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Cypen & Cypen
NEWSLETTER
for
FEBRUARY 18, 2004

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001

1. RETIREES SUE CITY OVER HEALTH CARE:
IAccording to the Akron Beacon Journal, the city’s police and firefighter retirees have filed suit, claiming the city has backed out on the promise of free, lifetime health care. The suit, which requests certification as a class action, seeks an order that the city begin paying the retirees’ health care premiums and reimbursement thereof for the last ten years. Apparently, the City of Akron did pass an ordinance in 1963 that promises lifelong health care for retiring police officers, firefighters and their families. Instead, retirees are being forced to pay monthly premiums as high as $500.00. Of course, the city disagrees with the retirees’ position. Stay tuned.

2. PLANSPONSOR.COM STARTS SERIES ON “MISBEHAVING IN PUBLIC”:
Plansponsor.com has begun the first of a two-part series. Public pension funds have been a “target-rich” environment for unscrupulous individuals. Will greater public scrutiny be enough to stop cronyism? The article recounts the cases of Connecticut State Treasurer (and sole fiduciary) Paul Silvester, who had demanded and received kickbacks from private equity firms doing business with the state fund and of Miriam Santos, Chicago City Treasurer, who was convicted of extortion and fraud in connection with solicitation of campaign contributions from firms doing business with the city. The Santos and Silvester cases prompted the SEC to study pay-to-play practices in 17 states. As a result, the SEC drafted a stringent new rule that would have barred investment managers from receiving any compensation from managing money for two years after the firm made a campaign contribution to an elected official or candidate who could have influenced the money manager’s selection. Not unexpectedly, the SEC received many negative comments both from officials of large public funds and from investment firms. And after SEC Chairman Arthur Leavitt left office, the momentum for a rule evaporated. Then there is the example of Nathan Chapman, an investment manager who ran money for the state retirement and pension systems in Maryland. Chapman allowed one of his submanagers to buy stock in Chapman’s own company, resulting in a $4 Million loss to the state pension fund. At the same time Chapman was indicted for the illegal investments, a trustee was indicted for failing to reveal to a grand jury that Chapman had given her $46,000.00 in money and gifts while they were personally involved. Pay-to-play posts a threat to the investment process, because it opens up the possibility that the most qualified advisor may not be selected, leading to inferior management, diminished returns or even losses. The pension plan may pay higher fees because advisors must recoup the cost of contributions or because contract negotiations may not occur at arms’-length. Pay-to-play also may mean that board members are not always inclined to do the right thing when a manager is underperforming.

3. A CALL TO ACTION FOR THE SEC:
Speaking of pay-to-play, in its February 2004 Current Alert the Benchmark Companies calls upon the SEC to scrutinize pension consultants. The commentary recognizes that the economics of pension consulting will be radically altered by the elimination of pay-to-play practices. Stated, disclosed fees will rise, as kick-back schemes are exposed and pension plans will benefit as consultant objectivity is enhanced. Today, pension consulting fees are artificially low, as a result of the willingness of consultants subject to conflicts of interest to offer their services for free or without a stated fee, in exchange for the opportunity to serve as “gatekeeper” to a fund. Fees derived from advising plan sponsors are inconsequential -- the exponentially greater surreptitious compensation available to unscrupulous firms is the prize. The SEC’s Office of Compliance and Inspections has recently asked some of the leading consulting firms to provide information about the consulting services they offer and the revenues related to those services. The goal is to identify and quantify conflicts of interest that may be harmful to pension plans. If the SEC’s inquiry into pension consulting pay-to-play schemes results in meaningful disclosure of conflicts of interest, quantification of conflicting sources of revenue and a demand by pension plans to end such abuses, then firms may be forced honestly to price the consulting services they provide. Why should pension plans care that consultants earn millions in secret compensation from managers, if that results in pensions paying lower stated consulting fees? The answer is because the cost of a corrupt consultant ultimately is borne by the plan and can be enormous -- far greater than even the undisclosed compensation earned by the consultant. The consultant keeps the kick-backs paid by the manager for allowing the manager to handle pension assets but the fund takes all the risk. When managers are selected, not on the merits but based upon pay-to-play, underperformance ensues and it is the fund that suffers. The SEC’s current inquiry into pension consulting should be a call to action to all pension plans. The SEC is really saying that it has serious concerns about consulting conflicts and resulting harm to funds. Pension plans, the potential victims, should be asking for the very same information their consultants have been asked to provide to the SEC.

4. PENSION ASSET/LIABILITY GAP WIDENS:
According to a short piece from plansponsor.com, pension plans’ assets had a somewhat impressive 1.42% gain in January. However, a 2.14% liability increase lead to a -.72% asset/liability gap. Further data from Ryan Labs indicate that 2003 ended up significantly positive, with a 20.04% asset growth compared to a mere 1.96% liability increase. The gap numbers are -30.89% for 2002 and -8.48% for 2001. Cumulative asset/liability data since December 1999 show a -46.95%, suggesting that most pension funds will have funding ratios below 70%. Ryan’s data are based on roughly $200 Billion in assets tracked by its Custom Liability Index System.

