Santa Claus and the Fiduciary Standard

At this time of the year, when Santa Claus is making his list of who has been naughty and nice, optimists rub their hands in glee, anticipating a stocking full of goodies. Pessimistic believers resign themselves to something worse. In pension land, if you embrace fiduciary change, the incoming head of the U.S. Senate Finance Committee may be about to hand you the proverbial lump of coal.

According to Washington Bureau Chief Melanie Waddell, Senator Orrin Hatch intends to push anew for the passage of his Secure Annuities for Employee Retirement or "SAFE" Act. He spoke about pension reform and the "pension debt crisis" on July 9, 2013 in his "Introduction of the SAFE Retirement Act of 2013."  His objective is to "stop the Department of Labor from writing fiduciary rules for individual retirement accounts" and "over-regulating IRA investment advice." See "Sen. Hatch's 2015 Priority: Torpedo DOL Fiduciary Efforts" (Investment Advisor Magazine, December 15, 2014).

Put forward as a Conflict of Interest Rule-Investment Advice, the U.S. Department of Labor seeks to "reduce harmful conflicts of interest by amending the regulatory definition of the term 'fiduciary' set forth at 29 CFR 2510.3-21(c) to more broadly define as fiduciaries those persons who render investment advice to plans and IRAs for a fee within the meaning of section 3(21) of the Employee Retirement Income Security Act (ERISA) and section 4975(e)(3) of the Internal Revenue Code. The amendment would take into account current practices of investment advisers, and the expectations of plan officials and participants, and IRA owners who receive investment advice, as well as changes that have occurred in the investment marketplace, and in the ways advisers are compensated that frequently subject advisers to harmful conflicts of interest."

As with any mandate, if approved, some will be impacted more than others. In its "DOL 2014 Fall Regulatory Agenda," ERISA attorneys Fred Reish, Bruce Ashton and their Drinker Biddle & Reath LLP colleagues assert that broker-dealers and their registered representatives will likely bear the brunt of new rules. They write that "Adoption of an expanded definition will likely affect both the status for broker-dealers as fiduciaries and their compensation (due to the fiduciary prohibited transaction rules of ERISA). In response, these broker-dealers may need to develop RIA fiduciary programs for advisors who focus on retirement plans and decide how to manage the plan business of those who do not."

Whatever your holiday preference may be, keep a look out for the "gifts" that 2015 has in store for plan sponsors and their service providers.

Taxpayer Bailout of Underfunded Pension Plans

Over dinner last night with friends, my husband told a joke about Kim Kardashian and Paris Hilton (or whomever you want to designate as fact-challenged individuals). The hotel heiress asks "Which is closer to us - Florida or the moon?" The reality star replies - "Hello, can you see Florida from here?" Unfortunately, this type of silliness has reared its head often over the years with regard to the topic of promising too much and funding too little. The math just does not work. To the logical observer, this flight of fantasy was always destined to self-destruct. It was more a question as to how long the downward spiral would take for impacted U.S. and non-U.S. government plans.

On July 27, 2006, I wrote "Tea Party Redux: State Pensions in Turmoil." It was blatantly clear that trouble was heading our way. Since then, headlines about retirement plan gaps continue to dominate the news.

In what could be a bellwether situation, the State of Illinois wants to address a shortfall that is referred to as "the biggest in the U.S" and is fighting the court system to be empowered to do so. See "Illinois Fights Court Block of $111 Billion Deficit Fix" by Andrew Harris (Bloomberg, November 27, 2014). In "Why Illinois pension reform may be constitutional" (Crain's Chicago Business, December 6, 2014), Joe Cahill explains that "important state interests" may justify the limiting of pension contracts that are deemed constitutional and therefore inviolable. He references Felt v. Board of Trustees. Those who disagree that reform is legally possible suggest that taxpayer hikes and/or reduced overall municipal spending are inevitable.

Now it appears that U.S. lawmakers may have their sights set on private pension plans too. In "Congress could soon allow pension plans to cut benefits for current retirees" (December 4, 2014), Washington Post journalist Michael A. Fletcher describes a move that, if enacted, would see lower payouts for plan participants of multi-employer plans in distress. The alternative is to have the Pension Benefit Guaranty Corporation ("PBGC") take over any failed plans. As stated in "Solutions not Bailouts" (February 2013), Randy G. Defrehn and Joshua Shapiro write that benefits would be lowered anyhow in the event of a PBGC assumption of plans deemed as insolvent. In "The lame-duck Congress plots to undermine retiree pensions," Los Angeles Times reporter Michael Hiltzik urges readers to stay tuned as the December 11, 2014 vote on an omnibus spending bill may contain language that, if passed into law, would snip dollars from union retirement arrangements. He quotes advocates of defined benefit plans as pushing for careful deliberation instead of rushing ahead.

Expect lots of changes in 2015 and thereafter. The pension crisis (at least for some sponsors and their employees) is not going away anytime soon. In the meantime, smart cookies are invited to the negotiations table. The worst thing that could happen is to ignore reality. Leave that to Kim and Paris. 

ERISA Plan Investment Committee Governance

In case you missed "ERISA Plan Investment Committee Governance: Avoiding Breach of Fiduciary Duty Claims" with Dr. Susan Mangiero (Fiduciary Leadership, LLC), Ms. Rhonda Prussack (Berkshire Hathaway Specialty Insurance) and Attorney Richard Siegel (Alston & Bird), click to download the November 17, 2014 presentation or visit the Strafford CLE website to obtain the audio recording.

Given the importance of the investment committee governance topic and emerging market trends in the area of outsourcing, my comments focused on committee structure, guiding documents, training and implications when third parties sign on as fiduciaries. Points I made during the webinar include, but are not limited to, the following:

  • The ERISA Advisory Counsel, in its 2014 Issue Statement about outsourcing employee benefit plan services, cites a desire to understand how vendor contracts address provisions such as termination rights, indemnification, liability caps and service level agreements.
  • An evaluation of the outsourcing business model is not surprising given a service provider push to serve as an Outsourced Chief Investment Officer or Fiduciary Risk Manager. (An Asset International publication refers to the OCIO movement as a fast-growing segment of investment consulting.)
  • Once an investment committee has been authorized by the sponsor's board of directors, a core set of qualifications and experience needs can be assembled. Plan counsel can play a vital role in explaining fiduciary obligations.
  • Beyond that core base, facts and circumstances such as plan design, company size, industry structure and investment strategy should be taken into account as part of determining requisite training and experience.
  • Regular meetings are encouraged with frequency being determined in part by what has to be done by the investment committee and related time sensitivity of completing a task(s).
  • Notwithstanding the voluntary nature of having an Investment Policy Statement ("IPS") in place, an ERISA plan investment committee should establish one nevertheless that makes sense for a particular plan. Some organizations have been questioned after creating an IPS but not following it.
  • Creating (and following) an appropriate Risk Management Policy can likewise be useful, especially for ERISA plans that utilize derivative instruments and/or allocate money to more complex products or strategies.
  • Training is another mission-critical area. (According to "DOL Investigators Quiz Plan Sponsors On Training of Fiduciary, Attorneys Say" by Bloomberg BNA contributor Joe Lustig, fiduciaries are being asked by regulators whether training programs exist.)
  • Continuing education is beneficial since regulations, market conditions and plan-related objectives and strategies can change over time.

Someone from the audience asked whether it made sense for an investment committee to consist of a senior corporate executive such as a Chief Financial Officer and her direct reports. The point is that each fiduciary is equal at the investment committee "table" but otherwise unequal. This can present a big problem if any or all of the investment committee members disagree with the Chief Financial Officer. Worse yet, a subordinate (in corporate organization terms) may be reluctant to whistle blow about an imprudent decision made by the CFO while wearing her hat as ERISA fiduciary. I will leave the question as to legal protection to attorneys. However, in doing some research, it turns out that U.S. federal pension law does address whistle blower protections. Interested persons can click to read "ERISA Has a Whistleblower Provision? Yep." by Seyfarth Shaw attorneys Ada Dolph and Robert Szyba (June 19, 2014).

There is a lot more to say on the topic of investment committee governance, notably because ERISA lawsuits that are adverse to a plan sponsor tend to include all investment committee members as defendants. An effective infrastructure and good governance policies and procedures can help to mitigate fiduciary personal and professional liability and position the investment committee to better serve participants.

Susan Mangiero of Fiduciary Leadership, LLC Earns the "Professional Plan Consultant" (PPC) Credential

Trumbull, CT (November 6, 2014) – Dr. Susan Mangiero is pleased to announce her designation by Financial Service Standards, a division of fi360, Inc. (Pittsburgh, PA) in the area of retirement plan consulting.  She is the recipient of this specialized designation known as the Professional Plan Consultant or PPC.

Recent regulatory changes to the qualified retirement plan industry have sparked an urgency to ensure that retirement plan service professionals have specialized training and resources to help sponsors meet their fiduciary obligations and a means of documenting that prudent practices are being followed in the management of an employer-sponsored plan.  Those professionals that help retirement plan fiduciaries and their counsel are seeking accreditation and certification to demonstrate a high level of knowledge and the ability to provide sponsors with the tools necessary to manage their plan effectively.

The Professional Plan Consultant™ designation was developed by Financial Service Standards with a goal of helping professionals that work with employer-sponsored retirement plans specialize in this increasingly regulated niche of the financial industry.  Program graduates must sit for either a two-day training class or complete the equivalent web-based training program, pass a comprehensive final exam, sign off on the FSS Code of Ethics, and commit to ongoing training in retirement plan management. 

Susan Mangiero is a Managing Director with Fiduciary Leadership, LLC. She is a CFA charterholder, certified Financial Risk Manager and Accredited Investment Fiduciary AnalystTM. Dr. Mangiero has been working within the investment management industry for over twenty years. She provides a variety of investment risk governance and valuation services to attorneys, regulators, asset managers, investment committees and other types of fiduciaries. Services include board training, business intelligence surveys, calculation of damages for dispute resolution purposes, expert witness testimony, investment best practices research, white papers, financial model reviews and procedural prudence assessments. She is the author of Risk Management for Pensions, Endowments and Foundations and the lead contributor to the award-winning blog, www.pensionriskmatters.com.

According to Dr. Mangiero, she is proud and excited to have received this distinguished designation. "It requires industry experience and reflects my dedication to raising the service standards in the retirement plan industry, whether for 401(k) plans, defined benefit ("pension") plans, Employee Stock Ownership Plans ("ESOP"s) or other types of employee benefit arrangements. This designation is an indicator that a professional has added to her knowledge and can access unique tools and resources that can help plan sponsors meet certain industry requirements."

Sharon Pivirotto, Founder & Managing Director of Financial Service Standards of Pittsburgh congratulates Dr. Mangiero on this achievement and "applauds her initiative to help customers plan, build and maintain a successful and compliant company-sponsored retirement plan. This kind of commitment and service approach ultimately means better retirements for many employees."

The 40lk Service Training Program, sponsored by Financial Service Standards, has been accepted for 12.5 continuing education credits by the Certified Financial Planner Board of Standards Inc. The PPC designation is listed on the FINRA website.

