Good Risk Governance Pays - Investment Best Practices | Risk Management | Valuation

Join me on May 1, 2012 for a timely and interesting program about alternative investment fund due diligence and other considerations for ERISA plan sponsors, their counsel and consultants. Click here for more information.

This CLE webinar will provide ERISA and asset management counsel with a review of effective due diligence practices by institutional investors. Best practices will be offered to mitigate government scrutiny and suits by plan participants.

Description

With the DOL's and SEC's new disclosure rules and heightened concerns about compliance and valuation, corporate pension plans that invest in alternatives must focus on properly vetting asset managers more than ever before or risk being sued for poor governance and excessive risk-taking.

The urgencies are real. The use of private funds by asset managers is crucial for 401(k) and defined benefit plan decision makers. Understanding the obligations of private funds is essential to any retirement funds with limited partnership interests.

In addition, suits and enforcement actions against asset managers make it incumbent on counsel to hedge fund and private equity fund managers to fully grasp and advise on full compliance with the duties of ERISA fiduciaries to plan participants.

Listen as our ERISA-experienced panel provides a guide to the legal and investment landmines that can destroy portfolio values and expose institutional investors and fund managers to liability risks. The panel will outline best practices for implementing effective due diligence procedures.

Outline

Benefits

The panel will review these and other key questions:

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

Faculty

Susan Mangiero, Managing Director
FTI Consulting, New York

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

Alexandra Poe, Partner
Reed Smith, New York

She has over 25 years of experience in investment management practice counseling managers of hedge funds, private equity funds, institutional accounts, mutual funds and broker-dealer advised programs. She counsels hedge and private equity fund advisers in all stages of their business and due diligence matters.

Courtesy of Strafford Publications, Dr. Susan Mangiero spoke on the topic of ERISA investment fiduciary pain points and the role of service providers. She was joined by esteemed colleagues Andrew L. Oringer (Partner, Ropes & Gray) and Christine A. Dart (Vice President, Chubb & Son) in a lively and informative debate about current ERISA litigation trends, "must do" action items regarding ERISA fiduciary liability insurance procurement and the vetting of investment decisions relating to fees, third parties, use of derivatives, hard-to-value investing, leverage and risk management.

Click to read the transcript of comments by Dr. Susan Mangiero on the topic of ERISA investment fiduciary considerations.

Click to order a recording of the full 90-minute program entitled "ERISA Fiduciaries Under Attack: Key Litigation and Regulatory Developments."

Getting a financial expert involved sooner than later offers countless benefits. As someone who provides litigation support services, I realize that the message is self-serving. Still, it's a reality that I encounter with every case.

The more work I do in the litigation support arena, the more I realize that documents I'd like to have are simply not obtainable because discovery is long over.

I understand that budgets are often tight but the economics of getting better (and sometimes more) documents earlier in the process can often provide a huge windfall in terms of analysis. Kudos to an attorney who recently engaged me to help at the outset to best identify core financial issues that are outside his scope of knowledge.

The addage "time is money" applies in the converse too. Money is time.

In other words, spend less now, possibly sacrifice the acquisition of precious data and information earlier in the process when it can be arguably more helpful and incur higher costs later due to a more protracted process.

I recently had the pleasure of speaking at an American Conference Institute ("ACI") sponsored conference about ERISA litigation. It's no surprise that fiduciary liability was the subject du jour, especially with an unprecedented number of lawsuits alleging breach and conflicts of interest. Even those who did not attend have taken the baton and opined on this important topic.

In "Resolving the 401(k) Fiduciary Dilemma" by Jeff Mamorsky (CFO.com, April 25, 2011), the point is made that Chief Financial Officers ("CFOs") are placed in a "precarious" position when serving as the named fiduciary "because of the inherent conflict between corporate and plan fiduciary responsibility," particularly in the event that employer stock is offered to participants as one of the choices available to them. Since a CFO owes a "fiduciary duty to shareholders," attorneys continue to debate how company executives should impart material non-public information that, if known, would sway share price.

On April 28, 2011, ERISA attorney Stephen D. Rosenberg writes about the dual role of the CFO in "Playing Hot Potato With Employer Stock" as "one of the most loaded issues in ERISA litigation. While the creation and monitoring of a stock volatility index (something described by Mamorsky and reflecting some of my comments made to him and others several years ago) offers one way to instill objectivity about whether to include company stock as a 401(k) choice, Rosenberg counters that no system is foolproof. He adds that "the best approach to the defense of such corporate officers" is "either to keep employer stock out of the plan itself" or "move the entire management and decision making on whether to hold company stock or not," "when to buy and sell it" and so on to "very qualified outside advisors."

