Ignoring risk is folly, especially when the downside could be complete ruin for a business or investment portfolio. That’s why it’s essential for risk managers to persuade others to pay close attention to things that go bump in the night and then figure out a way to prevent loss, to the extent possible. Unfortunately, risk management is often seen as dull, overly complex or unlikely to be a path to career advancement. I know this firsthand. Having worked in various corporate settings, risk managers have few fans. They are the people who say “no” or ask others to gather data and documents instead of doing the kind of glamorous work that adds to one’s bottom line. Risk management is a thankless task until it isn’t. When the stars align, no one cares about managing uncertainty. It’s the “oops” moments that remind the world why taming risk before disaster occurs is a big deal.

For frustrated risk managers, there is hope, especially if you are willing to tweak your communication skills in pursuit of a worthy cause. Don’t take my word. Check out what Scott Adams Says.

According to the creator of the successful Dilbert cartoon strip and author of bestselling books such as How to Fail at Almost Everything and Still Win Big, simplicity is a core element of convincing others. In his recent video about doing laundry, I laughed out loud when he explained how he avoids the risk of discoloration. Buy clothes that don’t have to be washed separately. It’s such a basic and obvious solution that one wonders why it’s not more commonplace. (As I write this post, I’m wearing yoga pants and a sweatshirt with spots from something else I mistakenly cleaned in the same load.)

In one of Adam’s many insightful essays, the reader learns that another persuasion technique involves the use of visuals, especially those that appeal to people’s emotions. In investment land, think about the photos of senior citizens who lost retirement money in 2008 juxtaposed next to images of wealthy bankers with cigars and fancy cars. Regardless of case-specific facts, such powerful images scream “good” versus “bad.” It’s no surprise that financial service ads tend to focus on comforting images whereas political commercials show pictures likely to rile voters.

Yet another tool in the persuasion toolbox is what Adams describes as the “high ground maneuver” or the art of advancing an argument to a level that garners widespread agreement, thereby trivializing any other position. For fiduciaries being sued over their management of other people’s money, they might silence critics by demonstrating (if they can) how their risk management actions broadly advantage beneficiaries such as retirees or endowment recipients. The goal would be convincing others to overlook short-term strategy misdirection in pursuit of a lofty and prudent long-term focus.

When it comes to risk management, it’s not just about numbers. Rallying others to do their part is critical. One has to be an effective cheerleader to grapple with the unknown. I’m convinced that this persuasion “thing” has legs. That’s why I’ve just pre-ordered Win Bigly by Scott Adams for a dose of wisdom and a few chuckles.

If you open a box and a dog pops out, your enthusiasm will be curbed if you were expecting something else. Surely this is how several private equity funds must feel now about one of their investments. According to "Private Equity Funds Liable to Union Pension Plan" by Jacklyn Wille (Pension & Benefits Daily, March 30, 2016), a federal judge recently ruled that several Sun Capital funds are "jointly liable for more than $4.5 million in withdrawal liability" that one of its portfolio companies, Scott Brass, "owed to a Teamsters pension fund." (You can visit Bloomberg Law to read the March 28, 2016 decision by clicking here.)

I will defer to attorneys to address the legal issues. So far, I found two commentaries on the heels of this 2016 legal decision. See "District Court Concludes Private Equity Fund Is Liable for Pension Obligations of the Portfolio Company" (Fried Frank Harris Shriver & Jacobson LLP, March 30, 2016) and "Private Equity Funds Held Liable for Pension Liabilities of a Portfolio Company" (Sullivan & Cromwell, March 31, 2016).

From my perspective as an economist, any surprise claim on future cash flows could be disastrous if it is large enough to jeopardize the ongoing viability of a business. Even if a business has sufficient resources to maintain itself as an ongoing concern, utilizing cash for something that was not planned for could lead to a lower growth rate than originally expected. Keep in mind that pension funds, endowments and foundations frequently allocate monies to private equity on the basis of expected returns for this asset class.

