ACI ERISA Litigation Conference - New York City

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

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

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

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

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

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

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

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

New GAO Study Addresses Performance Audit Reports

Courtesy of the U.S. Government Accountability Office, a new study looks at performance audits for different types of pension plans. The report is entitled "Oversight of the National Railroad Retirement Investment Trust" (May 2014) and responds to requests from members of the U.S. Congress for information about this $25 billion retirement plan. Based on countless interviews with regulators, private fiduciary experts (and yes, I did answer some questions about benchmarking) and pension fund executives, the authors put forth the idea that performance audits could be mandated to occur more often. Interestingly, GAO researchers point out that "the frequency with which the Trust has commissioned performance audits is comparable to or exceeds most state efforts," adding that "...nine state plans are audited at least once every 2 or 3 years" with interviewees from 19 states pointing out that retirement plans "were subject to audits at longer set intervals that varied from state to state or were not reviewed according to any established time frame."

Pension fund accounting and performance benchmarking is certainly getting its share of attention. U.S. Securities and Exchange Commissioner Daniel Gallagher recently decried what he believes is an under-reporting of "trillions of dollars in liabilities. In his May 29, 2014 speech before attendees of the Municipal Securities Rulemaking Board's 1st Annual Municipal Securities Regulator Summit, Commissioner Gallagher talks about pension and OPEB liabilities as a serious threat and warned that "...it is imperative that bondholders know with precision the size of the potential pension liabilities of the entities in which they are investing. And yet, they do not." He adds that the "threat has been hidden from investors." As Lisa Lambert and Lisa Shumaker describe, government officials say that these sharp remarks sting and will scare people into thinking that a systemic problem exists. Read "Pension groups strike back at SEC commissioner's criticism" (Reuters, June 16, 2014). In its Q1-2014 update, the National Association of State Retirement Administrators ("NASRA") show that public pension fund assets have grown to $3.66 trillion, up slightly from the year-end 2013 level of $3.65 trillion.

On the rule-making front, the Governmental Accounting Standards Board ("GASB") just published an update to its pension accounting standards and posted a pair of brand new proposals to "improve financial reporting by state and local governments of other post-employment benefits, such as retiree health insurance." See "GASB Publishes Proposed Accounting Standards for Government Post-Employment Benefits" by the editor of AccountingToday.com, Michael Cohn. You can download the three documents by visiting the GASB website. Click to access GASB's microsite about Other Postemployment Benefits ("OPEB").

The good news, as I have said all along, is that initiatives for heightened transparency are underway. For more difficult situations, don't be surprised if litigation about disclosures continues to occur. In case you missed the February 24, 2014 Practising Law Institute ("PLI") CLE webinar, you can purchase the slides and audio recording of "Muni Bonds, Pensions and Financial Disclosures: Compliance, Litigation and Regulatory Trends." I co-presented with Orrick, Herrington & Sutcliffe LLP partner, Elaine Greenberg. My focus was on risk management, valuation, performance and investment decision-making.

Pay to Play and Pension Funds

Having just co-authored an article about the Foreign Corrupt Practices Act ("FCPA") and its application to pension plans, the topic of economic inducements and fiduciary duties is fresh on my mind. As part of my research, I investigated what "pay to play" rules currently exist and what initiatives are underway to avoid inappropriate monies being paid by vendors to persons who control or have influence over the public purse. Certainly the topic is attracting attention. On October 8, 2013, the Superintendent of the New York State Department of Financial Services ("DFS"), Benjamin M. Lawsky, wrote to the Honorable Thomas P. DiNapoli, Comptroller of the State of New York, about the auditing of government pension plans and their service providers. "Controls to prevent conflicts of interest, as well as the use of consultants, advisory councils, and other similar structures" was listed as one of several areas of emphasis.

Jump ahead to this week's headlines and, not surprisingly, "pay to play" appears once again. With his June 9, 2014 press release, New York City Comptroller, Mr. Scott Stringer, announced the approval by all five New York City pension plans (with roughly $150 billion in assets) to ban the use of placement agents. This extends the prohibition of placement agents for all asset classes and not just the restriction imposed earlier for private equity investments. Click to read "New York City Pension Funds Enact Placement Agent Ban" for a list of the current trustees for the New York City Employees' Retirement System, Teachers' Retirement System, New York City Police Pension Fund, New York City Fire Department Pension Fund and the Board of Education Retirement System.

The "thumbs up" from New York City pension plan trustees follows Comptroller Stringer's six point plan that he announced on January 30, 2014. Besides putting the kibosh on the use of placement agents, his office intends to "...dramatically reform policies and procedures governing [Bureau of Asset Management] by appointing senior risk and compliance officers to strengthen, monitor and continually improved operations..." Investment disclosures about personal trading of in-house fiduciaries is part of the game plan for New York City pension plans.

On a separate note, disclosure mandates about personal trading for members of the U.S. Congress and their aides and federal employees making more than $119,554 appears to have taken a step backwards with respect to government sunshine. According to "Insider Trading in DC Just Got Easier" by John Carney (CNBC.com, April 16, 2013), a modification of the Stop Trading on Congressional Knowledge ("STOCK") Act was passed by lawmakers on April 12, 2012 and then signed into law on April 15, 2013. As a result, any disclosures about personal trades that are part of the public record "aren't readily available...and have to be requested from individual agencies using the names of the individuals about whom information is sought." When asked about the change in disclosure requirements for all but the President, the Vice President, Members of and candidates for Congress and certain appointed officers, White House Press Secretary Jay Carney referred to recommendations made by the National Association of Public Administration ("NAPA") as the basis for "indefinite suspension" due to "substantial national security, personal security, and law enforcement issues on this matter." You can decide for yourself. Click to download "The STOCK Act: An Independent Review of the Impact of Providing Personally Identifiable Financial Information Online - A Report by a Panel of the National Academy of Public Administration Submitted to the Congress and the President of the United States" (March 2013).

Pension Usage of Swaps

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Longevity Derivatives Seem Poised For Further Growth

If this photo of senior ski fans is representative of the upward global trend in longevity, creators of derivatives could be on to something big. Deal count suggests that 2013 will be described as a banner year for banks and others types of financial companies as their respective corporate clients, in search of protection against the greying of their plan participants, took the plunge to get rid of risks they find difficult to manage. Financial News reports a December deal for 2.5 GBP between AstraZeneca and Deutsche Bank that "will cover the drug company against the risk that 10,000 of its former employees will live longer than expected." This follows a 1 billion GBP swap between Carillion and Deutsche Bank and a second transaction between BAE Systems and Legal & General, also in December 2013. See "A shot in the arm for longevity swaps" by Mark Cobley (January 6, 2014) for more details.

Certainly the topic is gaining importance in policy-making circles and at an international level. In December 2013, the Bank For International Settlements ("BIS") released an updated version of a study about longevity risk transfer markets. The product of the Joint Forum on longevity risk transfer ("LRT") markets, the report strongly encourages those with regulatory authority to carefully track the nature of deals being done and by which organizations as a way to gauge capacity to handle risks being transferred to the financial sector. Longevity risk exposures should be properly measured and attention should be paid to the extent to which "longevity swaps may expose the banking sector to longevity tail risk, possibly leading to risk transfer chain breakdowns." The study likewise notes the importance of supervisors to be able to evaluate whether those in possession of longevity risk have the "appropriate knowledge, skills, expertise and information to manage it."

These words of caution make sense, especially given the large amounts at stake. In its December 20, 2013 press release, the BIS cites estimates of the aggregate "global amount of annuity- and pension-related longevity risk exposure" as ranging between $15 and $25 trillion. Based on World Bank data, U.S. Gross Domestic Product for 2012 was $16.2 trillion. It was reported at $8.2 trillion for China and $5.9 trillion for Japan. The implication is clear. Get it wrong and it could mean big losses for a delicate global financial system that has had its share of risk management twists and turns. Click to access "Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks" (Basel Committee on Banking Supervision Joint Forum, December 2013).

As at least one major bank moves forward to develop a longevity derivative instrument that is meant to be traded, expect more news from insurance company and banking regulators about capacity, internal controls, assessment of risk, posting of capital and adequate disclosure about the transfer of large amount of longevity risks to financial intermediaries. Risk Magazine author, Tom Osborn, describes some of the impediments to a full-scale launch of the longevity transfer market, including limited disclosure about how transactions are priced, absence of a liquid index that would facilitate cost-effective hedging and avoid capital adequacy-related basis risk problems and questions about how exposures should be accurately modeled. Click to read "Longevity: Opportunity or flop?" (September 20, 2013).

Muni Bonds, Pensions and Financial Disclosures: Compliance, Litigation and Regulatory Trends

Mark your calendars to attend "Muni Bonds, Pensions and Financial Disclosures: Compliance, Litigation and Regulatory Trends."

At a time when unfunded pension and health care obligations are accelerating the budgetary crisis for some municipalities, experts fear that current problems are the tip of the iceberg. A new focus on accounting rules, the quality of disclosure to muni bond investors and the due diligence practices of underwriters, portfolio managers and advisers could mean heightened liability exposure for anyone involved in the nearly $4 trillion public finance marketplace. Add the history-making Detroit bankruptcy decision to the mix and attorneys have the makings of a perfect storm as they attempt to navigate these unchartered waters. The U.S. Securities and Exchange Commission has made no secret of its priority to sue fraudulent players in the public finance market. Insurance companies are reluctant to underwrite policies for high-risk government entities at the same time that municipal fiduciaries are more exposed to personal liability than ever before, especially as the protection of sovereign immunity is being challenged in court. Litigation that involves how much monitoring of risk factors took place is on the rise.

Public finance and securities litigation counsel, both in-house and external, can play a vital role in advising municipal bond market clients as to how best to mitigate litigation and enforcement risk or, in the event that an enforcement action has already been filed, how best to defend such litigation. Please join Orrick, Herrington & Sutcliffe LLP partner, Elaine C. Greenberg, and retirement plan fiduciary expert, Dr. Susan Mangiero, for an educational and pro-active program about the complex compliance and litigation landscape for municipal bond issuers, underwriters, asset managers and advisers. Topics of discussion include the following:

  • Description of the current regulatory environment and why we are likely to see much more emphasis on the disclosure activities of public finance issuers and the due diligence practices of underwriters and advisers;
  • Overview of hot button items that impact a bond issuer’s liability exposure, to include valuation of underlying collateral, rights to rescind benefit programs in bankruptcy and the use of derivatives as part of a financing transaction;
  • Explanation of GASB accounting rules for pension plans and likely impact on regulatory oversight of securities disclosure compliance and related enforcement exposures;
  • Discussion about trends in municipal bond litigation – who is getting sued and on what basis; and
  • Description of pro-active steps that governments and other market participants can take to mitigate their legal, economic and fiduciary risk exposures.

Featured Speakers:

Ms. Elaine C. Greenberg, a partner in Orrick, Herrington & Sutcliffe LLP’s Washington, D.C., office, is a member of the Securities Litigation & Regulatory Enforcement Group. Ms. Greenberg’s practice focuses on securities and regulatory enforcement actions, securities litigation, and public finance. Ms. Greenberg is nationally recognized for producing high-impact enforcement actions, bringing cases of first impression and negotiating precedent-setting settlements, she possesses deep institutional knowledge of SEC policies, practices, and procedures. Ms. Greenberg brings more than 25 years of securities law experience, and as a Senior Officer in the SEC's Enforcement Division, she served in dual roles as Associate Director and as National Chief of a Specialized Unit. As Associate Director of Enforcement for the SEC's Philadelphia Regional Office, she oversaw the SEC's enforcement program for the Mid-Atlantic region and provided overall management direction to her staff in the areas of investigation, litigation and internal controls. In 2010, she was appointed the first Chief of the Enforcement Division's Specialized Unit for Municipal Securities and Public Pensions, responsible for building and maintaining a nation-wide unit, and tasked with overseeing and managing the SEC's enforcement efforts in the U.S.’s $4 trillion municipal securities and $3 trillion public pension marketplaces. Ms. Greenberg recently gave a speech entitled “Address on Pension Reform” at The Bond Buyer’s California Public Finance Conference in Los Angeles on September 26, 2013.

Dr. Susan Mangiero is a CFA charterholder, certified Financial Risk Manager and Accredited Investment Fiduciary Analyst™. She offers independent risk management and valuation consulting and training. She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors. Dr. Mangiero has served as an expert witness as well as offering behind-the-scenes forensic analysis, calculation of damages and rebuttal report commentary on matters that include distressed debt, valuation, investment risk governance, financial risk management, financial statement disclosures and performance reporting. She has been actively researching and blogging about municipal issuer related retirement issues for the last decade. She has over twenty years of experience in capital markets, global treasury, asset-liability management, portfolio management, economic and investment analysis, derivatives, financial risk control and valuation, including work on trading desks for several global banks, in the areas of fixed income, foreign exchange, interest rate and currency swaps, futures and options. Dr. Mangiero has provided advice about risk management for a wide variety of consulting clients and employers including General Electric, PriceWaterhouseCoopers, Mesirow Financial, Bankers Trust, Bank of America, Chilean pension supervisory, World Bank, Pension Benefit Guaranty Corporation, RiskMetrics, U.S. Department of Labor, Northern Trust Company and the U.S. Securities and Exchange Commission. Dr. Mangiero is the author of Risk Management for Pensions, Endowments and Foundations  (John Wiley & Sons, 2005), a primer on risk and valuation issues, with an emphasis on fiduciary responsibility and best practices. Her articles have appeared in Expert Alert (American Bar Association, Section of Litigation), Hedge Fund Review, Investment Lawyer, Valuation Strategies, RISK Magazine, Financial Services Review, Journal of Indexes, Family Foundation Advisor, Hedgeco.net, Expert Evidence Report, Bankers Magazine and the Journal of Compensation and Benefits. Dr. Mangiero has written chapters for several books, including the Litigation Services Handbook and The Handbook of Interest Rate Risk Management.

Private Equity Performance and Underfunded Pensions

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

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

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

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

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

Some U.S. Senators Seek to End Traditional Pensions For New Federal Employees

Whenever I am in New York City and have a chance to walk down Fifth Avenue, I marvel at the number of stores that have been "going out of business" for years. They advertise change and nothing happens. Many people feel the same way about government programs. Once they breathe life, it is hard to extinguish a federal promise unless there is an urgent reason to stop. Several U.S. Senators think the time is now to truncate one such program.

According to "Senators Propose to End Defined Benefit Pensions for New Federal Employees" by FedSmith.com reporter, Ian Smith (November 13, 2013), the Public-Private Employee Retirement Parity Act (S. 1678) would maintain the Thrift Savings Plan (along with the current match up to 5%) for existing and new federal employees but jettison the traditional retirement compensation component. Members of Congress would likewise take it on the chin. Sponsors Richard Burr (R-NC), Tom Coburn (R-OK) and Saxby Chambliss (R-GA) assert that individuals who work for the U.S. government "receive far more generous retirement benefits than private sector employees. The cost to taxpayers of these benefits is unsustainable and we simply cannot afford it."

Not surprisingly, federal workers are none too happy. They counter that their sacrifices are already large. In "Congess could wring $300B in deficit savings from federal pay, pension changes," Jack Moore (Federal News Radio, November 15, 2013) describes a series of proposed changes, including increased contributions from employees. These would be in addition to a pay freeze already in place.

As with discussions about retirement plan reform throughout the country, federal workers complain that they are paying for the deficit sins of others. Unfortunately, that does not negate large and real problems. According to the Office of Personnel Management, the Federal Employees Retirement System or FERS recorded a $20.1 billion gap in funding at fiscal year end 2011. This marked a serious turnaround from its estimated $12.2 billion surplus at fiscal year end 2010. See "Federal pension systems' unfunded liabilities skyrocket" by Stephen Losey (Federal Times, February 20, 2013).

Keep in mind that older workers at one point had a choice to be either part of the Federal Employees Retirement System ("FERS") or the Civil Service Retirement System ("CSRS"). While newer workers can only be part of FERS, the funding issues for the legacy program are challenging at best. According to "Federal Employees' Retirement System: Budget and Trust Fund Issues," Katelin P. Isaacs with the Congressional Research Service (June 13, 2013) explains that, since its inception in 1920, the CSRS was structured as a pay-as-you-go program. In 1956, Congress mandated federal agency employers to make contributions on behalf of working participants.  Employees made contributions too but they have been insufficient to "pre-fund the future retirement benefits of federal employees." The likely outcome, absent reform, is a reduction of pension benefits or a rise in what employees must contribute going forward.

Said another way, federal workers are confronted by similar difficulties that many of us in the private sector cannot ignore. Planning for an early and bountiful retirement is becoming a veritable quest for the hard-to-grasp brass ring.

Fiduciary Management For Pension Plans

Besides being knowledgeable about medicine, nutrition and state-of-the-art health research, my doctor has a great sense of irony. He says things that make me laugh out loud. When I saw him recently, I mentioned how much I was enjoying reruns of some older television shows like Quincy, M.E. He replied, in typical clever fashion, "yea, but Sam did all the work and Quincy took the credit." It struck a chord because his statement is mostly true. In case you never watched the popular series about a coroner who helps the police solve crimes, veteran actor Jack Klugman (now deceased) applies Criminal Scene Investigation ("CSI") like smarts and tenacity in pursuit of justice. Sam Fujiyama (played wonderfully by actor Robert Ito) is likewise a medical doctor. He works alongside Dr. Quincy and is portrayed as an integral part of uncovering the truth.

In pension land, it is often the case that sponsors think they have hired someone to play the role of helpful Sam. The notion is that the advisor, consultant or fund of funds professional will be paid a fee to carry out a certain level of due diligence about action items such as setting up or revising an appropriate investment strategy, selecting or terminating an asset manager, redesigning a plan or evaluating pension transfer structures. Once the engagement letter is signed and a retainer fee is in place, the plan sponsor, like Dr. Quincy, can breathe a sigh of relief. Help is supposedly on the way - maybe. The safety net concept attached to bringing a third party on board, combined with what a colleague of mine describes as fiduciary fatigue, is reflected in the global growth of firms that describe themselves as fiduciary managers. While the retirement plan regulatory regime varies by country, the investment outsourcing model is gaining sway in the United States, the United Kingdom, the Netherlands and elsewhere. The undeniable trend to delegate merits discussion.

Before employers get too comfortable and think that their pension problems now belong to someone else, it is noteworthy to acknowledge that there are more than a few lawsuits that have been filed against third parties. Some of them allege breach on the basis of a failure to properly oversee and respond accordingly.

My observations come from firsthand experience. I have served as an economic analyst or testifying expert on disputes between an institutional investor such as a retirement plan, endowment, foundation or family trust. For other matters, I have provided due diligence training to fiduciaries and board members or reviewed the risk practices in place prior to a vendor being selected or as part of a later review of said vendor, once hired. As the founder of an educational start-up company a few years ago, I had a front row seat to the ongoing discussions between buyers and sellers of investment, risk and valuation services. Information in the form of repeated and in-depth surveys and numerous conversations about what pensions, endowments, foundations, family offices and other types of trust investors want and need from those who provide advice is telling. One issue that came up often from institutional investors was how to benchmark the quality of the work being provided by a delegate. This is a critical subject, especially for those outsourced professionals who are doing a terrific job and want their clients to be satisfied.

The topic of service provider due diligence is timely, important and the focus of my presentation on October 25, 2013 as part of the American Conference Institute's 6th Annual ERISA Litigation Conference. Interested readers are welcome to download my fiduciary due diligence slides.

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

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

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

Continue Reading...

Audrey Hepburn, Gary Cooper and Pension Governance

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

Pension governance comes to mind.

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

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

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

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

Qualified Professional Asset Manager (QPAM) Webinar Slides

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The U.S. Department of Labor estimates that there are roughly 4,400 financial organizations relying upon the DOL’s Qualified Professional Asset Manager (“QPAM”) class exemption when managing the assets of their own employee benefit plans. Maintaining QPAM status is important for these asset managers as this class exemption facilitates their ability to make investment decisions with respect to their plans without the need to monitor compliance with the prohibited transaction rules of Section 406(a) of ERISA.  Following an amendment to the QPAM class exemption by the DOL that went into effect in 2012, to secure their QPAM status when they manage the assets of plans they sponsor, financial firms must satisfy an additional hurdle to be able to meet the QPAM exemption requirements - an annual compliance audit conducted by an independent party.

With an impending June 30, 2013 deadline to complete their QPAM audits, financial firms managing assets of their sponsored ERISA plans are confronting the intricacies of this audit process. The goal of this informative and timely webinar is to help asset managers understand what is required to maintain QPAM status with respect to transactions they direct for their own plans.  Join an inter-disciplinary panel of legal, auditing and economic experts to learn about these QPAM audit requirements and how to conduct a QPAM audit.  Topics that will be covered include:

  • The QPAM exemption, why and when an audit is required;
  • QPAM audit requirements;
  • How trading activity is tested;
  • What policies and procedures must be reviewed;
  • Logistics of data gathering and examination of this data;
  • Type of report that an organization is likely to receive; and
  • Correcting any deficiencies uncovered by the audit team.

On May 1, 2013, Dr. Susan Mangiero co-presented as part of a webinar entitled "QPAM Compliance Audits: How Asset Managers Can Minimize Regulatory Risks and the Cost of Breach." Sponsored by Seyfarth Shaw, LLP, the program described the consequences of non-compliance as well as the governance and risk management benefits associated with a QPAM audit.

