Pension Risk News & Analysis : Pension Governance, LLC : Pension Risk & Investment

Sunday was no day of rest for the Board of Governors of the Federal Reserve System.  A unanimous vote to "create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets" accompanied approval to decrease the discount rate by 25 basis points, to 3 1/4 percent. A third initiative was the approval of a deal for JPMorgan Chase & Co. to buy The Bear Stearns Companies Inc. (ticker symbol BSC).

An announced acquisition price of $2 per share (or $236 million in aggregate) is an economic fall from grace by most counts. Bear common last closed at $30 and traded as high as $159 and change over the last year. Click for BSC information. While good news for some, others are reeling from the precipitous drop in stock price. According to "Bear execs lack golden parachutes as stock plan crunched" (Reuters, March 17, 2008), journalist Joseph A. Giannone writes that executives will have little to celebrate since "shares held by the top handful of executive officers plunged in value from about $1.8 billion 14 months ago to just $22 million today." Employees are likely to fare no better with 30 percent of company stock in their various benefit plans (profit sharing, options and so on).

Litigation is underway with Pittsburgh law firm, Stember Feinstein Doyle & Payne, LLC, announcing "possible illegal conduct relating to the Bear Stearns Companies Inc. Employee Stock Ownership Plan, Profit Sharing Plan and Deferred Compensation Plan." According to the March 14, 2008 press relelase, the firm is investigating whether identified plan fiduciaries "knew or should have known that Bear Stearns was concealing its large exposure to highly risky Collateralized Debt Obligations, subprime mortgages, and other poor-quality securities, which has rendered Bear Stearns common stock and certain funds that it manages and offers as a risky investment for Plan participants."

Editor's Note: Does anyone know if BearMeasurisk, LLC is likewise sold to JPMorgan? The BSC web page for institutional investors currently links to a description about this web-enabled product for pensions as follows.

<< Our plan sponsor offering addresses Corporate, Public and Taft Hartley Funds with defined benefit and defined contribution plans. We provide Value at Risk (VaR) analysis at all levels of your fund, including security level, asset class, country, account and total fund. We also provide marginal VaR (contribution of risk), Relative VaR (risk versus benchmark) and risk of the total fund as compared to a policy portfolio. >>

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In today's issue, New York Times reporter Eric Dash ("The Price of Any Departure Will Be at Least $159 Million") writes that Merrill Lynch CEO Stanley O'Neal will be well off if asked to resign. With $30 million in retirement benefits, along with $129 million in "stock and option holdings," this is one top executive who won't need to celebrate National Save for Retirement week. Dash goes on to say that O'Neal is far from unique in tems of post-employment largesse for CEOs.

This blogger, a staunch advocate of pay-for-performance, is no critic of scrimping for those who create shareholder wealth (though, in the case of Merrill, large surprise losses are hard to explain as wealth-creating). Still, the constrast between those who are likely to find retirement a harsh financial reality, versus those who will quit in style, gives one pause.

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

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

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

This case is sure to attract attention.

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In "Backdating Fine May Set Model - Brocade Is the First to Pay Penalty in Options Probe (June 1, 2007)," Wall Street Journal reporter Kara Scannell describes a $7 million settlement with the SEC over option backdating. Law.com reporter Jessie Seyfer describes a judge's refusal to dismiss the case, with significant focus surrounding the issue of material economic harm to shareholders. (Is there harm or not?) Click here to read the May 14, 2007 article.

In the wake of several stories about 401(k) stock drop litigation, one connects the backdating - company stock dots by asking: "How much extra homework should pension fiduciaries undertake before recommending company stock (if at all) when the terms of prevailing option awards are misunderstood, questionable or insufficiently transparent?" Should pension fiduciaries ask to meet with the compensation committee and more thoroughly vet company stock risk factors related to option awards for those at the top of the management ladder? 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). 

Not addressed in the article but an interesting point to ponder relates to possible conflicts of interest. When the compensation committee and the pension investment committee are one in the same, will individuals who approve the granting of executive options be able to support an arm's length assessment of company stock as a viable defined contribution plan choice? The answer is not necessarily "no" but it does pose some added complexities.

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Hot off the press, the U.S. House of Representatives says okay to amending the Securities Exchange Act of 1934 to provide stockholders more power in approving executive pay. Click here to read the Shareholder Vote on Executive Compensation Act. Arguably the rationale is to empower shareholders to veto executive pay packages deemed "excessive." One can argue about the efficacy of the legislation (and likely will). However, it begs an interesting question for citizens of pension land.

What type of say do they get about the operation of a defined contribution and/or defined benefit plan? How can they corral perceived conflicts of interest, alleged misdeeds and/or questionable decisions? On the flip side, how can they say "bravo" to effective investment stewards, perhaps voting for better financial rewards and job title recognition for good do bees (honest players)?

