Cypen & Cypen
JUNE 7, 2007
Stephen H. Cypen, Esq., Editor
A committee of the Stanford Institutional Investors’ Forum at Stanford Law School has announced new standards designed to improve fund governance and curb abuse of fund assets. The Clapman Report (named for committee chairman, the legendary Peter Clapman), a set of best practice principles for managing pension, endowment and charitable funds, calls for institutional investors -- who today are the central repository of capital in the United States -- to adopt basic policies aimed at improving how they govern. According to the announcement, among the Clapman Report recommendations are that funds should: (1) clearly define and make publicly available their governance rules; (2) mandate tough and transparent policies to address conflicts of interest; (3) take steps to ensure funds have trustees who are competent in financial and accounting matters; (4) establish clear reporting authority between trustees and staff; and (5) define appropriate responsibilities and delegation of duties among fund trustees, staff and outside consultants. The committee members conclude that institutional investors serve an important purpose in the nation’s economy. The significant pools of wealth controlled by institutional investors provide for an effective means of financing retirement, education, charities and other important economic objectives. They do so while providing investment capital to fuel our marketplace and create the innovation and technology that produce jobs now and for the future. In their best form, institutional investors can contribute to a dynamic cycle of beneficial economic activity that enriches both the national and global economies. The committee recognizes that the vast majority of fund professionals and trustees are intelligent, dedicated, hardworking, honest individuals who strive to fulfill their fiduciary obligations to fund beneficiaries. The committee also recognizes that it is impossible to describe a universally effective governance process, and that no governance process can provide for an absolute defense against the misuse of fund assets by unscrupulous trustees, investment managers or advisors. Years ago, few observers anticipated the immense influence that institutional investors would come to assert on the corporate and political spheres. With this influence comes increased responsibility, and the governing bodies of these institutional investors must evolve the skill mix necessary firmly to protect funds against the disquieting prospects of influence peddling, fraudulent investment reporting, corruption, unaccountability and potentially massive transfers of wealth from the beneficiary owners to favored service providers, money managers, and consultants. We cannot forget that in the last few years every kind of institution in American society, from government, to industry, to the church, has experienced unexpected scandals. The lesson in each instance is that every institution is vulnerable to unethical conduct. The best defense against those who would misuse the trust of others is to ensure the institution has transparent governance, where the individuals in charge are accountable to the beneficial owners through established procedures that strengthen the fiduciary relationship between trustee and beneficiary. The report is the committee’s attempt at defining a minimum set of best practice principles and standards to help funds ensure that their trustees have the skills and oversight mechanisms necessary to protect their funds and to manage fund assets appropriately in the best interests of fund beneficiaries. Committee members look forward to comments and contributions of their colleagues, who they hope will join them in their endeavor. The entire 31-page report, http://www.law.stanford.edu/clapmanreport, is a must-read for trustees.
The Governmental Accounting Standards Board has issued Statement No. 50, Pension Disclosure, which more closely aligns current pension disclosure requirements for governments with those that governments are beginning to implement for retiree health insurance and other post-employment benefits. Specifically, Statement 50 amends GASB Statements No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and No. 27, Accounting for Pensions by State and Local Governmental Employers, by requiring:
GASB's standards for retiree health insurance and other non-pension retirement benefits make disclosures more informative and understandable. This new Statement extends those advancements to reporting of pension benefits. After issuing Statement 50, GASB will continue a broader research project to determine whether existing accounting standards for government pensions have been effective. Based upon constituent feedback received during that research, the Board will determine at a future date whether further changes to the current pension standards are necessary. The provisions of Statement 50 generally are effective for periods beginning after June 15, 2007, with early implementation encouraged. Requirements relating to governments using aggregate actuarial cost method are effective for financial statements and required supplementary information that contains information from actuarial valuations as of June 15, 2007, or later. For your information, GASB is the independent, not-for-profit organization formed in 1984 that establishes and improves financial accounting and reporting standards for state and local governments.
A large percentage of U.S. investors would fall for a guaranteed return investment scam, according to a poll by “Money-Trap,” a public television series, and Investor Protection Trust, an investor education group. The poll surveyed investors on eight basic investing principles, including performing a background check on financial professionals and knowing the definition of diversification. Of the over 1200 people surveyed, just 1% understood all the basic principles. Given investment swindle scenarios, such as the opportunity to invest in an options-trading system with guaranteed returns of at least 100%, 43% of investors said they would take the bait. According to the survey, some 66% of respondents would meet with a financial professional without first doing a background check with the Securities and Exchange Commission or NASD. Many investors still need help preparing for retirement. Two in five investors said they expected Social Security to make up a major part of their retirement income, while half said they hadn’t created a financial plan. Apparently, P.T. Barnum knew whereof he spoke.