Click to download the QPAM webinar slides from May 1, 2013.

DOL Issues Advisory Opinion About Use of Swaps by ERISA Plans

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

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

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

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

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

Registered Investment Advisor (RIA) Fiduciary Liability Risk

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

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

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

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

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

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

U.S. Department of Labor Audits and ERISA Litigation

According to "Attorney, Official Discuss DOL Investigations, Give Recommendations on Avoiding Litigation," by Andrea L. Ben-Yosef (Pension & Benefits Daily, BNA Bloomberg, October 15, 2012), trouble may come in pairs. The same complaints from plan participants, leads from government authorities and/or news about a company's financial distress that trigger U.S. Department of Labor ("DOL") scrutiny could invite plaintiffs' counsel to file a contemporaneous lawsuit.
 
Speakers Mabel Capolongo, Director of Enforcement with the U.S. Department of Labor, Employee Benefits Security Administration ("EBSA") and Attorney R. Bradford Huss with Trucker Huss suggested that persons being examined for possible breach should familiarize themselves with the EBSA enforcement manual and notify their ERISA liability insurance carrier right away. Cited potential areas of investigation include:
  • Fiduciary breach;
  • Co-fiduciary liability;
  • Plan expenses;
  • Plan operations;
  • Plan investing;
  • Prohibited transactions;
  • Company securities in a plan, including Employee Stock Ownership Plan ("ESOP") issues;
  • Real estate holdings;
  • Bonding;
  • Reporting; and
  • Disclosure.

For regulatory information, click to access the EBSA Enforcement Manual.

In a related online interview for the Professional Liability Underwriting Society ("PLUS"), Chartis Executive Vice President Rhonda Prussack cites financial distress (including the filing for bankruptcy protection) as a significant concern for ERISA fiduciary liability. She adds that a troubled plan sponsor may see the value of company-issued securities plummet which in turn could trigger an ERISA "stock drop" case if such securities are part of the mix for a 401(k) or profit-sharing plan. A company seeking to save cash may switch from a defined benefit plan to a cash balance plan which in turn could pave the way for a lawsuit over allegations relating to the change in design. A company in trouble could shut down factories, instigate large-scale layoffs and/or cut back benefits, all of which lead to unhappy individuals who are more likely to sue. Ms. Prussack emphasizes that happy workers are less likely to sue. She further adds that plan participant actions are likely to take the form of putative class actions.

The bottom line is that there is a long list of potential risk exposures for ERISA fiduciaries and a continued need to mitigate liability.

New Focus of ERISA Fee Litigation

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

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

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

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

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

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

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

 

Join me on May 1, 2012 for a timely and interesting program about alternative investment fund due diligence and other considerations for ERISA plan sponsors, their counsel and consultants. Click here for more information.

This CLE webinar will provide ERISA and asset management counsel with a review of effective due diligence practices by institutional investors. Best practices will be offered to mitigate government scrutiny and suits by plan participants.

Description

With the DOL's and SEC's new disclosure rules and heightened concerns about compliance and valuation, corporate pension plans that invest in alternatives must focus on properly vetting asset managers more than ever before or risk being sued for poor governance and excessive risk-taking.

The urgencies are real. The use of private funds by asset managers is crucial for 401(k) and defined benefit plan decision makers. Understanding the obligations of private funds is essential to any retirement funds with limited partnership interests.

In addition, suits and enforcement actions against asset managers make it incumbent on counsel to hedge fund and private equity fund managers to fully grasp and advise on full compliance with the duties of ERISA fiduciaries to plan participants.

Listen as our ERISA-experienced panel provides a guide to the legal and investment landmines that can destroy portfolio values and expose institutional investors and fund managers to liability risks. The panel will outline best practices for implementing effective due diligence procedures.

Outline

  • ERISA fiduciary duties for institutional investors
    1. Hedge funds and private equity funds compared to traditional investments
  • Regulatory developments
    1. Disclosure
    2. Compliance
    3. Valuation
  • Developments in private litigation involving pension plan fiduciaries and alternative fund managers
  • Best practices for developing due diligence plans

 

Benefits

The panel will review these and other key questions:

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

  • Regulatory developments
    1. Disclosure
    2. Compliance
    3. Valuation
  • Developments in private litigation involving pension plan fiduciaries and alternative fund managers
  • Best practices for developing due diligence plans
  • What are the regulatory concerns for ERISA pension plans that allocate assets to hedge funds and private equity funds?
  • What are the potential consequences for service providers that fail to comply with new fee, valuation and service provider due diligence regulations?
  • What can counsel to pension plans and asset managers learn from recent private fund suits relating to collateral, risk-taking, pricing, insider trading and much more?
  • How should ERISA plans and asset managers prepare to comply with expanded fiduciary standards?

 

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

Faculty

Susan Mangiero, Managing Director
FTI Consulting, New York

She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors as well as offered expert testimony and behind-the-scenes forensic analysis, calculation of damages and rebuttal report commentary for various investment governance, investment performance, fiduciary breach, prudence, risk and valuation matters.

Alexandra Poe, Partner
Reed Smith, New York

She has over 25 years of experience in investment management practice counseling managers of hedge funds, private equity funds, institutional accounts, mutual funds and broker-dealer advised programs. She counsels hedge and private equity fund advisers in all stages of their business and due diligence matters.

 

 

New Regulations About ERISA Plan Fee Disclosures

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

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

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

Louisiana Pension Funds and Hedge Fund Redemption Concerns

As I've written many times herein, understanding transferability restrictions is a "must do" for institutional investors who allocate monies to asset managers. While a pension, endowment, foundation or family office may decide to invest part of its portfolio in illiquid securities for strategic reasons, it is still necessary to understand how to exit if necessary. In "Hedge Fund Lock Ups and Pension Inflows" (July 4, 2011), the point is made that investors who want to redeem but are barred from doing so may seek redress in a court of law. Regulators are paying close attention too.

According to recent news accounts, several Louisiana pension funds that sought to withdraw some of their money from a New York hedge fund were given promissory notes with assurances that it could get cash in several years. Moreover, it may be that the hedge fund in question has counted assets under management more than once due to a feeder fund organizational structure that boasts over a dozen smaller vehicles which cross trade with one another.

In a joint statement dated July 11, 2011, the Firefighters' Retirement System ("FRS"), New Orleans Firefighters' Retirement System and the Municipal Employees' Retirement System ("MERS") describe how attempts by FRS and MERS "to capture some of the profits that had been earned in an investment known as the FIA Leveraged Fund" initially met with resistance on the part of the fund manager to provide cash right away. Instead, the two requesting institutions were told to expect paper IOUs while certain assets were to be liquidated in an orderly manner over a period of up to two years. The statement goes on to say that the pension plans had each been promised a return of at least 12 percent per annum and that if the "collateral supporting the preferred return declines to a level that is 20% above the systems' collective account values, there is a trigger mechanism requiring a mandatory redemption of the systems' investment" with the 20% cushion" designed to protect the systems' accounts against any loss in value."

Getting a promissory note has not made for happy campers who now worry about the liquidity of the FIA fund and "the accuracy of the financial statements issued by the two renowned independent auditors." The statement goes on to say that the hedge fund manager has been apprised that the pension plans intend to "closely examine" performance records by putting together a team that consists of their board members, internal auditors and investment consultant. A forensic economist may be added to the team.

Click to read the July 11, 2011 joint statement from these Louisiana pension plans about hedge fund liquidity concerns for this particular manager.

Having just checked the SEC website, this blogger does not yet see the formal inquiry statement. Speaking from experience, complexity is never a good thing. Someone somewhere has to understand what risks might give rise to material problems. Moreover, proper due diligence of funds that invest in "hard to value" instruments has to take into account how they are modeled and who is vetting the integrity of the model numbers. Regarding organizational structures that encompass multiple money pools, it is imperative to understand who exactly has a claim to assets in a worst case situation of forced liquidation.

A few years ago, I refused to continue with a valuation engagement of a hedge fund because neither the general partner nor the master fund's attorney could adequately answer my questions about priority of claims for a complex offshore-onshore ownership structure. In several recent matters where I have served as expert witness, concerns about restrictions of transferability and collateral monitoring have taken center stage. Be reminded that in distress, book values often fall seriously short of fire sale or even orderly liquidation (auction) values.

Let's hope that questions can be cleared up in a timely fashion.

Readers may want to check out these articles:

  • "S.E.C. and Pension Systems to Examine Fletcher Fund" by Peter Lattman, New York Times, July 12, 2011; and
  • "Pensions Want Look Into Fund's Records" by Josh Barbanel, Steve Eder and Jean Eaglesham, Wall Street Journal, July 13, 2011.

Counterparty Credit Risk Guidance From Bank Regulators

On June 29, 2011, the Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Board of Governors of the Federal Reserve System and the Office of Thrift Supervision issued its latest thinking on derivatives trading by banks. "Interagency Supervisory Guidance on Counterparty Credit Risk Management" considers the role of senior management, methods to measure risk, ways to manage risk and model validation.

Given the increasing number of institutional investors that deploy derivatives - directly or indirectly via third party organizations - for return enhancement or risk minimization purposes, this twenty-six page document is worth a read. Anything that impacts the costs of major derivatives dealers is likely to have a trickle down impact on pensions, endowments, foundations and family offices.

The list below offers a preview of takeaways from the regulators' perspective.

  • Assessment of counterparty credit risk models should reflect their "conceptual soundness," along with "an ongoing monitoring process that includes verification of processes and benchmarking; and an outcomes-analysis process that includes backtesting."
  • Develop a comprehensive process surrounding bank monitoring of collateral.
  • Discuss how to control "wrong-way risk" which occurs "when the exposure to a particular counterparty is positively correlated with the probability of default of the counterparty itself."
  • Banks need to regularly measure the "largest counterparty-level impacts across portfolios, material concentrations within segments of a portfolio (such as industries or regions), and relevant portfolio-and counterparty-specific trends."

Pension fund investment committee members can use the guide to draft or add to an existing questionnaire for interviews they conduct with their asset managers, banks and consultants.

Hedge Fund Lock Ups and Pension Inflows

Various sources tout increasing inflows to hedge funds from public and corporate pension plans.

In "Strong start to hedge fund activity in 2011" (April 1, 2011), Pensions & Investments reporter Christine Williamson writes that "First-quarter institutional hedge fund activity, including net inflows and pending searches, totaled $18 billion - the highest since the intense investment pace of the first quarter 2007, which saw $25 billion in activity." James Armstrong of Traders Magazine describes the billions of dollars going to hedge funds in recent months as a catalyst to "increased trading volumes for the equities trading business." See "Hedge Funds Could Juice Volume" (June 2011). Imogen Rose-Smith of Institutional Investor gives readers a detailed look at the love affair with hedge funds in "Timeline 2000-2011: Public Pensions Invest in Hedge Funds" (June 20, 2011).

Fortune writer Katie Benner says "wait a minute" to what seems to be an upward trajectory in retirement plan allocations to hedge funds with a 51% increase since 2007 and a doubling of the mean allocation to 6.6% (according to a study by Preqin). In "Hedge fund returns won't save public pensions" (March 30, 2011), she cites willful underfunding and a "mish-mash of accounting tricks" as fundamental problems that will not be corrected with more money in alternatives.

In her May 16, 2011 article for Pensions & Investments and entitled "Promises, promises: $100 billion still locked up," Christine Williamson writes that assurances made to institutional investors in 2008 and 2009 about redemptions are not being met by some hedge fund managers. At that time, jittery pension funds, endowments and foundations that wanted out were asked to be patient rather than force hedge funds to unwind hard to value positions at sub-par prices. Quoting Geoff Varga, a senior executive with Kinetic Partners US LLP, a consultancy for asset management firms, there is an estimated $100 billion in "exotic" or non-standard investments that were stuffed into "emergency side pockets." He adds that it is hard to come up with an exact number, especially since managers' valuations of these illiquid positions are not always realistic.

Certainly the issue of side pockets is unlikely to go away any time soon. On October 19, 2010, Emily Chasan reported that the U.S. Securities and Exchange Commission ("SEC") had filed a civil complaint against several hedge fund managers for overvaluing illiquid assets. See "SEC charges hedge fund of inflating 'side pockets'" (Reuters). Click here to read the SEC complaint and October 19, 2010 press release from the SEC. On March 1, 2011, Azam Ahmed with the New York Times Deal Dook described another case in "Manager Accused of Putting $12 Million in Side Pockets."

This blogger, Dr. Susan Mangiero, has written extensively on the topic of hard to value investments and liquidity and served as expert witness on cases involving due diligence allegations. Acknowledging that not all hedge funds invest in hard to value instruments, the following items may be of interest to readers:

Hedge Funds, Private Equity Funds and ERISA Pension Plans

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

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

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

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

Public Pension Risk Management and Fiduciary Liability

A few weeks ago, Attorney Terren B. Magid and Dr. Susan Mangiero jointly presented on the topic of pension risk management and fiduciary liability with a particular emphasis on public plans. Attorney Magid's insights reflect a particularly unique perspective inasmuch as he served as executive director of the $17 billion Indiana Public Employees' Retirement Fund ("PERF"). Dr. Mangiero shares her views as an independent risk management and valuation consultant, author, trainer and expert witness.

Click to download the 25-page webinar transcript for public pension fiduciaries entitled "Are You Properly Mitigating Risk? Assess Your Fiduciary IQ" with Attorney Terren B. Magid (Bingham McHale LLP) and Dr. Susan Mangiero (Fiduciary Leadership, LLC). Comments about ERISA plans are provided when applicable.

Topics discussed include, but are not limited, to the following:

  • Public Pension Transparency Act
  • Discount Rate Choice
  • Dodd-Frank Wall Street Reform and Municipal Advisor Registration
  • Expanded Definition of ERISA Fiduciary
  • Fee Disclosure Under ERISA 408(b)(2)
  • Failure to Pay and Actuarially Required Contribution ("ARC")
  • Benefit Reductions
  • RFP Process
  • Fiduciary Audits
  • D&O Policy Review
  • Vendor Contract Examination
  • Qualitative and Quantitative "Investment Risk Alphabet Soup"
  • Interrelated Risk Factors
  • Key Person Risk
  • Hard to Value Investing
  • Model Risk
  • Stress Testing
  • Pension Litigation
  • Fiduciary Breach Vulnerability
  • Characteristics of a Good Model
  • Side Pockets and Investment Performance.

Comments are welcome.

Gateway to More ERISA Litigation

According to a March 30, 2011 regulatory update from attorneys at Goodwin Procter, ERISA litigation may increase as the result of U.S. Department of Labor ("DOL") efforts. Click to access "Regulatory Update - DOL Initiatives Potentially Affecting ERISA Litigation."

For one thing, should the definition of fiduciary be expanded, more persons will have potential liability. The pushback from various segments of the financial services industry has been considerable, leading to an extension of the time allowed for official comments through April 12, 2011.

A second hurdle to overcome emphasizes disclosure and takes the form of a final rule that goes into effect for plan years that start on or after November 1, 2011. Specifically, plan participants who are allowed to self-direct their investments must now be given granular performance and fee information about "designated investment alternatives," including identification of asset managers and arrangements and restrictions on brokerage accounts and participants' flexibility (or lack thereof) to give orders.

A third new item on the growing ERISA compliance checklist, if adopted by the DOL, will force service providers to submit a written statement of what services it will offer to the retirement plan(s) and copious data about how it expects to be indirectly and directly compensated.

I concur with the authors that more rules likely beget more lawsuits. Part of the current ills that the DOL seeks to cure is to make sure that a sufficient quantity and quality of information is available to decision-makers.

Clearly, more and better datapoints can be helpful. Absent an inflow of information, what are decision-makers doing now to properly carry out their fiduciary duties? Understanding what is or is not being conveyed as billions of dollars are committed is of significant import in terms of good process.

Note to Readers:

  • Click to read the 469 page transcript of March 1, 2011 testimony on the topic of an expanded definition of ERISA fiduciary.
  • Click to read the 387 page transcript of March 2, 2011 testimony on the topic of an expanded definition of ERISA fiduciary.

PBGC and Risk-Based Premiums

In his just proposed federal budget, President Barack Obama opens the door for the Pension Benefit Guaranty Corporation ("PBGC") to determine insurance premiums as a function of the riskiness of the plan sponsor. Having been an advocate for this approach for numerous years, my response is "yippee yahoo." There is empirical evidence aplenty about the costly consequences of forcing good risks to subsidize bad risks. The common sense notion of charging plan sponsors higher insurance premiums if they are deemed "higher risk" is logical and is a long overdue move in the right direction.

The excerpted text from "Low Risk Premium Makes PBGC Bargain Insurer" (In the Money, Dow Jones Newswires, July 18, 2005) by Steven D. Jones addresses the concept of risk-based premiums as follows:

 A separate bill that emerged from a House committee in June changes a number of rules governing funding levels and grace periods to meet them. It also ties premiums for PBGC coverage to hikes in the national wage index. But the formula wouldn't impose higher premiums on higher risk plans. "That's a mistake, says consultant Susan Mangiero, author of Risk Management for Pensions, Endowments and Foundations." To be effective, a premium structure needs to reflect the risk of the insured. Without a risk mechanism, "you invite adverse selection" in the insurance plan, she says. For example, a driver with several tickets and an accident record pays more for auto insurance. If there's no cost to the behavior, the carefree driver has no incentive to change, losses mount and premiums go up for every participant. Discouraged by the cost, clients with good risk profiles leave the plan. Companies can't seek pension insurance elsewhere, but they can end defined-benefit plans and shift to defined-contribution plans, such as a 401(k), in which employees share the risk. Such plans are not covered by the PBGC. "The net effect of flat-based insurance, not taking into account different risk levels, is that you have a riskier system, which is counter to the purpose of having an insurance plan," she says.

Think about the issue this way. Would you buy stocks or bonds issued by a public insurance company that charged the same premium for all insured parties, irregardless of their risk behavior? Hopefully your answer is "of course not."

If plan sponsors do the right thing in terms of careful risk-taking and good procedural prudence, they should not be penalized by having to pay for the sins of others who are less careful or, worse yet, sloppy, indifferent and/or take excessive risks unnecessarily and to the detriment of their plan participants.

Note to Readers: Check out "Obama's 2012 Budget: What It Means for Pension Plans and the PBGC" by John Sullivan, Advisor One, February 16, 2011,  "Let PBGC set employer premiums based on risk: Obama" by Jerry Geisel, Business Insurance, February 14, 2011 and "Budget Would Raise Pension-Insurance Costs" by David Wessell (Wall Street Journal, February 14, 2011).

U.S. Department of Labor and Definition of Fiduciary

As the U.S. Department of Labor ("DOL") prepares to expand the definition of fiduciary, at the same time that the U.S. Securities and Exchange Commission is doing likewise, the financial industry is girding for some potentialy massive changes.

In response to the DOL's request for comments about an expanded definition of fiduciary as relates to retirement schemes, I warned that the law of unintended consequences could push knowledgeable professionals out of the marketplace. If fears that the liability costs will outweigh the benefits of working with plan sponsors, perhaps materially so, it will be difficult to attract the talent that is so badly needed to assist with implementing pension governance policies and procedures. 

I further wrote that a hefty dose of transparency could do wonders for differentiating "good" fiduciaries from others. This problem is not new. In fact, I wrote in 2006 that trying to identify who serves as a member of a plan's investment committee is like searching for hidden treasure. Click to read my 2006 post about pension fiduciary disclosure.

Click to read my January 20, 2011 letter to the U.S. Department of Labor about their proposed expansion of who should serve as a fiduciary.

Click to read the other letters submitted to the U.S. Department of Labor about this important issue of who properly counts as a fiduciary. Letters I read suggest the need for a universal education standard. As is the case in other countries, the United States could well end up with a mandate for independent fiduciaries to serve on investment committees, after having been properly vetted, licensed or otherwise credentialed.

Help With Form 5500 Reporting

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.

Bad Disclosures - Recipe For Disaster?

According to "State workers face privatization" by Jason Stein (Milwaukee Journal Sentinel, January 6, 2011), over 300 Wisconsin State Department of Commerce employees may soon be classified differently. The stated goal is to better deploy its $183 million budget to try to create jobs. (Whether you believe that governments are the engine of jobs creation is a post for another day.)

Questions remain about the benefits for identified employees and whether they will be covered by the state's retirement system. A related question is whether the general public will have a true assessment of Wisconsin's retirement plan IOUs if these privatized workers are counted as "public" for some purposes but not for others. In reading the many comments posted for the aforementioned article, emotions are running high about the real costs associated with this decision. Clearly, more information would go a long way to quelling any concerns.

The topic of financial disclosures may soon create real problems for public plans and, by extension, ERISA plans that are sponsored by companies that issue stocks and/or bonds. In today's New York Times, Mary Williams Walsh reports that the U.S. Securities and Exchange Commission ("SEC") may be investigating the large California pension plan known as CalPERS. It's premature and inappropriate to speculate but the inference is that bond buyers may have been in the dark about the "true" risks associated with this $200+ billion defined benefit plan. If true, California could pick up an even bigger than expected tab and municipal security investors could be in a position of having paid too much to own state debt. See "U.S. Inquiry Said to Focus on California Pension Fund."

