Pension Risk Matters

Economic Indicators to Include Focus on Pensions

Susan Mangiero — Tue, 14 May 2013 00:32:05 -0500

In what most people would call a significant announcement, the U.S. Bureau of Economic Analysis ("BEA") will begin measuring economic growth this summer by taking pension finance into account. According to its March 2013 announcement, BEA will record defined benefit plan transactions on an accrual accounting basis. This entity, part of the U.S. Department of Commerce, will now include a pension plan subsector in the national income and product accounts ("NIPAs"). As much as possible, the BEA will "provide estimates of the current receipts, current expenditures, and cash flow for the subsector." The intended changes contrast with the current method of including information about disbursements and earnings of pension plans as participants' personal items and using a cash basis for reporting.

The goal of enhancing transparency about employer-provided defined benefit retirement plans is laudable. However, in reading the fine print, one wonders if the opposite will occur and users of post-implementation data will be more confused. For one thing, the BEA states that it will adopt an accumulated benefit obligation ("ABO") for "both privately sponsored and state and local government sponsored plans" and use a projected benefit obligation ("PBO") for federal government plans. This means that you will never be able to compare all defined benefit plans with a single set of rules. Second, the BEA describes a discount rate assumption that "will be based on the AAA corporate bond rate published by the Federal Reserve Board." Since debt issued by the U.S. is no longer rated AAA and recent regulations allow for temporary funding relief for corporate pension plans, how will BEA numbers compare and contrast with financial accounting numbers over time? Third, since certain data is not available prior to 2000, the BEA will extrapolate to generate "normal costs" for past years. Will their method of extrapolation allow for an accurate "apples to apples" assessment of historical pension earnings and costs? In the plus column, applying the same discount rate for private pension plans versus state and local offerings will help to better assess the economic viability for each sector.

Should the Public Employee Pension Transparency Act move forward, disclosures will be based on the BEA approach. Understanding what BEA numbers do or do not show will therefore be a critical exercise for policy-makers, investors and participants.

For a detailed discussion of these intended changes on the part of the BEA, read "Preview of the 2013 Comprehensive Revision of the National Income and Product Accounts: Changes in Definitions and Presentations," BEA, March 2013. Click to read about advantages of passing the Public Employee Pension Transparency Act. Click here to read criticisms of this proposed rule. On April 23, 2013, the U.S. Senate received a version of the Public Employee Pension Transparency Act in the form of S. 779. This proffered legislation cites a staggering $5.170 trillion in pension liabilities of the 50 states combined. It is no wonder that numerous individuals want a true tally of what is owed.

Pensions and Politics

Susan Mangiero — Wed, 08 May 2013 23:50:53 -0500

I have a favorite shirt that gets a few laughs when I wear it. The message is "Change is good. You go first." That is how I feel when I hear pundits talk about the future of pensions and the need for reform. What I continue to believe and have said many times in the last ten years is that the retirement issue is getting closer to the point of no return. Politicians will jump in to allegedly save the day. Part of the problem is that there is a battle of interests with few constituencies aligned to move in the same direction. When this occurs, a central authority typically intervenes.

On May 2, 2013, one speaker who presented as part of the "Bloomberg Forum on Pension Reform" called the situation "desperate." Another speaker said that he is optimistic that the U.S. Congress is proceeding apace with relevant reform. Another speaker hinted at inevitable higher premiums to be paid by plan sponsors to the Pension Benefit Guaranty Corporation ("PBGC"). Comments were made that some underfunded plans will have to materially cut retirement benefits in order to survive.

People are starting to ring the alarm bells. In its 2013 Retirement Confidence Survey, the Employee Benefit Research Institute ("EBRI") found that only 13 percent of workers feel "very confident" about the ability to enjoy a comfortable retirement. That means that 87 percent of workers do not feel confident. Click to see the results of the 2013 Retirement Confidence Survey.

It is unclear how much power voters will have to effect movement as relates to retirement reform such as tax incentives to save, especially when the issue is seldom discussed as part of political campaigns. That could change over time.

When I recently took my 22-year old nephew out to lunch, we talked at length about his views on the budget. He has no debt and has found a job but he knows that many of his peers are not so fortunate. They are graduating with large school loans, have not found a job and are sleeping on mom's couch. These "boomerang" kids are growing in numbers around the world. While they may not be an economic force right now, they vote. At the polar opposite end in terms of desire for how the system should change, if at all, retirees vote as well.

How will politicians respond to younger persons who do not want to shoulder the high costs of social safety net programs and seniors who want them?

Politics and pensions may not make for strange bedfellows after all. As a champion of free markets, I am not particularly happy about the prospect of a "one size fits all" law(s) that seeks to create a national retirement system and/or levies tax penalties for those who wish to save more than $3.4 million or whatever level is deemed "too much." Think higher compliance costs, perverse incentives, the law of unintended consequences, moral hazard and the loss of flexibility. Unfortunately, with disparate owners who each want different things, something will have to take place soon. Many of the retirement piggybanks around the world are close to empty.

