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Cypen & Cypen
July 18, 2019

Stephen H. Cypen, Esq., Editor

The $57 billion L.A. County pension fund abruptly terminated its CEO earlier this month. The former chief executive officer and interim CEO of Los Angeles’ county retirement system (LACERA) improperly approved thousands of dollars of board expenses, an internal memo shows. LACERA’s boards fired CEO Lou Lazatin June 7 after putting her on leave one week earlier. Chief counsel Steven Rice declined to explain the reason why, citing policy against commenting on personnel issues. But Rice authored a June 3 memo laying out improper travel approvals made by Lazatin and former interim CEO Robert Hill, whom she replaced. Hill and Lazatin approved thousands of dollars of flight and hotel expenses for board members to attend LACERA meetings and CEO candidate interviews, the memo stated. Travel to board meetings is not covered under the retirement system’s reimbursement policy, Rice wrote, and the CEO does not have authority to approve exceptions. Last year, for example, investments board member Gina Sanchez “was attending a personal business trip in London, and Mr. Hill approved changing her airfare so she could attend the CEO interviews,” the memo stated. “The change fee was $3,024.01 for a roundtrip flight from London to Los Angeles and back to London. In addition, Ms. Sanchez incurred local transportation in London of $112.34.” Lazatin verbally signed off on more flight changes for Sanchez in February, amounting to $2,258.88, according to the document. Sanchez was not alone in allegedly receiving unauthorized expense approvals from Lazatin and Hill. The memo also named current investment board members Herman Santos and Wayne Moore. Hill approved a $200 airline change fee for Santos to attend the October CEO interviews, Rice wrote. Lazatin permitted travel expenses for Moore, which only amounted to about $450 because “the airline made a mistake in changing his flight, and therefore no air expenses were incurred.” Rice’s memo asked the board whether to authorize the expenses, which he argued “are not permitted” under LACERA policy unless approved by the board. “The CEOs alone lacked authority to approve them,” he wrote. On May 31, Sanchez attended a joint board meeting in Los Angeles, despite having made arrangements to be in Boston at that time. The memo shows that Lazatin and assistant executive officer JJ Popowich approved $639.60 in flight changes for Sanchez to be there. At that meeting, “LACERA’s governing Board of Retirement and Board of Investments placed Ms. Lou Lazatin on administrative leave from her position as LACERA’s Chief Executive Officer,” the organization said in a statement late last week. “During the same meeting, the Boards voted to terminate Ms. Lazatin at a future date.” Leanna Orr, Institutional Investor, June 17, 2019.
As the Tax Cuts and Jobs Act (TCJA) was enacted to simplify tax calculations, one area where such simplification was welcomed was the so-called “kiddie tax.” The kiddie tax was originally created to prevent wealthy parents from shifting income to their children to benefit from their lower tax rate, in order to decrease the overall family tax burden. Prior to December 31, 2017, the kiddie tax calculation involved taxing a child’s unearned income over $2,100 at the parents’ tax rate. This was often a complex calculation, only to be further complicated when there were multiple children in the family. Under the TCJA, the kiddie tax applied to the child’s unearned income over $2,100 at the same tax rates as estates and trusts. While the kiddie tax is undoubtedly easier to calculate under TCJA, with the new tax brackets for trusts and estates unearned income reaches the top marginal rates much faster. Families already subject to the top tax rate generally fare better or the same under the new kiddie tax calculation. However, middle- to low-income families are at a disadvantage because children reach the highest tax bracket at more compressed income, and it is likely that a child’s income will now be subject to a rate higher than their parents’. Another unintended consequence of the new rule is the taxing of military survivor benefits, Alaska permanent fund dividends, tribal funds for Native American children and scholarships used for expenses other than tuition and books. The first legislative remedy came from the Senate on May 21, 2019. The Gold Star Family Tax Relief Act reclassifies survivor benefits as earned income subject to regular tax rates, for 2018 and going forward. Any taxpayer who has already filed a 2018 return has the option to amend their tax return to reflect this change. However, as the voices of other affected groups echoed louder, lawmakers sought to find a more sweeping solution. On May 23, 2019, the Setting Every Community Up For Retirement Enhancement (SECURE) Act of 2019 was passed by the House of Representatives. This act completely repeals the 2017 changes to the kiddie tax under TCJA, restoring the original rules, effective with tax years starting in 2019. For 2018, taxpayers have the option of computing the kiddie tax under both pre-TCJA and post-TCJA rules and filing their returns using whichever method is more advantageous. The changes to the kiddie tax in the last few weeks have been the first to revert to tax law in place prior to the TCJA. Because the TCJA was passed in such a short timeframe, before the beginning of the 2018 tax filing season, we have yet to see all of the consequences of the new law. Senator Charles E. Grassley of Iowa, who worked on correcting the kiddie tax issue, further affirms this sentiment by saying, “Historically, after major tax legislation, the longstanding practice has been to correct drafting errors and other technical issues on a bipartisan basis.”  The kiddie tax was merely the first. As time progresses and we see how the TCJA plays out for other tax issues, additional modifications to tax law can be expected. Taylor Brown, Senior, Marcum, LLP, June 17, 2019.