As recently as 2009, then Special Advisor to California Governor Arnold Schwarzenegger, David Crane, referred to public pension plan reporting as "Alice-in-Wonderland" accounting. He added that "state and local governments are understating pension liabilities by $2.5 trillion, according to the Center for Retirement Research at Boston College." Since these are legal contracts that bind the state, city or municipal sponsor, they are on the hook for bad results, with large cash infusions likely.

It's not rocket science to conclude that other states and municipalities could face the same type of securities regulation inquiry. Indeed, even ERISA plans are vulnerable to allegations of fraud or sloppy reporting if their risk disclosures are incomplete, inaccurate, misleading or all of the above. See "Testimony for Securities and Exchange Commission Field Hearing re: Disclosure of Pension Liability" (September 21, 2010). Investors want to know whether they have a striped horse or a zebra in their stable. They need and deserve a solid understanding of investment risks to which they are exposing themselves. That can only occur if accurate and complete information is provided. To its credit, CalPERS seems to be emphasizing risk-adjusted performance as paramount. A December 13, 2010 press release describes the adoption of a "landmark" asset allocation that emphasizes "key drivers of risk and return."

Email Dr. Susan Mangiero, CFA and certified Financial Risk Manager if you would like information about what a risk disclosure assessment entails for your organization or on behalf of a client(s). You may likewise be interested in one of our workshops for directors, trustees and/or members of the investment committee about performance reporting within a fiduciary and financial risk management framework.

Valuing Positions in Alternatives - New DOL Scrutiny

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

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

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

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

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

What Can You Do With Five Cows? Morality Tale for Financial Reform?

When I am not traveling for business, I drive the back roads from my house to our company office in Shelton, CT. For those who don't know, Shelton is south of New Haven and north of New York City. While true that either city is relatively close by, I live in a somewhat rural area. Our town boasts about 20,000 people with one McDonald's, a few gas stations, some sheep, lots of deer and five cows.  I know this because I pass by a corner house on what is, for local denizens, a main road.

Ordinarily, I just scoot by, anticipating my morning expresso. However, since warm weather began, I've noticed that a handful of friendly bovines are out and about each morning, chewing, mooing and looking generally happy. Since this house is not a farm, I've been pondering of late why someone would own five cows. Do they make for good pets? Can you sell milk on the side and, if so, is the money worth the fuss? What the heck do you do with a few furry friends who are bigger than a breadbox and seldom house trained?

One of these days, I ought to stop my car and politely ask the man or woman of the house why they collect cows. Until then, I've concluded that this may be the small town version of the theater of the absurd.

That brings me to the topic of financial reform. Oh boy, where does one start? Those who pushed for strong reform are disappointed. Critics think the impending bill goes too far. According to writer Alain Sherter in "Funny Business: Why the Financial Reform Bill Has Become a Joke" (BNET.com, June 30, 2010), taxpayers are left holding the bag in more ways than one. Let us count the ways: 

  • Regulatory consensus is needed to address systemic risk
  • Behemoth financial institutions are free from arduous capital reserve requirements
  • Credit rating agencies will be studied but not immediately reformed.

Worse yet, "its passage would create a false sense of security, a hollow complacency" while it "entrenches Wall Street's control over the financial system."

Only time will tell if this sweeping "reform," destined to become the nation's law, will thwart future meltdowns. I'd much prefer to see capital market participants taking steps towards a robust risk management culture (if not in place already) and then providing transparency to interested parties about their risk mitigation (not the same as minimization) policies and procedures.

Animals and supposed strict mandates may seem warm and inviting but might end up costing a lot, generating few benefits and urging rational thinkers to ask why.

P.S. A future post will address the issue of derivatives and financial reform.

Pension Funding Relief Passed Into Law

Signed on June 25, 2010 by President Obama, the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act (H.R. 3692) allows plan sponsors to amortize funding gaps over a longer period of time than is currently allowed. In addition, this legislation enables funding relief for up to two years.

While the financial markets have not been kind to more than a few defined benefit plans, new rules are going to make it even more difficult for financial statement users to assess the true economic health of any given retirement arrangement. This is not a good thing. Beneficiaries and shareholders alike deserve user-friendly information, especially if a plan is in trouble. The new law will make things even more challenging in terms of deciphering reported numbers and that's saying something.

As I wrote in "The Plan That Didn't Bark" (CFA Magazine, March-April 2008), financial analysts and other interested parties must learn to think like detectives. The current state of pension accounting is far from perfect. Taking into account the likely impact of H.R. 3692, published funding information is going to be clear as mud.

Click here to access the full legislation. Clear to read "The Plan That Didn't Bark" by Dr. Susan Mangiero. (Editor's Note: Pension Governance, LLC is now part of Investment Governance, Inc.)

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.

U.S. Department of Labor Targets Target Date Funds

 

In its May 6, 2010 guidelines about target date funds, the U.S. Department of Labor encourages investment decision-makers to:

  • Consider investment style
  • Carefully review a fund's prospectus for information about asset mix
  • Evaluate how investments could vary over time
  • Think about an employee's timeline for income needs
  • Examine the fees being charged.

Whether you agree that target date funds are a retirement plan salvo, there are numerous risk issues to take into account and manage. Look for details about upcoming educational events on the topic of target date fund risk management.

 

Target Date Fund Fiduciary Checklist - Coming Soon

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

The Lawyers Are Coming

Law scholar, author and derivatives pundit Frank Partnoy had an interesting piece in the Financial Times on April 19, 2010. In "Wall Street beware: the lawyers are coming," Mr. Partnoy warns that the floodgates of litigation are about to open with the SEC's filing of a fraud lawsuit against Goldman, Sachs & Co. He asserts that the regulatory enforcement takes complex financial alchemy and spins a "morality tale." A second take is that litigation picks up where regulations stop with Wall Street heretofore having interpreted "detailed rules as a shield from liability."

Leaving the Goldman case aside (as only those involved can opine with the clarity of full information), Professor Partnoy provides food for thought. Indeed, as I have written lo these last four years since the inception of this blog, Main Street pain invites legal and regulatory action. Investment losses are vote killers for elected officials who turn a deaf ear to calls for change.

I agree emphatically with the notion that regulations can only do so much.Worse yet, regulations could lull market participants into having a false sense of security. Post implementation of new rules and regulations, investors might think that all is good with the world when the truth could be the polar opposite, i.e. "compliance" having masked a host of bad practice nasties. I've often made the point in print and at the podium that onerous mandates induce the Law of Unintended Consequences, leading to a costly and counterproductive outcome that is antithetical to the original problem. Pick any accounting rule or regulation and it's possible to show the costs and benefits in terms of changed behavior.

There are noble-minded regulators and attorneys alike who really want to make a difference on behalf of the ultimate beneficiaries - retirees, shareholders, taxpayers, working families and so on. They are going to be beyond busy in the coming months and years unless, and until, investment stewards in need of improvement snap to. The wagons are circling. Count on luck or hunker down and get a good fiduciary risk management process in place ASAP. Otherwise, start preparing for deposition.

Editor's Note: Click here to read "Tips From the Experts: Working Effectively With A Financial Expert Witness" by Susan Mangiero (Expert Alert, Summer 2008, American Bar Association). While we prefer by far to help asset owners and their advisors before the fact, call us if you need help with "after the fact" analysis.

Default Swaps Get the Credit

In "It's Time for Swaps to Lose Their Swagger," New York Times reporter Gretchen Morgenson points the finger at regulators for not doing enough to stem the tide of moral hazard with respect to credit default swaps. While this superstar financial analyst rightly points out that risk transference continues to favor "high octane" traders and cost taxpayers and shareholders plenty, I don't agree that more "one size fits all" regulation is the answer. There is simply no evidence that a greater quantity of statutes will bridge the gap between risk management and reward. I don't have to be a behavioral expert to know that financial traders are motivated by the money they can make in a relatively short period of time. New rules beget changed incentives and often times perverse behavior. Does the law of unintended consequences ring a bell? Let's undo all the bad rules in place and focus on incentives that count. Start with bonuses that take into account the risk cost associated with expected return. Risk budgetize trading payouts.

If I'm playing by the rules, doing a great job of risk controls and acting in good faith on behalf of the proper constituencies, why should I be forced to pay for others' folly? Wouldn't my money and time be better spent on trying to encourage prudence on the part of industry participants, while informing the market at large how much my organization is doing right? For those who are in the vanguard of excellent risk management, take a bow. Get out the megaphones. Let the world know!

In December 1994, I was honored by the International Association of Financial Engineers with first place for my student paper presentation. Entitled "In Defence of a Free Financial Derivatives Market," I cite chapter and verse about why free markets trump. Though the statistics are fifteen years old, the philosophical and economic reasons remain valid to this day. I have listed a few tidbits below.

  • Compliance costs are high and divert precious resources away from shareholder wealth creation.
  • When buy-sell preferences are masked, it is difficult, sometimes impossible, to come to terms on a particular trade. The net result could be reduced volume which could lower liquidity.
  • Not all risks are equal and to treat them that way makes no sense.
  • Derivatives, used properly, can help to reduce risk.
  • Inovation is the lifeblood of economic growth. Regulation that is designed in the dark, away from public view, discourages problem-solving.
  • The right to contract with another party is part of free enterprise. Do you really want regulators to pick and choose your business partners?

 This is not to say that the status quo works. Far from it, change is needed and fast. As a shareholder, I would like to know more about the risk management policies and procedures in place at all major financial services organizations, not to mention the knowledge and experience of their board members with respect to internal controls, leverage and complex securities trading. Disclose how changes are made to strategy and tactics and on what basis.

Let the sunshine in. Information is a great equalizer.

The View From The Other Side - Regulatory Insight

Sometimes seeing over the other side of the desk is difficult, if not impossible. That's too bad because regulators and those they oversee have a lot to learn from each other. This is especially true if you embrace a primary goal of ultimately allowing for complete self-governing as a way to ensure more efficient markets.

"Pension Funds' Risk-Management Framework: Regulation and Supervisory Oversight" by Fiona Stewart (Working Paper No. 11, International Organisation of Pension Supervisors, November 2009) gets us part of the way. This new compendium of rules and regulations categorizes pension risk rules for Australia, Brazil, Germany, Kenya, Mexico, Netherlands and the UK in four areas - "management oversight and culture, strategy and risk assessment, control systems and information, reporting and communication." An audit checklist that pension supervisors can use in their examination work is offered as an appendix as is a convenient summary table that lays out country-specific risk management regulations about things such as the role of the Chief Risk Officer.

The two sides of the fence may never shake hands but studies like this enhance the understanding as to what is expected of plan sponsors by regulators.

Glass-Steagall Redux: A Gift to M&A Bankers?

 

There are few things in business that are outright bad for everyone. Usually someone, somewhere is a winner when the rules change. In the case of proposed new bank regulations, merger and acquisition ("M&A") deal makers may be about to enjoy a bonanza.

On January 21, 2010, the White House issued a press release entitled "President Obama Calls for New Restrictions on Size and Scope of Financial Institutions to Rein in Excesses and Protect Taxpayers" in which the 44th U.S. President proposes to limit banks from owning a hedge fund or a private equity fund or "proprietary trading operations unrelated to serving customers for its own profit." Additionally, unfettered deposit-taking growth would be strictly curtailed in order to avoid another federal bailout on the basis of "too big to fail." 

Another day, another mandate, another perverse outcome. 

  • Risk transfer requires a willing party to accept the uncertainty that is anathema to someone else. Companies cannot hedge unwanted price risk if there is no one on the other side of the equation. Restrictions on proprietary trading, otherwise referred to as Volcker's Rule, could arguably (and significantly) depress liquidity in numerous financial markets around the rule.
  • Lumping all hedge funds into one category is a mistake. Some hedge fund portfolios are highly liquid, with net asset values being reported to investors every day. Forcing a "one size fits all" solution to a financial market sector that varies in terms of strategy, scope and risk factors is a recipe for disaster.
  • Private equity funds tend to adopt a longer view than a trading operation. Is the suggested federal grab for power meant to discourage this source of  capital at the same time that bank credit is limited at best and cost-prohibitive at worst?
  • Why would Fannie Mae and Freddie Mac be exempt, especially given their stated track record in the area of risk-taking?

Not everyone is a sad sack. Think about all the equity carve outs and spin-offs that will result if banks are forced to shed their prop trading portfolios. This type of forced corporate restructuring will be a huge boon for investment banks, law firms and accountants who earn considerable fees for fairness opinions, buy-sell matchmaking and papering the deals.

Don't get me wrong. Excess in the trading room is bad news for everyone. Instead of binding limits introduced by regulators, why not encourage banks to increase capital reserves, evidence better risk management policies and procedures and let the market punish those organizations that get it wrong?

Perhaps not so coincidental, sales of Atlas Shrugged by Ayn Rand are skyrocketing. In its January 21, 2010 press release, the Ayn Rand Institute cites that more than seven million copies of this 1957 novel have been sold. The premise of this international best-selling book is that captains of industry who create wealth walk away from those who take, leaving the city of Gotham in the dark, unable to survive.

Investment Ethics, Balloon Boy and Sizzle

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.

 

Over the Counter No More - Blessing or Curse for Institutional Investors?

According to the Bank for International Settlements, the global over-the-counter ("OTC") derivatives market toppled $683.7 trillion as of June 2008. See "OTC derivatives market activity in the first half of 2008" (November 2008). It should come as no surprise then that hungry regulators have set their sights on this economic juggernaut. We're regulating almost everything else. Why should OTC instruments be any different?

Hot off the press, the U.S. Department of Treasury today announced plans to regulate "all Over-The-Counter derivatives" with stated objectives that include:

  • "Preventing activities within the OTC markets from posing risk to the financial system
  • Promoting efficiency and transparency within the OTC markets
  • Preventing market manipulation, fraud, and other market abuses
  • Ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties."

This is not the first time that Washington has tried a D-word power grab. In May 2002, I wrote "Anyone up for OTC Derivatives Regulation?" in which I pondered whether more government intervention would help. (H.R. 4038, mandating derivatives market reform, did not survive a Congressional vote.) Quote me as saying that "Mandatory regulation comes with a hefty price tag. Compliance diverts resources that could be expended elsewhere on behalf of shareholders. The law of unintended consequences loom large and the 'one-size-fits-all' approach encourages adverse selection. This, in turn, rewards imprudent risk-taking and exacerbates problems associated with misuse."

In 1994, the International Association of Financial Engineers selected my student paper for presentation at their annual conference in New York City. Entitled "In Defense of a Free Financial Derivatives Market," I emphasized the costs of compliance and the oft-perverse aftermath, as countless organizations scramble to avoid regulatory problems by seeking loopholes. So far, few have disputed the factors I laid out then as expensive and therefore aptly deemed as "economic bads." I'm not alone in believing that what I scribed then remains true today in terms of the many costs of regulation. The list includes:

  •  "The cost of compliance, related to regulatory recordkeeping
  • The cost associated with creating an asymmetry of market information
  • The cost of creating the problem of adverse selection by treating all risks as equal
  • The cost of abrogating the legal right of individuals to contract with agents and to own private property
  • The cost of making hedge management more difficult, and
  • The cost of stifling product innovation."

Was I prescient in 1994 and 2002? Perhaps but I think many could read the handwriting on the wall. What goes up must come down, right? After all, the topic du jour is whether any market or organization should be allowed to grow "too big to fail."

What does OTC derivative instrument regulation mean for pensions, endowments and foundations? One likely outcome is that the cost of hedging will go up at the same time that some institutional investors favor a more systematic approach to risk management. Will regulation make the world safer? Probably not. There is the danger that some will be lulled into complacency by equating more rules with less uncertainty. I'd much prefer an effort to have OTC derivative buyers and sellers better assess and manage risks. As CPA Michael Jellison wrote in response to "U.S. Lays Out New Derivatives Rules" by Kara Scannell and Corey Boles (Wall Street Journal, May 13, 2009):

"To the investor - if the instrument does not make intuitive sense to you on its face, stay away from it. That's the best form of regulation."

Touche!

Editor's Note: Email your name and fax number if you would like a hard copy of "In Defense Of A Free Financial Derivatives Market" by Susan Mangiero, 1994. Some of the statistics are dated but the principles remain valid.

Does More Financial Regulation Make Us Safer?

 

According to its March 26, 2009 press release, the U.S. Department of Treasury advocates what they call "comprehensive reform" to modernize the U.S. financial system and seek to avoid major meltdowns. Key components include:

  • Addressing systematic risk rather than focusing on "potential insolvency of individual institutions" alone
  • "Strengthen enforcement and improve transparency for all investors" as a way to safeguard consumers and investors
  • Create a "substantive system of regulation that meets the needs of the American people," avoid turf wars and "assign clear authority, resources, and accountability" to those in charge of enforcement
  • Outreach to non-U.S. regulators in order to "address prudential supervision, tax havens, and money laundering issues in weakly-regulated jurisdictions."

For those who think this is all bark and no bite, consider that U.S. Treasury Department Secretary Geithner is calling for (a) registration of hedge fund advisers above a certain size, not to mention additional reporting requirement for said alternatives (b) "comprehensive framework of oversight, protection and disclosure for the OTC derivatives markets" (c) more stringent capital requirements for organizations deemed to be major financial market participants and (d) a single independent regulator to oversee "important" entities. Click to read "Treasury Outlines Framework for Regulatory Reform" (March 26, 2009).

Not everyone thinks that more regulation is smart regulation. During a recent interview with First Business, hedge fund consultant Kristin Fox voiced two problems with a regulatory power grab. Enhanced disclosure may lull people into false security, discouraging them from probing further. Additionally, regulators may struggle to understand the economics of "complex" instruments. Click to view "Financial System Overhaul," written by Beejal Patel (March 26, 2009).

Let me ask what may seem like simple questions.

The point is that we've had more than a trivial amount of regulation in place for years yet we've still had problems. How are new mandates going to trump existing rules?

Retirement Plan Pundits Address Conflicts of Interest

On March 24, 2009, various experts gave testimony before the U.S. House of Representatives Committee on Education & Labor, Health, Employment, Labor and Pension Subcommittee about potential conflicts of interest in the event that firms are allowed to give "conflicted financial advise" to 401(k) plan participants. Click here to access the testimonial statements of experts that include:

  • Ken Baker, Corporate Director of Human Resources Applied Extrusion Technologies Terra Haute, IN
  • Mercer Bullard, Founder and President Fund Democracy, Nonprofit Advocate for Mutual Fund Shareholders Oxford, MS
  • Sherrie Grabot, CEO GuidedChoice Los Gatos, CA
  • Charles Jeszeck, Assistant Director, Education, Workforce and Income Security Issues U.S. Government Accountability Office Washington, DC
  • Melanie Nussdorf, Partner Steptoe & Johnson LLP, on behalf of SIFMA Washington, DC
  • Andrew L. Oringer, Partner White and Case, LLP. New York, NY

Pork Spending Gone Wild - Warning, R Rated News

Image Source: http://www.cagw.org

I awoke feeling zippy - another day, another gift of life. While I remain hugely appreciative for what I have (good health, great family and much more), I must say that watching Sunday talk shows does not inspire. Today's theme was the economy and what is being done around the world to get us back on track. Unless you've just come back from a remote island, you are all too aware that global economic conditions are anemic at best and on life support at worst. Adding hundreds of billions of dollars to our national debt is bad enough. Earmarking monies for questionable projects is beyond the pale.

Legislators everywhere - Practice what you preach. We don't care what political party you represent. We simply want to know that you are good investment stewards of our hard-earned money. If corporate executives are chastised for taking private jets with taxpayer dollars, why is it okay for you to seize our dollars for your pet project? Individuals everywhere are making tough decisions about their household finances. We don't get to print money. If it ain't there in the checking account, we make do. Why is that rocket science? Here are a few items to ponder.

  • Citizens Against Government Waste reports that proposed earmarks include $2.9 million more for shrimp acqualculture research, "being done in seven states, including Arizona, where the most likely outcome is the shrimp will just fry in the sun." (See "CCAGW Calls Failed Omnibus Vote an Urgent Wake-Up Call," February 12, 2009.)
  • Paul Kane of the Washington Post writes that manure management and water taxis have been given the thumbs up by the U.S. Senate. (See "Democrats Stop Effort to Remove Earmarks," March 5, 2009.)
  • According to IOUSA.com, a new film documentary about the U.S. debt, three programs alone (Medicare Parts A and B, Medicare Part D and Social Security) account for an eye-popping $53 trillion in present value terms (or an added debt burden of $175,000 per person). 

For plan sponsors, the state of the economy is the elephant in the room.

At the micro level, you are confronted with new challenges galore: (a) asset allocation revisions (b) whether to make up for losses by possibly doubling up on risk (c) longer lifespans and (d) new accounting and disclosure rules that give problem plans (regardless of plan design) nowhere to hide.

At the macro level, legislators are almost surely NOT going to take the blame for the inevitable fallout associated with underfunded retirement plans - lowering benefits, raising taxes or both. As the doubtful viability of Social Security and other entitlement programs becomes more apparent, plan sponsors will be handed the bill and told to "do something to help people retire in dignity."

No suprises here - This messge is R rated:

  • Recession
  • Regulation
  • Rationing
  • Retirement Postponed
  • Rough Times Ahead
  • Restrictions on Decision-Making Flexibility
  • Ridiculous Perversion of Economic Incentives

Send an email with your favorite "R" word and/or example of wasteful spending. Let's remind the spendthrifts on both sides of the aisle that every dollar they earmark is the result of someone's gainful employment and not to be frittered away.

