Chief Retirement Officer Redux

Skittishness about an individual's financial ability to retire is one factor that I believe underlies continued ERISA litigation activity. As I suggested to Wall Street Journal reporter Anne Tergeson, "'There has been quite a focus on the retirement crisis which has created significant nervousness about this gigantic pool of' 401(k) money and whether it is being managed properly." See "Lawsuit Alleges Anthem 401(k) Plan Exposed Participants to Higher Fees," January 8, 2016. (As an aside, I am not involved in this litigation and did not comment on this case for the article.)

Perhaps these same jitters about retirement readiness explain why some might consider the installation of a Chief Retirement Officer. Senior ERISA attorney Stephen D. Rosenberg writes that this idea is "so simple...and so brilliant..." in his commentary entitled "What Can a Chief Retirement Officer Do for You?" (December 9, 2015). In my piece about the same topic, I countered that hiring this kind of C-level executive may still prevent ERISA puzzle pieces from snapping easily into place. In "Chief Retirement Officer and a Seat at the Table," I cite the challenges of finding someone knowledgeable enough to navigate complex issues that transcend law, corporate finance, human capital enhancement, governance and investment management. I further question whether a Chief Retirement Officer would help or hinder the work of a Chief Risk Officer if one exists.

Stirring the pot further, Dr. Richard Glass, president of Investment Horizons, shared with me his view that a Chief Collaboration Officer may be a smarter move. Such a person would have a "primary duty" "to break down corporate and consulting silos." His view is that "These silos prevent the successful implementation of talent management (including engagement efforts) and business strategies and thus the level of profitability." Coincidentally, I spent nearly an hour on the phone today in a lively discussion about how to adjust enterprise value to reflect defined benefit plan underfunding. Earnings, share price and overall corporate worth is impacted by ERISA plan economics.

A "silo mentality," as defined by, is "A mind-set present in some companies when certain departments or sectors do not wish to share information with others in the same company. This type of mentality will reduce the efficiency of the overall operation, reduce morale, and may contribute to the demise of a productive company culture." A reasonable person could quickly conclude that a failure to communicate across functions is fraught with problems. Using case studies and her knowledge of anthropology, prominent Financial Times editor Dr. Gillian Tett makes the case for getting rid of organizational walls in her 2015 book entitled The Silo Effect: The Peril of Expertise and the Promise of Breaking Down Barriers.

Fortunately, there is a solution as long as corporate management has the will to create a unifying vision and motivate management teams to work towards common goals. Forbes contributor and management consultant Brent Gleeson adds that people must be properly incentivized and that goals must be measurable. Read "The Silo Mentality: How to Break Down The Barriers" (October 2, 2013) for more of his insights.

Applied to ERISA plans, the temptation to hoard information is ill-advised. If true that corporate power grabs exist and impede the ability for investment fiduciaries to carry out their duties, a Chief Retirement Officer might not have the clout to coalesce competing interests. Unlike a Chief Risk Officer who reports to a corporate board to ensure her authority and independence, a Chief Retirement Officer would likely wear the hat of fiduciary and have to put participants' interests ahead of those of shareholders. (The plot thickens when plan participants are contemporaneously shareholders by virtue of investing in company stock as part of a 401(k) line-up.) I defer to ERISA attorneys to address the separation of fiduciary "church and state" but could see someone crying foul if a Chief Retirement Officer communicates too often with company directors. Interested readers can download "Pension risk, governance and CFO liability" by Dr. Susan Mangiero for comments about two-hat conflicts. (Note that my work affiliation is Fiduciary Leadership, LLC.)

One step in the right direction towards effective pension governance is to appoint fiduciaries who have different backgrounds and can therefore facilitate a thorough discussion of various and important topics around the unifying theme of duty and care. Other ingredients of a well-baked set-up include having sensible metrics in place to assess whether fiduciaries are doing a good job. Rewarding them when they step around silos to make better decisions is likewise needed.