The answer - Not much!

This topic arose in 2005 when I was asked to appear on CNN Financial to talk about United Airlines. The anchor asked me to cite steps that defined benefit plan participants could take when they know a company is encountering financial difficulties and want to exit the plan or change their share of the investment mix. When I explained to the producer that employees are extremely limited in being able to exert influence over the management of the trust (other than through litigation, and only after losses have occurred), we all agreed that a gloomy message may not make for great ratings.

Sob - my fifteen seconds of fame, evaporated in a moment of candor.

So now that Congress is taking steps to empower shareholders, why not tackle the same for plan participants? Yes, post-Enron, reforms were made. No, to this day, plan participants still have little influence on whether a plan is well run or not.

Part of the problem arises because information is scattered, often obtuse when available and sometimes contradictory (depending on the source). And for those on the outside looking in, access to documents such as the Summary Plan Description (SPD) is nil.

Just an aside - This issue of limited beneficiary control extends to defined contribution plans as well.

Hence, plan participants MUST depend on the integrity, knowledge, experience and solid intentions of the persons in charge.

So to all of those plan beneficiaries everywhere - ask yourself this. How much do you know about the people in charge? Would you like to know more?

To plan stewards - If you aren't providing transparency about everyone with authority to make decisions about plan design and investment governance, wouldn't it be a good idea to do so? Besides creating a sense of "I don't want to hide anything," you open the door to suggestions for improvement and possibly close a door to litigation or otherwise unwanted scrutiny.

Why wait?

Continue Reading...

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Alleging questionable stock option practices at technology giant Apple Inc, the New York City Employees' Retirement System ("NYCERS") will serve as lead plaintiff in a lawsuit filed a few months ago. Citing the Private Securities Litigation Reform Act of 1995 ("PSLRA"), NYCERS claims the largest financial interest in the lawsuit. (Click here to read the original filing and here to read "Recent Developments Under the PSLRA.")

According to Reuters (January 22, 2007), the NY fund's ownership stake is roughly one million shares or about $87 million in current value terms. Its 2006 Comprehensive Annual Financial Report shows $46.34177 billion as plan net assets as of June 30, 2006. While NYCERS equity exposure to Apple is large in absolute terms, it is small compared to the equity interests held by institutional investors such as Fidelity Management & Research (60,316,011 shares as of September 30, 2006) or AllianceBernstein L.P. (48,637,731 shares in second place). Click here to review ownership statistics, courtesy of Thomson Financial (and reprinted by the Wall Street Journal.)

The intent of this post is not to single out any one company nor to imply that the filing of a complaint supports any or all of the allegations. That's for the trier of fact to determine. What is important is to understand that executive compensation practices can (and often do) impact shareholder value. If the market interprets a particular practice as far removed from economic reality and/or regulators start sniffing around, defined benefit and defined contribution participants stand to lose a bundle. In order to reduce the likelihood of an adverse outcome due to investing in company stock, pension fiduciaries must carefully consider relevant risk factors. That includes the percentage of company stock already part of a particular plan (whether self-directed or not). See "Options, Pensions and the SEC" for additional comments about backdating and pension fiduciary duty.

With more than 120 companies being asked questions about their respective option practices, there is surely much more to say on this topic!

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It's hard to pick up a newspaper these days without reading some story about stock options - when they are granted, how often they are repriced, what portion of an executive's total compensation they represent and so on. What has authorities particularly busy is a fast-expanding review of practices such as option backdating and spring loading. As of December 31, 2006, the Wall Street Journal counts 120 companies on their option backdate list. Click here to view the options scorecard and learn about executive departures and various regulatory agency investigations.

The Free Dictionary defines backdating as "dating any document by a date earlier than the one on which the document was originally drawn up." Spring loading can mean either that "a company purposely schedules an option grant ahead of expected good news or delays it until after it discloses business setbacks likely to send shares lower." See "SEC eyes 'springloading'" as published by the New York State Society of Certified Public Accountants. In both cases, the idea is to inflate the value of the executive's stock option. (Experts remind that neither backdating nor spring loading is necessarily illegal per se, a conclusion that is best left to attorneys and regulators.)

These and other practices are important to pension fiduciaries and plan participants alike. Defined benefit plans sometimes invest in company stock. Defined contribution plan participants are often given a similar choice. Any problems with option grants, especially when they result in tax and/or accounting penalties, not to mention regulatory enforcement levies or litigation payouts, can do serious harm to an employee's retirement plan. From a fiduciary perspective, real questions could arise about the ex-ante assessment of company stock as a viable investment vehicle for a sponsored plan(s). Did an adequate due diligence review of risk factors that influence company stock price occur? Did pension fiduciaries sufficiently understand existing practices regarding executive compensation, including option awards? How often did pension fiduciaries assess option grant practices and/or inquire about industry norms, internal controls and likely impact on "shareholder" retirement plan participants?