Attorneys who presented at the aforementioned ACI conference on the topic of ERISA litigation were not universal in their thoughts about whether a company CFO should serve on a participant-directed retirement plan investment committee. Given cases that involve investing in company bonds at a time of distress, I wonder if stock drop litigation may eventually lay the groundwork for "bond drop" lawsuits that involve defined benefit plans.

According to its April 19, 2011 press release, Advisen Ltd's new survey about lawsuit filings suggests lots more activity in the courtroom. Their examination of documents related to 362 securities litigations is an increase from 342 filed in the first quarter of 2010. What caught my eye in particular was the breakdown of cases. Notably, securities class action suits "had accounted for more than one third of securities suits filed" in the past but was declining as "breach of fiduciary duties suits continue to account for most of the largest settlements."Their statistics suggest an average securities class action settlement of nearly $55 million.

Attorney Kevin LaCroix has a nice wrap-up of the full survey. Click to read "Advisen Releases First Quarter 2011 Corporate and Securities Litigation Report," posted on April 19, 2011. Not surprisingly, in the aftermath of the sub-prime and credit crisis, many of the lawsuits included in the Advisen study report involve financial industry defendants. Author of the D&O Diary, uber blogger LaCroix describes the breach of fiduciary duty suits as mainly filed in state court and filed "shortly after the announcement of a proposed merger or acquisition." He adds that "These breach of fiduciary suits represent about a third of all corporate and securities lawsuit filings in the first quarter of 2011, up from only eight percent of all corporate and securities filings as recently as 2004."

My discussions with ERISA attorneys suggest that fiduciary breach allegations are on the rise and will continue to make their way to federal courts. Whether this parallel phenomenon portends a worldwide trend - more frequently holding fiduciaries accountable by triers of fact - remains to be seen. This would make sense since the definition of fiduciary is being expanded by the U.S. Department of Labor ("DOL") for federally regulated employee benefit plans at the same time that the U.S. Securities and Exchange Commission is focused on augmenting fiduciary standards.

Fiduciary is fast becoming the veritable "buzz" word of modern financial times.

Russell research strategist, Mr. Bob Collie, writes about the growing liabilities and assets of large public U.S. corporations. Large indeed!

According to 2010 data, 16 publicly traded U.S. corporations boast membership in what he refers to as the "$20 billion club." Their combined balance sheet liabilities of $740 billion or roughly 40% of corporate America's pension IOUs gives them investment muscle in terms of market price movement and influences what and how financial service providers deliver retirement plan solutions.

While improving economic conditions boosted assets by $21 billion to $619 billion, declining interest rates pushed liabilities upward wih a "total shortfall of assets below liabilities of $121 billion" or about the same as 2009 levels.

I concur with conclusions made by Mr. Collie that companies are going to be forced to reckon with their defined benefit plans. Figuring out where the cash will come from in order to write checks to participants is one challenge. Another task will be conducting a capital budgeting analysis of the money going to meet pension IOUS instead of investing in positive net present value projects. Notably however, studies do suggest that companies often need to provide good benefits in order to attract talent. This means that the costs of employee benefit plans (retirement, health, profit-sharing) must be netted against the expected advantages of having a productive workforce in place as a result of providing incentives.

A reasonable response by corporations would be to include retirement plans as part of enterprise risk management ("ERM") activities. However, in a study I conducted with the Society of Actuaries in 2008, the results were sobering. Specifically, "Pension Risk Management: Derivatives, Fiduciary Duty and Process" by Dr. Susan Mangiero summarizes survey results about ERM for 169 organizations with pension plans as follows:

• Only 30% of companies that used derivatives in their pension plans had corporate Chief Risk Officers in place.
• Of those roughly fifty organizations, only 25% of them or about 12 companies included pension plans as part of their corporate risk endeavors.
• Only 25% of organizations that used derivatives in their pension plans had ever discussed a link between Sarbanes-Oxley obligations and ERISA fiduciary duties. For those organizations that did not use derivatives in their pension plan, only 19% had discussed corporate governance versus pension governance.