Projecting cash flows as part of due diligence is nothing new for many investors. That said, I am not convinced that all enterprise investigations fully address the impact of an underfunded defined benefit plan. I was recently contacted by a firm that was tasked to render a fairness opinion and wanted my views about pension math. The investment bankers were reviewing documents from bidders that radically differed with regard to the treatment of the target company’s benefit plan burden. When I was asked to speak and also write about pensions and enterprise value, the invitation came from a senior valuation executive who felt that the topic was not being adequately addressed. See "Pension Plans: The $20 Trillion Elephant in the (Valuation) Room" by Dr. Susan Mangiero (Business Valuation Update, July 2013). Email me if you would like a copy of my 2013 slides about this topic.

In 2013, when this Sun Capital case originally made its way to the court, it struck me as an important issue. (I was not involved in this matter as an expert.) Several editors agreed and I ended up co-writing two articles with Groom Law Group partner David Levine. I’ve uploaded one of these articles to this pension blog. Click here to read "Private Equity Funds and Pension Plans: A Changing Dynamic" (CFA Institute Magazine, March/April 2014). At my request, Attorney Levine responded to this 2016 decision by emailing the following: "In short, while some private equity firms have already moved to evaluate and, in some cases, clarify their fund structures, this case is likely to lead to a second look at their structures and methods of involvement with their portfolio companies."

If certain limited partners are not already asking questions of their private equity fund general partners about the nature of portfolio company pension plans, controlling interest status and deal structure, their due diligence could quickly change in the aftermath of the 2016 Sun Capital litigation.

Interested persons can click on the links provided below to read earlier blog posts about this topic:

In carrying out research for a client about public pension fund trends, I came across a website called Pension Litigation Tracker. Maintained by the Laura and John Arnold Foundation, this collection of court documents and descriptions of ongoing developments in "pension reform lawsuits" looks to be a helpful resource at a time when there is increased pressure on numerous municipalities to address the challenges associated with underfunded retirement plans, including questions about the constitutionality of benefit arrangements. A drop down menu allows the user to search by state or by topics such as double dipping, increased employee contribution, pension rights and reduced benefits.

As I have discussed extensively in analyses about the impact of pension deficits on the sponsor’s ability to raise capital, service debt and/or sustain economic growth, it is no surprise that litigation and regulatory enforcement that alleges either contractual non-performance or fiduciary breach (or both) is growing. Interested readers can download "Muni Bonds, Pension Liabilities and Investment Due Diligence" by Dr. Susan Mangiero, Dr. Israel Shaked and Mr. Brad Orelowitz (American Bankruptcy Institute Journal, July 2014). Also visit the Municipal Bond section of the Good Risk Governance Pays website.

These cases have the potential to be large in terms of dollar damages as well as the cost of defense. An example is the class action filed against the Board of Trustees of the Kentucky Teachers’ Retirement System by its "75,000 active members, and over 45,000 annuitants."

While http://pensionlitigation.org/ emphasizes the legal nature of disputes about benefit reforms proposed by cities and states, it does not showcase the large number of investment-related lawsuits wherein a public pension plan(s) files a 10b-5 lawsuit against the issuer of a security that is owned by the plaintiff, alleging securities fraud. These actions are likewise large and plentiful. More will be said about this topic in a later post.

I am delighted to share my recent article with readers of this pension blog. Entitled "An Economist’s Perspective of Fiduciary Monitoring of Investments" (by Dr. Susan Mangiero and published in Bloomberg BNA Pensions & Benefits Daily, May 26, 2015), I wrote this article in the aftermath of the May 18 Tibble v. Edison decision by the U.S. Supreme Court.

A central thesis is that "ongoing oversight is an exercise in risk management" and that "[r]isk management is a never ending process." The article emphasizes the importance of (a) examining multiple risk factors and not relying on performance numbers alone (b) understanding the presence of financial leverage (should it exist) (c) clarifying the role of a service provider when an outside party is used and (d) letting participants know about the type of monitoring being done by an investment committee.

The topic of this article readily lends itself to at least one lengthy book as there is a considerable amount to say. I am co-writing a sequel article with fellow economist, Dr. Lee Heavner.

