Union Pension Power

In response to a request from the United Brotherhood of Carpenters and Joiners of America, American Express Co. is slicing retirement benefits for top executives by more than ten percent. According to Wall Street Journalreporter Robin Sidel, the changes “come amid shareholder criticism over supplemental executive retirement plans, or SERPS, that award big pay packages to departing executives.” (See “Top Executives at American Express Will See Retirement Benefits Shrink” – January 27-28, 2007).

This is not the first time that unions have taken an activist stance nor will it likely be the last. Check out the long list of Annual Group Meeting (AGM) resolutions brought by union pension plans, courtesy of Ms. Jackie Cook, a researcher on director interlocks and corporate social responsibility. Click here to access the list.

Now that new, and arguably more rigorous, SEC executive compensation disclosure rules are in effect, it will be interesting to observe union response. Will juicy corporate pay packages encourage even more attempts at reform? Will rank-and-file workers find it difficult to lobby for cuts in executive perks while asking for personal hikes? How will the dual role of employee and shareholder affect union clout?

“Workers unite” could start to take on an altogether different meaning.

Compliance and Litigation Remain Hot Button Issues

According to Fulbright & Jaworski partner and global chair of the Litigation Department, Stephen C. Dillard, fear may be appropriate with respect to all things litigation. In “Litigation Nation” (Wall Street Journal, November 25, 2006), Dillard describes results from their third Litigation Trend Survey, emphasizing an increasing upward trend in lawsuits here and abroad. “Even we were surprised by the volume and scope of legal actions across all major industries and regardless of company size.”

Besides finding that “Some 89% of companies report being hit with at least one new lawsuit in the past year,” companies stateside “face an average of 305 lawsuits pending world-wide.” At the same time, “companies with sales of $1 billion or more” face an average of 556 cases, “with 50 fresh suits emerging each year for nearly half of these firms.”

The cost of litigation is far from trivial. The survey cites corporate legal expenditures averaging $12 million, up from $8 million last year and with some industries – engineering and insurance – spending over $35 million.

Given the nature of this blog, what caught my eye were the assertions that “more than half of the in-house counsel cited employment as their top litigation concern” and that “disputes over wages and hours can be brought as class actions in many jurisdictions, creating more waves of litigation.”

Other press accounts about corporate lawsuits are similarly engaging.

According to the Chief Legal Officer Survey 2006, compliance and litigation are huge concerns. Conducted by Altman Weil, Inc. and LexisNexis Martindale-Hubbell, respondents lament that time and money used to fight and/or prevent lawsuits could not be otherwise used to grow the company.

New York Times reporter Paul B. Brown describes the concept of litigation funding companies in “What’s Offline: Next, a Lawsuit Futures Exchange?” Citing Joshua Lipton in “Litigation 2006,” Brown informs that hedge funds are researching the possibilities of investing now in anticipation of enjoying hefty case outcomes later on. That same supplement to the American Lawyer & Corporate Counsel includes a piece by Alison Frankel that offers insight about the globalization of litigation.

Lest you need more of a reminder that a sea change is upon us, consider the U.S. Appeals Court decision that found a fiduciary personally liable for nearly $180,000 due to losses realized by the International Brotherhood of Industrial Workers Health and Welfare Fund. In “Ruling highlights fiduciary need for hindsight”, Reid and Riege attorneys David M.S. Shaiken and Eileen M. Marks describe the serious fallout from Chao v. Merino, 452 F.3d 174 (2d Cir. 2006), stating that the individual in question “was permanently prohibited from serving as a fiduciary or service provider to any employee benefit plan.”

Other excerpts from the November 2006 Employee Benefit News article merit attention.

1. “The Court of Appeals’ holding underscores how important it is for new plan fiduciaries to inform themselves thoroughly about a plan’s operations, consultants and service providers with whom the plan has contracted. New fiduciaries should raise with co-fiduciaries any concerns about existing relationships after conducting their review.

2. The mere fact that an imprudent relationship predates a fiduciary’s tenure does not shield the fiduciary from liability. The duties to be informed about plan business and to act prudently include a duty to be informed about, raise objections to, and protect the fund from any imprudent relationships that are in place with consultants and service providers when a fiduciary’s term begins.