5. NCPERS WEIGHS IN AGAINST THE PRESIDENT’S RETIREMENT PROPOSALS:
The Administration’s retirement savings proposals -- including Lifetime Savings Accounts (LSAs), Retirement Savings Accounts (RSAs) and Employer Retirement Savings Accounts (ERSAs) -- would hurt public employee retirement systems and a long history of providing guaranteed benefits to retirees with unique needs and characteristics, so says NCPERS. Concluding that nothing in the Administration’s proposal will increase savings for retirement, NCPERS found that the net effect of LSAs would be to siphon off the limited amount of available money that would otherwise go toward retirement savings. The Administration’s retirement proposals would cause confusion, discourage savings and ultimately undermine financially sound government pension plans. Public pension plans are created by constitutional and statutory law, and are managed by qualified trustees with fiduciary responsibilities. Prudent, long-term investments have produced returns where 75% of lifetime pension benefits come from plan investments ($1.7 Trillion over the past twenty years!), with remainder from individual and employer contributions. Due to their size, government pension funds negotiate lower fees and take advantage of economies of scale. Unlike individual investors, public plans have the ability to wield purchasing power to obtain lower fees and distribute the cost over a large number of participants. More than 97% of public employees are covered under government pension plans. Most employees have a defined benefit plan that provides guaranteed benefits, disability and survivor benefits, with a defined contribution add-on to enable these employees to save more toward their retirement. Employee participation in the private sector is far less.

6. PARDONED FELON WHO RECEIVED REFUND OF PENSION CONTRIBUTIONS NOT ENTITLED TO BENEFITS:
Yasak was convicted of a federal felony. His request for pension benefits was denied based upon the Illinois Forfeiture Statute. Yasak then applied for and received a refund of his pension contributions. Many years later Yasak received a full and unconditional pardon from then-President Clinton. Yasak thereupon asked the pension board to restore his pension benefits (prospectively and retroactively), offering to repay the amount necessary for reinstatement. Upon denial by the board, Yasak sought a declaratory judgment in federal court. The U.S. District judge agreed that the pension board had no duty to reinstate benefits, and dismissed the case. On appeal, the U.S. Circuit Court of Appeals affirmed. Although there was a lengthy discussion on the nature of a pardon -- an act of grace by which an offender is released from the consequences of his offense -- the court’s affirmance came down to the simple fact that Yasak voluntarily applied for and accepted a refund of his contributions. Despite Yasak’s claim to the contrary, the board did not force him to accept a refund of his pension contributions. Yasak himself filled out an application and requested a refund. According to Illinois law, a policeman who withdraws the amount credited to him surrenders and forfeits all rights to any annuity or other benefit from the fund, for himself and for any other person or persons who might otherwise have benefitted through him. Rather than claiming his refund, Yasak could have waited out the pardon process and thus retained his property interest. No law required him to seek a refund within a certain time frame. The dissent makes a cogent argument that the pension board exacted a penalty because Yasak was a convicted felon. Now that this status had been removed by order of the President, the dissenter felt that there was no basis for the board to render ineffective the Presidential Order by continuing to exact the penalty for commission of the pardoned crime. Yasak v. Retirement Board of Policemen’s Annuity and Benefit Fund of Chicago, Case No. 03-1733 (U.S. 7th Cir., February 4, 2004).


7. THE LATEST ON DROPS:
The February 2004 Public Sector Letter from The Segal Company focuses on the most current DROP designs. Entitled “DROP Update: The Latest Variations on a Popular Theme,” the piece first gives an overview of traditional deferred retirement option plans. Then, the letter turns to the latest innovations in DROP design, including

Immediate DROP or partial lump-sum option payouts (PLOP) -- no prior election to participate is necessary; at time of retirement, participant may choose a percentage reduction in his monthly benefit amount and a partial lump-sum amount.

Retroactive DROP (Back DROP) -- similar to a PLOP, in that the employee continues working and is not required to elect DROP until actual retirement; however, unlike PLOP, lump sum is an accumulation of monthly benefits that would have been paid and not the actuarial equivalent thereof.

DROP with optional features -- for example, a decreasing DROP period; a reduction in DROP participation for every year worked beyond eligibility for DROP (in our experience, quite prevalent in Florida).

The analysis also discusses advantages/disadvantages for employers (to influence employee behavior/adverse selection) and employees (flexibility/less valuable benefit). Finally, Segal treats the following policy issues:

Would a DROP support benefit and workforce objectives?

Would a DROP be consistent with or contradictory to other benefit programs?

How will the plan monitor future amendments and their impact on the DROP?

What retirement benefits are realistic?

All in all, a terrific primer on deferred retirement option plans. Thanks, Rocky.

.

8. WE HAVE A DEFINITION OF CASH BALANCE PLAN:
Plansponsor.com has reported on the Financial Accounting Standards Board’s adoption of a new definition of cash-balance pension plan. After formal review of rules pertaining to such plans, FASB concludes that a cash-balance pension plan is a defined-benefit pension plan that defines the promised employee benefit by reference to a notional account balance. An employee’s notional account balance is increased with periodic notional principal credits and notional fixed or variable interest or investment credits, and may be increased for other notional ad hoc credits. Despite IRS’s decision in 1999 to stop approving new cash-balance plans and a court ruling that IBM’s discriminated against older workers, companies continue to adopt cash-balance plans.

9. IT MAY HAVE BEEN ONLY A TWO-DOG NIGHT:
The following piece is from Court TV. Do dogs make good drinking pals? Well, Glenda Jane Davis and her cocker spaniel were both nabbed for public intoxication after she apparently shared some hooch with her pooch. The police department received a call from a downtown restaurant about a woman with a small dog. The woman appeared to be intoxicated and was cursing. She left the restaurant with the dog, but was nabbed by police nearby. She was arrested, while her dog was taken to a local animal shelter. Upon arrival at the shelter, the cocker reportedly was wobbly and had bloodshot eyes. And as with humans, the dog was given an aspirin, quickly pepped up and became friendly again. The woman pleaded guilty to public intoxication. The dog pleaded not guilty, and is attempting to negotiate an acceptable flea bargain -- just kidding.

Copyright, 1996-2004, all rights reserved.

Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.


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