Profit Privatization and Socialization of Losses

Complex problems deserve a lively debate about potential solutions. That is why I've asked both colleagues and critics to guest blog on www.pensionriskmatters.com from time to time. Interestingly, few have taken me up on the offer (though I get plenty of emails about various posts). One person who has accepted the challenge to disturb and entice is Mr. Wayne Miller. Formerly CEO of Denali Fiduciary Management and a self-described passionate fiduciary advocate, Wayne invites readers to ponder his suggestions about how to (a) manage the current banking crisis and (b) save the U.S. Social Security system. When asked why he expended time in penning his thoughts, Wayne wrote that "there must be a very clear example as to how personal responsibility will be incorporated into a market principle-based framework that could lead us out of this storm" and move our nation away from "political expediency" in order to avoid being "condemned to stir inside the box we made for ourselves."

While Wayne and I have had more than a few lively debates about the merits of free markets, he and I agree that the improvement of investment best practices redounds to everyone's benefit. 

Read Wayne's proposal. Decide for yourself. You can sign his petition by visiting www.sociallyresponsiblerescue.org.

Connecticut State Legislators Target Hedge Funds

  

 Following up on "Hedge Fund Haven Gets Double Whammy from Pension Plan and New Regulations" (March 2, 2009), here are links to the three regulations being considered by the State of Connecticut General Assembly:

Here are a few interesting questions.

  • If the Nutmeg State implements and enforces new hedge fund laws, anticipating that investors are now protected, how will they explain any future losses?
  • How will legislators seek to protect investors in the case of hedge fund look alikes? Federal Reserve Chairman Ben Bernanke referred to AIG as an "irresponsible" hedge fund. (See "AIG An 'Irresponsible' Hedge Fund, Regulators Say," FINalternatives, March 4, 2009.) A quick read of the aforementioned state proposals would suggest that these proposed laws will not apply to this insurance giant or other non hedge fund "hedge fund."
  • In the event that the U.S. Congress and non-U.S. regulators each create their own set of rules and they conflict with one another, which ones trump?

It's Ayn, Not Anne

Tonight's commentary deviates from pension issues but can't be helped - too many headlines about new rules and regulations...

Whether you embrace her philosophy or disdain her work (and ignoring your feelings about her personal life), Ayn Rand remains a best-selling author, long after her death. A quick check of Amazon.com today reveals that Atlas Shrugged (Centennial Edition - Hardcover) ranks 133 with 974 of 1,660 book reviewers giving this 1200+ page novel a rating of 5 stars. The Fountainhead (Centennial Edition - Hardcover) ranks 6 in Literature & Fiction and 2,353 overall.

In "Why Do CEOs (Still) Love Ayn Rand?," BNET.com author Kim Girard  writes that "Many executives are taking refuge in Rand's heroes today," believing that "she was right" in railing against "incompetent CEOs, federal bailouts, bloated government." Rand died in 1982 yet her prescient words describe much of what is happening now, twenty-seven years later.

With one power play after another to further socialize the U.S. economy, Ayn Rand must be rolling over in her grave. Certainly free market advocates (myself included) are taking it on the chin big time. I know, I know. There are those who think that deregulation was the culprit and further regulation is the answer. Alas, where does one begin?

  • Banks around the world have long been heavily regulated so it is factually incorrect to say that the financial services industry was unregulated. Nothing could be further from the truth.
  • If you accept the reality that banks have been heretofore heavily regulated, how do you explain mind-boggling losses, let alone support increased regulation as a panacea?
  • What exactly is "smart" regulation and how does that differ from what I guess one would describe as "dumb" regulation?
  • What problem has been fully solved by nationalizing private property? (I welcome readers' feedback here and invite you to drop me a line. Let me know if I can publish your comments or whether I should attribute them to an anonymous party.)
  • In a truly free market (a theoretical construct at this point), who has the right and/or intellect to decide how much someone can earn or what constitutes an appropriate price at which two willing individuals trade? (Yes, I agree that there are many situations that preclude an unfettered exchange of information that would otherwise determine market equilibrium. For advocates of additional regulation, how do you net the costs of further impeding information and creating perverse incentives against projected benefits? How is an onslaught of bureaucracy meant to help Joe and Sally Consumer or BIll and Penny Investor?)

I could go on but I'll leave readers with my long-held view. Freedom is not free. When it comes to the proper governance of capital markets, self-interest should drive participants to carry out financial best practices, recognizing that the costs of implementation are far outweighed by the benefits of fair exchange. In a truly free economy, bad players would be recognized as such and lose business as clients, shareholders and vendors flee as fast as they can, seeking those who accept responsibility and strive to earn a risk-adjusted profit by providing a quality product or service. In contrast to pundits who avow the tragedy of the commons, capitalists counter that public ownership leaves no one properly motivated to take care of an asset and so it eventually deteriorates, being useful to no one.

About a month ago, I had a prickly discussion with my nephew. A prize-winning member of his high school debate team, he called me with questions. Apparently, his freshman economic professor had urged his class to enthusiastically support higher, "fairer" taxes on the "rich." No doubt Dr. "I'll Take Other People's Money Please" is thrilled with the just-published proposal to tax "wealthy" families in order to pay for government largesse. As I explained to my sister's son, why should initiative be punished? If someone works longer hours, takes calculated risks with his or her own money to start a busines, goes to school at night to improve skils, studies for a professional certification or otherwise retool for a new career, should this person be treated as a societal pariah? (By the way, as a former professor, I implore those in authority to engage young minds in a lively debate rather than push economic and philosophical dogma. Let them decide for themselves, regardless of the outcome.) Lest you say that the "rich" get unfair tax breaks, I concur but add that the current tax system is a gigantic mess (a view held by countless legislators who keep adding to the complex maze).

So there you have my soapbox speech for tonight. Some of my dearest friends couldn't disagree with me more. I count my blessings for the right to open discourse.

France Pushes for Hedge Fund Regulation

Financial Times reporters Ben Hall and James Mackintosh report that France is calling for stricter regulation on hedge funds. Possible changes include: (a) higher capital requirements imposed on banks that lend to hedge funds and otherwise provide services as prime brokers (b) more transparency and (c) mandatory registration of hedge funds with regulators "in the country where they are sold." (See "France to call for hedge fund crackdown," February 12, 2009.)

France's finance minister, Christine LaGarde, has been calling for additional hedge fund rules for months, urging other countries to band together in this effort. Just a few months ago, LaGarde told Daily Telegraph readers that "the health of hedge funds had long been her prime concern. She cited the adverse impact of leverage for many alternative fund managers, some of whom were forced to sell assets quickly in order to stay afloat. See "Hedge Funds could be next to be hit, says French finance minister Christine Lagarde" by Henry Samuel and Harry Wallop (October 17,2008).

With heightened public scrutiny, the inevitable increased costs of regulation can't be welcome news to industry participants. Investors will have to weigh the perceived benefits of new rules against the potential economic impact on performance. Picking sides may not be possible for too much longer.

C'est la guerre! 

Full Moon Influence - Will Financial Normalcy Return?

In case you were out and about today, there was a fantastic full moon that caught my eye and gave me pause. Okay, it didn't look quite like this lovely photograph, courtesy of The National Aeronautics and Space Administration ("NASA"), but it sure looked magnficent to this astronomy layman's eye. The superstitious say that a full moon encourages crazy behavior. Listening to the ongoing debates about the jumbo U.S. stimulus program of late makes me wonder if Washington isn't moonstruck. Talk about a runaway train. Yet free-spending Congressmen and women are not the only "luneatics." A Connecticut colleague says that people are doing illogical things now that he has never seen is his 40-year career as a corporate contracts attorney. According to "Some See a Rat in the Year of the Ox for Investors Seeking Advice," reporter Jonathan Cheng writes that wealthy clients are turning to feng shui as a way back to prosperity (Wall Street Journal, February 9, 2009). Well, best of luck to them. Maybe it couldn't hurt.

Editor's Note:

Vive Le Free Markets - Oh Never Mind!

French economist Frédéric Bastiat must be rolling over in his grave as more and more headlines decry capitalism in favor of stringent regulation. In "Policy Makers Weigh Fed Oversight of Derivatives" (February 2, 2009) Wall Street Journal reporter Deborah Solomon writes that Washington movers and shakers are all a twitter about whether to regulate over-the-counter derivative instruments. (One could argue that some regulation currently applies since federally regulated banks dominate this space but that's a discussion for another post.) House Financial Services Chairman Barney Frank (Democrat, Massachusetts) is quoted as saying that "It's not a brand-new regulation but an expansion of the authority of the Federal Reserve."

According to his official website, Senator Chuck Grassley (Republican, Iowa) - along with Senator Carl Levin (Democrat - Michigan) - have introduced legislation to "close a loophole in securities law that allows hedge funds to operate under a cloak of secrecy." In "Grassley and Levin introduce hedge fund transparency bill" (January 29, 2009), this new legislation, if passed, would empower the U.S. Securities and Exchange Commission ("SEC") to force hedge funds to register, thereby putting them under the auspices of the Investment Company Act of 1940. 

In his January 29, 2009 statement, Senator Levin described three basic elements of The Hedge Fund Transparency Act, besides registration. These include the filing of an annual statement that would be available to the public, the maintenance of books and records as required by the SEC and the cooperation with the SEC as relates to examination or information requests.

Levin adds that "The information to be made available to the public must include, at a minimum, the names of the companies and natural individuals who are the beneficial owners of the hedge fund and an explanation of the ownership structure; the names of any financial institutions with which the hedge fund is affiliated; the minimum investment commitment required from an investor; the total number of investors in the fund; the name of the fund's primary accountant and broker; and the current value of the fund's assets and assets under management. This information is similar to what was required in the disclosure form under the SEC's 2004 regulatory effort. The bill also authorizes the SEC to require additional information it deems appropriate."

About two weeks earlier, the President's Working Group on Financial Markets ("PWG") released its best practices for hedge funds, encouraging market participants to adopt comprehensive policies and procedures to (hopefully) thwart problems. The institutional version, entitled "Principles and Best Practices for Hedge Fund Investors: Report of the Investors' Committee to the President's Working Group on Financial Markets" (January 15, 2009), includes an entire section devoted to fiduciary issues. Some of the text is overly broad but it is a good start in terms of getting people to think hard about subjects such as suitability and oversight.

The industry version, entitled "Best Practices for the Hedge Fund Industry: Report of the Asset Managers' Committee to the President's Working Group on Financial Markets" (January 15, 2009), has a noteworthy section about valuation (a topic near and dear to my heart). I am particularly interested in tracking which hedge funds decide to set up a valuation committee, if one does not currently exist. If hedge fund managers follow the report's recommendations, they will likely be spending lots of money on independent pricing services.

Two key questions loom. Will industry attempts at best practices slow down or possibly ward off increased regulation? If not, will regulation and enforcement parallel or conflict with suggested best practices?

This blogger gal goes on the record as favoring industry self-regulation. Sadly, when too few participants fail to recognize the benefits of taking responsibility to preserve open and fair markets, the strong arm of government is inevitable. Consider what Bastiat wrote in the 1800's, still relevant today:

  • "Everyone wants to live at the expense of the state. They forget that the state wants to live at the expense of everyone."
  • "Taxes must, in the end, fall upon the consumer."
  • "The worst thing that can happen to a good cause is, not to be skillfully attacked, but to be ineptly defended."

Whether we end up talking about "smart" or "better" regulation, financial market participants STILL have a chance to eat, live and breathe best practices, for themselves and for their investors.

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.

Is More Regulation for Corporate Plan Sponsors On Its Way?

Two items caught my eye of late, mostly because they seem to intimate new bargaining power for organized labor. Yes, I know, it hardly seems plausible when automotive workers are currently being challenged to accept lower benefits in order to keep their employers afloat.

In "Organized labor 'thrilled' with Obama's pick for labor secretary" (December 18, 2008), CNN.com reports that Representative Hilda Solis, if confirmed, would be considered a "voice for people who work." Hailing from California, this Democrat lawmaker is the "daughter of two immigrant workers and union members."

In "The Employee No Choice Act" (CEO Magazine, November/December 2008), law professor Richard Epstein writes that a new political regime in the United States will force a "major sea change in labor relations law." This notable University of Chicago free marketeer opines that interest arbitration, a key component of this proposed legislation, empowers an arbitration panel to "dictate a 'first contract' lasting two years that will govern all aspects of the employment relationship." Wages, work conditions, job security and outsourcing are a few of the items that can be decided by those outside of any particular corporation.

Epstein offers that unionization could become a foregone conclusion, with employers having little or no sway over the final outcome, once an initiative to organize commences. In stark contrast, he writes that arbitrators "are empowered to flesh out all the book-length terms of that first key contract, terms never put to a vote." He adds that workers who sign cards to authorize the creation of a union will not be permitted to withdraw them if they change their view later on. Epstein further adds that this legislation, if approved, would be "tantamount to giving a new union a powerful claim on  firm assets."

If Epstein is right, how will shareholders, plan participants and union members co-exist peacefully, if at all? Many questions arise, a few of which are shown below:

  • Will shareholders' economic interests in an ongoing concern become inferior to those of union members and, if so, how will that reveal itself in share price?
  • How will union members deal with conflicts that arise from wearing multiple hats as might be the case if a Taft-Hartley plan owns stock issued by contributing employers?
  • In the event of a bankruptcy filing, who gets what and when? Will union members rank pari passu or superior to everyone else?
  • How will a multinational firm fare if its U.S. operations fall under the auspices of the Employer Free Choice Act but offshore units are unaffected by similar rules?

This next year will be an interesting one for sure but not likely to be one in which everyone sits on the same side of the table.

Editor's Note: For an opposing perspective about the Employee Free Choice Act, click to visit a site sponsored by AFL-CIO.

What People Have to Say About OTC Derivatives

According to the Bank for International Settlements ("BIS"), the global market size for over-the-counter ("OTC") derivatives, as of June 2008, exceeded $683 trillion (yes trillion) or $683,725 billion. (These numbers reflect notional amounts outstanding.) Notably, an expanded use of interest rate swaps helped to push non-exchange traded interest rate derivative product outstandings above $450 trillion, a rise of 17% over the last half-year. It would be helpful to know whether, and to what extent, pensions' use of Liability-Driven Investing strategies influenced the numbers. Click to access "Table 1: The global OTC derivatives market."

Since June, a lot has happened in the global market place. Until BIS reports updated figures, it is hard to quantify how various players have responded to increased volatility with respect to their use of OTC instruments such as swaps, options and structured products. One might logically assume that valuation and liquidity concerns will reflect themselves in lower numbers for H2-2008. On the other hand, uncertainty could encourage hedging, in which case both OTC and exchange-traded activity might see a boost.

In the meantime, I asked a few financial market participants for their feedback. Here is what they had to say in answer to the following query.

Do You Think More Regulations Will Inhibit the Use of OTC Derivatives by Institutional Investors?

  • A director at a non-U.S. financial organization advises regulators not to throw the baby out with the bath water, adding that "Regulation should be framed to drive generic flows into more efficient 'plumbing' systems, while allowing custom-built trades to proceed when standardized terms don't make sense. Unless the market volunteers solutions, one must fear that knee jerk regulation will fail to differentiate, and therefore deprive end-users access to these undeniably valuable risk management tools."
  • Mr. Daniel Chertok, a quant by background, writes that "Any regulation inherently stifles innovation. However, it may deter those who should not be in this business from entering in the first place or encourage someone to rightly exit the market. There is likely to be a loss of liquidity but a drop in defaults should follow. What regulation will not do is eliminate the next bubble that occurs due to reckless derivative trading."
  • Mr. Luis Antonio Rangel, commodity derivatives professional and now President of Rockford Brownstone Rangel, thinks that regulation will inhibit use of OTC swaps and other kinds of derivatives by institutional investors. He adds that "the big downturn in this market recently has less to do with fear of regulation and more to do with counterparty risk. Regulators may help to repair the OTC market if their rules: (a) can improve market transparency as relates to how much leverage a particular manager employs (b) shed light on risk exposures to various counterparties across the spectrum For example, if Company DEF has a plain vanilla swap with Bank ABC but Bank ABC has a complex swap with Hedge Fund XYZ, how is Company DEF potentially hurt if Hedge Fund XYZ goes belly up? (c) improve investors' knowledge of liquidity, especially for instruments that have heretofore been deemed "low risk" and (d) mandate issuers of credit default swaps to reserve capital, in the same way that insurance companies must set aside monies. Too much regulation could push business offshore or impede transactions that, for viable economic reasons, should take place."
  • Mr. Patrick Rooney, Business Analyst at Trading Technologies, writes that "Initially, yes, more regulation will freeze OTC trading. As participants adjust to the new environment, the OTC market will flourish as new participants join. There are many misconceptions regarding the complexities and risks involved associated with OTC transactions. A centralized clearing environment is likely to vastly improve things."

Email us your comments. It would be great to get your feedback.

Pension Plan Metrics - What's Wrong With This Picture?

In a November 12, 2008 letter to Congress, the American Institute of Certified Public Accountants ("AICPA") and 300 plan sponsors and pension associations urge new legislation that would help employers avoid "huge, countercyclical contributions," for credit crisis induced losses. The authors' stated rationale is that monies diverted to support defined benefit plans could instead be used for "current job retention, job creation and needed business investments." The letter suggests that, worse yet, employers may be forced to freeze plans altogether unless the Pension Protection Act of 2006 is modified to allow "full smoothing of unexpected losses." Click to read the letter.

One of the letter writers, Watson Wyatt, criticizes the averaging method which, unlike smoothing, does not include projected returns as part of the determination of market values. According to this consultancy's website, "averaged assets cannot exceed (or trail) current market value by more than 10 percent. Prior rules allowed for 20 percent. When asset values drop sharply as they have in recent months, this tight limit around market value creates considerable funding challenges for pension plan sponsors." Finally, the Pension Protection Act of 2006 accelerates replenishment of "underfunded" plans, putting pressure on employers to pony up cash at the same time that they are unlikely to be flush.

While this blogger fully empathizes with the economic pain that can occur when "artificial" reports force real change (i.e. rating downgrade, higher cost of capital, cash squeeze, share price hits, etc), I think Joe and Sally Retiree are still left in the dark as to the financial soundness of their retirement plan. This knowledge gap about which numbers are the right numbers is something we've addressed here before. (See "Will the Real Pension Deficit Please Stand Up?" June 22, 2006.) Global accounting imperatives, national laws and regulatory urgencies add to the confusion about pension metrics - which ones deserve attention and which ones are outright "bad" representations of a plan's ability to send checks every month, made more so when they result in expensive consequences.

This entire debate reminds me of a great line in the 2008 HBO movie entitled "Recount." In this small screen version of uncertainty related to the 2000 U.S. presidential election (remember hanging chads?), the Kevin Spacey character turns to his colleague at one point and says, with great frustration, how he wishes he just knew who won.

In the same vein, one asks - "What is the truth?" Understandably, plan sponsors are upset at having to outlay cash contributions "forced" by the Pension Protection Act of 2006, FAS 158 and/or other "cannot ignore" dictates but should they not counter with a robust solution that gets to economic reality? Should retirees be worried that all or some published numbers lead astray or assume instead that pension decision-makers have it under control?

According to best-selling business author and leadership guru, Warren Bennis, "We have more information now than we can use, and less knowledge and understanding than we need. Indeed, we seem to collect information because we have the ability to do so, but we are so busy collecting it that we haven't devised a means of using it. The true measure of any society is not what it knows but what it does with what it knows."

I raise my hand for reporting rules that (a) reflect the sponsor's true ability to pay, now and later on (b) avoid confusion (i.e. too many regulations can result in conflicting data points or real questions about how to comply with statutory reporting standards) (c) explain the process by which the plan manages its alphabet soup of pension risks and (d) help shareholders, taxpayers, plan participants and other interested parties assess whether a defined benefit plan is "excessively risky."

Is this too much to ask?

Pensions and Politics: Argentina Seeks to Nationalize Private Pensions

According to Wall Street Journal reporter Matt Moffett, Argentina's leader would like to nationalize the private pension system, allowing this South American country to "raid new pension contributions to cover short-term debts due in coming years." The picture appears bleak indeed. Trounced by lower commodity prices and rising IOUs, the $30 billion plan looks like a juicy target. (See "Argentina MakesGrab for Pensions Amid Crisis," October 22, 2008).

In "Argentina stocks, bonds plunge on pension reform plans" (October 21, 2008), Reuters reports that investors look unfavorably upon a takeover of the private retirement system. In "Argentina Pension Funds Attack Government Plan, Defend Result" by reporter Michael Casey (Dow Jones Newswires, October 21, 2008), a coalition of Argentinian private pension plans decry the need for a takeover. Asserting the need to review long-term performance, private pension leaders say "the reform project was founded on results incurred during the current financial market crisis."

This reminds one of the optical illusion that asks the viewer to recognize both a beautiful woman and an "old hag." Some see Argentina's pension reform as good news and others question the real motivation behind such a proposal.

Is this likely to become a trend around the world? We never thought global megabanks would be nationalized and now they are.

Successful Hedge Fund Manager Bids Adieu, Insults and All

In a somewhat scathing goodbye letter to his investors, hedge fund manager Andrew Lahde lambastes his investors. Calling them "low hanging fruit" and worse, click here to read for yourself.