Real Estate Investment Trusts (REITs) and ERISA Plans

Susan Mangiero — Wed, 08 May 2013 23:25:03 -0500

According to "REITs By The Numbers," published by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), real estate is gaining favor with 401(k) investment committees that decide on asset allocation. They write that the last ten years has seen a rise from 5 percent to 30 percent of 401(k) plans that offer Real Estate Investment Trusts ("REITs") as an investment option. Moreover, the market is large at $1 trillion of real estate held in the form of an investment pool.

If you are a member of a 401(k) investment committee, advisor, consultant or individual participant, you will want to keep up with current guidelines and rules. Some of these are described in "Real Estate Investment Trust Valuation Guidelines Published." This blog post by Susan Mangiero includes FINRA and SEC comments about non-listed REITs as relates to items such as illiquidity, valuation and disclosures.

Valuation and ERISA Fiduciary Liability: Traps for the Unwary Appraiser

Susan Mangiero — Tue, 07 May 2013 22:26:21 -0500

An esteemed panel of experts will speak on May 14, 2013 from 1:00 PM EST to 2:40 PM EST as part of a webinar that is sponsored by Business Valuation Resources. Entitled "Valuation and ERISA Fiduciary Liability: Traps for the Unwary Appraiser," Dr. Susan Mangiero, CFA, FRM and Accredited Investment Fiduciary Analyst, will be joined by Mr. Robert Schlegel, ASA, MCBA and ERISA attorney James V. Cole II. Dr. Mangiero is a Managing Director with Fiduciary Leadership, LLC. Mr. Schlegel is a principal with Houlihan Valuation Advisors. Attorney Cole is a principal with Groom Law Group.

Why You Should Attend

As retirement, healthcare, and other employee benefits continue to grow, they are placing new stresses on firms of all sizes, whose commitments to these funds are beginning to outpace their revenues. Regulations and lawsuits are now challenging the defined responsibilities and liabilities of the financial professionals who create, manage, and even analyze these entities. This means that every appraiser now needs to assess risk, and the extent to which employee benefit plans impact enterprise value.

In this webinar, Dr. Susan Mangiero, Mr. Rob Schlegel, and ERISA attorney James Cole discuss existing, emerging, and proposed disclosure rules, an understanding of which are imperative to navigate the maze of actuarial, accounting, and regulatory numbers. Learn why estimating future expected cash requirements to service a plan(s) is imperative if an appraiser wants to opine whether a firm can realize its growth targets, and how benefit plan economics, such as withdrawal liabilities, change when derivatives or annuity transactions are in place. Appraisers need to understand emerging discussions now taking place at FASB and other regulatory agencies that will affect market participant activity relating to exchange value. Markets are waking up to this emerging area, and appraisers can no longer afford to remain asleep of these issues.

According to Mr. Blake Lyman, Professional Program Manager with Business Valuation Resources, LLC, "BVR is thrilled to be offering this program with Susan, Rob, and Jim. As the go-to resource for all professionals involved with business valuation, we always seek to present the most in-depth content on the most pressing issues for the many experts who rely on us. With Susan, Rob, and Jim's experience and expertise, this program is sure to surpass the high standards we set for ourselves and that our customers have come to expect."

To register, visit the Business Valuation Resources website.

Qualified Professional Asset Manager (QPAM) Webinar Slides

Susan Mangiero — Tue, 07 May 2013 00:04:46 -0500

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.

Hard to Value Assets and Pension Funding

Susan Mangiero — Tue, 23 Apr 2013 01:10:12 -0500

Add wine and cheese to the picnic basket and the pension fund too. According to "Companies Substitute Tangibles, Like Cheese, for Investments" by Mary Williams Walsh (New York Times, April 19, 2013), gaps in funding status are tempting some sponsors to add "unusual assets" to their portfolio. Her list of in-kind contributions includes cheese, whiskey, water rights, precious stones, oil wells, a restaurant, a brewery and a slaughterhouse.

An obvious advantage to a plan sponsor is the preservation of cash when an intangible or tangible asset is instead contributed. Another benefit is the potential upside associated with an asset poised for capital growth. This is especially true if cash contributions would be parked in a low-interest rate security or fund.

The downside is that an expectation of higher returns almost always means a greater uncertainty of realization.

Requisite approval by the U.S. Department of Labor may or may not mandate the hiring of an independent fiduciary to in turn engage someone to assess the value of an intended in-kind contribution. As a trained appraiser, I would tell anyone who asks that there are multiple items that must be assessed as a precursor to determining fair market value of the asset in question. Some of the items are listed below. This is not an exhaustive tally by any means.