Fiduciary Leadership, LLC is an investment risk governance and forensic economic analysis consulting company. Clients include asset managers, transactional attorneys, litigation attorneys, regulators and institutional investors.

ERISA Plan Investment Committee Governance

Following up on the theme I discussed about investment committee dynamics in "Decision Making When You Don't Like Your Colleagues" (September 9, 2014), Strafford Publications is sponsoring a related webinar. Entitled "ERISA Plan Investment Committee Governance," this November 17 2014 continuing legal education event will address oversight and management issues from multiple perspectives. If you are interested in attending as my guest, the first ten people who email contact@fiduciaryleadership.com will be registered on a no-fee basis. If you have questions for the panelists, letting us know in advance will be helpful.

Speakers are Dr. Susan Mangiero (Managing Director - Fiduciary Leadership, LLC), Ms. Rhonda Prussack (Vice President and Fiduciary Liability Product Manager - Berkshire Hathaway Specialty Insurance) and Attorney Richard Siegel (Alston & Bird LLP).

The panel will answer questions such as the following:

  • How important is investment committee governance?
  • How best must plan sponsors vet fiduciary risks when selecting an investment committee?
  • What is the role of ERISA fiduciary liability insurance?
  • What litigation techniques can be implemented to minimize the likelihood of a finding of breach of fiduciary duty by an investment committee?

Join us if you can. Click here to learn more.

Public Plans For Private Sector Employees - Say Whaaat?

The news about public retirement plans for private workers may not be as snappy as a dog with red sunglasses taking a selfie but it sure caught my attention.

On June 17, 2014, Pensions & Investments reported that efforts are underway to "provide retirement security for all New Yorkers - not just participants in the $150 billion New York City Retirement Systems." In "NYC comptroller to launch advisory panel for retirement security," writer Robert Steyer tells readers that Chief Investment Officer Scott Evans will lead the group, with members yet to be appointed. The Nutmeg State is on the same glide path with its creation of the Connecticut Retirement Security Board. Michelle Chen of The Nation applauds this initiative while Bill Cummings of the Connecticut Post decries the costs that small business owners will bear if a mandatory offering occurs.

In "State-based retirement plans for the private sector" (August 6, 2014), the Pension Rights Center lays out legislative happenings elsewhere as part of a "movement afoot to use the efficiencies of public retirement systems to administer new types of pension plans for private-sector workers." The list includes Arizona, California, Colorado, Illinois, Indiana, Maine, Maryland, Massachusetts, Minnesota, Nebraska, Ohio, Oregon, Vermont, Washington, West Virginia and Wisconsin.

Certainly there is merit for any effort that helps to promote savings and financial independence. That said, there is a plethora of critical questions to be answered before any products are developed, let alone forced on taxpayers and employers. For one thing, who will serve as a fiduciary for each plan and what regulatory regime will prevail? ERISA does not extend to government plans. Will state trust law apply? Second, some of the aforementioned states are struggling with underfunded plans for municipal workers. If said deficits are revealed as the result of questionable investment and benefit mix decisions and/or limited oversight, does it make sense to put these same persons in charge of a new plan? Third, to the extent that state funding is used to install these new plans, how will fiscal policy change as a result? Fourth, are there true efficiencies to exploit and in what areas - investment, operational, technology, etc?

Maybe state delivery of private retirement benefits makes sense but I hope that a lot of important issues get vetted before too much big spending takes place.

ERISA Pension Law Turns 40

Get out the party hats and horns. The Employee Retirement Income Security Act ("ERISA") turns 40 years old today. Signing this legislation into law on September 2, 1974, U.S. President Gerald R. Ford proclaimed a new era, noting that "the men and women of our labor force will have much more clearly defined rights to pension funds and greater assurances that retirement dollars will be there when they are needed. Employees will also be given greater tax incentives to provide for their own retirement if a company plan is unavailable."

Since 1974, change has not been a stranger. In her testimony before the ERISA Advisory Council on June 18, 2014, Honeywell in-house counsel Allison Klausner talked about greater mobility of the work force and a significant reliance on technology over time. The use of third parties was another area of emphasis. She added that "As ERISA turns 40, to effectively deliver 'benefits' (perhaps best stated as 'the delivery of support for the well-being of our workers and retirees') in an employer-sponsored system, plan sponsors find that it cannot be done without outsourcing some (or all) of the administrative and other work associated with and necessary to operate employee benefit plans."

Statistics about plan design paint a dramatic picture of change as well. According to the Private Pension Plan Bulletin Historical Tables and Graphs (U.S. Department of Labor, June 2013), the number of single-employer sponsored defined benefit plans fell from 101, 214 in 1975 to 43,813 in 2011. In contrast, the number of single-employer defined contribution plans rose from 207,437 in 1975 to 637,086 in 2011. As plan design preferences reflect demographic and economic shifts, they also present new challenges for fiduciaries.

For those who want to learn more about the history of ERISA and predictions of things to come, the American Bar Association and various co-sponsors are offering a free webinar on the topic. Click to register for "ERISA Turns 40: The Past, Current and Future State of Pension Plans," The event will be held on September 9, 2014 from 1:00 to 2:30 PM EST and will feature speakers from the U.S. Department of Labor and ERISA attorneys in private practice.

U.S. Supreme Court and Tibble v Edison International

According to SCOTUSBLOG.com, Glenn Tibble, et al. v. Edison International, et al ("Tibble v Edison") is seeing continued action after a petition for a writ of certiorari was filed on October 30, 2013 by counsel of record for the petitioners. Click here to download the 319 page document. On February 7, 2014, attorneys for respondents filed a brief in opposition. On March 3, petitioners' counsel filed a supplemental brief. Thereafter, on March 24 of this year, the Solicitor General was asked to file a brief in this ERISA fee case. That brief has now been filed and can be accessed by clicking here. (Thank you to Fiduciary Matters lead blogger, Attorney Thomas Clark, for sending the file.)

According to this 29-page "Brief For The United States As Amicus Curiae," the Solicitor General, the Solicitor of Labor and others conclude that the petition for a writ of certiorari should be granted with respect to the question as to "[w]hether a claim that ERISA plan fiduciaries breached their duty of prudence by offering higher-cost retail-class mutual funds to plan participants, even though identical lower-cost institutional-class mutual funds were available, is barred by 29 U.S.C. 1113(1) when fiduciaries initially chose the higher-cost mutual funds as plan investments more than six years before the claim was filed."

As an economist who leaves the legal issues for attorneys to vet, it seems that this filing opens the door to another review of ERISA matters by the U.S. Supreme Court. Whether that is good or bad, depends on your perspective. I would like to think that further discussions about fiduciary best practices by the highest U.S. court would be a positive outcome.

Brown M&Ms and Investment Service Provider Due Diligence

 

According to marketing guru Steve Jones, parties seeking to do business with one another can learn a lot from rock musician David Lee Roth. As explained in "No Brown M&M's: What Van Halen's Insane Contract Clause Teaches Entrepreneurs" (Entrepreneur Magazine, March 24, 2014), each of their agreements included a rider that was designed to force a promoter to pay attention to the band's true objective about ensuring safety. By adding what may have seemed like a silly provision about "melt in your mouth" candies being unwelcome, Van Halen was testing whether the promoter had read the contract in its entirety and was therefore more likely to install equipment properly. "If any brown M&M's were found backstage, the band could cancel the entire concert at the full expense of the promoter," leaving him or her with a possible loss in the millions of dollars.

In institutional investment land, there are intriguing parallels. For one thing, there is the safety issue. If a pension plan is poorly managed, beneficiaries may suffer. Second, if there is confusion or ambiguity about who is supposed to do what, when, how and at what price, there are likely to be disputes and economic consequences. There is a growing number of lawsuits and regulatory investigations that are scrutinizing service providers and/or the pension plan trustees who are tasked with diligently selecting them.

The developing market in outsourcing various services to a third party is yet another reason for paying close attention to the quality of engagement letters and vendor contracts. Earlier this year, the ERISA Advisory Council announced its plan to study "current contracting practices with respect to outsourced services, including provisions such as termination rights, indemnification, liability caps, service level agreements, etc. that might assist plan sponsors and other fiduciaries in negotiating service agreements."See "Outsourcing Employee Benefit Plan Services."

As someone who has done business intelligence research and trained investment fiduciaries and their advisors, I often hear the same frustration being expressed about a gap in expectations. Budget-strapped buyers want more for less. Consultants, asset managers and banks say they are searching for ways to satisfy their clients while still being able to earn a reasonable rate of return for their efforts. One solution is to streamline operations, to the extent possible, while acknowledging any fiduciary implications associated with prevailing law and governance standards. If cutting corners to preserve a profit margin ends up sacrificing requisite quality, trustees could be at risk of being investigated for anemic oversight of service providers. Vendors could be at risk for failing to deliver contractual services.

Based on my work for both defense and plaintiff counsel (depending on the matter and whether there is a counterclaim), a poorly worded agreement can be a potential trouble spot. Another hugely important issue is whether a service provider has self-identified as a fiduciary. An attorney or judge may categorize a particular service provider as a functional fiduciary even if a written contract is silent on that point. Trust counsel can play a critical role in assisting with negotiations before authorized persons sign on the dotted line.

ERISA attorneys David C. Kaleda and Theodore J. Sawicki address the issue of fiduciary status in a 2012 article for the National Society of Compliance Professionals. See "Should You Have a Formal ERISA Compliance Program?" In a recent discussion about the best practices for creating and adhering to service level agreements, ERISA attorney Howard Pianko expressed his strong view that there are numerous ways to ensure "plausibility" and still be able to hire affordable outside organizations to assist. He went on to describe the advantages of having a systematic mechanism in place such as the Six Sigma type model that his firm employs. Click to read about Seyfarth Lean. (Having earned a Green Belt in Six Sigma, I can attest firsthand to the upside of developing a process to control quality.) 

For those involved in the selection and oversight of service providers or the delivery of said services, ask yourself if you know as much about an existing or anticipated contract as you should.

ERISA Advisory Council Investigating Fiduciary Management

According to a 2014 statement, the ERISA Advisory Council intends to investigate the nature of retirement plan outsourcing and report its research to the U.S. Department of Labor ("DOL"). "Outsourcing Employee Benefit Plan Services" cites objectives to include the following:

  • Discussion about current practices in outsourcing and whether variables such as plan size or type impact the services provided to ERISA plans;
  • Clarification of "the legal framework under ERISA for retaining outsourced service providers..." and possible areas for regulatory guidance;
  • Getting suggestions about the management of potential conflicts of interest;
  • Further discussing the "scope of co-fiduciary liability in the outsourcing context" for 3(16), 3(21) and 3(38) relationships;
  • Discussion about how contracts are put together between an ERISA plan and a service provider to address issues such as termination rights, indemnification, liability caps; and
  • Examination of insurance coverage and ERISA bonds when an outsourcing arrangement exists.

