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DOL to Propose New New-Rule on the Definition of Fiduciary

The Employee Benefits Security Administration (EBSA), the U.S. Labor Department agency charged with enforcing ERISA compliance, will attempt again to fashion a new definition of "fiduciary" under ERISA.

As Tony Maul wrote in these pages in October of last year, the current definition is over 35 years old. Investment choices for pension plans have changed drastically in the intervening years and the DOL has been trying to address the greater breadth of responsibility investment advisers have acquired as a result.

The definition proposed in 2010 generated significant commentary from the financial services industry, plan fiduciaries and beneficiaries. The DOL held two days of hearings in March where it received oral and written testimony from dozens of witnesses and reviewed hundreds of letters from the public. A House subcommittee held its own hearing in July.

Industry players argued the rule would have a chilling effect on the information advisers could give investors, would reduce their compensation by prohibiting more transactions, and would increase compliance costs. Unions and participants' representatives claimed the rule was not expansive enough. Legislators, such as Rep. Barney Frank, the ranking member of the House Financial Services Committee, urged a rethinking of the definition to address concerns the current proposal limited investment choices and didn't take into account potentially conflicting SEC rules.

Nearly all agreed that the proposed language needed clarification. That group included Phyllis Borzi, Assistant Secretary of Labor, who said: “We honestly weren’t as clear as we could have been and we’re trying to fix that." The DOL expects to publish the proposed new new-rule in January 2012.

Department of Labor Proposes Change to Definition of "Fiduciary"

The U.S. Department of Labor recently proposed a rule change broadening its definition of “fiduciary” under the Employee Retirement Income Security Act (“ERISA”).  The Labor Department surmised that the existing definition, which hasn’t been updated since 1975, provides employee beneficiaries with inadequate protections against potential conflicts of interest on the part of investment advisors.  Specifically, the current definition is so old it predates the creation of 401(k) plans.  The proposal notes that, compared to traditional pensions, the 401(k) marketplace presents a high danger of conflicts of interest among those hired to provide investment advice to employees.

Under the new definition, “fiduciary” would include those who provide “[a]dvice, appraisals or fairness opinions concerning the value of securities or other property; recommendations as to the advisability of investing in, purchasing, holding, or selling securities or other property, or advice or recommendations as to the management of securities or other property.”

If adopted, the proposed rule change could have effects not only on enforcement actions initiated by the Department of Labor’s Employee Benefits Security Administration, but could also potentially broaden the scope of private actions brought under ERISA against investment advisors.

Minnesota Court Delays Decision on Pension Cuts

A judge in Minnesota’s state District Court has declined to render a decision on whether or not to grant the State summary judgment against a class of current retirees who have challenged proposed cuts to their benefits.  The litigation, captioned Swanson v. Minnesota, No. 62-cv-10-5285, arises from legislation enacted last year that lowers or eliminates annual benefit increases for retirees until the state pension fund is 90% solvent.  The case is being watched both as a potential weathervane for similar cases pending in other states (including Colorado and South Dakota), as well as a guidepost for what other state legislatures may do to confront underfunded pensions.  However, during a hearing last week, Judge Gregg E. Johnson deferred judgment 90 days in order to allow the plaintiffs to conduct document discovery and depositions probing the State’s internal deliberations with regard to its pension gap.  It remains to be seen how the facts disclosed in discovery will impact that court’s evaluation of the retirees’ claims, or whether summary judgment will be back on the table in three months.   

NYC Pensions May Join in Hedge Fund Trend

The pension funds for New York City firefighters, police and civil employees are currently contemplating investments in hedge funds for the first time.  To that end, the city comptroller has recently sought out proposals from hedge fund consultants, which he will be receiving through August 9th.  Should the city funds decide to open their portfolios to hedge fund investments, they would be joining a larger trend that has pension funds increasingly putting their money into alternative investments.  For example, the California State Teachers’ Retirement System (“CalSTRS”) has credited its recent bump in returns to a shift of its assets towards alternative investments, including hedge funds.  Similarly New Jersey’s state pension fund has recently considered expanding the percentage of assets it allocates to alternatives, especially hedge funds.