Control - If there are multiple owners of an asset, it is important to assess the extent to which the ERISA plan can exercise authority over how an asset is used, disposed of and/or managed for purposes of adding to the asset's value.
Priority of Economic Claims: Understand whether the pension fund will be first in line to receive cash from the service and/or subsequent sale of the item being considered for contribution.
Collateral: If the value of the intended in-kind contribution item is supposedly dependent on other assets, it is critical to know whether that collateral is fungible and if there are sufficient assets in place.
Customer Diversification: If all or part of an operating business will be contributed to an ERISA plan, someone must make sure that revenue is generated from a sufficiently large number of clients so that if one or more large customers disappear, the value of the asset being contributed will not be adversely diminished.
Marketability: Not all assets trade in an active secondary venue. Discounts for lack of marketability need to be carefully examined so that the ERISA plan does not overpay.
Legal Protection: The appraiser must know whether an item such as a trademark or patent or other type of intangible or tangible asset is protected under law in terms of ownership and/or restricted use.
Quality of Management: If the pension fiduciaries are tasked with running a business or maximizing the value of an intellectual property asset to be contributed to a plan but do not have the time or requisite knowledge, someone may cry foul if the item loses value.
Maintenance: The value of an asset such as real estate, a building or piece of heavy equipment will go down if not cared for in a timely fashion. The cost of upkeep and/or the speed of obsolescence are two of many considerations that cannot be ignored. If an asset requires significant cash to keep it in tip top shape, it could be a drain on scarce pension plan resources.

Besides the valuation-related issues, an objective third party needs to assess the prudence of including a particular asset in the plan's portfolio. Then there is the issue of how the intended in-kind contribution will impact regulatory reporting, financial statement representation and actuarial requirements, not to mention future cash inflows and outflows.

The decision to contribute an in-kind asset is far from trivial. Like any other decision for an ERISA plan, care and diligence must be demonstrated before taking action.

Dr. Susan Mangiero Speaks About ERISA Plan Valuation and Appraiser Liability

Susan Mangiero — Sun, 31 Mar 2013 19:36:45 -0500

I am delighted to co-present on May 14, 2013 from 1:00 pm to 2:40 pm EST for Business Valuation Resources about the urgent need to properly assess pension fund economics as part of any opinion of value.This is a particularly timely topic as the U.S. Department of Labor seeks to designate appraisers as a fiduciary for an assessment they render about an ERISA plan such as an Employee Stock Ownership Plan ("ESOP"), 401(k) plan and/or defined benefit plan.

The session is entitled "Valuation and ERISA Fiduciary Liability: How to Protect Yourself." Speakers include:

Dr. Susan Mangiero, CFA, certified Financial Risk Manager, Accredited Investment Fiduciary Analyst, trained appraiser and past president of the Connecticut chapter of the National Association of Certified Valuation Analysts (Fiduciary Leadership, LLC;
Mr. Robert Schlegel, ASA, MCBA and past president of the Indiana chapter of the American Society of Appraisers (Houlihan Valuation Advisors); and
Senior ERISA attorney James V. Cole II, with the Groom Law Group.

Click here to register for this ERISA valuation program.

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

Susan Mangiero — Sun, 31 Mar 2013 17:55:19 -0500

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.

Pension Risk Governance Blog Celebrates Seventh Birthday

Susan Mangiero — Mon, 25 Mar 2013 20:01:52 -0500

I am delighted to announce our seventh year as an educational resource for the $30+ trillion global retirement plan industry. With over a million visitors to www.pensionriskmatters.com, I appreciate the ongoing feedback and encouragement from financial and legal readers. This blog began as a labor of love and continues to be personally rewarding as a way to help guide the discussions about pension risk, governance and fiduciary duties.

Here is a link to the March 25, 2013 Business Wire press release about www.pensionriskmatters.com, an educational pension risk governance blog for ERISA, public and non-U.S. pension plan trustees and their advisors.

As always, your input is important. Click to send an email with your comments and suggestions.

Thank you!

Tibble v. Edison and ERISA Fiduciary Breach Issues

Susan Mangiero — Fri, 22 Mar 2013 03:56:39 -0500

Speedy and insightful as always, ERISA attorney Stephen Rosenberg has commenced a series of blog posts that describes his view of the "hot off the press" conclusions made by the United States Court of Appeals for the Ninth Circuit in Tibble v. Edison. Click to access the March 21, 2013 Tibble v. Edison opinion. This ruling will no doubt receive much attention in the coming days as jurists and ERISA fiduciaries digest its content. Some will view this adjudication as yet another reminder that prudent process must be undertaken and can be demonstrated with respect to a host of issues (although the outcome is mixed in terms of plaintiff versus defendant "wins"). Issues include the selection of investment choices and the fees paid accordingly. Click to access the amicus brief filed by the U.S. Department of Labor in support of the plaintiffs.

In his first post about yesterday's opinion, Attorney Rosenberg points out that the timeline that determines ERISA's six-year statute of limitations was deemed to have started "when a fiduciary breach is committed by choosing and including a particular imprudent plan investment" and did not continue by virtue of the investment mix remaining in the plan. He further asserts that defendants will want the clock to begin on the day an investment option is first introduced and that "any breach of fiduciary duty claims involving that investment that are filed later than six years after that date are untimely."

I will leave court commentary to the legal experts. Click to access the Boston ERISA & Insurance Litigation Blog for his analysis about this case and many more.

