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Cypen & Cypen
AUGUST 15, 2003

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001

On July 29, 2003, the Securities and Exchange Commission approved new NASD Rule 1050 (Registration of Research Analysts) and amendments to Rule 1120 (Continuing Education Requirements) and Rule 2711 (Research Analysts and Research Reports). Generally, the new rule and amendments impose registration, qualification and continuing education requirements on research analysts; further separate analyst compensation from investment banking influence; prohibit analysts from issuing “booster shot” research reports; prohibit analysts from soliciting investment banking business; and require members to publish a final research report when they terminate coverage of a subject company. The amendments also revise Rule 2711 to augment disclosure requirements and make other changes necessary to comply with the research analyst provisions of the Sarbanes-Oxley Act of 2002. The new rule requires all persons associated with an NASD member who are to function as research analysts to be registered with NASD. Before registrations can become effective, a research analyst shall pass a Qualification Examination for Research Analysts as specified by the Board of Governors. For purposes of the rule, “Research Analyst” means an associated person who is primarily responsible for preparation of the substance of a research report or whose name appears on a research report. The SEC simultaneously approved similar amendments to New York Stock Exchange Rules 344, 345A, 351 and 472. NASD will generally phase in the new rule and amendments during the period from July 29, 2003 to January 26, 2004.

The Maryland State Employee Pension System has decided that, as of next month, no benefit checks will be sent out unless a retiree has a compelling reason not to use electronic funds transfer. The decision, which has provoked complaints from older pensioners, follows a lengthy campaign to prepare recipients for mandatory direct deposits. More than 91,000 of the $26.7 Billion system’s 93,000 retirees have already moved to direct deposit. (Those who retired after 1994 had already been required to use direct deposit.) Retirees seeking a waiver must show that direct deposit will create an undue hardship -- which will be decided on a case-by-case basis. Waivers are automatic for retirees who do not have bank accounts. By the way, Social Security also sends checks to recipients who claim hardship. Surprisingly, only 77% of Social Security payees receive direct deposit. And, while the Social Security Administration saves 40¢ every time it transmits a payment electronically instead of cutting a check, the Maryland System will not save anything because it will still mail out statements in lieu of checks!

According to a recent report, when offered a choice, many retirees select a lump sum benefit. Retirement experts say this phenomenon is a cause for concern. Workers are retiring earlier and living longer, adding to the risk they will outlive their nest eggs. (Of course, an annuity is intended to alleviate financial uncertainty by providing a stream of income for as long as the retiree lives.) When receiving a lump sum, retirees have a tendency to be either too frugal or to use up a lot of money in the early years for travel and big-ticket items. There is no one-size-fits-all pension choice; each person needs to evaluate his or her circumstances, skill and inclination to manage investments. However, as the Director of the Center for Retirement Research at Boston College says, “In my view, lump sums are a very scary proposition.”

A recent New York Times article, entitled “A Lump-Sum Threat to Pension Funds,” deals with a rush by individuals to pull cash out of a weakened fund, representing a hidden risk to pensions. Though little chronicled, accelerated withdrawals can work like a bank run, draining so many assets that the plan’s solvency can be threatened. If sudden withdrawals reduce the plan’s finances below a certain level, the company can be required to make large catch-up contributions within a short period of time. In the worst case, the plan could fail, and, even with government insurance (Pension Benefit Guaranty Corporation), workers and retirees could lose benefits. This threat is increasing as plans become underfunded and more companies than in the past allow employees to be paid in a lump sum at retirement. As we have said (see Item 3 above), decisions about when to retire and whether to take benefits monthly or in a single check are thorny. However, when an employee must factor in a ailing pension plan, the decision is even more difficult. About 44 million Americans are covered by private defined-benefit pensions -- the kind that pay a predetermined benefit and are government insured -- and a little more than half allow lump-sum payouts. A generation ago, runs on pension funds would have been unlikely: the ability to take money out in a single payment was generally limited to executives; the rank and file got annuities. But twenty years ago IRS required companies to offer lump-sum benefits to all employees if they did so for executives.