If you are interested in discussing investment fiduciary monitoring as relates to trustee training, compliance or dispute resolution, please email contact@fiduciaryleadership.com.

Seeking to accomplish a goal without having the right tools can result in frustration and possible failure. One solution is to get outside help when needed as long as the party being hired is knowledgeable and independent. Otherwise, what looks like a solution could quickly become a problem. Applied to ERISA plans, trouble might take the form of costly and time-consuming enforcement and/or litigation. Over the last few years, that reality has set in for more than a few employers.

Recognizing the importance of abiding by good governance principles, several of us agreed to speak as part of an educational webinar on April 8, 2015 about fiduciary tools, pitfalls and lessons learned. Sponsored by fi360 and entitled "ERISA Litigation and Enforcement: The Role of the Independent Fiduciary and Best Practices for Financial Advisors," this webinar joined Attorney Tom Clark (Counsel with the Wagner Law Group), Dr. Susan Mangiero (Managing Director with Fiduciary Leadership, LLC) and Mitchell Shames, Esquire (Partner with the Harrison Fiduciary Group) to address the (a) use of an independent fiduciary (b) clarifying what an outside vendor should be doing and (c) avoiding legal and economic landmines that have revealed themselves in prominent court cases and regulatory examinations.

If you missed the event, email contact@fiduciaryleadership.com for a copy of the slides. Click here to download the written transcript. Edited for clarity (and because the audio file is spotty in some places), this fourteen page document lays out cornerstone concepts and includes suggestions for plan sponsors and the advisers who serve them. These include, but are not limited to, the following:

  • The outsourced fiduciary market is growing in the United States and elsewhere.
  • When an outside party is hired by a plan sponsor, it is critical to specify responsibilities and contract accordingly. When an "expectations gap" exists, some critical tasks may be left wanting or not addressed at all.
  • When multiple fiduciaries are in place, a plan sponsor must ensure that a central person or team is adequately coordinating the efforts of all fiduciaries.
  • The newly proposed Conflict of Interest rule is predicted to materially change the landscape of fiduciary relationships between plan participants and retirement advisers.
  • A fiduciary status may exist due to either a contractual agreement or by virtue of the functions assumed by an individual or organization.
  • ERISA litigation is getting more attention these days, with a particular focus on fees, use of proprietary funds, revenue-sharing and disclosure of compensation paid to investment consultants, advisers and asset managers.
  • Demonstrating procedural prudence in part depends on what others in the industry are doing (or not doing as the case may be) and whether actions make sense for a given plan.
  • A renewed focus on disclosure and transparency is in the works according to comments made by the U.S. Department of Labor.
  • An independent fiduciary can be engaged for a singular transaction or for a task that continues over a long period of time.
  • An independent fiduciary can be engaged by either a defined contribution plan or defined benefit plan or both.
  • When there is a perception or reality of a conflict of interest, it may be prudent for an independent fiduciary to be engaged. The participants pay for said party because the independent fiduciary works on behalf of the participants.
  • The concept of co-fiduciary status is important and should be paid heed by any adviser who has an ERISA plan as a client.
  • Before delegating duties (to the extent allowed) to a third party, a plan sponsor should decide what financial issues should be vetted. Liquidity, the use of leverage by asset managers and asset allocation are a few of the many topics that a delegated fiduciary could be asked to measure, monitor and manage.
  • A fiduciary audit can be extremely helpful as a tool for identifying areas of improvement for an ERISA plan sponsor.

It may be no surprise that over 500 people registered for this educational webinar about fiduciary foibles. After forty years since its inception, ERISA remains a force that cannot be ignored.

I have just returned from Chicago where I spent two days listening to transaction attorneys, litigators and insurance company executives talk about trends in ERISA enforcement and legal disputes. Sponsored by the American Conference Institute, this assembly about ERISA litigation included sessions on class actions, Employer Stock Ownership Plan ("ESOP") problem areas, the role of economic experts in litigation, challenges to the church plan exemption, questions about excessive fees, de-risking, stock drop defense strategies, health care reform, how much ERISA fiduciary liability insurance to purchase and much more.

