Free Educational Webinar About Fee Assessment, Form 5500 Reporting Compliance and Fiduciary Liability

Please join ERISA attorney Linda Ursin and Ms. Jamie Greenleaf, Senior Partner with Cafaro Greenleaf on June 29 from Noon to 1:00 PM EST to learn more about assessing management fees for reasonableness, new Form 5500 rules and fiduciary liability for failure of oversight of service providers. To register, visit

BP, Fat Tails and Risk Management

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

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

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

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

Fees, Form 5500 and Fiduciary Liability - The New F Words

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

Attendees will learn more about:

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

And much more!

Click here to register for this free educational webinar.

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 for a copy of the two-part interview series.

Investment Losses Lead to Desperate Act

According to the British Broadcasting Corporation ("BBC"), four unhappy investors in Germany were found guilty of kidnapping their financial advisor. Ranging in age from 61 to 80, the defendants took justice into their own hands, seeking a return of over 2 million Euros. Retirement hopes dashed, jail time is a reality for at least one of the quartet. Read "German pensioners guilty of abducting financial adviser" (March 23, 2010).

In a related "believe it or not" news item, Wall Street Journal reporters Dionne Searcey and Amir Efrati describe giving financial advice to a fellow inmate, urging him to focus on passive index funds and to avoid day trading unless he had "millions to spare." See "Madoff Beaten in Prison" (March 18, 2010).

What is the Proper Role of an Investment Consultant?


In response to my post about the merger of Towers Perrin and Watson Wyatt ("Two Giants Merge - Que Pasa?" June 29, 2009), I wrote that generalists are finding it tough going in terms of assisting pension decision-makers, in large part because the issues that confront them are becoming more complex. Though my statement was not directed to any particular firm and reflected what I often hear from pension executives, one reader took me to task.

Mr. Alberto Dominguez writes that "The folks who work at Towers Perrin (disclosure: that would include me) and Watson Wyatt are hardly generalists. One argument in favor of the merger is that it will allow an even greater depth of talent and more specialization, enhancing the ability to assist clients with these increasingly specialized decisions." (Check out Alberto's blog on pension issues from an actuary's perspective, "What's An Actuary?". Also note that he has given me permission to reprint his comments but with the caveat that he is not rendering an official statement on behalf of Towers Perrin.)

In speaking to industry experts about the consulting industry in general, several trends appear to be taking hold. Anyone who wants to guest blog about this topic or offer their opinion (for attribution or not) is encouraged to email Pension Governance, Incorporated at

This list (which is far from exhaustive) includes:

  • Greater tilt towards specialization under one roof if seen by investment executives as being easier than contracting with multiple parties
  • A desire to have a consultant wear the hat of fiduciary continues to have appeal if it is affordable, noting that most organizations will logically charge more for greater liability exposure
  • Strident calls for transparency with respect to who is doing what, how and on what basis in terms of fees and buy-sell relationships.

Keep in mind that while consultants are being asked to do more, there are tremendous pressures to contain costs on the part of the organizations that write checks. There is no doubt that the investment consulting world is starting to change. As with any period of tumult, opportunities are there for those who know where to look.

New Study Says Plan Sponsors Must Improve Fiduciary Practices

As I stated during my September 11, 2008 "hard-to-value asset" testimony before the ERISA Advisory Council, there are some stellar examples of pension risk management and there is everyone else. Given the dearth of publicly available information about pension financial best practices, one can only guess at the size of each of the two buckets, “great” and “not so great” except for occasional studies that offer empirical validation. In October 2008, Pension Governance, LLC (now Pension Governance, Inc.) released a unique study about the use of derivatives by plan sponsors. Sponsored by the Society of Actuaries, “Pension Risk Management: Derivatives, Fiduciary Duty and Process” found that the “everyone else” bucket is rather large, hinting at future problems if poor process is left unchecked. (Click to read my hard-to-value asset testimony. Click to download "Pension Risk Management: Derivatives, Fiduciary Duty and Process.")


Now, a new report offers additional and troublesome evidence that the “everyone else” bucket remains large. Hot off the press, the MetLife U.S. Pension Risk Behavior IndexSM (“PRBI”) considers investment, liability and business risk management among the largest U.S. defined benefit pension plan sponsors. (Pension Governance, Incorporated is proud to have assisted with what we think is path-breaking research.)


Designed to measure both the aptitude and attitude of employee benefit decision-makers, the research creates a base case gauge as to the current state of pension risk management. Not surprisingly, respondents ranked the following risk factors as “Most Important,” in part it is believed because they are the simplest to model and measure:


  • Asset Allocation
  • Meeting Return Goals
  • Underfunding of Liabilities
  • Asset and Liability Mismatch

Given radically changing demographic patterns and the related, oft material economic impact on plan sponsors, it is surprising that the following risk factors were identified as relatively unimportant (and in some cases ignored altogether):


  • Early Retirement Risk
  • Mortality Risk
  • Longevity Risk
  • Quality of Participant Data.

Also disturbing is what appears to be a disconnect between the importance attached to prudent process by plan sponsors and the regulatory and legal reality that PRUDENT PROCESS IS IMPORTANT. Not only can plan participants suffer untold harm in the absence of a good process or the presence of a bad process, fiduciaries are professionally and personally on the hook. (As this blog has urged many times before, questions about prudent process and fiduciary duty are best answered by plan counsel.)  


According to the MetLife press release, dated January 26, 3009, “While respondents ascribe a particularly high rating to the quality of their Plan Governance, they do not seem to carefully consider the effectiveness of their decision making methods or how to improve the way they make decisions. This suggests that many respondents don’t perceive decision making process as an integral element of plan governance, when recent ERISA litigation would suggest just the opposite. In addition, plan sponsors report that they routinely review liability valuations and understand the drivers that contribute to their plan's liabilities. However, at the same time, they indicate that they do not actively implement or regularly review procedures to manage either mortality, longevity or early retirement risk, which are major determinants of both the timing and level of future liabilities. These inconsistencies may indicate that plan sponsors tend not to systematically consider the interrelationships among risk items and plan their implementation of risk management measures to maximize effectiveness across all items. Over time, a lack of holistic risk management may have serious repercussions, including unnecessary volatility in earnings and/or cash flow or potential plan failure. “


Unlike other studies, this research sought to quantify attitudes and aptitudes, in essence creating a unique score card against which subsequent results can be compared. The news is not great. On a scale of 0 to 100%, the PRBI level is 76. Roughly translated, defined benefit managers earn an average grade of C with respect to how they manage defined benefit plan risk.


These results beg a hugely important question. Is “mediocre” performance acceptable or does the MetLife study sound a warning that someone needs to stay after school for extra help? This blogger thinks it is the latter and welcomes your suggestions about how to fix a wobbly system. (Email with comments.)


As I’ve said many times, reward good process and make life difficult for those who do sub-par work. With trillions of dollars at stake, how can we accept anything less?


Editor's Note: Click to read the MetLife press release, dated January 26, 2009, about this new study. Click to download "MetLife U.S. Pension Risk Behavior IndexSM: Study of Risk Management Attitudes and Aptitude Among Defined Benefit Pension Plan Sponsors."

