Foreign Corrupt Practices Act and Implications for Institutional Investors

For those who don't know, I am the lead contributor to an investment compliance blog known as Good Risk Governance Pays. I created this second blog as a way to showcase investment issues that had a wider reach than just the pension fund community. While I strive to publish different education-focused analyses on each blog, sometimes there are topics that I believe would be of interest to both sets of readers. A recent article that I co-wrote is one example. Entitled "Avoiding FCPA Liability by Tightening Internal Controls: Considerations for Institutional Investors and Corporate Counsel" (The Corporate Counselor, September 2014), Mr. H. David Kotz and Dr. Susan Mangiero explain the basics of the Foreign Corrupt Practice Act. Examples and links to reference materials are included, along with a discussion as to why this topic should be of critical importance to pension funds and other types of institutional investors. Click to download a text version of "Avoiding FCPA Liability by Tightening Internal Controls: Considerations for Institutional Investors and Corporate Counsel."

Brown M&Ms and Investment Service Provider Due Diligence

 

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

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

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

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

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

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

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

New is Not Necessarily Better and Could be Worse

Every now and then, my husband likes to remind me that older is better in terms of quality. His father's tools still get used, our washer and dryer from twenty years ago are in place and his 1989 Honda was only recently sold when I nudged him to buy a car with air bags. Incidentally, the CRV was sold with 400,000 miles to a neighbor who still drives it on a regular basis. I was reminded of his words when I read a New York Times article on the failure of "new math." More recently the concept that new can be counterproductive came to light when a meeting organizer insisted on using technology that was so "cutting edge" that a few of us could not join because we did not have the requisite equipment. As a result, we have to schedule anew, costing time that could have been avoided.

Applied to pensions, adding too much complexity by trying something untested and/or sold as "the next big thing" can spell trouble. As I wrote in "Investment Complexity Risk" (August 1, 2014), transactions that are hard to explain make it difficult for an investor to "appropriately identify the right benchmark to track performance." When that occurs, tasks such as portfolio rebalancing, assessment as to whether fees paid are "reasonable" and/or constructing an effective hedge strategy are difficult to achieve.

While "new" does not automatically mean "complex," the reality is that capital markets and service providers such as asset managers are increasingly dependent on one another. What happens with one organization can have a far-reaching impact on others. Consider Goldman Sachs Group Inc. ("Goldman"). Its plan to retract prime brokerage services to some hedge funds while increasing fees to those that remain as clients will impact the institutional investors that have exposures to asset managers that either need to look elsewhere for capital or will pay more money to Goldman. See "Goldman Sachs Cuts Roster of Hedge-Fund Clients" by Justin Baer and Juliet Chung (Wall Street Journal, August 4, 2014).

Some institutional investors are throwing their proverbial hands in the air when it comes to in-house management. Pensions & Investments reporter Douglas Appell describes a trend in seeking third party help as the result of "today's volatile markets." Refer to "Complexity of investments pushes funds to seek outsourcing help" (July 9, 2012). Asset managers are similarly outsourcing certain tasks such as performance measurement and attribution. According to "Managing complexity and change in a new landscape: Global survey on asset management investment operations" (Ernst and Young, 2014), partners Alex Birkin and Alan Fish write that "Firms are only beginning to realize the opportunity in outsourcing more complex processes."

Contracting others to augment one's core business is not bad or good on its face. Importantly, end-users must understand what they are buying and what may not be covered by the agreement. Based on my experience as a forensic economist and investment risk governance expert, disputes often arise when expectations - even those that are codified with a letter of engagement - differ. Ambiguous language is one culprit. In-house and external counsel as well as those tasked with dotting the due diligence "i's" can play a vital role in clarifying the terms of outsourcing. Similarly, attorneys can work with their institutional investor clients to ensure that a Request for Proposal ("RFP") questionnaire includes ample questions about the nature of the contracts in place between asset managers being considered and the vendors to said asset managers.

The principles of good contracting are tried and true. Some may sneer at old fashioned ideas but they have a place in one's investment risk governance toolbox. When the lights go out, a pencil has a lot more value than a computer that doesn't work.