Internal Revenue Service has alerted taxpayers to the latest versions of an e-mail scam intended to fool people into believing they are under investigation by the agency’s Criminal Investigation Division. The e-mail purporting to be from IRS Criminal Investigation Division falsely states that the person is under a criminal probe for submitting a false tax return to the California Franchise Board. The e-mail seeks to entice people to click on a link or open an attachment to learn more information about the complaint against them. IRS warns people that the e-mail link and attachment is a Trojan Horse that can take over the person’s computer hard drive and allow someone to have remote access to the computer. IRS urged people not to click the link in the e-mail or open the attachment. Similar e-mail variations suggest a customer has filed a complaint against a company and IRS can act as an arbitrator. The latest versions appear aimed at business taxpayers as well as individual taxpayers. IRS does not send out unsolicited e-mails or ask for detailed personal financial information. Additionally, IRS never asks people for PIN numbers, passwords or other similar secret access information for their credit, bank or other financial accounts. Other fraudulent e-mail scams try to entice taxpayers to click their way to a fake IRS website and ask for bank account numbers. Another widespread e-mail tells taxpayers IRS is holding a refund (often $63.80) for them and seeks financial accounting information. Still another e-mail claims IRS’s anti-fraud commission is investigating their tax returns. Don’t be fooled. IR-2007-109 (May 31, 2007).
Morningstar, Inc. has announced that it is considering formation of a pension, endowment and foundation database. Initially working with the National Conference on Public Employee Retirement Systems, Morningstar is now asking representatives from the broader pension plan, endowment and foundation community to fill out an online form to indicate their willingness and ability to provide performance, expense and portfolio holdings data on a monthly basis. There will be no cost to participate in the voluntary database, and participants will receive periodic analysis reports comparing their performance to their peers within a geographic region or nationwide. Morningstar and NCPERS recently completed a preliminary analysis of NCPERS’ member plans. Initial results showed strong risk-adjusted plan performance comparable to mutual funds. On a dollar-weighted basis, which accounts for all cash inflows and outflows from purchases and sales and growth in fund assets, participating NCPERS member plans outperformed mutual funds over several time periods. This result is likely due to differences in asset allocation, manager selection, and market timing -- individual investors frequently buy and sell funds at the wrong time, whereas public plans tend to have more stable cash flows and take a longer-term, buy-and-hold approach to investing. A pension, endowment and foundation database would provide valuable information to administrators, managers, trustees, consultants, plan participants, annuitants, taxpayers, shareholders and donors. Public plans impact everyone, not just trustees, managers and participants. The strong preliminary results were very encouraging to NCPERS, which hopes the public plan community will recognize value in a comprehensive, national pension, endowment and foundation database. Pension, endowment and foundation representatives can indicate their interest in participating in the database by going to http://corporate.morningstar.com/MStarPEFDatabase, by June 29, 2007. Morningstar will then engage the plans, foundations and investment consultants and conclude whether the database is viable. Why not go for it?
The Executive Board of the Airline Pilots Association, International, has voted by an overwhelming 80% margin to end the union’s longstanding support for the FAA age 60 mandatory retirement age for airline pilots. In face of concerted efforts to change the rule in Congress and the FAA (see C&C Newsletter for February 8, 2007, Item 4; see C&C Newsletter for January 11, 2007, Item 1; C&C Newsletter for December 21, 2006, Item 1; C&C Newsletter for December 7, 2006, Item 2 and C&C Newsletter for October 19, 2006, Item 2), the ALPA Executive Board directed that union resources be committed to protecting pilot interests by exerting ALPA’s influence in any rule change. ALPA pilots want to be fully engaged in shaping any rule change. Any legislative or regulatory change needs to address ALPA’s priorities in the areas of safety, medical standards, benefit issues, no retroactive application of change, liability protection and appropriate rule implementation. Founded in 1931, ALPA represents 60,000 pilots at 40 airlines in the United States and Canada.