DOL Issues Advisory Opinion About Use of Swaps by ERISA Plans

Susan Mangiero — Thu, 07 Mar 2013 00:04:25 -0500

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 Advisory Opinion 2013-01A;
"DOL Advisory Opinion 2013-01A: Cleared Swaps Under ERISA - Margin Not a Plan Asset/CCPs & FCSm Are Not Fiduciaries/No Prohibited Transactions" by Attorney Andrew P. Cross and Allison W. Sizemore, The Swap Report, February 14, 2013;
"DOL Resolves Important ERISA Issues About Cleared Swap Transactions," Bloomberg BNA, February 27, 2013; and
Risk Management for Pensions, Endowments and Foundations by Dr. Susan Mangiero, John Wiley & Sons, November 2004.

Yahoo and Moms Gone Wild - How Will Shareholders Respond?

Susan Mangiero — Tue, 26 Feb 2013 22:22:58 -0500

On February 24, I blogged about Yahoo's just-issued memo to employees. The message from the top is to get your shoes on and be seen in the office. See "What Companies Are Doing About Working at Home."

Jump ahead a few days later and mom blogs are chockablock with negative comments. Kristin Rowe-Finkbeiner and Joan Blades, co-founders of MomsRising, issued a press release that denigrates the decision to ban telecommuting. They go on to describe the role of female workers as critical to the majority of families that require two incomes to pay bills. Their primary argument is that talented workers will go elsewhere in search of flexibility and a chance to stay on the fast track without being forced to sacrifice time with family. (Elsewhere, some suggest that Yahoo may have designed this pseudo layoff without having to officially let go of people.) Direct from Cafe Mom Studios, Amy Boshnack asks lots of women for their two cents. "Backward" was one mother's description of the new policy, especially for a technology company. Several women said that they understood the need for in-person brain storming but said that commuting four or five hours a day from a rural location is neither realistic nor productive for those individuals who live far away. Click to view the video discussion on cafemom.com.

Moms are not alone in their dissent. NBC News reports that some might interpret this edict as "anti-parent." Others counter that mothers and fathers could win by being forced to accept a more traditional schedule in the office since telecommuting arguably encourages "creep" with emails and phone calls occurring well after 5 pm. Founder of the Virgin Group, Richard Branson, decries the move as "perplexing" and not compatible with a well-connected labor force and a modern work day that no longer spans 9 to 5. See "Give people the freedom of where to work" by Richard Branson (February 25, 2013).

In the end, the decision will likely be deemed successful (or not) if it makes it easier for the company to go where the CEO, Marissa Meyer, and other Yahoo board members want to be. There are numerous moving parts. Indicting this or any other policy per se is hard. One must consider (1) job descriptions and the need for on-site dealings (2) the economics of working together face to face versus the cost savings of having fewer and/or smaller offices (3) strategic objectives of the firm (4) company morale and much more.

My prediction is that we will see a lawsuit or two for any workers who were contractually allowed some latitude with respect to how, when and where they work. If that occurs, the cost of a lawsuit(s) will not be welcome news to the 71% of institutional and mutual fund owners of Yahoo (ticker is YHOO) stock.

What Companies Are Doing About Working at Home

Susan Mangiero — Sun, 24 Feb 2013 00:34:28 -0500

According to All Things Digital, uber technology journalist Kara Swisher writes that Yahoo is calling remote employees back to the office. Should they say "no," they are invited to consider employment elsewhere. You can read her February 22, 2013 article by clicking on "Yahoo CEO Mayer Now Requiring Remote Employee to Not Be (Remote)." Click to read the original Yahoo memo that emphasizes the need for the kind of communication and collaboration that allegedly disappears when the work force is scattered throughout the world.

While the official text is interesting, a read of the 172 comments (as of February 24, 2013) are telling. Some suggest that Yahoo is likely to send talent packing at a time when smart and productive people are needed. Besides the fact that certain employees may have been promised a work-at-home arrangement and are not happy about a reverse decision, others may simply find it prohibitively expensive to live closer to Yahoo headquarters or too time-consuming to commute several hours each way from places where real estate is more affordable. At a certain point, individuals could be better off making less money in exchange for a shorter commute. Ask anyone who has regularly traveled into New York City or other cities for many years. A daily dose of driving, training and walking for three to five hours round trip can take its toll. Others offer that professionals who are well suited for telecommuting because they like freedom and flexibility will bristle at the structure of having to show up in person. Then there is the argument that telecommuting enhances productivity, especially if it means that a quiet home versus a noisy office allows for fewer interruptions to one's work flow and facilitates the kind of concentration required for complex problem-solving.

It will be interesting to monitor whether Yahoo's new policy to work on site at one of its locations pays off for shareholders. It certainly seems to differ from what I am hearing in the workplace. In the last few months alone, executives from two major insurance companies told me that many of their employees are being forced to telecommute and that physical offices will be replaced with a hotelling arrangement for days when they travel to a company location.

Unlike Yahoo, the message being sent by those who advocate telecommuting is to leave those family photos at home. Use technology to shave off "bricks and mortar" expenses and take a coffee break on your own time.

Fiduciary Duty is More Than Numbers

Susan Mangiero — Tue, 05 Feb 2013 22:16:54 -0500

As a published author, I am constantly assessing what has appeal to readers. I try to write about topics that are relevant and timely and welcome feedback. Click here to send an email with your suggestions. As a financial expert, I continuously seek to stay on top of what is being adjudicated. As a risk manager, I regularly evaluate what might have been done differently when things go seriously awry.