3. Plan fiduciaries may wish to review their and their plan’s insurance coverage. ERISA plan fiduciary liability insurance covers claims against current and former plan trustees and, if they are named in the policy, plan administrators who have fiduciary duties. In case of a claim of breach of fiduciary duty, within the insurance policy’s limits the insurer provides and pays for defense counsel, and indemnifies the plan fiduciary from liability, provided that the claim is not excluded from the policy’s coverage.”

Given the tsunami of litigation (with all indications that more is on its way), pension fiduciaries need to assess their personal and professional risk.

It’s scary stuff indeed. Email us if you want to know more about our fiduciary and board training programs. If you are an attorney, ask to receive our complimentary pension governance kit.

The 401(k) Fee Blame Game: Who’s Next?

Chances are you’ve read about the flurry of cases recently filed against nearly a dozen 401(k) plan sponsors, alleging fiduciary breach by allowing plans to levy unreasonably high fees. Regardless of the legal outcome, the complaints are creating a buzz while encouraging plan sponsors everywhere to reassess their own situation.

In a recent client alert, law firm Dechert LLP wrote that “Under ERISA, an employer that provides a 401(k) plan to its employees is a “Plan Sponsor” and may also serve as “Plan Administrator.” Both the Sponsor and Administrator are fiduciaries of the 401(k) plan. ERISA requires that that the Sponsor and Administrator ensure that fees borne by the plans be reasonable, and be incurred solely for the benefit of plan participants. In addition, 401(k) plans generally provide for participant-directed investment and are designed to comply with the rules under ERISA Section 404(c) which permit Plan Sponsors and Administrators to avail themselves, under certain circumstances, of a statutory safe harbor from fiduciary liability for the results of such investment elections. The safe harbor under ERISA Section 404(c) is available only where the fiduciaries allow the participants “the opportunity to obtain sufficient information to make informed decisions with regard to investment alternatives available under the plan.”

More recently, Mr. Robert J. Grassi (Director, Pensions & Investments – Corning Inc.) and Attorney Michael J. Prame (Principal, The Groom Law Group) addressed this important issue as part of the Association for Financial Professionals Annual Conference – “401(k) Plan Fees: What You Need to Know and What You Need to Do.” Citing concerns such as lack of fee transparency, hidden costs and potential conflicts of interest, Grassi and Prame provided audience members with a laundry list of types of direct and indirect compensation, respectively.

Both gentlemen talked about “the other shoe still to drop”, adding that the U.S. Department of Labor is “formulating guidance that would essentially require plan fiduciaries, before contracting with a service provider, to consider the indirect compensation to be received by the service provider.” They described a basis for imposing this obligation on fiduciaries in the form of the Frost/Aetna letters whereby “fiduciaries have a duty to obtain ‘sufficient information’ about the compensation that service providers receive from third-parties so that plan fiduciaries can make ‘informed decisions’ about whether the amounts that the plan pays are reasonable.” Expected U.S. Department of Labor initiatives to amend 408(b)(2) regulations are likely to accelerate additional disclosure about plan fees.

Regulatory and policy-making scrutiny is on the rise. As we wrote in an earlier post, the U.S. Department of Labor wants to amend Form 5500, Schedule C, to include more stringent information about fee arrangements with service providers beyond what is currently required. U.S. Congressman George Miller has requested a report from the General Accounting Office about pension fees and the SEC reported on the relationship between pension consultants and fees in 2005.

Noteworthy is the sentiment that company decision-makers in the hot seat today will likely be followed by external plan fiduciaries next. According to attorney Stephen D. Rosenberg, author of the Boston ERISA & Insurance Litigation Blog, “Given the number of different advisors and other players involved in the operations of these types of retirement vehicles, there are bound to be plenty of fiduciaries – as that term is understood in the context of ERISA – involved in almost any 401(k) plan, making for plenty of targets for such suits.”

One thing is certain. The spotlight will not dim on the fee issue any time soon.

Editor’s Note:
The paper about fees by banker Ed Lynch, attorney Fred Reish and Dr. Susan M. Mangiero, Accredited Investment Fiduciary Analyst will be completed soon. We have created a list of recipients who requested our paper.

Can Poor Pension Governance Land You in Jail?

In a riveting and timely article, senior Greenberg Traurig ERISA attorney Jeff Mamorsky provides a serious wake-up call to pension fiduciaries everywhere. (Click here to read “Is Today’s Pension Plan Environment Cause for Concern?”,CEO Magazine, August 2006.)