The Securities and Exchange Commission charged KPMG LLP with altering past audit work after receiving stolen information about inspections of the firm that would be conducted by the Public Company Accounting Oversight Board (PCAOB). The SEC’s order also finds that numerous KPMG audit professionals cheated on internal training exams by improperly sharing answers and manipulating test results. KPMG agreed to settle the charges by paying a $50 million penalty and complying with a detailed set of undertakings, including retaining an independent consultant to review and assess the firm’s ethics and integrity controls and its compliance with various undertakings. “High-quality financial statements prepared and reviewed in accordance with applicable accounting principles and professional standards are the bedrock of our capital markets. KPMG’s ethical failures are simply unacceptable,” said SEC Chairman Jay Clayton. “The resolution the Enforcement Division has reached holds KPMG accountable for its past failures and provides for continuing, heightened oversight to protect our markets and our investors.” “The breadth and seriousness of the misconduct at issue here is, frankly, astonishing,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “This settlement reflects the need to severely punish this sort of wrongdoing while putting in place measures designed to prevent its recurrence.” “This conduct was particularly troubling because of the unique position of trust that audit professionals hold,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division. “Investors and other market professionals rely on these gatekeepers to fulfill a critical role in our capital markets.” Five former KPMG officials were charged last year in a case alleging they schemed to interfere with the PCAOB’s ability to detect audit deficiencies at KPMG. According to the SEC’s order issued against KPMG, these senior personnel sought and obtained confidential PCAOB lists of inspection targets because the firm had experienced a high rate of audit deficiency findings in prior inspections and improvement had become a priority. Armed with the PCAOB data, the now-former KPMG personnel oversaw a program to review and revise certain audit work papers after the audit reports had been issued to reduce the likelihood of deficiencies being found during inspections. The SEC’s order also finds that KPMG audit professionals who had passed training exams sent their answers to colleagues to help them also attain passing scores.  The exams related to continuing professional education and training mandated by a prior SEC order finding audit failures. They sent images of their answers by email or printed answers and gave them to colleagues. This included lead audit engagement partners who not only sent exam answers to other partners, but also solicited answers from and sent answers to their subordinates. Furthermore, the SEC’s order finds that certain KPMG audit professionals manipulated an internal server hosting training exams to lower the score required for passing.  By changing a number embedded in a hyperlink, they manually selected the minimum passing scores required for exams. At times, audit professionals achieved passing scores while answering less than 25 percent of the questions correctly. “The sanctions will protect our markets by promoting an ethical culture at KPMG,” said Melissa Hodgman, Associate Director of the SEC’s Enforcement Division. “To that end, KPMG will take additional remedial steps to address the misconduct and further strengthen its quality controls, all of which will be reviewed and assessed by an independent consultant.” In addition to paying a $50 million penalty, KPMG is required to evaluate its quality controls relating to ethics and integrity, identify audit professionals that violated ethics and integrity requirements in connection with training examinations within the past three years, and comply with a cease-and-desist order. The SEC’s order requires KPMG to retain an independent consultant to review and assess the firm’s ethics and integrity controls and its investigation. KPMG has admitted the facts in the SEC’s order. It has also acknowledged that its conduct violated a PCAOB rule requiring the firm to maintain integrity in the performance of a professional service and provides a basis for the SEC to impose remedies against the firm pursuant to Sections 4C(a)(2) and (a)(3) of the Exchange Act and Rules 102(e)(1)(ii) and (iii) of the Commission’s Rules of Practice. The SEC’s investigation, which is continuing, has been conducted by Ian Rupell and Paul Gunson and supervised by Rami Sibay. Washington D.C., U.S. Securities and Exchange Commission, June 17, 2019.