What I have noticed is that enumeration seems to offer comfort. Lists of this or that are common to many best-selling books and widely read articles. A trip to the Inc. Magazine website today illustrates the point. Consider this excerpted list of lists:

12 Great Motivational Quotes for 2013;

6 Habits of Remarkably Likable People;

9 Daily Habits That Will Make You Happier;

6 Things Really Productive People Do;

5 Things That Really Smart People Do;

6 Ways to Enhance Your Credibility; and

Top 5 Business Books of 2012.

The popularity of laying out "to do" items extends to the retirement industry as well. For example, Attorney Mark E. Bokert provides insights in his article entitled "Top 10 ERISA Fiduciary Duty Exposures - And What to Do About Them" (Human Resources - Winter Edition, Thomson Publishing Group, 2007). His list of vulnerabilities - and prescriptive steps to try to avoid liability - includes the following:

Identify who is a fiduciary and making sure that they are properly trained;
Create a proper process by which investments are selected and monitored;
Monitor company stock in a 401(k) plan and consider whether to appoint an independent fiduciary;
Assess the reasonableness of "like" mutual funds versus existing plan choices;
Ensure that communications with plan participants are adequate;
Undertake a thorough assessment of vendors and review their performance thereafter;
Assess whether 401(k) deferrals and loan repayments are being made in a timely fashion;
Identify the extent to which service providers enjoy a float and whether they are entitled;
Understand what is allowed in terms of providing investment advice to participants and abide by the rules accordingly; and
Critically evaluate whether auto enrollment makes sense and the nature of any default investment selection.

One could easily break out each of the aforementioned items into sub-tasks and create appropriate benchmarks to ascertain whether fiduciaries are doing a good job. Indeed, ERISA attorneys are the first to invoke the mantra of "procedural process" as a cornerstone of this U.S. federal pension law. Importantly however, relying only on numbers is not sufficient. Increasingly legal professionals and regulators are asking that process be demonstrated and discussed. Expect more of the same in 2013. Analyses and expert reports may be deemed incomplete if they do not include a deep dive of the fiduciary decision-making process that took place (or not as the case may be).

House of Cards, Netflix and the Bottom Line

Susan Mangiero — Sat, 02 Feb 2013 15:21:45 -0500

I spent hours this weekend glued to my computer screen. Curious to know if "House of Cards" would entertain as promised, I watched the first few episodes as a skeptic, only to be rewarded with solid acting, clever writing and a story line that kept on giving. This political thriller boasts a bevy of Hollywood talent, with Kevin Spacey at the helm. After losing a bid to be the next Secretary of State for a new president, this ethically challenged Congressman plots revenge and an alternative path to power. If you liked "The West Wing" and won't get discouraged by the seemingly realistic portrayal of what happens behind closed doors in Washington, you will enjoy the thirteen episodes of Season 1 and anxiously await the next baker's dozen.

Here's the rub. You need to be an existing Netflix subscriber or sign up tout-suite. In a move that has Hollywood paying close attention, this self-described "leading Internet television network" laid out $100 million to a star cast of writers and actors to recreate a Yankee version of this popular UK theatrical offering.

Why would a company do this? Some assert that original content is where the money is. According to several recent studies, "Streaming videos online are becoming more popular as technology evolves and more content is created for the Internet." See "NPD study: More people watch Internet videos on TVs than computers." CBS News, September 26, 2012. If you hate the countless ads that now consume the first twenty minutes of any in-person showing, you will be glad to have an alternative to movie-watching.

For institutional investors, this push to garner new subscribers and hopefully add to the bottom line is noteworthy. According to the NASDAQ website, 86.85% of the $8+ billion capitalization for Netflix, Inc. (ticker is NFLX) is in the hands of institutional owners. Some of them may not be appeased, certainly those who have sued the company over financial statement disclosures. In April 2012, Judge Samuel Conti appointed the Arkansas Teacher Retirement System and State-Boston Retirement System as lead plaintiffs in this putative class action. Click to read the "Netflix Inc. Securities Litigation" court order.

Fiduciary Shortcuts To Valuation Can Be Dangerous

Susan Mangiero — Thu, 31 Jan 2013 23:28:15 -0500

Despite a plethora of information about how to implement shortcuts to enhance workplace productivity, fiduciaries need to ask themselves whether a "jack in the box" approach that equates speed with care and diligence is worth pursuing.

This topic of shortcuts came up recently in a discussion with appraisal colleagues about the dangers of using a "plug and play" model to estimate value. Although New York Times journalist Mark Cohen rightly cites the merits of having a business valuation done, he lists all sorts of new tools such as iPhone valuation apps that some might conclude are valid substitutes for the real thing. Rest assured that punching in a few numbers versus hiring an independent and knowledgeable third party specialist to undertake a thorough assessment of value is a big mistake, especially if the underlying assumptions and algorithms of a "quick fix" solution are unknown to the user. See "Do You Know What Your Business is Worth? You Should," January 30, 2013.