Congress and Hedge Fund Regulation

Many financial market participants seem resigned to an onslaught of new regulations. For them, it is no longer a question of "if" but "when," with the unknown being the form of eventual rule-making. One area that is likely to receive more than a passing glance is the role of the service provider to pensions, endowments and foundations. Always important, the Madoff scandal has pushed the issue front and center as institutional investors, reeling from reported losses, ask their advisors for clarity about their exposure to the now defunct Bernard L. Madoff Investment Securities LLC. According to "Crackdown on hedge funds after Madoff affair" (December 29, 2008), Financial Times reporters Deborah Brewster and Joanna Chung suggest that funds of funds may be especially feeling the pinch, with an anticipated change in how due diligence is conducted.

Next week's Congressional hearing should be telling. Convened by U.S. Congressman Paul Kanjorski (Democrat - Pennsylvania), this investigative meeting may be "standing room only" as members of the Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises seek to understand what went awry before being able to "craft a strong, effective, modern regulatory system for the financial services industry." 

Though best left to legal experts, one wonders if a likely inquiry will center on the allocation of fiduciary duties across investors and advisors. Under what circumstances might an advisor or consultant be seen as encouraging an "unsuitable" investment? This of course begs the question as to what is deemed "appropriate" for a particular buyer and on what basis should an investment be assessed for a particular pension, endowment or foundation? We've heard that some financial professionals are responding to l'affaire Madoff by imposing more stringent, and arguably prudent, literacy requirements BEFORE accepting client money.

Dr. Susan Mangiero to Speak at NYSSA Pension Event

Mark your calendars for an exciting event about pension risk realities. Dr. Susan Mangiero, President of Pension Governance, Incorporated, will join other pension professionals for a half-day workshop entitled "Pensions at Risk: A Meeting of Fiduciary and Financial Minds." Presented by the New York Society of Security Analysts, Derivatives Committee, the event will be held in midtown Manhattan on January 21, 2009 from 8:30 am to noon.

Click to register. A description of the program is excerpted below.

<< Recent market turmoil, coupled with changes in pension funding and accounting rules, have helped produce a “perfect storm” of volatility and risk in our defined benefit pension plans. As pension investment and risk management strategies continue to evolve to meet these demands, so does the need for informed fiduciary decision-making. This program is intended to provide an up-to-date and in-depth discussion regarding the fiduciary legal and risk management considerations involved in the design and implementation of pension investment management strategy, including liability driven investing (LDI) approaches and those integrated within a framework of corporate finance. Topics will include performance benchmark development, asset/liability duration matching, timing of implementation and the use of derivatives, alternative asset classes and leverage. >>

Martin Rosenburgh, Esquire, will moderate a panel to include the following speakers:

  • Nell Hennessy, President and Chief Executive Officer, Fiduciary Counselors Inc.
  • Susan M. Mangiero, PhD, AIFA, AVA, CFA, FRM, President, Pension Governance, Inc
  • James Moore, PhD, Executive Vice President, Pension Strategist, PIMCO
  • Michael W. Peskin, CERA, Managing Director, Morgan Stanley.

Pension Magic

I had the pleasure of speaking on October 23, 2008 in Stamford, CT about "New Directions for the Financial Services Industry." Part of the "Securities Forum 2008: Weathering the Economic Storm," sponsored by the State of Connecticut Department of Banking, panelists addressed the litany of current financial problems, proposed reforms and the likely future for investors and service providers alike.

I was asked to address FAS 157 and international equivalents. In doing so, I urged audience members to make a clear distinction between accounting representation and economic reality or accept the consequences. Unless one truly understands what reported numbers say (or just as importantly don't convey), poor decisions made on the basis of incomplete or even illusory information can lead to costly outcomes (GIGO = Garbage In, Garbage Out).

I've long maintained that disclosure about process is arguably more important than single numbers, derived at a particular point in time. For example, if I'm a pension fund decision-maker who has allocated monies to a manager that in turn invests in "hard-to-value" assets, which information is more helpful to me in understanding my risk exposure to that asset manager - (1) a FAS 157 disclosure that describes possible changes that could affect results or (2) identified likely risk drivers and the controls that have been established to mitigate risk accordingly?

Said another way, am I properly discharging my fiduciary duties by evaluating risk ex poste or instead assessing uncertainty ex ante? I think the answer is obvious, isn't it? After all, no one can respond to "what was" but can certainly act in anticipation of "what might be." By the way, I do believe there is merit in regularly conducting a post-audit of what went wrong and trying to learn lessons as a result.

According to FORTUNE Magazine senior editor Allan Sloan, critics of FAS 157 allege real harm is being done when illiquid securities are marked-to-model at "artificially low market prices." Call me clueless but finger-pointing seems to answer the wrong question. Instead of focusing on FAS 157 as the culprit because it supposedly forces reporting entities to document "bad" economic numbers, why not create a standard that instills confidence in financial statement users? Sloan writes "It's easier to blame accountants for your problems than to admit you made your institution vulnerable by overleveraging its balance sheet and buying securities you didn't understand." Click to read "Playing the blame game: Will 'mark to market' accounting take the fall for the Wall Street mess?" (October 27, 2008).

Just like the magic impossibility of growing a silver dollar into four years of college tuition, accounting representation should be more than smoke and mirrors.

New Book on 401(k) Issues

In Fixing the 401(k): What Fiduciaries Must Know (And Do) To Help Employees Retire Successfully, author Joshua P. Itzoe suggests that the 401(k) industry is broken and in bad need of repair. As many employers migrate away from defined benefit plans to defined contribution plans, it is critical to understand any weaknesses in the current system and work vigorously to correct them.

Chapter 1 states conflicts of interest and opaque fee disclosures as two of the biggest issues faced by the 401(k) industry. Chapter 3 explains basic fiduciary duties as codified by U.S. pension law in the form of ERISA, co-fiduciary liability and how fiduciary types differ from one another. Subsequent chapters are rich with descriptions of relevant industry players (and there are many of them), inherent conflicts of interest and the generally accepted compensation arrangement for each category of service provider. Though there is an entire chapter devoted to types of fees, it would have been nice to sink one's teeth into some meaty math examples, along with some empirical data about magnitude and dispersion of fees across plans. 

Written for 401(k) fiduciaries, the basic nature of the book is both refreshing but worrisome. If current plan fiduciaries (the target market for the book) are unaware of their core duties, how have they been getting along so far? Far from being pedantic, Mr. Itzoe includes several chapters with concrete advice for improving 401(k) fiduciary practices. His provision of important questions at the end of each chapter is a nice touch, along with some helpful appendices such as a "Sample Fiduciary Audit File," "20 Steps to 404(c) Compliance" and a relatively long glossary. There is no index but a short bibliography is provided for interested readers.

For more information, check out Click to read the author's bio. At $13 and change, I recommend this primer. Kudos to Mr. Itzoe, CFP and Accredited Investment Fiduciary, for putting forth a solid book on an important topic.

Pension Litigation Trends - What Do You Want to Know?

On January 14, 2008, we announced the launch of Since then, we've collected over 2,000 cases that involve pension funds, either as plaintiff or defendant. We are adding about 300 to 400 cases per quarter. A joint venture of Pension Governance, LLC and The Michel-Shaked Group, this continuously updated and searchable database reflects the dramatic rise in pension lawsuits. Topics include, but are not limited to, prudence, fees, risk management, diversification, suitability and plan design.

