|
|
Federal E-News
Summer 2009
NCTR's Federal e-News provides important information
on the issues and events in Washington, D.C. that may impact NCTR
members. For more
information, contact Leigh Snell, NCTR's Director of Federal Relations,
at (540) 333-1015 or by email at: lsnell@nctr.org.
Public
Sector Offers Strong Response to GASB ITC on Possible Accounting
Rules Changes
A wide range of public sector officials, including
scores of fiduciaries, administrators, and participants of NCTR member
systems, filed comments with the Governmental Accounting Standards
Board (GASB) in response to its Invitation to Comment (ITC) on possible
revisions to GASB Statements 25 and 27. GASB is considering whether
changes to its standards for accounting and reporting on the pension
benefits that governments provide to their employees are needed,
and had asked for comments on a number of issues related to such
possible revisions by July 31, 2009. In addition to pension plans
and their board members, state officials and national organizations
representing a large majority of users of public pension financial
reports also weighed in, stating their strong opposition to the so-called “Market
Valuation of Liabilities” method, or MVL. GASB is also holding
a public hearing later in August to discuss the ITC, at which public
pension representatives will also testify, as will proponents of
MVL.
A joint letter signed by 107 plan administrators, board chairs,
and others representing 61 public pension systems was filed on
July 31st
and encourages GASB to “proceed with caution” in making
major modifications to its existing statements. The letter argues
that significant changes to the current reporting model “could
result in confusion on the part of the user community and could disrupt
the consistency of public pension reporting,” and that such
confusion and inconsistency could in turn reduce the accountability
and decision usefulness of such reporting.
This joint letter, drafted by NCTR and NASRA staff, opposes the
use of MVL, which would require a so-called “risk-free” rate
of return as the basis for determining a plan’s discount rate
(used for discounting projected pension benefits to their present
value for accounting purposes). Instead, the letter supports the
continued use of a plan’s estimated long-term investment return
based on the plan’s asset allocation as the appropriate measure, “consistent
with both the perpetual nature of governments and the enduring, long-term
nature of public pensions.” The letter goes on to note that
the current GASB approach “also is the most likely to promote
interperiod equity, because the long-term investment return assumption
is the plan’s best estimate of future earnings from investments,
which are the fund’s largest revenue source.” In addition to MVL, the joint letter specifically addresses a
number of other issues posed by the ITC.
For example, the comment
letter
concludes that:
Public pension financial reporting should focus on the process
by which benefits are financed, and not on the incurrence approach,
which would result in unnecessary and undesirable volatility and
inconsistency of pension obligations and required costs.
The current standard for reflecting a pension liability—the
difference between amounts paid based on the employer’s Annual
Required Contribution and amounts actually contributed—is
appropriate, while the unfunded accrued benefit obligation,
which is based on future, projected events, is uncertain
and cannot
be measured with a high degree of reliability.
Interperiod equity is best achieved through deferred recognition
of pension costs amortized over a period of years, since
recognizing changes annually in the unfunded accrued benefit
obligation would
result in significant volatility, causing uncertainty
and challenging the principles of decision usefulness.
Current GASB standards are appropriate in including
projected automatic COLA’s, projected future
salary increases, and projected future service
credits, as no
meaningful purpose
is
served in requiring public pension plans to calculate
or report a value
without projecting future benefits when there is
a strong likelihood those benefits will be paid.
(The
joint
letter took no position
on ad hoc COLAs.)
A maximum amortization period of 30 years should be retained,
since this timeframe is most consistent with the long-term
nature of public sector entities and provides pension plans
the flexibility
to employ amortization periods that are shorter, should
the plan find that to be prudent.
The authority to use both level percentage of pay and level dollar
amortization methods should be continued because different
circumstances, unique to each plan, may justify the more appropriate
use of one
or the other; for the same reason, the authority of plans
to use both open and closed periods should also be continued.
With respect to the method for determining the actuarial
value of plan assets, plans should continue to be permitted
to phase
in (“smooth”) investment gains and losses over
multiple years.
The current GASB approach to accounting for the cost sharing
employer and cost sharing multi-employer plans is sufficient
and should be continued.
While essentially supporting the current standards in many areas,
the letter does suggest some changes. For example, it encourages
GASB to consider adding a requirement that public pension financial
reports present as required supplementary information changes in
the plan’s unfunded actuarial accrued liability (UAAL) resulting
from differences between the plan’s experience and actuarial
assumptions, and from benefits approved during the reporting period.
It also suggests that GASB may wish to consider requiring this information
on an historical basis, such as over a five-year period.
A number of NCTR and NASRA members, as well as other governmental
plans and statewide associations of governmental plans, also filed
individual responses, some of which contained other suggestions for
possible changes in the existing standards.
In addition to assisting in the joint letter effort, NCTR also
joined NASRA and twenty other national organizations in submitting
a separate
joint comment letter to GASB that focused solely on opposition
to the MVL approach. This letter underscored that it represented
the
views of “a wide range of users of public retirement system
financial reports, including state legislators and other policymakers;
executive officials, such as mayors, county officials, treasurers,
and comptrollers; public employers, public employees and retirees;
and trustees or other governing bodies of governmental pension
plans.”
Signatories included the National Conference of State Legislatures
(NCSL), the National League of Cities (NLC) and other employer
representatives; the National
Association of State Treasurers (NAST), the National Association of State Auditors,
Comptrollers and Treasurers (NASACT) and other representatives of government
finance functions; the NEA and AFT as well as other public employee unions;
AARP; and national organizations representing other state and local
government functions.