It's bad enough that a small company owner opts for a drive-in appraisal. It's arguably worse when institutional investors do so, especially as their portfolios are increasingly chock a block with "hard to value" holdings. In the event that a valuation incorrectly reflects the extent to which an investment portfolio can decline, all sorts of nasty things can occur. A pension, endowment or foundation could end up overpaying fees to its asset managers. Any attempts to hedge could be thwarted by having too much or too little protection in place due to incorrect valuation numbers. Asset allocation decisions could be distorted which in turn could mean that certain asset management relationships are redundant or insufficient.

Poor valuations also invite litigation or enforcement or both. As I wrote in "Financial Model Mistakes Can Cost Millions of Dollars," Expert Witnesses, American Bar Association, Section of Litigation, May 31, 2011:

"Care must be taken to construct a model and to test it. Underlying assumptions must be revisited on an ongoing basis, preferably by an independent expert who will not receive a raise or bonus tied to flawed results from a bad model. Someone has to kick the proverbial tires to make sure that answers make sense and to minimize the adverse consequences associated with mistakes in a formula, bad assumptions, incorrect use, wild results that bear no resemblance to expected outcomes, difficulty in predicting outputs, and/or undue complexity that makes it hard for others to understand and replicate outputs. Absent fraud or sloppiness, precise model results may be expensive to produce and therefore unrealistic in practice. As a consequence, a “court or other user may find a model acceptable if relaxing some of the assumptions does not dramatically affect the outcome.” Susan Mangiero, “The Risks of Ignoring Model Risk” in Litigation Services Handbook: The Role of the Financial Expert (Roman L. Weil et al, eds., John Wiley & Sons, 3d ed. 2005).

In recent months, it is noteworthy that regulators have pushed valuation process and policies further up the list of enforcement priorities. Indeed, in reading various complaints that allege bad valuation policies and procedures, I have been surprised at the increased level of specificity cited by regulators about what they think should have been done by individuals with fiduciary oversight responsibilities. Besides the focus of the U.S. Department of Labor, the U.S. Securities and Exchange Commission has brought actions against multiple fund managers in the last quarter alone. Consider the valuation requirements of new Dodd-Frank rules (and overseas equivalent regulatory focus) and it is clear that questions about how numbers and models are derived will continue to be asked.

For further reference, interested readers can check out the following items:

"Mitigating Risks of Breach of Fiduciary Duty Claims," June 16, 2011;
"SEC Charges Eight Mutual Fund Directors for Failure to Properly Oversee Asset Valuation," December 10, 2012;
"SEC Charges New York-Based Fund Executives for Overvaluing Assets During Financial Crisis," November 28, 2012; and
"SEC Charges Hedge Fund Adviser and Two Executives With Fraud in Continuing Probe of Suspicious Fund Performance," October 17, 2012.

Pension De-Risking: Compliance and ERISA Litigation Considerations

Susan Mangiero — Thu, 24 Jan 2013 23:48:59 -0500

On January 16, 2013, this blogger - Dr. Susan Mangiero - had the pleasure of speaking with (a) Attorney Anthony A. Dreyspool (Senior Managing Director, Brock Fiduciary Services) (b) Attorney David Hartman (General Counsel and Vice President, General Motors Asset Management) and (c) Attorney Sam Myler (McDermott Will & Emery) about compliance "must do" items and litigation vulnerabilities. Sponsored by Strafford Publications, "Pension De-Risking for Employee Benefit Sponsors" attracted a large audience of general counsel, outside ERISA counsel and financial professionals. In addition to numerous talking points shared by all of us presenting, we had lots of attendee questions about issues such as balance sheet impact, case law and annuity regulations.

Click to download the slides for "Pension De-Risking for Employee Benefit Sponsors."

In my opening comments, I described some of the factors that are being discussed as part of conversations relating to whether a plan sponsor should de-risk or not. These include, but are not limited to, the following:

Low interest rates;
Higher life expectancies;
Increased PBGC premiums;
Company's debt capacity;
Intent to go public or sell to an acquirer;
Available cash; and
Knowledge and experience of in-house ERISA fiduciaries.

Attorney Hartman urged anyone interested in de-risking to allow ample time of between six to eighteen months in order to file documents, research and create or modify policies and procedures as needed. He also advised companies to make sure that participants are fully apprised of their rights and to explain the merits of any particular transaction. For companies that may want to redesign a plan(s) for hourly workers, more time may be needed, especially if collective bargaining agreements are impacted. His suggestion is to inform plan participants about state guarantees that apply in the event of an insurance company default. When retirees are emotionally attached to getting a check from their employer, care must be taken to allay any concerns that future monies will come from an outside third party. Keep in mind that the market may be moving at the same time that a deal is being put together. Regarding the transfer of assets, Attorney Hartman stated the importance of finding out early on what an insurance company is willing to accept. An independent appraiser may be required to determine the appropriate value of certain assets.

