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Cypen & Cypen
JUNE 16, 2005

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


On June 9, 2005, Social Security’s Director of Education, Workforce and Income Security testified before the House Ways and Means Committee’s Subcommittee on Social Security about a GAO study on coverage of public employees and implications for reform. Social Security covers about 96% of all U.S. workers. The vast majority of the rest are state, local and federal government employees. While these noncovered workers do not pay Social Security taxes on their government earnings, they may still be eligible for Social Security benefits. This situation poses difficult issues of fairness, and Social Security has provisions that attempt to address those issues, but critics contend these provisions are themselves often unfair. The subcommittee asked GAO to discuss Social Security’s effects on public employees as well as the implications of reform proposals. Social Security’s provisions regarding public employees are rooted in the fact that about one-fourth of them do not pay Social Security taxes on the earnings from their governmental jobs. Even though noncovered employees may have many years of earnings on which they do not pay Social Security taxes, they can still be eligible for Social Security benefits based on their spouses’ or their own earnings in covered employment. To address the issues that arise with noncovered public employees, Social Security has two provisions -- the Government Pension Offset (GPO), which affects spouse and survivor benefits, and the Windfall Elimination Provision (WEP), which affects retired worker benefits. Both provisions reduce Social Security benefits for those who receive noncovered pension benefits. However, because complete and accurate information on receipt of such noncovered pension benefits is not available from many state and local pension plans, the GPO and the WEP are not applied consistently. In recent years, various Social Security reform proposals that would affect public employees have been offered. Some proposals specifically address the GPO and the WEP and would either revise or eliminate them. Such actions, while they may reduce confusion among affected workers. would increase the long-range Social Security trust fund deficit and could create fairness issues for workers who have contributed to Social Security throughout their working lifetimes. Other proposals would make coverage mandatory for all state and local government employees. According to Social Security actuaries, mandatory coverage would reduce the 75-year actuarial deficit by 11%. It could also enhance inflation protection, pension portability and dependent benefits for the affected beneficiaries, in many cases. However, to maintain the same level of spending for retirement, mandating coverage would increase costs for the state and local government that sponsors the plans, and would likely reduce some pension benefits. Moreover, the GPO and the WEP would still be needed for many years to come even though they would become obsolete in the long run. So what reform does GAO recommend? It recommends giving the Internal Revenue Service authority to collect the information that Social Security Administration needs on government pension income, which could perhaps be accomplished through a simple modification to a single form! So, rather than support repeal of the GPO and the WEP -- as we do -- GAO merely wants Social Security to get “better information” to implement these reductions from Social Security benefits. Hard to believe. Read the testimony in its entirety at www.gao/gov/cgi-bin/getrpt?GAO-05-786T.


And speaking of mandatory coverage, Alicia H. Munnell, Director of the Center for Research at Boston College, has authored a paper entitled “Mandatory Social Security Coverage of State and Local Workers: A Perennial Hot Button.” Ms. Munnell is well-known for her views supporting such mandatory coverage (see C&C Newsletters for November, 2000, Item 11, January, 2001, Item 8 and January, 2002, Item 2). By way of background, the Social Security Act of 1935 excluded state and local workers from mandatory coverage due to constitutional concerns about whether the federal government could impose taxes on state governments. As Congress expanded coverage to new groups of private sector workers, it also passed legislation in the 1950s that allowed states to elect voluntary coverage for their employees. The question of mandatory, as opposed to voluntary, coverage for government workers surfaced in the 1960s and 1970s. In response to increasing interest in such a change, 1977 amendments to the Social Security Act required a study of the desirability and feasability of covering all public employees. After that study, Congress extended mandatory coverage to new federal employees in 1983 and to state and local workers who had no other pension plan in 1990. Since then, several groups have proposed extending Social Security coverage to all state and local workers on the grounds that it is equitable, helps the system’s finances and also improves the insurance benefits of state and local workers. But uncovered state governments, local governments, unions and many workers strongly oppose being forced to participate in Social Security. They say it will impose a big financial burden on states and localities and that public employees will get little in return. About 30% of state and local workers -- five million or so -- still are not covered by Social Security. Three-fourths of uncovered workers reside in seven states: California, Colorado, Illinois, Louisiana, Massachusetts, Ohio and Texas. In California, Illinois and Texas uncovered state and local workers constitute, respectively, 49%, 62% and 55% of the total. In Colorado, Louisiana, Massachusetts and Ohio virtually no government workers are covered by Social Security. Simply put, the case for mandatory coverage rests on issues of equity and alleged better protection of state and local workers. (That is, mandatory coverage would better distribute the burden of paying for the system’s legacy debt and would improve benefits.) The case against mandatory coverage centers on the issue of higher costs for state and local governments: about 6% of payrolls. The author also makes passing reference to the Government Pension Offset established by Congress in 1977 and the Windfall Elimination Provision introduced in 1983, “to reduce the unfair advantage enjoyed by these double dippers and/or their spouses.” One other point that might be of interest to readers: the Center for Retirement Research, publisher of the piece, was established through a grant from the Social Security Administration! Hmmmmm.