(Many of these national organizations, such as NEA, AFT and NASACT, also filed
their own individual comments with GASB.)
The national organizations’ letter points out that replacing
the current GASB approach with MVL “would only serve to confuse
users of public retirement system financial reports,” and argues
that MVL would also “lead to lower investment earnings, higher
costs, lower funding ratios, and increased volatility of costs and
funding levels.” Such volatility in funding levels and required
costs would significantly disrupt public sector budget processes,
the letter notes, stressing that “[p]redictability and stability
of required costs are critically important to effective budgeting
in the governmental sector, and the imposition of MVL would be unnecessarily
disruptive, particularly in these difficult economic times.”
Although the National Governors Association (NGA) did not sign onto
the group letter, the Office of the Governor of Pennsylvania, Edward
G. Rendell – who is the outgoing NGA chairman – filed
comments signed by the Governor’s Secretary of the Budget.
The letter states that “the Commonwealth of Pennsylvania believes
that the reporting of the liabilities of public pension plans using
a single-point market value would improve neither the nature nor
the amount of information currently disclosed under existing reporting
standards.” On the contrary, the letter says that “Instead,
market valuation could produce an inaccurate perception of plan funding
that could confuse rather than inform the public and provide misleading
information to policymakers.”
However, it is well to note that the Office of the Governor of California,
Arnold Schwarzenegger, also filed comments, signed by his Special
Advisor for Jobs and Economic Growth. These comments argued that,
at a minimum, GASB should require pension plans to (1) discount their
liabilities “utilizing a rate reflecting the recourse and in
some cases secured nature of those obligations” and (2) “report
plainly and clearly” the investment return assumed by pension
funds for determining contribution amounts, unfunded accrued actuarial
liability (UAAL) and the actuarial value of plan assets and how the
contribution amounts and the UAAL would change if that investment
return assumption were set equal to rates of return on U.S. Treasuries
on the date of valuation and if the actuarial value of plan assets
were set equal to the market value of pension fund assets.
Twenty-seven state treasurers also signed a joint comment letter
that cautions against making changes in the current GASB standards
which could cause confusion by interrupting the consistency of financial
reporting and disrupt a “common understanding that has developed
among users of public pension financial reporting.”
The treasurers specifically oppose the use of MVL, noting that it
is “likely to overstate present costs and obligations, and
to understate future costs, violating the principle of interperiod
equity.” Their letter also expresses concern with the volatility
of interest rates, which, if used as the discount rate, would cause
volatility in the funding level of pension plans and “wreak
havoc on public pension plan sponsors’ budget process.”
In a somewhat pleasant surprise, the American Academy of Actuaries,
which last year had seemed intent on taking a position in favor of
the use of MVL, decided in its comments to take a more Solomon-like
approach. Noting that there is a wide divergence of opinion within
the actuarial community on the subject of the proper accounting for
public pension plan benefits, the Academy decided to present both
sides of the MVL argument. Their comments therefore include a “market-based
view” prepared by a group of actuaries from the Pension Finance
Task Force, jointly sponsored by the Academy and the Society of Actuaries,
as well as a “modified conventional approach” drafted
by actuaries from the Academy’s Public Plans Subcommittee.
The “market-based view” argues that the discount rate “should
normally be based on yields on fixed income investments that are
default free or have a low probability of default.” However,
this group also conceded that “It’s not clear which specific
discount mechanism – Treasuries, swaps, TIPS or some other
curve – is most appropriate, or indeed if any single mechanism
is appropriate in all situations.” Nevertheless, they did insist
that “discounting based on a yield curve with characteristics
similar to the accrued benefit obligation produces a value consistent
with the valuation of other government debt.”
The actuaries supporting the “modified conventional approach” argued
that the 50th percentile among the expected long-term rates of return
for the plan is the most appropriate discount rate. Opposition to
MVL was also expressed by a group of 43 public pension actuaries,
who also filed joint comments with GASB.
However, it is interesting to note that supporters of the “modified
conventional approach” on the Academy’s Public Plans
Subcommittee, in response to the ITC’s question concerning
what should be the primary focus for financial reporting and disclosure,
diverged somewhat from their colleagues. Specifically, the Academy
group believes that information about both the process of incurring
pension obligations as well as the process whereby those obligations
are financed should be provided by governmental accounting and financial
reporting. While they concede that information about funding costs
and liabilities is, “by far, more important for employers and
plans viewed as going concerns,” their Academy response also
states that information about benefit accruals and liabilities “could
become more important in the event that either the employer or the
plan is in financial distress.”
Therefore, they believe that the employer’s financial statement
should provide information about the process by which an employer
finances its projected future cash outflows and the plan’s
financial statement should provide information about the process
by which an employer incurs (and transfers to the plan) a benefit
obligation to employees. “Depending on the particular user,” they
point out, “only one of the financial statements might be sufficient
for the user’s specific purpose at the time.” However,
information found in both financial statements “should be considered
for a full understanding of the plan and related costs and liabilities,” they
conclude.
GASB, by its count, has received 102 separate communications in response
to the ITC, although the number of individuals and entities represented
by that figure is clearly much higher. A quick review of the responses
indicates that the majority of individuals and organizations represented
generally oppose MVL. In addition, GASB has received requests from
17 individuals/organizations to testify at a public hearing before
the GASB board. Given the number of requests, there will be two days
of hearings, one on August 26th in Norwalk, CT, and the second on
August 28th in Washington, DC.