I talked about the various risks that can be mitigated via de-risking versus those that are introduced as the result of some type of defined benefit plan transfer or derivatives overlay strategy. The point was made that there is no perfect solution and that facts and circumstances must be taken into account. I added that litigation may arise if a plaintiff (or class of plaintiffs) question any or all of the following items:

Whether executives are unduly compensated as the result of an earnings or balance sheet boost due to de-risking;
Timing of a transaction and whether interest rates are "too low" at the time of a deal;
Completeness (or lack thereof) of information that is provided to participants;
Amount of fees paid to vendors;
Use of an independent fiduciary;
Level of asset valuations;
Use of an independent appraiser;
Extent to which due diligence was conducted on the structure of deal; and/or
Level of vetting of "safest available" annuity provider.

Attorney Dreyspool emphasized that ERISA fiduciaries must demonstrate procedural prudence. This could entail an assessment of factors that include but are not limited to:

Amount of cash out;
Which participants will be impacted;
How the plan is to be terminated; and/or
Alternative transactions that a plan sponsor might have adopted instead.

He gave a long laundry list of items that must be considered when vetting an insurance company, should a transaction involve an insurer. While not exhaustive, factors to review include the following:

Quality and diversification of insurer's investment portfolio;
Size of insurer relative to proposed contract;
Level of insurer's capital and surplus;
Lines of business of the insurer and other indications of its exposure to risk;
Structure of the annuity contract;
Guarantees supporting the annuities, like separate accounts;
Availability of protection through state associations; and/or
Size of the guarantee.

The audience was encouraged to review DOL Advisory Opinion 2002-14A (dated December 18, 2002) and ERISA Section 404(a).

Attorney Myler presented litigation slides prepared in part by senior ERISA litigator Nancy G. Ross (also with McDermott Will & Emery). He explained the civil enforcement law relating to contract claims, asserting that a lawsuit could focus on what a participant was promised versus what they received. He differentiated between settlor functions and fiduciary acts as a cornerstone of any lawsuit that could be brought against a member of a company's investment committee and/or any of the service providers involved in a particular de-risking transaction.

There seems to be no shortage of case precedents with respect to disputes already making their way through the court system. Attorney Myler discussed Kuntz v. Reese, Call v. Ameritech Management Pension Plan, Laurenzano v. Blue Cross/Blue Shield and Lee v. Verizon Communications Inc., inter alia.

Indeed, it is worthwhile listening to review the in-depth comments made by all speakers. The topic is broad and important with no doubt more activity to occur in the U.S. and elsewhere.

Flu Economics For Companies

Susan Mangiero — Sat, 12 Jan 2013 00:50:44 -0500

If you escaped the flu bug this year, congratulations and best wishes for not getting sick in the next few months. Unfortunately, I was not as lucky. After five tough days of sneezing, coughing and aching, and despite getting a flu shot, I am finally feeling better. I still don't know the culprit other than possibly riding a crowded train last week. Why visibly sick passengers were out and about was a mystery to me until I read "Sniffling, Sneezing and Turning Cubicles Into Sick Bays" by Michael Mason (New York Times, December 26, 2006). He explains that the tendency for employees to show up at work has to do with economics.Some companies do not offer sick pay and days missed translate into a smaller paycheck. In other cases, people tell survey-takers that they feel pressured to show up and fear possible suspension or being fired if they miss work. When companies offer PTO or personal time off, workers may opt to punch the time clock rather than give up days that could instead be spent on vacation. Some companies may not have a telecommuting policy or technology that supports work at home. Other times, individuals may feel that missing work will put them further behind, especially if their firm has downsized and asked those who remain behind to make up the difference.

In what has become known as "presenteeism," the act of attending work while sick has drawn attention from benefits professionals and researchers alike. Companies that scale back benefits may do so to cushion the bottom line but end up losing money. This is because workers who show up sick often underperform while on the job and then infect others around them who in turn get sick and underperform. According to "Unhealthy U.S. Workers' Absenteeism Costs $153 Billion" by Dan Witters and Sangeeta Agrawal (Gallup.com, October 17, 2011), the cost in lost productivity "would increase it if included presenteeism, which is when employees go to work but are less productive in their jobs because of poor health or wellbeing."

Occupational psychologist and founder of a website about work-related behavioral issues, Rebecca Quereshi writes that the topic is viewed differently across countries. She asserts that the UK and European study the "precursors of presenteeism" or why people are compelled to show up to work when they are sick. In contrast, the U.S. focus is on the productivity loss attributable to presenteeism. She adds that "There is widespread agreement that presenteeism accounts for more aggregate productivity loss than absenteeism," in large part because it is "much less accounted for." See "Presenteeism in the workplace, reviewed" (January 19, 2011).

In other articles read by this blogger on the topic of healthcare and the bottom line, the point was made that those who make higher incomes may be more inclined to show up at the office when feeling less than robust. Perhaps that is true but what is known for sure is that bad health impacts the bottom line. According to its September 12, 2012 press release, a study conducted by the Integrated Benefits Institute cites absenteeism and presenteeism as contributors to a loss of $227 billion to the U.S. economy.

As companies grapple with new health care rules and regulations and the challenges of a fragile global economy that keeps everyone on a tight budget, individuals are best served by going on the offensive in terms of trying to avoid a cold or the flu. Chicken soup anyone?

