy and insightful as always, ERISA attorney Stephen Rosenberg has commenced a series of blog posts that describes his view of the "hot off the press" conclusions made by the United States Court of Appeals for the Ninth Circuit in Tibble v. Edison. Click to access the March 21, 2013 Tibble v. Edison opinion. This ruling will no doubt receive much attention in the coming days as jurists and ERISA fiduciaries digest its content. Some will view this adjudication as yet another reminder that prudent process must be undertaken and can be demonstrated with respect to a host of issues (although the outcome is mixed in terms of plaintiff versus defendant "wins"). Issues include the selection of investment choices and the fees paid accordingly. Click to access the amicus brief filed by the U.S. Department of Labor in support of the plaintiffs.

In his first post about yesterday's opinion, Attorney Rosenberg points out that the timeline that determines ERISA's six-year statute of limitations was deemed to have started "when a fiduciary breach is committed by choosing and including a particular imprudent plan investment" and did not continue by virtue of the investment mix remaining in the plan. He further asserts that defendants will want the clock to begin on the day an investment option is first introduced and that "any breach of fiduciary duty claims involving that investment that are filed later than six years after that date are untimely."

I will leave court commentary to the legal experts. Click to access the Boston ERISA & Insurance Litigation Blog for his analysis about this case and many more.

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ERISA plans have long relied on over-the-counter swaps to hedge or to enhance portfolio returns. Given the high level of attention being paid to de-risking solutions these days, the role of swaps is even more important since these derivative contracts are often used by insurance companies and banks to manage their own risks when an ERISA plan transfers assets and/or liabilities. Big dollars (and other currencies) are at stake. According to its 2012 semi-annual tally of global market size, the Bank for International Settlements ("BIS") estimates the interest rate swap market alone at $379 trillion. Click to access details about the size of the over-the-counter derivatives market as of June 2012. It is therefore noteworthy that regulatory feedback has now been provided with respect to the use of swaps by ERISA plans.

In its long awaited advisory opinion issued by the U.S. Department of Labor, Employee Benefits Security Administration ("EBSA"), ERISA plans can use swaps without fear of undue regulatory costs and diminished supply (due to brokers who do not want to trade if deemed a fiduciary).

In its rather lengthy February 7, 2013 communication with Steptoe & Johnson LLP attorney Melanie Franco Nussdorf (on behalf of the Securities Industry and Financial Markets Association), EBSA officials (Louis J. Campagna, Chief - Division of Fiduciary Interpretations, and Lyssa E. Hall, Director - Office of Exemption Determinations) made several important points about whether a swaps "clearing member" (a) has ERISA 3(21)(A)(i) fiduciary liability if a pension counterparty defaults and the clearing member liquidates its position (b) is a party in interest as described in section 3(14)(B) of ERISA with respect to the pension plan counterparty on the other side of a swaps trade and (c) will have created a prohibited transaction under section 406 of ERISA if it exercises its default rights. These include the following.

• Margin held by a Futures Commission Merchant ("FCM") or a clearing organization as part of a swap trade with an ERISA plan will not be deemed a plan asset under Title 1 of ERISA. The plan's assets are the contractual rights to which both parties agree (in terms of financial exchanges) as well as any gains that the FCM or clearing member counterparty may realize as a result of its liquidation of a swap with an ERISA plan that has not performed.
• An FCM or clearing organization should not be labeled a "party in interest" under ERISA as long as the swap agreement(s) with a plan is outside the realm of prohibited transaction rules.

There is much more to say on this topic and future posts will address issues relating to the use of derivatives by ERISA plans. In the meantime, links to this 2013 regulatory document and several worthwhile legal analyses are given below, as well as a link to my book on the topic of risk management. While it was published in late 2004 as a primer for fiduciaries, many of the issues relating to risk governance, risk metrics and risk responsibilities remain the same.

• U.S. Department of Labor Advisory Opinion 2013-01A;
• "DOL Advisory Opinion 2013-01A: Cleared Swaps Under ERISA - Margin Not a Plan Asset/CCPs & FCSm Are Not Fiduciaries/No Prohibited Transactions" by Attorney Andrew P. Cross and Allison W. Sizemore, The Swap Report, February 14, 2013;
• "DOL Resolves Important ERISA Issues About Cleared Swap Transactions," Bloomberg BNA, February 27, 2013; and
• Risk Management for Pensions, Endowments and Foundations by Dr. Susan Mangiero, John Wiley & Sons, November 2004.

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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:

• 12 Great Motivational Quotes for 2013;
• 6 Habits of Remarkably Likable People;
• 9 Daily Habits That Will Make You Happier;
• 6 Things Really Productive People Do;
• 5 Things That Really Smart People Do;
• 6 Ways to Enhance Your Credibility; and
• Top 5 Business Books of 2012.

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).

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On January 16, 2013, this blogger - Dr. Susan Mangiero - had the pleasure of speaking with (a) Attorney Anthony A. Dreyspool (Senior Managing Director, Brock Fiduciary Services) (b) Attorney David Hartman (General Counsel and Vice President, General Motors Asset Management) and (c) Attorney Sam Myler (McDermott Will & Emery) about compliance "must do" items and litigation vulnerabilities. Sponsored by Strafford Publications, "Pension De-Risking for Employee Benefit Sponsors" attracted a large audience of general counsel, outside ERISA counsel and financial professionals. In addition to numerous talking points shared by all of us presenting, we had lots of attendee questions about issues such as balance sheet impact, case law and annuity regulations.

Click to download the slides for "Pension De-Risking for Employee Benefit Sponsors."

In my opening comments, I described some of the factors that are being discussed as part of conversations relating to whether a plan sponsor should de-risk or not. These include, but are not limited to, the following:

• Low interest rates;
• Higher life expectancies;
• Increased PBGC premiums;
• Company's debt capacity;
• Intent to go public or sell to an acquirer;
• Available cash; and
• Knowledge and experience of in-house ERISA fiduciaries.

Attorney Hartman urged anyone interested in de-risking to allow ample time of between six to eighteen months in order to file documents, research and create or modify policies and procedures as needed. He also advised companies to make sure that participants are fully apprised of their rights and to explain the merits of any particular transaction. For companies that may want to redesign a plan(s) for hourly workers, more time may be needed, especially if collective bargaining agreements are impacted.  His suggestion is to inform plan participants about state guarantees that apply in the event of an insurance company default. When retirees are emotionally attached to getting a check from their employer, care must be taken to allay any concerns that future monies will come from an outside third party. Keep in mind that the market may be moving at the same time that a deal is being put together. Regarding the transfer of assets, Attorney Hartman stated the importance of finding out early on what an insurance company is willing to accept. An independent appraiser may be required to determine the appropriate value of certain assets.

I talked about the various risks that can be mitigated via de-risking versus those that are introduced as the result of some type of defined benefit plan transfer or derivatives overlay strategy. The point was made that there is no perfect solution and that facts and circumstances must be taken into account. I added that litigation may arise if a plaintiff (or class of plaintiffs) question any or all of the following items:

• Whether executives are unduly compensated as the result of an earnings or balance sheet boost due to de-risking;
• Timing of a transaction and whether interest rates are "too low" at the time of a deal;
• Completeness (or lack thereof) of information that is provided to participants;
• Amount of fees paid to vendors;
• Use of an independent fiduciary;
• Level of asset valuations;
• Use of an independent appraiser;
• Extent to which due diligence was conducted on the structure of deal; and/or
• Level of vetting of "safest available" annuity provider.

Continue Reading...

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According to its Fall 2012 issue of Pension Pulse, published by the J.P. Morgan Asset Management Strategy Group, 2013 is going to be "grim" for pension funds after a less than jovial 2012. Citing a drop in funded status for many U.S. plans this year, "despite a 14% stock market rally," trouble spots are unlikely to disappear any time soon, putting continued pressure on the size of liabilities.

To tame the beasts in the form of "funded status volatility, unfavorable changes in the index used to value pension liabilities and longevity assumptions that increase liability values," employers continue to explore de-risking transactions such as offering lump sums and buyouts. Contrary to popular belief, the authors point out that even companies with underfunded plans like lump sum arrangements. The appeal is in part motivated by tax rules that allow "certain plans to use backdated discount rates to value lump sum payouts" that are higher than current discount rates.

Although the evidence suggests an increased demand on the part of plan sponsors to de-risk, J.P. Morgan professionals reference a ceiling of about $70 billion more over the next four or five years before industry capacity is reached for pension risk transfers. Of course, any time that demand increases and supply remains static, prices will rise as a result. At the margin, that could encourage some organizations from de-risking.

The report goes on to describe a "surreal discount rate" situation as the result of some bank securities being downgraded below AA in June of 2012. The net effect - a change in the discount rate curve that "reduced the weight of financials" - left only ten issuers to make up 75% of the market value of the index. Arguably, this increases the "inherent concentration risk" which in turn could increase the volatility of the index, thereby sending employers off on a measurement roller coaster ride. Shareholders could then feel the pinch if companies have to add cash to a plan as funding levels sink.