Both sides of the MVL debate will be represented. Keith Brainard
will testify on behalf of NASRA and NCTR, while others representing
the public sector viewpoint include Rob Wylie, Executive Director
of the South Dakota Retirement System; John Chiang, California State
Controller; Nancy Kopp, Maryland State Treasurer; Luke Huelskamp
CFO, Municipal Employees’ Retirement System of Michigan, on
behalf of the Public Pension Financial Forum; and Jake Lorentz, Assistant
Director, Technical Services Center, for the Government Finance Officers
Association (GFOA). A number of public sector actuaries, including
Paul Angelo, Rick Roeder, Robert M. May, Mark R. Fenlaw, and Jim
Rizzo, will also appear.
Proponents of MVL and critics of public pensions who are scheduled
to testify include Jeremy Gold; David Crane, Special Advisor to the
Governor of California for Jobs and Economic Growth; Sheila Weinberg
with the Institute for Truth in Accounting; and Diann Shipione, former
Trustee of the San Diego City Employees’ Retirement System,
often credited with blowing the whistle on its funding problems.
Following the hearing, the GASB and its staff will review the comments
and testimony and then deliberate for several months. Any further
formal action in connection with this review project will probably
not take place until the middle of next year. Exactly what that step
will be -- a preliminary views document, or a formal exposure draft – remains
to be seen.
In any case, the first major step in what should prove to be a multi-year
process has been taken, and the public sector -- including NCTR and
its members -- has made an outstanding presentation of its concerns
with the potential application of MVL. But there is much more that
is covered by this GASB project than the discount rate, and based
on the thoughtful comments of many, there could be room for improvement
in the overall financial reporting and disclosure rules – to
the benefit of all concerned.
Public Plans Joint Letter
Letter from NCTR, 21 Other National Public Sector Organizations
Letter from 27 State Treasurers
SEC Proposes
New "Pay to Play" Rules; Would Ban Third Party Placement
Agents
The Securities and Exchange Commission (SEC) has agreed unanimously
to approve for comment a proposed new rule on so-called "pay
to play" practices involving public pension plans. The proposed
rule would also ban the use of so-called third party marketers to
solicit government entities for business on behalf of an investment
adviser. SEC Chairman Mary Shapiro said that in the public pension
and government plan world, "pay to play" refers to an "often
unspoken, but well-understood arrangement" whereby investment
advisers who make political contributions and related payments to
key officials "are then rewarded with, or afforded the opportunity
to compete for, contracts to manage public pension plans and other
government accounts." Chairman Shapiro and all the other Commissioners
stressed that public pension plans hold more than $2.2 trillion of
assets and represent one-third of all U.S. pension assets, thus underscoring
the importance of the SEC’s action.
As expected, on July 22nd, the SEC voted unanimously to propose new “pay
to play” rules designed to prevent an investment adviser from making political
contributions or hidden payments in order to improve their chances of being selected
to perform government work, particularly for public pension plans. In summary,
the SEC’s proposed new rule would (1) prohibit an investment adviser from
providing advisory services to a government entity for two years after the adviser
(or any of its covered associates) makes a political contribution to a public
official of a government entity that is in a position to influence the award
of advisory business; and (2) ban the use of so-called third party marketers
and other “gatekeepers” (who are not “related” to the
adviser) to solicit government entities for advisory business on behalf of an
investment adviser. According to the SEC, their proposed rule “would apply
broadly to investment advisory activities for government clients,” regardless
of whether or not these government clients are retirement funds.
1. Pay to Play “Time Out”
The two-year “pay to play” prohibition would be triggered
by a “contribution” by an “investment adviser” to
an “official” of a “government entity.”
The proposed rule would apply to any investment adviser registered
(or required to be registered) with the SEC, as well as to unregistered
investment advisers who are exempt from registration because they
do not hold themselves out to the public as an investment adviser
and had fewer than 15 clients during the last 12 months. The SEC
says that it is including this category of exempt advisers within
the scope of the rule “in order to make the rule applicable
to the many advisers to private investment companies that are not
registered under the Advisers Act.” The rule would not apply,
however, to most small advisers that are registered with the State
securities authorities (i.e., investment advisers with less than
$25 million in assets under management). Nevertheless, the SEC
says “We believe that the rule would apply to most advisers
to public pension plans.”
A “government entity” under the proposed rule would
include all state and local governments, their agencies and instrumentalities,
and all public pension plans and other collective government funds
such as 403(b) and 457 plans.
An “official” would include an incumbent, candidate
or successful candidate for elective office of a government entity “if
the office is directly or indirectly responsible for, or can influence
the outcome of, the selection of an investment adviser or has authority
to appoint any person who is directly or indirectly responsible
for or can influence the outcome of the selection of an investment
adviser.” Thus, not only would executive or legislative officers
who actually sit on boards (i.e., hold a position that could influence
the hiring of an investment adviser) be considered “government
officials” under the proposed rule, but it would appear that
trustees who run for their board seats would also be covered, and
a “contribution” to them would trigger the two-year “time
out.” Furthermore, the prohibition would be triggered if
the contribution were made, for example, to a governor who does
not serve on a board but who has the power to appoint a board member(s).
As for what constitutes a “contribution,” it would
generally include “any gift, subscription, loan, advance,
deposit of money, or anything of value made for the purpose of
influencing an election for a Federal, state or local office, including
any payments for debts incurred in such an election.” However,
the SEC specifically asks if it should broaden this definition
of “contribution” to include “the expenses an
investment adviser would incur in organizing or sponsoring a conference
at which a government official is invited to attend or is a speaker.” While
this could potentially cover a wide range of events and sponsorships,
it does appear that the SEC is more interested in payments of “expenses” that
could be subterfuges for the making of contributions, since the
SEC’s request for comments also wants to know, if it decides
to include such activities, how its rule should “distinguish
legitimate conferences or meetings from those that are more akin
to fundraising events.”