Employer-sponsored defined benefit pension plans face unprecedented challenges in the midst of significant changes in the nation’s retirement landscape. Many defined benefit plans and the federal agency that insures them, Pension Benefit Guaranty Corporation, have accumulated large and growing deficits that threaten their survival. Meanwhile, the percentage of American workers covered by defined benefit plans has been declining for about 30 years, reflecting a movement toward defined contribution plans and perhaps fundamental changes in how are society thinks who should bear responsibility and risk for the retirement income security of American workers. Policymakers must address not only the challenges facing the defined benefit system and the PBGC, but also consider broader questions about overall retirement income policy. To address these issues, the United States Government and Accountability Office convened a diverse group of knowledgeable individuals who have been influential in shaping the defined benefit pensions debate over the years. Participants included government officials, researchers, accounting experts, actuaries, plan sponsors, employee group representatives and members of the investment community. There were varying levels of agreement on the following statements:

  • Current pension funding rules do not adequately ensure sound funding in plans that are at the greatest risk of termination, and the federal government needs to do more to hold employers accountable for the benefit promises they make.
  • Addressing deficiencies in the pension funding rules would be more effective and more important than reforming the PBGC premium structure, since policymakers should focus on getting employers to fulfill the promises they make to employees.
  • Greater pension funding flexibility could help maintain adequate pension funding and remove disincentives that have stopped plan sponsors from contributing more to their plans in the past.
  • Improvements should be made to the transparency and timeliness of pension plan financial information that is reported to plan participants and regulators.
  • Although the traditional defined benefit system has been in retreat for about 30 years, this trend might be halted if policymakers would clarify the legal ambiguities surrounding cash balance and other hybrid plans.
  • Rather than focusing on promoting certain types of pension plans, policymakers should identify and encourage those features of pension plans (both defined benefit and defined contribution) that are most likely to provide sufficient income security for American retirees.

Sometimes GAO comes up with good stuff.


The National Labor Relations Act, which does not apply to state and local government employers, protects individual union members, agents and representatives from civil liability, so long as their conduct and actions are within the purview of the collective bargaining agreement. Weiner, a terminated former employee of the Clark County School District, filed a state court malpractice action against his union and the attorney it had provided to represent him in his unsuccessful quest for reinstatement. The Supreme Court of Nevada affirmed a district court order granting summary judgment in favor of the attorney: state labor laws should be interpreted consistently with the NLRA, which bars legal malpractice claims against lawyers supplied by unions. When a union provides an attorney to represent a union member in a matter related to a collective bargaining agreement, that attorney is an agent of the union. As an agent of the union, the attorney is not susceptible to a malpractice claim; rather, a claim by the union member will lie only against the union itself based on a breach of the duty of fair representation. Weiner v. Beatty, Case No. 39605 (Nev., June 9, 2005).


