New Litigation Risks For Retirement Plan Providers

Posted by Susan Mangiero on March 19, 2012

Pile of Papers.jpg

According to Shannon Barrett, attorney and partner in O'Melveny & Myers' ERISA litigation practice, new fee disclosure regulations could mean more lawsuits against record-keepers and other organizations that provide services to U.S retirement plans. Cited in "New Fee-Disclosure Regs Pose New Litigation Risks for Retirement Plan Providers" by Fran Lysiak (Insurance News Net, March 2, 2012), Barrett adds that new rules "will force record-keepers and similar service providers to 'stake a position on something that is a very disputed legal issue,' referring to fiduciary status.

For more information, check out "DOL Retirement Plan Fee and Expense Disclosure Compliance: Navigating New Rules for Service Providers and Plan Sponsors." Sponsored by Strafford Publications, this March 27, 2012 webinar will feature two senior ERISA legal experts with Morgan Lewis, Michael B. Richman and Daniel R. Kleinman, and will explain Section 408(b)(2) disclosure rules and what compliance (or lack thereof) means.

Transparency is a continued mantra with regulators and lawmakers in the United States and elswhere. In a recent conference in Washington, DC called "SEC Speaks," speakers from the U.S. Securities and Exchange Commission reiterated the need for robust disclosures to promote "fair and orderly markets."

Of course more disclosure does not always translate into better disclosure but certainly there are numerous best practices as to how numbers should be reflected to empower investors and plan participants with what they need to know. As I have said many times, numbers are helpful but certainly not the totality of the risk factors that should be considered with any vendor or asset manager relationship. The process of vetting economic, fiduciary and operational risks (among others) is a complex but hugely necessary expenditure of time and money.

Europe Readies For High Frequency Trading Compliance

Posted by Susan Mangiero on February 24, 2012

Computers_For HFT Blog Post.jpg

In addition to sovereign debt restructuring, European financial market executives have a new mandate - high frequency trading governance. On February 24, 2012, the European Securities and Markets Association ("ESMA") published the final version of "Guidelines on systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities" in all official languages of the European Union ("EU"). As a result, regulatory supervisors must "declare whether they intend to comply with the guidelines or otherwise explain the reasons for non-compliance."

What caught this blogger's attention is the document's emphasis on governance as being "central to compliance with regulatory obligations" and having to address technical, business and operational risks, among other things. The document continues that policies and procedures must be in place to monitor a firm's trading systems and algorithms for adherence with the firm's internal control requirements. Additionally, it is critical for a firm to be able to detect when failures occur.

Whether these directives have an impact on high frequency trading remains to be seen. Bruce Love does a nice job of explaining the likely impact of ESMA's guidance. See "ESMA's HFT rules widen net, cash shadow over dark pools" (The Trade, January 24, 2012).

The Cats and Dogs of Derivative Instrument Regulation

Posted by Susan Mangiero on July 07, 2011

Animals.jpg

In survey after survey, capital market participants complain about regulatory overload and complexity. The last thing any compliance officer wants to have happen is that his or organization is trying to do everything right but ends up on the wrong side of the law because rules differ across jurisdictions. Then there are the clever arbitrageurs who recognize regulatory differences as opportunities to exploit loopholes.

In the case of the global over-the-counter derivatives market, sized in excess of $600 trillion in terms of notional principal amount, Reuters reporter Jim Brunsden describes disparate mandates from European Union and U.S. regulators, respectivley. According to "Differing EU, U.S. Derivative Rules May Discriminate, Groups Say" (July 6, 2011), margin amounts and "different sets of licensing rules on cross-border business" could introduce costly uncertainty for investors.

In a July 5, 2011 letter to The Honorable Timothy Geithner and Commissioner Michael Barnier, ISDA and other financial market organizations listed some of the extra-territorial concerns that should reflect coordination:

  • Licensing, authorisation or registration rules for entities to trade derivatives;
  • Application of margin requirements to banks, broker dealers and asset managers with operations throughout the world;
  • Extent to which foreign operating entities would be subject to competing authorities in multiple jurisdictions even when the parent entity is complying with home country regulations;
  • Standards for recognition of central counterparties ("CCPs") in each others' jurisdictions to minimize ambiguity; and
  • Indemnification provisions as relates to data collection by U.S. based Swap Data Repositories ("SDRs"), pursuant to the Dodd-Frank Act.

Those institutional investors that employ derivatives - directly or indirectly - are wise to track the regulatory discussions underway. Their costs, and related investment performance, are likely to be impacted by the constraints borne by major market dealers.

For further information, check out the following items:

$200 Million Settlement Paid Relating to Mortgage Backed Security Valuations

Posted by Susan Mangiero on July 06, 2011

Bear Near Tent.jpg

Investors rely on the net asset values ("NAVs") provided to them as a way to make all sorts of financial decisions such as asset allocation, rebalancing, hedging and possibly exiting a particular money pool.