Like it or not, lawsuits are growing in number, severity and frequency. If we can learn from attempts to seek legal redress or understand why a case is dismissed, perhaps we can gain a better understanding of fiduciary vulnerabilities and ways to improve bad practices, when they exist. (It should go without saying that the filing of a case does not necessarily equate to culpability.)

We want your feedback in order to make our first trend analysis paper (and those to follow) as helpful as possible to pension fiduciaries and professionals who work with them. We currently use nearly one hundred codes to categorize each case (by court and topic).

  • Readers (attorneys or otherwise) - What kind of information about pension litigation do you want to know? Click to send an email with your thoughts.
  • Attention attorneys (litigators on either side, general counsel or plan counsel) - If you would like to contribute an analysis or helpful hints to and our fast-growing audience, send an email with your suggestions and contact information.

We want to hear from you!

Hedge Fund Investing: Change is Good, You Go First

Thanks to Scott Adams and his popular Dilbert for continued wisdom in the work place.  I own a few Dilbert tee shirts, including one that says it all - "Change is Good, You Go First." It's rather apt when you consider the flurry of news about hedge fund investing by pension funds. As we reported on February 29, the U.S. GAO study takes a serious look at billions of dollars flowing into hedge fund coffers. (See "Hedge Funds: Regulators and Market Participants Are Taking Steps to Strengthen Market Discipline, but Continued Attention Is Needed.)" In the UK, the Hedge Fund Working Group published "Hedge Fund Standards: Final Report" in January 2008. With over 130 pages of suggested guidelines about risk management, valuation and investment policy, it reminds institutions, consultants and managers that due diligence is a weighty endeavor.

A read of these and other attempts to shed light on the growing hedge fund industry begs several central questions, ones that arose many times during the February 28 master class I led on hedge fund risk management and valuation.

  • Who is responsible for writing the checks to hire an independent third party who can review valuation policies and procedures - the investor or the fund manager or both?
  • Should a pension/endowment/foundation hire a consultant or fund of funds manager or both?
  • What if neither the consultant or fund of funds manager is willing to vet mark to model numbers for complex securities? (As we've discussed before, more than a few organizations are declining to review valuation numbers and instead accepting marks from traders who are seldom impartial since their compensation is tied to reported performance.)
  • Who properly bears the liability of poor decision-making with respect to hedge fund risk management and valuation? In "Illiquid Assets Expose Fund Directors to Legal Risk," Hedgeworld reporter Bill McIntosh cites Baronsmead Insurance Brokers as saying that fund directors "may be taking on personal liability for the fair valuation of highly illiquid assets." What about pension fiduciaries who delegate oversight? What is the extent to which they are liable?

If Dilbert is correct, change is impossible unless someone makes the first move. With respect to hedge fund investing, identifying who pays for what and when is a big deal.

Fiduciary Fallout in Canada, US and UK

According to, NatBank Brokerage will pay $750,000 (assume this is Canadian dollars) to medical doctor, Gilles Dussault. Representing lost income and interest on such, the court-determined fine follows a rough and tumble relationship between the physician and his brokers, a father and daughter team. Advised to short $2 million of savings bonds and then left to make his own decisions when prices rose, Dussault's losses grew until, two and a half years later, his holdings were liquidated to "cover what he owed in 1996." As a result, Dr. Dussault sued, alleging that the "original short sale was contrary to his investment objectives and financial interests." The bank countered, asserting that he knew the risks all along and that his losses would have been smaller had he closed his position sooner than occurred. In a 29-page opinion, Judge Mark Peacock described the plaintiff as "a man alone in a rowboat in a storm in the mid-Atlantic," adding that "The firm had always been his guiding light in the past and now that the waves were towering over him, the beacon was gone." He further characterized the transaction as conflicting with the investor's objectives and lambasted the brokers for not providing adequate information about the riskiness of the short sale. (See "Bitter pill for NatBank brokerage,, January 16, 2008 for the full text of the article.)

Thanks to Mr. Carlos Panksep, General Manager of the Centre for Fiduciary Excellence, for pointing out this item. When asked what caught his attention about this news story, Carlos responded as follows. "In reading about this case, I could sense the lack of fiduciary accountability on the part of the advisor, possibly due to her inexperience. However, a firm which promotes a high priority to fiduciary education and sensitivity would have possibly avoided this outcome. I hope this firm will improve its practices as a result rather than bury this incident as unimportant or rare."

On the institutional front, Massachusetts Secretary of State William F. Galvin is asking Merrill Lynch about a $12+ million loss incurred by the City of Springfield. According to The Republican, the Springfield Control Board accuses the brokerage firm of "investing funds in an unsafe manner not permitted by state law." Focus on a collateralized debt obligation ("CDO") known as "Centre Square" ("a fund based in the Cayman Islands and Delaware") will logically examine why a $12.6 million spring 2007 outlay fell to $1.2 million by November. Reporters Peter Goonan and Dan Ring write that Merrill Lynch has declared the city responsible for making "its own investment decisions." (See "State subpoenas Merrill Lynch officials in Springfield investment loss," January 14, 2008). 

Expect more articles along these lines of "he said, she said." Inevitably losses (especially big ones) are going to result in lawsuits. Determining who bears ultimate responsibility is far from trivial and opens the door to other inquiries. Disclosure is a factor. Education is another consideration.

  • Suppose a broker (advisor) provides significant information about risk drivers but the investor is unable to digest it properly. Should the broker (advisor) turn down the business even if it means that he (she) might lose his (her) job for not bringing in enough clients? How will he (she) know that a client is ill-equipped to invest in a particular instrument or strategy?
  • In the absence of mandatory education and experiential requirements to sit on a city board (or state or company equivalent), what controls should be in place to preclude individuals from being able to inappropriately commit funds? How should the institution better vet the broker (advisor) at the outset and during the investment period?
  • What constitutes fraud on the part of the broker (advisor) for not "properly" disclosing risk factors?
  • Will the typical broker (advisor) be able to adequately explain the risk trouble spots associated with a complex investment instrument or strategy? If not, why are they promoting such to investors?
  • For individuals or institutions, what safeguards (action steps) should kick in as an investment is heading south, if at all? (Value may plummet only to rise again as long as the position is not liquidated before recovery.)
  • How should regulators better define and enforce suitability?
  • What role should the market play in terms of "lessons learned" by various players? 
  • Will attorneys have a different take on suitability than that of brokers (advisors)?

A recent article about UK trustees suggests that fiduciaries may acknowledge a problem but not feel comfortable moving towards a solution. In "Trustees ask for help," Global Pensions reporter Heather Dale (January 21, 2008) cites grim statistics from Hewitt Associates. Requests from British plan decision-makers "have doubled over the past 18 months" at the same time that more work, due to increased regulatory scrutiny, adds pressure. Do the math. More work, more complexity, more pressure, more scrutiny = big challenges. Does this mean that trustees must forge an even closer relationship with the fund's broker (advisor)? If so, how will questions of responsibility be impacted?

Caveat emptor will surely be the watchword for months to come. At what point are individuals (institutions) considered "duped" into investing in "excessively risky" assets and on what basis? How should suitability vary by type of institution? How can plan participants, shareholders and taxpayers better inform themselves about the risks being taken by a particular city, state or company pension?

The questions are endless. The answers are important.