For interested readers, the D&O Diary, authored by attorney Kevin LaCroix, has an excellent collection of articles about option backdating.

Option valuation is another topic with considerable import. Relatively new accounting rules in the form of FAS 123R set the stage for a vigorous debate about how to value employee and executive stock options (ESO's). Unlike shorter-term options that actively trade in ready markets, ESO's are more challenging to value for a host of reasons. Though a bit outdated with respect to regulations, readers may nevertheless find my article about option valuation of interest because it highlights the importance of having good inputs and an appropriate model. (Click here to read "Model Risk and Valuation," Valuation Strategies, March/April 2003.)

In a recent decision, the SEC notified Zions Bancorporation that its Employee Stock Option Appreciation Rights Securities (ESOARS) is "sufficiently designed to be used as a market-based approach for valuing employee stock option grants for accounting purposes under Financial Accounting Standards (FAS) No. 123R." According to Zion's press release, it is their intent to assist other public companies in valuing ESOs. I took a quick look at their site and plan to read more. Certainly a mechanism that facilitates marketability is a step in the right direction. After all, the coming together of willing buyers and sellers, under ideal circumstances, permits a flow of information that should result in the "right" price.

Editor's Note:
I am currently writing an article about option backdating as it relates to pension fiduciaries.

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No more cream for fat cats if Congress gets its way. According to Financial Times journalists, Francesco Guerrera and Eoin Callan, the U.S. Senate votes this Tuesday to curb tax breaks tied to executive retirements. (See "Retirement tax will hit US executives - January 29, 2007). They write: "Under the new regime, executives would be allowed to defer up to $1m a year or the average of the previous five years' taxable salary, whichever is lower. Any sum above that would incur taxes and a 20 per cent penalty."

I could not find any details posted yet to the U.S. Senate Finance Committee website but I'll scour C-SPAN tomorrow for the exciting showdown.

The real shame is that, once again, we have a "one size fits all solution" that does not differentiate between "excessive" compensation arrangements and what's required to attract and retain leadership talent. Ben & Jerry's earlier use of a salary cap made it difficult to lure a CEO to Vermont, despite the promise of an unlimited supply of Chunky Monkey and Cherry Garcia (the low-fat version being my personal favorite). Ditto for other companies that did not heed the supply-demand dynamics of a competitive marketplace. (Click here to read "Putting a Ceiling on Pay: No Whole Foods executive can earn cash pay of more than 14 times what its average worker makes. Will other companies follow?" by Andrew Blackman, Wall Street Journal - April 12, 2004).

By extension, if deferred compensation at a certain level facilitates the hiring of a skilled CEO, why should it be discouraged? Shareholders may save money in the short-run but lose in the long-run. This could include 401(k) and defined benefit plan participants whose fortunes rise or fall with the price of company stock.

This story has legs, especially now that many experts predict a return to populism and a move against "mean, greedy executives."

Editor's Notes:

1. The topic of optimal executive compensation is broad and complex. However, there is real merit in letting companies self-police AS LONG AS shareholder stewards do what they are supposed to do. Be vigilant. Ask questions. Exercise proper fiduciary oversight.

2. Click here if you want to read last week's blog post about the proposed taxation of health care benefits.

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

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

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

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

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In case you missed it, Donald Trump, co-owner of the Miss USA pageant, just announced that the reigning titleholder will be given a second chance, despite questions about her behavior, post-win.

In stark contrast, former CEO of Pfizer has been forced into early retirement "in part because of investor anger about his rich retirement benefits." Hang on to your hats. It's written that SEC disclosures describe truly golden years for this former executive - an $83 million pension and nearly $78 million in other deferred compensation. No second chance here but with that much in the bank, one might ask who cares. (For additional information about pensions at the top, see "Executive Paywatch.")

Well, reputation and legacy issues are important to some. Then there is the possibility that allegations of excess compensation could result in legal action. According to New York Times reporter Eric Dash, Fannie Mae's primary regulator has filed suit against top executives in an effort to take back more than $200 million in bonus payouts. Notwithstanding questions about recent accounting restatements, the former head received a "pension valued around $25 million." (See "Fannie Mae Ex-Officers Sued by U.S." by Eric Dash, December 19, 2006.)

So what's the takeaway for pension fiduciaries?

Second chances are a gift, allowing those in charge to improve current practices, stave off trouble and be good, or better, stewards on behalf of plan participants. However, not everyone gets a chance to go round again, begging a logical question.

Why not get it right from the outset?

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A few thoughts come to mind regarding the new SEC executive compensation disclosure requirements.