Note to Readers:

• Click to read "Sharp increase in both assets and liabilities for the pension world's $20 billion club" by Bob Collie, Russell Investments, March 2011.
• Click to read "Pension Risk Management: Derivatives, Fiduciary Duty and Process" by Susan Mangiero, October 2008. The new email address for Dr. Mangiero is susanm@fiduciaryleadership.com.
• Click to visit www.pensionriskmatters.com for information about pension funding, financial and fiduciary risk management, governance and ERISA litigation.

If The Bond Buyer journalist Dan Seymour is correct, litigators may soon be even busier. According to "Headline Risk Drains Muni Bond Funds" (Money Management Executive, January 31, 2011), the week ending on January 19, 2011 saw investors withdraw an unprecedented $4 billion from mutual funds that invest in bonds issued by municipalities. In context, this is roughly 1% of the $470+ billion market and about $1 billion more than the former exit record of $3.1 billion for the week ending on November 17, 2010. Seymour adds that "Muni bond funds have now reported $29.3 billion of redemptions in the past 10 weeks" or "65% more than the previous record for outflows in a 10-week period of $11.5 billion established in 2000."His conclusion is that investors are scared. With credit spreads not moving out as would be expected during a flight to quality path, investors just want to leave the asset class altogether.

Another journalist with The Bond Buyer cites several muni bond portfolio managers as saying "not so fast." Headlines about bankruptcy risk grab attentions but may lure investors away from "solid, safe investments because of distorted opinions in the media." See "Don't Let Headlines Overshadow Buys: DWS" by Christine Albano, Money Management Executive, January 31, 2011.

A hat tip to the "Securities Arbitration and Litigation" blogging team. Their February 8, 2011 post entitled "Enough Transparency in the Municipal Bond Market?" cites a recent study from DPC Data about the paucity of financial disclosures by municipal bond issuers. According to "DPC Data Issues New Study on Transparency in the Municipal Bond Market" (February 3, 2011):

• Issuers of 60 to 70 percent of 17,000 municipal bonds file information "too late to be of practical use in credit risk analysis."
• For the bonds issued from 1996 through 2003 that were still outstanding between 2005 and 2009, "56 percent of issuers/obligors did not file annual disclosures for one or more years; 19 percent did not file for any of those years."
• "At least a third of the expected disclosures were never filed in the designated official repositories."

As DPC Data CEO Peter J. Schmitt suggests "there is no way around the fundamental need for timely financial statements to obtain critical information that can warn investors of impending problems."

Pension plan IOUs are another drain on municipal coffers. With unfunded retirement plan liabilities estimated at $3 trillion, state, city and county issuers with employee benefit funding gaps (excluding healthcare obligations), the last thing a municipal bond investor wants is a nasty surprise heretofore not disclosed in a timely and complete manner.

Late last week, U.S. Congressman Devin Nunes and U.S. Senator Richard Burr introduced the House version of the Public Employee Pension Transparency Act, H.R. 567. The goal to "amend the Internal Revenue Code of 1986" and "provide for reporting and disclosure by State and local public employee retirement pension plans." Failing to comply with this proposed rule, if approved and passed into law, could push the cost of borrowing up for numerous public entitities since they would be denied federal tax exemption status. This means that investors in turn would not be able to exempt realized bond income and would likely rethink the risk-return profile of muni bonds.

Having done a lot of work in the area of performance metrics and risk measurement, I will be the first to tell you that numbers can be misleading. Investors must look beyond reported data to have a solid understanding of the economic exposures they face when deploying assets. The problem is that one cannot even begin a proper analysis without access to information.

As the U.S. Securities and Exchange Commision begins its exploration of the disclosures made (or not as the case may be) by state and local bond issuers, expect a lot of questions from unhappy investors about the due diligence conducted by their advisors and consultants if no one has sufficiently granular information to do a good job of default risk assessment.

Reader's Note: Click to read "$3 Trillion Challenge" (Governing Magazine, October 2007) and a sidebar interview with Q&A Interview With Dr. Susan Mangiero about public pension finances.

According to "Securities Lawsuits Set New Record Despite Slowdown in Credit Crisis" (Insurance Journal, January 21, 2011), a new study about securities litigation by Advisen, Ltd. and sponsored by Kaufman Dolowich Voluck & Gonzo LLP, 2010 saw more action than the year before. While class action suits dropped "sharply" in 2010, a nevertheless higher number of filings consisted of securities fraud suits (35% of the total) and allegations of breach of fiduciary duties (33%). The study further asserts that plaintiff attorneys continue to "favor financial institution defendants" with nearly one-third of securities complaints naming "financial firms or their directors and officers."