Headline Risk For Investment Fiduciaries

Following up my May 12, 2014 post entitled "Golf Course RFPs and Other Mistakes That Retirement Plan Fiduciaries Make," the source of that wisdom has given readers even more food for thought about the topic of service provider selection. In "More on the Golf Course RFP," senior ERISA attorney Steve Rosenberg warns that appointments "to smaller and mid-size companies, where benefit plans, particularly 401(k)/mutual fund programs, may be chosen by a company owner simply based on the vendors that are already in the owner's social circle, such as, yes, those at his or her country club." He adds that "picking a plan's vendor in that manner will most certainly come back to the bite the company owner" and that, "in a fiduciary duty lawsuit over that plan," such a selection would be deemed a "smoking gun used to show poor processes and a corresponding breach of fiduciary duty."

Attorney Rosenberg raises some good points about company size. Smaller to mid-size firms often have ownership that is concentrated in the hands of its owners or top managers. Diversification considerations can differ from those made by bigger plan sponsors as a result. That said, I have worked as a forensic and fiduciary expert on matters that entail carrying out an analysis of the service provider selection process used by various large companies.

More than a few investment fiduciaries have told me that they worry about personal and professional reputation in addition to liability for actions taken (or not as the case may be). A central take away is that standing out for the wrong reasons can have disastrous consequences.

Golf Course RFPs and Other Mistakes That Retirement Plan Fiduciaries Make

Litigation attorney and uber ERISA blogger, Steve Rosenberg, recently shared his slide deck entitled "Common Mistakes of Plan Sponsors."  Part of an educational presentation to U.S. Department of Labor examiners, Steve addressed the importance of getting competitive bids, thoroughly investigating service providers before selecting one or more individuals or firms and avoiding what he coins the "Golf Course RFP." He worries that members of a retirement plan investment committee could bypass best practices in selecting a bank, advisor, consultant, third party administrator and/or asset manager and instead rely too much on a vendor's brand name or overly friendly relationship with someone who works at a company before considered. Deciding to hire someone on the basis of a handshake over a glass of beer or chatting on the greens is ill-advised if it shortcuts proper research about the abilities of a service provider, fees they intend to charge and whether their offerings are likely to meet the needs of a particular defined contribution or defined benefit plan.

Steve warns about other mistakes to avoid, including the identification of who will do what tasks, how often they will be performed and whether a service provider contracts to be a fiduciary. In particular, he frets that members of an ERISA plan committee may select a provider to serve as an investment fiduciary and then incorrectly assume that they have passed the baton and no longer have any liability.

Other errors he cites are part of what he calls the "ESOP Private Company Valuation Problem." These concerns include "insufficient reliance on outside experts" and not hiring an independent fiduciary to oversee a transaction when there are clear conflicts of interest or further expertise is needed.

Interested readers may want to investigate the following educational resources to include:

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).

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.

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

Please join us for a timely and information webinar entitled "ERISA Assets: QPAM and INHAM Audit Legal Requirements: Navigating DOL Rules for Pension Asset Management Compliance" on August 29, 2012 from 1:00 PM EST to 2:30 PM EST. 

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

Description

An opportunity to manage part of the $17 trillion retirement industry assets is a key business strategy for many financial organizations. ERISA plans present a number of unique challenges due to the rules, regulations and increasing litigation brought against asset managers. Compliance is critically important.

In 2010, the U.S. DOL changed rules on activities asset managers can undertake if they manage ERISA assets. Entities like banks, insurance companies, hedge funds and SEC-registered investment advisors must have documented policies and procedures for types of trading, parties in interest and internal controls.

In addition, a regular audit of the activities of a Qualified Professional Asset Manager (QPAM) and/or in-house asset manager (INHAM) must be conducted by persons who are knowledgeable about ERISA and can render an objective assessment as to whether the exemption is justified.

Listen as our ERISA-experienced panel provides a guide to this recent mandate, why it is important, how to comply, and what an asset manager can learn from the audit process to mitigate litigation risk.

Outline

1. QPAM and INHAM Rules: Definition, Exemptions and Consequences of Not Getting Audit

2. Nature of the QPAM/INHAM Audit: Qualifications of Auditor, Components of Audit and Role of Counsel

3.Use of Audit: Regulatory Scrutiny, Correcting Deficiencies, Marketing Audit Results, Lessons Learned

Benefits

The panel will review these and other key questions:

  • Who is a QPAM or INHAM?
  • What determines when a QPAM or INHAM audit is required?
  • What is the audit process like in terms of length of time it takes to complete, the documents needed, and the role of outside counsel and the QPAM or INHAM auditor?
  • How can the QPAM or INHAM audit be used to mitigate suits about procedural prudence and fiduciary breach?