In a recent case, the bear invaded the tent, eventually denying investors for several funds any illusion about security related to being able to use "good" valuation numbers. According to a June 22, 2011 cease and desist order against Morgan Asset Management, Inc. and other respondents, the way that valuation numbers were assembled for purposes of providing daily NAVs "inaccurately inflated the prices of certain securities, contrary to the Funds' valuation procedures." In addition, several accounting professionals failed to "document justifications for such pricing adjustments."

At stake with any of these valuation cases is a legitimate desire on the part of the investing public to understand how the numbers come to be. In this particular case, Morgan funds held subprime mortgages that had to be "fair valued" with market quotations not always readily available. When broker-dealer confirmations were available, they were not always used and sometimes discarded.

Besides the payment of $200 million in disgorgement and civil fines, Morgan Asset Management Inc. and Morgan Keegan & Company agreed to be censured, fully cooperate with the SEC in any other investigations that relate to trading and/or valuing a fund's portfolio or its components and a prohibition against fair valuing any fund portfolio instruments for three years. Click to download the SEC Cease and Desist Order "In the Matter of Morgan Asset Management" et al, June 22, 2011. 

The harm to investors should be clear. For one thing, in bad markets when it became harder to liquidate complex instruments, inflated valuation numbers may have incorrectly dissuaded some investors from redeeming had they known the truth. Additionally, better than real numbers line the pockets of fund personnel when investors end up paying "higher" fees for "artificially" better performance.

Attorney Robert Robertson at Dechert has an interesting article about this case, laying out the facts, the violations and related cases. His conclusion from a review of various SEC cases involving the valuation of fund portfolios is that sound procedures must be adopted and followed. Moreover, he adds that procedures need to be properly documented and that "there should be checks and balances so that one person does not have the ability to circumvent the system." Click to read "Morgan Keegan Settles SEC Fraud Charges Related to Mortgage-Backed Securities Valuations in its Registered Funds," Dechert On Point, July 2011.

The terms of the settlement are far from trivial and may have influenced the decision to find a suitor for the Morgan Keegan enterprise. According to "TARP pressure behind Regions putting Morgan Keegan up for sale" by Ted Carter (Mississipi Business Journal, June 27, 2011), raising capital and regulatory costs are proffered explanations for why Regions Bank (owner of Morgan Keegan) has hired Goldman Sachs to "review 'strategic alternatives' for Morgan Keegan."

SEC Proposals For Swaps Dealers - A Lot At Stake

Posted by Susan Mangiero on July 03, 2011

Blue Puzzle Piece.jpg

In her June 29, 2011 comments, SEC Chairman Mary Shapiro laid out proposed rules for over-the-counter swaps dealers, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. In addition to mandating more and better communication about potential conflicts of interest (and related pay to play problems) for special entities such as pension plans, financial institutions will have to "provide the counterparty with information concerning the daily mark for the security-based swap." For ERISA plans, security-based swap dealers would likely have to transact via independent agents of the plan sponsors who in turn would be deemed fiduciaries.

Interested persons can respond to the U.S. Securities and Exchange Commission before August 29, 2011. Rules proposed by the U.S. Commodity Futures Tradign Commission ("CFTC") have generated a range of comments. One in particular caught my eye about the need to provide valuation numbers as well as scenario analysis results in the context of a pension plan's portfolio. Given the increased use of swaps by institutional investors around the world to manage risk, this notion has appeal.

Suggested links for readers include the following:

Risk and Reward Gets a Push From Financial Regulators

Posted by Susan Mangiero on April 24, 2011

Risk Reward.jpg

As I've long maintained, it is critical to align the interests of executives with shareholders, taxpayers and/or other beneficiaries who depend on the wisdom of managerial decisions. How those in charge get compensated is therefore of utmost importance. In an ideal world, excessive risk-taking is not rewarded but rather penalized in favor of incentive pay that encourages disciplined risk-taking and management of identified and measured uncertainty factors. Whether financial reform will do the trick remains to be seen.

According to New York Times contributor Steven M. Davidoff, current proposals by the Federal Deposit Insurance Corporation ("FDIC") relating to performance pay are weak and could induce perverse behavior with respect to risk-taking. While the stated objective is to penalize senior-level managers for making imprudent decisions that take banks to the brink, he posits that federal regulators are focused on "gross negligence" as opposed to imprudent process which could be just as harmful in economic terms. His piece entitled "In Regulator's Proposal, Incentive for Excessive Risk Remains" (New York Times, April 13, 2011) excerpts draft language that would require a "degree of skill and care" and could be liberally interpreted to give all but the most egregious bank executives a hall pass. He further adds that the fact that large financial institutions enjoy a size subsidy from taxpayers makes them even more accountable than their non-financial corporate peers.