Investing in Hedge Funds? Check Out Valuation Process

Featured in the January 2008 issue of Emerging Manager Focus ("People to Know"), this blog's author reiterates the need for investors to verify how a hedge fund marks its positions to market (or model). An excerpt is provided below. To read more, download the pdf file by clicking here.

"Mangiero admonishes institutional investors to steer clear of any fund that provides their own marks for infrequently traded instruments. “Traders are encouraged to inflate asset values if their bonus emphasizes return and ignores the risk side of the equation. Those responsible for due diligence cannot look the other way. Independent third party providers must be involved in the valuation process. Surprisingly, this message is only beginning to resonate because it’s not always clear who is doing what. A pension fund may hire a consultant or fund of funds manager, thinking that they are investigating how numbers for ‘hard to value’ assets are determined, only to discover that neither they nor the administrator, custodian or prime broker do anything more than accept inputs from the traders.” Other elements of good valuation process are addressed in her newly developed course on hedge fund valuation for the National Association of Certified Valuation Analysts, including an overview of the part of the Pension Protection Act of 2006 that addresses valuation."

Pension Litigation Database Launches as Lawsuits Surge debuts with over 1,500 retirement plan legal actions, each classified by nearly 100 fields, including court circuit, type of allegation, plaintiff, defendant and date. A joint venture of Pension Governance, LLC and The Michel-Shaked Group, this continuously updated and searchable database reflects the dramatic rise in pension lawsuits. Market volatility, complex investment strategies, new accounting rules, federal regulations and heightened scrutiny of financial decision-making are a few of the many reasons that explain the addition of hundreds more cases each quarter.

This unique web-enabled tool helps attorneys, trustees, board members and policy-makers to better understand the nature of individual pension lawsuits and related litigation trends, thereby encouraging improved practices. “We’re excited to introduce as a way to stimulate the conversation about fiduciary responsibilities,” said Dr. Susan Mangiero, President and CEO of Pension Governance, LLC. “Litigation is a fact of life now. Regardless of plan type, those in charge need to understand the personal and professional liability. Our hope is that subscribers can learn valuable lessons about what to avoid.” Co-founder of The Michel-Shaked Group, Dr. Israel Shaked urges outside and corporate counsel to pay close attention to ERISA cases, adding “These lawsuits are greater in number, more severe and often accompany securities litigation filings, including class actions.”

A charter annual subscription rate of $695 provides unlimited access to the site, saves decision-makers countless hours of research time and offers otherwise hard-to-find intelligence about pension litigation issues. Users will find cases about a variety of topics such as prudence, duty to monitor, reasonableness of fees and plan design. Circuit commentaries written by and for attorneys are available and cover numerous retirement plan pain points that challenge sitting fiduciaries and their service providers. Assessing statistical patterns, evaluating case precedents, tracking fiduciary hot button issues by circuit, case type and time to settlement are just a few of the information tools you will find here.

For more information, visit

Risk Management Lapses Cost Money

It's always hard to get back to work after a few days off. It's especially difficult when economic uncertainty is casting a cloud of gloom over financial markets. As a result, investment risk continues to rank high as a "must do," making lapses seem even more questionable.

Our December 29, 2007 post talked about a risk management post-audit at Morgan Stanley ("Lonely CROs - Why Pensions Should Care"). A few weeks ago, Financial Times reporters Chris Hughes and Haig Simonian wrote about UBS woes, with the chairman admitting that the "Swiss bank's risk and finance unit had failed to understand the sub-prime mortgage positions that led to its $10bn writedown, even though it was aware of the massive figures involved."

In "CIBC plummets after 'underestimating' subprime risk," Financial Post reporter Duncan Mavin (December 6, 2007) cites multi-billion dollar losses due to sub-prime assets and a "hedged subprime exposure" of nearly US$10 billion, "including US$3.5-billion in a CDO with a counterparty that is single-A-rated and ratings-watch-negative." Peter Routledge, senior credit officer with Moody's, is quoted as saying that "The existence of concentrated risks in [CIBC's derivatives] portfolio points to weaknesses in strategic risk decision-making at the bank and indicate that improvements in the bank's risk management discipline have not permeated the organization as fully as Moody's had expected." A read of the CIBC Risk Management Committee Mandate suggests a focus, however incomplete, on process. In fact, a prominent risk expert sits on that committee, prompting Globe and Mail's Fabrice Taylor to write "The multibillion-dollar question: Who's minding the shop at CIBC?" (December 21, 2007). 

From the outside looking in, one can only surmise what might have happened. Lessons learned, as details are made public, will be invaluable to 401(k) and defined benefit plan fiduciaries who rely on banks all the time and for many reasons.

Pension Litigation - Investment Link

In "Pension Fund Litigation Could Slow Investments," New York Sun journalist Liz Peek quotes yours truly on the surge in pension lawsuits, notably those alleging breach of fiduciary duty. Attorney Stephen Rosenberg, and creator of a popular ERISA law blog, is likewise quoted as citing the Herculean challenge faced by plan sponsors. Charged with a bevy of everyday tasks, now added to the list is the need to familiarize themselves with increasingly complex instruments and investment strategies. The article suggests that "increased accountability could dampen institutional enthusiasm for alternative investments."

In contrast, a survey just released by Russell Investments finds a worldwide trend on the part of endowments, foundations and pensions towards continued allocation of monies to alternatives such as hedge funds and private equity funds. With increases expected by 2009 in most countries, the twin issues of risk management and valuation will become arguably even more important (though they have never been unimportant).

The next several years promise to be interesting ones, to say the least.

LaRue, ERISA and the U.S. Supreme Court

Inside the hallowed halls of the U.S. Supreme Court, pension history may be in the making. On November 26, 2007, justices heard the case of LaRue v. DeWolff, Boberg & Associates Inc. The long awaited outcome could put employers in the ERISA litigation spotlight as never before by allowing individuals to sue, one person at a time.

By way of background, Mr. James LaRue sought to have his employer switch his 401(k) monies from one mutual fund to another, in his attempt to migrate to "safer" investments. The plan administrator failed to make the change, allegedly costing LaRue an estimated $150,000 in lost profits. In August 1996, the United States Court of Appeals for the Fourth Circuit, in Richmond, Virginia denied LaRue an opportunity to seek redress, claiming that ERISA emphasizes harm to a plan in aggregate. The opinion reads:

<< In ERISA, Congress sought to provide fair and generous remedies for plan participants without imposing ruinous personal liability on plan fiduciaries. That balance pervades the statute, and it is not for us to readjust it. With respect, we think the Secretary’s view does recalibrate the balance, and we do not possess authority to modify plain statutory text, several Supreme Court decisions, and the corpus of circuit law on the subject. If the Department believes fiduciaries should face personal liability for every wrong alleged by individual beneficiaries, even in the absence of personal profit or misuse of plan assets, it will have to seek a forum other than this court. >>

This begs the question then as to how an individual plan participant can hold administrators and relevant parties accountable for mistakes. The import of this issue is huge. At a time when countless companies are terminating defined benefit plans and opting to offer 401(k) plans in their stead, anything that makes that strategy more expensive and/or troublesome could create pushback. If this occurs, employees are going to be under even more pressure to save for their retirement on their own. Add Social Security and Medicare woes, along with what some predict is an imminent recession, and Joe Everyman is likely to truly feel the pinch in a major way. On the other hand, employers fear an honest mistake that arguably opens the floodgates to costly litigation.