No matter how hedge funds perform (off .7% through April, with further losses expected in May), hedge fund managers continue to earn big bucks. For the first time since Institutional Investor started its survey four years ago, somebody has cracked the $1 Billion mark: Edward Lampert, of ESL Investments, at $1.02 Billion. The following is a list of the top ten earners in the hedge fund industry for 2004:

1. Edward Lampert, ESL Investments, $1.02 Billion
2. James Simons, Renaissance Technologies Corp., $670 Million
3. Bruce Kovner, Caxton Associates, $550 Million
4. Steven Cohen, SAC Capital Advisors, $450 Million
5. David Tepper, Appaloosa Management, $420 Million
6. George Soros, Soros Fund Management, $305 Million
7. Paul Tudor Jones II, Tudor Investment Corp., $300 Million
8. Kenneth Griffin, Citadel Investment Group, $240 Million
9. Raymond Dalio, Bridgewater Associates, $225 Million
10. Israel Englander, Millennium Partners, $205 Million

In all, the top twenty-five hedge managers reaped an average of $251 Million from fees and from gains on their investments in their funds. By comparison, the CEO of a typical top-500 U.S. corporation made $10 Million last year. Sophisticated investors who know how hedge fund managers’ fees are calculated will understand why payoffs are so large.


The number of millionaires in the United States increased by almost 10% last year as the stock market rallied, according to Bloomberg News. Incredibly, almost one in every 110 Americans has more than $1 Million worth of stocks, bonds and other financial assets. According to Forbes, half of the world’s ten richest billionaires are from the United States. The biggest change was in real estate as the percentage of assets, falling to 13% from 17%. The percentage edged up in fixed income, reaching 27% from 25%, while equities slipped to 34% from 35%. In the United States, the number of millionaires last year increased to 2.5 million people -- out of a population of about 291 million. The figures, which do not include value of personal homes, apparently do not take into account liabilities.


The California Public Employees’ Retirement System’s Board of Administration on June 13, 2005 adopted a new conflict of interest policy and internal protocols to assure CalPERS investment advice is fair and unbiased. The policy requires current consultants to identify any future circumstances that may create actual, potential or perceived conflict of interests prior to providing advice on a specific subject or investment, including a recommendation on a money manager. Consultants seeking to do business with CalPERS would also be required to disclose conflicts, as part of the bidding process. Under CalPERS policy, a “conflict” exists when a consultant knows or has reason to know that he or she, his or her spouse or a close relative, domestic partner or other significant personal or business relationship, has a financial or other interest that is likely to bias the consultant’s advice to CalPERS. Some examples of potential conflicts that would have to be reported include instances when the consultant recommends its own proprietary products and services, enters into a business arrangement that is competitive with CalPERS interest or has a financial relationship with a placement agent who has an investment opportunity under consideration by CalPERS. The policy further directs CalPERS staff to follow specific protocol to determine whether an actual conflict exists, whether it could give rise to a future conflict and how such conflict could be properly managed to prevent it from resulting in an actual conflict in the future. The new policy also places some proactive responsibilities on pension staff, including reviewing with each consultant annually all of its disclosable interests to discuss any potential ongoing or cumulative effect such an interest could present. In addition, staff would be required to provide annually, or more frequently if needed, a summary of the types of disclosable interests and actions taken by staff in response to the such interests. The adoption of CalPERS policy is timely following a May 16, 2005 SEC staff report that found conflicts of interest among a majority of 24 pension consultants examined (see C&C Newsletter for May 19, 2005, Item 1). We strongly urge all trustees, administrators and other interested persons to download the policy at, and consider adoption of it or something similar.


Russell Investment Group has posted its preliminary list of companies that will join or leave the broad-market Russell 3000 Index when Russell’s family of U.S. Equity Indexes is constituted June 24. There are 208 companies that will be added to the Russell 3000 -- fewer than last year’s 323 companies and far less than a 10-year average of 455. Russell’s index reconstitution process is followed closely by many investors because the Russell indexes currently have $2.5 Trillion in assets benchmarked to them. Among the 12 sectors that compose the broad-market Russell 3000, the weighting of each will remain relatively constant after the Index is reconstituted. (The weighting of financial services-related stocks, for example, is expected to increase from 22% to 22.1%.) The total market value of the Russell 3000 will likely increase to $14.3 Trillion in total capitalization, indicating the broad market rose by $1 Trillion from last year. Stocks ranking smaller than the largest 3,000 U.S.-based firms will settle into the new Russell Microcap Index. Only 24 companies will move completely out of Russell’s index universe. The Russell 3000 represents approximately 98% of the U.S. stock market and a vast majority of traded securities. The largest 1,000 companies in the ranking make up the large-cap Russell 1000, while the remaining 2,000 companies become the small-cap Russell 2000.


