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Cypen & Cypen
July 31, 2014

Stephen H. Cypen, Esq., Editor

1. NEW SEC RULES FOR MONEY MARKET FUNDS: The United States Securities and Exchange Commission is adopting amendments to the rules that govern money market mutual funds under the Investment Company Act of 1940. The 869-page amendments are designed to address money market funds’ susceptibility to heavy redemptions in times of stress, improve their ability to manage/mitigate potential contagion from such redemptions and increase transparency of their risks, while preserving, as much as possible, their benefits. SEC is removing the valuation exemption that permitted institutional non-government money market funds (whose investors historically have made the heaviest redemptions in times of stress) to maintain a stable net asset value per share and is requiring those funds to sell and redeem shares based on the current market-based value of the securities in their underlying portfolios rounded to the fourth decimal place (that is, $1.0000), transact at a “floating” NAV. SEC also is adopting amendments that will give boards of directors of money market funds new tools to stem heavy redemptions by giving them discretion to impose a liquidity fee if a fund’s weekly liquidity level falls below the required regulatory threshold, and giving them discretion to suspend redemptions temporarily (that is, to “gate” funds) under the same circumstances. The amendments will require all non-government money market funds to impose a liquidity fee if the fund’s weekly liquidity level falls below a stated threshold, unless the fund’s board determines that imposing such a fee is not in the best interests of the fund. In addition, SEC is adopting amendments designed to make money market funds more resilient by increasing diversification of their portfolios, enhancing their stress testing, and improving transparency by requiring money market funds to report additional information to SEC and to investors. Finally, the amendments require investment advisers to certain large unregistered liquidity funds, which can have many of the same economic features as money market funds, to provide additional information about those funds to SEC. The rules are effective 60 days after publication in the Federal Register. The compliance date for floating NAV and liquidity fees and gates amendments is two years after the effective date. Release No. 33-9616, IA-3879; IC-31166; FR-84; File No. S7-03-13.

2. MORNINGSTAR WARNS ABOUT NEW MONEY MARKET FUNDS RULES: As you just read (see item 1 above), The U.S. Securities and Exchange Commission has adopted new rules for money market funds. Now, Morningstar has sent out warning flags: inasmuch as SEC did not publish the new rules until after they were ratified, media coverage has been somewhat muddy. Several reports seem to suggest, as does SEC's press release itself, that the rules apply only to institutional funds. Not so fast -- the most notable modification, requiring some money funds to float their net asset values rather than fix the price at a constant $1.00, is indeed for institutional funds only. But provisions for liquidity fees and redemption gates apply to all funds, both institutional and retail. The changes are actually somewhat modest. Floating the NAV may complicate an institution's accounting or tax situation, thereby pushing it toward other cash options, but it does not alter a money fund's basic investment characteristics. Calculating an NAV with more decimals, imposing liquidity fees or creating a redemption gate does not either. The latter two items will no doubt prove irksome when implemented, but they are unlikely to be so common as to discourage money fund investors. In short, money funds’ future looks much the same as it did a week ago. The funds are currently unattractive to both investors and their sponsoring fund companies (which often find themselves rebating management fees to support the funds' meager yields) because short term interest rates are low. When rates rise, and thereby boost money fund yields, the new legislation is unlikely to stand in the way of sales. Unfortunately, it also will not do more than slow future market panics.

3. YOU SHOULD KNOW BETTER THAN TO LISTEN TO US: A short while ago we did an item on creative financial ideas for retirement (See C & C Newsletter for July 24, 2014, Item 3). Well, as the saying goes, everything is fun and games until somebody loses an eye. A piece on FINDLAW tells of a woman’s experience with an unruly Airbnb tenant in her Palm Springs condo, which illustrates the dark side of the burgeoning sharing economy. The tenant stopped paying rent 30 days into his stay, but now refuses to leave and is using California's tenant's rights rules to remain in the woman's condominium rent free. The lady has owned the condominium for 18 months, and had been listing it on Airbnb to help pay her expenses. A “guest” from Texas booked the condo for 44 days this summer, but after paying the first month in advance, refused to pay the remaining balance due. When the 44 days were up, the tenant had neither paid nor vacated, the woman texted the tenant and said she was turning off the power in 24 hours. He texted back, saying he was legally occupying the condo and that shutting off the power would prevent him from bringing in up to $7,000 a day from his home-based business. He also threatened to sue her for negligence, blackmail and malicious conduct for damaging his $3,800 espresso machine. Apparently, under California landlord/tenant law, the squatter acquired tenant's rights after living in, and paying rent for, the condo for 30 days. With these rights, the tenant cannot be removed as a trespasser, but rather must be evicted formally. Typically, an owner must first give notice to a tenant of the reason for the eviction. The owner can then institute an unlawful detainer action against the tenant, which is the legal process by which a court determines whether the tenant can be evicted. If the court finds in the owner's favor, it will issue a writ that may be executed by local law enforcement to remove the tenant. For now, the tenant gets a free ride, while the woman learns the hard way that even in today's world, sharing is not always caring. Turn out the lights, Gracie.

