Fiduciary Challenges and Opportunities

March 8, 2010

Dr. Susan Mangiero, CEO of Investment Governance, Inc., interviews Mr. Samuel (Skip) W. Halpern to get his thoughts about fiduciary pain points and the role of the independent fiduciary. Mr. Halpern is President of Independent Fiduciary Services, Inc. ("IFS") in Washington, D.C. Prior to helping to establish IFS in 1986, Mr. Halpern was a partner in a Washington, D.C. labor law firm, where he specialized in investment matters subject to the fiduciary responsibility provisions of ERISA. Earlier work includes time at the U.S. Department of Labor where Mr. Halpern litigated fiduciary responsibility cases under ERISA. For a full bio, click here.

Susan: Welcome Skip. It's nice to get your insights today about the changing world of fiduciary challenges.

Skip: I appreciate the chance to talk to you about this important topic.

Susan: Let's start with getting your thoughts on who needs to focus on governance and what factors are motivating increased interest.

Skip: Governance is very important for all

Susan: Are there particular challenges that have surfaced over the last several years since we last spoke? funds. Form follows function and for that matter, function follows form. If the plan structure is poorly designed, the fund cannot operate effectively or efficiently. Independent Fiduciary Services, Inc. (IFS) has recently seen more interest in governance from company 401(k) plans, especially with respect to employer stock as an investment option. We’re fielding many inquiries about revenue sharing and fees charged by outside service providers as well. These are key governance issues. We’ve also seen considerable interest in governance among boards of multi-employer plans and, to a lesser degree, among corporate defined benefit (DB) plans. Concern over securities and/or ERISA litigation is one of several drivers. The governance issue is generally more obvious and evident in public funds because of their political context. Also many state and municipal funds are so large. Over the past several years, IFS has seen a groundswell in the interest of public fund boards in best practices studies of their investment programs and administration.

Skip: Absolutely. Let's start with employer assets. We continue to see corporate employers establish and maintain stock investment funds as an option in their 401k plans. In our role as a decision-maker (and on occasion, as an adviser) to plan sponsors, we determine whether the employer stock fund remains an appropriate
investment option and if not, to discontinue that choice. However, we’ve seen employer securities of various sorts, along with employer-owned real estate assets, expanding into other types of plans. With defined benefit plans, companies propose to contribute employer stock. We are often asked to assist with the determination as to whether and on what terms the stock should be accepted and, thereafter, to manage and dispose of it, over time. Voluntary employee beneficiary associations (VEBAs) for retiree medical coverage are also impacted when employers choose to contribute various types of employer securities such as public or private debt and/or equity securities. A prominent example is the VEBA for retirees of Ford, which the UAW negotiated with that company.

Susan: I know you have commented on the case of investment vehicles that are not deemed ERISA plan assets.

Skip: Since the onset of the financial crisis in late 2007, we’ve seen a profusion of investment vehicles seeking to take advantage of severe dislocations in the markets. This includes investments in various types of fixed income instruments, sometimes with leverage from the Federal Govt. (the PPIP and TALF programs) and ranges from bank loans to all sorts of asset-backed and mortgage-related instruments. Besides a complex structure, these instruments tend to be illiquid and, more to the point, are often designed so that the underlying assets are deemed non-ERISA plan assets. As a result, the investment firm managing the vehicle is not classified as an ERISA investment manager. Any board of trustees or investment committee that wishes to invest in such a vehicle may have concerns about its own expertise and liability for evaluating this vehicle and for making the decision whether to invest. We’ve taken on quite a few assignments where we act as a special purpose investment manager, evaluating the potential investment for its appropriateness.

Susan: Litigation is another factor, wouldn't you agree?

Skip: Indeed. When a plan settles litigation claims with a party-in-interest such as the plan sponsor, it typically compromises it claims and grants the sponsor a release from future liability. Pursuant to an ERISA class exemption, a fiduciary who is independent of the sponsor is needed to determine whether the settlement, and related release, is in the plan’s interest. A large decline in equity values as well as allegations of fraud are two contributing factors to the increase in lawsuits being files.

Susan: Are more firms spending money to conduct operational reviews?

Skip: That seems to be the trend, especially in the wake of well-publicized financial scandals. As I earlier stated, in the past, numerous, and mostly large, public pension plans supported "best practices" studies. Corporate plans - both defined contribution and defined benefit - increasingly recognize the need for assessment, including those organizations with in-house asset managers (“INHAMs”). Middle market public pension plans are similarly paying more attention to the need for a process-focused report card about internal procedures. Sometimes budget dictates may result in a slimmed down version of a full-scale operational review.

Susan: I've written and spoken extensively about enterprise risk management. I know you concur that this is an important area.

Skip: It is a good thing that institutional investors are extending their focus beyond price risk and taking a hard look at internal controls, separation of functions, audit practices and compliance that goes beyond minimal legal requirements.

Susan: What is the difference between an operational review and a fiduciary audit?

Skip: Frequently the terms are used interchangeably. In other situations, there may be significant differences between the two. “Audit” could be used to connote an independent verification, without relying on representations of the entity subject to review. The term “audit” likewise might suggest that its ultimate goal is to assess blame or identify something awry. Thus, a “forensic audit” is frequently conducted in the context of litigation. In contrast, an operational review or management review may rely on representations of the board and staff and tends to be forward-looking and constructive. Interested parties can learn more by reading my article entitled “The Role of the Independent Fiduciary.”

Susan: Whom do you think benefits most from having an operational review and/or fiduciary audit conducted?

Skip: All stakeholders benefit but, given the particular situation, some may reap greater rewards. In each case, the participant should benefit – insofar as the process identifies excess risk, inefficiencies or undue expense. In a public fund context, the parties who benefit include the board, staff, taxpayers and legislative oversight committees. Regardless of plan type, public or pension, the fiduciary liability insurance underwriter benefits because the pension fund has gone through the process of identifying (and then, hopefully mitigating) various aspects of risk. The underwriter certainly should take that into account in terms of premiums.

Susan: Skip, as always, your comments are highly informative. Many thanks for your time today.

Skip: My pleasure and best of luck with FiduciaryX.com.