A read of the June 19, 2006 and August 8, 2006 LaRue opinions is instructive, as are the salient documents presented to the U.S. Supreme Court. Click here to download relevant files. Click here to read an informative overview provided by law professor Paul Secunda (who predicts a 6-3 victory for LaRue). One item in Secunda's text that struck me as notable is the line of inquiry by Chief Justice Roberts wherein he "points out that the SPD does not say administrators have to follow the investment directions of participants."  Reading these words catches one's breath. Is the honorable jurist suggesting that the Summary Plan Description ( a guiding document as regards the administration of the plan) preclude an asset allocation change? If so, how are employees to deal with market volatility or altered circumstances that mandate a different investment risk-return tradeoff? I await feedback from ERISA attorneys on this and other points.

Pay close attention when this opinion is rendered. It will make a difference! 

FAS 157 is Heeeeere!

As of November 15, 2007, those organizations who did not adopt FAS 157 early on will be obliged to disclose much more information about their "hard to value" assets and liabilities. Despite industry's attempts to forestall compliance for another year, the Financial Accounting Standards Board reiterated its intent to force implementation for financial assets and liabilities. Read "FASB Rejects Deferral of Statement 157 for Financial Assets and Liabilities" (November 14, 2007 FASB press release).

For those seeking a user friendly version of this new accounting rule, check out "A FAS 157 Primer" by Mark Gongloff (Wall Street Journal, November 15, 2007). Also check out "A Summary of Statement No. 157" on the FASB website. One important element of FAS 157 is the requirement that items be categorized as belonging to Level 1, 2 or 3 in order of ease of valuation with respect to observable prices (or lack thereof). Predictions abound that FAS 157 will force larger asset write-downs, creating jitters for pensions, endowments and foundations who invest in Level 2 and Level 3 sensitive funds. In a November 15, 2007 CNBC video, economist Nouriel Roubini warns of an impending global recession and a financial meltdown that could roil financial markets for months to come. He is not alone.

In "Why FAS 157 strikes dread into bankers - Just when we hoped the worst was over," William Rees-Mogg (The Times, November 12, 2007) cites research by financial analyst Martin Hutchinson. Financial giants such as Bear Stearns, Lehman  and J.P. Morgan Chase account for more than $100 bilion of FAS 157 Level 3 assets, requiring mark to model information not heretofore provided. The author adds "Even these figures may be understated, since the banks have themselves decided whether assets belong to level three or the more acceptable level two, and they have an interest in placing as little in level three and as much in level two as they reasonably can." Noteworthy is Hutchinson's analysis that Goldman Sachs has disclosed $72 billion of Level 3 assets. That number is relatively big or small, depending on the point of comparison - a $900 billion asset base but capital of $36 billion.

Lest pension decision-makers think they are immune from valuation issues, nothing could be further from the truth. Decision-makers for both 401(k) and defined benefit plans are squarely on the hook for vetting external money managers. This absolutely includes asking copious questions about managers' valuation policies and procedures. A poor job, or ignoring the issue altogether, is going to keep the plaintiff's bar busy indeed.

Can Changing Investment Strategy be a Fiduciary Breach?

Click here to check out attorney Stephen Rosenberg's response to our October 27, 2007 post about 130/30 funds. His comments are thought-provoking.

Valuation Problems Are Going To Cost Plan Sponsors Big Time

This blog's author recently had the pleasure of addressing an audience of hedge fund compliance officers and auditors about valuation issues - a topic near and dear to my heart. As an accredited appraiser, a certified financial risk manager and someone who has worked with models and trades, I am fully aware (and in fact often tout) the inextricable relationship between risk analysis and valuation. Simply put, effective financial risk management does not occur in a vacuum but rather depends on reliable valuation numbers. GIGO (Garbage In, Garbage Out). If a fund manager relies on faulty information, the inevitable result is flawed process, including (but not limited to) inaccurate hedge size (if hedging occurs), imprecise performance reports, possible asset allocation or portfolio re-balancing mistakes, trading limit utilization problems and so on. 

From the investors' perspective, the trickle down effect can be costly. Any "issues" at the asset manager level directly impact fees paid by pension funds, their own asset allocation decisions, not to mention cash flow and funding status breach as possible forms of "valuation fall-out." Valuation is the proverbial four-letter word in investment risk management. Cause for consternation, valuation issues are often complex and demand rigor with respect to policy creation, implementation and review.

Being somewhat impolitic, yet wanting to convey an important message to an important audience of hedge fund professionals, I cited chapter and verse about valuation pitfalls from a pension fiduciary's perspective. Including the need to get private placement memorandums that address what and how the fund manager intends to assess the portfolio on a regular basis, I explained the rationale for use of an independent third party to either render opinions of value, or at the very least, conduct a valuation process check. Even when a hedge fund does not exceed the twenty-five percent ERISA money limit (pursuant to the Pension Protection Act of 2006), best practices abound for both the fund manager and the pension investors alike. Interviewing traders, along with the asset manager's Chief Risk Officer, about valuation policies and procedures is another good idea. If a fund has no functional risk manager, ask why. Interestingly, one person responded to my comments by declaring success at drafting sufficiently obtuse documents that would likely keep investor accusations at bay.

In today's Wall Street Journal, reporter Eleanor Laise tells readers that it's not just hedge funds caught in the valuation cross-hairs. Mutual funds have their own issues. For example, when a security is not frequently traded, multiple methods might generate disparate "fair value" estimates. Quotation quality runs the gamut from the use of stale prices to "accommodation quotes" offered by "friendly brokers." Time-of-day selection is another conundrum, especially in the case of non-U.S. securities or instruments such as highly customized derivatives. Laise adds that "valuation policies can vary substantially from fund to fund." In some situations, an independent outside firm provides prices. Elsewhere, internal models or broker-dealer quotes are used. (See "Funds Struggle with Pricing Pitfalls," Wall Street Journal, September 17, 2007.)

As I've written (and presented) many times before, plan sponsors who sit silently by, without grilling asset managers about their valuation policies and procedures, are asking for trouble. Pension fiduciaries have a duty to oversee external fund manager performance as relates to the stated risk tolerance and return goals. This includes a weighty discussion about price quotes, marking to market (or model) and provider quality. (Not being an attorney, plan sponsors should seek counsel for a precise assessment of their responsibilities.)

With new accounting rules on their way and a variety of significant valuation unknowns, subprime loan-related losses may look like a walk in the park. What we don't know can hurt!

Editor's Note:

Pension Governance, LLC has partnered with the National Association of Certified Valuation Analysts to develop a technical workshop on hedge fund valuation. Click here for a course description. Other programs are in the works. Click here to read more about our June 28, 2007 webinar about hedge fund valuation. (The recording and program materials are available for a modest fee.) If you want additional information about valuation training for your board, risk analysis or process checks, click here to drop us a line.




Prosecution of Former Pension Trustees Moves Forward

Voices of San Diego reporter Evan McLaughlin writes that the Fourth District Court of Appeal "upheld the district attorney's prosecution of six former pension board members." After several years of wending its way through the court system, allegations that trustees violated California's "conflict-of-interest law" will be heard. Charges emphasize "an agreement in 2002 that boosted the future pension pay of the defendants and thousands of other city employees in exchange for allowing the city to underfund the pension trust that year." Click here to read "DA's Pension Case Moves Forward" (September 7, 2007). Click here to read the ruling.