Becerra’s personal representative brought an action against firefighters, paramedics and emergency medical technicians employed by Nashville, Tennessee. A federal trial judge denied their motion to dismiss the § 1983 complaint on the basis of “qualified immunity.” The personal representative, Becerra’s grandmother, alleged that defendants violated Becerra’s Fourth Amendment rights in the course of administering requested medical aid during an ongoing epileptic seizure. Specifically, she claimed that defendants, who were answering a 911 call, used excessive force in restraining Becerra and refused him appropriate medical attention when he was in an unconscious epileptic state, resulting in his death. On appeal, the court reversed, finding no case authority holding that paramedics answering a 911 emergency request for help engaged in a Fourth Amendment “seizure” of the person when restraining him while trying to render aid. Hence, there is no “clearly established law” creating federal liability for a constitutional tort under the circumstances. The appellate court analyzed the claim of qualified immunity using a three-prong test:
Here, the personal representative/plaintiff’s case failed under all three prongs. Peete v. Metropolitan Government of Nashville, Case No. 06-5321 (U.S. 6th Cir., May 22, 2007).
Defined contribution plan executives are beefing up disclosure on plan fees to participants, well ahead of regulatory guidance expected by year end, says pionline.com. Companies are taking steps to enhance disclosure on fees, prompted by last year’s enactment of the Pension Protection Act, which sets new disclosure and funding requirements for private plans. The Department of Labor is expected to issue guidance clarifying fee disclosure requirements later this year. Some public defined contribution officials are also boosting disclosure, even though they are not governed by PPA. For example, the New York State Deferred Compensation Plan has made plan fee disclosure changes in light of the upcoming guidance. Debate over proper fee disclosure has stepped up in recent months. A Congressional hearing resulted in calls for greater fee disclosure, while the Department of Labor said it will issue guidance later this year, and the Securities and Exchange Commission said it will seek to require improved disclosure by mutual funds. In addition, recent lawsuits against major employers allege that current fee disclosure is inadequate and that participants lack sufficient information to make appropriate investment decisions. The biggest challenge is two major costs: investment cost and administrative cost. Almost all plans these days are in a bundled or quasi-bundled arrangement, and these two expenses are intertwined. Bundled plans do not break out record-keeping and administrative costs, which could look cheaper to participants.
The Chicago Tribune reports that a judge has sided with state retirement officials, ruling that convicted former Governor George Ryan is not entitled to a $60,000-a-year pension that he “earned” early in his political career, allegedly before any corruption occurred (see C&C Newsletter for November 22, 2006, Item 3 and C&C Newsletter for December 7, 2006, Item 5). The court rejected arguments from Ryan’s attorneys that he should lose only the portion of his pension from his terms as Secretary of State and Governor, the offices involved in his corruption conviction. They contended he should be allowed to keep his benefits from when he earlier served (scandal-free) as a county official, state representative and lieutenant governor. State retirement officials argued that since Ryan’s corruption occurred while he was a state employee, he must give up the pension from all of his state jobs. They also stressed that allowing Ryan to keep even a portion of his pension would undermine laws put into place to discourage malfeasance by public officials. Ryan’s attorneys said they would appeal.
The Securities and Exchange Commission has begun an inquiry into New Jersey’s handling of its pension fund for public employees (see C&C Newsletter for April 5, 2007, Item 2 and C&C Newsletter for April 12, 2007, Item 8), suggesting that federal regulators are concerned that the state did not properly disclose its contributions to the fund. The inquiry was reported by the New York Times, and follows an earlier report in the same newspaper about accounting maneuvers that made it look as if New Jersey was putting more cash into the pension fund than it actually did, over a period of many years. Some offering statements for New Jersey’s bonds, for example, incorrectly described money spent on health insurance as pension contributions. SEC has authority to ensure the state makes full and correct financial disclosures to municipal bond markets. The United States Attorney’s Office is also involved, perhaps probing whether any officials were improperly rewarded in connection with pension transactions. The Internal Revenue Service also has jurisdiction over certain parts of federal pension law. IRS officials would not comment on the New Jersey situation or on any other government that operates a pension fund. State officials have previously acknowledged that the pension fund has a serious deficit of billions of dollars, and needs big contributions that will require cuts in other programs, higher taxes or another source. But dealing with the thorny accounting questions to satisfaction of regulators could take years and even require more contributions than officials now anticipate. It could also affect New Jersey’s creditworthiness. With reported assets of about $80 Billion, New Jersey’s fund is the nation’s ninth-largest public fund.