Given a plethora of new rules and regulations that directly impact the financial sector, 2011 will likely see more complaints that involve at least one financial sector party. However, other industries are still vulnerable. As authors of "2010 A Record Year for Securities Litigation: An Advisen Quarterly Report - 2010 Review" suggest, the Dodd-Frank Act extends to a non-financial organization if it is deemed to be a "potentially significant threat to the financial system should it fail." Furthermore, questions about executive compensation, a shareholder's right to opine on pay and clawback provisions related to the filing of incorrect financial information could potentially create trouble for non-compliant businesses across the industry spectrum.

In a related commentary, uber Director and Officer ("D&O") liability insurance blogger Kevin LaCroix provides insights as to how the Advisen report might be streamlined by starting with a separation of civil fraud complaints from regulatory enforcement actions. He further adds that securities class actions, should they occur, are often severe in nature and potentially impose a material burden on companies and their D&O insurers.

In its 2011 edition of Workplace Class Action Litigation Report, law firm Seyfarth Shaw predicts  a "make-or-break year" with a flurry of labor-related class action lawsuits being filed and regulators flexing their enforcement muscles. Not out of the recessionary woods yet, lots of retirement plan participants have lost plenty of money and are not prepared to sit back and rest easy. This 664-page tome, authored by Seyfarth Shaw partner Gerald L. Maatman, Jr. and in its seventh annual publication, provides some scary numbers.

• "The top ten settlements of wage & hour, ERISA, and governmental enforcement class actions increased to $1.16 billion, the highest amount ever."
• Employment-related class action settlements rose four-fold in 2010 versus dollar outlays paid in 2009.
• The U.S. Supreme Court has three cases under review (Dukes v. Wal-Mart, AT&T Mobility v. Concepcion and Smith v. Bayer) that are destined to change class and collective action litigation, regardless of the outcome.

While interested parties can register for a February 8, 2011 webinar that details the results of this new study, Seyfarth Shaw attorney and co-chair of the ERISA litigation practice was kind enough to provide insights for readers of www.goodriskgovernancepays.com about ERISA litigation trends.

Q: Please comment on the general theme of the just published 2011 - Annual Workplace Class Action Litigation Report, an evaluation of nearly 900 employment law class action decisions, including dozens of ERISA cases. 

A: We don't see the end of the tunnel with respect to mammoth work place class action lawsuits. Despite defense-friendly precedents, the plaintiff's bar is filing more and more cases. Many of them relate to alleged discrimination or benefit claims. Others are examining procedural prudence on the investment side. More than a few large 401(k) sponsors have found themselves on the receiving end of stock drop litigation. Some cases focus on risk-taking as relates to securities lending programs by pension funds. Transparency may also  prove to be a hot button if the SEC's risk disclosure case against CalPERS changes things for state and municipal bond issuers.

Q: How did the credit crisis of 2008 and 2009 impact the current state of the ERISA litigation landscape?

A: The last few years have been tough. The global economy continues to endure an extreme stress test. The credit crisis has exposed potential weaknesses in previously unchallenged investments and poor investment returns have triggered a host of other pension woes. Then there is the spate of cases relating to the sub-prime meltdown and others that focus on benefits cutbacks, illiquid assets, service provider due diligence and much more.

Q: The new study documents much larger settlements in 2010 than 2009. Is that true for all types of ERISA cases?

A: No. Settlements in 2010 for stock drop cases  were down substantially. In 2009, we saw settlements in the $30 million  and higher range, but in 2010, most settlements were less than half that amount. Defense friendly rulings have made  fiduciaries and plan sponsors more willing to take the stock drop cases further than before and not to settle early.

Q: What other factors influence settlements?

A: The likelihood of a settlement, let alone the amount, depends on other factors as well. Some judges are reluctant to deny motions to dismiss. The plaintiff's bar is becoming increasingly sophisticated and well financed. Keep in mind too that the political climate encourages regulatory enforcement, the outcome of which could impact civil litigation outcomes. Another interesting phenomenon are the counterclaims being filed in securities lending cases. Some banks that were sued by plan fiduciaries for supposedly taking on too much investment risk have countersued, likely to drive settlements. 

Q: Are large organizations more vulnerable to litigation than small to mid-size organizations?