My rationale for posting the letter is not to sensationalize but rather point out that people seem to be getting more vocal about the economic and political state of affairs. I think this angst is going to have a dramatic impact on the legislative landscape. Recently asked whether I think more regulation is on its way, I answered "without doubt."

Plan sponsors are likely to see a lot more politicians passing the retirement benefit plan "hot potato. The calculus is simple.

  • More pension plan woes + Social Security gaps (or international equivalents)
  • Blame game begins
  • Hold plan sponsors responsible for helping retirees make up for losses.

In response, plan sponsors that take pension governance seriously (and are demonstrated fiduciary leaders) are likely to have more influence on the outcome.

Low-touch regulation, not black letter rules

I had the pleasure of speaking twice at the annual SIBOS conference last week in Austria. (The 2007 event was in Boston. The 2009 forum will be held in Hong Kong.) The first panel could not have been more timely, given the current regulatory frenzy underway. Sure to cause a stir on any day, you can imagine the lively banter as market prices tumbled. Here is a summary of what ensued. This article was first published in Sibos Issues, SWIFT's daily newspaper devoted to reporting the Sibos conference sessions. You can view more articles and download each issue from SWIFT's website.

                           Regulation that fails to keep up could damage the funds market

Panelists at Wednesday's session on whether regulation helps or hinders the investment funds industry claimed to see no threat from regulation as such but plenty from sledgehammer regulation that failed to keep up with the market.

"We work in an industry that prefers light-touch regulation to black-letter rules," said moderator Bob Currie, editor of FSR. "It has good reason to." Overall, the question for panelists was not whether but how much and what kind. "Regulation creates trust and makes the system work. It's a fiduciary business with a risk asymmetry between investor and provider," EFAMA chairman Mattias Bauer pointed out. "But regulators need to ensure they create a level playing field between products, with no regulatory arbitrage."

In the UK, that's precisely what regulators had failed to do, claimed EU Consumer Representative Mick McAteer. By treating insurance products and mutual funds differently, he said, UK regulators had "failed to improve market conditions, increase confidence in the market, or create a level playing field for consumers."

A.P. Kurian, chairman of the Association of Mutual Funds of India, took a contrarian position, urging "regulatory activism" as an approach and posing as a metric for existing regulations, "whether it had survived the test of a crisis." He claimed "strict regulation and strict compliance" had helped the funds industry in his native India minimize the impact of current economic volatility.

In contrast, Pension Governance CEO Susan Mangiero warned that over-regulation counterproductively increased risk because it impeded the transfer of information between buyers and sellers. "When you have excess regulation, it becomes difficult to reward good people and penalize bad ones because everyone's concerned with compliance rather than best practice in risk management. The result is that they have no incentive to do what they should be doing," she said.

A compromise came from Jack Gaine of the Management Funds Association, who cited what he described as a "compact" between regulators and the US hedge fund industry whereby hedge funds exclusively target institutions and high net worth clients in return for a waiver on short-selling restrictions.

In any case, Mangiero suggested finally, the debate was most likely academic. "I advocate a free market approach but what I expect is more regulation," she said.

                                                                            * * * * * *

Editor's Note: While I realize that espousing capitalism during a horribly tough economic environment is inviting verbal tomatoes, it is critical to acknowledge both sides of the argument. Check out the video entitled "The Resurgence of Big Government" by Yaron Brook, September 18, 2008. Dr. Brook is the President of the Ayn Rand Institute and a former finance professor.

Treasury Program to Buoy Money Market Funds

New York Times reporter Tara Siegel Bernard cautions that some money market funds do not represent a safe haven. Who would have thunk it? Several asset managers have now broken the buck, reporting Net Asset Values less than a dollar. See "Money Market Fund Enter a World of Risk" (September 17, 2008).

With everything else going on, perhaps it is no shock that the U.S. government has responded with a quick fix. In "Temporary Treasury Program to Support Money Market Funds," readers learn that this new measure seeks to "enable money market funds to maintain stable $1.00 net asset values." Click to access Notice 2008-81, effective September 22, 2008.

Details are still evolving though Deal Book adds that the U.S. Treasury Department will "use $50 billion to back money market mutual funds whose asset values fall below $1." Those who pay a fee are eligible to have their holdings insured. See "Treasury to Backstop Money Market Funds," September 19, 2008."

Federal insurance is likely to be good news for 401(k) plan participants who are busily shifting funds to what they hope are safer choices. The impact on taxpayers' wallets is yet to be determined.

Testimony of Dr. Susan Mangiero About "Hard to Value" Assets

 

At the invitation of the ERISA Advisory Council, I presented testimony about "Hard to Value Assets" on September 11, 2008 in Washington, D.C. Some of the questions I was asked to answer are listed below:

  • Should valuation issues play a role in the selection of plan investments, and in achieving proper asset allocation and diversification?
  • What, if any, modifications to plan investment policies and guidelines should plans consider when utilizing "hard to value assets?"
  • As fiduciaries, what do you deem to be or what do you expect to be "hard to value assets?"
  • Who can the fiduciary rely upon when ascertaining the value of "hard to value assets" when the fiduciary is incapable of valuing, in order to fulfill their fiduciary responsibility to plan participants?
  • What valuation policies and procedures should a fiduciary adopt when holding "hard to value" assets?
  • What disclosures and education measures are required or suggested for participants and fiduciaries with respect to plans which invest in "hard to value" assets?

Given the recent tumult in the global financial markets, it seems as if an eternity has passed since the September 11 hearing date. Valuation continues to be a hugely important topic. I hope that my comments are informative and helpful to readers. Let me know what you think. Click here to read "Testimonial Remarks Presented by Dr. Susan Mangiero." 

SIBOS 2008 in Vienna

I'll be blogging from Vienna, Austria shortly. I look forward to attending the SIBOS 2008 conference, billed as "the world's premier financial services event." I am honored to be speaking twice, once about regulation and a second time about pension issues. The theme is definitely global and the mood is serious. If you want more information, click here. The program is jam packed with terrific sessions and will no doubt offer interesting topics for www.pensionriskmatters.com.

I've included details about my participation below.

EVENT ONE: September 17 - "Will regulation help or hinder the investment funds industry?"

The funds industry is facing a tide of regulation, of which UCITS (Undertaking for Collective Investment in Transferable Securities) III and IV are the latest examples. In addition, the European regulator is demanding more transparency from the fund industry, especially around cross - border distribution (for example the Klinz report). How much impact will these initiatives have? What does the industry need to do to comply? Can initiatives such as the Fund Processing Passport provide an answer? And, most importantly, will the regulation help or hinder the industry going forward?

Speakers:

  • Mattias Bauer, Chairman, EFAMA
  • John G. (Jack) Gaine, Managed Funds Association
  • A.P. Kurian, Chairman, Association of Mutual Funds in India
  • Mick McAteer, EU Consumer Representative, Fin-Use
  • Susan Mangiero, CEO, Pension Governance LLC

Moderator:

  • Bob Currie, Editor, FSR Magazine

EVENT TWO: September 18 - "Where is my pension?"

The issue of pension shortfalls is a universal one, caused by a combination of longer life expectancy and inadequate planning. How does the financial services industry need to respond? In most markets, you need returns way above forecast beta. Does that mean that leveraged investment will become the norm? How should we fill the holes?

Speaker:

  • Robert Brown, CEO, Ausmaq
  • Glyn Edward, Funds, Custodian and Administrators, SWIFT
  • Susan Mangiero, CEO, Pension Governance LLC
  • Clive Witherington, Head of Business Development, Watson Wyatt

Pensions for Sale?



According to "Now Wall Street Wants Your Pension, Too" by Matthew Goldstein (Business Week, August 5, 2008), troubled banks have no business fiddling around with pension caretaking.  Citing a $2.3 trillion "pension honey pot" that could grow to $7+ trillion in a few years, Goldstein says pension buyouts would be a great prize for investment banks, hedge funds, private equity funds and insurers. (Editor's Note: I've seen estimates of much larger numbers but the message is the same. There is thought to be "gold in them thar hills.)

What motivates advocates of the pension transfer movement? Let me count the ways. More than a few corporations may seize the opportunity to clean up their balance sheets and income statements as new accounting rules kick in, making "problems" more visible to shareholders. Some posit that taxpayers benefit if certain plans are transferred to stronger financial buyers, giving these plan sponsors a fighting chance to steer clear of bankruptcy court. As a result, the Pension Benefit Guaranty Corporation ("PBGC"), could arguably stablilize or even reduce its $14+ billion deficit. (Though the PBGC is technically funded by insurance premiums paid by plan sponsors, experts suggest that mounting IOUs could potentially result in a bailout by Uncle Sam.)

This trend to take over pension liabilities by third parties, popular in the UK, seems to have hit a snag in the U.S. According to an August 6, 2008 press release ("Treasury, IRS Issue Ruling Preventing Certain Pension Transfers"), newly issued Revenue Ruling 2008-45 states that "a transfer of a tax-qualified pension plan from an employer to an unrelated taxpayer when the transfer is not connected with a transfer of significant business assets, operations, or employees, is not permissible under current law. This is clearly a big disappointment to Wall Street as banks have been busy at work, assembling teams to value pension liabilities and trade them, in anticipation of developing a lucrative transfer business.

Accompanying this somewhat rare tax promulgation, readers are told of legislative preferences on the part of the current Administration (IRS, U.S. Department of Labor, U.S. Department of Commerce and the Pension Benefit Guaranty Corporation) that might eventually open the door to pension liability sales. Relevant text is excerpted below:

"Under the legislative framework, a pension plan (or portion of a plan) under which benefits are no longer accruing (i.e. a frozen plan) could be transferred to an entity unrelated to the employer (or former employer) of the participants in the plan, provided that certain conditions are met. The conditions would reflect the following fundamental requirements:

  • Plan participants, their representatives, and ERISA regulators would be required to receive advance notice of a plan transfer, and the parties to the transaction would be required to provide regulators information necessary to review and approve the proposed transaction.
  • Only financially strong entities in well-regulated sectors would be permitted to acquire a pension plan in a plan transfer transaction.
  • The parties to the transaction would be required to demonstrate that participants' benefits and the pension insurance system would be exposed to less risk as a result of the transfer, and that the transfer would be in the best interests of the participants and beneficiaries.
  • Limitations on transfers would be imposed to limit undue concentration of risk.
  • Transferees and members of their controlled groups would assume full responsibility for the liabilities of transferred plan and would comply with post-transaction reporting and fiduciary requirements.
  • Subsequent transfer transactions would be subject to the rules applicable to original transfer transactions."

Don't count the financial institutions out yet. No doubt the next Congress is likely to receive a lot of inquiries from the bank lobby to initiate legislation in favor of pension buyouts. On the positive side, well-capitalized and properly managed banks and other types of money powerhouses could draw on sophisticated risk analytics to strengthen plans. In contrast, poor risk management practices could worsen things. (See "Bank Risk Managers - Missing in Action," November 26, 2007.)

The fiduciary question is of course a big one. Is there a  possibility that a financial institution takes over a pension plan and finds itself in the uncomfortable position of being loyal to plan participants at the expense of shareholders or vice versa? Cynthia Mallett, Vice President, Corporate Benefit Funding, Met Life adds that "Stranger-owned pension plans raise both philosophical and public policy issues, none more telling than the potential for placing plan participants' interests in the hands of unrelated investors who are not regulated in the same fashion as insurers." 

ERISA Attorney Dan Wintz, partner with Fraser Stryker PC, offers the following insight. "While the practice of 'selling' pension plans and transferring their sponsorship to unrelated companies (that is, speculator or investment companies that do not employ the participants covered by the plan) has not yet become widespread, it is heartening to see that the Internal Revenue Service intervened early. However, the Ruling may be overly broad in its application and could prohibit or impede some plan transfers in legitimate re-organizations or other transactions that do not involve the direct transfer of business assets, operations, or employees from the employer to the unrelated taxpayer which will maintain the plan. We will have to see whether this is an absolute prohibition (as appears to be stated in the Ruling) or if it can be applied on a 'facts and circumstances' basis where there is a legitimate business purpose for the arrangement and there are protections for the plan's participants."

A fellow of the Society of Actuaries, David Godofsky, partner with Alston + Bird LLP and leader of the Employee Benefits and Executive Compensation Group, concurs that buyouts may serve a vital function. His comments are provided below.

"As for the meaning, the ruling was rather narrowly tailored to a specific fact pattern, which has been widely discussed and known as "selling" pension plans. Here is a very simplified version of the basic idea:

  • Company X has a frozen pension plan with assets of $100 million and liabilities of $100 million. The liabilities are measured by reference to mortality tables and interest rates that are intended to approximate the cost of buying annuities, or the cost of funding those pension benefits when very safe investments are used. In other words, the assumed rate of return on the $100 million of assets is very low, reflecting investments that are nearly risk free.
  • However, Company Y believes it can invest the assets of the plan to achieve a higher rate of return. If it does so successfully, there will be money left over when all benefits are satisfied... possibly a LOT of money.
  • So Company Y offers to buy the pension plan from Company X. A shell corporation ("ShellCo") is formed as a sub of Company X, and then ShellCo assumes the pension plan from Company X. Company X sells ShellCo to Company Y for $2 million.
  • Company Y has no employees and no other assets. Company Y invests the $100 million in investments designed to beat the low assumed rate of return. The assets grow to $120.
  • Company Y then buys annuities to cover the liability for $100 million, and is left with a pension plan with no liabilities and $20 million. It then finds a company with an underfunded plan - Company Z.
  • Company Z is willing to buy ShellCo for $20 million, and merges the pension plan into its own. So, everyone comes out ahead. X is ahead by $2 million and Y is ahead by $18 million.
  • BUT, suppose that Company Y doesn't do so well. It invests the money aggressively, and the assets drop to $80 million instead of increasing to $120 million. Now, the owner of Company Y is insulated, and the PBGC steps in to cover the $20 million underfunding. X is now ahead by $2 million, Y has lost its $2 million investment. As you can see, if Y invests aggressively enough, it has a great upside and a limited downside. This is what is known as "heads I win, tails you lose."

The IRS ruling focused on whether Company Y has an relationship with the employees - that was the way they chose to get to this transaction. However, what is really going on is whether you can take over pension liabilities from another company and try to make a profit by investing the assets to "beat" the actuarially assumed rate of return. Obviously Company X can do that, but so can Company Y. The difference is that X is a real company with real employees and presumably assets at risk. With Company Y, you don't quite know what you have. There is a way of selling pension liabilities - it is to buy annuities. Insurance companies sell annuities and they have to maintain reserves and invest their assets in a way that avoids losses. Basically, the Company Y's of the world wanted to do the same thing without having to comply with all those pesky insurance regulations.

Bottom line - the transaction that the IRS prohibited has the potential for an increased risk to the PBGC and a corresponding gain to the buyer (reward without risk). Now, the challenge for the investment firms that wanted to do this is to come up with a regulatory approach that has financial protections that are as strong as the insurance regulations."

Editor's Notes: There are numerous articles about the UK buyout experience. A few of them are listed below, along with the link to the July 21, 2008 report about plan freezes, published by the U.S. Government Accountability Office ("GAO").

Expect more news on the topic of pension buyouts and transfers.

This blog welcomes a chance to publish the pension buyer perspective. Send us an email if you want to comment.

Seal of Approval for Hedge Funds

In a recent interview, Mr. Stanley Goldstein announced the creation of an industry watchdog group, led by the New York Hedge Fund Roundtable. Its goal is to self-enforce otherwise voluntary and "weak" hedge fund practices. (As I wrote in "Doris Day, Scarlett O'Hara and Financial Market Tumult," July 19, 2008, a July 17, 2008 Financial Times editorial refers to such guidelines as cosmetic, meant to attract institutional investors and to keep regulators at bay.)

Goldstein, a CPA and founder of several hedge funds, explains that the aim is "not to start a separate organization but to use the existing one to compile and disseminate standards for hedge funds to follow," adding that "We do not see enforcement as practical or desirable but rather, hope that 'industry usage' will evolve along the lines which we, and others like us, deem appropriate."

Goldstein's support of the free market to act as the ultimate enforcer is laudable, especially at a time when global regulators are far from silent about the need for more stringent rules. Will Adam Smith's "invisible hand" really work? Let's hope so. As this blogger as written many times before, regulations no doubt change the way market participants behave, often leading to the "Law of Unintended Consequences."

Goldstein strongly believes in the power of collective self-policing. "By analogy, you will notice that more and more not-for-profit organizations are beginning to create audit committees on their boards and some have adopted "whistle blower" policies. There was no mandate nor promulgation forcing them to do this. What happened? Donors asked questions and boards had no choice but to make sure the right boxes could be checked off or risk losing contributions, the lifeblood of funding. These charities are run by smart people who are taking the hint. They want to be good players. With luck, time and some coordination, we can edge hedge funds in the same direction."

In the absence of a serious industry attempt to do better (for those funds who are not already at the top of their game), new accounting rules (FAS 157 or IAS 39 for example) and/or regulators' admonitions (such as the U.S. Department of Labor's recent letter to a plan sponsor, urging them to do their own valuation homework) could cause institutional investors to shy away from alternative investments such as hedge funds. If true that alternatives might help to diversify a portfolio, then a rejection due to a statutory artifice (versus an economic exigency) would be yet another example of the "Law of Unintended Consequences." (Read "Regulators Tell Pensions to Independently Value Positions," August 9, 2008, to access the aforementioned letter about valuation.)

This blogger says "bravo" and wishes the New York Hedge Fund Roundtable the best of luck. If Pension Governance, LLC can be of assistance, count us in. We agree that volitional "best practice" attempts are almost always far superior to a "one size fits all" authoritative mandate.

Editor's Notes:

  • According to economist Adam Smith in his Wealth of Nations, "Every individual...generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention." Click for more quotes by Adam Smith.
  • According to the Library of Economics and Liberty, the "Law of Unintended Consequences" states that "actions of people - and especially of government - always have effects that are unanticipated or 'unintended.'" The concept is related to Adam Smith's invisible hand theory wherein the famous economist wrote "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own self interest."
  • In aftermath of mandates such as FAS 133 (U.S. derivatives accounting standard) or FRS 17 (UK retirement benefit plan accounting standard), experts documented a clear change in the way impacted parties went about their business.
  • Interested readers can download "The Failings of FRS 17 and the Impact of Pensions on the UK Stock Market" by SEI researchers and Laurence Copeland (Cardiff Business School). The assertion is that, several years after its  2001 implementation, "the majority of UK pension schemes have closed to new entrants." In an attempt to promote transparency about retirement plans, the unintended effect is a diminution of aggregate employee benefits.
  • Another interesting publication is "The Impact of FAS 133 on the Risk Management Practices of End Users of Derivatives, "Association of Financial Professionals, September 2002. Researchers conclude that reduced hedging activity is likely due in part to the implementation of what users describe as an "excessive burden" in order to comply.
  • Regulators have called for more rules to govern non-profit boards, leading some to suggest that improvements are part "stick" as well as "carrot." For example, the Pension Protection Act of 2006 mandates enhanced disclosures and distribution limits for non-profits. Read "The Pension Protection Act of 2006 and Nonprofit Reforms" by Eileen Morgan Johnson, Whiteford, Taylor & Preston, LLP, January 2006. Also click to read "Nonprofit Governance In the United States" by Francie Ostrower, The Urban Institute, 2007. Click to access the Appendices to this paper.

U.S. SEC and U.S. Department of Labor Join Forces

In its July 29, 2008 press release, two regulatory giants "formally recognize their effective and informal working relationships and their expectation of continued cooperation." This includes:

  • Regular meetings "to discuss matters of mutual interest"
  • Points of Contact "to facilitate communications between the SEC and DOL staffs"
  • Cross-training "in order to enhance each agency's understanding of the other's mission and investigative jurisdiction"
  • DOL Access to Non-Public SEC Examination Information "to facilitate the exchange of examination-related information concerning investment advisors or other firms of mutual interest to the SEC and the DOL"
  • SEC and DOL Access to Non-Public SEC and DOL Enforcement Information "to facilitate the exchange of enforcement-related information concerning investment advisors or other firms of mutual interest to the SEC and the DOL."

One wonders if this portends more scrutiny of pension plans and their service providers. Click to read "Memorandum of Understanding Concerning Cooperation Between the U.S. Securities and Exchange Commission and The U.S. Department of Labor" (July 29, 2008).

SEC Issues Compliance Alert About Sloppy Valuation Process

Hat tip to fellow blogger gal Wendy Fried for news about the recent release of an important ComplianceAlert, issued by the U.S. Securities and Exchange Commission. Click to read "Sloppy subprime valuations on Wall Street?..." (footnoted.org, July 25, 2008)

According to the SEC website, a ComplianceAlert letter highlights results of examiners' audits in an attempt to "encourage" institutions to better their current compliance and supervisory efforts. In its July 2008 letter that starts "Dear Chief Compliance Officer," the SEC staff provides a laundry list of concerns, including, but not limited to:

  • Inadequate monitoring of personal trading by advisory staff
  • Weak oversight of mutual fund boards to "confirm that the proxy service providers' recommendations were consistent with funds' policies and procedures"
  • Stale valuations of high yield municipal bond fund holdings
  • Poor or no disclosure of the increased valuation and liquidity risk when "the percentage of illiquid securities held by a fund dramatically increased"
  • Questionable quality of price verifications of collateral held by certain broker-dealers
  • Inexperienced staff who were nevertheless tasked to validate model prices
  • Lack of documentation as to valuation standards relied upon by some broker-dealers.