4. ABSENCE OF KEY POLICY PROVISION MAY COST INSURERS BIG-TIME IN MALAYSIAN AIR CRASHES: A summary of a New York Times piece in Today’s General Counsel says the aviation insurance industry is reeling after the second major Malaysian Airlines disaster within months, largely because the airline’s $2.25 billion overall liability policy is missing common phrasing that would limit what insurers have to pay for search and rescue expenses. Insurers could be on the hook for hundreds of billions if the Malaysian and Australian governments seek reimbursement for the considerable expense of searching for Flight 370, which vanished March 8, 2014. At the same time, war risk insurers did not prohibit commercial flights from passing over the Ukraine, where that country is engaged in conflict with Russian separatists. The United States has accused the separatists there of shooting down Malaysian Airlines Flight 17 on July 17, 2014. (Now, the lawyer who drew those policies for the insurance companies better check his own malpractice insurance policy.)

5. ARE ACTIVE MANAGERS EVIL?: That provocative question is the title of a article on distinctions between active and passive managers. One of the talking points that is emerging from the ongoing critique of 401(k) plans is that "good enough" investment management can be delivered for around 20 to 25 basis points. Obviously, you only get fees down to 25 basis points by using index funds. So, part of what is going on here is an attack by the random-walk people (those who believe it is impossible to outperform the market without assuming additional risk) against the active management people. There is a lot to what these critics are saying. In a world of double digit returns, maybe it did not matter that a fund manager was taking 100 to 150 basis points off the top. That world no longer exists. Over a lifetime, at around a 7% return on assets, 75 basis points in fees winds up decreasing the participant's benefit by almost 20%. On average, investors and fund managers chasing alpha do the same as the market does. After you subtract the higher fees active managers charge, on average, they do worse. Some would argue that 401(k) plan investment fiduciaries chase alpha in the worst possible way -- by picking last year's winners. But the following should be obvious to anyone: if you did not have some active managers, companies could issue stock at whatever price they felt like. In real life, there are two sorts of active managers. Group A is made up of active managers that work at producing an information advantage versus the market. In a market where everybody knows everything, there is no one in Group A. If there is such a perfect market, the folks in Group A avoid it. What they do is invest time, money and brain power learning about assets/firms that everyone does not know. They then exploit that advantage to make above average returns. Because those in Group A pursue their aims, the things they know "become the market,” their hard won alpha becomes beta. Engaging in this alpha-seeking activity is not easy.  If it were, everyone would do it, and, instead of being alpha, it would be beta. The next Group, B, includes active managers in the sense that they do not just buy a stock index and charge a lot for their services (about 100 basis points). Their business is mainly marketing; they are sales-and relationship-driven. They typically do not add much value in terms of returns. One of their talents is the ability to talk people into buying their services. Finally, there are the passive-investment hawks, the ones who say chasing alpha is a fool's game. Call them Group C. So, all those in Group B (sales-driven) want to say they are in Group A (disciplined alpha producers). Everyone in Group C (passive-investment hawks) wants to say that all the Group A firms are actually in Group B. And Group A is doing a poor job of explaining why it is actually possible, with a sophisticated and disciplined process, to generate above-market returns. Thus, maybe we need a fourth group, Group D, sales-and-relationship-driven index fund companies. In any event, we need to get beyond the active equals bad and passive equals good. There are distinctions that really matter to participants. Whose on first?
6. SIX WAYS NEW TAX LAW BENEFITS SUSTAINABLE RETIREMENT: Every now and then the Department of the Treasury and Internal Revenue Service surprise us with taxpayer-friendly legislation that addresses pervasive retirement income planning concerns. According to Legal Monitor Worldwide, one of the most anxiously provoking subjects that frighten many people more than death, is the possibility of outliving one's assets. Recognizing this issue, the Department of Labor, IRS and the Department of the Treasury began soliciting feedback in early 2010 about possibility of including advanced-age lifetime-income options in retirement plans. To make a long story short, Treasury and IRS finalized a regulation in the beginning of July that enables retirement plan participants to invest a portion of their plans in "longevity insurance" (see C & C Newsletter for July 17, 2014, Item 3). Longevity insurance is not an actual product you can purchase from a life insurance carrier. When you hear this term, it is referring to a deferred lifetime fixed income annuity with an advanced age start date, typically 80 to 85. Treasury and IRS are now blessing use of a specific type of advanced age fixed income annuity in retirement plans. Holding deferred fixed income annuities inside a retirement plan is not a new concept. Regulations in effect before the new legislation allow for inclusion of these types of investments without limit, provided that the periodic payments satisfy the required minimum distribution, RMD, rules applicable to fixed income annuities. Specifically, fixed-income annuities are deemed to comply with the RMD rules provided that payments (a) begin by April 1 of the year following the year that the owner turns 70½ and (b) are structured so that they will be completely distributed over the life expectancies of the owner and the owner's beneficiary. With the passage of the new tax law, there are six ways that you can longevitize, or extend, the financial life of your retirement:

  • Required minimum distributions can be reduced by up to 25% for up to 15 years.  
  • The lifetime of retirement assets can be extended. 
  • The lifetime of nonretirement assets can be extended. 
  • Sustainable lifetime income insures your retirement plan assets. 
  • The value of a portion of retirement assets can be insured in the event of death. 
  • Retirement plan assets allocated to fixed-income annuities provide protection against market declines. 

Given the fact that people generally underestimate how long they will live, combined with the uncertainty of sustainability of a traditional investment portfolio as a source of retirement income, there is often the need for a guaranteed lifetime income solution for the latter stage of one's life. Treasury and IRS's recent final regulation is an important step toward fulfilling this need and reducing widespread anxiety over possibility of outliving one's assets. The summary is so important that readers may want to read the entire piece at

7.  ANNUAL REPORT OF THE FEDERAL OLD-AGE AND SURVIVORS INSURANCE AND FEDERAL DISABILITY INSURANCE TRUST FUNDS: Each year the Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds report on the current and projected financial status of the two programs. The following summarizes the 2014 Annual Reports. At the end of 2013, the Old-Age, Survivors and Disability Insurance program was providing benefit payments to about 58 million people: 41 million retired workers and dependents of retired workers, 6 million survivors of deceased workers, and 11 million disabled workers and dependents of disabled workers. During the year, an estimated 163 million people had earnings covered by Social Security and paid payroll taxes. Total expenditures in 2013 were $823 billion. Total income was $855 billion, which consisted of $752 billion in non-interest income and $103 billion in interest earnings. Asset reserves held in special issue U.S. Treasury securities grew from $2,732 billion at the beginning of the year to $2,764 billion at the end of the year. 

  • Short-Range Results:  

Social Security’s cost exceeded its tax income in 2013, and also exceeded its non-interest income, as it has since 2010. The Trustees project that the reserves of the combined OASI and DI Trust Funds will increase for the next several years, growing from $2,764 billion at the beginning of 2014 to $2,878 billion at the beginning of 2020. Reserves increase through 2019 because annual cost is less than total income for 2014 through 2019. At the same time, however, the ratio of reserves to cost declines, from 320% of annual cost for 2014 to 233% of annual cost for 2020. Beginning in 2020, annual cost exceeds total income, and therefore the combined reserves begin to decline, reaching $2,698 billion at the end of 2023. The ratio of reserves at the beginning of a year to cost for that year declines to 187% as of the beginning of 2023. For last year’s report, the Trustees projected that combined reserves would be 315% of annual cost at the beginning of 2014 and 189% at the beginning of 2023.