Adding insult to injury, the authors describe a change in actuarial assumptions that could significantly push the costs upward for companies that sponsor pension and Other Post Employment Benefits ("OPEB") programs. Their assertions are that (1) "changing actuarial assumptions are likely to increase pension liabilities by 2% to 5%" and (2) uncapped post-retirement health care benefits could go up by 6% to 9%.

Taken individually or together, the various pressures on retirement plan liabilities suggest a busy year ahead for ERISA fiduciaries and their support staff.

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Click to register for a January 16, 2013 webinar entitled "Pension De-Risking for Employee Benefit Sponsors: Minimizing Risks and Ensuring ERISA Compliance When Transferring Pension Obligations to Other Parties." Sponsored by Strafford Publications, this Continuing Legal Education ("CLE") webinar will provide benefits counsel with a review of pension de-risking approaches used by companies to reduce some of the risks involved with employee retirement benefits. The panel will offer best practices for leveraging the precautions to prevent ERISA fiduciary law violations when making transfers.

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According to "De-Risking Focuses on Business Issues; Retirement Security a Concern, Critics Say" by BNA reporter Florence Olsen (Pension and Benefits Blog, November 2, 2012), the Pension Rights Center in Washington would like plan sponsors to catch their breath before partially or fully transferring its pension liabilities to third parties like insurance companies. Business Insurance editor-at-large Jerry Geisel writes that the Pension Rights Center wants the U.S. Congress to prohibit further pension de-risking transactions until legislators can assess the ramifications of giving some or all plan participants a choice to convert their future expected pension cash flows into a lump sum or having the employer contract with a group annuity provider to write checks instead of the original corporate sponsor. See "Pension Rights Center wants Congress to put moratorium on pension plan de-risking" (October 19, 2012).

In a forthcoming article for CFO Magazine, ERISA attorney Nancy Ross (with McDermott Will & Emery) and Dr. Susan Mangiero (with FTI Consulting) consider pension de-risking within the context of governance and the duty of loyalty to plan participants. They conclude that while there could be distinct advantages that accrue to retirees and workers when a sponsor enters into a pension de-risking transaction, ERISA fiduciary decision-makers may face personal and professional liability in the event that the economics of a deal mostly benefit shareholders.

In a recent announcement, one company that entered into a pension de-risking transaction cited the upside to include the following:

• Enhancing the sponsor's long-term financial position;
• Removing a "volatile" pension liability from the balance sheet;
• Reducing cash flow and income statement volatility; and
• Improving financial flexibility.

It is not known yet whether someone will challenge this kind of rationale as being too shareholder heavy or instead primarily in the best interest of plan participants who are impacted by a particular transaction. One might logically assert that a financially stronger plan sponsor means less risk for those participants who remain exposed to its credit risk and "ability to pay."

The use of an independent fiduciary could help to allay any concerns about issues such as deal terms, fees paid, the selection of the "safest available" annuity provider and the fair market valuation of contributed assets that are deemed "hard to value." Outsourcing or delegating the investment management function to a financial institution - in lieu of a pension transfer - may be another approach to consider.

Only time will tell whether the plaintiff's bar sees a possible "two hat" fiduciary conflict as a reason to file an ERISA lawsuit against corporate officers and/or directors.

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According to "Do plan advisers understand their risks?" by Rich Fachet (Investment News, October 8, 2012), some financial careerists may be woefully unaware of the risks they face as ERISA fiduciaries. The author, team leader with The Travelers Cos. Inc., goes on to say that the U.S. Department of Labor is serious about enforcement with $1.38 billion having been collected in 2011 "through prohibited-transaction corrections, restoration of plan benefits or the voluntary fiduciary-correction program." He adds that RIAs face both personal and professional liability. Whether tasked with discretionary authority over how to allocate an ERISA plan portfolio or giving advice with limited control over assets, these investment professionals have a lot to lose. Fachet lays out what kind of information should be gathered as a step towards mitigating fiduciary risk. The list includes, but is not limited to, the following tasks:

• Assessment of the nature and magnitude of liability, taking new regulations such as ERISA 408(b)(2) into account and the potential cost of non-compliance;
• "Lessons learned" from lawsuits that plaintiffs' counsel has won;
• Determination of ERISA 404(c) "safe" versus "unsafe" harbors and how to counsel a plan sponsor as a result;
• Review of "plan participant  options and models" as well as asset allocation percentages; and
• Analysis of insurance gaps to include a review of adviser errors and omissions, professional liability, fiduciary liability and/or ERISA bond coverage.

Gary J. Caine, FSA, with Multnomah Group, Inc. addresses the flip side, i.e. that ERISA fiduciaries must carefully vet investment advisers before they are hired and thereafter. In "Fiduciary Reliance on Registered Investment Advisors," he suggests that plan sponsors need to minimally ask about qualifications such as education, experience in assisting plans, professional designations and securities licenses. Conflicts of interest, liability insurance coverage and compensation arrangements are other areas to investigate.

Notwithstanding the need to carefully assess which registered investment advisers are appropriate partners for ERISA pension plans, merger and acquisition ("M&A") activity in this sector continues. According to a new study produced by Schwab Advisor Services, "year-to-date assets under management (AUM) for M&A deal activity reached $42.3 billion at the end of the third quarter, which nearly eclipses last year's AUM total of $43.9 billion.". See "New Clients Drive Steady Growth for Independent Advisors in Face of Uncertain Economic Environment, Say 2012 RIA Benchmarking Study From Charles Schwab" (July 17, 2012 press release).

With Retirement Savings Week just wrapped up on October 27, 2012, experts write that many individuals are still woefully unprepared for post-employment life. In "Retirement 'Savings Week' highlights savings gap," Market Watch reporter Elizabeth O'Brien describes a study from the Employee Benefit Research Institute ("EBRI") on October 22, 2012 that says that 44 percent of simulated "lifepaths" bolsters the reality of inadequate income for one's "golden years."

A glaring take-away from all of this is that registered investment advisers will have a large client base as long as people need help with retirement planning.

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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.

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In this timely and informative webinar hosted by FTI Consulting, legal and compliance experts will provide critical information about the Qualified Professional Asset Manager ("QPAM") exemption and related compliance audit requirement that applies to numerous financial institutions that manage or want to manage ERISA pension money. Speakers will likewise address the merits of managing money for captive ERISA benefit plans and what it means to be an In House Asset Manager ("INHAM").

Getting the right team to conduct the required audit is one important way to mitigate litigation and enforcement risk and to attract and retain institutional dollars. Having a proper audit conducted and using the information to correct deficiencies is another critical step for anyone who understands that non-compliance can be costly.

This timely and informative webinar will address issues that include the following:

• Background information about the new ERISA rule for a Qualified Professional Asset Manager (“QPAM”) audit;
• What it means to be a Qualified Professional Asset Manager or In-House Asset Manager ("INHAM");
• Who must comply and in what timeframe;
• Who can carry out a QPAM /INHAM audit;
• What a QPAM audit entails in terms of information-gathering and scheduling;
• Case study discussion; and 
• How the results of a QPAM audit can be used to improve operations and client relationships.

Who Should Attend:

• Chief Compliance Officers of asset managers
• Business development executives for asset managers
• Internal legal counsel for asset managers and other financial firms
• ERISA consultants and investment advisors

Please join Timothy Brennan, Assistant General Counsel at The Hartford; Howard Pianko, Partner, Seyfarth Shaw LLP; and Susan Mangiero, Managing Director, FTI Forensic & Litigation Consulting as they address these issues and your questions. To attend this free webcast scheduled for Tuesday, October 23, at 1:00 pm Eastern, please click to register for "Managing ERISA Pension Money - QPAM and INHAM 101."

For further information, click to read "Amendment to Prohibited Transaction Exemption (PTE) 84-14 for Plan Asset Transactions Determined by Independent Qualified Professional Asset Managers," Federal Register, July 6, 2010.

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Like many others, union members are grappling with a jittery economy and its impact on plan sponsors. As a result, companies are exploring ways to restructure employee benefit plans in order to contain costs and still keep pension promises.

Just yesterday, Pensions & Investments' Barry Burr wrote that United Parcel Service, Inc. ("UPS") is paying $1.2 billion as a withdrawal liability to the New England Teamsters & Trucking Industry Pension Plan. In exchange, and subject to approval by its employees who are union members, UPS will not have to pay for other companies' employees. According to "UPS to leave New England fund, strikes funding deal," the popular delivery company will write a check every year over the next half century for $43 million. An accounting charge of $896 million will be recognized in this year's financial statements.

On August 28, 2012, Dow Jones Newswires explains that UPS sees the creation of this new pension plan - to replace the old one - as "being fair" to multiple constituencies such as shareholders as well as to employees.According to "UPS Restructures Pension, Sees $896 Million 3rd-Quarter Change" (Nasdaq.com, August 28, 2012), over 10,000 employees will be affected.

The action did not go unnoticed by at least one rating agency. On August 28, 2012, Standard & Poor's explicitly referenced the company's liability exposure to multi-employer plans as part of its rating assessment of UPS and added that the IOU is seen as a "debt equivalent" and "significant."

The take-away points are clear.

