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Cypen & Cypen
NEWSLETTER
for
OCTOBER 28, 2004

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001

1. IRS 2005 PENSION PLAN LIMITATIONS OFFICIAL:

As anticipated (see C&C Newsletter for August 26, 2004, Item 2), the Internal Revenue Service has announced cost of living adjustments applicable to dollar limitations for pension plans and other items for tax year 2005. Effective January 1, 2005, the limitation on annual benefits of a defined benefit plan under Section 415 is increased from $165,000 to $170,000. Similarly, the limitation for defined contribution plans under Section 415 is increased from $41,000 to $42,000. And the annual compensation limit under Section 401(a)(17) is increased from $205,000 to $210,000. Finally, the limitation on deferrals under Section 457 deferred compensation plans of state and local governments is increased from $13,000 to $14,000. For those of you who are sticklers for details, the first three increases arose by virtue of a rise in the cost-of-living index that met statutory thresholds triggering adjustment. The last item, however, was specifically scheduled to increase in 2005 under the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001.

2. ACTIVE MANAGERS TRAIL INDEXERS LAST QUARTER:

As reported by plansponsor.com, like year-to-date and three-year totals, Standard & Poor’s benchmarks outperformed actively managed funds in most domestic equity styles in the quarter ending September 30, 2004. For that quarter, the S&P 500 beat about 59% of large-cap funds, the S&P MidCap 400 outperformed 58% of mid-cap funds and the S&P SmallCap 600 bested almost 70% of small-cap funds. For the first nine months of 2004 and for the three-year period then ending, indices similarly beat their respective actively-managed accounts in almost every style and size.

3. CREDIT RATINGS FLAWED? WHAT’S NEXT?:

From a Daily Business Review report: Corporate financial professionals are questioning the accuracy and timeliness of credit ratings and believe the Securities and Exchange Commission must take a more active role in promoting competition among the credit rating agencies, according to an Association for Financial Professionals survey. One-third of financial professionals believe that their company’s ratings are inaccurate, while only 42% believe changes in their organization’s ratings are made on a timely basis. More than a third of organizations that were recently upgraded believe that their ratings are inaccurate; 48% believe that the ratings are not timely. Half that received downgrades believe that their ratings are inaccurate, while 55% believe the ratings are not timely. At the same time, just 57% of the financial professionals responded that they understand the methodologies used by rating agencies! And 60% of them agree that the SEC should take a greater role in overseeing credit agencies.

4. THE CASE AGAINST STOCK IN PUBLIC PENSION FUNDS:

A government has $1 Million of stock in a pension plan that covers its employees. The liability can be matched with a $1 Million dedicated bond portfolio. What are the consequences of shifting the pension fund from equities to bonds? The foregoing paragraph opens The Case Against Stock in Public Pension Funds, a Pension Research Council Working Paper from The Wharton School. The conclusion is that current funding and investment practices are costing taxpayers dearly. The authors do not directly address losses of the past few years, which they hope are temporary, but the poor decision-making stems from failure to understand the risks of equity investments. For example:

  • Governments issue pension obligation bonds to capture what they mistakenly believe is an arbitrage gain from the excess of expected pension fund returns over their borrowing cost. There is no real economic gain, only some profits for investment bankers, lower costs for current taxpayers and additional risk borne by future taxpayers.
  • Governments underprice employees’ pensions by anticipating risk premiums, and they share “excess” risk premiums earned with employees, further loading risks onto taxpayers for which they stand to earn no rewards.
  • Intergenerational risk-sharing is thwarted by each taxpayer generation’s inclination to take winnings off the table and let losses ride.

Risk has a cost, a cost that is overlooked by current accounting and actuarial standards and therefore by most public plan stakeholders. Correct recognition of that cost would greatly alter much public plan practice and improve the lot of tomorrow’s taxpayers.

5. SEC MAY EXPAND EXECUTIVE PAY DISCLOSURE RULES:

The U.S. Securities and Exchange Commission may propose expanding disclosure rules on executive pay to cover lower-paid executives, including general counsel, says a report from Bloomberg News. Now, domestic companies must report in their proxy statements compensation for the Chief Executive Officer and the next four highest-paid executives. The top lawyer and Chief Financial Officer’s pay must only be disclosed when their compensation is among the top five. Investors are seeking more detail and wider disclosure of executive pay after former Tyco International general counsel, Mark Belnick, received a $17 Million bonus. (It didn’t help, either, that General Electric failed to disclose perks provided to retired CEO Jack Welch, including an $11 Million Manhattan apartment, bodyguards and a leased Mercedes.) From 1996 to last year, pay for chief executives rose 36%, to $9.1 Million. More disclosure is never a bad idea.

6. SEC TO OVERSEE HEDGE FUNDS:

On a 3-2 vote, the U.S. Securities and Exchange Commission ordered hedge fund managers to register, subjecting the private investment partnerships to SEC oversight for the first time. The new rule, not unexpectedly, was opposed by many in the $850 Billion hedge fund industry, which caters to the very wealthy. And because investors are sophisticated -- and have a net worth of at least $1 Million -- hedge funds have been exempt from SEC scrutiny. Effective 2006, managers that run hedge funds with at least fifteen U.S. clients must register as an investment adviser with SEC. Registration also allows SEC to conduct periodic inspections of the investment advisers. Surprisingly, an estimated 40% of hedge fund managers have already registered with SEC. Most of those funds that chose to subject themselves to SEC oversight did so to attract pension funds and other institutional investors requiring investment funds to be SEC-registered.

 


Copyright, 1996-2004, all rights reserved.

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


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