This news is not particularly surprising. The topic of fiduciary management continues to attract attention, in part because it appears to be growing as a business model in the United States, United Kingdom and elsewhere. According to a survey of 73 pension plans and their advisors, Buck Consultants found that 70% "had at least considered going down that route." For those schemes that that had engaged a fiduciary manager, they cited motivations such as "improved speed in the decision making process, greater focus on the end game, and improved expertise." At the same time, UK-based Brian McCauley, Head of Fiduciary Evaluation at Buck Consultants, added that the governance burden is still "huge." In "Perceptions of Fiduciary Management," Stephenson Harwood attorney Fraser Sparks addresses concern about conceivable conflict of interest trouble spots when "an advisor turns into a provider." One offered solution is to engage an independent third party to evaluate the qualitative and quantitative characteristics of fiduciary manager short list candidates.

Stateside, ERISA legal experts debate the pros and cons of the outsourced fiduciary approach. In "New flavor of outsourced fiduciary for retirement plans hits the market" Investment News reporter Darla Mercado writes that "This latest service offering is popping up in an era when plan sponsors have a heightened awareness of their fiduciary responsibilities and are looking to offload some of them so that they can get back to the day-to-day work of running their business." Drinker Biddle & Reath attorney, C. Frederick Reish, talks about "3(16) lite" and the need to "[r]ead the fine print." The April 2, 2014 piece emphasizes that "...plan sponsors still have the responsibility of choosing and monitoring their service providers."

In "Expert Q&A on Outsourcing Fiduciary Investment Responsibilities" (Practical Law, February 2014), Groom Law attorneys David N. Levine and Allison Tumilty explain the legal dimensions of outsourcing fiduciary investment responsibilities and the advantages and disadvantages of passing the baton for certain delegated tasks. They add that outsourcing "can be appropriate for defined benefit and defined contribution plans of all sizes."

From my perch as a forensic economist who is sometimes hired to give expert testimony, I have observed a larger number of cases being filed that address the relationship between plan sponsor and service provider. Whether that trend continues remains to be seen. Given the foregoing, the ERISA Advisory Council inquiry is likely to be both timely and informative.

ACI ERISA Litigation Conference - New York City

I have the pleasure of announcing that Fiduciary Leadership, LLC is one of the sponsors of this recurring educational conference. For a limited time only, I am told that interested parties can register early and receive a discount. Contact Mr. Joseph Gallagher at 212-352-3220, extension 5511, for details.

Besides two full days of interesting and timely presentations, the American Conference Institute conference about ERISA litigation gives attendees a chance to hear different perspectives. Scheduled speakers include investment experts, corporate counsel, defense litigators, plaintiffs' counsel, class action specialists, judges and fiduciary liability insurance executives, respectively.

Click to download the ACI ERISA Litigation Conference agenda or take a peek at the list of topics as shown below:

  • Fifth Third v. Dudenhoeffer and the Impact of the Decision on the Future of Stock Drop Case and Litigation Regarding Plan Investments;
  • ERISA Class Actions Post-Dukes and Comcast: Standing, Commonality, Releases and Arbitration Agreements, Monetary Classes, Issue Certification, Certification of “Class Of Plans”, Class Action Experts and Halliburton, and More;
  • The Affordable Care Act, Health Care Reform and New Claims and Defenses in Workforce Realignment Litigation;
  • 401(k) Fee Cases: Current Litigation Landscape and Recent Decisions, Evolving Defense Strategies, DOL Enforcement Initiatives, Impact of Tussey and Tibble, Excessive Fund Fees, and More;
  • Retiree Health and Welfare Benefits: M&G Polymers USA, LLC v. Tackett and the Yard-Man Presumption;
  • Multiemployer Pension Plan Withdrawal Liability;
  • Independent Fiduciaries: Working with Them to Manage Plan Assets, Handle Administrative Functions and Authorize Transactions; and the Latest Claims Involving Failure to Monitor Independent Fiduciaries and/or Keep Them Informed;
  • ESOP: New and Emerging Trends in Private Company ESOP Litigation, Lessons Learned from Recent Decisions in ESOP Cases, and the Latest on DOL Investigations and Enforcement Priorities;
  • Benefit Claims Litigation: the Latest on ERISA-Specific Case Tracks Aimed at Discovery Disputes, Attorney Fees Post-Hardt, Limitation Periods in Plans, Addressing Requests for Evidence Outside of the Record in “Conflict” Situations, Judicial Review of Claims Decisions and the Battle Over Discretion, and More;
  • Fiduciary Liability Insurance: Assessing Current Coverage and Future Needs & Strategic Litigation and Settlement Considerations;
  • New Trends in Church Plan Litigation;
  • New Trends in Top Hat Plans: The Latest Litigation Risks;
  • Public Pension Developments and Trends; and
  • Ethical Issues That Arise in ERISA Litigation: The Fiduciary Exception to Attorney-Client Privilege, the Question of Who Really Is Your Client.

In April of this year, I presented at the ACI ERISA Litigation conference in Chicago about working effectively with an economic and/or fiduciary expert. Click to access the slides entitled "Expert Coordination: Working With Financial and Fiduciary Experts" by Attorney Joseph M. Callow, Jr. (Keating Muething & Klekamp PLL), Attorney Ronald S. Kravitz (Shepherd, Finkelman, Miller & Shah, LLP) and Dr. Susan Mangiero (Fiduciary Leadership, LLC). For a recap of this session, click to read "ERISA Litigation and Use of Economic and Fiduciary Experts" (May 5, 2014).

On October 28, 2014, I will be part of a panel about public pension fund issues. I will be joined by Attorney Elaine C. Greenberg (Orrick, Herrington & Sutcliffe LLP) and Attorney H. Douglas Hinson (Alston & Bird LLP). Topics we plan to cover are shown below:

  • Overview of Public Pension Market - Scope, Size and Funding Levels;
  • Government Plan Hot Button Issues;
  • Pension Reform:
  • Pension Obligations and Bankruptcy, With Discussion of Detroit;
  • SEC Enforcement Actions, With Discussion About the State of Illinois;
  • New Accounting and Financial Reporting Standards;
  • Use of Derivatives by Municipal Pension Plans;
  • Fiduciary Breaches as They Relate to Due Diligence; and
  • Suggestions for Risk Mitigation and Best Practices.

I hope to see you in the Big Apple in a few months!

Making Bets on U.S. Supreme Court Decisions

If I ever earn a spot on a game show like Jeopardy, answering questions about sports will be a challenge. I recognize that, unlike me, there are serious fans who spend more than a few hours each week, vetting all sorts of statistics and data points about what team is likely to win and by how much. At family gatherings, I hear nephews and in-laws waxing poetic about games such as Fantasy Football. According to the Fantasy Sports Trade Association ("FSTA"), only skilled parties need apply, adding that there is no gambling.

Big money is at stake. According to "Industry Demographics: At A Glance," nearly 34 million individuals, mostly men, played fantasy sports in the United States in 2013. Canada counts roughly 3.1 million fantasy sports players. Over a twelve month period, aggregate league fees for fantasy games tallied $1.71 billion. For information materials, the spend was $656 million. It was $492 million for challenge games. (For us neophytes, what is a challenge game?) Decade-long performance reflects "explosive absolute growth" of 241 percent or an annualized growth rate of 13.1 percent for 2008 through 2018. See "Top 10 Fastest Growing Industries" (April 2013).

So here I am, sitting at my computer, researching certain ERISA litigation matters, and lo and behold, what do I find? You guessed it - FantasySCOTUS. According to its dedicated website, over 20,000 lawyers, law students and "other avid Supreme Court followers" have opined as to how they believe cases will be decided. Click to view a short video about this Harlan Institute initiative.

For those who are waiting with bated breath for commentary about stock drop cases, fear not. Of 53 predictions, as of today, 23 votes are for affirmation by the U.S. Supreme Court and 30 votes are for reversal. There is even a breakdown of votes as to how each justice is expected to respond to the April 2, 2014 hearing about prudence. Click to check out the Fifth Third Bancorp v. Dudenhoeffer roster of votes. Click here to download a transcript of the hearing.

What will they think of next?

2nd Annual Tri-State Institutional Investors Forum

I have the pleasure of moderating a timely and topical panel on June 11 for US Markets Center for Institutional Investor Education. Entitled "Fiduciary Responsibility for Management & Trustees," this session will focus on the importance of the Board in creating good governance practices. Topics to be discussed include the role of audits as a way to monitor activities, creating proper standards that allow for stakeholder transparency and lines of authority and reporting. The role of staff, the investment consultant and investment manager will likewise be covered. Panel participants are shown below:

Moderator:

  • Dr. Susan Mangiero, Managing Director, Fiduciary Leadership

Panelists:

  • Charles Tschampion, Director of Special Projects, CFA Institute
  • Edward M. Cupoli, Board Member, New York State Deferred Compensation Plan
  • Patricia Demaras, Senior Counsel, Xerox Corporation.

Click to download the entire program for the 2nd Annual Tri-State Institutional Investors Forum. Click to register. I hope to see you there!

Pension Usage of Swaps

I have been writing, training and consulting about the use of derivatives by pension plans for many years. There is no shortage of topics, especially in the aftermath of the Dodd-Frank Wall Street Reform and Consumer Protection ("Dodd-Frank") and the fact that pension investing and derivatives trading are significant elements of the capital markets. The OECD estimates the size of the private pension system in 2012 at $32.1 trillion. The Bank for International Settlements estimates the June 2013 global derivatives market size at $692.9 trillion.  

Given the importance of the topic of pension risk management and the evolving regulatory landscape, it was a pleasure to have a chance to recently speak with Patrick S. Menasco. A partner with Steptoe Johnson, Attorney Menasco assists plan investors, investment advisers and broker-dealers as they seek to navigate the laws relating to hedging, swaps clearing and much more. Here are a few of the take-away points from that discussion.

Question: Do the swaps provisions embedded in the Dodd-Frank legislation contradict the netting rules that are part of U.S. bankruptcy law?

Answer: No, the netting provisions of the Bankruptcy Code remain intact and should be taken into account in negotiating swap agreements. To the extent feasible, a performing counterparty wants to be able to net obligations in the event of a counterparty insolvency and default.

Question: Your firm obtained Advisory Opinion 2013-01A from the U.S. Department of Labor ("DOL") on February 7, 2013 regarding swaps clearing, plan assets and ERISA fiduciary duties. Explain the importance of identifying plan assets in the clearing context.

Answer: ERISA, including its prohibited transaction rules, governs "plan assets." Thus, it is critical to determine whether margin posted by a plan in connection with swaps clearing and the swap positions held in the plan's account are considered "plan assets" for ERISA purposes. Among other things, Advisory Opinion 2013-01A gives comfort that (1) margin posted by the investor to the clearing agent generally will not be considered a plan asset for ERISA purposes and (2) clearing agents will be able to unilaterally exercise agreed-upon close-out rights on the plan's default without being deemed a fiduciary to the plan, notwithstanding that the positions are plan assets.

Question: The headlines are replete with news articles about swap transactions with pension plans that could be potentially unwound in the event of bankruptcy. Detroit comes to mind. Should non-pension plan counterparties be worried about a possible unwinding in the event of pension plan counterparty distress?