I took a lot of notes and intend to write about implications for plan sponsors and their service providers through an economic and governance lens.

It may be coincidental but certainly not trivial that the United States Department of Labor released its fiduciary proposed rule about conflicts of interest on the second day of this important ERISA litigation convening, i.e. on April 14, 2015. The thinking is that the adoption of a more rigorous rule could open the door wide to a multitude of further disputes and heightened examinations. Click here to access the language of the proposed rule and supporting documents.

It sounds like many will be even busier in the coming months.

Anyone who has been on the receiving end of major surgery may tremble after reading "How to Make Surgery Safer" (Wall Street Journal, February 16, 2015). Journalist Laura Landro describes a panoply of horribles such as operating on the wrong body part or leaving a foreign object inside a patient’s body. Honing in on "never events" (i.e. those that are serious and should never occur), she describes attempts by hospitals to reduce human error in a quest to contain the rate of injury, minimize the number of deaths and avoid the billion dollar whack for serious faux pas. Besides the collection and analysis of big data to glean lessons learned and track performance, the writer describes how operating room teams are being prepped to emphasize safety in numerous ways. These include, but are not limited to, the following:

  • Adding radio frequency tags to instruments and sponges;
  • Empowering nurses to override a doctor’s orders to wrap up if questions exist about missing items;
  • Convening as a team to agree on strategy before any cuts occur;
  • Identifying ahead of time what procedure should take place and on what part of the body;
  • Training all staff about how to use electrical equipment;
  • Creating, and then following, an appropriate checklist; and
  • Asking patients to actively participate by getting into good shape ahead of time and scrubbing with anti-bacterial soap prior to surgery.

In the pension world, setting a risk management objective by proverbially marking the target spot with a big X merits consideration. After all, if the goal (or set of goals) is vague or flat out wrong, chances are that the "operation" will fail. Should that happen, the "patient" (i.e. participants) could suffer.

The concept of proper goal-setting is far from trivial. Fiduciary breach allegations are undeniably here to stay, courtesy of an increasingly active plaintiffs’ bar. Settlements can cost sponsors millions of dollars, even when a company feels strongly that it has done everything correctly. Changing regulations could up the ante. According to "President Obama to Address DOL Fiduciary Redraft at Monday AARP Meeting" (Think Advisor, February 22, 2015), proposed standards put forth by the U.S. Department of Labor appear to be moving closer towards some type of final conflict of interest rule. In a January 13, 2015 memo, the White House seems to be taking the view that retirement plan fees are often too high and have cost savers more than $6 billion. No doubt the financial industry will continue to rebut these estimates.

Based on my experience as a forensic economist and someone who has served as a testifying expert, goal-setting is hugely important when it comes to resolving disputes. An inevitable question is whether something went awry and, if so, what monetary damages should be paid (and to whom). Answering inquiries about whether wrongdoing occurred (and its magnitude) has to start with identifying the objective(s) and then examining the achievement of said goals (or lack thereof).

Similar to the health care profession, continuing to up its game in terms of process improvement, retirement plan sponsors (and their service providers) have a vested interest in creating goals that are (a) clear (b) measurable (c) realistic and (d) appropriate for the situation at hand.

In case you missed "ERISA Plan Investment Committee Governance: Avoiding Breach of Fiduciary Duty Claims" with Dr. Susan Mangiero (Fiduciary Leadership, LLC), Ms. Rhonda Prussack (Berkshire Hathaway Specialty Insurance) and Attorney Richard Siegel (Alston & Bird), click to download the November 17, 2014 presentation or visit the Strafford CLE website to obtain the audio recording.