The proposed prohibition would apply to contributions made by
an investment adviser and its “covered associates,” which
would include the adviser’s general partners, managing members,
executive officers, or other individual with a similar status or
function. Any employee of the adviser who solicits government entity
clients for the investment adviser would also be a covered associate,
as would any political action committee (PAC) controlled by the
investment adviser or any of the adviser’s covered associates.
The SEC asks if it should “extend the rule to cover all portfolio
managers, or just those portfolio managers responsible for managing
government client assets.”
There would be an exemption for aggregate contributions of $250
or less, per election, to an elected official or candidate if the
person making the contribution is entitled to vote for the official
or candidate.
2. Ban on use of Third Party Solicitors
The proposed rule would also make it unlawful for essentially any
investment adviser or any of its covered associates to provide
or agree to provide, directly or indirectly, “payment” to
any person to solicit a government entity for investment advisory
services unless such person is: (i) a “related person” of
the investment adviser (or, if the related person is a company,
an employee of that company); or (ii) any of the adviser’s
employees, general partners, LLC managing members, executive officers
(or other person with a similar status or function, as applicable).
The rule’s prohibition on an adviser’s payments to
third-party solicitors would apply to “finders,” “solicitors,” “placement
agents,” or “pension consultants.” However, the
proposed rule would not prohibit government entities from retaining “pension
consultants” (or other third-parties) and paying them to
recommend particular investment advisers for the management of
public funds.
The proposed rule would define a “related person” of
an investment adviser as any person, directly or indirectly, controlling
or controlled by the investment adviser, and any person that is
under common control with the investment adviser. Thus, the SEC
does not include any of the following within the prohibition on
payments for solicitation of government clients: executive officers,
general partners, managing members (or, in each case, persons with
similar status or function), employees, or “related persons” of
the investment adviser.
The SEC defines “payment” as any gift, subscription,
loan, advance or deposit of money or anything of value. According
to the SEC, they are proposing this definition “to cover
the various means by which an adviser and its covered associates
may seek to compensate a third-party solicitor,” such as
a “finder’s fee.” The SEC also says that “It
could also include payments made to pension consultants for performing
various services, such as attending or sponsoring conferences,
if those services are intended to obtain government clients.”
According to the SEC’s proposal, “pension consultants” include
those who provide advice to pension plans and their trustees with
respect to their investments, selection of money managers and other
service providers, and other investment-related matters. “Pension
consultants may act as third-party solicitors,” the SEC points
out, while others “may act as investment advisers subject
to our rule.”
The proposed rules raise a number of peripheral issues. For example,
is it possible that the SEC rule could impact investment advisers
who pay expenses associated with conferences or other meetings at
which certain government officials -- including elected pension trustees
-- are present?
The Municipal Securities Rulemaking Board (MSRB) explicitly recognizes
in its "pay to play" rule (MSRB Rule G-37) -- which is
very similar to the rule proposed by the SEC for investment advisers
-- that there is a possibility that the MSRB restrictions could apply
when dealers “sponsor” meetings and conferences where
elected officials may be present. The MSRB says that in such circumstances, "it
is incumbent on dealers to have appropriate supervisory procedures
in place" to review the nature of, and activities surrounding,
these types of events in order to ensure that the MSRB rule is not
violated. The MSRB rules, which clearly are directed at ensuring
that sponsored events do not in effect become fundraising events
for the issuer official -- and are not intended to curtail the legitimate
hosting or sponsoring of meetings or conferences where issuer officials
are invited to attend or are featured speakers -- could be a model
that the SEC may choose to follow.
Then there is the issue of the impact of the ban on third party marketers
on smaller investment firms, and the efforts by many plans to help
support minority and women-owned advisers. This area was a concern
for SEC Commissioner Troy Paredes (R) when the SEC voted to propose
the new rule. Paredes said specifically that "I am particularly
interested in comments that address how the ban on the use of third
parties to solicit government business may impact smaller and less-established
advisers.” He said that his “specific concern is that
the outright ban on third-party solicitation may adversely impact
advisers who legitimately use third parties because the advisors
themselves do not have the kind of relationships and contacts needed
to compete effectively for business."
The SEC’s proposal therefore specifically asks for comments
on the extent to which the proposed ban may disproportionately impact
the ability of certain investment advisers, such as those that are
smaller and less established, to compete in the market.
Finally, there is the issue of the potential application of the new
proposed rules to securities law firms. Commissioner Paredes also
acknowledged a belief by some, including Utah Senator Robert Bennett
(R), that the rule should also cover such law firms that may make
political contributions in order to be chosen to represent public
pension funds in securities cases. In a statement following the SEC
action, Senator Bennett expressed his disappointment that this was
not included in the proposed rulemaking. (Earlier in July, Senator
Bennett sent a letter to the SEC requesting the agency expand its
review of "pay to play" cases to examine the potential
cases across the country in which private law firms received contracts
to represent pension funds soon after disbursing large campaign contributions
to elected officials managing the funds. The SEC responded by declining
the request.)
Comments are due on the proposed rule by October 6, 2009.