On June 10, 2005, National Association of State Retirement Administrators, National Conference on Public Employee Retirement Systems and National Council on Teacher Retirement made its submission to the President’s Advisory Panel on Federal Tax Reform. The President has charged that panel to evaluate options that “promote long-term economic growth and job creation, and better encourage work effort, saving, and investment, so as to strengthen the competitiveness of the United States in the global marketplace.” First, by way of background, over 14 million workers -- 10% of the nation’s workforce -- and 6 million retirees or their beneficiaries are covered by state and local government retirement systems. Contrary to popular belief, the majority of pension revenue comes from investment earnings, not contributions from employers. In fact, for the 20-year period ended 2002, 62% of all pension fund revenue came from pension earnings! The balance was derived from employees (12%) and employers (25%). The submission deals with three overarching themes:

1. State and Local Government Retirement Plans are Economic Engines that Support and Fuel the Financial Marketplace. As a group, State and local government plans are in good financial condition, averaging nearly 90% funded. The over $2 Trillion in assets held in trust for public employees are not only a large part of the nation’s retirement assets, but represent an important source of liquidity and stability for financial markets. State and local retirement systems distribute over $120 Billion annually in pension and other benefits. When pension benefits are distributed, they provide a significant and continuous source of stimulus not only to local and state economies, but also to the nation’s economy as a whole.

2. State and Local Government Retirement Plans Encourage Work Effort That Assists Taxpayers in Recruiting and Retaining Trained, Experienced First Responders and Educators. Employees covered by State and local government retirement plans provide services that are essential to protecting and serving the public. Approximately one-half of all State and local government workers are teachers or otherwise employed in an education-related capacity. When combined with police officers, firefighters and correctional officers, these groups make up nearly two-thirds of all state and local government employees. States and localities must continue to have access to tools needed to recruit and retain qualified and trained personnel in these key areas.

3. State and Local Government Retirement Plans Promote Savings and Retirement Self-Sufficiency that Permit Retirees to Remain Participants in the Economy Rather than Relying on Public Assistance
. Ninety per cent of State and local government employees have a defined benefit plan as their primary retirement benefit. A key characteristic of DB plans is that they provide a pension benefit that is assured for life, protecting retirees from the risk of outliving their assets. The average annual benefit for a retired public employee participating in a DB plan is about $20,000, and most public pension plans provide some form of cost-of-living adjustment as a hedge against inflation. While fairly modest, this average benefit is enough to keep most retired public workers out of poverty, particularly when combined with the Social Security benefit that most retired public employees receive.

Under federal tax incentives, States and localities are permitted to establish and regulate retirement plans that meet their unique needs. This effective structure should be preserved. Most plans are overseen by independent boards of trustees who are responsible for making decisions solely in the interest of plan participants. Congress has worked over the years to refine the tax code to address the unique policy issues affecting State and local plans. Abandoning these longstanding and effective provisions in the name of tax simplification would be counterproductive, imposing immense burdens on State and local workers and their employers, and undercut successful State and local retirement policies. Similarly, any modifications to tax laws should strengthen, not weaken, retirement savings in State and local government retirement programs. (For example, the proposed repeal of pick-up arrangements under Section 414(h)(2) of the Internal Revenue Code would have the effect of imposing an immediate tax increase on first responders, teachers and other public employees around the country.) While tax simplification can produce great benefits, a one-size-fits-all approach may not address the needs of the public sector’s diverse workforce and legal framework, or have a positive effect on retirement savings. The bottom line with State and local retirement systems is that they work. Any recommended changes to the federal tax system should ensure these programs continue. Long-standing federal policy supporting employer-sponsored retirement plans, including those provided by State and local governments, should be preserved. Bravo!

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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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