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.

Dr. Susan Mangiero Speaks at Fiduciary Conference About Due Diligence for Alternative Investments

I am delighted to have been invited to join the faculty of the Master’s Track at the annual fi360 investment fiduciary conference, held this year in Scottsdale, Arizona. Speakers include: (1) ERISA attorney Charles Humphrey (2) Edward Lynch, AIFA, RF, GFS with Fiduciary Plan Governance, LLC (3) Dr. Susan Mangiero, AIFA, CFA, FRM with Fiduciary Leadership, LLC and (4) pension auditor Michelle Sullivan, CPA with Freed Maxick CPAs

The fi360 Master’s Track offerings are created especially for those with a knowledge of fiduciary standards and how that standard applies to the topics being presented.

Our session is entitled "Due Diligence for Alternative Investments." Our panel will focus both on the legal issues and the internal control compliance issues that cannot be ignored by anyone with a fiduciary responsibility to prudently select and monitor. This session will describe the impact of Dodd-Frank on investing in alternatives, various court cases and regulatory enforcement actions as well as the DOL/IRS regulatory guidance on alternative investment allocations. Click to read more about this session and the other sessions to be presented at this conference of investment fiduciary professionals from April 17 to April 19.

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.

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.

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.

SIFMA Study Intimates Fiduciary Standard Cracks

Hot off the press, a study commissioned by the Securities Industry and Financial Markets Association ("SIFMA") questions whether a uniform fiduciary standard of care makes sense. Conducted by Oliver Wyman consultants, "Standard of Care Harmonization: Impact Assessment for SEC" (October 2010) suggests that a "one size fits all" approach for fee-based advisors and broker-dealers may force consumers to bear higher costs and/or limit their access to financial products that are distributed through broker-dealers and/or lower access "to the most affordable investment options." The authors assert that only one out of every twenty retail investors rely only on fee-based accounts. Their analysis considers three different types of investors to include "small," "affluent" and "high net worth." Researchers cite the regulatory burden on asset managers due to compliance with Europe's Markets in Financial Instruments Directive as a harbinger of things to come in the United States.

Critics of the study have raised eyebrows about the type of data collected for examination. They add that the Dodd-Frank Act does not require all of a broker-dealer's activities to be subject to an imposed fiduciary standard of care so the emphasis of this new research is misplaced. See "Advisory Industry: SIFMA Fiduciary Study Raises Lots of Questions" by Melanie Waddell, AdvisorOne, November 2, 2010.

At a time when numerous financial professionals are aggressively courting investors who seek to buoy their retirement nest eggs, how fiduciary standard of care rules are finalized will be important in numerous ways and to numerous individuals and organizations.