Whether a Chief Retirement Officer can assist here is unclear. Surely more discussions about this role make sense.

Pulling Rabbits Out of the Hat At Sea

According to up-to-the minute press accounts, some 100 magicians are stranded in the middle of the ocean on a cruise ship with a faulty engine. Expecting a few days of fun and legerdemain, these tricksters are awaiting rescue and forced to dine on cold goodies with no air conditioning. When a colleague brought this news to my attention tonight, my immediate query was why help was taking so long. In response, I was told that passengers had to wait for a tugboat that could transport over 3,000 people (magicians included). Help is expected in short order with a full refund and a free trip for those affected.

No doubt Jay Leno and others will get a few guffaws out of this unpleasant experience for the sailing "Houdinis" - something to the effect that magicians should be able to snap their way out of trouble. The reality is that bad things can happen, leaving one feel helpless and stressed out. Also true is that adversity should and can be anticipated. That's why stress tests are so important as a way to model the unthinkable and plan accordingly. Maybe the cruise company in question did just that but, if so, why are paying customers forced to hang out for more than a few hours?

If we've learned anything from the financial market rollercoaster of late, it's this. We can't rely on sleight of hand to properly identify, measure and manage risks. Putting a contingency plan in place for any and all of the risk factors considered potentially material is good business sense. In pension land, failure to have tested the limits of a significant negative equity market has cost numerous sponsors big money. Other types of institutional investors and asset managers must heed this cautionary tale too.

Notably, in an in-depth survey conducted by MSCI Barra in 2009, "73% of pension plans and 26% of asset managers surveyed do not currently run stress tests, but cite this as a key focus going forward." This is encouraging. After all, ignoring the tail risk can lead to nasty consequences.

Other results that MSCI Barra uncovered are similar to what I found in a study of over 150 U.S. and Canadian pension plans, done in conjunction with the Society of Actuaries. Like MSCI Barra, few of our queried plan sponsors had Chief Risk Officers in place, considered retirement plan management as part of an enterprise-wide risk exercise and did not always pay close attention to risks such as liquidity. Click to access a full version of this 2008 study about the use of financial derivatives and fiduciary duty.

Pulling rabbits out of the hat is not as easy as it appears. Isn't it better to depend on a systematic and disciplined approach to mitigating those things that have the potential to destroy, if left unchecked?

Hail to the Chief - Risk Officer That Is


In "Risk Redux" by Kristin Fox, founder of Fox Inspires, LLC (Private Wealth, January 7, 2010), I am quoted extensively on the topic of risk management. I'm happy to note that others interviewed for the article reiterate many of the points I made.

Given the changed landscape, post Madoff and so on, the life of a Chief Risk Officer ("CRO") is even more harried than ever before. He or she is often expected to save the ship without impeding the traders' ability to turn a profit. Applied to hedge funds, the task is arduous indeed as the threat of global regulation looms closer and investors clamor for heightened transparency about fees, concentration of positions and overall risk-taking.

Since so many pensions, endowments and foundations are adding to their hedge fund allocations, the article is worth a read. Some of my talking points are listed below:

  • Risk management is an integral part of a firm’s culture and one of the keys to its success. “Instead of looking at risk management as a roadblock, it should be promoted as part of your culture and viewed as the best way to ensure the firm’s longevity.”
  • There is no one size fits all approach to hedge fund risk management. It depends on the size of the organization, strategy, type of clients, risk tolerance, to name a few items.
  • A CRO must ask tough questions about the risk "cost" of every expected dollar in return.
  • Compensation must support the notion of a risk culture or any other efforts to mitigate risk are doomed to fail.
  • Kick the tires on models. Ask if underlying assumptions prevail.
  • Make sure that everyone understands the nature of leverage, from the back office clerk to the front room trader.
  • Acknowledge that risks seldom live in isolation. One of the unpleasant surprises of 2008 and 2009 had to do with the convergence of risks. The traditional reliance on correlations had no place in the volatility maelstrom that created heartburn for a lot of investment professionals. "For example, with structured products, liquidity risk was arguably greater than anticipated because the quality and quantity of supporting collateral was sometimes wanting. For any financial institution that had hedged part of its structured product portfolio, it may have found itself with another risk in the form of counterparty defaults. The risks are often not additive, and a good CRO needs to truly understand the interrelationships among financial, operational and legal risks, to name a few."
  • Figure out a way to overcome the resistance of those who are already burdened with their own work but who are nonetheless critical to the risk management process. A good CRO must make friends and motivate accounting, legal, systems and trading to hold hands and come together to properly manage the R word.