Regardless of the outcome, and acknowleging a presumption of innocence until proven guilty, a key take-away is that pension fiduciaries are absolutely on the hook. Not to be taken lightly, the job of retirement steward is a serious one. Civil and criminal penalties in the event of proven wrong-doing are possibilities. It's no surprise then that liability underwriters are fielding frequent calls for greater and more comprehensive coverage.

Pension Fiduciaries and Hedge Fund Clones, Fees and Fiduciary Duty

In a June 22 article, Lipper HedgeWorld reporter Emma Trincal writes about the imminent debut of a hedge fund replication index product, courtesy of Barclays Capital. According to Managing Director and Head of Equity Derivatives, Hassan Houari cites research that "up to 80% of the performance of hedge fund indexes" can be explained by changes in the market. Houari further adds that Barclays seeks to offer a "cheaper, more liquid and more transparent alternative." Click here to read the article entitled "Barclays to Debut Hedge Fund Clone." (Registration is required.)

Clones are a popular topic these days. Last week, during Part Two of the Hedge Fund ToolboxSM, sponsored by Pension Governance, LLC, Dr. Susan Mangiero, CFA and Accredited Valuation Analyst talked about increasing pressure for fiduciaries to justify fees. "Amid a flurry of 401(k) lawsuits alleging 'excessive' fees, it doesn't take a rocket scientist to know that hedge fund fees are next. If a plan sponsor can synthesize a signicant portion of expected returns for a particular hedge fund strategy, how can they justify paying for active management?"

Not everyone concurs that replication is possible. During the June 19 online event, co-founder of Bulldog Investors and the David who conquered Goliath SEC in the battle over regulation of hedge funds, Philip Goldstein challenged the notion that investors would be better off with a passive approach. "An Elvis impersonator is not Elvis." Ed Stavetski, CFA and Chief Investment Strategist for CMG Investment Advisors, LLC added that "Many hedge fund professionals work hard to identify value on behalf of their investors."

Emphasizing fiduciary duty, Ed Lynch, Senior Vice President and Investment Officer with Dietz & Lynch Financial Strategies Group of Wachovia Securities, LLC, reminded listeners that ERISA is clear on fiduciary duties that mandate a rigorous analysis of fees. Echoing the urgent need for discipline in the form of a systematic process to assess alternatives (in fact, any type of investment), Mangiero elaborated. "Fees drive performance and performance drives strategic asset allocation and re-balancing decisions. Plan sponsors need to get it right. Every trade costs money."

Click here to purchase the broadcast and slides for a nominal fee. (Past webinars are listed in chronological order.) Pension Governance subscribers enjoy webinar access for no additional charge. Click here to subscribe.

Pension Fiduciaries - Time to Wake Up and Smell the Coffee, Part Three

In his pension blog, ERISA litigator Stephen Rosenberg recently wrote about the forthcoming legal battle between the San Diego County Employees Retirement Association ("SDCERA") and Amaranth Advisors, LLC. In response to an original complaint against the once mighty energy hedge fund, its high-power attorneys countered with a motion to dismiss. Claiming caveat emptor, defendants assert that the plan sponsor understood the risks and went ahead anyhow. Click here to read the original complaint and here to read the motion to dismiss.

How this case will be adjudicated is anyone's guess. Nevertheless, the outcome will be closely watched as it goes to the very heart of investment disputes by asking who bears responsibility.

In our kick-off of the Hedge Fund ToolboxSM webinar series on June 14, 2007, we heard from former FBI agent Mr. Ken Springer (now president of Corporate Resolutions) and senior attorney and former regulator, Rick Slavin (now partner of law firm Cohen and Wolf P.C.). Both gentlemen vigorously urged pension investors to undertake a background investigation of key principals, check documents and never shy away from asking tough questions. Springer added that "material non-disclosure of critical events in one's career" represents a major concern, along with the need to do additional follow-up to explain discrepancies. Late payment of credit card bills or a faillure to pay child support suggest carelessness with other people's money.

In his overview of case precedent and enforcement actions, Slavin offered that sloppy, obtuse or incomplete paperwork is usually the beginning of trouble. He reiterated that the use of outside parties does not absolve plan sponsors of their fiduciary duties. Oversight obligations remain.

Springer told listeners that Bayou's problems, pre-meltdown, were evident had investors carefully reviewed available facts. "Blatant conflicts of interest, overstating of employees' accomplishments, suits by former employees, suits filed by investors and even suits filed by hedge fund managers" should have caught investors' attention before money changed hands. Slavin suggests that we're in for a bumpy ride. "There is every indication that more litigation and enforcement is on its way."

Rosenberg agrees. "We are currently watching the rise of a pension/401(k) investment plaintiffs bar, clearly modeled after the securities litigation class action bar, ready and waiting to sue pension advisors and anyone else in the line of fire for excessive fees, poor investment choices, and anything else that affects returns in the plans." He adds that, "If the hedge fund’s lawyers are right, then aren’t the plan’s fiduciaries and other advisors potentially liable for breaching their own obligations to the plan and its participants to properly select and monitor plan investments? And if so, then their best defense should the newly forming class action bar come after them for this mess would be that, contrary to what the hedge fund’s lawyers say, they actually did full and complete due diligence, and therefore lived up to their obligations and cannot themselves be liable for the fact that the investment went south."

Wise words to remind us of the importance of good process!

If you are interested in purchasing the recordings of any webinars that have already taken place, click here. (Webinars are listed in chronological order.) Click here to register for any or all of the forthcoming webinars in this exciting new series. Speakers will address the roles of financial advisor and consultant on June 26. Valuation is the topic of the June 28 event.

Pension Fiduciaries - Time to Wake Up and Smell the Coffee, Part Two

In "A Conversation with a Fiduciary" (published by Morningstar), independent pension fiduciary Matthew D. Hutcheson provides a thought-provoking assessment of ERISA Section 404 and passive versus active investment choices for 401(k) plan participants. Click here to read the article and here to read Hutcheson's March 6,2007 testimony about 401(k) fees before the U.S. House of Representatives.

On the other side of the fence, Financial Times writer John Authers extolls the virtues of Dave Swenson's "uninstitutional portfolio" approach in his June 9, 2007 article about the Capital Asset Pricing Model and market efficiency. With more than two-thirds of the endowment fund for Yale University in alternative assets "which are not readily marketable," the contrast is telling. While the evidence seems to strongly support Swenson's approach for Yale, issues abound with respect to alternatives investments and command attention. "See "Yale puts academic theory of investment into practice.")

I co-led a workshop on the valuation of "hard to value" assets on June 12, 2007 and came away with a renewed appreciation of the fact that more than a few institutions may truly be in the dark with respect to risk factors. Worth mentioning again is that risk itself is not bad. However, risk that is ignored cannot be measured and, by extension, can certainly not be managed. For most investors, limited resources make it difficult to replicate the Connecticut Ivy's success. Addressing a recent gathering of alumni, Swenson said that "Yale is set up to make high-quality active management decisions" with a staff of twenty and a long time horizon.

