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

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

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

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

• Email This
• Print
• Comments
• Trackbacks
• Share Link

For those in need of help, click to access the "Troubleshooter's Guide to Filing the ERISA Annual Report" (U.S. Department of Labor, October 2010). This 70-page publication includes a handy reference chart that relates to the Form 5500 and Form 5500-SF (for small firms), along with related attachments. Another helpful resource is "FAQs About The 2009 Form 5500 Schedule C."

School's still out regarding the extent to which plan sponsors will be able to comply with new rules. So far, Schedule C seems to be a sticking point with numerous questions being asked about how to properly report "indirect" versus "direct" compensation to service providers.

As more pension plans allocate monies to mutual funds, hedge funds, private equity funds and funds of funds, they will need to report details about fees paid to these organizations as they too are now deemed service providers.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Given that mutual funds are a popular 401(k) plan choice, it's not surprising that further regulatory scrutiny of the use of derivatives by traders is underway.

"SEC Staff Evaluating the Use of Derivatives by Funds" (U.S. Securities and Exchange Commission Release 2010-45, March 25, 2010) talks about a new initiative to review the current practices by pools of capital regulated under the auspices of the Investment Company Act of 1940. Scrutiny will focus on items such as:

• Leverage, concentration and diversification
• Existing risk management policies and procedures
• Oversight of use of derivatives by fund board of directors
• Rules for proper pricing
• Prospectus disclosures.

Click here for more information.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A colleague called me the other day, after attending a recent Connecticut event that addressed "too big to fail" concerns on the part of state regulators. In response to her comment about the large crowd size, I queried her about whether a forum on investment ethics would likely be a similar draw. Somewhat surprising to me she said "no" with nary a hesitation in her voice. Teasing her for more information, she simply declared that the topic of ethics is boring. Is she right?

Is ethics too dry to appeal, even to those tasked with compliance and investment best practices? Should we even compare ethics hounds to those of us who watched the silver spaceship-like balloon, floating above the Colorado countryside a few weeks ago, wondering if Balloon Boy was safely tucked inside? (Go on, admit it. You took at least one peek to hear whether a 6-year old really can fly, unsupervised, 8,000 feet above ground.)

Let's assume for a moment that celebrity and quirky news stories trump discussions about ethics and governance. Should we care? 

I've long maintained that carrying out one's professional duties with integrity does indeed impose a need to pay attention to what is right. Yet recognizing that one should be "ethical" is a necessary but insufficient condition. One can acknowledge the need to act properly yet do nothing about it, exposing ultimate beneficiaries to potential ruin. Then there are those who embrace the mantra but are blind to the gap between "investment best practices" and compliance. One can adhere to the letter of the law and yet fail miserably in terms of improving internal controls (and much more) so that investment risk is mitigated.

Since compensation levels are in the headlines of late, I'd like to repost an article that my colleague Wayne Miller and I wrote several years ago. Though written for retirement plan executives, the issues we discuss in "Do Fiduciaries Need Better Incentives to Make the Retirement System Work?" ring true today and will apply tomorrow. The primary assertion is that individuals behave according to incentives in place. The rewards must be clearly positive and attainable for anyone who rightly walks the extra mile on behalf of beneficiaries (mutual fund investors, retirement plan participants, etc).

What will entice my friend to race to a meeting to learn more ethical behavior, along with hundreds of others? Free wine and cheese or a true belief that comprehensive risk management is simply the only course of action for high-integrity stewards of other people's monies? Alas, she may not soon have a choice. Regulators and politicians will not be handed the next Madoff scandal on their watch.

According to her October 27, 2009 speech to attendees of the SIFMA Annual Conference, the SEC Chairman Mary Schapiro has created a new Division of Risk, Strategy and Financial Innovation and has its sights set on "new products - particularly those related to retirement investing." She emphasizes the need for "simple, clear disclosure" in lieu of "complex fee arrangements or product descriptions...Already on the radar screen are target date funds and securitized life settlements."  Click to read "The Road to Investor Confidence."

Is the SEC focus a faux reward? Comply and stay out of trouble (a carrot of sorts) but not necessarily map actions to best practices (hence one runs into a proverbial brick wall with attendant pain). How will good players be differentiated from bad but lucky investment professionals? Alas, this is a topic for another day.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to Financial Times reporter Deborah Brewster ("Investors pull out of mutual funds," April 27, 2008), nearly all U.S. mutual fund managers saw a drop in assets in Q1-2008. Sagging returns are a main driver on the retail side. Citing Strategic Insight, Brewster writes that individuals and institutions have pulled $100 billion from American, European and Japanese equity funds.