1. Will it be hard for analysts to interpret information about executive pensions if they are reported on an accumulated benefit basis but FASB requires the use of a projected benefit approach?

2. How do company compensation committees determine who gets what and why? Understanding the process by having access to meeting notes would be particularly helpful.

3. What volatility numbers will be used to determine the value of executive stock options?

4. How are D&O insurance costs likely to change in response to disclosures about the timing of option grants to executives?

5. How are pensions determined for non-executives and does the Compensation Committee interface with the company's benefits team?

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SEC Chairman Christopher Cox announces new disclosure rules about executive compensation by stating that "With more than 20,000 comments, and counting, it is now official that no issue in the 72 years of the Commission's history has generated such interest." (Read the announcement online.)

Besides wages, options and other types of compensation, the investing public will now have access to a Pension Benefits Table which, among other things, will include "disclosure of the actuarial present value of each named executive officer's accumulated benefit under each pension plan, computed using the same assumptions (except for the normal retirement age) and measurement period as used for financial reporting purposes under generally accepted accounting principles".

This comes as good news, especially as Wall Street Journal reporters Ellen E. Schultz and Theo Francis highlighted the "hidden burden" for shareholders in the form of executive pensions. According to their June 23, 2006 article, "As Workers' Pensions Wither, Those for Executives Flourish", "Compensation committees often aim for a pension that replaces 60% to 100% of a top executive's compensation" versus "20% to 35% for lower-level employees." Their research revealed that "executive benefits are playing a large and hidden role in the declining health of America's pensions."

Talk about a morale buster for everyone below C-level!

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April 10 closes the comment period for the SEC's proposed rule about executive compensation reporting. As we await the final version, we have some indication about what lies ahead. According to the Wall Street Journal ("Adding It All Up" by Joann S. Lublin, April 10, 2006), directors are shocked to learn how much C-level executives are really making. The New York Times reports a widening gap between those at the top and everyone else ("Off to the Races Again, Leaving Many Behind" by Eric Dash, April 9, 2006).

We could have a vigorous and long debate about the merits of executive pay. Should executives be paid commensurate with performance? What amount is sufficient to assume the responsibilities that others shun? In a free market environment, what is the proper differential reward for advanced skills, including the ability to lead?

While efforts to reform the way executives are paid are laudable, the numbers themselves are of limited interest. Once we know that Mr. or Ms. Big makes a lot, what then? Isn't it just as important to understand how compensation committee members decide on a final recommendation? Equally helpful, how does a company choose how much to compensate its employees, especially with respect to post-retirement benefits? Should a one size fits all approach be used or should employees below executive rank be given a bevy of choices?

Shedding light on the process itself offers invaluable lessons. Otherwise, we are left in the dark about a topic that has import for employees and shareholders alike.

If a retirement crisis is truly upon us (and not all agree that this is so), what is a company's risk of being branded "bad" if pensions for line workers take a hit at the same that its executives walk off into the sunset? What is the cost associated with a damaged reputation, possible litigation and financially ruined lives?

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Pension fiduciaries inside a company have a tough life. They are tasked with making multi-million dollar decisions at the same time that they are seldom rewarded for the time and energy required to do an excellent job. What's odd is that so few people pay attention to all things "fiduciary" in terms of how these individuals get selected, compensated and evaluated for performance. In contrast, extensive time and money is expended in an effort to determine the optimal pay package for an executive (including pension benefits), how to gauge leadership acumen and when to pull the chord on the golden parachute.

Several questions come to mind. Are fiduciaries getting paid enough? Do they have an appropriate educational and experiential background to decide how to properly select and review external money managers, assess operational controls, determine suitability of 401(k) investment choices, evaluate plan performance, interpret actuarial estimates of explicit and pseudo liabilities, identify hidden risks and otherwise carry out their fiduciary duties? How should they be rewarded for a job well done? Should the job of pension fiduciary be a full-time position? Should information about who serves as a pension fiduciary be made public to shareholders and other interested parties? Should C-level executives and board members be made more accountable for pension fiduciary recruiting and decision-making? Is it time for a "fiduciary expert" that parallels the notion of a financial expert, a la Sarbanes Oxley?

There are a few training programs that specifically address retirement fiduciary concerns. Stanford University Law School has Fiduciary College and Peter Hapgood, president of Public Pensions Online, is working on the municipal side with several public fund organizations. The U.S. Department of Labor established "Getting It Right" several years ago.

Notwithstanding these efforts, I think it would be fair to say that fiduciary management has a long way to go. If there was ever a time when the issue of defined benefit and defined contribution plan stewardship deserves examination, now is that time. With so much at stake, why wait?

For a discussion of the topic of fiduciary compensation, see "Do Fiduciaries Need Better Incentives to Make the Retirement System Work?", co-authored with Wayne Miller (Executive Decision Magazine, January/February 2006).

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