Though written in 2003, my article entitled "Life in Financial Risk Management: Shrinking Violets Need Not Apply" is still relevant. I describe the building block concepts as well as the skill set required for an effective CRO.

Pension Fiduciaries - Have You Asked Your Bankers About Their Risk Controls?

In a November 5, 2007 statement, Citi announced that current CEO Charles Prince will step down. Robert E. Rubin will become Chairman of the Board and a search for a new leader will begin immediately. In a related story, Wall Street Journal reporters Carrick Mollenkamp and David Reilly describe Citigroup's struggles to estimate trading losses, in large part due to the fact that internal quantitative models relied heavily on credit ratings assigned to securities that were used in structuring Collateralized Debt Obligations (CDOs). With recent downgrades (to arguably better reflect risk levels), the value of Citi's sub-prime holdings similarly sank. Credit fears dampened already limited trading interest, forcing a heavy reliance on a mark-to-model approach.

As this blog's author has stated many times before, model risk is real. Bad or inappropriately used models lead to imprecise outputs. Decisions based on poor information can only lead to trouble. According to "Why Citi Struggles to Tally Losses Swelling Write-Downs Show Just How Fallible Pricing Models Can Be" (Wall Street Journal, November 5, 2007), modelers projected future expected payments for then high-rated sub-prime backed CDOs on the basis of how similar credit rated corporate bonds were trading. By not recognizing that default experience for corporate versus sub-primed backed securities differed dramatically, Citi's rocket scientists painted too rosy a valuation picture.

In a related article ("Where Did the Buck Stop at Merrill? November 4, 2007), New York Times reporters Graham Bowley and Jenny Anderson describe oversight problems at Merrill Lynch. Following a $8.4 billion charge and the recent resignation of CEO O'Neal, questions have arisen about whether board members should be more aware of daily operations, especially those areas that are likely to present problems if things go awry. Quoting Meredith Whitney, CIBC World Markets financial analyst, the point is made that Merrill had no one with sub-prime experience to serve on any of the committees charged with risk oversight and auditing. Despite creating a post for Chief Risk Officer in early September 2007, other experts cited in the article decry the lack of board/oversight committee independence from senior management, at the same time that large trading books were "hard to value."

By extension, this notion of oversight applies to pension fiduciaries. As this blog's author has repeatedly emphasized, plan sponsors MUST do a thorough job of vetting service providers (including banks) with respect to their "red flag" controls. How many pension fiduciaries ask about the existence of a Chief Risk Officer (or lack thereof)? How much detail do pension fiduciaries demand to know about each bank's risk management function, certainly for key parts of trading operations? Do pension fiduciaries ask to speak to members of the valuation team and/or those responsible for collateral management? Have pension fiduciaries asked banks about their progress with respect to preparing for Basel II and related model requirements? (Click here to read the November 2, 2007 press release from the Federal Reserve Board which describes their approval of new risk-based capital rules.) The list of other "must know" queries is long but nevertheless essential to proper due diligence.

Will clever attorneys make a case for poor process if pension fiduciaries have allocated monies to any or all of the banks now making headlines, citing breach if they failed to dig deep about risk and valuation policies and procedures?