Answer: Yes and no. The case in Detroit (which is currently on appeal) illustrates the risk that, notwithstanding state or local law to the contrary, federal bankruptcy judges may disregard the legal separation between municipal governments and the pension trusts they sponsor, treating those trusts as part of the estate. This may present certain credit and legal risks to the trusts' swap counterparties, although the Bankruptcy Code's swap netting provisions may mitigate some of those risks. I doubt that we will see anything similar to Detroit in the corporate pension plan arena because ERISA not only recognizes, as a matter of federal law, the separate legal existence of such plans, but also affirmatively prohibits the use of plan assets for the benefit of the sponsor. Separately, many broker-dealers negotiate rights to terminate existing swaps upon certain credit events, including the plan sponsor filing for bankruptcy or ceasing to make plan contributions.

Question: How does Dodd-Frank impact the transacting of swaps between an ERISA plan and non-pension plan counterparties such as banks, asset managers or insurance companies?

Answer: Dodd-Frank does a number of things. For one, it adds a layer of protection for ERISA and government plans (and others), through certain "External Business Conduct" standards. Generally, these standards seek to ensure the suitability of the swaps entered into by the investors. Invariably, swap dealers will comply by availing themselves of multiple safe harbors from "trading advisor" status, which triggers various obligations relating to ensuring suitability. Very generally, these safe harbors seek to ensure that the investor is represented by a qualified decision-maker that is independent of, and not reliant upon, the swap dealer. Under protocol documents developed by the International Swaps & Derivatives Association ("ISDA"), the safe harbors are largely ensured through representations and disclosures of the plan, decision-maker and swap dealer (as well as underlying policies and procedures).

Question: Dodd-Frank has a far reach. Would you comment on other relevant requirements?

Answer: Separately, Dodd-Frank imposes various execution and clearing requirements on certain swaps. These requirements raise a number of issues under the prohibited transaction rules of ERISA and Section 4975 of the Internal Revenue Code. Exemptions from those rules will be needed for (1) the swap itself (unless blind) (2) the execution and clearing services (3) the guarantee of the trade by the clearing agent and (4) close-out transactions in the event of a plan default. This last point presents perhaps the thorniest issue, particularly for ERISA plan investors that direct their own trade swaps and thus cannot avail themselves of the Qualified Professional Asset Manager ("QPAM"), In-House Asset Manager ("INHAM") or other "utility" or "investor-based" class exemptions. The DOL expressly blesses the use of the QPAM and INHAM exemptions in the aforementioned Advisory Opinion 2013-01A, under certain conditions. Senior U.S. Department of Labor staff members have informally confirmed that the DOL saw no need to discuss the other utility exemptions (including Prohibited Transaction Class Exemption ("PTCE") 90-1, 91-38 and 95-6) for close-out trades because they assumed they could apply, if their conditions were met.

Question: Is there a solution for those ERISA plans that direct their own swap trading?

Answer: It is unclear. There are only two exemptions, at least currently, that could even conceivably apply: ERISA Section 408(b)(2) and Section 408(b)(17), also known as the Service Provider Exemption. The first covers only services, such as clearing, and the DOL has given no indication that it views close-out trades as so ancillary to the clearing function as to be covered under the exemption. In contrast, the Service Provider Exemption covers all transactions other than services. But it also requires that a fiduciary makes a good faith determination that the subject transaction is for "adequate consideration." If the close-out trades are viewed as the subject transaction, who is the fiduciary making that determination? The DOL's Advisory Opinion 2013-01A says that it isn't the clearing agent. Thus, to make the Service Provider Exemption work, you have to tie the close-out trades back to the original decision by the plan fiduciary to engage the clearing agent and exchange rights and obligations, including close-out rights. That argument has not been well received by the DOL, at least so far.

Many thanks to Patrick S. Menasco, a partner with Steptoe & Johnson LLP, for taking time to share his insights with PensionRiskMatters.com readers. If you would like more information about pension risk management, click to email Dr. Susan Mangiero.

Fifth Third Bancorp v John Dudenhoeffer

For those unable to attend the April 2, 2014 U.S. Supreme Court hearing, a review of the transcript of Fifth Third Bancorp et al v. John Dudenhoeffer et al (No. 12-751) may be of interest. Appearances were made by Robert A. Long, Esquire and partner with Covington & Burling LLP (on behalf of Petitioners), Ronald Mann, Esquire and Albert E. Cinelli Enterprise Professor of Law with the Columbia Law School (on behalf of Respondents) and Edwin S. Kneedler, Esquire, Deputy Solicitor General, Department of Justice (on behalf of the United States, as amicus curiae, supporting Respondents.)

I will leave the legal interpretation to attorneys. The bullet points shown below are excerpted from the transcript and by no means reflect the totality of today's discussion. No doubt we will soon get insights from practicing attorneys who can properly parse the legal issues, ahead of a formal opinion from the U.S. Supreme Court bench.

From my perspective as an economist, I think it is always good whenever further guidance is provided about the important role of the ERISA fiduciary. Notwithstanding this notion of "more is better" in terms of shedding light on fiduciary duties, I envision a kerfuffle as it relates to the discussion about stock valuation. Encouraging the use of an independent appraiser makes sense. However, the valuation community has already been vocal about its fears that an expanded fiduciary standard could increase its liability and thereby cause some firms to exit the market and push up the price of an appraisal as a result. As an aside, during her April 1, 2014 presentation before Practising Law Institute pension plan investment workshop attendees, Counsel for Appellate and Special Litigation, Elizabeth Hopkins mentioned that ESOP enforcement continues to be an active area for the U.S. Department of Labor, with a particular emphasis on the valuation of company stock.

  • There were several questions about what constitutes "prudence," along with comments about the value of a stock that is issued by the plan sponsor and related disclosure requirements if the price of said stock is deemed to be "overvalued".
  • Throughout the proceeding, there were questions and comments about ERISA versus SEC Rule 10b-5 with respect to the use of information known by company executives.
  • Justice Kennedy asked about the landscape relating to the use of an independent fiduciary. Attorney Long commented that not all problems would be solved that way since "you'd have to have a monitoring trustee who would have to give the independent trustee any inside information that they had."
  • Justice Alito asked if an ERISA fiduciary can "take into account the interests of the participants as employees as opposed to their interests as investors" and offered that "It doesn't seem to me that those will necessarily be the same. And there may be situations in which something that would be potentially good for the participants as investors would be quite bad for them as employees." For example, individuals could lose their jobs if decision-makers for an Employee Stock Ownership Plan ("ESOP") stop buying company stock and this signal possibly leads to "bankruptcy and liquidation for the company."
  • Attorney Mann started to address what he called a "rock and a hard place" issue. Various justices commented thereafter, asking what a fiduciary is supposed to do when they have information about a stock. His reply was that, similar to a "corporate context where directors ordinarily are protected by the business judgment rule, if a situation arises in which their interests patently diverge from the interests of the shareholders, they don't simply decide to represent both interests but pick one over the over. They instead step aside and appoint...allow independent people to represent the shareholders."
  • Justice Kennedy asked Attorney Mann how he would write a statute to promote employee ownership of company stock.
  • Attorney Kneedler began his comments with a reference to Section 1104 and the focus of "operating the plan for the exclusive purpose of providing benefits to participants and their beneficiaries, which means the interests of employees are taken into account only insofar as they are participants in the plan, not more generally." He agreed with Justice Sotomayor that a "stock drop in and of itself" is not necessarily proof of poor procedural prudence. He added that "fiduciaries have an obligation to actually exercise their discretion and actually investigate...monitoring of the ... investment."
  • Justice Breyer inquired about the materiality issue, i.e. how much "in assets is accounted for by the ownership" of company stock by an ERISA plan.
  • Subsequent questions and comments focused on the notion of selling existing positions of company stock versus not buying anymore when material information suggests that the stock is expensive relative to its intrinsic worth.
  • When the podium returned to Attorney Long, he stated that "There is no circuit split on the issue that we've spent all our time discussing this morning. The only circuit split is on whether this presumption applies at the motion to dismiss stage." He cited the intent of Congress to encourage company ownership and suggested that rendering ESOPs "unworkable" would "basically cause many companies to say we can't put fiduciaries in that situation, so we're not going to have ESOPs at all."

The case was submitted at 11:30 a.m. Click here to download the Fifth Third Bancorp v. John Dudenhoeffer hearing transcript.

Pension Risk Blog Is Eight Years Old

Wow - eight years and counting since I started www.PensionRiskMatters.com. I have worked with the Lex Blog team for half a dozen years and credit them for wonderful technical support and customer service.

Well over a million viewers and nearly a thousand posts later, I am told that my analyses and educational insights about a host of timely topics have been helpful to others. As I look back on what I have written over the years, I am struck by how much of what was deemed critical in its day remains immensely important now. Indeed, one might assert that topics such as pension risk management, service provider due diligence, fiduciary education and fee benchmarking have taken on a new life. There is more scrutiny of what goes on inside the investment committee meeting room and litigation seems to be on the rise. According to the producer of the upcoming American Conference Institute about the topic of ERISA litigation, he is facing a sell-out crowd this year. (I am happy to announce that I will be a co-panelist for a session at this conference and will address the topic of how to work effectively with an economic expert.)

I am deeply grateful for the feedback from this blog's many readers and always welcome comments and suggestions.

Happy 8th birthday PensionRiskMatters.com!

Peanuts and Pensions

In case you missed it, Kraft Foods Group Inc. ("Kraft") reported a fourth quarter 2013 increase in profit and a $1.11 per share accounting gain, due in part to its pension plan. Higher discount rates and bigger returns on its portfolio were cited factors, with a nod to the company's use of "some of the cost savings to boost marketing behind brands like Jello-O dessert and Planters peanuts." See "Kraft Net Soars on Pension-Related Gain" by John Kell (Wall Street Journal, February 13, 2014). Other news, straight from its earnings call, describes the use of roughly $600 million of the company's free cash flow to add contributions to the pension plans in 2013. The result is a rise in the funded ratio to 96 percent at calendar year-end, up from 77 percent one year earlier. Expected contributions for 2014 will run around $200 million, with $60 million of that number representing required cash to fund Kraft's Canadian pension plans. See "Q4 2013 Earnings Call Transcript," February 13, 2014 and "Kraft Foods Group Reports Fourth Quarter and Full Year 2013 Results," February 13, 2014. Noteworthy is that Kraft commenced a liability-driven investment ("LDI") strategy, to be phased in over multiple years, (and I am paraphrasing here) as a way to more appropriately line up "pension assets with the projected benefit obligation to reduce volatility" by moving towards an 80% fixed income, 20% equity securities mix. See page 62 of the latest Kraft 10-K filing.