The letter concludes with a variety of recommendations, including but not limited to:

  • Improvement of price verification and assessment of "modeled inputs and the calibration of valuations against trades or trade information inferred from activity in similar securities and or the derivative markets"
  • Retention of records "used in determining value"
  • Getting independent product control groups involved in "monitoring collateral valuations"
  • Creating and maintaining a database that "serves as the internal repository for security position information, including periodic valuations, in order to ensure consistency amongst various inventory trading accounts and collateral valuations."

I hate to say "we told you so" but this blog has been on a tear about proper valuation process for a long time. Check out a few of our many past posts. 

With FAS 157 and international equivalent accounting rules forcing change, pension fiduciaries need to take a hard look at their external service providers' trading controls and valuation policies and procedures, if not already. Check with legal counsel but likely they will remind plan sponsors that delegation does not absolve one of the fiduciary duty to properly select and oversee vendors.

What is your biggest concern about how "hard to value" instruments are currently being assessed by banks and broker-dealers? Send us an email with your opinions.

SEC Short Selling Rules - Fallout for 130/30 and Hedge Funds?

Trading today may be wild as Wall Street back office staff and short sellers scramble to comply with new rules, imposed via emergency order by the U.S. Securities and Exchange Commission ("SEC"). By way of background, on July 15, 2008, the SEC issued "Securities Exchange Act of 1934, Release No. 58166/July 15, 2008," prohibiting naked short sales for 19 identified financial company stocks. (The company names and ticker symbols are shown below.)

The official stated goal is to avoid panic selling as a result of outright short trading and discourage false rumors. (A naked short contrasts with the situation whereby an individual borrows shares and then sells them at the prevailing market price. The short can be closed at a profit when the trader buys shares back at a lower price, assuming that prices do eventually fall).

Only a few days later, the SEC issued "Securities Exchange Act of 1934, Release No. 58190/July 18, 2008," amending its earlier emergency order and exempting certain parties such as "registered market makers, block positioners, or other market makers obligated to quote in the over-the-counter market, that are selling short as part of bona fide market making and hedging activities related directly to" the identified securities and related derivative instruments and exchange traded funds. The order is set to terminate at 11:59 p.m. EDT on July 29, 2008 "unless further extended by the Commission."

According to "SEC Short-Sale Rule Gets Negative Reviews," Wall Street Journal reporter Kara Scannell (July 19-20, 2008) reports that certain companies did not make the list but have nevertheless seen their stocks come under recent "selling pressure." Some firms complain that SEC list inclusion will add to jitters and thereby exacerbate woes for existing shareholders, big and small.

Important questions remain unanswered, notably the impact on non-exempted parties and their institutional investors. Take 130/30 managers. By their very nature, they short stocks they deem "over-valued." How will this SEC mandate impact quarterly 130/30 fund performance and beyond, especially if trading costs mount as a result of compliance? What about those pension plans that have allocated monies to 130/30 managers who are adversely impacted by the SEC order? Could their funding status be in jeopardy? The same concerns extend to hedge fund managers whose specified strategy requires short-selling in any or all of the SEC "specified" stocks. Additionally, will the regulatory effect be materially different if shorted shares already represent a large percentage of outstanding common equity?

Will the SEC emergency order solve one problem but create others?

Financial Services Firm Name (Ticker Symbols) Covered by the Order and Amendment:

  • BNP Paribas Securities Corp. (BNPQF or BNPQY)
  • Bank of America Corporation (BAC)
  • Barclays PLC (BCS)
  • Citigroup Inc. (C)
  • Credit Suisse Group (CS)
  • Daiwa Securities Group Inc. (DSECY)
  • Deutsche Bank Group AG (DB)
  • Allianz SE (AZ)
  • Goldman, Sachs Group Inc (GS)
  • Royal Bank ADS (RBS)
  • HSBC Holdings PLC ADS (HBC and HSI)
  • J. P. Morgan Chase & Co. (JPM)
  • Lehman Brothers Holdings Inc. (LEH)
  • Merrill Lynch & Co., Inc. (MER)
  • Mizuho Financial Group, Inc. (MFG)
  • Morgan Stanley (MS)
  • UBS AG (UBS)
  • Freddie Mac (FRE)
  • Fannie Mae (FNM)

Comments from Readers About Financial Tumult

In response to our July 19, 2008 post ("Doris Day, Scarlett O'Hara and Financial Market Tumult"), a reader with thefinance_section adds "Freedom certainly isn't free. I think you are only truly free once you can live off your passive income, i.e. income from investments."

In response to general market volatility, the chief actuary of a major retirement services firm writes the following:

"The market will continue to find instruments to dampen the losses from the large bubble of speculative loans created over the past three years. Government will also act to smooth the market. Congress & the Executive Branch cannot allow the full chaos that comes from destroying the equity of so many lenders by forcing them to write off the bad loans quickly. This is similar in scope to the issues of the S&L crisis of a prior generation, and the market should be watching closely to see how the industry and govt will follow the old pattern or try another approach.

In some respects, this crisis follows the prior bubble problem with tech stocks. A large number of people who get paid for activity (commissioned stockbrokers) were guilty of pushing "POS" investments in the late 90's. A large number of people (mortgage brokers and bank loan officers) were guilty of pushing more loans through the system in this decade. Both were speculative bubbles in the classic Holland Tulip style of the 1700's but both also had regulators to punish the truly criminal operators. Who will emerge as winners?

However, the sharper investment managers will try to find the higher performing assets of firms that are less exposed to the losses. Are there enough quality investments for those who are running to quality? Will this create another surge to buy from the banks least affected by the loan crisis? Who will seize the initiative? Who will be able to make timely value-style investment choices? The swift and the brightest will continue to prosper, and may even pick up some bargains along the way.

What will be the new "due diligence" rules for pension trustees?" 

Doris Day, Scarlett O'Hara and Financial Market Tumult

Remember the 1939 epic classic "Gone with the Wind" wherein Scarlett O'Hara protests serious conversation? Interrupted by news of an imminent Civil War, this party gal (with the famous 17-inch waist) complains. "Fiddle-dee-dee. War, war, war: this war talk's spoiling all the fun at every party this spring. I get so bored I could scream." 

As I read "Why No Outrage" by James Grant (Wall Street Journal, July 19, 2008), I wonder if this southern belle might now be heard to say "Loss, loss, loss: this loss talk is spoiling all the fun..." About structural reforms (a 2007-2008 equivalent of losing Tara, the family homestead), Scarlett might encourage delayed action. "After all...tomorrow is another day." Why fuss now?

Well, as we all know, Main Street and Wall Street are inextricably linked. Unlike Las Vegas, what happens in the financial markets,  does not "stay here." (Read "Slogan's run" by Newt Briggs, Las Vegas Mercury, April 8, 2004.) When huge losses roil capital markets (not just in the U.S. but around the world), real people can get hurt:

  • Employees lose jobs
  • Shareholders see their portfolios plummet in value
  • Pension plans that allocate big money to equities and bonds scramble to improve funding
  • Retirees who depend on the financial health of plan sponsors pinch their pennies further
  • Vendors who do business with financial institutions tighten their belts and/or layoff staff
  • Businesses, seeking to grow, borrow at higher rates, if they can borrow at all...

It is therefore a mystery to the editor of Grant's Interest Rate Observer that relatively few bad players are taken to task "in the wake of the 'greatest failure of ratings and risk management ever,' to quote the considered judgment of the mortgage-research department of UBS." Grant conjectures that high gas prices and an election-focused Congress may be to blame or that "old populists" have hoisted themselves by their own petard, having pushed for paper money, federal insurance subsidization of higher risks and government intervention with respect to credit decision-making. From the tone of this long, yet fascinating, commentary, Grant rants about big government at the same time that, ironically, big government seeks to become even bigger in the form of new financial market regulations.

For my two cents as an advocate of free markets (not faux capitalism as exists around the world), a return to the gold standard merits serious consideration. Improperly priced federal insurance of bank deposits and pension liabilities (and much more) induces adverse selection and moral hazard. Riskier organizations get subsidized by more prudent market participants and have little incentive (arguably no incentive) to get their risk management house in order. Regarding government intervention as to how credit is allocated, plenty of empirical studies quantify the economic "bad" that results from information asymmetry. When buyers and sellers are not fully informed, supply and demand cannot intersect at the"correct" price of money or the optimal level of borrowing/lending.

Then there is the shame factor. In an era of reality shows, can we expect honor and accountability? Grant has few kind words for market behemoths (current and now extinct) who watch(ed) the Titanic sink "under the studiously averted gaze of the Street's risk managers." Will today's villains of excess rise, Phoenix-like, as have infamous names of yore, now reincarnated as media superstars? (Nick Leeson of Baring's fame has his own website and earns a living as a consultant and speaker. Henry Blodget pens "Internet Outsider" and e-newsletter, Silicon Alley Insider - a fun read for this bloggerette.)

Related to Grant's provocative piece, a recent article about voluntary standards caught my eye with its suggestion that industry attempts may be more show than reality. In its "agenda-setting column on business and financial topics," the Financial Times' Lex states that such guidelines receive little scrutiny and are put in place as a way to attract risk-averse institutional investors and/or to avoid the harsh spotlight of global regulators. (See ""Funds of hedge funds," Financial Times, July 17, 2008.) An easy way to check is simply ask each hedge fund manager about his/her reliance on published guidelines. Inquire how traders are compensated. Are they encouraged to take pure risks or are they instead benchmarked on the basis of risk-adjusted returns (with "risk" referring to the holistic assessment of uncertainties)? Don't stop with hedge funds. Ask any service provider or trader about their controls and how they monitor the quality of their processes.

The creation of an effective reward system and "best practices" are favorite topics of this blog. Our team (Pension Governance, LLC) and fiduciary community colleagues decry the status quo that makes it difficult to reward good players, at the same time that questionable practices are frequently left untouched. Poor quality disclosure is just one factor that inhibits the design of a better mousetrap.

Two hours into this post, I'm going to conclude with the notion that "freedom is not free" (anonymous). To enjoy flexibility and regulatory latitude, people of great courage must buck the existing system and both demand and assume accountability. At a minimum, interested parties (retirees, shareholders, taxpayers) want to better understand what went wrong and how internal controls will be strengthened post-haste as a result of introspection. Leaders at troubled institutions do a great service by informing the public about corrective actions underway.

For pension fiduciaries, a critical lesson learned is this. If you are not already doing so, waste no time in getting an operational review. This extends to tough and detailed interviews with your external money managers and service providers about all things risk management. Communicating your process to plan participants (for all types of plans) and shareholders/taxpayers gets you brownie points and helps to raise the "best practices" bar. 

Doris Day's sentiment may be great for meditation class but has no place in a discussion about financial system reform and governance of individual organizations, plan sponsors included. "What will be, will be" is the wrong answer (though "Que Sera, Sera" is a favorite tune).

The power of one keeps us in awe. Who will step up to the podium and say - "The buck stops here?"

Please email us with examples of pension and financial service leaders whom you believe inspire and lead the way in terms of governance. Let us know if we may attribute your comments or should post them anonymously.

 Editor's Notes:

Fair Disclosure for Retirement Security Act of 2007 Soon Up for a Vote

On April 16, 2008, members of the U.S. House Education and Labor Committee will mark up the proposed bill that, if adopted, will mandate additional disclosures as relates to retirement plan fees (1:00 p.m. in room 2175 Rayburn H.O.B.) As fee-related litigation soars (frequency and size of alleged economic damages) and individuals struggle to ready themselves for a long retirement haul (due to extended life spans), the import of any disclosure regulation is considerable.

To learn more, check out these resources. Note that the bill is renamed the "Fair Disclosure for Retirement Security Act of 2008."

Dr. Susan Mangiero Speaks at World Bank Pension Conference

Don't think there are no crocodiles because the water is calm.
...Malayan proverb

This blog's author (Dr. Susan Mangiero) joins internationally recognized leaders as part of the World Bank/IOPS 4th Contractual Saving Conference: Supervisory and Regulatory Issues in Private Pensions and Life Insurance. Nearly 200 regulators and practitioners convene in Washington, DC, hailing from countries such as the United States, Australia, Norway, Denmark, Mexico, Chile, Sweden and New Zealand.

Dr. Mangiero will address hidden risks from an implementation perspective. Other presentations similarly emphasize the message that risk mitigation is the sine qua non of modern asset-liability management. Without a dynamic and comprehensive process, fiduciaries leave themselves wide open to allegations of breach. Click to access the conference agenda.

Note: The International Organisation of Pension Supervisors (IOPS) is an "independent international body representing those involved in the supervision of private pension arrangements. The organisation currently has around 60 members and observers representing approximately 50 countries and territories worldwide."

Who is John Galt and Should Pension Fiduciaries Care?

The answer is absolutely YES!

This blog will address the impact of regulatory changes (there;'s more on the way) in the next few days. They are impossible to ignore.

Plan Sponsors Win - Beneficiaries Over 65 Lose

In today's edition, New York Times reporter Robert Pear describes a recent action by the Equal Employment Opportunity Commission ("EEOC") that gives employers free rein to cut back benefits for persons 65 and older. (See "Many Retirees May Lose Benefits From Employers.") The rationale seems to be that, once eligible for Medicare, senior workers should transition fully or partially out of private benefit programs because they are otherwise covered. Quoting EEOC Chair, Naomi C. Earp, the goal is to encourage plan sponsors to continue voluntarily providing and maintaining health benefits. Premiums deemed "too high" and the fact that people are living so much longer than ever before is creating havoc with corporate bottom lines. As a result, "many employers refuse to provide retiree health benefits or even to negotiate the issue." In some cases, if they are unable to contain costs for benefits offered to older workers, companies may decide to cut back altogether. This means that younger workers would be exposed - no employer provided coverage, no Medicare.

According to the December 26,2007 Federal Register, the new policy protects plan sponsors from legal threats of age discrimination in the event that they create a two-class benefits program. The "Appendix to Sec. 1625.32--Questions and Answers Regarding Coordination of Retiree Health Benefits With Medicare and State Health Benefits" provides additional information. The upshot is that employers now enjoy flexibility to (a) provide retiree healthcare benefits “only to those retirees who are not yet eligible for Medicare" (b) modify, reduce or eliminate benefits upon an employee's 65th birthday and (c) decrease or eliminate health benefits for the spouse or children of a retiree of a certain age.  

How many companies rush to the door remains to be seen. As employers struggle to attract and retain good workers, including those with a bit of gray, providing or reinstating diminished benefits may come to pass. Only time will tell.

U.S. Department of Labor Provides New Tool to Identify Fiduciary Status

Check out the new online "ERISA Fiduciary Advisor." Designed to inform about who is a fiduciary and what duties they are obliged to carry out, the Advisor "was developed by the Employee Benefits Security Administration (EBSA) in its continuing effort to increase awareness and understanding about basic fiduciary responsibilities when operating a retirement plan."

Click here to learn more.

IRS Provides Tool for 401(k) Plan Check-Up

In a special edition of employee plans news (October 2007), the Internal Revenue Service provides a link to its new web-based tool to help with 401(k) plan compliance. This 43-page document includes a chart that describes eleven "problem areas in retirement plans" as well as suggested ways to identify, correct and avoid such mistakes.

Click here to access the tool.

Can the Pension World Learn Something from Ayn Rand?

Love her or hate her (the woman), many feel that Ayn Rand's literacy legacy is beyond reproach. Author of best-selling books such as The Fountainhead, her main message is one of self-determinism and excellence of work. New York Times reporter describes the business glitterati who embrace her words to this day, including former Federal Reserve Chairman, Alan Greenspan, and a bevy of Fortune 500 CEOs. No wonder then that her books continue to sell. According to "Ayn Rand's Literature of Capitalism," Atlas Shrugged, published nearly fifty years ago, "is still drawing readers; it ranks 388th on Amazon.com’s best-seller list. 'Winning,' by John F. Welch Jr., at a breezy 384 pages, is No. 1,431."

So why does her work capture the hearts and minds of corporate scions and entrepreneurs alike and what could the pension world learn from Ms. Rand's work?

Addressing the first question, consider her many admirers who describe the inspiration they draw from reading this long (1,200+ pages) novel about the philosophical integrity and strength of characters such as Dagny Taggart (slated to be played by Angela Jolie in the Hollywood film version now underway), Hank Reardon and the all-time favorite, John Galt. Withstanding immense scrutiny and criticism from the entrenched bureaucracies, each fictional business persona fought steadfastly to create wealth by building a better mousetrap and to resist, at all costs, the temptation to be mediocre and do "just enough." 

Part of the book's appeal is its timelessness. As one Atlas Shrugged reviewer recently wrote, this 1957 book could just as easily have been written today. As Rand railed against excessive government regulation (influenced no doubt by her childhood experiences of living in Bolshevist Russia), contemporary critics decry the "excesses" of regulations such as SOX. Rand extolled the virtues (and urgent need) for bold leadership. She cautioned what would happen if the world fell from the shoulders of Atlas and the producers of high-quality products and services (without government help) left the "exploiters" to their own feeble devices. She impugned those who defrauded or otherwise took what did not belong to them. Her words resonate loud and clear in the aftermath of a wave of corporate fraud and scandals. She allowed only for strong property rights and proper commercial incentives (economic profit) to support a better quality of life for all in the form of unfettered markets. (How many innovations occur in the lands of despots and closed markets?) 

Should Atlas Shrugged be a guidebook for pension trustees? Asked in other ways, should benefit plan decision-makers focus on full transparency and accountability? Should fiduciaries bravely step up to the plate and make decisions that are in the interests of beneficiaries first and and always? Should plan sponsors map out a detailed plan (and follow it closely) to avoid conflicts of interest? Will plan sponsors adopt best practices that, in the short-run may cost more in terms of time and money, but in the long-run, create a better outcome for participants and shareholders alike? Should high-integrity fiduciaries be economically rewarded for their insight, commitment and diligence? Conversely, should those who accept sub-par quality of work be penalized?

If the answer to any or all of these questions is affirmative, the following quotes are for you.

"A creative man is motivated by the desire to achieve, not by the desire to beat others."

"Throughout the centuries there were men who took first steps, down new roads, armed with nothing but their own vision."

"The ladder of success is best climbed by stepping on the rungs of opportunity."

New IRS Form Mandates Governance Disclosures for Non Profits - What About Pensions?

Little noticed inside the pension community is a provision of the Pension Protection Act of 2006 that directly impacts reporting by tax-exempt organizations. What's interesting is that required changes mandate important governance disclosures for churches and foundations and other non-profits. According to Guidestar.org, "Form 990-T was considered a tax return and was not open to public inspection. The Pension Protection Act of 2006, however, mandates that any IRS Form 990-T filed by a 501(c)(3) organization after August 17, 2006, is now a public document. The exception is a Form 990-T filed solely to request a refund of the telephone excise tax."

Too bad the same disclosures are out of reach for anyone interested in understanding the nature of fiduciary risk attached to pension plans. As we pointed out in "Searching for Hidden Treasure" (April 17, 2006), even seemingly "mundane" information such as who makes primary decisions about defined benefit and defined contribution plans is often out of reach. As I wrote then, other than the names of the plan sponsor and plan administrator (found on Form 5500), no one knows much about who is in charge. (Some databases provide this information for a fee and various plan sponsors voluntarily provide this information online or in writing.)

Wouldn't it be grand to know more about who is making critical decisions regarding the $10 trillion pension industry? After all, how can we reward "good players" and hold "bad" or "careless" fiduciaries accountable if they operate in the shadows?

At a time when the SEC is asking for additional information (executive compensation decisions, audit committees, etc) and FASB wants to know more (having just announced plans to promote pension investment risk disclosure) where is the upset about pension fiduciaries - who they are, how they are selected and whether they are qualified for the tasks put upon them?

Editor's Note:

Part III questions of the newly revised form 990 are shown below. The IRS website provides detailed instructions and commentary.

  • Enter the number of members of the governing body
  • Did the organization make any significant changes to its organizing or governing documents?
  • Does the organization have a written conflict of interest policy?
  • Does the organization have a written whistleblower policy?
  • Does the organization contemporaneously document the meetings of the governing body and related committees through the preparation of minutes or other similar documentation?
  • Enter the number of independent members of the governing body
  • If “Yes,” how many transactions did the organization review under this policy and related
    procedures during the year?
  • Does the organization have a written document retention and destruction policy?
  • Does the organization have local chapters, branches or affiliates?
  • If yes, does the organization have written policies and procedures governing the activities of such chapters, affiliates and branches to ensure their operations are consistent with the organization’s?
  • Does an officer, director, trustee, employee or volunteer prepare the organization’s financial statements?
  • Does the organization have an audit committee?
  • How do you make the following available to the public?

Fly Away Pension Promises?



Memorial Day fireworks will be extra special for two airlines - American and Continental. In a pre-holiday move, Congress and the White House okayed the use of an 8.25% rate to determine the estimated DB liability, attempting to create parity for solvent airlines. (Higher discount rates lower the projected net unfunded liability for a defined benefit plan.) According to reporter John Crawley ("US Congress weighs new pension relief for airlines," May 24, 2007), this is "still below Northwest and Delta but more generous than the tougher formula required by lawmakers last year." Click here to read the article.