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

Faculty

Susan MangieroManaging Director
FTI Consulting, New York

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

Terry OrrSenior Managing Director
FTI Consulting, Dallas

He provides forensic and investigative due diligence services to companies and their counsel in a variety of industries. His twenty-five years of experience as an independent auditor of both public and private businesses includes the examination of numerous ERISA plans.

David E. PicklePartner
K&L Gates, Washington, D.C.

He represents clients in matters dealing with ERISA’s prohibited transactions and exemptions and ERISA’s fiduciary rules. He represents investment managers, financial institutions and plan sponsors in a variety of matters including investments and other transactions with ERISA plans and in litigation and government enforcement actions.

William A. SchmidtPartner
K&L Gates, Washington, D.C.

He works in the areas of institutional investing and employee benefits, with particular emphasis on fiduciary responsibility matters under ERISA. He advises major financial institutions, including banks, insurance companies, registered investment advisers, and large employee benefit plans about ERISA restrictions relating to plan investments and to fee arrangements for investment management.

 

ERISA 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.

 

 

Trust, Institutional Investors and Their Service Providers

 

Financial scandals, decimated 401(k) plans and significant fallout on Wall Street are only a few of the pain points that leave one longing for halcyon days of yore. There is a lot of talk about broken promises and attempts to regain client trust.

Even outside the financial services sector, long known for its reliance on interpersonal relationships, sellers are working hard to rekindle the love with their consumers. In "Corporations work to regain customers' trust" (September 18, 2009), Business Week reporters David Kiley and Burt Helm write that "In the world of branding, trust is the most perishable of assets." Adding to marketers' woes, recent polls suggest gross unhappiness with business in general, something that slick ads are unlikely to fix.

Closer to home, "Can You Trust Your Consultants and Service Providers? (Human Resources, October 2009) addresses the critical relationship between service providers and consultants and 401(k) plan fiduciaries. The article quotes Nixon Peabody attorney Sherwin Kaplan as saying that "trust with providers should be earned, not implied" and that sponsors must properly select and then monitor each vendor. Aside from the obvious problems associated with conflicts of interest and fees, Attorney Kaplan mentions new worries in the form of fiduciaries suing each other over questions about suitability and due diligence.

In yet another related item, uber venture capitalist Fred Wilson opines on "Ten Characteristics of Great Companies" (September 3, 2009) with attribute number 10 being that "Great companies put the customer/user first above any other priority." We concur absolutely but know that more than a few service providers are challenged to deliver above and beyond the call of the duty at the same time that sales and client relationship management budgets are being cut to (in some cases) unsustainable levels. 

In "Broker's World: Fiduciary-Like Process Could Become Voluntary" (September 23, 2009), Wall Street Journal reporter Annie Gasparro describes the inevitability of a national (U.S.) focus on new broker-dealer rules. Boston University law professor Tamar Frankel is quoted as saying that "If the clients can trust them, they won't have to do all the freebies like lunches to get their business."

As both a buyer and seller of services, I like to think that my perspective considers both sides of the aisle. In the spirit of open conversation, I've listed a few thoughts below. I welcome your comments.

  • Integrity (a precursor to building a relationship of trust) must be a core element of an organization's enterprise-wide culture.
  • Customer service does not have to deteriorate with budget cutbacks.
  • Discounting of fees does not necessarily translate into automatic trust, especially if it encourages a service provider to cut back on quality or lose money instead.
  • Clients should be willing to provide constructive feedback to service providers before calling it quits. A reasonable period of "remedy" should be decided upon before pulling the plug.
  • The compensation structure on both the buy and sell side should encourage long-term value maximization on behalf of relevant constituencies.
  • Conducting assessments as to what remains critically important to institutional investors versus "nice to have" or "waste of time" should occur on a regular basis.

It is undeniably a brave new world. Without trust and a focus on long-term relationship building, new business for investment service providers may end up costing a bundle. Instead of being hired to "rescue" institutional investors such as pensions, endowments and foundations by granting advice, an absence of trust could induce more risk in the form of litigation and harm to reputation, resulting in service providers themselves asking for a safety net.