The U.S. Supreme Court on Monday declined to review an appellate court ruling in a case brought against the Pension Benefit Guaranty Corp. by Delta Air Lines Inc. pilots seeking $600 million in investment returns. The U.S. Court of Appeals for the District of Columbia Circuit ruled Dec. 21 in favor of the PBGC in a case brought by retired Delta pilots, who argued that the agency underestimated their benefits. After Delta filed for bankruptcy in 2005, the Delta Air Lines Pilots Retirement Plan was terminated and the PBGC became trustee in December 2006. At the time, the plan's assets were valued at $1.99 billion, court filings said. The PBGC gained some assets in a settlement agreement with Delta and later recovered additional assets valued at $1.28 million, which the retired pilots allege in the lawsuit should have been shared with them, instead of being kept by the PBGC. The plaintiffs, representing many of the 1,784 plan participants who disagreed with the PBGC over their benefit levels, are claiming the agency earned "massive investment returns" off the recovered assets, instead of sharing some returns with participants, which they argue constitutes a fiduciary breach. The lawsuit was filed in December 2014 after the PBGC's internal benefit determination and appeals process had been exhausted. The Supreme Court denied a petition for review, without comment. Hazel Bradford, Pensions & Investments, June 17, 2019.
Just how dumb do our Harrisburg politicians really think we are? Once again, Governor Wolf and our Harrisburg legislators are proposing creating a new, “protection” tax to finance the state police. But they have done absolutely nothing to fix the real, underlying problem here, which of course, is the excessive and obscene, defined benefit pensions paid to our state police. The same pensions our legislators failed to fix several years ago when they switched all other state employees and teachers to a 401(k) type of pension. And, as a result, the cost of these pensions has continued to grow uncontrolled--to the point $800 million was siphoned off from the state’s road and bridge fund during FY 2016-2017 for the state police. They knew it was a serious problem then, but did nothing whatsoever to correct the problem permanently. Instead, they did what Harrisburg politicians always seem to do in situations like this--they just kicked the can down the road. They could have told the State Police then that we Pennsylvania taxpayers can no longer afford to finance this luxury--like almost all companies in private industry have already done with their pension plans. The solution is to contact your local state representative and senator and tell him/her you will no longer vote for any state legislator who fails to properly correct this problem once and for all, and that any new tax is totally unacceptable until that is done. Ignoring this problem is no longer an option. Jack L. Fisher (Lewisburg), The Daily Item, June 15, 2019.
City council members approved using the net proceeds from the sale of the city’s sanitary sewer system to fund the Fireman’s Pension Fund and the City of Alton Board of Trustees Police Pension Fund. Under the resolution, funds from the sale of the city sanitary sewer system to Illinois American Water will be divided equally between the two pension funds, which are the highest listed expenses for the city. Also, council members approved a resolution to consider the 2019-2020 fiscal year budget and appropriations ordinance. The measure passed 6-1 with Alderwoman Stephanie Elliott opposed. General fund expenditures are budgeted for $83.65 million, with a projected revenue of $91.1 million. Comptroller Kirby Ontis had told Elliott the budget is balanced, with total expenditures expected to be fully covered by the city’s projected revenue. In other matters, the council voted unanimously granting special use permits at 508 William St. for a guest house and at 1317 Milton Road allowing for a taxi company. Jeanie Stephens, The (Alton) Telegraph, June 14, 2019.