In response, the Allied Pilots Association (APA), "representing the 12,000 pilots of American Airlines (NYSE: AMR)" cautioned management not to use new rules as an an excuse to reduce funding. APA president , Captain Ralph Hunter, reiterated the unions' agreement to annual concessions of more than $600 million, motivated in part by the recognition of being "at risk in bankruptcy court." Click here to read the full text of the May 25, 2007 press release.

This is not the first, nor the last time, that discount rate discussions will take center stage. Questions about appropriate assumptions linger. (According to the H-15 Statistical Release, 20-year U.S. treasury bond yields as of May 21, 2007 were reported as approximately 5.02%.)

In a December 11, 2006 speech to CPAs, SEC Fellow Joseph B. Ucuzoglu cites an important element of the Pension Protection Act of 2006, taken together with the Financial Reporting Release No. 72. Registrants "should provide transparent disclosure in Management's Discussion & Analysis of the Act's anticipated impact on the company's liquidity and capital resources. Although in some circumstances it will be difficult to forecast precise funding requirements due to the annual recomputation required by the Act, it will often be possible to provide disclosure of the magnitude of cash commitments for future annual periods assuming present market conditions remain constant."

What are the implications?

1. New legislation allows additional airline carriers to use an estimated discount rate that is, by some accounts, "too high."

2. If the result is an artificially low estimated liability number, SEC filings could reflect an overly optimistic assessment of a company's liquidity situation and related ability to pay.

3. Plan participants may therefore want to take a tour "behind the numbers." After all, cash is required to pay benefits, irregardless of discount rate assumptions.

4. Don't stop with airlines. Compare reported discount rate assumptions with economic reality for a given plan. Does the number comport with current capital market conditions? Is it sustainable? If not, what is the likely TRUE impact on benefit plan payouts and the funding needs of the plan sponsor and isn't that important information to have?

Insider Trading and Pension Funds




In a May 23 meeting, open to the public as a byproduct of the Government in the Sunshine Act, the SEC will address a host of issues, not the least of which is a possible relaxation of the Sarbanes Oxley Act. Long awaited relief could help companies with what many cite as "burdensome" and costly compliance requirements. Financial Times reporter Jeremy Grant writes that "Wednesday’s likely approval of a set of guidelines originally proposed in December will provide executives with a clearer idea of how the SEC intends corporate America – and foreign companies listed in the US - to implement Section 404 of Sarbox." (See "SEC set to approve guidance on Sarbox," Financial Times, May 23, 2007.)

Ironically, at a time when regulatory muscle may be giving way to paunch, questions abound regarding transparency. In "Side Deals in a Gray Area," New York Times reporter Jenny Anderson describes a practice known as “big-boy letters” as "typically used when an investor has confidential information about a stock or bond and wants to sell those securities. By signing the letter, the buyer effectively recognizes that the seller has better information but promises not to sue the seller, much like a homebuyer who agrees to buy a house in 'as is' condition."

In "Big Boy Letters: Playing It Safe After O’Hagan," attorneys Wendell H. Adair Jr. and Brett Lawrence write that "big boy letters are designed to limit an insider’s liability under both securities laws and common law" and that a "trader in a company’s debt typically does not assume any fiduciary duty to the company or other security holders, assuming the person is not a member of an official committee or the board of directors and does not hold a similar insider position" unless he or she has signed a non-disclosure agreement.. Click here to read their analysis of U.S. v. O’Hagan, a "seminal case" that implied that a trader in possession of material, nonpublic information could avoid liability under misappropriation theory by disclosing his intention to trade to the information provider without actually disclosing to the trading counterparty the nonpublic information."

While attorneys seem to disagree on the legal exposure attached to big boy letters, the issue may soon be resolved in court. In the aforementioned New York Times article, Anderson describes "a lawsuit set to go to trial next month" in which "a Texas hedge fund contends that it was on the losing end of such a letter in 2001, when Salomon Smith Barney, now Smith Barney, sold more than $20 million worth of World Access bonds to the Jefferies Group, the investment bank, using a big-boy letter."

Not being an attorney (and so relying on the legal expertise of others), institutional investors like pension funds may want to add big-boy letters to the laundry list of "must know" items when evaluating trading practice risk as part of their selection of outside professionals. It is no stretch to see that challenges to statutory requirements all around (SOX, 13F, FASB, to name a few) could impede the flow of information to investors. (A discussion of regulation and information economics is outside the scope of this post.) This in turn could make it more difficult for pension fiduciaries to carry out their duties as informed decision-makers. Of course, mandatory rules can be replaced with industry self-regulation (something most free market economists advocate, including myself). Money managers who volunteer details about their trading practices to existing and prospective pension fund clients should win brownie points for candor.

Until then, one wonders - Are we opening the window to let in more sunshine or introducing darkness?

Hedge Fund Settlements with SEC - Lessons for Pension Plans

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 ToolboxSM will cover many important topics such as valuation, risk management, fee structure, disclosure and ERISA considerations.

Eeny, Meeny, Miny, Mo - What Accounting Rules Do You Want?

Throughout my career, I've been fortunate to work on multi-disciplinary projects, many of which combined accounting with finance. It is my personal view that the two areas are integral to good business decision-making. Whether I've taught eager MBAs or corporate executives or managed analysts, I've cautioned people to look beyond the numbers, try to ascertain what information is missing and identify whether there are gaps between the accounting representation and potential economic profitability. Citing Columbo and the need to "be a good financial detective," I've suggested that (dare we say it?) accounting numbers can be illusory and therefore require a proper vetting. (By the way, my mention of the venerable television sleuth drew blank stares from the students so I had to switch to CSI characters instead.)

What does this mean for institutional investors?

Anyone committing funds to fixed income, equity or hybrids must have a solid understanding of what financial statements convey, and by extension, what they do not reflect. Assessing the quality of earnings (balance sheet) is often difficult. Rules are complex. Companies can have tremendous latitude in their reporting choices. This puts the onus on the investor to do a good job of comparing reported numbers against industry/company factors as they relate to predicting future expected cash flow or some other measure of economic profitability.

Always challenging, it may become more so now that the SEC has opened the door to foreign companies (and perhaps U.S. firms by extension) being able to choose which standards make sense for them. In his April 25 article, ("SEC to Mull Letting U.S. Companies Use International Accounting Rules"), Wall Street Journal reporter David Reilly writes: "The commission said it will begin soliciting comments this summer on a possible change allowing foreign companies registered with it to file financial results using international financial reporting standards, or IFRS. Currently, foreign companies that file with the SEC must reconcile their results to U.S. GAAP, a costly and time-consuming process that many companies, especially in Europe, want to do away with."

Whatever the choice, financial statement users have a tough job. First of all, analyzing industry peers could require even more attention being paid to HOW numbers are put together. Company X uses U.S. GAAP (Generally Accepted Accounting Principles) and Company Y uses an altogether different approach. You have two sets of numbers. Which one is right in terms of assessing economic potential?

Still a classic (but pay attention to new rules) is Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, 2nd edition by Dr. Howard Shilit.  Also check out Michelle Leder's blog, Footnoted.org. Author of Financial Fine Print: Uncovering a Company's True Value," Leder drills down deep into the footnotes that many ignore.

On the pension accounting front, European firms are still reeling from rigorous rules. The adoption of new financial strategies and plan redesign (or perhaps termination) are not uncommon in some countries such as the UK. Stateside, FAS 158 is getting lots of attention with much more to come.

If people ignored accounting numbers and chose instead to focus on economic forecasts alone (i.e. take a fundamental approach to investing that emphasizes competitive structure, operating environment, etc), that would be one thing. However,  there is extensive research that suggests that companies DO behave a certain way in response to accounting rules.

Therefore, as companies get to choose accounting rules by which they will abide, investors must:

1. Understand what the different standards mean in terms of an accounting - economics "gap"

2. Identify whether a reporting entity is perversely changing its behavior to game a particular rule and buoy its numbers

3. Roll up those shirt sleeves and sleuth away. What you see may not be what you get!

Uncle Sam Wants You ... To Get a Fiduciary Advisor Audit

San Diego is hopping with over three hundred financial professionals attending the FI360 Annual Conference. Topics on the agenda include fiduciary requirements in the aftermath of the Pension Protection Act of 2006 (PPA), trends in fiduciary liability insurance claims, prudent investment fiduciary practices and 401(k) plan economics.

One item in particular - the PPA-required audit of  "eligible investment advice arrangements" (EIAA) - is taking center stage. By definition, an EIAA is "an arrangement that, among other things, provides that any fees (including any commission or other compensation) received by the fiduciary adviser for investment advice or with respect to the sale, holding, or acquisition of any security or other property for purposes of investment of plan assets do not vary depending on the basis of any investment option selected." Click here to read Field Assistance Bulletin No. 2007-01 (U.S. Department of Labor - February 2, 2007).

In response, the Centre for Fiduciary Excellence just announced an audit and certification program to ‘fiduciary advisers’ as defined by the PPA, "who intend to serve in EIAA’s. The fiduciary adviser certification program is supplemental to the existing CEFEX Investment Advisor Certification based on the fiduciary practices published by Fiduciary360 of Sewickley, PA. These practices are defined in the Fiduciary 360 publication "Prudent Practices for Investment Advisors" which was reviewed by Reish, Luftman Reicher & Cohen of Los Angeles, CA, and edited by the American Institute of Certified Public Accountants (AICPA)."

Read more by opening the press release file.

PG Editor's Note: The Centre for Fiduciary Excellence and the Foundation for Fiduciary Studies (and its affiliate, FI360) are partners with Pension Governance, LLC (owner of this blog). We all agree on a similar mission - to empower plan sponsors and their vendors and agents by providing educational information about fiduciary investment issues and promoting transparency about investment fiduciary practices. Click here to learn more about all of our partners.

You Can Get Sick But Not Too Sick



In case you haven't heard, most people think any pension problems are a walk in the park compared to a looming health care crisis. Some think the answer is national health care. Others persist - "Let the market do its thing." This blogger tends to be in the second camp but I am pretty sure we'll end up with socialized medicine at some point . Some say we are already there. After all, who REALLY knows the true cost of a particular service or pharmaceutical? There is seldom a supply-demand dynamic at work.

In a recent Wall Street Journal article, journalist Chad Terhune describes the Tennessee response in the form of a mini-medical plan called CoverTN. Made available to businesses that meet certain criteria, it allows employers to offer health care coverage at a cost far below that of catastrophic insurance. The bad news is an annual per capita limit of $25,000. One hospital stay could wipe this out in short order. Nevertheless, even a few corporate biggies are looking at mini-medical as a way to contain costs.

To read more, go to www.wsj.com and search for "Guarded Health: Covering the Uninsured, But Only Up to $25,000 - Tennessee Experiment Goes Against the Grain As States Remake Care", April 18, 2007.

Pension Risk Matters Editor's Note: Hear what guest blogger, Dr. Michael Kraten, CPA, has to say about health care. His recommendation for more transparency in benefits administration is one we soundly support. Founder and President of Enterprise Management Corporation, a management consultancy based in Connecticut, Kraten is doing interesting research in the area of virtual reality negotiations, health savings accounts and non-profit governance. He is also an accounting professor at Suffolk University in Boston, Massachusetts. To learn more, visit his website at www.enterpriseman.net.

Text from Dr. Kraten:

What is the Aflac duck selling?

If you answered “general health insurance” ... surprise! You are not correct. The Aflac web site offers dental, hospital confinement indemnity, hospital confinement sickness indemnity, hospital intensive care, and specified health event policies ... but not general health insurance.

What's the difference? Well, general policies are designed to cover most medically necessary services, with perhaps a few carve-outs and a relatively high lifetime maximum coverage limit tossed in for good measure. Aflac's policies, though, are only designed to cover a few narrowly defined services, and often include a relatively low annual coverage limit as well.

In other words, these are not general insurance policies at all. They're really prepaid service plans, where the plan manager (i.e. Aflac) keeps the premium if the services are not used by the end of the coverage period. And because the services frequently reflect relatively rare catastrophic events, the premium often goes unused ... and are thus typically converted to profits.

This type of plan is certainly not new to the commercial markets. Delta Dental, for instance, has been offering narrowly defined service contracts with low annual reimbursement ceilings for many years. But now many states are considering the implementation of such programs as well. Tennessee, for instance, recently launched a government subsidized small business plan called Cover TN. Its Program Summary states that it simply covers “basic health needs” only, with an annual maximum coverage limit of $25,000 per year ... not nearly enough to cover many complicated hospital stays.

Other states, such as California and Massachusetts, have opted to pursue a different path, proposing universal coverage programs that would cover most medically necessary services. But the costs of such plans are far more significant, and critics complain that their resultant taxation financing mechanisms are both onerous and self-defeating.

Time will tell whether the universal coverage programs will prove to be cost-effective, or whether the prepaid service programs can provide more than “band aid” protection for bleeding state program budgets. The American public might benefit, though, by receiving honest and transparent explanations from their health plan funding organizations regarding what they can expect ... and what they cannot expect ... for their premium dollars.

House Approves Say on Pay - What About Pension Empowerment?



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

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

The answer - Not much!

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

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

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

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

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

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

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

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

Why wait?
Continue Reading...

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 www.pensiongovernance.com - 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!

California Dreaming About Pension Conflicts of Interest


A few months ago, California Governor Schwarzenegger created the Public Employee Post-Employment Benefits Commission. Tasked with identifying the nature of their $49 billion unfunded liability for state retirement programs, this group must submit a report to the Governor and state legislators by January 1, 2008 that (a) quantifies unfunded post-employment health care and dental benefits for which the state is obliged to pay (b) assesses and compares possible solutions to address unfunded liabilities and (c) recommends which course of action makes sense. Click here to read the official press release about the Commission. Click here to access the names, titles and affiliations of the original appointees.

A few weeks ago, San Francisco Chronicle reporter Greg Lucas wrote that two of the dozen members, including the head of the commission, have business ties with California pension funds. Not surprisingly, eyebrows raised. In response, "Schwarzenegger administration officials and CalPERS -- the nation's largest institutional investor -- say there is no conflict between the two commission members' private business ties and their role on the commission, but some independent observers say the connection could harm the credibility of the panel's recommendations." Click here to read "Pension reform panelists' ties to firms questioned" (San Francisco Chronicle - March 8, 2007).

Call me crazy but doesn't it make sense to remove any doubt about the ability for commission members to render an impartial analysis? The persons in question may be the most honest of men. I don't know them personally. What I do know is that this type of news is likely to be yet another nail in the coffin of uncomplicated pension reform. I've spoken to countless taxpayers across this great country who are starting to wake up and smell the cappuccino. They are not happy about the prospect of soaring taxes to fund these benefits and even less satisfied with the way change is proceeding.

Kudos to Governor Schwarzenegger for creating the Commission in the first place. However, for a task so important -- huge dollars at stake and millions of plan participants  -- why keep dreaming that no one will mind a few conflicts of interest, perceived or actual? Continue Reading...

The 2007 Pig Book

In case you missed it, Citizens Against Government Waste (CAGW) released their 2007 Pig Book on March 7. Reminding us all that insane spending of tax dollars DOES occur, a companion report rightly points out that waste likewise diminishes the competitiveness of the U.S. marketplace. Given the work of the Paulson Committee and other advocates of deregulation, excessive outlays should make news beyond CSPAN.

CAGW president Tom Schatz applauded some restraint but urged lawmakers to keep tightening their belts before spending other people's money. Here are a few of the goodies he cites as part of the "2,658 pork projects at a cost of $13.2 billion" included in the Defense and Homeland Security Appropriations Acts for fiscal 2007.

1. $1,190,000,000 for full funding of 20 F-22A fighter jets, which the Government Accountability Office criticized as unnecessary and out of date;

2. $5,500,000 for the Gallo Center to study the effects of alcohol and drug abuse on the brain;

3. $1,650,000 to improve the shelf life of vegetables;

4. $1,350,000 for the Obesity in the Military Research Program; and

5. $1,000,000 for a telescope searching for extra-terrestrial intelligence. >>

Click here to download the 2007 Pig Book in its entirety. As you read, don't forget the words of British historian Lord Acton - "Power tends to corrupt; absolute power corrupts absolutely."

At a time when programs like Social Security and Medicare represent behemoth unfunded liabilities to taxpayers (not to mention more than a few state and municipal pension and health care programs), do we really need a space alien telescope or vegetable research? Decide for yourself next election cycle.

Pensions, Hedge Funds and Risk

On February 22, 2007, the President's Working Group on Financial Markets (PWG) released a set of principles and guidelines concerning "private pools of capital, including hedge funds." In concert with various U.S. agencies, the PWG report urges investors, creditors, counterparties, pool managers and supervisors to identify and understand fund-specific risks or walk away.

For fiduciaries, the guidelines (some of which are excerpted below) are clear. Individuals who are unable to demonstrate that a rigorous investigation of risk has taken place, BEFORE investing, put themselves in the line of fire with respect to personal and professional liability.

<< 1. Fiduciaries should consider the suitability of an investment in a private pool within the context of the overall portfolio and in light of the investment objectives and risk tolerances.

2. Fiduciary evaluation should include the investment objectives, strategies, risks, fees, liquidity, performance history, and other relevant characteristics of a private pool.

3. Fiduciaries should evaluate the pool’s manager and personnel, including background, experience, and disciplinary history. Fiduciaries also should assess the pool’s service providers and evaluate their independence from the pool’s managers.

4. Fiduciaries should consider the private pool’s manager’s conflicts-of-interest and whether the manager has appropriate controls in place to manage those conflicts.

5. Fiduciaries should conduct the appropriate due diligence regarding valuation methodology and performance calculation processes and business and operational risk management systems employed by a private pool, including the extent of independent audit evaluation of such processes and systems. >>

It will be interesting to watch what happens. Will some pension decision-makers forego investing in alternatives because the risks are considered too difficult to understand, let alone accept? Who will embrace the challenge and recognize the reality that risk management is an integral part of investment management? You simply cannot select funds without understanding how managers address financial and operational risk. When a fund invests in less liquid and/or complex instruments, the plot thickens.

Click here to read Agreement Among PWG and U.S. Agency Principals on Principles and Guidelines Regarding Private Pools of Capital.

Nutmeg State Seeks Pension Disclosure from Hedge Funds



According to reporter and financial professional Julie Fishman-Lapin, Connecticut could soon become less hedge-fund friendly if state legislators have their way.
In " State readies for a debate on regulation..." (Greenwich Times, February 9, 2007), Fishman-Lapin describes an initiative by Fairfield County Republican John E. Stripp that, if passed, would "require Connecticut-based hedge funds that receive more than $10 million from a pension fund to report the investment to the state banking commissioner within 30 days. The disclosure would include the name of the pension fund, the beneficiary organization and the address of the fund manager." Click here to read Proposed H.B. No. 5102, Session Year 2007 - An Act Concerning Hedge Fund Activity With Respect To Pension Funds.

Democratic state senator Bob Duff cites hedge fund disclosure requirements as part of his overall intent to focus on consumer protection. He will soon introduce a bill that likewise emphasizes disclosure. Click here to read his January 25, 2007 press release.

On December 5, 2006, addressing the U.S. Senate Committee on the Judiciary, CT Attorney General Richard Blumenthal urged federal regulators to increase penalties for fraud, raise the amount of money to qualify investors and adopt federal standards before states take matters into their own hands. Click here to read his remarks. Blumenthal is walking the walk, having formed the Hedge Fund Task Force last fall. The goal? To improve things and hopefully avoid an expensive Amaranth-type meltdown. (See "Hedge hunting season in Connecticut - In the wake of the Amaranth disaster, Connecticut Attorney General Richard Blumenthal seeks to reform the hedge fund industry" by Ellen Florian Kratz, Fortune, October 4, 2006.)

There is so much to write about the hedge fund - pension fund nexus. We will continue to focus on this important topic area. Until then, and in case you missed them, here are a few links to prior blog posts about hedge funds, along with links to some articles about hedge fund risk management and valuation.

Hedge Fund Notables for Pension Investors (December 29, 2006)

Hedge Fund Disclosure - Round Three (November 12, 2006)

Will Private Equity Stay Private? U.S. Dept. of Justice Makes Inquiries (November 5, 2006)

Pensions, Hedge Funds and Disclosure (October 27, 2006)

Legislative Matchmaker: Hedge Funds and ERISA (August 1, 2006)

Survey Shows That Institutional Investors Are Worried (July 28, 2006)

Will Hedge Funds Displace Pension Plans in Court? (July 9, 2006)

Hedge Fund Valuation: What Pension Fiduciaries Need to Know (Journal of Compensation and Benefits - July/August 2006)

Do You Know the True Cost of Your Retirement Plan? (May 14, 2006)

Hedge Fund Basics: Risk, Return and Reality (Family Foundation Advisor - January/February 2005)

Hedge Fund Imperatives (Hedge Fund Manager - December 2004)

New Rules for Soft Dollars - Pension Buyers Beware



In his July 12, 2006 speech, SEC Chairman Christopher Cox describes soft dollars as "inflated brokerage commissions" and urges reform to ensure their use for research only. "Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934," issued a week later, sought to clarify the extent to which money managers could properly purchase research without breaching their fiduciary duties to "seek the best execution for client trades, and limit money managers from using client assets for their own benefit." (Click here to access the 63-page file.)