The large and long-lived costs associated with offering ERISA plans continue to dominate the discussions in numerous corporate corridors. Besides having to infuse cash (sometimes billions of dollars), company plan sponsors may be in danger of ratings downgrades. A drop ratings boots the cost of capital which in turn narrows the universe of positive net value opportunities that help to grow enterprise value. Funding issues with employee benefit plans could force M&A deals to evaporate.

Expect other companies to announce pension restructurings.

What remains to be seen is whether a showdown between shareholders and participants will ensue with either or both groups asking ERISA fiduciaries to justify the terms of a particular deal in court.

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Please join us for a timely and information webinar entitled "ERISA Assets: QPAM and INHAM Audit Legal Requirements: Navigating DOL Rules for Pension Asset Management Compliance" on August 29, 2012 from 1:00 PM EST to 2:30 PM EST. 

This CLE webinar will prepare counsel to advise asset manager clients regarding QPAM and INHAM audits as required by the Department of Labor. The panel will review the new exemption rules, who can conduct an audit, what the process entails, and how to showcase good practices with existing and prospective plan sponsors.

Description

An opportunity to manage part of the $17 trillion retirement industry assets is a key business strategy for many financial organizations. ERISA plans present a number of unique challenges due to the rules, regulations and increasing litigation brought against asset managers. Compliance is critically important.

In 2010, the U.S. DOL changed rules on activities asset managers can undertake if they manage ERISA assets. Entities like banks, insurance companies, hedge funds and SEC-registered investment advisors must have documented policies and procedures for types of trading, parties in interest and internal controls.

In addition, a regular audit of the activities of a Qualified Professional Asset Manager (QPAM) and/or in-house asset manager (INHAM) must be conducted by persons who are knowledgeable about ERISA and can render an objective assessment as to whether the exemption is justified.

Listen as our ERISA-experienced panel provides a guide to this recent mandate, why it is important, how to comply, and what an asset manager can learn from the audit process to mitigate litigation risk.

Outline

1. QPAM and INHAM Rules: Definition, Exemptions and Consequences of Not Getting Audit

2. Nature of the QPAM/INHAM Audit: Qualifications of Auditor, Components of Audit and Role of Counsel

3.Use of Audit: Regulatory Scrutiny, Correcting Deficiencies, Marketing Audit Results, Lessons Learned

Benefits

The panel will review these and other key questions:

• Who is a QPAM or INHAM?
• What determines when a QPAM or INHAM audit is required?
• What is the audit process like in terms of length of time it takes to complete, the documents needed, and the role of outside counsel and the QPAM or INHAM auditor?
• How can the QPAM or INHAM audit be used to mitigate suits about procedural prudence and fiduciary breach?

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.

Terry Orr, Senior Managing Director
FTI Consulting, Dallas

He provides forensic and investigative due diligence services to companies and their counsel in a variety of industries. His twenty-five years of experience as an independent auditor of both public and private businesses includes the examination of numerous ERISA plans.

David E. Pickle, Partner
K&L Gates, Washington, D.C.

He represents clients in matters dealing with ERISA’s prohibited transactions and exemptions and ERISA’s fiduciary rules. He represents investment managers, financial institutions and plan sponsors in a variety of matters including investments and other transactions with ERISA plans and in litigation and government enforcement actions.

William A. Schmidt, Partner
K&L Gates, Washington, D.C.

He works in the areas of institutional investing and employee benefits, with particular emphasis on fiduciary responsibility matters under ERISA. He advises major financial institutions, including banks, insurance companies, registered investment advisers, and large employee benefit plans about ERISA restrictions relating to plan investments and to fee arrangements for investment management.

 

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Seyfarth Shaw ERISA attorneys Ian Morrison and Violet Borowski wrote an interesting blog post about what they describe as a discernible growth in lawsuits "filed by (or on behalf of) ERISA plans (sometimes class actions) against investment providers for charging excessive fees or otherwise gleaning improper profits from investments used in ERISA plans."

What they point out as noteworthy is the fact that the plans' fiduciaries frequently have no involvement in filing a complaint against a service provider(s) since several courts have allowed plan participants to seek redress without getting permission or even having an obligation to inform a company sponsor. 

At first blush, they offer that this situation may seem benign and possibly even helpful to a sponsor if the result of litigation against a service provider(s) results in reduced costs for everyone. The plot thickens however if a participant's complaint and related discovery later leads to legal scrutiny of a plan's fiduciaries, alleging that they knew about problems but did little or nothing to rectify a "bad" situation.

Attorneys Morrison and Borowski point out the challenges that fiduciaries must confront when a participant(s) files a lawsuit.

• "Do they join with the service provider on the theory that a common defense is the best defense?
• Should they join the participant plaintiffs in attacking the provider and at the same time potentially implicating themselves?
• Or, should they remain on the sidelines, potentially risking being sued for taking no post-litigation action to recover for the provider's alleged breach?"

According to "Wait, You Mean My Plan Is A Plaintiff?" (May 24, 2012), attorneys Morrison and Borowski suggest that plan sponsors set up Google alerts to track any lawsuits that involve a company's benefit plan(s).

As an expert who has been involved in service provider cases, Dr. Susan Mangiero adds that a good offense is to conduct a comprehensive review of agreements on a regular basis. Should litigation occur and an expert is engaged, that person(s) will likely have to review whatever communications were provided to plan participants during the relevant time period as well as the contracts between the plan sponsor and a vendor(s). Another prescriptive course of action is to ensure that communications are robust, especially now with new fee disclosure rules in place.

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Are we there yet?

While traveling to New York City the other day on Metro North, I sat behind a little boy who kept asking his parents the same question that many in the pension field are pondering.

The issue of what end game applies is noteworthy, especially now that Congress has adopted pension reform.

In "Looking for Cash, Congress Finds Some in a Corporate Pension Rule Tweak," New York Times reporter Mary Williams Walsh (June 28, 2012) describes the parts of the just passed highway bill that could force costs upward for American businesses. For one thing, sponsors will be able to stretch out their cash outlays to buoy underfunded defined benefit plans over time. As a result, tax-deductible contributions will be smaller in the next few years, taxable income will be higher and federal tax coffers will go up by an estimated $9.4 billion over the next 10 years." In addition, insurance premiums that companies pay to the Pension Benefit Guaranty Corporation ("PBGC") will be higher to the tune of roughly $10 billion in the coming decade.

The news is troublesome for numerous reasons.

For one thing, employees, retirees, creditors and shareholders are going to find it even more challenging to assess the true cost to companies that offer benefit plans. As a result, they could be in for a nasty surprise later on if reported performance numbers are overly optimistic and mask a large liability that eventually will require cash. Second, the increased PBGC premiums are slated for general revenue which means that incremental dollars may never be available to pay participants of troubled sponsors because they have already been spent elsewhere. Third, using corporate pension plans as a national piggyback to pay for other programs goes against the nature of the trust arrangement that was put in place with the 1974 creation of the Employee Retirement Income Security Act ("ERISA"). Fourth, measuring pension risk and managing it effectively requires those in charge to have a good handle on the economic objectives they are seeking to satisfy. Chief financial officers ("CFO"s) and treasurers could be doing an excellent job of mitigating relevant uncertainties but not be rewarded if capital market participants emphasize accounting numbers that do not capture what is really going on.

Dr. Susan Mangiero, CFA charterholder, certified Financial Risk Manager, Accredited Investment Fiduciary Analyst and author of Pension Risk Management for Pensions, Endowments and Foundations will continue to write about pension risk management. There is a lot more to say.

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According to Troutman Sanders ERISA attorneys Jonathan A. Kenter and Gail H. Cutler, the outcome of a recent 401(k) plan lawsuit known as Tussey v. ABB did more than force the sponsor to write a check for $37 million. It led to lessons learned about the need to regularly review record-keeping and investment management fees, negotiate for rebates if possible and adhere to documented investment guidelines. What it did not resolve was "whether the record keeping costs of a 401(k) plan may be borne exclusively by those participants whose investment funds enjoy revenue sharing...while participants whose accounts are invested in investment funds with no revenue sharing pay little or nothing."

In "The Next Frontier in Fiduciary Oversight Litigation?" (April 27, 2012) they suggest that courts will likely be asked to opine as to whether ERISA fiduciaries have justified prevailing revenue sharing arrangements, taking allocation and class-based fee levels into account. Their recommendation is to decide on a disciplined approach that makes sense rather than making arbitrary decisions. Allocation rules to consider include the following:

• Apportion record keeping fees on a pro-rata basis so that each participant is only charged his or her "fair share." Credit any revenue sharing received back to the "funds or participants as part of a periodic expense balance true-up."
• Levy the same record keeping fee for each participant. Allocate revenue sharing monies ratably "to all investment funds or participants."
• Adopt a combined pro-rata and per capital allocation such that a record keeping fee would consist of a fixed amount and a variable amount. Imposing a cap on total fees could be included.
• "Hard wire the allocation method in the plan document" so that how record keeping fees are charged becomes a settlor function versus a fiduciary task.

In 2007, the ERISA Advisory Council's Working Group on Fiduciary Responsibilities and Revenue Sharing Practices reviewed industry practices as a way to improve disclosure for 401(k) plan participants. One recommendation made to the U.S. Department of Labor thereafter was to categorize payments for certain professional services as settlor functions and thereby protect fiduciaries from allegations of breach. Another request was for clarification that revenue sharing is not a plan asset "unless and until it is credited to the plan in accordance with the documents governing the revenue sharing."