  • Long-Range Results:  

The Trustees project that annual OASDI cost will exceed non-interest income throughout the long-range period (2014 through 2088) under the intermediate assumptions. The dollar level of the theoretical combined trust fund reserves declines beginning in 2020 until reserves become depleted in 2033. Considered separately, the DI Trust Fund reserves become depleted in 2016 and the OASI Trust Fund reserves become depleted in 2034. The projected reserve depletion years were 2033 for OASDI, 2016 for DI, and 2035 for OASI in last year’s report. Projected OASDI cost generally increases more rapidly than projected non-interest income through about 2035 primarily because the retirement of the baby-boom generation will increase the number of beneficiaries much faster than the number of workers increases, as subsequent lower-birth-rate generations replace the baby-boom generation at working ages.

  • Conclusion 

The Trustees recommend that lawmakers address the projected trust fund shortfalls in a timely way in order to phase in necessary changes gradually and give workers and beneficiaries time to adjust to them. Implementing changes soon would allow more generations to share in the needed revenue increases or reductions in scheduled benefits. Social Security will play a critical role in the lives of 59 million beneficiaries and 165 million covered workers and their families in 2014. With informed discussion, creative thinking, and timely legislative action, Social Security can continue to protect future generations.
8. WHAT IS PENSION SMOOTHING (AND NOT THE KIND YOU’RE USED TO HEARING ABOUT?): When budget deficits collide with campaign season, politicians are bound to get tricky, says If only there were a way to give the people the increased services they want without the increased taxes they do not want. The latest solution to this problem is something called pension smoothing. Despite its relaxed name, pension smoothing could make for very rough times ahead. Pension smoothing is a typical "play now, pay later" scheme, but with an added risk to corporate retirement plans. Say, the government needs money for something like building and maintaining highways, and does not want to raise taxes. Instead, it can postpone rules on how much corporations are federally obligated to contribute to their pension plans to keep them solvent. Because pension contributions are tax deductible, smoothing what corporations shell out on behalf of employees actually raises the taxable income from those corporations in the short term. For a time, taxable revenue does increase. Over the long term, however, corporations will have to contribute more to their pension plans to make up those pension shortfalls, plus interest, which ends up lowering the taxable income the corporations will pay in the future, not to mention that it puts pensions at risk if corporations cannot meet those funding obligations. Remember, when pensions are at risk, it is the government, through the Pension Benefit Guaranty Corp., that must step into help. In short, the solution is anything but smooth. In July of 2014, US Congress proposed using pension smoothing as a means to help provide $10 billion to support the Highway Trust Fund, a fund that receives revenues from a federal gas tax, and is used to help rebuild and maintain America's roads, bridges, and tunnels. The fund is at risk of insolvency, which threatens more than 800,000 jobs. The pension smoothing plan could raise more than $6 billion in the short term. The gas tax, however, has remained at around $0.18 per gallon since 1993. Democrats and Republicans both disclaim the idea of pension smoothing, but it does not seem to matter. It was used to fund a transportation bill in 2012: Moving Ahead for Progress in the 21stCentury (MAP-21), which expires on September 30, 2014. Provisions referred to above raise no revenue in the long run, and could eventually cost the government money if pensions fail. Pretending to raise revenue, while adding to long-run fiscal woes and undermining the retirement security of American workers, seems like the worst possible option.
9. INTERESTING FACTS: The tooth is the only part of the human body that cannot heal itself.

10. TODAY IN HISTORY: In 1953, Department of Health, Education and Welfare created.

11. KEEP THOSE CARDS AND LETTERS COMING: Several readers regularly supply us with suggestions or tips for newsletter items. Please feel free to send us or point us to matters you think would be of interest to our readers. Subject to editorial discretion, we may print them. Rest assured that we will not publish any names as referring sources.

12. PLEASE SHARE OUR NEWSLETTER: Our newsletter readership is not  limited  to  the   number  of  people  who  choose  to  enter  a  free subscription. Many pension board administrators provide hard copies in their   meeting   agenda.   Other   administrators   forward   the   newsletter electronically to trustees. In any event, please tell those you feel may be interested that they can subscribe to their own free copy of the newsletter at


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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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