SEC Chairman Shapiro Statement on "Pay to Play"
Proposed "Pay to Play" Rule
NCTR,
NASRA Clarify Position on Normal Retirement Age Regulations with
Treasury, IRS
Following a meeting with Mark Iwry, the new Treasury
Deputy Assistant Secretary for Tax Policy for Retirement and
Health Policy, and IRS officials earlier in the year, at which
NCTR and
NASRA reiterated their concerns with the problems raised for
State and local governments by the IRS’ final Normal Retirement Age
regulations, a proposal has been submitted that suggests a way in
which to deal with the situation. While there has been no response
to the suggested solution to governmental plans’ issues
with the IRS regulations, a meeting with Mr. Iwry is scheduled
for September,
at which this and other public plan issues will again be discussed.
The so-called Normal Retirement Age regulations that the IRS
issued in May of 2007 actually deal with the ability of individuals
(both
public sector and private sector) to receive “in-service” distributions.
Generally speaking, the Internal Revenue Code (IRC) permits pension
distributions only after a participant terminates employment, or
reaches “normal retirement age” (or eligibility for an
unreduced benefit under the terms of the plan). These new regulations,
which currently apply to the private sector only, now additionally
permit a pension plan to pay benefits to an employee who has not
terminated if the employee has attained age 62 – which was
contained in the “Distributions During Working Retirement” provision
of the Pension Protection Act of 2006 (PPA).
With regard to what qualifies as “normal retirement age,” the
regulations require that the normal retirement age under a plan be
an age that is “not earlier than the earliest age that is reasonably
representative of the typical retirement age for the industry in
which the covered workforce is employed.” Furthermore, the
final IRS regulations – whose application to governmental
plans was extended until January of 2011 by the IRS last year
-- would,
for the first time, require governmental pension plans to specifically
define a normal retirement age, imposing a one-size-fits-all
federal definition onto governmental plans without regard to
the complexity
of State and local governing statutes in this area or the fact
that Congress generally exempted governmental plans from the
section of
the Code defining normal retirement age.
At the meeting with Iwry, NCTR and NASRA representatives explained
that many governmental plans define normal retirement age or
normal retirement date as the time or times when participants
qualify for
unreduced retirement benefits under the plan, which is set forth
in State and/or local statutes and often based wholly or partly
on years of service—a practice which the IRS has specifically
called into question in IRS Notice 2007-69 (Part VI). Other governmental
pension plans do not specifically define normal retirement age.
Many sponsors of governmental pension plans with normal retirement
ages
conditioned on service as well as sponsors of governmental pension
plans that do not employ either term have received a series of
favorable determination letters with respect to their plans.
Furthermore, under many governmental pension plans, a participant
can reach normal retirement age by satisfying one of several
age and service combinations. Sponsors of such plans would find
it very
difficult to select a single age to be the plan’s normal
retirement age. Selecting an age that is higher than the lowest
age would likely
impair the constitutionally protected rights of the participants
to any benefit conditioned on normal retirement. Selecting an
age that is lower than the highest age could impact the actuarial
cost
of the plan. NCTR and NASRA representatives underscored that
the IRS has not identified an abuse it is aiming to address with
respect
to governmental plans. Nevertheless, it is unnecessarily creating
a plan qualification issue for a substantial number of plans
covering millions of public employees that would require a State
legislative
initiative and/or an opening of the pension statutes by other
elected governmental bodies.
In order to address the problems with the Normal Retirement Age
regulations -- which were detailed in a joint NCTR/NASRA letter
to the IRS in
December, 2007– NCTR and NASRA followed up their meeting
with Mr. Iwry with a specific proposal in June.
First, defined benefit plans not subject to the ERISA vesting
rules (“non-ERISA plans” such as governmental plans) would
not be required to define normal retirement age. For those "non-ERISA
plans" that do define a normal retirement age or date, such
normal retirement age or date may be based on age, service, or a
combination of age and service. Whether or not normal retirement
age or date is specifically defined for a "non-ERISA plan," in-service
distributions by the "non-ERISA plan" would be permitted
when made on or after the earlier of age 62 or the date on which
the participant is permitted to receive unreduced benefits under
the plan.
There has been no response to the NCTR/NASRA proposal, but a meeting
with Mr. Iwry is scheduled in September at which this and other issues
such as the IRS Governmental Plans Compliance Initiative will be
discussed. It is hoped that a resolution of the problem can be developed,
without the need for additional legislation, before the current regulations
are to apply to governmental plans in 2011.
NCTR/NASRA 2007 Joint Comment Letter on Normal
Retirement Age Regulations
House
Passes "Say on Pay" Legislation while SEC Moves to
Beef Up Proxy Disclosures Related to Executive Compensation
The House of Representatives has passed legislation
that would give shareholders a so-called “say on pay” for
top executives, providing for a non-binding, advisory vote on their
company’s pay practices. It is very similar to a bill that
passed the House in the last Congress but did not get out of committee
in the Senate. In related action, the Securities and Exchange Commission
(SEC) has proposed revisions to its rules aimed at improving the
disclosure provided to shareholders of public companies regarding
compensation and corporate governance matters in proxy and information
statements. But the U.S, Chamber of Commerce is pushing back against
such corporate governance proposals, pointing to a study that purports
to show that shareholder activism by union pension funds provides
no economic benefit for plan participants, and may actually reduce
shareholder value.
On July 31st, the House approved H.R. 3269, the Corporate and Financial
Institution Compensation Fairness Act, by a vote of 237-185. The
bill would also require federal regulators to proscribe any inappropriate
or imprudently risky compensation practices as part of solvency
regulation of all financial institutions. In addition, the legislation
would require financial firms to disclose any compensation structures
that include incentive-based elements. Financial institutions with
assets of less than $1 billion would be exempt from the bill’s
incentive-based compensation disclosure requirements and related
compensation structure oversight. The legislation reflects proposals
on executive compensation and compensation committee independence
proposed by the Obama administration as part of its package of
financial reforms.