Mamorsky chronicles the parade of corporate horribles in the U.S. that eventually led to the Sarbanes-Oxley Act of 2002 (SOX). He points out the irony that “All this happened in the USA despite the fact that the federal pension law, the Employee Retirement Income Security Act of 1974 (ERISA), contains rules that require plan sponsors to establish internal control procedures to monitor compliance with the fiduciary responsibility requirements of ERISA.”

In the spirit of the stick winning over the carrot, Mamorsky adds that “These rules were in some cases not followed since there were few real teeth in the law. It took SOX with its draconian certification penalties and ERISA’s ‘white collar’ criminal penalty provisions to make plan sponsors take pension governance more seriously.”

Emphasizing the nature of personal liability for pension fiduciaries, the article explains the critical, and undeniable, connection between SOX compliance and pension governance. In a rather ominous statement, Mamorsky warns “This liability has increased as the result of legislation such as SOX that requires a public company CEO, CFO or other responsible fiduciary to certify the establishment and adequacy of ‘disclosure controls and procedures’ relating to material items in the annual financial report. What companies sometimes overlook is that this SOX section 404 management assessment of the adequacy of internal control procedures requirement applies to pension and benefit expenses.”

If you aren’t scared at this point in the article, he goes on to describe SOX sanctions of money and jail – “$2m and up to ten years’ imprisonment for non-wilful ($5m / up to 20 years’ imprisonment for wilful) certification of any statement that does not comply with SOX requirements.” Then there is the matter of heightened IRS scrutiny of pension plan governance (or lack thereof), a rise in litigation and general upset about the topics du jour, pension funding gaps, rescinded benefits and so on.

Mamorsky concludes that the rest of the world is starting to feel the pinch as the UK and other countries address governance as an important element of the “global pension world.”

As an aside, our sister company, BVA, LLC is soon to launch a pension litigation database, chock full of analyses and trends. We had planned to launch earlier but found many more cases than we originally anticipated.

A harbinger of days ahead in pension governance land?

Hedge Fund Valuation is a Big Deal for Pension Fiduciaries

As earlier stated, asset valuation is the cornerstone of investing. (See “Do You Really Know the Value of Your Portfolio?”)

The absence of good valuation numbers makes it virtually impossible to execute vital tasks:

1. Asset allocation

2. Risk management

3. Performance evaluation

4. Selection and comparison of managers …

(The discussion of what constitutes “good” numbers is left for another posting.)

Regulators and politicos are hardly alone in urging more prudence with respect to the valuation of certain positions. Industry groups have jumped into the fray, and some assert, it’s none too soon. The Private Equity Industry Guidelines Group posted valuation guidelines a few years ago. Its mission: “To promote increased reporting consistency and transparency while at the same time improving operating efficiency in the transfer of information among market participants by establishing a set of standard guidelines for the content, formatting and delivery of information.” The “MFA’s 2005 Sound Practices for Hedge Fund Managers” has a lot to say about valuation policies and procedures and is well worth a read.

So why is this important to pension fiduciaries? For one thing, countless fiduciaries are allocating monies to hedge funds. Second, a recent article offers that hedge funds could have as much as fifty percent of their money tied up in relatively illiquid assets, in part (some argue) to avoid having to register their managers.

According to U.S. SEC Commissioner Roel C. Campos, “To avoid dilution and unfairness, valuation numbers must be accurate and unbiased. A key element of monitoring the risk of hedge funds is to understand the valuation used by said funds and counterparties to the funds.”

Hiring an independent appraiser can go a long way to aiding this process, especially when accreditation itself entails satisfying rigorous education and experiential requirements. In fact, courts and regulatory bodies are increasingly turning away experts on valuation matters unless their credentials include specialized valuation training. (Note: As an Accredited Valuation Analyst and someone who has completed course and exam requirements for two other specialized valuation designations, I can attest to the rigor.)

With so much at stake, pension fiduciaries should be asking tough questions of their hedge fund managers (and/or consultants who recommend hedge fund managers).

1. Does the hedge fund rely on independent appraisers to provide assessments of fair market value?

2. Has a hedge fund established a proper valuation process?

3. How often are the valuations updated? *

4. Is each opinion of value well documented?

5. Are all terms and conditions of a particular economic interest specified and analyzed accordingly?

6. Does the hedge fund manager acknowledge how much of its portfolio is not valued on a regular basis, thereby affecting reported portfolio performance?