This is the time of year when publicly traded companies host their annual shareholder meetings. During these meetings the shareholders vote their shares on various issues impacting the company. The company’s proxy statement will include shareholder resolutions on everything from executive pay to proposals that impact how the company operates. This is a critical part of keeping management focused on increasing shareholder value (i.e., growing the company). This can be a complicated cycle for public pension plans that typically have thousands of issues to vote on for hundreds of companies. Most pension plans hire outside consultants to advise on how to vote the various issues confronting shareholders, and in some cases, public plans assign their vote directly to the proxy advisory firms. I disagree with this for two reasons: first, proxy voting firms are not fiduciaries and are not required to be registered with the Financial Industry Regulatory Authority (FINRA); second, they are not managing the money--typically pension funds hire money managers to do that. As Connecticut State Treasurer in 1995, I made sure that all our asset managers only collected fees when they out-performed their benchmark. That is the quintessential “alignment of interest”. The problem with proxy advisory firms is that they have no alignment of interest. They may make a recommendation of how to vote based on issues that have a political impact but not a shareholder value impact. No matter what--they still get paid their fee. A far better way would be to do what we did in Connecticut--let the money managers whom you have chosen based on a myriad of factors, including their performance, vote the proxy shares--and pay them their fees only when they outperform the benchmark. Now that is an incentive for money managers to force corporate managers to stay focused on strengthening and growing the company. Politicians may argue that good politics makes for good shareholder value, but unfortunately, this is a violation of fiduciary responsibility. Make politics in the legislatures, but please leave our precious retirement funds free from your personal political opinion. The two largest proxy advisory firms, ISS headquartered in Rockville, MD, and Glass Lewis, headquartered in San Francisco, CA, control 97% of the advisory market. Among other services, they develop proxy proposals, analyze proxy proposals, and provide clients with recommendations on how to vote all other proposals. These two companies recommend proxy proposals, provide suggestions to clients about how to vote on those proposals, and in some cases, vote their clients proxy. In other words, they have the ability to control the entire proxy process which has led them to have a duopoly on how institutional investors vote. This concentrated power has prompted the SEC to take action and begin reviewing the current rules governing proxy firms. This started with a panel discussion in November, 2018 to hear from the various stakeholders that would be affected. Since then, and since the official comment period opened, the SEC has sharedmore than 250 unique comments on the issue of proxy advisory firms, with a majority in favor of reform. But how should the SEC deal with this monopolistic concentration? First and foremost, those in charge of our public pension plans (which is not the SEC) should let money managers do their job--and managing money in my mind also means managing the proxy votes. Let those who manage your money also vote your shares in the best interest of all shareholders. However, if plan sponsors want to continue to use third party firms, then these firms should be held to the same fiduciary standard to which money managers are held--and as a first step they should have to register with FINRA, and the SEC should assign fiduciary responsibility to them for their fiduciary advice. Our public pensions funds are facing an almost unfathomable unfunded liability burden that will impact the retirement security of our teachers, firefighters, and public servants, including me, very shortly. Proxy advisory firms are making recommendations on decisions that impact company performance. They should be making those decisions in the best interest of improving returns and not based on the political whims of the day or upcoming elections. Applying fiduciary responsibility to proxy advisory firms would be an important first step. This op-ed originally appeared in Forbes on June 13, 2049. Institute for Pension Fund Integrity, June 14, 2019.
Pension benefits for employees of state and local governments are paid from trust funds to which public employees and their employers contribute during employees’ working years. Timely contributions are vital to adequate funding and the sustainability of these plans: failing to pay required contributions results in higher future costs, due to foregone principal and investment earnings that the contributions would have generated. Nationally, contributions made by state and local governments to pension trust funds in recent years account for just less than five percent of all spending. Overall, the experience for FY 17 reflects a continuation of an improved effort among state and local governments to make actuarially determined pension contributions: on a dollar-weighted basis, the percentage of required contributions that was paid by public employers increased for the fifth consecutive year, while pension costs continued to grow at a slower pace than previous years. This has occurred even as plans have reduced their investment return assumptions and implemented more aggressive amortization strategies to pay off unfunded pension liabilities. Pension spending levels, however, vary widely among states and are actuarially sufficient for some pension plans and insufficient for others. Unlike employees, who must always contribute the amount prescribed in statute or by plan rules, a broad range of funding statutes, rules, policies, and practices is used to determine the contributions public employers--states, cities, etc.--make to public pension plans. This disparity in contribution governance arrangements is one of several factors contributing to a wide range of experience among public employers concerning required contributions. This brief describes how contributions are determined; the recent public employer contribution experience; and trends in employer contributions over time.