With ERISA Rule 408(b)(2) fee disclosure compliance just ahead, numerous questions remain. This had led litigators and transaction attorneys alike to comment that further lawsuits and enforcement actions are likely to follow.

Note: Interested persons can read "Final Regulation Relating to Service Provider Disclosures Under Section 408(b)(2)," published the U.S. Department of Labor in February 2012.

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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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Who would have thunk that a discussion about pension governance and risk management would keep audience members in their seats for nearly three hours? Yet that is what occurred on January 24, 2012 as a panel convened to discuss such weighty issues as whether companies have a fiduciary duty to hedge and whether inaction can lead to litigation.

In his opening remarks as part of a January 24, 2012 event that was hosted by the Hartford CFA Society, ERISA attorney Martin Rosenburgh cautioned that fiduciaries could find themselves open to questions for not taking steps to mitigate risks. Attorney Gordon Eng, a former litigator and now general counsel and Chief Compliance Officer for a high yield bond fund, adds that any investment decision should be supported with ample documentation that reflects a careful and thorough deliberation of the issues at hand.

For more details about this lively, topical and informative event, read "Considering a Duty to Hedge" by Christopher Faille.

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According to a July 13, 2011 press release from the U.S. Department of Labor, a final regulation is now in place regarding retirement plan fee disclosures. Pursuant to ERISA Section 408(b)(2), a rule issued in interim form on July 16, 2010, will now be made permanent with an effective date of April 1, 2012. The goal is to enhance transparency about how much money is paid to pension plans by service providers.

Click here to read the official announcement. Click here to read 29 CFS Part 2550, "Reasonable Contract or Arrangement Under Section 408(b)(2) - Fee Disclosure; Interim Final Rule," issued on July 16, 2010.

Given the lawsuits on the topic of ERISA plan fees paid to service providers, it will be interesting to review disclosure results after full implementation occurs.

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Alternative fund managers and regulators will convene in Washington, D.C. from July 19 through 21, 2011 to talk about pension investing in hedge funds and private equity funds. Over several days, those who present before the ERISA Advisory Council will be asked to address questions such as those listed below:

• What differentiates a hedge fund from other types of investments?
• What differentiates a private equity fund from other types of investments?
• How are hedge funds and private equity funds, respectively, correlated with the returns of traditional equity and fixed income investments?
• How can defined benefit and defined contribution plan sponsors mitigate "the lack of liquidity that is characteristic of these investments?"
• How can fee transparency be enhanced?
• "Are there any unique diversification benefits offered by hedge funds and private equity investments as opposed to a fund of funds?"
• What is the view of target date fund managers with respect to including hedge funds and/or private equity strategies within their funds?

According to U.S. Department of Labor documents, the aim is to create best practices guidance in areas such as leverage, liquidity, transparency. valuation, operational due diligence, client and asset concentration and offering documents. Click to download "2011 ERISA Advisory Council: Hedge Funds and Private Equity Investments." Click to read the June 22, 2011 U.S. Department of Labor news release about the forthcoming meetings to address hedge funds and private equity investments by ERISA plans.

Interested readers may want to check out the following of many items that are available for further research:

• "Testimony of Dr. Susan Mangiero About 'Hard to Value' Assets Before the ERISA Advisory Council," September 11, 2008;
• "The Growth and Impact of Direct Investing," Citi Prime Finance, June 2011;
• "Pension Fund Investment in Hedge Funds" by F. Stewart, OECD Working Papers on Insurance and Private Equity Pensions, No. 12, OECD Publishing, 2007;
• "Defined Benefit Pension Plans: Plans Face Valuation and Other Challenges When Investing in Hedge Funds and Private Equity Funds," U.S. Government Accountability Office, July 20, 2010;
• "A Guide to Institutional Investors' Views and Preferences Regarding Hedge Fund Operational Infrastructures," Alternative Investment Management Association, May 2011;
• "The Hedge Fund of Tomorrow: Building an Enduring Firm," Casey Quirk, April 2009;
• "Pensions and private equity: where does the relationship go from here?" by Toby Lewis, Global Pensions, June 6, 2011; and
• "Private Equity Principles, Version 2.0," Institutional Limited Partners Association, January 2011.

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I am pleased to announce that I will be speaking in an upcoming live phone/web seminar entitled "ERISA Fiduciaries Under Attack: Key Litigation and Regulatory Developments" scheduled for Thursday, June 16, 1:00pm-2:30pm EDT.

Litigation surveys cite breach of fiduciary duties as a fast-growing driver of ERISA lawsuits involving securities fraud and questions about investment-risk governance and prudence. Economic losses and investment complexity are only a few reasons for continued new rules, regulations and claims.

In addition, significantly increased liability exposure is expected due to the SEC's and DOL's focus on expanding the definition of plan fiduciaries.

Evolving case law is putting plan sponsors and service providers in the spotlight as never before with regard to their investment-related processes. Litigation claims are focusing on who is making the investment decisions, and the due-diligence and other procedures these decision-makers use.

My fellow panelists and I developed this program to guide attorneys through the ERISA fiduciary minefields, address best practices for fiduciaries, discuss practical realities regarding case management and settlement, and recommend action steps for counsel to investment committees, board members and the advisers, consultants, appraisers, custodians and managers who provide products and services to employee benefit plan sponsors.

We will offer our perspectives and guidance on these and other critical questions

• When are plans adopting risk management strategies?
• What should the composition of the investment committee be?
• How may an expanded "fiduciary" definition impact potential damages?
• Does Dodd-Frank affect plan-management concerns?
• How should insurance coverage be reviewed and managed?

After our presentations, we will engage in a live question and answer session with participants — so we can answer your questions about these important issues directly.

I hope you'll join us.

Click for more information or to register for this webinar about ERISA litigation.

Sincerely,

Susan Mangiero, PhD, CFA, FRM

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Dr. Susan Mangiero, CFA, FRM joins an esteemed panel of speakers as part of "Conflicts in Plan Sponsor and Service Provider Relationships." She is joined by:

• Attorney Michael J. Prame, Groom Law Group
• Attorney Elizabeth J. Bondurant, Smith Moore Leatherwood LLP and
• Attorney Bradley J. Schlichting.

According to the agenda, the panel will address the "unique issues that arise in connection with the provision of services to employee benefit plans, understanding the division of responsibilities and whether discretion has been delegated to the service provider, assessing the fiduciary status of third-part service providers" and much more.

Given current worldwide efforts to broaden the definition of who serves as a fiduciary and a classification of their duties, this panel's purview is timely and important.

Click to visit the American Conference institute website.

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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.

The courts have not spoken uniformly about recourse between the plan and outside fiduciaries, but the plan sponsor's supervisory role, or the lack of it, has come under intense scrutiny in recent years. Because errors and disputes are a fact of life, it is long past time for the service agreement to become an integral part of the advisor vetting process from the beginning.

 

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Kudos to the Stable Value Investment Association for encouraging several days of lively discussions about important topics such as asset allocation, behavioral investing and risk management.

In my comments about stable value risk management, I emphasized the importance of having robust policies and procedures in place across all providers. I likewise mentioned the need for plan sponsors to investigate the use of derivative instruments on the part of both the asset managers and the wrappers, adding that some stable value funds may pose valuation challenges. Given the approximate $700 billion size of the stable value market and the widespread use of these products in 401(k) plans, financial service organizations have a golden opportunity to differentiate themselves from competitors by making their risk stance transparent with investment committee member buyers. This is especially true at a time when plan sponsors are increasingly asked to justify their due diligence and oversight of service providers.

Click to read "Stable Value Risk Management - Remarks Made by Dr. Susan Mangiero Before the Stable Value Investment Association on November 19, 2010."

You might also want to check out "Fiduciary Alert: Stable Value," provided by the team at Harrison Fiduciary. In speaking to Attorney Mitch Shames the other day about stable value risk management, he concurred with many points I made in my speech and added a few of his own. See below for his comments.

"Most of the time stable value ("SV") products are sold by recordkeepers. Often plan fiduciaries simply sign-off, thinking that they are getting a turn-key "stable" product which provides "value".  Plan fiduciaries rarely understand that SV is a hybrid product,   with an investment component and an insurance component. For instance, ask a fiduciary about the crediting rate on the stable value vehicle and they may give you a blank stare. Ask them to identify the wrap provider and describe their crediting rating and they may be equally in the dark. Finally, fiduciaries are sometimes surprised when they find out that traditional HR issues can have an impact on the wrap contract. Most all wrap contracts provide that if the work force is reduced by a certain percentage, then the wrap provider is released from the wrap coverage. So, if a sponsor has a significant plan closing, this can give rise to problems under the SV Program. Similarly, there are often restrictions on the number of participants who can withdraw from an SV plan.  Imagine if participants get sick of low returns and start shifting assets out of the SV program into equities, emerging markets, etc. This can create huge problems for SV programs.The point is that SV is extremely complicated and the devil, as always, is in the details. All fiduciaries must be familiar with the terms of the wrap agreement."