The NYC funds’ consideration of hedge funds also occurs at a time when hedge funds are facing a shifting regulatory environment.  Most prominently, the Dodd-Frank Financial Reform Bill enacted last week requires hedge fund advisers to, depending on the size of their funds, register with either the SEC or their home state regulators.  The interplay of these new regulations with pensions’ increased participation in hedge funds  is sure to be an interesting area to watch in the coming months.

From the Pages of The Pomerantz Monitor: The Crash Hits Pension Plans

As Susan Weiswasser reports in the January issue of The Pomerantz Monitor, the economic slump has hit pension funds hard. The Center for Retirement Research at Boston College estimates that the value of investments in each of private sector and state/local defined benefit plans dropped by nearly $1 trillion in the 12-month period ended Oct. 9. The Wall Street Journal reports that in October alone, the 100 largest corporate pension plans collectively lost $120 billion. The pensions of the average company in this group were 100% funded as of January, but will probably fall to 76% by the end of the year.

The Pension Protection Act of 2006 (PPA) imposed funding deadlines that kicked in this year. The PPA was supposed to strengthen plans by closing alleged loopholes and significantly tightening funding requirements while raising funding obligations. Sponsors claimed that reliance on old rules and the Pension Benefit Guaranty Corporation (PBGC), which insures the retirement savings of 45 million Americans, was insufficient to guarantee that pension obligations would be met. The PBGC was already too burdened rescuing survivors of massive corporate collapses to provide adequate protection should more plans fail. 

Among other things, the PPA requires companies to have on deposit 92% of projected future pension plan obligations by the end of the year, and a full 100% by the end of 2011. Given the severe decline in market values over the last couple of years, there has been enormous concern that such onerous funding requirements would be more than many plans could afford. A new study by Mercer LLC, a benefits consulting firm, concludes that at the beginning of the year the 800 largest private pension plans collectively had a $60 billion surplus, but by the end of November were $280 billion short. To meet the 92% requirement, companies would have had to contribute an additional $92 billion to their plans. So absent a change in the law, many pension plans would likely have been frozen by the end of next year.

In early November, over 300 organizations, including Pfizer, IBM and UPS, sought relief from Congress. They got it. Congress passed legislation in mid-December pushing back some of the deadlines and clarifying methods for meeting funding targets that will save corporate plan sponsors hundreds of billions of dollars, at least in the short term. President Bush is expected to sign the relief bill.

Public retirement plans are, not surprisingly, also in dire straits, as their assets have also declined in value by at least 10%. Governor Corzine of New Jersey has already proposed that local pension fund contribution deadlines be pushed back to 2012.

From the Pages of The Pomerantz Monitor: Read This Book

In the September issue of The Pomerantz Monitor, Teresa Webb reported on a notable new book, “When the Good Pensions Go Away – Why America Needs a New Deal for Pension and Health Care Reform,” by Dr. Thomas J. Mackell Jr.  Recently, the New York Times Book Review asked authors to recommend books that presidential candidates should read. Had we been polled, we would have heartily recommended Dr. Mackell’s book.

In his book, Dr. Mackell gives the reader a better understanding of how benefit programs have been negatively affected by social, political and economic forces over the last 40 years. Also, he sets forth a “Call to Action”: a list of twelve action statements/activities to address the retirement challenges each of us faces. Suggestions for initiating nationwide change range from creating a new cabinet position devoted to the social and economic implications of long-term demographics, to using the power of protest to draw attention to the plight of the American worker.

As the 2008 election approaches, the need for innovative thinking and decisive action in addressing the challenges of this and future generations must be a high priority. Dr. Mackell’s book should be on everyone’s reading list.

Dr. Mackell is the Chairman of the Board of Directors for the Federal Reserve Bank of Richmond and President of the Association of Benefit Administrators. He is married to Pomerantz Partner Cheryl Hamer Mackell.