The debate continues with respect to style because it is a crucial (nay impossible to ignore) element of investment management. Strategic asset allocation and tactical implementation are likewise integral determinants of fiduciary liability for a given organization. To the extent that Hutcheson reminds us to focus on the "F" word and move the conversation to process that supports duty, plan beneficiaries applaud.

Tell us what you think. Should fiduciaries do a better job of justifying when active strategies make sense? We will talk more about these issues because there is a lot to say.

Click here to email your comments. Please indicate if you would like the comments kept private.

Pension Fiduciaries - Time to Wake Up and Smell the Coffee, Part One

Today's post and the next few that follow focus on pension governance (the name of our new website and a term that is often used to describe fiduciary duties and best practices). For a discussion of what pension governance means, click here to read interviews with market leaders. It's such an important topic yet often overlooked. In fact, the U.S. Department of Labor created an educational program ("Getting It Right") in order to help individuals understand their duties. (The results of countless audits apparently left examiners nervous about the folks who did not properly self-identify as fiduciaries.)

"Hot off the press" is a set of standards devoted to the topic of pension governance. Newly published by the Stanford Law School, the so-called Clapman report urges pension funds, endowments and charitable funds to adopt principles that reflect prudence, ethics and transparency. Citing some big dollar "no-no's" on the part of institutional decision-makers, chief architect of the report, Peter Clapman,and others rightly point out that giant institutions must walk the walk if they admonish corporations to do the same. CEO of Governance for Owners USA and former chief investment counsel of TIAA-CREF, Clapman adds that “Bad governance also weakens funds by eroding public support for them." One element of the report calls for funds to provide clear (and make public) information about governance rules.

Yippee Yahoo!

A few of us sometimes feel as if we've been screaming in the wind about the urgent need to know who is in charge and how they are running the show. (I'm sure Clapman and others would agree.) To read how bad things are in terms of NOT being able to easily identify where the buck stops, check out "In Search of Hidden Treasure." More than a year ago, I wrote "that a systematic identification of who does what and why with respect to employee benefits is simply not a reality as things stand today. This makes it difficult (perhaps impossible) to effect change."

The Clapman Report suggests that funds hire "trustees who are competent in financial and accounting matters." Read "Practice What You Preach" for our list of basic questions about pension fiduciary selection, training and performance evaluation. Anecdotally, I've often queried trustees and  other types of fiduciaries - "How do you become and stay a fiduciary? Do you take a quiz? Do you possess a certain amount of relevant experience? Do you get paid what you're worth in terms of liability exposure and hours spent on plan-related tasks?"

Scary to say, selection is frequently a function of who is seen as having a few hours of free time. Unfortunately, being a plan fiduciary is arguably a full-time job. Moreover, with so many complex decisions to make, someone with a limited background in topics such as investing may truly struggle to understand basics, let alone nuances of evaluating risk-adjusted return expectations. Even when an external consultant is used, a fiduciary still retains oversight responsibilities (a topic deserving of its own separate post).

Another proffered recommendation from the Clapman Report is to "establish clear reporting authority between trustees and staff" and to "define appropriate responsibilities and delegation of duties among fund trustees, staff, and outside consultants." We couldn't agree more. Check out our earlier discussion about the importance of incentives in "Paper Clip Theory of Pension Governance."

One thing is clear. Pension governance is starting to attract attention. That's great news for the many fiduciaries already doing things the right way. (You deserve recognition.) For those who need to improve, perhaps the spotlight on practices, good and bad, will encourage change. That would be a huge plus for plan beneficiaries, taxpayers and shareholders.

Here are a few resources for interested readers.

1. Committee on Fund Governance: Best Practice Principles -"Clapman Report" (Stanford University)

2. Prudent Practices for Investment Stewards (Fiduciary 360, AICPA, Reish Luftman Reicher & Cohen)

3. Asset Manager Code of Professional Conduct (CFA institute)

4. Standards of Membership and Affiliation (The National Association of Personal Financial Advisors)

5. CFP Certification Standards (Financial Planning Standards Board)

6. Regular Member Code of Ethics (National Investor Relations Institute)

7. Code of Professional Responsibility (Society of Financial Service Professionals)

8. Also check the site for the Financial Planning Association. I understand that they are soon to release a new set of standards for financial advisors.

Large Endowment Loses Auditor Over Valuation Issues

According to the Daily Texan, the University of Texas Investment Management Company will soon have to rely on its internal audit staff. Chairman of the University System's Audit, Compliance and Management Review Committee, Regent Robert Estrada "reported to the board that Ernst & Young was uncomfortable with pricing the investment company's private equity and hedge fund investments. Regent Robert Rowling added that the firm also had issues with the time gap between UTIMCO's quarterly reports." Click here to read the article.

In a related piece, this blogger was interviewed about the topic of hedge fund valuation in Securities Industry News. Part of a June 4, 2007 special report entitled "Critical Issues for Hedge Funds," the topic of how, why and when hedge funds get valuation help (or don't as the case may be) arose. As an accredited appraiser, I know from firsthand experience that many people in hedge fund land do not acknowledge the presence of the traditional business valuation community. That's not necessarily good since the latter group has long ago acknowledged the regulatory prohibition against a formulaic approach and the need for specialized valuation training. Judges are none too happy and are tossing expert opinions out of their courtroom if they fail to reflect established valuation concepts and practices.

When asked why valuation is so important in this industry, I said the following:

<<  Valuation numbers drive nearly every financial decision. Hedge fund managers need to know how to rebalance their portfolios, adjust risk management positions and report numbers to investors upon which they earn their fees. Valuation becomes especially important in the case of illiquid investments like private equity, distressed securities, emerging-market securities and complex derivatives. It is also an issue as more hedge funds go public. How else will you come up with a net asset value for the initial public offering, without a formal assessment? Additionally, institutional investors are on the hook to understand how hedge funds value their holdings. The last thing pension fund, foundation or endowment fiduciaries want is a blowup that could have been prevented with a thorough vetting of the managers' valuation process. That includes assurance from the hedge fund managers that numbers are being provided by an independent third party. >> (To read "The State of Valuation", go to A subscription is required but you can register for a trial.)

If you would like a copy of some of the articles I've written about hedge fund, derivative instrument and asset valuation, click here to send an email.

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 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!

Paris Hilton Syndrome in Pension Land?

The latest news on Hilton heiress Paris is not good. Sentenced to forty-five days time for violating probation over a suspended license, she must report to jail on June 5. Click here for the story.

Ordinarily we wouldn't include a story about Paris Hilton except that it gives one pause for the following reason. In the last week, we've been busily focused on gathering news about litigation, enforcement and general stories about fraud in the financial world for and

Our conclusion? There are a lot of Paris Hilton wannabes out there if you think of her as a role model for "let them eat cake."

One can barely keep up with allegations of wrong doing - securities fraud, option backdating, imprudence of investment selection, lack of oversight, accounting "flexibility," incorrect valuations, conflicts of interest, absence of prudence, excess this, excess that. Many of the cases being filed allege fiduciary breach on the part of pension decision-makers or directors and officers or both.

To be VERY clear, allegations mean little until due process takes place and individuals have their day in court to argue their case. Additionally, we recognize that it's easy to hang our hat on the most egregious events, letting them taint everyone in the business. This too is an injustice for those folks who work diligently to execute best practices.