The National Association of State Retirement Administrators and the National Council on Teacher Retirement have released the results of their August, 2003 Public Fund Survey. The survey contains data on a combined 12.7 million active members, 5.3 million annuitants and $1.8 Trillion in assets, representing more than 85% of these public retirement system characteristics. The report focuses on fiscal year 2002, and contains selective data from fiscal year 2001 for purposes of making comparisons. The survey covers 98 systems and 121 plans. The summary contains a terse explanation of the meaning and implications of actuarial funding ratios. Perhaps the most recognized measure of a public retirement plan’s health, its actuarial funding ratio is derived by dividing the value of its assets by its actuarial liabilities accrued to date. A pension plan whose assets equal its liabilities is funded at 100% and is considered fully funded; any shortfall of assets is an unfunded liability, and a plan with an unfunded liability is underfunded. However, underfunded typically does not mean the plan is unable to pay benefits for which it is presently obligated; in fact, substantially all underfunded pension plans are able to meet their current obligations. All plans, underfunded and fully funded alike, that are open to newly-hired workers, rely on future contributions and investment returns. A key difference between underfunded and fully funded plans is that the former require contributions both to fund benefits currently being accrued as well as to eliminate the shortfall between assets and accrued liabilities. Because fully funded plans have no such shortfall, they require contributions only to fund benefits currently being accrued. “Fully funded” can be mistakenly interpreted to mean that no future contributions to the plan will be required. Actually, “fully funded” means that the actuarial value of assets on hand equals the plan’s actuarial accrued liabilities -- contributions and investment earnings still will be required to cover benefit obligations as they accrue going forward. Although the funding ratio is a useful indicator of a plan’s health, its utility and meaning should not be overstated: calculating an actuarial funding ratio involves many financial and demographic assumptions, of which most, if not all, will be incorrect to one degree or another in a short-term. Other interesting findings are (1) 82% of plans surveyed have an actuarial funding ratio above 80%, the average being 92.9%; (2) the average asset allocation to domestic fixed income is 33.2%, to domestic equities, 41.1% and to international equities, 13.9%; (3) the aggregate number of annuitants grew at more than twice the rate as the number of active members, 4.1% versus 1.6%; (4) the median benefit multiplier is 2.4% for those who are Social Security-ineligible; (5) median contribution rates for Social Security-ineligible members are 8.3% (employee) and 10.3% (employer); and (6) the median investment return assumption is 8%, including an inflation assumption of 4%. The entire survey can be viewed at

The West Virginia Teachers Retirement System with only 19.2% of the assets necessary to pay current and future benefits, is the worst-funded public pension plan in the nation. (What else should we expect from a state that until a few years ago had a constitutional prohibition on investment of public funds in equities?) Now the state is preparing to borrow $4 Billion to rescue the teachers’ fund. Like other states that failed adequately to fund their public employee retirement systems, West Virginia will learn an expensive lesson: the bailout will cost taxpayers between $300 Million and $700 Million a year for the next thirty years. Take me home, country road, to the place where I don’t belong.

Xerox Corporation and IBM Corporation came out on the short end of recent Federal Court rulings.

Berger v. Xerox Corporation Retirement Income Guarantee Plan, Case No. 02-3674 (7th Cir., August 1, 2003). A federal appeals court has affirmed a judgment of some $300 Million in a class action on behalf of participants in Xerox’s cash balance plan. (A cash balance plan is a defined benefit plan rather than a defined contribution plan, but resembles the latter. The ordinary defined benefit plan entitles the employee to a pension equal to a specified percentage of his salary in the final year or years of his employment. In contrast, a cash balance plan entitles the employee to a pension equal to a percentage of his salary plus annual interest on the “balance” created by each yearly “contribution” of a percentage of the salary to the employee’s “account,” at a specified interest rate. Because the account is hypothetical, the cash balance form of defined benefit plan resembles a defined contribution plan.) Xerox’s cash balance plan entitles a departing employee, not to the balance in his (hypothetical) account, but to the balance when he receives the “distribution” of his pension benefit. If he defers distribution until reaching normal retirement age of 65, the cash balance will grow by the specified interest rate between when he leaves Xerox’s employment and when he turns 65. So, when employees who left Xerox before reaching age 65 and asked for a lump sum rather than waiting until they reached that age, they did not receive the actuarial equivalent of what they would have received either as an annuity or a lump sum had they waited until age 65. The three-judge panel found that ERISA requires any lump-sum substitute for an accrued pension benefit be the actuarial equivalent of that benefit.

Cooper v. The IBM Personal Pension Plan, Case No. 99-829 (S.D. Ill., July 31, 2003). A federal trial court has granted summary judgment in favor of plaintiffs, determining that IBM’s pension plan violates the age discrimination prohibitions of ERISA. The judge sided with plaintiffs, who argued (1) that a 1995 amendment introducing a Pension Credit Formula is age discriminatory because the PCF’s benefit conversion factor increases in direct correlation to an employee’s age, thus causing an older employee to receive a lower rate of benefit accrual and to have a smaller accrued benefit at age 65 than a younger employee, despite having worked the same number of years at the same salary as the younger employee; and, (2) that a 1999 amendment creating a hypothetical Personal Pension Account also violates ERISA’s prohibition against age discrimination, based on how interest credits accrue on a participant’s PPA balance until he reaches normal retirement age.