Another noteworthy read is "Risk Controls and the Coming Stable Value Surge." According to the author, Robert Whiteford, Bank of America, "wrappers and asset managers have made great progress in reducing risk in a way that should allow the existing wrappers to increase capacity in the future," adding that "new investment guidelines have been constructed to more faithfully reflect the mission of stable value funds."

Like most industries, the stable value sector is confronted with challenges to be more transparent and thereby lessen the pain for their fiduciary buyers and plan participants.

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According to "DOL rule could raise pension funds' costs: Proposed fiduciary requirement would hit appraisers of alternative investments" by Doug Halonen (Pensions & Investments, November 15, 2010), those who provide independent valuations could soon be declared fiduciaries. Remembering that there is no free lunch and that every new rule has unintended consequences, third party pricing experts are already running for cover. Some say they may exit the appraisal business at the same time that ERISA plans are enlarging their positions in alternatives and also being called upon to provide more information in their Form 5500 filings.

In case you missed it, click to access my comments on this topic, entitled "September 11, 2008 Testimony Presented by Dr. Susan Mangiero before the ERISA Advisory Council Working Group on Hard to Value ("HTV") Assets."

I had the pleasure of presenting on the same topic of risk management and valuation to the OECD and International Organization of Pension Supervisors in Paris in June 2010.

Clearly, pension plan decision-makers and their advisors, attorneys and consultants are going to be challenged to find the right balance between return and risk (with valuation questions being one type of risk). Not every alternative investment is "hard to value." Indeed, some mutual funds and other "traditional" choices have their own challenges in terms of pricing and liquidity.

Click to read "Hedge Fund Valuation: What Pension Fiduciaries Need to Know" by Susan Mangiero, Journal of Compensation and Benefits, July/August 2006.

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According to the U.S. Department of Labor's website, plan sponsors will soon have a fiduciary checklist about how to evaluate and select target date funds as part of the 401(k) plan mix. Given that nearly one out of two plans offer target date funds as an investment choice and that there are numerous questions about related investment best practices, the guidance comes none too soon. Click here to read more about the Spring Regulatory Agenda of 2010.

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Dr. Susan Mangiero, CEO of Investment Governance, Inc., is pleased to join a panel of experts as part of the upcoming RIMS (Risk and Insurance Management Society) 2010 conference in Boston on April 28. Entitled "Coping Mechanisms: ERISA Best Practices," other speakers include Ms. Pamela Britt Schneider (Director, Global Risk Management - Avon Products, Inc.), Ms. Rhonda Prussack (Executive Vice President and Product Manager, Fiduciary Liability Insurance - Chartis U.S.) and Rene E. Thorne (Partner/Resident Manager, Jackson Lewis). The program description is provided below.

Learn how to best to protect directors and officers in the event of plan-related litigation in this critical era of new litigation theories, legislation and aggressive enforcement. Employee Retirement Income Security Act (ERISA) litigation has spiked in the last year, spurred by plan investment losses, mass layoffs, benefit cutbacks and an invigorated plaintiff’s bar. New types of litigation, such as suits related to qualified default investments in 401(k) plans, are on the upswing. At the same time, leadership at the Department of Labor is spurring new enforcement strategies. Join this panel discussion of methods to avoid litigation and establish a record of procedural prudence, a critically important component in the defense of any ERISA litigation.

Click here for more details.

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Dr. Susan Mangiero joins a panel of senior-level insurance executives and attorneys for a discussion about ERISA best practices. Sponsored by the Risk and Insurance Management Society (RIMS), the April 28 discussion takes place in Boston and addresses financial, legal and operations challenges, along with suggested "must do" items. The program description is provided below or you can read more about "Coping Mechanisms: ERISA Best Practices."

Learn how to best to protect directors and officers in the event of plan-related litigation in this critical era of new litigation theories, legislation and aggressive enforcement. Employee Retirement Income Security Act (ERISA) litigation has spiked in the last year, spurred by plan investment losses, mass layoffs, benefit cutbacks and an invigorated plaintiff’s bar. New types of litigation, such as suits related to qualified default investments in 401(k) plans, are on the upswing. At the same time, leadership at the Department of Labor is spurring new enforcement strategies. Join this panel discussion of methods to avoid litigation and establish a record of procedural prudence, a critically important component in the defense of any ERISA litigation.

Presenters include:

• Ms. Tara Cronin of Chartis Insurance (Coordinator)
• Ms. Charlotte Peedin of Golden Corral Corporation (CPC)
• Ms. Pamela Britt Schneider of Avon Products, Inc. (Speaker)
• Dr. Susan Mangiero of Investment Governance, Inc. (Speaker)
• Ms. Rhonda Prussack of Chartis Insurance (Speaker)
• Attorney Rene Thorne of Jackson Lewis (Speaker).

Investment Governance, Inc. recently interviewed leading fiduciary liability insurance underwriters about their concerns for covered organizations to improve policies and procedures. Email Editors@InvestmentGovernance.com for a copy of the two-part interview series.

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According to Attorney Fred  Reish, Managing Director at Reish & Reicher, the "word on the street" is that the new 408(b)(2) regulation - sent from the U.S. Department of Labor to the Office of Management and Budget on March 3 - will be an "interim final regulation and will have a delayed effective date." He adds that "effective" refers to the date on which people must begin complying with its terms. ERISA attorney Reish adds that:

My sense is that the delayed effective date will be somewhere between January 1, 2011 and 12 months after the regulation is issued. However, that is just a guess. That effective date would probably apply only to new plan clients. That is, there would probably be a transition period for existing  plan clients. Also, it is not yet clear whether the regulation will apply to individual retirement accounts, but it could."

For background on this important disclosure rule, see "The DOL's Proposed 408(b)(2) Regulation: Impact of the Mandated Disclosures on Registered Investment Advisers (RIAs)" by Fred Reish, Bruce Ashton and Debra Davis (February 2008).

Also see "Private Pensions: Additional Changes Could Improve Employee Benefit Plan Financial Reporting" (United States Government Accountability Office, December 2009).

I will post further information about fees paid to plan service providers in coming weeks.

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

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

A Scary Halloween Gift from the Eighth Circuit?

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

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

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

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

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Though he prefers to remain anonymous, the creator of a new blog takes delight in being ever so slightly irreverent. An ERISA attorney by trade, the creator of xtremERISA is a big fan of pop culture so expect more than a few references to art and music. For example, a recent post about TARP recalls the lyrics of Head East's song entitled "Never Been Any Reason." Though I'm not familiar with Head East (Does that make me an unhip fogey?), I have to agree with the blogger's sentiment that recent regulatory initiatives seem out of sorts.

"You've been talking in circles

Since I've been able to cry

There's never been any reason

For never telling me why, yeah, yeah"

Welcome xtremERISA. The field needs some humor now and then.

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 At a time of great market turmoil, plan participants, shareholders and taxpayers want to know whether their retirement plans are in good hands. Risk is truly a four-letter word unless plan sponsors can demonstrate that a comprehensive pension risk management program is in place. Unfortunately, there is little information that details if, and to what extent, plan sponsors are doing a credible and pro-active job of identifying, measuring and mitigating a variety of risks. The risk alphabet includes, but is not limited to, asset, operational, fiduciary, legal, accounting, longevity and service provider uncertainties.

While no one could have predicted the extreme volatility that characterizes the current state of global capital markets, it has always been known that poor risk management can make the difference between economic survival and failure. Applied to pension schemes, ineffective risk management could prevent individuals from retiring at a certain age and/or leaving the work force with much less than anticipated. Others pay the price too. Taxpayers worry about rate hikes that may be inevitable for grossly underfunded public plans. Shareholders could find themselves on the hook for corporate promises or experience depressed stock prices due to post-employment benefit obligations.

In an attempt to shed some light on this critical topic area, Pension Governance, LLC is pleased to make available a new research report that explores current pension risk management practices. In what is believed to be a unique large-scale assessment of pension risk practices since the publication of a 1998 study by Levich et al, this survey of 162 U.S. and Canadian plan sponsors seeks to: (1) understand why and how pension plans employ derivative instruments, if they are used at all (2) identify what plan sponsors are doing to address investment risk in the context of fiduciary responsibilities and (3) assess if and how plan sponsors vet the way in which their external money managers handle investment risk, including the valuation of instruments which do not trade in a ready market. The report was written by Dr. Susan Mangiero, AIFA, AVA, CFA, FRM, with funding from the Society of Actuaries.

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

In answering broad questions, a large number of surveyed plan sponsors describe themselves as doing all the right things to manage investment, fiduciary and liability risks. However, answers to subsequent questions - those that query further about risk procedures and policies at a detailed level - do not support the notion that pension risk management is being addressed on a comprehensive basis by all plans represented in the survey sample.

Key findings include the following points:

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

Click to download the 69-page study, entitled "Pension Risk Management: Derivatives, Fiduciary Duty and Process" by Susan Mangiero. Given the large file size, readers are encouraged to (a) first save the file (right mouse click) and then (b) open the file from wherever you have saved the file. Otherwise, you may receive an error message, depending on your computer configuration. 

