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Cypen & Cypen
APRIL 23, 2003

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001

By Final Judgment dated April 11, 2003, a United States Bankruptcy Judge has ordered Miami Police Relief and Pension Fund to pay the Chapter 7 Trustee of the bankruptcy estate of The Florida Fund almost $910,000.00, including pre-judgment interest (plus post-judgment interest and costs to be assessed separately). The case was tried upon a complaint to recover avoidable transfers and for other relief, in which the Trustee sought to avoid and recover certain preferential and/or fraudulent transfers made to the Pension Fund. The Florida Fund operated a “Ponzi” scheme, whereby investments from new investors were used to pay fictitious returns to prior investors. Approximately 27 creditors, including the Pension Fund, lost over $7 Million in the fraud. The Pension Fund, however, was the only investor that learned of The Florida Fund’s fraud several months prior to suicide of The Florida Fund’s principal, and was one of the few investors able to recover part of its lost investment before the Ponzi scheme collapsed. The Court found that The Florida Fund operated as a Ponzi scheme from its inception, was insolvent from day one, continuously lost or misappropriated investments from its investors and was never engaged in any legitimate business activity -- yet the Pension Fund “invested” about $1.4 Million. The Court found several close long-standing relationships between the Pension Fund and the principal of The Florida Fund: (1) he was a part-time employee of the Pension Fund, providing accounting services such as reviewing monthly statements, reviewing quarterly distributions, providing accounting information and producing the Pension Fund’s year-end audits; (2) he served as accountant and investment advisor to the Pension Fund, providing general accounting services and investment advice; (3) he provided the Pension Fund with office equipment, a receptionist, a data input person and personnel to assist with issuing periodic reports; (4) in his capacity as accountant for the Pension Fund, he routinely attended and participated in board meetings for many years; (5) he provided personal tax services to the Chairman of the Pension Fund and other police officers associated with it; (6) he was a close friend of the Pension Fund’s sole administrator and employed her, as well; (7) he maintained offices directly adjacent to the Pension Fund’s offices and had unfettered access at all times to the Pension Fund’s offices, records and information stored in its computer, which was part of his own general computer system. The Pension Fund mounted a vigorous defense, asserting that it had never knowingly invested any of its assets in The Florida Fund and therefore was not an investor, partner or creditor. However, the Pension Fund had filed a sworn civil complaint against The Florida Fund, alleging that in 1996 it had made investments therein based upon representations of The Florida Fund’s principal. Further, the Pension Fund had filed a proof of claim in the bankruptcy estate for almost $1 Million, plus interest, court costs and attorneys’ fees. Given the Pension Fund’s claims that it never knew anything about The Florida Fund until it learned in 1999 that its money had been lost, “what the Court finds most astounding is what is not included in the minutes of its board meetings: that is, none of the minutes reflect any surprise or concern that the [Pension Fund] had invested substantial sums in an entity whose name and operation was supposedly totally unknown to its board.” Having performed a “fraud audit” in early 1999, the Pension Fund obtained actual knowledge that its investments had been misappropriated -- the only outside party to learn the key fact that The Florida Fund’s operations were a fraud. Yet, rather than institute suit immediately upon learning of the fraud, the Pension Fund did not bring suit until four months later -- at a point in time when the transfers sought-to-be-avoided had already been received. When asked why the Pension Fund delayed filing suit after learning of The Florida Fund’s fraud, the Pension Fund’s counsel testified “[w]ell, payments were being made.” In fact, the Pension Fund expressly requested its former Chairman to use his personal relationship to influence The Florida Fund’s principal to repay the lost investment: “the strategy was. . .he who gets there first is going to get the money and we need to move quickly. . .the strategy of the board was, how are we going to get this money back? . . .I think they felt my relationship with [The Florida Fund’s principal] would make it easier for me to squeeze him, and that’s basically what I was doing, squeezing him. . .” Among its “plethora of defenses,” the Pension Fund also claimed that the Trustee could not seek relief against it, but instead must seek relief against each individual police officer who may be entitled to distribution of benefits from the Pension Fund (which is a “share plan”). In disposing of this particular argument, the Court noted that the Pension Fund had acted independently of its police officer constituency through making investment decisions, pursuing legal action in state court relating to its investments and filing a claim in the bankruptcy case seeking recovery of losses related to such investments without ever seeking prior approval or joining individual police officers in such proceedings. Actually, the Court found that this particular argument borders on the frivolous: the Pension Fund could even steal money, place the money into its share accounts and then claim immunity from process and execution; “such a position is not only inequitable and illogical, it shocks the conscience.” According to local press reports, the Pension Fund intends to appeal. We hasten to add here that this particular pension fund is not our client City of Miami Fire Fighters’ and Police Officers’ Retirement Trust. In re: The Florida Fund of Coral Gables, Ltd., Case No. 99-40395-BKC-RAM (Bankr. S.D. Fla. April 11, 2003).