This alert from Kraft is yet another example of the link between pension management and corporate finance. There are lots of other companies that have made similar declarations about the relationship between employee benefit plan economics and company operations. As I wrote in "Pension risk, governance and CFO liability" by Susan Mangiero (Journal of Corporate Treasury Management, 2012), private sector plan sponsors are acutely aware of the economic and legal aspects of offering ERISA plans to their respective work force. A dollar paid by shareholders for benefits could be seen as a cost that takes away from growing the enterprise or an investment in happy workers who add to the bottom line. Either way, the Treasury and Investor Relations teams are increasingly involved in discussions and related action steps to address the management of retirement plans. This is no coincidence. Liquidity, enterprise risk management, valuation, shareholder relations, talent retention and capital adequacy are a few of the numerous touch points that bring together the worlds of Human Resources ("HR"), the board and C-level officers such as the CEO and the Chief Financial Officer. This trend is unlikely to go away any time soon. To the contrary, expect more interactions across company functions and around the world.

To read a related blog post, see "Pension Risk, Governance and CFO Liability," PensionRiskMatters.com, March 4, 2012.

Private Equity Fund Limited Partners and Pension Funding Levels

Some pension plans invest in private equity funds or funds of funds. Certain private equity funds invest in companies with pension plans. This means that pension funds that invest in this asset class need to be aware of any deficiencies in their plans as well as those portfolio company plans to which they are likewise exposed. While the notion of "my brother's keeper" may not resonate well with stewards of billions of dollars, it is a reality. This is especially true, in the aftermath of the Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund decision, No. 12-2312 (1st Circuit, July 24, 2013).

Despite the "record year" described by Wall Street Journal reporter Ryan Dezember, private equity investments, like any other, necessitate careful due diligence on the part of institutional investors that seek a seat at the limited partner table. (See "Private Equity Enjoys a Record Year: Firms That Buy and Sell Companies Are Set to Return More Than $120 Billion to Investors in 2013," December 30, 2013). A critical question is whether continued gains will be diminished if a portfolio company has to divert cash to top off an underfunded pension plan. One way to address the issue is for a pension plan, endowment or foundation to ask the private equity fund general partner how much attention they pay to ERISA economics.

There are numerous other queries to make. In the March/April 2014 issue of CFA Institute Magazine, ERISA attorney David Levine (with Groom Law Group, Chartered) and Dr. Susan Mangiero, CFA (with Fiduciary Leadership, LLC), provide insights for improved due diligence, in a post-Sun Capital world. Suggested action steps include, but are not limited to, the following items:

  • Ask whether a private equity fund is "relying on the position that it is not a 'trade or business' and is therefore not subject to liability for a portfolio company's" ERISA plan deficit;
  • Request to see a list of the holdings for purposes of knowing whether a particular private equity fund has a majority ownership in any or all of its portfolio companies;
  • Investigate whether the Pension Benefit Guaranty Corporation ("PBGC") has red flagged any of the pension plan(s) of a business that is part of a private equity fund's portfolio;
  • Understand how, if at all, a private equity fund is planning to solve a pension plan underfunding problem;
  • Acknowledge that a portfolio company's ERISA liabilities could make an exit difficult, whether via an Initial Public Offering or an acquisition, and that this in turn could lengthen the time before a limited partner can cash out;
  • Identify the extent to which a private equity fund regularly examines the degree to which any or all of its portfolio companies are parties to labor contracts that may be difficult to modify; and
  • Be aware that this important legal decision could invite more litigation and regulatory actions that, regardless of outcome, have a cost and therefore a potential impact on future private equity fund returns.

If you have any difficulty in accessing our article, please send an email request to contact@fiduciaryleadership.com.

Pensions, Politics and the ERISA Fiduciary Standard

Thanks to the folks at the Mutual Fund Directors Forum for disseminating a January 13, 2014 letter from members of the New Democrat Coalition to the Honorable Thomas Perez, Secretary of the U.S. Department of Labor ("DOL"). The gist of the four-page communication is that these members of the current U.S. Congress would like to see regulatory coordination in order to "protect investors while reducing confusion." They add that they are still concerned that a new version of the fiduciary standard, when proposed anew, might discourage plan participant literacy and disclosures. The worry seems to be that individuals with low or middle incomes as well as small businesses could be adversely impacted, depending on the ultimate version.

According to the Securities Industry and Financial Markets Association ("SIFMA") website, Republicans have likewise communicated their concerns to the U.S. Department of Labor as well as the Office of Management and Budget. These ranged from "the impact on an individuals' choice of provider to potential unintended consequences limiting access to education for millions of individuals saving for retirement." Click to access SIFMA's DOL Fiduciary Standard Resource Center.

On October 29, 2013, the Retail Investor Protection Act (H.R. 2374), sponsored by U.S. Congresswoman Ann Wagner (Republican, 2nd District of Missouri), was approved by the United States House of Representatives in a vote of 254 to 166. According to the Gov Track website, U.S. Congressman Patrick Murphy (Democrat, 18th District of Florida) joined as a co-sponsor on September 19, 2013. The stated legislative intent is to preclude the "Secretary of Labor from prescribing any regulation under the Employee Retirement Income Security Act of 1974 (ERISA) defining the circumstances under which an individual is considered a fiduciary until 60 days after the Securities and Exchange Commission (SEC) issues a final rule governing standards of conduct for brokers and dealers under specified law." It further prevents the SEC from implementing a rule "establishing an investment advisor standard of conduct as the standard of conduct of brokers and dealers" prior to assessing the likely impact on retail investors. Click to read more about the Retail Investor Protection Act. Click to read the mission of the United States Department of Labor which states "To foster, promote, and develop the welfare of the wage earners, job seekers, and retirees of the United States; improve working conditions; advance opportunities for profitable employment; and assure work-related benefits and rights."

As I have repeatedly predicted in this pension blog and elsewhere, the retirement crisis, not just in the United States but around the world, is increasingly showing up as a political hot button issue. No one wants to lose votes from retirees who are struggling and employees who cannot afford to stop working any time soon. In his State of the Union address, U.S. President Obama described a new type of retirement account, i.e. "myRA," that is meant to help millions of individuals whose companies do not offer retirement plans. See "What you need to know about Obama's 'myRA' retirement accounts" by Melanie Hicken (CNN Money, January 29, 2014). More details will no doubt follow.

There is a lot we don't know about how politics will impede or enhance the state of the global retirement situation. As a free marketeer, I am not particularly optimistic about new rules and regulations that prevent an efficient supply-demand interaction from taking place. However, this is a lengthy topic and the hour is late so I will leave a discussion about the positive and normative aspects of capitalism for another day.

Dodd-Frank, Swaps Clearing and Compliance for Pension Plan Asset Managers

According to the Bank for International Settlements, the notional amount outstanding, as of June 2013, of global over-the-counter derivatives exceeded $692 trillion. Interest rate swaps reflect the largest category at about $425.6 trillion. Given the jumbo size of this market, it is no surprise that regulators have demanded more transparency about the mechanics of the global swaps market, including reporting to regulators and the public dissemination of reported information. It is also no surprise that regulators have demanded what they deem to be risk-reducing measures such as the clearing of these instruments and collateral collection. With the promulgation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), numerous market participants are now required to clear their swaps. Click here to learn about the three categories of organizations that are required to adhere to swap clearing and trade execution requirements under Section 2(h) of the Commodity Exchange Act (“CEA”). Given the complexity of the prevailing swaps-related rules and regulations as well as the evolving nature of these mandates, any educational insights are welcome.

As an economic consultant, trainer and expert witness who regularly does work in the pension risk management arena and author of Risk Management for Pensions, Endowments and Foundations, I was delighted to have a chance to get comments about this important topic of swaps clearing and trade compliance from Davis Polk attorneys Lanny A. Schwartz and Gabriel D. Rosenberg. Mr. Schwartz is a partner, and Mr. Rosenberg is an associate in Davis Polk’s Trading and Markets practice. Besides the questions and answers provided below, and acknowledging that there is a lot to learn about swaps-related compliance, readers may want to download "Are You Ready? New Swap Trading Requirements For Pension Plan Asset Managers" (August 2013) by Attorneys Schwartz and Rosenberg, in conjunction with BNY Mellon.

Question: What is your motivation for writing about this topic as well as offering educational webinars?

Answer: We continue to receive numerous inquiries from swap market participants, many related to clearing. Swaps dealers were the first to have to demonstrate compliance with Dodd-Frank's swaps clearing mandate in March of last year. Most asset managers were required to clear specified types of interest rate swaps and credit default swaps as of June 2013. Other entities, including ERISA plans, had a deadline of September 2013.

Question: What areas have you identified as requiring more time and attention?

Answer: We are still mid-stream in terms of implementing a wide array of rules. Compliance is not a simple “check the box” exercise. Some swaps are now subject to mandatory clearing, but this is a relatively small part of the universe in terms of instruments traded in the market. Trading on a regulated futures exchange or swap execution facility is currently voluntary. Margin requirements are not yet final. Documentation requirements are similarly critical and require significant attention.

Question: What is a qualified independent representative and why is that important to an asset manager that has pension plan clients?

Answer: Before a swap dealer can act as an advisor to a pension plan regarding swaps, which in this context means making customized recommendations, the plan manager must verify that the pension plan has a qualified independent representative ("QIR") in place. A QIR is an agent of a Special Entity (such as a corporate or public pension plan) that is knowledgeable and independent of any swap dealer counterparty.

Question: It sounds like there is a large amount of due diligence that must be carried out by swaps dealers, asset managers and end-users such as pension plans, respectively. Would you elaborate?

Answer: You are correct that each category of swap market participant has a large amount of due diligence to carry out in order to ensure that they are compliant with Dodd-Frank's trading, clearing and other provisions. Swap dealers will generally require counterparties to adhere to one or more of the International Swaps and Derivatives Association (“ISDA”) protocols and other documentation as relevant to their activity. For example, suppose Big Bank X is a leading dealer of swaps and has been approached by Global Asset Management Firm Y to handle its trades on behalf of various end-users such as pension plans of Fortune 500 companies. Before Big Bank X will speak in detail about swaps with Global Asset Management Firm Y, it generally will need to make sure it has proper documentation in place. Unless Global Asset Management Firm Y can demonstrate adherence (or enters into alternative documentation developed by the swap dealer, Big Bank X will generally not transact with them.

Question: What are some of the action steps that a pension plan must take?

Answer: A pension plan, whether a corporate ERISA plan or government employee benefits plan, must have an account with a Futures Commission Merchant (“FCM”) in order to enter into swaps trades that are subject to clearing. This requires diligence and negotiation of important documentation about the clearing relationship. Pension plans should also consider the trade-offs between using swaps and nearly equivalent futures contracts.

Question: Are there areas of vulnerability that need to be better addressed?

Answer: A firm needs to have people in place who are experienced and knowledgeable about Dodd-Frank, operational processing, legal documentation and the use of technology for data inputting and report generation. None of these areas are trivial and require care and diligence. Additionally, since things are in flux as new rules are being adopted, it is critically important for any swap market participant to stay abreast of compliance mandates.

Question: Headlines are replete these days with news about regulatory investigations and lawsuits about how London Interbank Offer Rates (“LIBOR”) are determined by quoting banks. Inasmuch as the majority of swaps are tied to some type of LIBOR fix, how is swaps trading likely to be impacted?

Answer: The increased scrutiny about LIBOR could result in increased regulatory interest in other indexes that are referenced by swaps.

Question: What is the role of external counsel versus the internal General Counsel?