The study is also available by visiting www.pensiongovernance.com. Send an email to PG-Info@pensiongovernance.com if you experience any difficulty in downloading the pdf file and/or want to comment about the study.

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According to reporter Doug Halonen, Beantown regulators have launched an inquiry into how corporate plan sponsors value their alternative fund investments. Upset with plans that have no process in place to verify mark-to-model or mark-to-market numbers from general partners, the head of the U.S. Department of Labor, Boston office, offers a warning. "It is incumbent on the Plan Administrator to establish a process to evaluate the fair market value of any hard to value assets held by the Plan." An absence of good process could be a violation of ERISA (Employee Retirement Income Security Act). The July 1, 2008 letter references parts of this federal law such as sections 402(a)(1), 103(b, 3(26), 404(a)(1)(B), 502(1) and 504(a). Invitation to scrutiny by the Internal Revenue Service might likewise occur if identical book values and market values show up on Form 5500s. (We've already seen this occur and puzzle over why plan sponsors think this is an appropriate way to disclose positions in alternative investments.)

Click to read "DOL targets plan valuation of alts" by Doug Halonen, Pensions & Investments, August 8, 2008.

This admonition is hardly news to this blogger. I've long been advocating (a) the use of an independent third party pricing professional and (b) the need for fiduciary training in this area. (Note: Email Pension Governance, LLC if you want to learn more about our pension risk management and valuation training programs and/or our abilities to assist plans with risk management/valuation process creation and review).

Several things come to mind.

• How many pension fiduciaries feel comfortable doing a second check on the valuation of complex financial instruments, especially those that seldom trade? (As an Accredited Valuation Analyst, I can say firsthand that certification requires hours of specialized training  and case work.)
•  If an alternative fund manager (hedge fund, private equity, commodities, real estate, etc) refuses to provide full transparency about its holdings, won't plan sponsors find themselves in the uncomfortable position of being unable to properly vet values?
• How will pension consulting firms respond, especially if their teams do not include valuation savvy experts?
• Will ERISA plan fiduciaries remain vulnerable to allegations of breach if they employ outside service providers such as consultants, appraisers and so on and do not conduct their own review?
• If a plan sponsor conducts its own review, might they still be liable if they fail to do so regularly?
• For positions that infrequently trade, how often should such a review take place?
• Will valuation mandates (and the possible dire consequences of not having a "good" valuation process in place) discourage pensions from investing in alternatives?

Check out some of this blog's many posts about valuation, authored by Dr. Susan Mangiero, AIFA, AVA, CFA, FRM.

• "SEC Issues Compliance Alert About Sloppy Valuation Process" (July 25, 2008)
• "Hedge Fund Liquidity - Maybe..." (June 12, 2008)
• "Can You Spell 'Bad Valuation Practices'?" (June 3, 2008)
• "Valuation - Getting on Track" (April 17, 2008)
• "Money House of Cards or Disciplined Approach?" (April 17, 2008)
• "Hedge Fund Investing: Change is Good, You Go First" (March 3, 2008)
• "Hedge Fund Valuation Goes Global" (February 24, 2008)
• "Investing in Hedge Funds? Check Out Valuation Process" (January 18, 2008)
• "Private Equity Returns Appeal to Pensions" (January 16, 2008)
• "Private Equity Valuation - Discount Dilemmas" (January 16,2008)
• "4P's - Pensions, Private Equity, Performance and Placement" (December 31, 2007)
• "FAS 157 is Heeeeere!" (November 19, 2007)
• "Can Banks and Pension Clients be Friends When It Comes to Valuation?" (November 13, 2007)
• "Will Auditors Become the Next Dismal Scientists?" (November 7, 2007)
• "FAS 157 and FAS 159 - Day of Reckoning for Pension Investors?" (November 4, 2007)
• "You Say Potato - I Say Potahtoe - Valuation Terms Differ" (November 4, 2007)
• "The Abracadabra of Valuation - Pension Fiduciaries Beware" (October 12, 2007)
• "Pension Risk and Hedge Fund Cherry Picking" (October 9, 2007)
• "Valuation Problems Are Going to Cost Plan Sponsors Big Time" (September 17, 2007)
• "Model Risk - Great Unknown for Pension Plans" (August 9, 2007)
• "Valuation Awakening - Does the Emperor Have Clothes" (July 25, 2007)
• "SEC Announces Investigation of Hedge Funds' Valuation Methodologies" (June 27, 2007)
• "Survey Shows That Pensions Worry About Risk Management and Valuation" (May 20, 2007)
• "Pensions and Hedge Funds and Private Equity - Assessing Risks" (May 18, 2007)

Send an email if you would like articles about valuation issues.

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On February 20, 2008, the U.S. Supreme Court released an opinion heard round Corporate America. In LaRue v. DeWolff, Boberg & Associates, Inc., these nine top justices held that ERISA does "authorize recovery for fiduciary breaches that impair the value of plan assets in a participant's individual account" and allows for lawsuits to enforce "liability-creating provisions" that involve fiduciary breach of duty. This is big news indeed, opening the door for individual participants in 401(k) plans to seek legal redress when their investment directives are ignored or incorrectly processed. In "Top Court Allows Suit Over 401(k)," New York Times legal reporter Linda Greenhouse describes this as "one of the most important rulings in years." It clarifies an otherwise somewhat ambiguous element of ERISA (Employee Retirement Income Security Act of 1974) as to whether fiduciary duty relates to the financial health of the plan versus that of an individual participant.

Click to read our November 28, 2007 post entitled "LaRue, Corporate Governance and the Next Pension Enron."

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Disclosure is fast becoming the proverbial four letter word in pension fiduciary land. Critical questions abound.

• How much information do pension fiduciaries need in order to make an "informed" decision?
• Who should provide that information, how often and in what form?
• Is there a danger of having "too much" information?
• What does the law currently require?
• What information is currently available and to whom?
• Is there an industry consensus about what constitutes "good quality" information?
• What are the consequences of "incomplete" disclosure and are they equally unpleasant for plan participants, shareholders, taxpayers and plan sponsors?
• What current roadblocks stand in the way of "better" disclosure (once that term is defined)?

 The topic of disclosure and transparency is as broad as it is critical to good plan governance. We've written extensively about this topic as applied to investment risk and will continue to do so. Click here if you would like to receive copies of some of our many articles. After hours of work, our research librarians are completing an Ebook on the topic of pension information resources. Click here if you want to be notified of its publication.

With a copyright date of July 4, 2007 (symbolic perhaps?), independent fiduciary Matthew D. Hutcheson addresses the topic of 401(k) plan information in "Retirement Plan Disclosure: A Declaration of Ethical Principles and Legal Obligations." Not known for being shy about his point of view, Hutcheson makes a compelling case for additional, complete and user-friendly disclosure about fees and related compensation arrangements.

“The Department (Department of Labor) emphasizes that it expects a fiduciary, prior to entering into a performance based compensation arrangement, to fully understand the compensation formula and the risks associated with this manner of compensation, following disclosure by the investment manager of all relevant information pertaining to the proposed arrangement. [Advisory Opinion Letter 1989 WL 435076 (ERISA)]

Thus, for a fiduciary to know all relevant information ahead of time, service providers must disclose all relevant information prior to entering into an engagement. The failure to disclose all relevant information effectively forces fiduciaries to violate the law unknowingly. The SEC has taken action against various service providers of 401(k) plans because of hidden compensation arrangements which obscured relevant information to fiduciaries. "

Hutcheson provides solid legal and regulatory evidence in support of full disclosure of all types of fees and related non-fee agreements. In addition, he reminds readers that fees impact economic performance and are therefore integral to any kind of investment decision-making. Would we buy a car or get surgery without enough information to gauge potential risk and rewards? 

His message comes at an opportune moment to begin a national "no holds barred" conversation about fees, fiduciary duty and protection of plan participants.  Countless companies are switching from defined benefit plans to defined contribution structures. In loco parentis NOT.  While employers transfer more responsibility to employees, research suggests that individuals are saving much less than is minimally needed to secure a reasonable lifestyle in retirement. Add to that an uncertain outlook for the long-term viability of Social Security and Medicare (and international equivalents to the U.S. post-employment safety net) and policy-makers are starting to take notice. Not a day too soon for many folks. If you think a train is about to crash, why wait to seek preventative measures?

Hutcheson concludes that "industry and regulators must either: (a) Return to the model originally contemplated under ERISA, in which recognized fiduciaries would make all decisions regarding trust assets; or (b) Empower participants to make their own individual decisions with respect to the assets in their personal tax-deferred 401(k) accounts. If the chosen course is to return to the original intent of ERISA, then fiduciaries of 401(k) plans must be armed with all relevant information necessary to construct a low-cost prudent portfolio for the benefit of the participants. Alternatively, if the chosen course is to enable those holding tax-deferred investments to, in essence, serve as their own mini-fiduciaries, then they must be afforded the information necessary to construct the same sort of prudent, low cost personal portfolio."