According to a study by Milliman USA, 45 of 100 companies examined used an annual rate of return of more than 9% for 2002. In fact, eight of those companies assumed their pension funds would have returns of 10% or more, when almost all plans lost money last year. The 9% figure is significant, because starting this year, federal regulators will audit financial statements of any company that uses a rate-of-return assumption greater than 9%; if the government is not convinced that the higher rate is valid, the company will be required to restate its earnings. The average return assumption for 2002 was 8.92%. On that basis, pension funds gave companies a collective income increase of $3.3 Billion. Had the companies used an average rate of 7.92% instead, not only would they have wiped out that increase, but their collective pretax earnings would have been reduced by $5.7 Billion. Interestingly, of the 100 companies surveyed, Merrill Lynch at 6% was lowest, followed by (of course) Berkshire Hathaway, at 6.5%. For a long time we have been saying that the next major scandal will be outrageous earnings assumptions -- we’ll have to wait and see.

The market value of the Employees Retirement System of Texas’s assets fell to $15.8 Billion, while its liabilities totaled $18.9 Billion. However, because like most systems it “smooths” gains and losses over a five-year period, the actuarial value of assets is recorded at $19 Billion. Already, the $17 Billion Teacher Retirement System of Texas, the state’s largest, faces a large funding gap: its assets are $10.1 Billion less than what it expects to pay in benefits. Incredibly, that shortfall was only $3 Billion a few months ago. Both funds assume average annual returns of 8% on their investments -- lower than most corporate plans, but, still, unlikely to be achieved. (For the record, the employee system, even though in better financial health than the teachers system, had the worst five-year performance of the five major state pension funds: 3.98% a year for the five years ending August 31, 2002.)

If a bill introduced into the California State Senate becomes law, California law enforcement officers would have a pension cap of 100% of final salary. For years, the cap was 75% of final pay. In 1999, the cap was increased to 85% of final pay -- at the same time the multiplier was increased from 2% to 3%. A few years ago, the cap increased to its current 90%. Supporters of the bill suggest it would save taxpayers money: by lifting the cap, police officers would be encouraged to work longer and thus would not be earning a pension during that period of time. In most cases, the higher pension eventually earned would not cost more over time than the saving by delaying retirement -- a theory to which we subscribe. Incidentally, Section 112.65, Florida Statutes, sets a 100% cap of average final compensation for those first participating in a retirement system or plan on or after January 1, 1980. For those becoming members prior to that date, there is no cap on the pension.

The cornerstone of Illinois’s budget proposal is to sell up to $10 Billion in low-interest bonds, $2 Billion of which would be used to make the state’s contributions to its pension systems. The remaining $8 Billion would also be put in the pension plans and invested, where state officials hope to earn more than the 6% borrowing rate on the bonds. If the investment earns the hoped-for average of 8% per annum over the next thirty years, enough money would be generated to provide pension income and pay interest and principal on the bonds. If not, the state will have to find other money to pay back the loans and make pension payments, which the state is legally bound to do. Our readers may remember that in 1997 New Jersey borrowed $2.7 Billion to fund its pension obligations (see C&C Newsletter for November, 1997, page 5). The deal included an interest rate of 7.6% for thirty years, which was okay while the stock market boomed before 2000. Now, the fund is down from $84 Billion to $55 Billion. And, instead of earning at least 7.6% in order to pay interest on the bonds, the fund has earned about 5.5% per year for the past five years -- not a pretty picture.

Facing a required contribution of $260 Million, San Diego County officials have asked its retirement board to cut the payment to $180 Million, according to a report. The County cites reduced revenues from the State, which itself faces a budget deficit of $35 Billion. Critics say letting the County contribute less would set a dangerous precedent that could affect pensions and benefits down the line. They also point to the City’s $2.5 Billion retirement system, which faces a $720 Million deficit fueled by years of City underfunding, among other things (see C&C Newsletter for March 5, 2003, Item 4). The $3.7 Billion County retirement fund, which lost $625 Million of market value over the last two years, admits that the system is underfunded but retorts that the City’s system is worse! Gee, that’s a real comfort.

Charlotte Mears retired from the Pennsylvania Liquor Control Board in 1989. In 1996, using her home computer, Mears created a phony death certificate, which she sent to the Pennsylvania State Employees’ Retirement System. She then forged the signatures of her mother and son on checks received from the System. (We do not understand why she could not have continued to receive pension checks as a retiree, unless she had a defined contribution plan that was exhausted.) In any event, guess how state retirement officials learned about the scam? The departed Ms. Mears applied for Social Security! -- whereupon the Social Security Administration called the Retirement System to determine if she was still receiving her monthly pension checks. Maybe she was only “brain dead.”

Employee Benefits Institute of America LLC, in its EBIA Weekly, reports on the case of a retired city police officer who brought suit in state court for various claims relating to the city’s health benefit plan in which he participated. Defendants removed the case to federal court on the basis that ERISA governed the plan, but plaintiff sought remand because the plan was a governmental plan exempt from ERISA. The defendants countered that the city had elected to “opt” into ERISA because of plan documents indicating that it was governed by ERISA. The federal district court agreed with plaintiff, holding that ERISA specifically exempts governmental plans from coverage, and that a governmental entity may not “opt” into ERISA jurisdiction either by stating that ERISA applies or by complying with ERISA’s reporting and disclosure requirements. “Had Congress intended that states and political subdivisions be covered, it could have expressly included them in the definition of ‘employer,’ but did not do so.”

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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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