The United States Court of Appeals for the Eleventh Circuit (which includes Florida), has reversed a lower court ruling to the contrary, and found that the Chief Executive Officer of DeKalb County, Georgia, and the County Fire Chief are entitled to qualified immunity in connection with the suspension of a firefighter for insubordination and conduct unbecoming an employee. Off duty, firefighter Travers was involved in a verbal exchange with the CEO while he and a group of other firefighters were picketing outside the County Administration Building. As the CEO was exiting, Travers turned to him and repeatedly chanted his first name in a “loudly, menacingly and taunting manner.” Travers acknowledged that he was a County employee and asserted that he was exercising his rights as a citizen. The CEO told him that, while he did not mind Travers exercising his rights, he would not tolerate Travers’s insubordinate actions. No individual other than Travers was disciplined for simply picketing in front of the Administration Building. The law is clearly established that an employer may not demote or discharge a public employee for engaging in protected speech. However, an employer may discipline an employee for insubordination. Once defendants established that they were acting within their discretionary authority, a point not in dispute, the burden shifted to plaintiff to show that qualified immunity is inappropriate. Thus, plaintiff had to allege facts showing that the officer’s conduct violated a clearly established constitutional right. Under plaintiff’s version of the facts, he was indeed engaging in protected speech. Under defendants’ version, Travers was insubordinate and engaged in unbecoming conduct. Ordinarily, this issue of fact would preclude judgment without a full trial. However, here, the issue had been resolved in a state administrative proceeding, wherein a merit system hearing officer found that Travers conducted himself in the manner described by the CEO. Travers v. Jones, Case No. 02-14043 (U.S. 11th Cir., March 11, 2003). Footnote: Travers’s lawyer has notified the trial judge of his intention to seek a writ of certiorari from the United States Supreme Court.

As reported by, the St. Tammany Parish, Louisiana, District Attorney has filed suit against three fire department administrators who allegedly falsified documents to inflate their own retirement benefits. In 1999, the trio allegedly (and improperly) reclassified themselves as civil service employees, allowing them to join the Firefighters Retirement System, which carries greater benefits than their previous plan. As a result, each of the three experienced an additional $50,000.00 in their account, for which the suit seeks reimbursement.

In an article entitled “The Slow But Sure Assent of Socially Responsible Investing,” PlanSponsor deals with a subject that seems to be commanding more attention nowadays. In 1998, the Department of Labor made it clear that ERISA’s fiduciary obligations did not prohibit socially responsible investing, as long as performance of the investment held up to its traditional peers. Since then, the asset class has begun to come into its own, and new analyses suggest that it will continue to do so. An estimated one out of every eight dollars under professional management is now socially screened in one way or another. Indeed, socially responsible mutual funds experienced a net inflow of $1.5 Billion last year, contrasted with an outflow of $10.5 Billion experienced by all equity funds. In fact, the share of socially responsible funds as a percentage of the entire mutual fund market rose from 17% in 1998 to 23% in 2002. Socially responsible mutual funds also outperformed the overall U.S. mutual fund universe in terms of earning Morningstar ratings for three-year performance. Finally, the number of domestic mutual funds that employed at least one type of social screen increased to 212 last year from 181 the year before.

A Merrill Lynch August, 2003 survey reported in the Daily Business Review shows that global investors are trimming bond holdings and buying stocks because they expect fixed-income investments to fall as a global economic recovery takes hold. More than half the fund managers questioned anticipate that yields on 10-year bonds will be higher next year at this time. Investors are betting that with the Fed’s benchmark interest rate at a 45-year low and signs of improving U.S. consumer confidence, the outlook for a worldwide economic pickup is positive. Of investors surveyed, 59% hold fewer bonds than their visual weighting in a balanced portfolio, compared with 56% last month. In fact, bond holdings are now at their lightest since the second quarter of 2002. Last, 29% of respondents expect the Fed’s next interest-rate change to be an increase, while only 18% forecast a cut.

Convicted Texas bank robber, J. L. Hunter “Red” Rountree, 91, is back in jail, charged with robbing his third bank in five years. Earlier this month Rountree entered a bank and handed a teller a large envelope with “ROBBERY” written on it. Unfortunately, the genius had parked his car near the bank, enabling a witness to get the license number. Less than five years ago, when he was almost 87, Rountree was arrested for robbing a bank in Mississippi. That time, he was apprehended within minutes (rather than the half-hour respite this time). Three years ago he was convicted of robbing a Florida bank, and sentenced to three years in prison. Rountree currently sits in jail, perhaps hoping for somebody else to rob a bank to provide his $150,000.00 bail. Oh, that Associated Press!

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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