Actuarially Determined Contributions
Funding a pension plan takes place over many years and, as described in the box to the left, typically involves a combination of contributions from employees and employers, which are invested to generate investment earnings. Contributions are a vital source of public pension funding: of the $7.5 trillion in public pension revenue since 1988, nearly 38 percent has come from contributions paid by employers and employees. The amount of contributions needed to fund a pension plan is calculated as part of an actuarial valuation, which is a mathematical process that determines a pension plan’s condition and cost required to pay promised benefits. For public pension plans, an actuarially determined contribution, or ADC, typically is consistent with the annual required contribution, or ARC, a concept introduced by GASB Statement 25 and defined essentially as the sum of the normal cost (the estimated cost of benefits earned each year); and an amortization payment. Amortization, or payment over time, is required when either a) contributions are insufficient and/or b) the plan’s demographic or investment experience cause the value of assets and liabilities to diverge. Amortization is intended to eliminate this difference, which is known as the unfunded actuarial liability. Various funding mechanisms, including statutorily-fixed rates, actuarially-determined rates, and annual appropriations, are used to fund public pension plans. Virtually all plans calculate an ADC, which serves as a benchmark to measure the sufficiency of the employer’s contribution. Pension plans typically maintain a funding policy by which they expect to reach full funding at the end of a specified period of time if the plan receives all of its actuarially determined contributions; and if all of the plan’s actuarial assumptions--about the many factors affecting the plan, such as future investment performance, how long plan participants will work, etc.--materialize as expected. Pension plans regularly monitor their condition through actuarial valuations and experience studies to determine if assumptions are being met and if adjustments are needed. Because actuarial methods, assumptions and benefit levels differ from one plan to another, the ADC also will vary. As a result, the ADC for two hypothetical plans with identical financial and demographic compositions could (and usually will) also differ. Also, laws and rules governing pension contributions vary widely among states and cities, and those provisions can affect public pension plan funding. For more information concerning the impact of funding policies, statutes and rules, see “The Annual Required Contribution Experience of Statewide Pension Plans, FY 01 to FY 13.” FY 2017 Contribution Experience, shows the median actuarially determined contribution received in FY 17 was 100 percent, and ranged from 38.4 percent to 174.0 percent. On a dollar-weighted basis, the average ADC received was 94.0 percent, up from 92.0 percent in FY 16 and marking the fifth consecutive year of improvement and the third consecutive year in which the combined annual contribution effort is above 90 percent. The FY 17 non-weighted average was 99.2 percent. The aggregate rate of increase in required contributions from FY 16 to FY 17 was 4.3 percent, which is the second lowest rate of increase during the measurement period and marks the fourth consecutive year of growth in required contributions below 5.0 percent. This reduced rate of increase also continues a trend seen in recent years of slower annual growth in required contributions, especially compared to the sharp increases experienced in FY 03-05, following the market decline of 2000-2002. The slower growth in recent years has occurred at a time when many public pension plans have reduced their investment return assumption which, other factors being equal, increases required costs. If return assumptions had remained the same, the increase to cost would have been smaller. The slower rate of increase is caused partly by pension reforms, including higher required employee contributions and lower benefit levels (and costs) enacted in every state since 2009. Another factor contributing to higher pension costs in recent years is a movement among public pension plans toward more conservative methods to amortize unfunded actuarial liabilities. Research indicates that more plans are employing methods to pay off their unfunded liabilities more aggressively, which increases costs in the near-term, and reduces long-term costs.
Recent History of Employer Contributions
Spending on pensions by states & local government is just below five percent of all spending. The employer contribution experience since FY 2001 covers an eventful period, including two economic recessions--impairing state and local fiscal conditions--sand two periods of sharp declines in capital markets, which increased unfunded pension liabilities. For the plans measured for this study, actuarially determined contributions rose from $27.8 billion in FY 01 to $109.4 billion in FY 17, an increase of 186 percent in inflation adjusted dollars. Actual contributions paid by employers during this period grew from $28.0 billion to $96.9 billion, an inflation-adjusted increase of 153 percent. A figure plots the weighted percentage of actuarially determined contributions received from FY 01 to FY 17. Because each state is unique in terms of its governance structure, pension funding policy and practice, the relative cost of its pension plan(s), fiscal condition, and other factors, the required contribution experience of each state is also unique, and ranges widely. On a weighted average basis, states’ percentage of cumulative ARC/ADC paid since FY 2001 ranges from just over 40 percent to more than 100 percent. In the median, state plans received 98.5 percent of their required contributions, and 86.4 percent as a weighted average. The average actuarially determined contribution received for the period was 92.6 percent, as a few larger plans pulled down the average because they received a relatively lower portion of their ADC.
Although contributions to public pensions remain on average a relatively small percentage of state and local government spending, they also have grown in recent years. Depending on the plan, the growth of required employer contributions is due to one or more factors, including investment market losses; insufficient contributions; more conservative actuarial methods and assumptions, including lower investment return assumptions and more aggressive amortization periods; and demographic and investment experience that differs from assumptions. The overall experience for FY 17 reflects continuation of an improving effort among state and local government employers to make the full actuarially determined contribution, which will forestall higher costs in the future and strengthen the long-term sustainability of public pension plans. National Association of State Retirement Administrators, June 2019.
Gain may be temporary and uncertain; but ever while you live, expense is constant and certain: and it is easier to build two chimneys than to keep one in fuel.
Why is it, whether you sit up or sit down, the result is the same?
What great thing would you attempt if you knew you could not fail? - Robert H. Schuller
On this day in 1925, Adolf Hitler publishes Mein Kampf (original title was the catchy "Four and a Half Years (of Struggle) Against Lies, Stupidity and Cowardice").

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