Those who advocate individual responsibility, and therefore favor the idea of choice at the employee level, get push-back from some that Sally or Joe "Every Worker" is unlikely to delve deep with respect to investment issues. Yet people make decisions for themselves every day - choosing a doctor, buying a car, voting, changing jobs and so on. But, for argument's sake, let's agree that a "mini fiduciarization" of the workforce is impractical, infeasible or otherwise unappealing. What then?

If only plan sponsors are to decide on all things 401(k), should we not be seriously engaged in identifying what makes for a "top quality" fiduciary? Besides access to good and complete information about fees and other pecuniary arrangements, we've long advocated a requirement for "suitable" qualifications (education and experience) before someone makes multi-million decisions with other people's money. To be clear, the use of the term "require" here refers to that which is self-imposed by plan sponsors, perhaps with the help of various industry and fiduciary organizations. Mandatory requirements would be problemmatic and could exacerbate the situation. (Our firm, Pension Governance, LLC provides fiduciary training, process checks and research in the areas of investment risk and valuation. Part of a growing industry to help fiduciaries do a better job, we complement work done by our partners but always with the same message. Good process is everything!)

On the topic of information, the more voices the better as long as it gets us to an enlightened place. This means that "good" disclosure would be seen as a value-enhancing tool for all concerned parties, not another costly, "go nowhere" exercise.

To read the full text of Hutcheson's article, click here. You will be taken to the Social Science Research Network site. Pension Governance, LLC is a proud sponsor of four SSRN sections. Click here to learn more about our sponsorship of a pension risk management section (created just for us) and a research section about mutual funds and hedge funds. Click here to learn more about our sponsorship of a research section about employment law and litigation and a research section about corporate governance.

For further reading, click on the title of each item listed below:

"Who Wants to be a Fiduciary Anyhow?"

"Do You Know the True Cost of Your Retirement Plan?"

"Searching for Hidden Treasure"

"Do We Need an Easy Button for Fiduciaries?"

"401(k) Fee Analysis - Who Benefits?"

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In "Test case looms on backdating" (June 1, 2007), FEI journalists Jeffrey Marshall and Ellen Heffes write that a legal precedent may soon be set in the form of a class action case against builder KB Home. Many managers and board members who participated in backdating decisions and also act as company fiduciaries for the 401(k) plan are named in the lawsuit. Alleging ERISA fiduciary breach due to the backdating of stock options, plan sponsors and their attorneys await the outcome.

"If this case survives summary judgment, plaintiff's attorneys will be emboldened and bring more employees onto the class-action backdating bandwagon," suggests attorney John Gamble, with Fisher & Phillips, a labor and employment law firm. Marshall and Heffes caution that a post-Enron amendment of ERISA  increases punishment. "Individuals who are caught willfully violating ERISA face 10 years in prison and fines up to $100,000."

A few months ago, I predicted an ERISA litigation fallout if companies recommend stock for the 401(k) plan yet do not properly vet the process by which executives receive options. Click here to read "Will Executive Option Issues Drive the Next Wave of Pension Litigation?" by Susan M. Mangiero (Journal of Compensation and Benefits, March/April 2007).

This case is sure to attract attention.

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Back from a somewhat relaxing weekend (I had to work part of the time), I opened my mail to find two publications, each with a front page article about 401(k) "stock drop" cases. Is it coincidental or a harbinger of next season's hottest trend in litigation?

According to "401(k) fee suits not soon to retire" by Amanda Bronstad (The National Law Journal, May 28, 2007), earlier filed cases focus on undisclosed fees levied by mutual funds. In contrast, more recent lawsuits look at fees charged for annuities while "others challenge the prudence of employers that invest in funds that charge high fees - even if they're fully disclosed to employees."

In "Stock-drop suits hitch 401(k) ride," writer Susan Kelly describes a resurgence in ERISA lawsuits (Financial Week, May 28, 2007) with companies of all sizes now vulnerable to allegations that stock in the 401(k) plan is a no-no.

Outcomes remain unknown at this time with federal judges in three cases having refused to dismiss (Kraft, Boing, Bechtel). Not all cases are home runs for the plaintiffs. As the National Law Journal article details, the federal judge in a case against Exelon Corp. "dismissed claims that excessive fees in a 401(k) plan caused investor losses." In the Northrup Grumman case, some of the defendants, "including the board of directors," were dismissed.

Along these lines, we think our forthcoming June 4 webinar on the topic of 401(k) plan governance is timely. Click here  to get more details and/or to register. We'll start at noon and end at 1:15 p.m. EST. The webinar is free to Pensiongovernance.com subscribers. The cost to non-subscribers is $125. Pension Governance, LLC is registered with CFA Institute as an Approved Provider of professional development programs. This program is eligible for 1.5 PD credit hours as granted by CFA Institute.

Topics to be discussed include the following:

• Description of fiduciary duties under ERISA
• Discussion of procedural prudence as relates to 401(k) plan selection of fiduciary advisors
• Overview of safe harbor and selection of fiduciary advisor pursuant to the Pension Protection Act of 2006
• Litigation trends in the area of investment fiduciary breach as relates to plan sponsors and service providers such as consultants
• Fiduciary investment process for assessing 401(k) provider fees
• Role of fiduciary advisor in providing financial education
• Governance considerations with respect to selection of default investment 
• Structural changes in money management industry in response to material shift away from defined benefit plans
• Fiduciary advisor “red flag” practices such as soft dollar questions, revenue-sharing, limited disclosure.
  

Dr. Susan M. Mangiero, AIFA, AVA, CFA, FRM, president of Pension Governance, LLC will moderate an expert group of panelists to include:

• Mr. Blaine F. Aikin, AIF®, CFA, CFP® - Managing Partner, Fiduciary360
• Mr. David J. Bauer - Partner, Casey, Quirk & Associates LLC
• Mr. David Vriesenga - Chief Rating Officer, Cefex - Centre for Fiduciary Excellence, LLC.
  

We hope you can join us for what is sure to be an informative and lively discussion!

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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.

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During a September 26, 2006 panel discussion about the use of derivatives by pensions, mention was made of a U.S. Department of Labor letter. Several people asked for more information. (The Pensions & Investments conference focused on liability-driven investing.)

Click here to read the letter. Excerpts are provided below. Several items are noteworthy, especially since liability-driven investing strategies often rely on the use of derivatives.

1. There is a clear focus on process.

2. Regulators cite the need to identify operational and legal risks.

3. Passing the baton to a money manager does not absolve plan decision-makers of oversight duties with respect to the use of derivatives by outside firms.

4. Methods used to assess market risk should be appropriate and could include stress testing and simulation.

<< Investments in derivatives are subject to the fiduciary responsibility rules in the same manner as are any other plan investments. Thus, plan fiduciaries must determine that an investment in derivatives is, among other things, prudent and made solely in the interest of the plan's participants and beneficiaries.

In determining whether to invest in a particular derivative, plan fiduciaries are required to engage in the same general procedures and undertake the same type of analysis that they would in making any other investment decision. This would include, but not be limited to, a consideration of how the investment fits within the plan's investment policy, what role the particular derivative plays in the plan's portfolio, and the plan's potential exposure to losses. While derivatives may be a useful tool for managing a variety of risks and for broadening investment alternatives in a plan's portfolio, investments in certain derivatives, such as structured notes and collateralized mortgage obligations, may require a higher degree of sophistication and understanding on the part of plan fiduciaries than other investments. Characteristics of such derivatives may include extreme price volatility, a high degree of leverage, limited testing by markets, and difficulty in determining the market value of the derivative due to illiquid market conditions.

As with any investment made by a plan, plan fiduciaries with the authority for investing in derivatives are responsible for securing sufficient information to understand the investment prior to making the investment. For example, plan fiduciaries should secure from dealers and other sellers of derivatives, among other things, sufficient information to allow an independent analysis of the credit risk and market risk being undertaken by the plan in making the investment in the particular derivative. The market risks presented by the derivatives purchased by the plan should be understood and evaluated in terms of the effects that they will have on the relevant segments of the plan's portfolio as well as the portfolio's overall risk.

Plan fiduciaries have a duty to determine the appropriate methodology used to evaluate market risk and the information which must be collected to do so. Among other things, this would include, where appropriate, stress simulation models showing the projected performance of the derivatives and of the plan's portfolio under various market conditions. Stress simulations are particularly important because assumptions which may be valid for normal markets may not be valid in abnormal markets, resulting in significant losses. To the extent that there may be little pricing information available with respect to some derivatives, reliable price comparisons may be necessary. After entering into an investment, a plan fiduciary should be able to obtain timely information from the derivatives dealer regarding the plan's credit exposure and the current market value of its derivatives positions, and, where appropriate, should obtain such information from third parties to determine the current market value of the plan's derivatives positions, with a frequency that is appropriate to the nature and extent of these positions.

If the plan is investing in a pooled fund which is managed by a party other than the plan fiduciary who has chosen the fund, then that plan fiduciary should obtain, among other things, sufficient information to determine the pooled fund's strategy with respect to use of derivatives in its portfolio, the extent of investment by the fund in derivatives, and such other information as would be appropriate under the circumstances.