House Financial Services Committee Chairman Barney Frank (D-MA) said
that “[t]his bill responds to the broad consensus among economic
analysts and regulators that flawed compensation systems have provided
excessive risk which has contributed to the recent systemic problems
in the financial marketplace.” Chairman Frank said that under
his legislation, “the question of compensation amounts will
now be in the hands of shareholders and the question of systemic
risk will be in the hands of the government.”
Earlier in the month, the Securities and Exchange Commission (SEC)
also took steps related to executive compensation, proposing a set
of rule revisions intended to improve the disclosure provided to
shareholders of public companies regarding compensation and corporate
governance matters when voting decisions are made. These new disclosures
are designed to enhance the information included in proxy and information
statements.
SEC Chairman Mary Shapiro, explaining that the “turmoil in
the markets during the past 18 months has demonstrated the importance
of ensuring that activities that materially contribute to a company's
risk profile are fully disclosed to investors,” said that the
proposed amendments to the SEC’s proxy rules “are the
result of a re-examination during which we repeatedly asked ourselves:
are investors being provided with the right information?”
The proposed changes are intended to improve proxy-related disclosure
in four key areas:
The relationship of a company's overall compensation policies
to risk;
The qualifications of directors, executive officers and nominees;
Company leadership structure; and
Potential conflicts of interests of compensation consultants.
In addition, the proposals are aimed to improve
the reporting of annual stock and option awards to company executives
and directors as well as to require quicker reporting of election
results.
Some in Congress want to go even further. For example, Senator
Richard Durbin (D-IL), the number two Democratic leader in the
Senate, has proposed legislation (S. 1006, the “Excessive
Pay Shareholder Approval Act”) that would require a supermajority
shareholder approval for any compensation equal to or in excess
of 100 times the average compensation for employees at the company.
And Congressman Paul Kanjorski (D-PA), Chairman of the House Financial
Services Committee’s Subcommittee on Capital Markets, Insurance
and Government Sponsored Enterprises, thinks that shareholders
should be given more power to bring lawsuits against companies
for paying excessive executive compensation.
But it is not necessarily going to be all smooth sailing for proponents
of corporate governance reforms such as the “say on pay” legislation
if the U.S. Chamber of Commerce has its way. It has stepped up
its opposition to such efforts, claiming that “[b]ig labor
unions are trying to achieve at the board table what they cannot
achieve at the negotiating table, under the guise of shareholder
protection," in the words of the president of the Chamber's
Center for Capital Markets Competitiveness, David Hirchsmann.
The Chamber points to a study by Navigant Consulting
that it claims demonstrates that shareholder activism by union
pension funds provides no economic benefit for plan participants,
and may actually reduce shareholder value.
The Chamber is also linking such union activism to pension funding,
claiming that this is what is behind organized labor’s efforts
to pass the “Employee Free Choice Act” or so-called
Card Check bill. A Chamber press release issued in June quotes
Steven J. Law, the Chamber’s chief legal officer and general
counsel, as saying “Organized labor wants Card Check as a
crutch to prop up crumbling union pension funds,” and that “rather
than focusing on sound investment strategies, many labor officials
are using shareholder activism to play politics with workers’ retirement
savings.”
Therefore, despite House passage of executive compensation reform,
and the SEC’s recent actions related to proxy access proposals
and possible revisions of its proxy disclosure rules, it looks
like the Chamber is going to make it a bumpy ride for corporate
governance advocates when the Senate takes up such proposals as
part of market reform. Fasten your seatbelts!
Summary of House-passed "Say on Pay" Legislation
Obama Proposal for Independent Compensation
Committees
SEC's Proposed Revisions to Compensation on
Corporate Governance Proxy Disclosure Rules
Navigant Study on Shareholder Activism
Public
Pensions are Increasingly the Focus of SEC Activitiy
Several recent actions taken by the Securities and Exchange Commission
(SEC) indicate that there is increasing attention being paid to
public pensions – and not just in their role as institutional
investors. While the SEC’s proposed restrictions on so-called “pay
to play” activities of investment advisors was not a surprise,
an “informal inquiry” into certain public pension fund
activities initiated by the SEC’s Division of Enforcement,
and the recent announcement of the creation of a new “Municipal
Securities/Public Pension Unit” to look into unfunded and
underfunded pension liabilities, among other things, are sounding
alarm bells. Even the SEC’s acting chief accountant has gotten
into the act, expressing concerns with pension plan smoothing activities.
1. SEC Public Pension Plan “Informal Inquiry”
Beginning in May, the staff of the SEC’s Division of Enforcement
began conducting a “confidential informal inquiry” into “Certain
Public Pension Fund Activities.” The SEC’s Philadelphia
field office contacted approximately a dozen public plans, requesting
that they “voluntarily” provide the documents and/or
information requested, usually in a very short period of time.
Then, in June, press reports appeared indicating that the SEC had
also asked investment and brokerage firms to turn over “an
array” of information concerning their dealings with public
pension funds.
The SEC’s inquiry of public plans deals with a range of issues.
For example, there is a section devoted to pay-to-play payments
as well as solicitations, and conflict of interest policies. Such
questions appear to be part of an effort to update information
obtained by the SEC in this area when the first pay-to-play rules
were proposed by the SEC in 1999, and have probably been used in
connection with their recent rule making in this area.