The list is long. One thing is certain. Hedge fund valuation is the topic “du jour”. Can a pension fiduciary afford to invest in a hedge fund, fund of funds, private equity fund, venture capital fund, commodity pool, derivatives fund and so on, without understanding whether, and to what extent, managers have considered various valuation issues?

* Not discussed here, there are those that assert that some positions should not be valued and that doing so would jeopardize the asset allocation decision that led to investing in relatively illiquid holdings in the first place. I welcome your comments regarding this point.

Do You Really Know the Value of Your Portfolio?

Proper asset valuation is a cornerstone of the investment management process. Without good numbers, it is virtually impossible to make meaningful decisions about asset allocation, portfolio re-balancing, risk control, and manager evaluation. The challenge is especially relevant as endowment, foundation and pension fiduciaries commit billions of dollars to hard-to-value instruments at the same time that regulators are asking tough questions about methodology and process.

Anyone with fiduciary responsibilities needs to have a solid grasp of valuation fundamentals AND understand what happens in the absence of good numbers. The consequences are dire.

Duties extend to assessing external money managers on the basis of their respective valuation processes. (If you get a blank stare, worry.)

1. Do they use independent appraisers or do traders provide their own marks at the same time that they are compensated for reported performance?

2. What valuation models are used?

3. Are they recognized as standard models?

4. Are the models tested?

5. Where does the model input data come from?

6. What systems are used to value individual positions and portfolios?

7. Is model risk well understood and analyzed on a periodic basis?

The list goes on. If a plan sponsor is uncomfortable with evaluating a manager’s policies and procedures, hire someone to help. Oversight is a core responsibility and cannot be outsourced away.

There is a lot to say about this subject. I’ll be speaking about valuation as part of the (a) Asset Allocation & Risk Management Strategies for Institutional Investors (AARMS) conference in Boston on May 18 (b) National Association of Certified Valuation Analysts (NACVA) annual conference on June 2 and (c) Hedge Funds 101 & 102 conference for FRA, LLC in New York on June 23.

If you are interested in presentations and/or articles on the topic of valuation and model risk, contact me . I’d like to know what keeps you up at night with respect to everything valuation.

Without doubt, there is increasing emphasis on the topic of valuation with respect to both process and outcome.

Valuation is in the news!

“Understand how a fund’s assets are valued. Funds of hedge funds and hedge funds may invest in highly illiquid securities that may be difficult to value. Moreover, many hedge funds give themselves significant discretion in valuing securities. You should understand a fund’s valuation process and know the extent to which a fund’s securities are valued by independent sources.” (Hedging Your Bets: A Heads Up on Hedge Funds and Funds of Hedge Funds, U.S. Securities and Exchange Commission)

“According to a survey conducted by the Alternative Investment Management Association (AIMA) in Q4 2004, 20% of the assets held by hedge funds are hard-to-value securities. But many of these hard to value assets are concentrated within specific strategies such as distressed debt, emerging markets and mortgage backed-securities. Investors in a non diversified hedge fund may therefore have up to 100% exposure to hard-to-value securities. A combination of assets with poor market liquidity, leveraged structures and their non-stable correlation with other related assets mean valuations can exhibit considerable volatility within a short period of time.” (Hedge Funds: Are their returns plausible? Speech by Dan Waters, Sector Leader Asset Management, Financial Services Authority – UK, March 16, 2006)

“The more unusual the instrument or the greater the degree to which the asset payoffs are determined by a tiny fraction of the economic states the harder is the instrument to value and assess the risk.” (The Growth of Derivative Securities speech by Chester S. Spatt, Chief Economist and Director of the Office of Economic Analysis, U.S. Securities and Exchange Commission, December 8, 2005)

“Diligence, prudence and caution should be applied when valuing private companies, and in particular when considering the valuation write-ups of early-stage companies, in the absence of market-based financing events.” (Industry Group Releases Clarification Valuation Guidelines Endorsed By ILPA press release, October 2004) – Note: ILPA = Institutional Limited Partners Association