As part of its evaluation of the investment, a fiduciary must analyze the operational risks being undertaken in making the investment. Among other things, the fiduciary should determine whether it possesses the requisite expertise, knowledge, and information to understand and analyze the nature of the risks and potential returns involved in a particular derivative investment. In particular, the fiduciary must determine whether the plan has adequate information and risk management systems in place given the nature, size and complexity of the plan's derivatives activity, and whether the plan fiduciary has personnel who are competent to manage these systems. If the investments are made by outside investment managers hired by the plan fiduciary, that fiduciary should consider whether the investment managers have such personnel and controls and whether the plan fiduciary has personnel who are competent to monitor the derivatives activities of the investment managers.

Plan fiduciaries have a duty to evaluate the legal risk related to the investment. This would include assuring proper documentation of the derivative transaction and, where the transaction is pursuant to a contract, assuring written documentation of the contract before entering into the contract.Also, as with any other investment, plan fiduciaries have a duty to properly monitor their investments in derivatives to determine whether they are still appropriately fulfilling their role in the portfolio. The frequency and degree of the monitoring will, of course, depend on the nature of such investments and their role in the plan's portfolio. >>

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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?

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In its newly released "Pension Insurance Data Book", the Pension Benefit Guaranty Corporation (PBGC) continues to show about a $23 billion deficit, adding that "typically, the plans trusteed by the PBGC are only about 50 percent funded on a termination basis. Very few of the claims against the agency (only 1.5 percent) come from plans that are at least 75 percent funded."

By way of background, the "PBGC is a federal corporation created by the Employee Retirement Income Security Act of 1974 to guarantee payment of basic pension benefits earned by workers. Its two insurance programs cover 44 million American workers and retirees participating in over 30,000 private-sector defined benefit pension plans, including some 1,600 multiemployer plans. The agency receives no funds from general tax revenues. Operations are financed largely by insurance premiums paid by companies that sponsor pension plans and by investment returns."

Could it get any worse?

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Wikipedia describes the Rashomon Effect, named after the 1950 classic movie, as the proper way to describe any situation "wherein the truth of an event becomes difficult to verify due to the conflicting accounts of different witnesses."

And so one wonders if the Rashomon Effect pervades in pensionland. After all, it seems that every day brings new headlines with gloomy news about pension losses. Can it all be bad?

Whether a pension crisis is upon us is an excellent question. Solving a problem is impossible without acknowledging its existence.

These thoughts arose a few days ago when a blog reader sent the following anonymous note:

Government plans are not covered by ERISA for sound constitutional reasons, state sovereignty, the 10th Amendment, etc. Take a closer look and you will see that most plans are soundly managed. They are also subject to multiple levels of state oversight. Don't buy the hype.

Importantly, one might have penned something similar about ERISA funds regarding what we read and hear. The focus of the newly passed Pension Protection Act of 2006 in all of its 907 page glory, and now awaiting Presidential approval, company pension headlines are often negative, replete with references to losses, rescinded benefits and/or impact on employee morale.

The National Association of State Retirement Administrators ("NASRA") has written extensively in support of municipal pension plan management. To illustrate, in an August 2, 2006 letter to federal lawmakers, they and other signatories wrote about the misperceptions of public pension finance and the benefits of a study by the Government Accountability Office to set the record straight.

There are fundamental differences between governments and businesses that result in critical distinctions between plans in each sector and the way in which they are accounted for and measured. These distinctions are often unknown or misunderstood.

Public plans are in sound financial condition and State and local governments take seriously their responsibility for paying promised benefits to their employees and retirees. Comprehensive State and local laws, and significant public accountability and scrutiny, provide rigorous and transparent regulation of public plans and have resulted in strong funding rules and levels. Public plans are backed by the full faith and credit of State and local governments. Additionally, a public plan participant's accrued level of benefits and future accruals typically are protected by state constitutions, statutes, or case law that prohibits the elimination or diminution of a retirement benefit, providing far greater protections than what is provided by ERISA or PBGC.

State and local retirement plan assets are professionally-managed and provide valuable long-term capital for the nation's financial markets. The $2.8 trillion held in plan portfolios are an important source of stability for the marketplace and are designed to withstand short-term fluctuations while still providing optimal growth potential.

The bulk of public pension funding is not shouldered by taxpayers.

The vast majority of public plan funding comes from investment income.

This author concurs that shedding more light on the financial health of public plans is a great idea. Ditto for ERISA funds.

Finger pointing is futile. Taxpayers, shareholders and plan participants just want to know what impacts their wallets.

1. Can I afford to retire?

2. Will my benefits be limited or, worse yet, pulled away once I've retired?

3. Will my taxes go up?

4. Will my equity investment fall in value because of a company pension problem?

Reasonable people want answers now, not later on when it's too late to do anything to salvage their financial stake. As mentioned many times before, a real dilemma is information - old, incomplete and/or difficult to interpret. (Click here to read "Will the Real Pension Deficit Please Stand Up?")

How can we get closer to the truth and then use it productively?

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According to PENSION AND BENEFITS, a CCH Business & Corporate Compliance publication, "EBSA, the PBGC and the IRS have proposed revisions to the Form 5500 Annual Return/Report forms. The goal is to modernize the ERISA fund disclosure process. While mandated by law, the current reporting system is in need of major improvements, something this author has described in several articles elsewhere.

What are some of the problems with the current reports? There is a long lag time between when data is submitted to the U.S. Department of Labor and when the information becomes available for public consumption. To illustrate, this author did a quick search of Freeerisa.com for several large U.S. companies and found data up to and including 2004 but nothing for 2005. As investors and beneficiaries know all too well, things can go downhill pretty quickly in which case a stale Form 5500 would be of no use whatsoever.

Moreover, the Form 5500 (Schedule H for large plans) provides scant details about a plan's investments. Nothing is provided about valuation methodology nor is any information proffered about risk measurements or risk mitigation strategies.

A welcome change is the expansion of information about service provider compensation. CCH reports the following.

The DOL has determined that it is appropriate to modify the Schedule C reporting requirements to ensure that plan officials obtain the information they need to assess the reasonableness of compensation paid for services rendered to the plan. As proposed, Schedule C would consist of three parts. Part I of Schedule C would require the identification of each person who received, either directly or indirectly, $5,000 or more in total compensation (money or anything else of value) in connection with services rendered to the plan or their position with the plan during the last plan year. This requirement would no longer be limited to the 40 highest paid service providers.

Filers would also have to indicate, for all service providers, whether the service provider received any compensation attributable to the person's relationship with, or services provided to the plan, from a party other than the plan or plan sponsor. Thus, if a fiduciary or anyone on a list of service providers received, directly or indirectly, $5,000 or more in total compensation and also received more than $1,000 in compensation from a person other than the plan or plan sponsor, then the Schedule C would have to provide information identifying the payor of the compensation, the relationship or services provided to the plan by the payor, the amount paid, and the nature of the compensation.

For further information, check out these sites.

1. IRS Form 5500 Corner

2. U.S. DOL "Troubleshooter's Guide to Filing the ERISA Annual Report (Form 5500), Part I"

3. U.S. DOL "General Guidelines for Completing Form 5500 and Schedules A, C, D, G, H and I"

4. Freeerisa.com (You can register for no charge and then search over 270,000 new filings.)

5. Article entitled "Deciphering Risk Management Disclosures" (While the article does not address Form 5500, it describes some important transparency issues.)

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Valuation and risk professional Dr. Susan M. Mangiero, CFA, AVA, FRM will moderate a panel of esteemed retirement plan experts at the forthcoming 42nd annual meeting of the Eastern Finance Association at the Sheraton Society Hill in Philadelphia on April 20 from 10:15 a.m. to noon. (The hotel is located at 1 Dock Street in Philadelphia.)

Months away from sweeping Congressional reform and accounting standards that will dramatically impact the financial health of Corporate America, a diverse and seasoned panel of experts will talk about plan termination, 401K plan design, pension governance, fiduciary compliance, ERISA litigation trends, liability-driven investing and pension risk management with respect to shareholder value and employee productivity and morale. With over $10 trillion and 100 million plan participants at risk, conference producer Dr. John Finnerty describes this presentation as "an urgent call to our 850 financial members who are helping finance leaders, at all levels, grapple with the real challenges that post-retirement benefits present". Moderator Dr. Mangiero concurs. "CEOs and CFOs alike are quickly realizing how vulnerable they are to pension problems that can force rating downgrades, invite litigation and higher regulatory compliance costs, increase the cost of capital and otherwise impede corporate growth. For more than a few companies, pensions have become a veritable albatross."

Panelists include Mr. I. Lee Falk, Senior Counsel (Morgan, Lewis & Bockius LLP), Mr. Wayne H. Miller, CEO (Denali Fiduciary Management), Mr. James V. Morris, Senior Vice President (SEI Global Institutional Group) and Mr. Norman Jackson, Deputy Regional Director (United States Department of Labor - Employee Benefits Security Administration's Philadelphia Regional Office).

The general public is invited. There is a nominal fee of $50, payable at the door. The Eastern Finance Association is a non-profit organization. Its members include college and university professors, officers of financial institutions and organizations, and others interested in finance and the objectives of the EFA. The Association sponsors The Financial Review, a journal that publishes original empirical, theoretical, and methodological research providing new insights into issues of importance in all areas of financial economics.

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