However, there are also other questions which are more troubling.
For example, there is a lengthy section of questions dealing with “Disclosure
of Unfunded or Underfunded Liabilities,” in which plans are
asked about disclosure documents ("Official Statements")
prepared in connection with their State's general obligation bonds
or similar State-supported bond issues. These questions deal with
such things as changes in actuarial asset valuation methods, actuarial
cost methods, or amortization methods, and ask for both the effect
of those changes and “how the change was disclosed in the
Official Statements of the bond issuer.” Other questions
in this section ask for detailed information about what has been
included in these Official Statements, and then inquire if the
State has changed its Official Statements in the last five years
to include or exclude any of this information. If so, the SEC also
asks the plans to provide an explanation as to why such information
was excluded or included.
Clearly, it seems that the SEC is assuming that the pension plan
is directly involved with both the preparation of these Official
Statements, as well as the decision-making process involving what
is or is not contained in them. This blurring of the distinction
between the plan and the employer/bond issuer is made even clearer
in a series of questions asking about “pension holidays” and
payments of less than the annual required contribution (ARC), and
the reasons why the employer made these decisions. There are even
questions asking for the plan to tell the SEC if the State considered
what effect(s) the failure to make contributions would have on
future pension obligations, and if the State has analyzed its ability
to fund future pension obligations over the next ten years or more,
(and if so, how the results of this analysis were disclosed in
Official Statements). While one may have a good idea of the answers
to such questions, is it really appropriate for a plan to speak
for the employer in such cases?
It would therefore appear that the SEC considers the plan and its
governing body to essentially be one and the same as the employer.
This viewpoint coincides with that reflected in the SEC’s
dealings with the City of San Diego and its violations of the antifraud
provisions of the Federal securities laws in connection with the
offer and sale of over $260 million in municipal bonds in 2002
and 2003.
In that case, San Diego was found to have failed to disclose material
information regarding substantial and growing liabilities for its
pension plan and retiree health care and its ability to pay those
obligations in the future in the disclosure documents for its 2002
and 2003 offerings, in its continuing disclosures filed in 2003,
and in its presentations to the rating agencies.
Furthermore, the SEC found the San Diego City Employees’ Retirement
System – which was administered by a board which, during
the relevant period, included eight City employees, including the
City Treasurer and the Assistant City Auditor and Comptroller,
one retiree, and three non-employee City citizens appointed by
the City Council – to be a “related party” in
the case.
The SEC settlement is replete with characterizations of the City “instructing” the
pension plan to take certain actions, such as using “surplus
earnings” to fund additional benefits for members, and with
the plan board agreeing to the City’s proposals in part because
the majority of the board consisted of City officials who received
benefit increases that were contingent on the board’s approval.
The chairman of the City of San Diego’s Pension Reform Committee
that submitted a report to the mayor and city council in 2004 on
the overall funding crisis, has recently put it this way: “During
the Pension Reform Committee process, we realized that one of the
underlying problems with the administration of the system was that
a majority of the retirement board members had a vested interest
in reducing the sponsor’s required payment.” She goes
on to say that “Additionally, because the plan sponsor has
full responsibility for actuarial variances and the employees only
share in the payment of Normal Cost, there was motivation and a
tendency for the board to make aggressive assumptions regarding
the assumed rate of return on invested funds.”
As confirmation of this perception of the public pension world
through the lens of the SEC’s experience with the City of
San Diego, the SEC’s inquiry also specifically asks if pension
funds are aware of the SEC’s 2006 Cease-And-Desist Order
in the Matter of City of San Diego, and whether and to what extent
the State or any of its pension funds “has taken any action,
made any changes in its policies or procedures, or made any other
changes in response to this Order.” Specifically, the SEC
wants to know if training has been provided to employees responsible
for creating and/or updating disclosures regarding pension funds
in Official Statements.
The SEC is also interested generally in whether plans have policies
and procedures to ensure compliance with the Federal securities
laws; whether Federal securities law training to its employees
are provided; and whether plans have a compliance officer who is
responsible for ensuring compliance with the Federal securities
laws. This is a clear reference to the SEC’s Report of Investigation
involving the Retirement Systems of Alabama, released in 2008,
which was issued, in the words of the SEC, “to emphasize
the responsibilities of all investment professionals, including
large public retirement systems and other public entities, under
the federal securities laws and to highlight the risks they undertake
when they operate without a compliance program.”
Finally, there is a section of questions that appear to be focused
on the adequacy of disclosure of investment risks by investment
advisers. However, questions in this section also could be viewed
as raising issues about a plan’s overall investment strategies,
particularly as they relate to certain types of investments. For
example, not only does the SEC want to know if plans invested in
a bond fund, hedge fund, private equity fund, cash collateral pool
or similar investment vehicle, but “where the actual investments
were different than the stated investment objectives.” The
SEC also wants to know, if so, “why the actual investments
differed from those investment objectives.”
Based on reports, it appears that a new round of such inquiries
may have been recently sent out. Where does the SEC get its authority
to make such detailed inquiries of public plans, and where does
all of this activity appear to be leading? The creation of a new
unit within the SEC’s Division of Enforcement may provide
some of the answers.
2. New SEC “Municipal Securities/Public Pension Unit”
In a recent speech, Robert Khuzamii, the new Director of the SEC’s
Division of Enforcement, announced as his “first major initiative” the
introduction of five national specialized units “dedicated
to particular highly specialized and complex areas of securities
law.” One of these new units is the Municipal Securities
and Public Pensions Unit.