Legal pundit Davidoff adds that critics describe the FDIC's proposed language as overly broad, unreasonable and possibly unconstitutional. I understand an executive's concern about giving up two years of compensation if he or she has been disciplined and systematic in terms of corporate finance and investment risk governance and then unfairly impugned. The flip side is that Joe Everyman is getting weary of reading about executives with questionable ethics who end up laughing all the way to their penthouse. As a believer in free markets and pay for good performance, I am not fully comfortable with having the U.S. government decide on how much an executive should make. As a taxpayer however, I would prefer to move away from ambiguity about who is responsible for what, when and on what basis towards more clarity about responsibilities, expectations, duties and performance evaluation standards.

Moreover, it would be refreshing to have good players rewarded by both Wall Street and Main Street for taking their stewardship duties seriously and focusing on the spirit of the law and not just the letter. Indeed, it must be awfully frustrating for those leaders who take great care to do the right thing for long-term wealth creation purposes and not be recognized for their diligence. Instead, one wonders if their ire is reserved for their corporate peers who may choose the opposite path without thinking twice.

Governance advocates will be paying close attention to how courts interpret clawback rules, once finalized, with respect to what constitutes diligence, skill, care and loyalty. There is a lot at stake for everyone.

The Views From An Activist Investor

Posted by Susan Mangiero on February 07, 2011

Phil Goldstein Standing_400 Pixels.jpg

Always a fighter for truth and clarity, Phillip Goldstein shared his insights about regulations, hedge fund transparency, activist investing and board accountability with me on February 7, 2010. Co-founder of Bulldog Investors, the name of this former engineer may sound familiar to you. Besides winning a skirmish with the U.S. Securities and Exchange Commission ("SEC") a few years ago about its right to require registration of investment professionals who work with hedge funds, Mr. Goldstein is now battllng the State of Massachusetts over the issue ofwhether the First Amendment allows asset managers like himself to engage in truthful speech about his business without fear of punishment. For more background on that case and the various briefs, see "Banned in Boston: The Bay State trots out a paternalistic rationale for its latest infringement on free speech" by John Berlau (Wall Street Journal, January 6, 2011) or click to read the motion to file amici curiae as relate to "Bulldog Investors General Partnership v Secretary of the Commonwealth, December 13, 2010.

In a phone interview that easily could have gone on for hours no doubt, we covered a lot of ground with a focus on my continued passion for investment best practices.

Q: Welcome and thank you for agreeing to talk about important issues for investors today. You co-founded Bulldog Investors after spending over twenty years as a civil servant. You invest primarily in closed-end funds, small-cap operating companies and special purpose acquisition companies or SPACs. What's your take on investing, post Madoff?

A: Pension funds and what I'll call allocators have a hard job. They need to vet numerous money managers and proposals that cross their desk. However, that doesn't absolve them from their fiduciary duties. Asset manager due diligence remains important but must encompass much more than just a review of numbers. I liken the process to picking a spouse. If you're an institutional investor, ask whether you want someone who looks like Angelina Jolie (Brad Pitt) for your wife (husband) or someone less flashy and able to offer depth for a long-term and successful marriage. I think it's critical for investors to consider the character of an asset manager and ask whether that person is honest and sufficiently talented to generate good returns on an ongoing basis. Investors must assess whether an asset manager has a "long-term sustainability edge." These are not easy tasks.

Q: You consider yourself a value investor, correct?

A: Over the last eighteen years, our fund has used what I call an activist's tool kit on behalf of our investors. It's a lot of work but we think due diligence and care should be present over the full range of economic cycles. Our strategy is not the only way to go but we are happy with our efforts.

Q: What worries you about investing in a particular company?

A: We like to find companies with hard assets that are undervalued in the marketplace. For example, a company may count raw land as a major asset that may be able to create value for investors, independent of what person is running the organization.

Q: I realize that you can't say anything specific about the open court case with the State of Massachusetts but can you comment on what is known to the general public? As I understand the issue, your fund published performance information on your website for anyone to read, even those who are not accredited investors. What do you think about the support you have received from several financial journalists who assert that hedge fund transparency is tantamount to free speech and necessary for them to track the industry on behalf of readers.

A: There seems to be an inconsistency with respect to hedge fund reporting. Tiffany & Co. showcases its jewels for everyone, rich and not rich. Should there be a rule that only allows people with a certain net worth to window shop? Some states, including Massachusetts, have a website devoted to state lotteries. As far as I can tell, the sites are not password protected to prevent young persons who are ineligble to buy tickets from reading the information. Furthermore, there is a real clamor for more information about hedge funds but advertising - which is broadly defined - is prohibited so the veil of secrecy remains.

Continue Reading