Attempting to promote better transparency in trading costs, the SEC emphasizes "the statutory requirement that money managers must make a good faith determination that commissions paid are reasonable in relation to the value of the products and services provided by broker-dealers in connection with the managers' responsibilities to the advisory accounts for which the managers exercise investment discretion." Another stated goal is to help money managers with pension fund clients avoid ERISA non-compliance as relates to soft dollars.

At a time when Congress is joining the fray about pension fees, little has been said about the SEC's dictate that "Market participants may continue to rely on the Commission's prior interpretations for six months following the publication of this Release in the Federal Register, that is, until January 24, 2007."

January 24, 2007 has come and gone. Where's the fanfare? A topic as important as this merits discussion.

Et Tu New York? What Deregulation Means to Pension Funds



According to Financial Times reporter David Wighton ("Regulation a threat to New York, report says", January 22, 2007), New York City stands to lose nearly 60,000 jobs over the next five years in the absence of significant regulatory reform. A McKinsey & Company report, commissioned by Mayor Michael Bloomberg and Senator Chuck Schumer, extols the virtues of London and other venues that are considered more user-friendly for derivatives trading and other financial service activities.

Mr. Kevin LaCroix, creator of the informative blog, The D&O Diary, provides a link to the report and some interesting comparisons with the Paulson report that likewise pleads for liberalization of U.S. capital markets.

While free marketeers applaud initiatives that permit capitalism to do its magic of bringing together diverse buyers and sellers, consider some recent statistics from the Conference Board.

1. In 2005, U.S. institutions such as pension funds, insurance companies, banks and foundations controlled $24.1 trillion in assets.

2. In 2005, these institutional giants owned 67.9% of the equity of the largest 1000 corporations versus 61.4% in 2000.

3. In 2005, four companies revealed institutional investor ownership in excess of 70%. In 2004, the number was two and one or none before then.

4. Public pension plans continue to prevail in important corporate matters. Co-author of the 2007 Institutional Investment Report (Report #1400, The Conference Board), Dr. Carolyn Kay Brancato, Senior Fellow and Director Emeritus of The Conference Board Governance Center describes their critical role. "Ten years ago, these funds weren't likely to join in lawsuits or exert pressure in out of court settlements, but now, having been severely burned by the Enron and WorldCom situations, these funds are asserting themselves as never before. In addition, as the election of directors becomes more heated, and as many companies adopt bylaws saying their directors will resign if they don't get a majority of shareholder votes, the voting clout of these activist investors becomes more meaningful."

What does this mean?

As stewards of trillions of dollars of retirement monies, pension fiduciaries must serve as the first line of defense with respect to sniffing out corporate misdeeds or identifying boards that are "oversight challenged." Already tasked with a daunting job, deregulation compels these watchdogs to do an even more rigorous search for red flag issues BEFORE they turn into financial calamities.

This goes back to a recurring theme of this pension blog. Do pension fiduciaries have what it takes? On what basis are they selected? How are they trained? Is there a pension fiduciary who can serve as a Sarbanes-Oxley type "financial expert," someone who understands how to go beyond financial statements to detect possible trouble? Are the right mechanisms in place for pension fiduciaries to gather adequate information about corporate policies, procedures and internal controls AND then evaluate the data in a meaningful way? Are fiduciaries compensated in such a way that encourages their active participation, before the fact? How has the role of lead plaintiff changed in the aftermath of the Private Securities Litigation Reform Act of 1995 and can litigation replace regulation?

I'm not saying that statutory regulation is a panacea. In fact, there is great comfort in being part of a system that permits a vigorous debate about the numerous merits of industry self-review.

As patriot Thomas Paine declared: "Those who expect to reap the blessings of freedom, must, like men, undergo the fatigue of supporting it."

Get Your Hands Off My Retirement Piggybank



Some things never change. On November 27, 1994, I wrote an op-ed piece for a local newspaper entitled "A prescription for Social Security" in which I warned of the entitlement mentality and the crushing debt load soon to be foisted upon young people everywhere. According to the editor, my suggestions for funding reform were not well-received, as evidenced by a flood of letters with the same message. "Keep your hands off my federal piggybank" and let someone else pay the price. (Like many others, I am an advocate of phased-in privatization for those who prefer to save on their own.)

Recognition of big problems ahead is certainly not unique to me. In his 1993 book, Generational Accounting: Knowing Who Pays, and When, for What We Spend, Dr. Laurence J. Kotlikoff warns of the great divide between the young and old. In their 2005 book, The Coming Generational Storm: What You Need to Know about America's Economic Future, Kotlikoff and co-author Scott Burns tell a grim tale of what has been chronicled many times before. A disproportionate number of persons are retiring from the work force, leaving those who remain to bear the staggering burden of a "pay as you go" system in the form of Social Security and Medicare.

Published last May, the 2006 Social Security Trustees Report states: "Over the 75-year period, the Trust Funds require additional revenue equivalent to $4.6 trillion in today's dollars to pay all scheduled benefits. This unfunded obligation is $600 billion higher than the amount estimated last year."

New York Times reporter Steven R. Weisman writes that Federal Reserve chairman Ben S. Bernanke is worried too, asserting that "Recent positive trends on the budget were a 'calm before the storm,' to be undone by huge deficits in federal entitlement programs. In "Fed Chief Warns That Entitlement Growth Could Harm Economy" (January 19, 2007), Weisman describes Senate testimony that sounds downright gloomy. "The longer we wait, the more severe, the more draconian, the more difficult the adjustment is going to be."

Unfortunately, as we know too well, attempts at entitlement reform are political folly and so the problem festers with little hope of short-term remedy

There are plausible solutions (hard ones but they do exist) IF only people would give up the ghost of an actual retirement piggybank in Washington, emblazoned with their names. In this case, Virginia - there is no Santa Claus.

Sorry kiddo!

Pension Regulation - Driving Under the Influence of a Muffin



I live in a lovely town of about 18,000 people. Thankfully, there is little crime other than an occasional act of mailbox vandalism or the theft of holiday inflatables. Credit good-hearted people and a vigilant police force, especially it seems, when it comes to driving. I know this firsthand because I was pulled over the other day for DUIM (driving under the influence of a muffin, blueberry in this case). Apparently, I was swerving slightly to the right even as I drove a cautious twenty-five miles per hour. When I rolled down my window to say hello, the police officer saw the muffin, gave me a warning not to eat while driving and said he was on the lookout for DUI's (driving under the influence). After I thanked him, a bit shaken for the experience, I got to thinking.

Can rules be too rigid and what happens when you cross the line ever so slightly?

These thoughts are not unique to me. The topic du jour in financial policy circles is whether regulation is too heavy-handed and thereby impedes capital market innovation. Just last week, wonk wizard and New York Times columnist Ben Stein queried the wisdom of the so-called Paulson Committee in seeking to redress the "onerous" audit standards attached to Sarbanes-Oxley. (See "So Many Millions, So Little Body Armor", January 7, 2007)

Citing a plethora of option problems on Corporate Boulevard, he asks: "Isn't backdating precisely an example of a failure of internal controls? Haven't we just found out that internal controls are far too lax, not too strict?"

The same question, applied to benefit plan governance, is apt. At a whopping 908 pages, the Pension Protection Act of 2006 has spawned a new industry to decipher the nooks and crannies of this far from simple regulation. Too soon to assess the fallout, one ponders. Could it be too much? If so, what can take its place?

I'm a big believer in industry self-regulation but that begs yet another question. Who represents the "pension industry" and do the players speak with one voice? Arguably, HR has a different perspective than Audit or Treasury. Without a unified world view about what pension governance means, it's hard to imagine a system without mandatory regulation.

Free marketeers will say this is troublesome. The regulatory burden is far from trivial. Real dollars are redirected to activities that may not reap rewards. Perverse incentives arise and the law of unintended consequences results. Look what happened in the UK. In the aftermath of FRS 17, a large number of companies terminated defined benefit plans as quickly as possible.

Then there is the issue of compliance. Many suggest that pension regulatory changes are outpacing the industry's ability to keep up. Does this put a fiduciary in harm's way (the equivalent of swerving slightly while eating a muffin)? You think you're doing the right thing but get "pulled over" nonetheless. How can a decision-maker protect herself (himself) from mounting personal and professional liability?

Here's to pension governance solutions - the sooner the better!

Pension Contagion - Should We Worry?



Similar to many of my peers, I spent the last few days in the same shape as this fella. Anxious now to avoid suspicious coughs or sneezes, I've been pondering what contagion might look like in the pension world. The upshot? Not a pretty picture.

Broadly defined, the spread of bad financial news, like a transmitted disease, moves quickly, has the potential to wreak havoc and is hard to contain once unleashed. This is why policy-makers worry about anything that can accelerate diminished investor confidence and panic market participants into selling off positions they would otherwise choose to hold.

Contagion itself is dangerous but when you consider what some describe as an inevitable convergence towards one global market, with trading that occurs 24/7, the potential for serious harm is real. Continued technological advances, international deregulation and investors' willingness to go offshore promote lightening speed information flow. When bad news hits, it's the shot heard 'round the world. Having worked on three trading desks during volatile times, I know firsthand how quickly things can change.

Taking a page from science, the "butterfly effect" describes how tiny changes can lead to large-scale disturbances. Click here to read about meteorologist Edward Lorenz and his seminal work in chaos theory. Does his notion that the flap of a butterfly's wings in Brazil can set off a Tornado in Texas apply to pensions?

Let's consider some facts.

1. The graying of the global population is real.

2. Life expectancies are climbing in the U.S. and in most developed countries.

3. Countless U.S. and non U.S. government plans are hamstrung by reluctant taxpayers, binding labor contracts and defined benefit plans with fixed terms.

4. Regulatory reform here and abroad has accelerated the need for liquidity.

5. Companies around the world rely on higher return (read higher risk) investments to close the pension gap.

6. Shareholders in U.S. companies are preparing for the worst with the first batch of annual reports that reflect FAS 158 compliance, similar to the FRS 17 effect in the UK. GASB 45 is keeping public plan leaders up at night.

7. Many companies outsource or have global staffs with benefits offered to all.

8. Different country governments and multinational companies alike invest in each other's securities.

Market returns are correlated. Labor mobility exists. Companies buy and sell around the world. News travels fast.

What does that infer? Pension contagion is a real possibility.

Editor's Note:

The World Bank website links to some research papers about financial contagion that may be of interest.

Angelina Jolie, Christopher Cox and Pension Funds



Strange bedfellows? Maybe not. Here's why.

1. Angelina Jolie has agreed to play the role of Dagney Taggart in the film verson of Ayn Rand's best-selling book, Atlas Shrugged.

2. Christopher Cox wrote a review of Letters of Ayn Rand.

3. Christopher Cox heads the SEC.

4. The SEC just proposed several major changes that potentially impact pension funds' investments in hedge funds, securities issued by companies that comply with the Sarbanes-Oxley Act of 2002 and non-U.S. issuers of equity, respectively.

In addition, U.S. Treasury Secretary Henry Paulson is busy advocating improved regulations in order to promote U.S. competitiveness. His remarks to the Economic Club of New York referenced a forthcoming Conference on Capital Markets and Economic Competitiveness early next year that will address regulatory, accounting and legal issues. He added that the strength of the U.S. economy can be a springboard to reform entitlement programs and "focus on economic and educational policies that will add jobs, improve productivity, and result in tangible income growth for all Americans."

With a new Congress and talk of regulatory investigations and oversight hearings, school's still out on how pension sponsors are likely to fare. At the same time, given the clear and significant link between regulation and pension finance, we all have a vested interest in monitoring what's happening in Washington.

Angelina may do a terrific job at entertaining us as capitalist heroine but it's the lawmakers and chief regulators who are getting the big reviews in pension land. No popcorn but lots of action.

Life of a Benefits Manager Heading Into 2007?



An homage to Norwegian painter Edvard Munch (born on December 12, 1863) Google's same day banner is reprinted herein. A reminder perhaps that 2007 is sure to create some agita for more than a few benefits managers and other related decision-makers?

Here are a few reasons for upset:

1. New pension accounting rules for companies

2. New OPEB (other post-employment benefit) accounting rules for municipalities

3. Forthcoming derivative accounting rules for public funds, similar to FAS 133 for companies (Remember that derivatives are getting more attention as possible elements of a liability-driven investment strategy.)

4. Anticipated Congressional oversight hearings about pension funds, 401(k) fees and hedge funds

5. Stated SEC consideration of rule changes as they apply to alternative investments (and possible impact on pension funds investing in hedge funds)

6. Proposed Form 5500 disclosure rule changes regarding service providers, fees and other elements of pension investing

7. Continued taxpayer upset regarding the cost of municipal benefits and a desire for lower property and state income taxes

8. Continued escalation in pension litigation

9. Continued focus on plan design and expected impact on an organization's cash flow

10. Continued focus on the Sarbanes Oxley - ERISA (corporate governance-pension governance) link

11. Anticipated guidance about default options for defined contribution plans (and related fiduciary impact)

12. The remaining 900+ pages of the Pension Protection Act of 2006

13. Projected worsening of the Social Security situation and likely impact on financing of the "three-legged" stool

14. Continued longevity patterns (good for retirees but expensive for employers)

15. Projected lower interest rates that increase liabilities

16. Anticipated pressure on asset returns

17. International pension woes and possible contagion for the U.S.

18. Predicted health care benefit cost increases that make pensions pale in comparison

19. Continued need to attract and retain scarce pool of talented workers with good benefits while keeping costs low

20. Continued scrutiny from ERISA and D&O liability insurance underwriters (and related impact on coverage and cost of coverage)

The good news is that there are lots of possible solutions but make no mistake. The new year will definitely entail major changes and challenges for all.

401(k) Fee Redux



In "Workers' suit highlights secrecy over 401(k) fees" (Baltimore Sun, November 5, 2006), journalist Eileen Ambrose looks at the effect of nearly a dozen plan-related lawsuits filed against large U.S. companies. Her conclusion? "Regardless of the merits of the lawsuits, consumer advocates and benefits experts say that increased attention to fees is a good thing."

Unfortunately, getting good information about fees is not a walk in the park since no one document tells a complete story. "Workers with sharp eyes and a calculator can generally figure out what they pay by going through the prospectus and quarterly statement, but they will have little luck uncovering the soft-dollar arrangements that could affect their nest eggs." Then there is the fact that there are many kinds of fees, with disparate effects on economic performance.

Edward M. Lynch Jr., a benefits expert with Dietz & Lynch Financial Strategies Group, a retirement plan consulting firm in Massachusetts, offers that no standard exists. Some mutual funds may charge a small or no administrative fee, planning instead to earn management fees. Other arrangements such as revenue-sharing do not show up on Form 5500 and are not always disclosed to plan participants. According to Lynch, "Revenue sharing could be a good thing if it is fully disclosed and reduces costs for workers." Otherwise, "it can be a problem if it influences the decisions on which mutual funds end up in the 401(k)."

Ambrose points out that, absent lawsuits, reform is on its way with the U.S. Department of Labor recommending improved disclosure about fees and the relationship between plan decision-makers and service providers. (In case you missed my blog about Form 5500 revisions and information resources, click here.)

Regarding employees, I am quoted as saying the following. "Ask about fees that you pay, even indirectly, for administration and record keeping" as well as the employer's selection process. "How often does that process get vetted" and on what basis?

With so much attention being paid to the topic of 401(k) fees, this may be the beginning of the end for performance reporting as it exists today.

Impact of Pension Regulation

New pension regulation text tips the scale at over nine hundred pages. No wonder then that discussions abound with respect to who wins, who loses and how to take the next step to comply.

Part of a three day conference about liability-driven investing, sponsored by Pensions & Investments, Dr. Susan M. Mangiero joins a panel of esteemed pension professionals to address the impact of regulation. More information is provided below.

"The regulatory environment in the US is set to change in response to widespread pension plan underfunding. However, no one knows when (or if) a change will be made to the actuarial discount rate used by the federal government in calculating pension liabilities. Changes are expected to accounting rules regarding pensions, particularly FAS 87, which will affect actuarial smoothing. And the Pension Benefit Guaranty Corp. is likely to impose risk-based premiums on the funding level of a company's pension scheme. So how does LDI help offset the predicted effects of changes in pension regulation? This panel will discuss the pros and cons."

For more information about this invitation-only event, click here.

Pension Protection Act of 2006: Lawsuit Lollapalooza?



Dr. Susan M. Mangiero, CFA, Accredited Investment Fiduciary Analyst, and author of the book Risk Management for Pensions, Endowments, and Foundations, will join forensic professionals with the Center for Financial Research & Analysis (CFRA) on a September 6 conference call to talk about the Pension Protection Act of 2006.

CFRA team members will address the key components of the Pension Protection Act of 2006 and update their report of April 11, 2006 which discussed at-risk companies. Dr. Mangiero will touch on the fiduciary implications of the Pension Protection Act, litigation vulnerabilities and possible financial concerns for institutional investors, ERISA and D&O liability insurance underwriters and regulators.

There are currently no more openings for this event. However, if you would like to have a copy of the transcript, click here to request information.

Off to Fiduciary School



It's back to school time and that includes this author. I'm attending a training program to earn the Accredited Investment Fiduciary Analyst (TM) designation.

As we await Presidential approval of the Pension Protection Act of 2006, two and a half days spent discussing investment issues in a fiduciary context will keep attendees very busy.

Click here to access Financial-Planning.com's article about financial designations.

Pension Truth Telling


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

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

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

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

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

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

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

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

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

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

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

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


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

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

1. Can I afford to retire?

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

3. Will my taxes go up?

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

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

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

Senate Thumbs Up for Pension Reform

Reuters reports that the Senate, with a vote of 93 to 5, has just passed a pension reform bill that now goes to President Bush. The Washington Post reminds readers that the U.S. House of Representatives approved this bill last week with a 279 to 131 vote.

Major elements of the Pension Protection Act of 2006 are listed below.

1. Sponsors will have to fully fund defined benefit plans within a seven year period, starting in 2008.

2. Airline companies get more time to satisfy obligations.

3. Hedge funds will find it easier to manage ERISA money before being subject to fiduciary requirements.

4. Financially weak plans will have to contribute additional amounts of cash.

5. Providing 401(k) plan investment advice by financial companies will be relaxed.

Comments and analysis will follow in the next few days.

Form 5500 Revisions


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

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

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

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

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

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


For further information, check out these sites.

1. IRS Form 5500 Corner

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

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

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

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

Dividends, Pensions and California Chaos



According to CFO.com, the State of California may soon prohibit a company from paying out dividends or buying back shares until all required defined benefit plan payments have been made. AB 2122, introduced by Democrat Johan Klehs, could impact corporate leaders individually as well since it "would make directors and officers of a corporation jointly and severally liable for improper distributions", even if they had no knowledge of the impropriety.

Needless to say that if this bill becomes law, other states would likely follow, creating a cascade of new challenges for chief financial officers everywhere.

Think about it.

Capital structure, securities issuance and debt rating assignments would necessarily change as a function of a company's mix of employee benefits. Modeling a defined benefit plan liability (and related liquidity obligations) would take center stage. Shareholders seeking current dividend income may get an unpleasant surprise if dividend payouts become more volatile, even if a company enjoys steady growth in economic earnings.

Then there is the philosophical issue about the role of government with respect to corporate management. Does the state have the right to micromanage this way? Would shareholders shy away from investing in companies with defined benefit plans, knowing that the state has the right to prevent dividend distributions? Would companies rush to shed defined benefit plans, possibly exacerbating an already pronounced trend towards defined contribution plans? Would companies lobby more aggressively for exemptions from the dividend rule? Would that worsen campaign finance problems? Would D&O insurance costs skyrocket as a result of increased liability exposure for board members? Would federal lawmakers seek to follow suit?

The little bill that could ...

Pension Reform - Why Wait?

The evidence that something is awry in global pension land is everywhere. While Rome burns, reform proceeds at a snail's pace. BenefitNews.com reports uncertainty about when Congressional action will occur in the U.S. Abroad, the pace of reform is different, depending on the country.

Is delay good or bad?

In his May 24 posting, American Enterprise Institute resident scholar Norman J. Ornstein makes a compelling case for acting now to reform what most people describe as a broken system. He advocates a national infrastructure that would give employees solid investment choices along with portability. While having the right to take your accumulated retirement monies from job to job makes perfect sense for today's mobile work force, we're haunted by the inevitable question about investor readiness.

Are employees willing and able to take full responsibility for making good investment choices? What role should employers play with respect to providing investment education and possibly exposing themselves to liability for offering "bad advice"? (These questions apply to defined contribution plans of any sort.) Other issues prevail.

Who picks up the tab for large unfunded liabilities that get either frozen or outright terminated? How do we best transition from point A to point B without exacerbating the situation for already troubled companies? One proposal, requiring immediate funding of high risk plans, might push sponsors into bankruptcy, thereby creating a host of unwelcome problems. States are not immune and are starting to enact legislation to do likewise. Whether these pension stabilization funds solve the problem or simply pass the buck to the taxpayer is debatable.

Finally, it's not a foregone conclusion that all reform is good. In fact, as columnist Rob Norton so nicely describes, there is a bounty of research that documents the law of unintendend consequences. Simply stated, the idea is that regulation is likely to change behavior in such a way that new (and more acute) problems arise as a result.

An alternative is industry self-regulation. While the economic merits of a free market approach are significant, it would probably be difficult to get politicos onboard.

Changes must occur. Let's just hope that regulators consider the opportunity costs and all potential outcomes for the $10 trillion retirement benefits market before speeding along the wrong path.