If you’ve ever thought about working for the State of Pennsylvania, now is a good time to apply. The state is expecting a surge in retirements before July 1, when new contracts take effect for most state workers, reports the Pittsburgh Post-Gazette. Almost 6,000 people are expected to retire this year, up from about 3,500 last year. That number represents about 6% of the state workforce, which includes social workers, troopers, secretaries, liquor store clerks, park rangers, corrections officers, attorneys and more. In recent years, retirement rates have typically increased after labor negotiations, because each new contract typically offers decreased health benefits. In 2003, the last time contracts were negotiated, for the first time state workers had to contribute toward their health care premiums. The rate, 1% of salary, will gradually increase under the new contract until it reaches 3% of salary in 2010. In the past, retirees have kept the health-care contribution rates in effect at the time of retirement, but the state has not guaranteed that practice will continue. Last year, benefits cost an average of $19,000 per employee, up from $18,000 the year before. Five years ago, the average was $13,000.
Throughout most of the past half-century, the private-sector defined benefit pension market has been characterized by the measured, orderly and -- with all but a handful of exceptions -- virtually homogeneous investment strategies of plan sponsors. Indeed, despite stark differences along such key dimensions as workforce demographics, pension funding ratios and credit ratings, the corporations controlling some $2.3 Trillion in Defined Benefit assets have nonetheless pursued astonishingly similar asset allocations, with long-only equities laying claim to almost two-thirds of the typical portfolio. For the financial firms serving this market, primarily asset managers, the result has been a long, enviable track record of rock-solid earnings performance. But for many players, that smooth ride is about to turn into a roller coaster: a huge redistribution of profits within the private-sector DB industry is now in the making, thanks to a rare intersection of accounting, regulatory and market forces that is spurring plan sponsors to overhaul their pension strategies. The addiction to equity is fast giving way to a new emphasis on risk management, rendering up for grabs, in the process, the majority of industry assets. And taking direct aim at those assets in this new risk-focused world are insurance companies, investment banks and alternatives players. The good news is that for firms across all channels, future revenue and profit opportunities will exceed current levels. But only those players willing to transform their product and delivery models to meet the new demands of plan sponsors will succeed in capitalizing on this opportunity. One thing is clear: this will be a zero-sum game. In a market where asset growth is almost non-existent, the gains accruing to the winners will come at the direct -- and probably permanent -- expense of those who fail to adapt their business models over the next three to five years. In essence, the cost of getting it wrong has reached a historic industry high. What's behind these assertions? McKinsey & Company has made an extensive research commitment to identifying the critical factors for long-term success in the private-sector DB market. McKinsey recently conducted in-depth interviews with plan sponsors that collectively hold about $1 Trillion in DB assets, to get a comprehensive picture of their key concerns and objectives. That research points to conclusions in four key areas:
A number of people profiled in Kiplinger’s Personal Finance made their millions as entrepreneurs. But working for the Man does not mean you have to be a wage slave or resort to buying lottery tickets to strike it rich. The trick is to maximize your income on the job (and know when to move on), make the most of your employee benefits/tax breaks and use that extra money to start investing. Here are 12 basics:
Words to the wise.
A high school employee is charged with spending and investing much of $2.6 Million accidently paid to her by the State of Minnesota. According to StarTribune.com, a single typographical error erroneously sent a $2.6 Million state check to a high school employee, who is charged with four felonies for allegedly spending much of the money on luxury cars, a U.S. treasury bond and an individual retirement account. The check was intended for a hospital, one of 17 receiving payment at the time, but a single digit was typed wrong in the vendor number and the check went to the teacher. The state learned of the check when the teacher called a financial operations employee six weeks after cashing the check, and asked why it was sent to her. The employee called her back, told her she had received the check in error and directed her to return it immediately. The teacher refused, and told the employee her lawyer would be calling the state. She then hung up. (The teacher only had a state vendor number because she had been paid $84.00 as a witness in a case.) The teacher had been working on her master’s degree, and earns $35,000 a year. Hey, it beats the lottery.
PlanSponsor.com reports on an off-duty police officer, who was awakened in his bed by a backyard motion sensor light. Alerted, he found a rear door open that he had locked earlier, and then spotted someone moving in his basement bathroom. He fired once, wounding his 18 year old daughter, who had snuck out of the house earlier that evening for a rendezvous with her boyfriend after her father thought she was in bed. No report on the daughter’s condition -- or, for that matter, the father’s.
“There’s nothing wrong with teenagers that reasoning with them won’t aggravate.” Anonymous
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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.