Money market funds, charging lower fees, seem to be picking up the slack. This suggests an inevitable decline in profitability for the asset management business. In "Has the Financial Industry's Heyday Come and Gone?" (April 28, 2008) Wall Street Journal reporter Justin Lahart writes that "the businesses of borrowing, lending, investing and all of the middlemen in between" are slowing and thereby creating ripples throughout the U.S. economy. With documented job cuts in the financial sector, new regulations and questions about "excess" risk, a discernible shift is underway. A shrinking financial sector and reduced availability of credit hits consumers and corporations hard.

In addition, defined benefit plans are moving assets away from equity to alternatives and fixed income. In "CalPERS to shift $44 billion" (December 24, 2007), Pensions & Investments reporter Raquel Pichardo describes the giant retirement plan's move into international equity, real estate, private equity and a "new inflation-linked asset class." On April 17, 2008, New York Times reporter Mary Williams Walsh offers insight into what some of American's biggest plan sponsors are doing to manage market volatility. Referring to a new study by Evaluation Associates in "Market Turmoil Has Taken a Toll on Big Pension Funds," Walsh writes that General Motors, Ford, Boeing and Deere are a few of the large plans to turn from equities.

The issue is important for many reasons, not the least of which is the impact on statutory funding requirements, cash flow and related share price. In March 2008, money manager Charles Gilbert spoke to a Society of Actuaries audience about the double whammy of falling interest rates (increases the defined benefit liabilty) and unhealthy stock returns (reduces portfolio value).

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Hedge fund Amaranth Advisors, LLC has settled an SEC complaint regarding violation of Rule 105 of Regulation M  which makes it "unlawful for any person to cover a short sale with offered securities purchased from an underwriter or broker or dealer participating in an offering, if such short sale occurred during the . . . period beginning five business days before the pricing of the offered securities and ending with such pricing.” Click here to read the SEC-Amaranth document.

Zurich Capital Markets Inc. has settled with the SEC on an issue relating to hedge fund trading. According to the order, "ZCM, an entity that provided financing, aided and abetted four hedge funds that were carrying out schemes to defraud mutual funds that prohibited market timing. Specifically, ZCM provided financing to four market-timing hedge funds that employed various deceptive tactics to invest in mutual funds. ZCM and these hedge funds knew that many mutual funds in which they invested imposed restrictions on market timing activity. In order to buy, exchange and redeem shares in these mutual funds, these hedge funds employed deceptive techniques designed to avoid detection by these mutual funds. ZCM came to learn that the hedge funds were utilizing deceptive practices to market time mutual funds, and nonetheless ZCM provided financing to them and took administrative steps that substantially assisted them. By providing assistance to the hedge funds, ZCM aided and abetted the hedge funds’ violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder." Click here to read the SEC-ZCM document.

One takeaway for pension fund investors is that a review of the manager absolutely must include a thorough assessment of trading practices.  Some of the many questions in search of answers include the following:

• What trading controls, by category, exist?
• Who oversees compliance?
• How are violations detected?
  
• What is the penalty for internal policy breach?

A second takeaway is to ask serious questions about the entire chain of command related to trade processing, reporting and who gets paid to do what.

Look for news next week about our hedge fund webinar series for pension fiduciaries. The Hedge Fund Toolbox^SM will cover many important topics such as valuation, risk management, fee structure, disclosure and ERISA considerations.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Wall Street Journal reporter, Eleanor Laise recently wrote that an increasing number of mutual funds are "venturing into the risky world of private-equity investments", "because of the prospects for higher returns." While SEC rules limit assets to no more than fifteen percent in illiquid holdings, Ms. Laise describes potential problems. Higher legal expenses for more complex deals, difficulty of unwinding a position and valuing private investments are far from trivial challenges. She cites one SEC investigation of a mutual fund that allegedly undervalued its private company positions to give the impression that it had not breached the fifteen percent limit. "The SEC also has charged funds with inflating the value of illiquid investments. Mutual-fund managers have an incentive to overestimate the value of these holdings because they collect fees that are calculated as a percentage of total assets in the fund." (See "Mutual Funds Delve Into Private Equity" by Eleanor Laise, Wall Street Journal, August 2, 2006.)

Applying a version of the transitive property from mathematics, the implication is clear. Some pension funds have increasing exposure to private equity investments that do not trade in a ready market.

1. Pension funds allocate money to mutual funds.

2. Mutual funds buy private equity.

3. Pension funds are exposed to private equity as an asset class. (This is in addition to any direct allocation by pension funds to private equity.)

The message is clear. For those pension funds investing more money in private equity (indirectly or directly), the valuation issues are real and cannot be overlooked.

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link