“Preliminary results from a survey on the pricing of hedge fund portfolio assets suggest that considerably more than one-third of managers mark hard-to-price securities in equity and fixed-income portfolios according to their own models, rather than using dealer’s prices.” (Model-Driven Pricing Common for Illiquid Securities, HedgeWorld.com, February 3, 2004)

“Investment Adviser Defrauded Hedge Funds, SEC Suit Alleges” (Derivatives Litigation Reporter, January 15, 2001)

“Ambiguity clouds valuation methods” (Financial Times, February 25, 2002)

Pension Lawsuits

The Administrative Office of the U.S. Courts reports an increase in new Employee Retirement Income Security Act (“ERISA”) case filings from 9,167 cases in 2000 to 11,499 cases in 2004. According to a March 2006 American Bar Association publication, about fifty stock-related lawsuits have been filed in the last two years, alleging employee benefit fiduciary violations and adding to a growing number of what some describe as “stock drop” actions.

The basic idea is this. Company stock is included as an investment choice for defined contribution plan participants. The stock falls in value. Employees suffer losses. Fiduciaries are asked to address whether: (a) their inclusion of company stock as an investment choice was appropriate (b) they conveyed accurate information about the company (c) they had put employees first or were influenced by conflicts of interest.

What has groups such as the Professional Liability Underwriting Society alarmed about the “startling” increase in these ERISA fiduciary breach cases? First, the amounts at stake are huge. Second, some experts suggest that it may be easier to bring suits on the basis of ERISA violations instead of securities fraud. (There is a lot written on this topic, including the requirements to become a lead plaintiff under the auspices of the Private Securities Litigation Reform Act of 1995, “PSLRA”). Third, various employee benefit reforms, expected out soon, could lead to financial restatements and unhappy investors.

Legal experts suggest that we’re in for a bumpy ride. Negative headlines, excessive executive compensation (perceived or real), market volatility, a dramatic shift away from defined benefit to defined contribution plans and regulatory reform that could force write-downs are some of the many factors that will continue to put fiduciaries in the spotlight.

Searching for Hidden Treasure

I’ve spent the last few weeks trying to uncover information about the retirement plan decision-makers at various companies. I’m willing to pay money for this information. Why?

Simply put, I want to know who has responsibility for making multi-million dollar decisions that affect thousands of employees and retirees. Once identified, I’d like to read their bios, understand how they were selected, read about how they are evaluated and identify to whom they report.

Unfortunately, my quest has provided scant results. Here is a summary of what I know. (I welcome comments about possible data sources.)

1. There is no universally accepted organizational structure to determine who is in charge of recommending and deciding on what retirement benefits to offer those outside the executive suite.

2. When a retirement benefits committee exists, it goes by different names, some of which are listed below.

(a) Master Retirement Committee
(b) Trust Selection Committee
(c) Saving and Investment Plan Committee
(d) Pension Committee
(e) Retirement Board
(f) Fiduciary Committee
(g) Benefits Committee
(h) Deferred Compensation Board
(i) Compensation and Employee Benefits Committee

3. Titles of benefits-related decision-makers vary. Some examples follow.

(a) 401K Board Chairperson
(b) Benefits Director
(c) Benefits and Compensation Director
(d) Benefits Administrator
(e) Head of Human Resources
(f) Compensation Committee Chairperson

4. The SEC has proposed a significant overhaul of reporting rules as relates to executive compensation and compensation committees. It appears to be silent with respect to the compensation decision-making process for employees below C-level.

5. Page 1 of Form 5500 requires the identification of the plan sponsor and plan administrator, respectively. Schedule P to Form 5500 requires the signature of a fiduciary and the name of a trustee or custodian. (According to the U.S. Department of Labor website: “Each year, pension and welfare benefit plans generally are required to file an annual return/report regarding their financial condition, investments, and operations. The annual reporting requirement is generally satisfied by filing the Form 5500 Annual Return/Report of Employee Benefit Plan and any required attachments.”)

6. ERISA mandates the distribution of a Summary Plan Description(SPD) to each plan participant and beneficiary currently receiving benefits. Required information includes “the name, title and address of the principal place of business of each trustee of the plan”. Education and experience are not mandatory disclosure items.

The bottom line is that a systematic identification of who does what and why with respect to employee benefits is simply not a reality as things stand today. This makes it difficult (perhaps impossible) to effect change.

Hunting for treasure shouldn’t be this hard!