Given the importance of the investment committee governance topic and emerging market trends in the area of outsourcing, my comments focused on committee structure, guiding documents, training and implications when third parties sign on as fiduciaries. Points I made during the webinar include, but are not limited to, the following:

  • The ERISA Advisory Counsel, in its 2014 Issue Statement about outsourcing employee benefit plan services, cites a desire to understand how vendor contracts address provisions such as termination rights, indemnification, liability caps and service level agreements.
  • An evaluation of the outsourcing business model is not surprising given a service provider push to serve as an Outsourced Chief Investment Officer or Fiduciary Risk Manager. (An Asset International publication refers to the OCIO movement as a fast-growing segment of investment consulting.)
  • Once an investment committee has been authorized by the sponsor’s board of directors, a core set of qualifications and experience needs can be assembled. Plan counsel can play a vital role in explaining fiduciary obligations.
  • Beyond that core base, facts and circumstances such as plan design, company size, industry structure and investment strategy should be taken into account as part of determining requisite training and experience.
  • Regular meetings are encouraged with frequency being determined in part by what has to be done by the investment committee and related time sensitivity of completing a task(s).
  • Notwithstanding the voluntary nature of having an Investment Policy Statement ("IPS") in place, an ERISA plan investment committee should establish one nevertheless that makes sense for a particular plan. Some organizations have been questioned after creating an IPS but not following it.
  • Creating (and following) an appropriate Risk Management Policy can likewise be useful, especially for ERISA plans that utilize derivative instruments and/or allocate money to more complex products or strategies.
  • Training is another mission-critical area. (According to "DOL Investigators Quiz Plan Sponsors On Training of Fiduciary, Attorneys Say" by Bloomberg BNA contributor Joe Lustig, fiduciaries are being asked by regulators whether training programs exist.)
  • Continuing education is beneficial since regulations, market conditions and plan-related objectives and strategies can change over time.

Someone from the audience asked whether it made sense for an investment committee to consist of a senior corporate executive such as a Chief Financial Officer and her direct reports. The point is that each fiduciary is equal at the investment committee "table" but otherwise unequal. This can present a big problem if any or all of the investment committee members disagree with the Chief Financial Officer. Worse yet, a subordinate (in corporate organization terms) may be reluctant to whistle blow about an imprudent decision made by the CFO while wearing her hat as ERISA fiduciary. I will leave the question as to legal protection to attorneys. However, in doing some research, it turns out that U.S. federal pension law does address whistle blower protections. Interested persons can click to read "ERISA Has a Whistleblower Provision? Yep." by Seyfarth Shaw attorneys Ada Dolph and Robert Szyba (June 19, 2014).

There is a lot more to say on the topic of investment committee governance, notably because ERISA lawsuits that are adverse to a plan sponsor tend to include all investment committee members as defendants. An effective infrastructure and good governance policies and procedures can help to mitigate fiduciary personal and professional liability and position the investment committee to better serve participants.

As an independent economic consultant, I am fortunate to have flexibility as to project selection and the make-up of my team. From what I hear from colleagues, others don’t feel as lucky. They tell me they feel stuck in a situation where they have important duties to carry out but do not necessarily trust or like their work mates. This could be dangerous, especially since plan fiduciaries are exposed to personal liability.

I’ve heard some say that you can dislike someone yet still have respect for their knowledge and integrity. Others suggest that you may want to break bread with an individual over lunch but want to avoid having to depend on their judgment about serious matters. I supposed the ideal is to both like and trust someone to be careful about things such as vendor selection, changing an investment line-up, freezing a plan and so on. When the perfect combination of sparkle, professionalism and gray matter is non-existent, what should a fiduciary do?

I haven’t seen much on this topic about how to select someone to serve as a fiduciary of a pension fund with respect to their personality and integrity. One public plan trustee asked for my opinion about a committee on which he served. His concern had to do with what he deemed to be anemic attempts on the part of one of his colleagues to gather information about various asset managers and asset classes. His fear was that this person would vote "yea" or "nay" without a proper basis. I told him that his anxiety was far from trivial. Based on my experience, this gentleman was right to be scared. When a fiduciary breach complaint is filed, all past and present members of the investment committee are often cited as defendants. The notion is that the fiduciaries were making important decisions on a collective basis.