Answer: It is critical for asset managers to develop an educational program that allows front, middle and back office professionals to understand what rules, policies and procedures need to be established and followed. External counsel can add value by explaining the ISDA Protocols and other documentation and compliance requirements to clients. An end-user’s General Counsel should make sure that everything is in place in order to comply with Dodd-Frank. Plenty of clients say they don’t even know where to start and feel overwhelmed.

Question: There is so much more to discuss. Readers should stay tuned for further updates. At the client level, it sounds like you will both remain quite busy.

Answer: Susan, we appreciate the opportunity to share our insights with readers of your blog. We urge everyone with a stake in good governance to pay attention and do whatever is needed to comply with Dodd-Frank's swaps rules.

Institutional Asset Allocation

My comments about institutional asset allocation, along with those made by Mr. Ron Ryan (CEO, Ryan ALM) and Lynn Connolly (Principal, Harbor Peak, LLC), were well received on January 8, 2014. Part of a joint program that was sponsored by the Quantitative Work Alliance for Applied Finance, Education and Wisdom ("QWAFAFEW") and the Professional Risk Managers' International Association ("PRMIA"), our audience of investment professionals added to the lively debate about topics such as strategic versus tactical asset allocation, fees, role of the pension consultant and the likely capital market impact due to the implementation of strategies such as liability-driven investing ("LDI") and/or pension risk transfers ("PRT"). 

With the size of the U.S. retirement market at $20 trillion and counting, big money is at stake. Bad asset allocation decisions can lead to a cascade of economic woes. It is no surprise that fiduciary breach allegations in the form of ERISA lawsuits are increasingly focused on questions about the appropriateness of a given asset allocation mix and whether an investment consultant or financial advisor has helped or hindered the way that pension monies are allocated. Noteworthy is that scrutiny about the efficacy of the asset allocation process and resulting money mix can, and has been, applied to both defined benefit and defined contribution plans. Keep in mind that asset allocation decisions are likewise central to assessing popular financially engineered products such as target date funds. Accounting issues and how changing rules influence asset allocation decisions are yet another topic that we will tackle in coming months.

Click to access Susan Mangiero's asset allocation slides, distributed to members of the January 8 audience, and meant to peturb a discussion about this always essential topic. Interested readers can check out "Frequently Asked Questions About Target Date or Lifecycle Funds" (Investment Company Institute) and "Annual Survey of Large Pension Funds and Public Pension Reserve Funds: Report on pension funds' long-term investments" (OECD, October 2013).

If you have a specific question about asset allocation and/or the procedural process associated with asset-liability management, send an email to me.

Working With Financial and Fiduciary Experts

I am delighted to join the panel about how to work with financial and fiduciary experts on ERISA (and more broadly, investment management) cases. This panel, entitled "Expert Coordination: Working With Financial and Fiduciary Experts," is part of the upcoming 7th National Forum on ERISA Litigation. Produced by the American Conference Institute, this Chicago event will run from April 28 to April 29, 2014. I will speak from 10:45 am to 11:35 am on April 29, 2014. See below for more details.

Many ERISA litigators will admit that the quality and communication skills of an economic expert can greatly impact the outcome of a case. Getting the right expert(s) in place sooner than later can be a distinct advantage. When that does not occur, important items may be excluded from discovery or pre-motion analysis. This panel will focus on the challenges associated with tight client budgets, working with multiple experts, knowing when to bring an expert(s) on board and evaluating how much information to share.

Private Equity Performance and Underfunded Pensions

Adopting a "half glass full" attitude, my co-author and I wrote about the business opportunities for private equity fund general partners ("GPs") with portfolio company problems. In "GPs Eye New Ruling" (Mergers & Acquisitions, December 2013 Issue) by ERISA attorney David Levine and Accredited Investment Fiduciary Analyst, Dr. Susan Mangiero, we talk about the aftermath of a recent legal decision that has the private equity world on high alert.

By way of background, in Sun Capital Partners v. New England Teamsters & Trucking Industry Pension Fund, the United States Court of Appeals for the First Circuit ruled that a private equity fund can be held liable for the pension obligations of a portfolio company. If left unchecked, private equity funds (and their limited partners such as pension plan investors) could see a diminution of performance for any number of reasons. For one thing, a GP may be unable to exit a position within a reasonable period of time if potential buyers get scared of being saddled with an expensive, underfunded retirement plan. In addition, cash that was otherwise earmarked to finance new growth projects may be used instead to comply with statutory contribution rules. Indeed, I have carried out financial analyses for prospective buyers on the basis of how much "extra" a pension problem is likely to cost.

While the downside possibilities are real, Attorney Levine and I point out that "lessons learned" from the Sun Capital decision enable a GP to take action preemptively as a way to potentially "maximize value from portfolio companies while also mitigating future risk." Savvy asset managers can adapt their due diligence process to help avoid any issues that could preclude an exit within the typical three to seven year time period from an initial funding round. Some of the many steps that a GP can take include, but are not limited, to the following:

  • To the extent that a private equity fund is relying on the position that it is not a “trade of business” and is therefore not subject to liability for a portfolio company’s pension underfunding, it is wise to review the potential economic, fiduciary and legal risks should this position be challenged in court.
  • Review its holdings that are at least 80 percent owned by the private equity fund. Total equity exposure should include common stock, preferred stock and possibly economic rights associated with warrants and/or equity derivatives such as swaps. Although a core focus of any such review should be with respect to holdings subject to jurisdiction in the First Circuit (Maine, Massachusetts, New Hampshire, Puerto Rico, and Rhode Island), a broader review of holdings elsewhere might also be considered.
  • Review underfunded pension plans before and after each acquisition of a portfolio company in order to develop strategies for addressing the Pension Benefit Guaranty Corporation’s aggressive litigation positions that it has been taking lately. Failure to do so could result in unnecessary delays in connection with corporation transactions, including the sale of portfolio companies. Examine the collective bargaining agreements for any or all portfolio companies. Although the Sun Capital Partners case was about liability for pension funding obligations under a multiemployer pension plan (i.e., a pension plan maintained independent of an employer pursuant to collective bargaining), there is some concern that the logic of Sun Capital Partners might be extended to conclude that a private equity fund is conducting a “trade of business” under the Internal Revenue Code through its management and oversight of portfolio companies. A decision concluding that a fund is a trade or business for Internal Revenue Code purposes could impact a fund’s representations of its attempts to minimize its unrelated business income tax liability and/or its acceptance, pursuant to the Internal Revenue Code, as a trade or business.
  • Assess the economic, fiduciary and legal attractiveness of all employee benefit plans that are offered by private equity portfolio companies. This includes traditional defined benefit pension plan, 401(k) plans, and health and welfare arrangement. Individually and collectively, ERISA plans can carry significant liabilities that have the potential to (a) materially reduce overall business profitability (b) increase insurance premiums (c) lead to expensive litigation and/or regulatory enforcement (d) impede liquidity and (e) hamper capital raising. As a result, a general partner may never be able to realize the growth targets that motivated a particular investment in the first place. Just as significant, a private equity fund may find itself limited in its ability to exit a particular investment.
  • Meet with retirement-focused advisers, actuaries and counsel before investing in a new portfolio company. The due diligence analysis should be comprehensive. This means that a private equity fund will want to assess both the current and projected pension plan liabilities for a portfolio company as well as the riskiness of its investments in its pension and 401(k) plan. If a pension plan’s assets are illiquid or overly conservative, a deficit may occur or grow bigger. It is likewise important to understand whether the assumptions underlying actuarial calculations are overly optimistic. The objective is to understand the seriousness of a given situation in terms of economic, fiduciary and legal vulnerability.
  • Assess the accounting impact for any and all retirement plans. Be prepared to explain performance volatility to LPs as the result of an ERISA problem.
  • As the family of “de-risking” products continues to expand, consider restructuring a portfolio company’s ERISA plan if, by doing so, a private equity fund owner can improve the likelihood of an exit within its target time horizon. However, because ERISA’s fiduciary rules impose a duty of loyalty to participants and beneficiaries, decisions on de-risking should be evaluated under these standards.
  • Determine, in conjunction with ERISA counsel, whether to engage an “independent fiduciary” for purposes of evaluating an array of possible restructuring solutions. Buying annuities to settle pension liabilities or investing in employer securities or other “hard to value” assets are examples.
  • Recognize that the Sun Capital Partners decision could encourage further litigation and regulatory activities. Private equity funds might be well served to consider whether minor tweaks to their structure merit use, including the creation of additional services entities that are commonly used in operating company structures. Clarification of offering documents, careful monitoring of activities and/or comprehensive documentation of its involvement with portfolio companies can go a long way to help insulate a private equity fund from a finding that it is engaged in an Internal Revenue Code trade or business.

For further reading about this important legal decision and the economic and compliance imperatives, you can read earlier blog posts and link to various law firm memos on this topic. See "Pension Liability Price Tag For Private Equity Funds and Their Investors". Also see "More About Private Equity Funds and Pension IOUs."

Pension De-Risking For ERISA Plan Sponsors

I am delighted to join the speaker faculty for a December 10, 2013 webinar entitled "Pension De-Risking for Employee Benefit Sponsors: Minimizing Risks and Ensuring ERISA Compliance When Transferring Pension Obligations to Other Parties." If this topic is of interest to you, send me an email. I can make ten (10) guest passes available on a complimentary, first come, first served basis. Otherwise, you and your colleagues can register by visiting the Strafford Continuing Legal Education site. This topic is important and timely. I look forward to having you join us on December 10, 2013.

As U.S. pension plans face record deficits, options for transferring some or all of a sponsor's plan risk make sense for many companies. General Motors, NCR and Verizon are a few companies that have chosen de-risking options in 2012.

De-risking transactions take many forms, from transferring company obligations to third parties, to offering payouts to plan participants, to undertaking liability-driven investing and other strategies. Counsel and companies must tread carefully to avoid ERISA-based litigation or enforcement actions.

Prudent de-risking requires thorough financial analysis and clear demonstrations that ERISA fiduciary standards are met. Counsel should guide companies on how to establish the reasonableness of decisions and prepare to defend against possible court challenges.

Susan Mangiero, Managing Member at Fiduciary Leadership; Sam Myler at McDermott Will & Emery; Anthony A. Dreyspool, Senior Managing Director at Brock Fiduciary Services and David Hartman, General Counsel and Vice President at General Motors Asset Management, 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.

The panel will review these and other key questions:

  • How can pension providers demonstrate they have met their ERISA standards of prudence, care and loyalty to plan participants?
  • What steps should be taken in preparation for termination of a pension plan?
  • What are the grounds for the various challenges to de-risking techniques and what are the techniques to avoid those challenges?

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

 

Effective Investment Stewards Should Take a Bow

In case you missed it, check out the quirky indie film "In A World..." If you like movies as I do, you will enjoy this lighthearted comedy about the supposed rough and tumble world of voice-overs. The first few minutes are devoted to the memory of Don Lafontaine, the uber vocal artist of countless trailers and commercials who died at the age of 68 in 2008. The story then proceeds to chronicle the efforts of a character played by actress Lake Bell, Carol Solomon, in competing for gigs in a mostly male-dominated industry. (Kudos to Ms. Bell for writing, directing and producing this cinematic gem as well.) Various sub-plots involve the reinforcement of a shaky marriage, connecting anew with a less than supportive father and getting "used" by a female film executive who sees dollar signs in empowering women at the expense of boosting Carol's ego.