Pension Funds Return to Health

According to two recent studies performed by two consulting firms, Towers Perrin and Watson Wyatt, and as reported in the Wall Street Journal today, pension plans appear to have recovered from the budget imbalances experienced over the last several years.  According to Towers Perrin:

For the first time since 2000, the assets of defined benefit pension plans offered by Fortune 100 companies exceed plan liabilities. . . The estimates show that the defined benefit pension plans are 102.4% funded in aggregate at year-end 2006, up significantly from the 91.6% aggregate funded level at the end of 2005. . . . Towers Perrin estimates that the 79 Fortune 100 companies that offer defined benefit pension plans now hold an aggregate pension funding surplus of roughly $23 billion at year-end 2006.

Watson Wyatt is in accord: 

pension plan liabilities posed relatively high amounts of financial risk for only 9 percent of companies, down from 17 percent in 2003 – a decline of about half over three years. Meanwhile, more pension sponsors experienced relatively low pension-related risk. Pension liabilities posed scant risk to the core business for 60 percent of plan sponsors, an increase from about 56 percent in 2004 and 51 percent in 2003.

Interestingly, this recovery does not appear to have been caused by (or even related to) the recent federal legislation designed to shore up the nation’s retirement systems.  Most of the provisions of that new law only went into effect this year.  Instead, this remarkable turnaround was caused by dramatic stock market gains in 2006, coupled with slightly higher interest rates.

We at PomTalk are obviously happy to see that workers pensions are on more stable financial footing.  However, given the cyclical nature of the stock market and interest rates, this is an issue that needs to be watched carefully in the coming years.

Why do companies convert to cash balance pension plans

In recent years, many companies have converted their defined benefit pension plans into so-called "cash balance" plans.  A recent analysis performed by Julie D'Souza of Cornell University, John Jacob of the University of Colorado, and Barbara Lougee of Morgan Stanley analyzes the reasons behind this phenomenon. 

Among other things, the authors conclude that while corporate defenders have argued that the end of the defined benefit plan is a good thing for workers -- because cash balance plans are more portable than defined benefit plans -- this advantage does not adequately explain why corporations abandon their defined benefit plans.  Instead, and not surprisingly, the authors believe that corporations convert to cash balance plans in order to save costs, and that they often do so as their workforce gets older.   

Click here for a link to the study.

Fiduciary Duties Take a Hit Under New Pension Reform Bill

There are a number of provisions in the new Pension Reform Bill (see our post from August 21 for a link to the summary of the new law) that make it easier for financial institutions and hedge funds to conduct business with pension funds.   While many of these provisions may be justified, we are concerned about the long-term effects of at least one provision.

Under the old law, if a hedge fund or private equity group had more than 25% of its assets from public, private, foreign or church plans, they were considered fiduciaries under ERISA. 

Under the new law, hedge funds and private equity groups will have a much easier time escaping the duties of an ERISA fiduciary.  Now, for purposes of calculating the 25% threshold, public, foreign and church plans are excluded. In other words, in order to be deemed a fiduciary, a hedge fund or private equity group must have more than 25% of its assets solely from U.S. private employee benefit plans.

While this change in the law may encourage hedge funds and private equity groups to do more business with public pension funds -- a good thing -- we are troubled by the fact that the cost of this new business is the watering down of the fiduciary relationship.    

Pension Bill Becomes Law

On August 17, 2006, President Bush signed the Pension Protection Act of 2006, requiring companies to fully fund their defined-benefit pension plans within seven years.  A critical provision in the new law permits companies to automatically enroll their workers in 401(k) programs.  While this will undoubtedly lead to increased use of the 401(k) investment vehicle, it is also likely to incentivize companies to terminate their traditional pension plans, particularly those that are already underfunded.  Moreover, insofar as the new law represents a move away from more traditional pension plans, it is likely to benefit high-income employees much more than low or middle income workers.  This issue is discussed in an interesting article from cnnmoney.com.

Click here for key sections of the law.