A: Yes and no. On one hand, large plan sponsors and their asset managers, custodian banks and consultants are perceived as having deep pockets. In addition, in some cases, plan assets can drive exposure. Even a few basis points tied to multi-billion dollar portfolios add up to real money. On the other hand, large plan sponsors tend to devote more resources to oversight and plan management, which can reduce the risk of liability. 

Q: Given the expanded definition of fidiuciary, as proposed by the U.S. Department of Labor ("DOL") and being reviewed by the U.S. Securities and Exchange Commission ("SEC"), do you agree with those who predict more lawsuits that involve advisors and consultants to plan sponsors?

A: I'm not convinced that heightened regulatory enforcement will necessarily lead to more and/or bigger ERISA lawsuits.

Q: What is the relationship between 10b5 lawsuits and ERISA claims?

A: Sometimes securities litigation cases occur first. In other situations, an ERISA lawsuit may be filed first, as a precursor to a 10b5 allegation.  In 10b5 cases, the governing statutes impose a very high standard for pleadings and pleading standards in ERISA cases were previously seen as more lenient.  However, the U.S. Supreme Court decision in Ashcroft v. Iqbal ("Iqbal") in 2009 raised the bar for  pleading all claims, including ERISA claims and this may be a deterrent to some of the "piggy-back" ERISA filings we have seen.

Q: What are your thoughts on the role of directors as retirement plan fiduciaries?

A: Post Enron, many companies tried to move directors and officers out of retirement plan fiduciary roles as a way to avoid perceived conflicts of interest and worries about material, non-public information being used to influence the menu of 401(k) plan choices for participants. At least at the motion to dismiss stage, however, many courts still allow claims against directors and officers to stand, even if they had little or nothing to do with plan administration. 

Q: What are some areas on which fiduciaries should focus on in 2011?

A: Investment fiduciaries need to pay attention to whether they have adequate ERISA and Directors and Officers ("D&O") liability insurance coverage. Additionally, they need to recognize the importance of process, if they don't already. So much litigation centers on incomplete and/or missing process. Also, not keeping participants properly apprised of investment risks and benefit plan changes is another trouble spot.  

Attorney Morrison's comments certainly provide food for thought. Interested readers can click "Seyfarth Shaw Publishes 2011 Workplace Class Action Litigation Report, 01/05/11. For those interested in the Iqbal case, click to read the 435 page memo from Andrea Kuperman to the Civil Rules Committee, Standing Rules Committee entitled "Review of Case Law Applying Bell Atlantic Corp. v. Twombly and Ashcroft v. Iqbal" and dated December 15, 2010.

According to today's news reports, the U.S. Securities and Exchange Commission may soon investigate the California Public Employees' Retirement System ("CalPERS") for its disclosures about inherent risks. If true, this type of inquiry could quickly lead to serious trouble for other public retirement plans as well as ERISA plans. For that matter, any issuer of securities (government or corporate) will be fair game if it's found that the investing public was ill-informed about the ticking time bombs associated with underfunded defined benefit plans, mismanaged 401(k) plans or both.

No public information has yet been made available on the topic of CalPERS and a federal regulatory examination so it is imprudent and inappropriate to speculate.

On a general note, at a time when investors are still reeling from losses in 2008 and 2009 and questions abound regarding the rules of the game, transparency and conflicts of interest, the last thing plan sponsors should do is to gin up their performance numbers. It's better by far to get the bad news out and deal with the aftermath in a legitimate fashion. One constructive approach is to engage a risk management expert to conduct an assessment of current economic vulnerabilities and how those risks are being communicated to bond buyers (and, for corporations, equity investors).

Email Dr. Susan Mangiero, CFA and certified Financial Risk Manager if you would like information about what a risk disclosure assessment entails for your organization or on behalf of a client(s). You may likewise be interested in one of our workshops for directors, trustees and/or members of the investment committee about performance reporting within a fiduciary and financial risk management framework.

Originally slated to debut in late November 2010, a busy fall delayed the launch of this compliance and litigation support blog, www.goodriskgovernancepays.com. With a new year and a plethora of important issues to address, I look forward to providing attorneys, arbitrators, investment decision-makers, compliance officers and regulators with insights, thought leadership and actionable information. 

Your feedback is invaluable. I welcome your suggestions and comments. Feel free to send an email to contact@fiduciaryleadership.com or call 203-261-5519.