Aside from its entertainment value, the production stayed on my mind, hours after the popcorn was gone. Here is why. In a final scene, Carol decides to help young women with squeaky voices learn how to better present themselves. She asks "Are you ready to be heard?"

Applied to the pension world, the question is apt. In an era of rising enforcement and litigation activity, I have often wondered why more governance-focused plan sponsors are refusing to take a bow. In speaking to several of their representatives, the feedback I received is that visibility can be a two-edged sword. My understanding of what others have said to me is that affirmative "best practice" communications might be viewed as a defensive tactic to hopefully keep participants happy and therefore unlikely to sue. The danger is that those same statements could be seen as raising awareness of issues that will lead to questions and unwelcome attention to topics such as fees, risk management and vendor selection.

The subject of how much information to provide is certainly an important one to address. The president of retirement plan services at Lincoln Financial Group, Chuck Cornelio, writes that "The move away from process-focused messages, such as how to enroll, plan mechanics and investment selection, to conversations around the projected outcomes of a participant's savings behaviors and strategies, including future monthly retirement income, spending power and retirement lifestyle, will not happen overnight." Click to read "5 critical elements of retirement plan communication" (Benefits Pro, November 12, 2012).

A recent court action has shed light on the attorney-client privilege as relates to ERISA plan communications. Interested readers can download the presentation about the fiduciary exception rule by Attorney James P. McElligott (Partner, McGuireWoods) and Attorney Ronald S. Kravitz (Liner Grode Stein Yankelevitz Sunshine Regenstreif & Taylor). It is entitled "ERISA Counsel's Communications with Plan Fiduciaries and Attorney-Client Privilege" (Strafford Continuing Legal Education, April 3, 2013). Attorney McElligott adds that "Fiduciary communication is a critical area. The process starts with a well-written Summary Plan Description ("SPD") but requires constant thought and vigilance."

In its "Fiduciary Checklist," T. Rowe Price authors provide a long list of items that should be disclosed to participants. It is certainly a good start but I would add numerous sections to that list about the governance of any particular retirement plan.

This topic will receive more attention from this blogger, especially as different countries approach the issue of pension governance as a recognized problem, with some plans badly in need of a solution.

New ERISA and Global Benefits Blog

I have been blogging for over seven years and enjoy it immensely. I never run out of topics but, like most bloggers, it is always good to read what others have to say. That is why I am excited to welcome Paul Hastings ERISA partners, Stephen Harris and Mark Poerio, to the blogosphere (although Attorney Poerio tells me that he created www.erisacloud.com and www.executiveloyalty.org several years ago for his Georgetown Law School students). My understanding is that the content for this newly launched blog will generally focus on the design, governance, and operation of retirement plans, health and welfare plans, and executive compensation plans. It will include information about legislative, regulatory, and litigation developments, from a practical business perspective. Attorney Poerio adds that "As lawyers, we are generally concerned with risk management, and our blog has that objective in mind."

Click to access the ERISA and Global Benefits blog. You can click here to add this new blog to your RSS reader as well.

Financial Executives Address De-Risking and ERISA Benefit Programs

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

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

For a copy of the study, click here.

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

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

More About Private Equity Funds and Pension IOUs

As I discussed in my July 29, 2013 blog post entitled "Pension Liability Price Tag For Private Equity Funds And Their Investors," a recent court decision by the First Circuit could mean the difference between "good" deals and "bad" ones. In "Doubling Down on a Bad Bet: Liability for Portfolio Company Pension Obligations After Sun Capital" (August 5, 2013), ERISA trial attorney with the McCormack Firm, Stephen D. Rosenberg refers to this legal opinion as "tremendously significant" as it will directly impact how acquisitions are structured, "in terms of examining whether it is possible to legally structure the acquisition and ownership of a portfolio company in a manner which will insulate the acquirer from unfunded pension obligations or, if it is not certain whether that can be achieved, will at least make it as hard as possible for potential plaintiffs to recover, thus hopefully dissuading future lawsuits..."

As creator of the popular and insightful Boston ERISA & Insurance Litigation blog, Attorney Rosenberg talked about the imperative to think ahead. Instead of trying to fix a problem after an acquisition has take place, he references my recommendations, as a business expert, to thoroughly value "the pension exposures of the target company" and account "for that exposure financially in the purchase price."

School is still out as to whether these actions are being done to the extent they should be. I have worked on due diligence initiatives that included a forward-looking assessment of cash needs and investment considerations. However, if everyone was tackling this type of economic analysis, in conjunction with a legal review, there would be no headlines about post-deal pension surprises. In other words, there are obviously some buyers that have not done sufficient homework and end up paying more than they had anticipated. If that happens too often, a private equity fund's general partners are ultimately going to get push back from their limited partners such as other pension plans, endowments and foundations. Why? Post-transaction costs impede performance.

Attorney Rosenberg and I both agree that doing the right things, prior to the closing of a transaction, is a good offense. As relates to pension-centric due diligence by a private equity fund, he adds that "Do that correctly, and you have already accounted for the possibility of being forced to cover the portfolio company's exposure; do that incorrectly, and you may have - as occurred in Sun Capital - doubled down on a losing proposition."

Pension Liability Price Tag For Private Equity Funds and Their Investors

I have long maintained that any individual or organization that invests in a company needs to check under the employee benefits hood before allocating money initially, and regularly thereafter. I can give you countless examples where incomplete due diligence led to an overly rich acquisition or investment that resulted in a new owner having to deploy cash to write checks to retirees and/or incur the costs of restructuring an otherwise untenable situation.

Failure to carry out a comprehensive ERISA-focused due diligence of a target portfolio company is not good for numerous reasons. Having done economic analyses of companies with underfunded pension plans, I know firsthand that it is often a rude awakening for investors such as private equity funds when they are confronted with the reality that what they want and what they end up with in terms of buying forecasted growth are not always the same. Reasons to worry include, but are not limited to, the following:

  • A private equity fund may not be able to realize its target rate of return because a portfolio company cannot sufficiently grow without cash that is now redirected to support employee benefit plans.
  • A pension plan that has invested in said private equity fund will be none too happy if performance falls short of expectations, especially for something that arguably should have (and could have) been considered and addressed as part of the original deal.
  • An unhappy pension fund investor may turn around and sue a private equity fund for alleged failure to have properly researched "what if" situations, taken on "too much" risk and disclosed too little information. Litigation in turn can be an expensive proposition for a private equity fund, making it even more difficult to achieve even minimum hurdle rates.

The issue of private equity ownership and portfolio company pension liabilities was heavily discussed as the result of a 2007 Appeals Board of the Pension Benefit Guaranty Corporation ("PBGC") decision about ownership, control and responsibilities for portfolio company pension plan gaps. In "Private Equity Funds: Part of the ERISA Controlled Group?" (December 19, 2007), O'Melveny & Myers LLP attorneys Wayne Jacobsen and Jeff Walbridge explained that "[i]f the PBGC's position endures, it could have significant ramifications for private equity fund investments in portfolio companies that sponsor defined benefit pension plans...[t]he fund could be required to use any or all of its assets, including the ownership interests of the fund in any or all of its portfolio companies, to fund the pension obligations of the bankrupt portfolio company."

Imagine the happy faces in private equity land when the U.S. District Court of Massachusetts opined on October 18, 2012 in favor of Sun Capital Partners III, LP and related parties. According to "Potential ERISA Title IV Liabilities of Private Equity Firms - Eliminated by the Sun Capital Decision?" (November 2012), Edwards Wildman attorney Mina Amir-Mokri describes the decision as a "significant victory for private equity firms" but explains that Sun Capital Partners v. New England Teamsters & Trucking Industry Pension Fund was to be appealed.

On July 24, 2013, the U.S. Court of Appeals for the First Circuit reversed the earlier decision and put private equity funds in a potential liability position once again. According to "Private Equity Funds Further Exposed to Portfolio Company Pension Plan Liabilities" (July 29, 2013) Latham & Watkins attorneys Jed Brickner and Austin Ozawa offer post-opinion practical hints such as the need for private equity firms to "carefully consider how to structure their funds and acquisition structures to avoid characterization as a trade or business and avoid inclusion in the same controlled group as their portfolio companies." Additionally, they urge private equity funds to pay attention to the "structure of their funds' investments"...possibly "dividing their investment between two or more of independently managed funds with distinct portfolios to support a finding that no individual fund (or group of 'parallel' funds) controls any portfolio company (and no set of funds is treated as a joint venture). Paul Hastings attorneys Stephen H. Harris, Eric R. Keller, Ethan Lipsig and Mark Poerio assert that private equity funds would do well to own "less than 80% of a portfolio company"...perhaps via "thoughtful adjustments to ownership structures and management operations" that can help to reduce the exposure to portfolio company pension liabilities. See "Private Equity ERISA Alert: Consider ERISA Pension Liability Risks from Portfolio Plans" (July 2013).

While legal experts weigh in on the important issue of what responsibilities belong to private equity funds, if any, to portfolio company ERISA plan participants, institutional investors such as pensions, endowments, foundations and family offices - and their investment consultants and advisors - should take heed. If a private equity fund's exposure to a portfolio company with a problem pension plan ends up shrinking the wallets of institutional investors, serious questions will understandably be asked about who should have done what and when.

ERISA Assets: QPAM and INHAM Audit Legal Requirements and Best Practices

I am happy to announce that I will be joined by esteemed colleagues Howard Pianko, Esquire (Seyfarth Shaw) and Virginia Bartlett (Bartlett O'Neill Consulting) on September 10, 2013 from 1:00 to 2:30 pm EST to talk about QPAM and INHAM compliance audits. See below for more information. Click to register for this forthcoming educational event about ERISA requirements. (Note: I am given a few complimentary guest passes. Contact me if you are interested and they are still available.)

This CLE webinar will prepare counsel to advise asset manager clients regarding Qualified Professional Asset Manager (QPAM) and in-house asset manager (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.

Continue Reading...

Audrey Hepburn, Gary Cooper and Pension Governance

Grab the popcorn. If you haven't seen the 1957 romantic film, "Love in the Afternoon," check it out. No nudity. No violence. No swear words. Just some clever banter, courtesy of Maurice Chevalier, Gary Cooper and Audrey Hepburn. I love these old-fashioned movies for their charm and ease of viewing. They remind viewers that there are some things that never get old. Yes, good ideas are fresh, sound and worth revisiting again and again.

Pension governance comes to mind.

When I created www.pensionriskmatters.com in 2006, my goal was (and still is) to provide educational information about process. Not only is procedural prudence a key element of various trust rules and regulations, it is the cornerstone of effective investment, risk and asset-liability management. Indeed, it is easy to show that bad process can be hugely expensive for plan sponsors and beneficiaries alike.