J.P. Morgan Predicts Gloomy Year Ahead For Pension Plans

Susan Mangiero — Wed, 26 Dec 2012 18:34:49 -0500

According to its Fall 2012 issue of Pension Pulse, published by the J.P. Morgan Asset Management Strategy Group, 2013 is going to be "grim" for pension funds after a less than jovial 2012. Citing a drop in funded status for many U.S. plans this year, "despite a 14% stock market rally," trouble spots are unlikely to disappear any time soon, putting continued pressure on the size of liabilities.

To tame the beasts in the form of "funded status volatility, unfavorable changes in the index used to value pension liabilities and longevity assumptions that increase liability values," employers continue to explore de-risking transactions such as offering lump sums and buyouts. Contrary to popular belief, the authors point out that even companies with underfunded plans like lump sum arrangements. The appeal is in part motivated by tax rules that allow "certain plans to use backdated discount rates to value lump sum payouts" that are higher than current discount rates.

Although the evidence suggests an increased demand on the part of plan sponsors to de-risk, J.P. Morgan professionals reference a ceiling of about $70 billion more over the next four or five years before industry capacity is reached for pension risk transfers. Of course, any time that demand increases and supply remains static, prices will rise as a result. At the margin, that could encourage some organizations from de-risking.

The report goes on to describe a "surreal discount rate" situation as the result of some bank securities being downgraded below AA in June of 2012. The net effect - a change in the discount rate curve that "reduced the weight of financials" - left only ten issuers to make up 75% of the market value of the index. Arguably, this increases the "inherent concentration risk" which in turn could increase the volatility of the index, thereby sending employers off on a measurement roller coaster ride. Shareholders could then feel the pinch if companies have to add cash to a plan as funding levels sink.

Adding insult to injury, the authors describe a change in actuarial assumptions that could significantly push the costs upward for companies that sponsor pension and Other Post Employment Benefits ("OPEB") programs. Their assertions are that (1) "changing actuarial assumptions are likely to increase pension liabilities by 2% to 5%" and (2) uncapped post-retirement health care benefits could go up by 6% to 9%.

Taken individually or together, the various pressures on retirement plan liabilities suggest a busy year ahead for ERISA fiduciaries and their support staff.

$89 For An Umbrella and No Money To Retire

Susan Mangiero — Sat, 22 Dec 2012 19:10:08 -0500

In between business meetings in Greenwich, Connecticut the other day, it started to rain heavily so this blogger walked a few blocks to an upscale department store (the closest in sight), in search of a reasonably priced umbrella. Since I have so many umbrellas already (but had forgotten to pack one), I figured I would spend a modest $15 or $20 to buy another umbrella to keep me dry. How much could an umbrella cost after all? To my surprise and shock, none of the umbrellas came in at less than $89 (plus tax of course). For some people, that's a tiny price for protection. Certainly this merchant was thriving with designer attire, shoes and jewelry finding its way into shoppers' bags.

However, the reality is that not everyone is going to shell out 89 big ones for an umbrella, no matter what the brand. For a large segment of the U.S. population, money is a scarce resource and confidence in a secure future is low. According to the results of a recent Wells Fargo/Gallup Investor study, optimism is down and pessimism is up. At the same time that 68% of respondents say they have "little to no" confidence in the stock market as a way to prepare for retirement, 80% of investors urge lawmakers to act now so that savings is encouraged.

Unfortunately, most of the initiatives that individuals cite as "must have" elements of a national retirement readiness program are in direct conflict with the political grab to raise taxes. Consider a few examples.

Sixty-nine percent of the survey respondents say it is "extremely" or "very important" that politicians encourage every company to offer a 401(k) plan to its employees. Since there is already talk in Washington, DC about stripping companies of the tax benefits associated with offering retirement plans, it is unlikely that employers will realize further tax advantages at the expense of big spenders having to lose tax "revenue."
Sixty-six percent cite the need for the government to figure out how Americans who participate in 401(k) plans can get "more quality investment advice." Anticipating increased regulations as relates to investment fiduciary duties, some financial advisors are becoming less generous with information for fear of being sued. As described in "401(k) Lawsuits, Investment Advisers and Fiduciary Breach" (November 18, 2012), breach of fiduciary duty is cited as the top complaint in FINRA arbitration matters.
Sixty-nine percent want the government to establish initiatives that will motivate individuals to participate in their employer's 401(k) retirement savings option, assuming that they work for a company that offers benefits. Yet here we are, talking about a fiscal cliff that could impact millions of people with incomes below the magical "rich" benchmark of $250,000. For one thing, in the absence of inflation indexing, the Alternative Minimum Tax that was enacted decades ago will show up as a nasty spring 2013 surprise for countless tax-paying middle-class households. Then there is the issue of jobs not created because employers will be writing larger checks to the IRS instead as various tax rates go up.

The United States is not alone in having to tackle difficult problems. The list is long and includes (but is not limited to) insufficient aggregate savings, underfunded social programs that are not sustainable safety nets without reform, high unemployment, corporate jitters about parting with cash, uncertain tax and regulatory environment and conflicting interests that make it almost possible to come up with near-term solutions.

There is a way forward to expand economic growth but that will require political courage. Let's hold our policy-makers accountable in 2013.