That said, however, the sheer number of news stories, allegations and complaints about financial bad acts is daunting to say the least. There are some who predict more to come, especially with so many millions of dollars at stake and increased exposure to complex securities and strategies.

We'd like to emphasize the importance of applauding the "good guys and gals." Let's learn lessons from demonstrated bad acts (for the sake of improvement).

For those who find it hard to resist temptation, keep in mind - The "pass the buck" mentality is unseemly and dangerous, especially when innocent bystanders stand to lose.

Pension Plan Plaintiffs Cost Corporate Defendants With Opt-Outs

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

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

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

Pension Risk Management Tipping Point

I am the author of a book entitled Risk Management for Pensions, Endowments and Foundations (John Wiley & Sons, 2005). A primer about risk management (no math by design), the feedback has been gratifying. I'm particularly proud of the comments citing ease of use. (The book is replete with examples, checklists and references).

However, it's no Da Vinci Code in terms of sales. While I'd like to write a sequel at some point, few are competing for the honor and no one is knocking down my door to buy the movie rights. (You can visit our online bookstore at - Products, Books for what we think constitutes a good readling list.) True, it's non-fiction and written for a limited audience. Yet one wonders why, in today's benefits climate, more people aren't fast and furiously laying pen to paper to describe how to tackle what is arguably one of the most important topics in pension land - risk management. If there is a single message I can impart to those who will listen, it is this.

ANYONE involved in pension investing is a de facto risk manager. Believe it. You are.

Whether focused on the asset or liability side (or both), risk is an integral part of financial management. Those who deny this truism expose themselves to possible trouble down the road. Personal and professional liability aside, plan sponsors who passively manage risk (whether defined benefit or defined contribution) through ignorance or benign neglect invite unwelcome scrutiny. Unless they are lucky, litigation, economic loss and/or damaging headlines are high probability events.

Besides, plan sponsors who give risk management short shrift lose a precious opportunity to improve things. An effective process forces a plan sponsor to identify, measure and control risk on an ongoing basis. Taking inventory (in terms of uncovering sources of risk) enables plan sponsors to make meaningful changes. Lower costs or enhanced diversification are two of many possible benefits associated with the activity of collecting and analyzing data as part of the identification of risk drivers.

So a natural question arises.

Why don't more plan sponsors pay attention to risk management, whether for themselves or as part of hiring, reviewing and perhaps firing money managers and consultants? Asked another way, what is the tipping point beyond which risk management becomes front and center at meetings of board members, trustees, investment committees and so on?

Here are a few thoughts.

1. Based on the preliminary results of the pension risk management survey now underway, and co-sponsored by Pension Governance, LLC and the Society of Actuaries, there seems to be a HUGE gap between belief and reality. Many respondents say they actively pay attention to risk management. At the same time, they cite limited or no use of risk metrics other than standard deviation and/or correlation. (We'll talk about limitations of basic risk metrics elsewhere.) How can you improve on something you think you are already doing well?

2. Many plan sponsors are tasked with benefits-related work as an add-on to their regular job. Often, there is little organizational incentive for them to excel. In a way, it's a lose-lose proposition. They assume significant fiduciary liability with little or no recognition in the form of additional money, better title or other types of perquisites. At the same time, if they do a bad job, there is no escape. It's all downside. Sadly, there is so much perceived ambiguity about what constitutes a "good" job that it's often difficult to hold someone accountable. (Note the term "perceived" versus "real.")

3. Not all attorneys (litigators and transactional) feel comfortable with finance concepts, let alone financial risk management. That knowledge void arguably makes it easier to let risk control gaps slide unless, or until, an egregious act occurs.

4. Establishing a financial risk management process is seldom fun (or at least sort of enjoyable) for most people. It is often a complex activity that requires copious amounts of money, time, concentration and energy, especially if a plan's investment mix (DB or DC) extends to multiple asset classes. Moreover, benchmarking the process, and making appropriate changes thereafter, likewise consumes large chunks of time and money. Is it any wonder then that its ranking on one's "to do" list plummets in the absence of a strong risk culture?

5. When market conditions are "good" and benefit costs decline as a result, people tend to get lulled into false security. Instead of focusing on structural issues, it's easier to breath a sigh of relief and say "problem solved." Alas, markets change all the time and putting off the inevitable is hardly a smart move.

So what's the tipping point that has everyone wearing "I'm a risk manager" button? Certainly lower interest rates and/or an anemic equity sector are factors, as is regulation. A few recent surveys cite mandates as a central force in encouraging, sometimes forcing, plan sponsors to radically revise their asset allocation strategies and focus on plan risk.

Most folks think we're moving closer to the pension risk management tipping point. I agree but counter that movement is relative. Until (and hopefully not "unless") plan sponsors recognize the URGENT need for financial risk management, investment stewards remain vulnerable on many counts and that is not a good thing for anyone!

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,, 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.

Pension Fiduciary Liability - Busy Times Ahead

The life of a pension fiduciary is no bowl of cherries. As I wrote on May 16 of this year, I parenthetically asked why anyone would want to be a fiduciary. Their job is critical to the process but less than easy.

"Often the pay is bad and the hours are long. (Individuals seldom receive any additional compensation at the same time that they are asked to assume significant responsibilities that put them directly in the 'line of fiduciary fire.') One might say it's like being asked to constantly eat your peas without any hope of ever getting dessert." (Click here if you want to read the entire post entitled "Who Wants to be a Fiduciary Anyhow?")

In "Liability of plan fiduciaries a still-growing concern", journalist Marion Davis (Providence Business News, November 11, 2006) writes that, post-Enron, employers are more aware of their fiduciary duties to "manage the plan honestly" and to "manage it reasonably well and provide accurate and complete information to participants."

She cites attorney Richard D. Hoffman with Nixon Peabody as saying that "he has seen a growing number of employers buy insurance to protect themselves from ERISA claims" at the same time that the "number of claims has increased as well" and "plantiffs have become more sophisticated."

Issues such as fees are just the tip of the iceberg. The Pension Protection Act of 2006 adddresses valuation and a cornucopia of investment-related issues such as qualified alternatives for 401(K) plan participants. The article quotes attorney David C. Morganelli with Partridge, Snow & Hahn as recognizing a heightened awareness of what is at stake, adding that "lawyers such as himself have been answering an increasing number of questions about obligations and liabilities under that law and under ERISA."

In January 2007, our sister company, Pension Governance, LLC, will be unveiling a searchable pension litigation database, along with regular updates about trends and highlighted cases as pertains to financial issues. We started on the database over ten months ago and quickly realized that the volume of cases to be analyzed and catalogued dwarfed our original expectations.

The good news is that there are many things that can be done upfront to mitigate fiduciary risk. The questions for pension fiduciaries are threefold. Are they fully aware of all relevant risks? Do they know what has to be done? Are they ready to move forward?

We'd love to give you our take. Email us if you want to be notified of the pension litigation database launch and/or would like to get our thoughts about the challenges that loom ahead.

Editor's Note:
Please be reminded that we do not provide accounting, investment or legal advice. We provide independent research and analysis to pension fiduciaries and/or their attorneys in the areas of financial risk, derivatives, valuation, fee economics, disclosure best practices, questions of suitability and prudential process as relates to financial/economic issues. In addition, we offer training and consultation to boards, investment committees, trustees, regulators and pension-focused money managers in the areas of financial risk and valuation.

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?