In my view, there is room for improvement as to how pension plan fiduciaries are selected, trained, monitored for appropriate performance and terminated, as needed. It wouldn’t hurt to assess the friendliness factor of each candidate either. Not that everyone has to bond over Friday night pasta but the investment committee typically works as a team. It is important that the members of said team can have an open and meaningful exchange among one another, debate various topics in depth and decide what makes sense for participants thereafter. Speaking in plain language helps. See "Even Pension Board Members Can’t Understand Pension Jargon" by Ari Bloomekatz (Voice of San Diego, September 5, 2014), for an interesting example of questions that fiduciaries are right to ask and the disparate level of investment knowledge reflected on a board.

If you have a good story to tell about investment committee dynamics, email contact@fiduciaryleadership.com.  

 

According to marketing guru Steve Jones, parties seeking to do business with one another can learn a lot from rock musician David Lee Roth. As explained in "No Brown M&M’s: What Van Halen’s Insane Contract Clause Teaches Entrepreneurs" (Entrepreneur Magazine, March 24, 2014), each of their agreements included a rider that was designed to force a promoter to pay attention to the band’s true objective about ensuring safety. By adding what may have seemed like a silly provision about "melt in your mouth" candies being unwelcome, Van Halen was testing whether the promoter had read the contract in its entirety and was therefore more likely to install equipment properly. "If any brown M&M’s were found backstage, the band could cancel the entire concert at the full expense of the promoter," leaving him or her with a possible loss in the millions of dollars.

In institutional investment land, there are intriguing parallels. For one thing, there is the safety issue. If a pension plan is poorly managed, beneficiaries may suffer. Second, if there is confusion or ambiguity about who is supposed to do what, when, how and at what price, there are likely to be disputes and economic consequences. There is a growing number of lawsuits and regulatory investigations that are scrutinizing service providers and/or the pension plan trustees who are tasked with diligently selecting them.

The developing market in outsourcing various services to a third party is yet another reason for paying close attention to the quality of engagement letters and vendor contracts. Earlier this year, the ERISA Advisory Council announced its plan to study "current contracting practices with respect to outsourced services, including provisions such as termination rights, indemnification, liability caps, service level agreements, etc. that might assist plan sponsors and other fiduciaries in negotiating service agreements."See "Outsourcing Employee Benefit Plan Services."

As someone who has done business intelligence research and trained investment fiduciaries and their advisors, I often hear the same frustration being expressed about a gap in expectations. Budget-strapped buyers want more for less. Consultants, asset managers and banks say they are searching for ways to satisfy their clients while still being able to earn a reasonable rate of return for their efforts. One solution is to streamline operations, to the extent possible, while acknowledging any fiduciary implications associated with prevailing law and governance standards. If cutting corners to preserve a profit margin ends up sacrificing requisite quality, trustees could be at risk of being investigated for anemic oversight of service providers. Vendors could be at risk for failing to deliver contractual services.

Based on my work for both defense and plaintiff counsel (depending on the matter and whether there is a counterclaim), a poorly worded agreement can be a potential trouble spot. Another hugely important issue is whether a service provider has self-identified as a fiduciary. An attorney or judge may categorize a particular service provider as a functional fiduciary even if a written contract is silent on that point. Trust counsel can play a critical role in assisting with negotiations before authorized persons sign on the dotted line.

ERISA attorneys David C. Kaleda and Theodore J. Sawicki address the issue of fiduciary status in a 2012 article for the National Society of Compliance Professionals. See "Should You Have a Formal ERISA Compliance Program?" In a recent discussion about the best practices for creating and adhering to service level agreements, ERISA attorney Howard Pianko expressed his strong view that there are numerous ways to ensure "plausibility" and still be able to hire affordable outside organizations to assist. He went on to describe the advantages of having a systematic mechanism in place such as the Six Sigma type model that his firm employs. Click to read about Seyfarth Lean. (Having earned a Green Belt in Six Sigma, I can attest firsthand to the upside of developing a process to control quality.) 

For those involved in the selection and oversight of service providers or the delivery of said services, ask yourself if you know as much about an existing or anticipated contract as you should.