At the inception of this pension blog, there were few studies and surveys about the topic of pension governance. Things have changed since then. Always an important topic, it is good to know that this "old-fashioned" topic is receiving more attention and will hopefully gain even more visibility over time.

According to a July 23, 2013 press release, a survey of U.K. employers indicates awareness of the importance of pension governance. Sponsored by SEI Investments, the survey answers reflect a frustration that companies need to do more since "current governance structure [do] not allow them to easily take advantage of market conditions to improve their funding levels, with many trustees unable to make informed and timely decisions due to a lack of resources, including limitations of time and/or expertise." Consultant relationships was another queried topic. Nearly one third of respondents expressed a "perceived lack of transparency around the costs associated with traditional investment consultants who often charge separately for investment reviews, manager changes, and ongoing support, and who are not fully accountable to the scheme." Click to learn more about how to access the SEI UK survey.

Will pension governance remain a classic a la Gary Cooper? One certainly hopes so. Too much is at stake for good process to end up on the shelf.

Dr. Susan Mangiero Will Speak at ACI ERISA Litigation Conference

I am delighted to join the roster of multi-disciplinary speakers for this exciting October 24-25, 2013 New York City event. Designed for and by attorneys, the American Conference Institute's 6th National Forum on ERISA Litigation will include comments from renowned judges, in-house counsel, insurance experts, economic consultants and practicing litigators in the ERISA arena. According to the conference flyer, attendees will learn about the following:

  • Emerging trends in multiple facets of ERISA litigation;
  • Understanding new theories of liability arising from investment decisions, including alternative investments and the trend towards de-risking;
  • 401(k) fee case considerations and a discussion about evolving defense strategies, the issue of service providers and the viability of float claims;
  • ESOP litigation to include an overview of DOL investigations and settlements;
  • Benefits claims litigation
  • ERISA fiduciary litigation and ways to minimize liability exposure:
  • Class action update; and
  • Ethical issues that arise in ERISA litigation.

Having spoken and attended prior ERISA litigation conferences sponsored by the American Conference Institute, I always learned a lot. In particular, the discussions among jurists, the plaintiffs' bar and defense counsel makes for a collection of timely and lively debates. I hope you will be similarly satisfied if you decide to attend.

As a courtesy to readers of this blog, the American Conference Institute has activated a discount code of $200 for anyone who registers for the conference. Simply type "PRM200" when prompted. Click here to register. Click to download the agenda.

Pension Plan Economics and Corporate Finance

Just published is an article I wrote about the urgent need for appraisers and deal-makers to make sure that they have adequately assessed the economics associated with defined benefit plan funding. Entitled "Pension Plans: The $20 Trillion Elephant in the (Valuation) Room" by Susan Mangiero (Business Valuation Update, July 2013), the objectives of this article are threefold: (1) shed light on the magnitude of the pension underfunding problem and the possible dire impact on enterprise value; (2) remind appraisers of the need to thoroughly understand and evaluate pension plan economics or engage someone to assist them; and (3) explain the adverse consequences on deal-making and corporate strategy when pension plan funding gaps are given short shrift. CEOs, Chief Financial Officers, private equity, venture capital, merger and acquisition and bank lending professionals will want to read this article as it showcases this timely and urgent topic.

Click to read my article about pension plan valuation.

In a related post, ERISA attorney Stephen D. Rosenberg wrote a commentary on his "Boston ERISA & Insurance Litigation Blog" (June 17, 2013) about why he believes that appraisers should not be designed as ERISA fiduciaries. He expresses doubt about whether imposing a fiduciary standard on appraisers will "improve the analysis provided to plan fiduciaries." He suggests that such a move by regulators could create a reluctance for valuation professionals to assume the liability associating with appraising a company with an ERISA plan.

For those who missed our program about appraiser liability, visit the Business Valuation Resources website to obtain a copy of "Valuation and ERISA Fiduciary Liability: Traps for the Unwary Appraiser." The program took place on May 14, 2013. Speakers included myself (Dr. Susan Mangiero), ERISA attorney James Cole with Groom Law Group and Mr. Robert Schlegel with the Houlihan Valuation Advisors.

Hedge Fund and Private Equity Fund Due Diligence for Pension Funds

If you missed the Strafford CLE event on June 5, 2013 entitled "ERISA Pension Plans in 2013: Due Diligence for Hedge and Private Equity Funds: Avoiding the Pitfalls with Alternative Investments for Institutional Investors and Fund Managers," there is still an opportunity to purchase the recording. Click here for more information.

In the meantime, click to access the due diligence slides that were used by Dr. Susan Mangiero (Fiduciary Leadership, LLC), private fund attorney Rosemary Fanelli (CounselWorks) and ERISA attorney Tiffany Santos (Trucker Huss).

While we ran out of time with so much left to discuss beyond our assigned 90 minute slot, the two attorneys who spoke with me talked a lot about their perception of a changed environment. Their message was that institutional investors seem to be under a lot more pressure now to demonstrate that comprehensive due diligence activities have taken place. One attorney listener in the audience echoed this sentiment presented by the two legal speakers. He offered his opinion that an investment consultant or financial advisor should work closely with both an ERISA counsel as well as a fund attorney as part of the due diligence process.

Real Estate Investment Trusts (REITs) and ERISA Plans

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.

Valuation and ERISA Fiduciary Liability: Traps for the Unwary Appraiser

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.

Dr. Susan Mangiero Speaks About ERISA Plan Valuation and Appraiser Liability

 

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.

Pension Risk Governance Blog Celebrates Seventh Birthday

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!

Tibble v. Edison and ERISA Fiduciary Breach Issues

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.

DOL Issues Advisory Opinion About Use of Swaps by ERISA Plans

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.

Fiduciary Duty is More Than Numbers

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

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

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

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

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

Pension De-Risking: Compliance and ERISA Litigation Considerations

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...

J.P. Morgan Predicts Gloomy Year Ahead For Pension Plans

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.

Pension De-Risking for Employee Benefit Sponsors: Minimizing Risks and Ensuring ERISA Compliance When Transferring Pension Obligations to Other Parties

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.

Description

As U.S. pension plans face record deficits, options for transferring some or all of a sponsor's plan risk make sense for many companies. General Motors, NCR and Verizon are a few companies that have chosen de-risking options in 2012.

De-risking transactions take many forms, from transferring company obligations to third parties, to offering payouts to plan participants, to undertaking liability-driven investing and other strategies. Counsel and companies must tread carefully to avoid ERISA-based litigation or enforcement actions.

Prudent de-risking requires thorough financial analysis and clear demonstrations that fiduciary standards under ERISA are met. Counsel should guide companies on how to establish the reasonableness of decisions and prepare to defend against possible court challenges.

Listen as our panel of experienced employee benefit practitioners provides guidance on precautions for companies undertaking transfers of pension plan obligations to third parties or other de-risking options. The panel will outline best practices for assembling a thorough financial review, complying with ERISA requirements, and responding to potential legal challenges from plan participants.

Outline

  1. De-risking overview
    1. Current trends
    2. Different approaches
      1. Transfers to third parties
      2. Lump sum payouts for participants
      3. Investment strategies
  2. Procedural prudence
    1. Financials
    2. Government filings and participant notifications
    3. Meeting ERISA fiduciary requirements
      1. Prudence
      2. Care
      3. Loyalty
  3. Potential challenges from plan participants
    1. Grounds for challenges
    2. Likelihood of success

Benefits

The panel will review these and other key questions:

  • What kind of financial reviews are needed to support a de-risking transaction?
  • How can pension providers demonstrate they have met their ERISA standards of prudence, care and loyalty to plan participants?
  • What steps should be taken in preparation for termination of a pension plan?

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
Fiduciary Leadership, LLC, New York Metropolitan Area
 

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.

Nancy G. Ross, Partner
McDermott Will & Emery, Chicago

She focuses her practice primarily on the area of employee benefits class action litigation and counseling under ERISA. She has extensive experience in counseling and representing employers, boards of directors, plan fiduciaries, and trustees in matters concerning pension and welfare benefit plans. Her experience includes representation of pension plans, ESOPs, trustees and employers.

Anthony A. Dreyspool, Senior Managing Director
Brock Fiduciary Services, New York

He specializes in the investment of assets of ERISA-covered employee benefit plans and all aspects of ERISA fiduciary law compliance.  He has more than 30 years of experience with respect to ERISA matters and has substantial knowledge in the structuring and formation of private real estate and equity funds for the institutional investment market.

De-Risking For Shareholders or Participants?

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.

Registered Investment Advisor (RIA) Fiduciary Liability Risk

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.

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

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

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

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

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

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

QPAM and INHAM Compliance Audit 101 For ERISA Asset Managers

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.

Withdrawal Liabilities, Corporate Sponsors and Union Members

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.

ERISA Assets: QPAM and INHAM Audit Legal Requirements and Best Practices

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 MangieroManaging 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 OrrSenior 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. PicklePartner
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. SchmidtPartner
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.

 

ERISA Litigation Against Service Providers

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.

Pension Risk End Game

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.

New Focus of ERISA Fee Litigation

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.

The Oops Factor and a Crackdown on Retirement Plan Advisors

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.

ERISA Pension Plans: Due Diligence for Hedge Funds and Private Equity Funds

 

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.

 

 

Fiduciary Duty to Hedge

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.

New Regulations About ERISA Plan Fee Disclosures

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.

Hedge Funds, Private Equity Funds and ERISA Pension Plans

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:

ERISA Fiduciaries Under Attack: Key Litigation and Regulatory Developments

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

Dr. Susan Mangiero to Speak at ERISA Litigation Conference

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.

Advisor Service Agreements: The Weak Link

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.

 

Stable Value Risk Management

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.

Valuing Positions in Alternatives - New DOL Scrutiny

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.

Target Date Fund Fiduciary Checklist - Coming Soon

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.

ERISA Best Practices - RIMS Presentation on April 28

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.

Fiduciary Liability and Insurance Issues

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:

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.

408(b)(2) Takes a Bold Step Forward

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.

A Halloween Trick or a Halloween Trick from the Eighth Circuit?

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.

Welcome xtremErisa.com to the pension blogroll

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.

Tags:

New Study Addresses Pension Risk Management Gaps

 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.

Regulators Tell Pensions to Independently Value Positions

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.

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

U.S. Supreme Court Rules 9-0 in Major Pension Case

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."

Disclosure and Fiduciary Implications - Big Problem?

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?"

First Case to Try to Link ERISA with Option Backdating

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.

401(k) Stock Drop Litigation - Back in Fashion Again?



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!

Compliance and Litigation Remain Hot Button Issues



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

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

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

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

Other press accounts about corporate lawsuits are similarly engaging.

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

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

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

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

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

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

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

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

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

ERISA and Derivatives

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. >>

Can Poor Pension Governance Land You in Jail?



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

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

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

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

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

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

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

A harbinger of days ahead in pension governance land?

PBGC Data Book Paints Grim Picture

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?

Pension Truth Telling


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?

Form 5500 Revisions


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.)

Expert Panel Addresses Financial Impact of Pension Crisis


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.