As Khuzamii explained it, “The market for municipal securities
is huge, and there is every reason to believe that the size and
importance of these markets will continue to grow, as the nation's
infrastructure needs increase and more and more investors seek
safe investment opportunities.” He said that a number of
areas “appear ripe for scrutiny,” including offering
and disclosure issues, tax and arbitrage-driven activity, “unfunded
or underfunded liabilities,” and pay-to-play schemes.
The new Enforcement chief explained that these new specialized
units “will provide the structure and resources for staff
to ‘get smart’ about certain products, markets, regulatory
regimes, practices and transactions,” and will permit the
Enforcement Division “to be better investigators, because
we will be more efficient and less likely to be misled by those
who use complexity to conceal their misconduct.” He said
that such specialization will also permit the SEC to be more proactive
and enable them to treat problems “systemically, swiftly
and thoroughly and on an industry-wide basis where appropriate.”
Each new unit will be headed by a Unit Chief, and will be staffed
by people in the Division “who already have expertise in
these topics, or have a desire to learn.” “They will
receive specialized and advanced training,” Khuzamii said,
and individuals with practical market experience and other expertise
will also be hired.
Undoubtedly, the SEC’s informal public pension inquiry is
linked to the creation of this new Unit. Unfortunately, however,
as noted above, their experience with public pensions seems limited
to the City of San Diego case, and based on reports from pension
plans who have spoken with SEC staff working on the project, their
knowledge of pensions appears limited to private sector ERISA plans.
Accordingly, they appear to be working off the premise that the
employer and the plan are essentially one and the same.
As for their jurisdiction over public plans, the San Diego case
provides an explanation. While State and local governments are
exempt from the registration and reporting provisions of the Securities
Act and the Exchange Act, and the SEC’s authority to establish
rules for accounting and financial reporting does not extend to
municipal securities issuers, State and municipal securities issuers
are nevertheless still subject to the antifraud provisions of Securities
law. That is, any disclosures and other statements made to the
market in connection with the offer or sale of securities cannot
contain misrepresentations or omissions of material facts, and
the SEC can take enforcement action if such misrepresentations
or omissions are done with the intent to deceive, manipulate or
defraud.
Thus, it would appear that the SEC’s inquiries are essentially
attempting to determine possible links between pension plans’ funded
status and potential misrepresentations or omissions contained
in disclosure documents prepared in connection with their sponsor’s
bond issues.
This much seems certain: the ultimate purpose of the Unit is surely
linked to the SEC’s efforts to obtain greater authority over
the municipal bond market. In recent days, the SEC has made it
clear that it thinks it should have greater control of municipal
accounting standards; increased regulation of market intermediaries;
and the ability to change the composition of the Municipal Securities
Rulemaking Board (MSRB) – which currently has two-thirds
of it 15 members made up of bank and securities dealers – to
make it into a more independent self-regulator.
In order to do so, the SEC would have to convince Congress to repeal
the so-called Tower Amendment, which prevents the SEC (as well
as the MSRB) from directly or indirectly requiring municipal bond
issuers to file documents with them before their securities are
sold. Therefore, if the SEC can build a strong case that pension
plans’ unfunded or underfunded status is not being accurately
disclosed, then it could potentially bolster its arguments in favor
of expanded jurisdiction in this area.
Of course, this then raises the question of how “accuracy” is
measured. Misrepresentations can clearly occur if the issuer fails
to accurately disclose information provided to it by the pension
plan. But what if the question is whether the pension plan failed
to accurately measure its funded status in the first place, which
was then the cause for inaccuracies in the issuer’s public
disclosures?
As Shakespeare’s Hamlet would say, “Therein lies the
rub.” Is the SEC positioning itself to become the arbiter of
such judgment calls? Is this new Unit also part of the SEC’s
desire to acquire the same type of statutory authority over financial
accounting and reporting standards for State and local governments
as it has over publicly held companies? After all, it is no secret
that the SEC wants oversight authority over GASB similar to that
provided over FASB in the Sarbanes-Oxley Act of 2002. Is the SEC
beginning to try to do indirectly what it is not permitted to do
directly?
In any case, this involvement by the SEC in public pension plan funding
of liabilities poses a number of serious concerns. One has only to
look at the SEC’s actions related to private sector pensions
and smoothing to get a flavor of what could be in the works. For
example, in 2004 the SEC began investigating pension accounting at
several large corporations, including General Motors (GM). Kenneth
Lench, an assistant director in the SEC's Division of Enforcement,
was quoted at the time as saying that "Among other things, we're
looking to see if companies have reverse-engineered the rates to
get to a certain financial result." Mr. Lench is still in his
position at the SEC.
GM ultimately settled its case and the SEC filed settled charges
in January of this year relating to GM’s disclosures concerning
two pension accounting estimates and other matters. With regard to
GM's pension plans, the SEC alleged that GM made material misstatements
or omissions concerning two pension accounting estimates - its pension
discount rate for 2002 and its expected return on pension assets
for 2003. Among the problems the SEC cited was GM’s public
statement that it used a duration matched approach to select its
discount rate, but failed to later disclose that its use of a 6.75%
discount rate was developed from a non-duration matched approach,
which was materially higher than the rate developed from a duration
matched model. The SEC also alleged that since at least the mid-1980s,
GM's expected return assumption had never been higher than its most
recent 10 year average return, and that it failed to disclose that
its most recent 10 year average return was below its new assumption.
GM settled the charges, without admitting or denying the allegations.
As for smoothing, the SEC has historically been opposed to its use
in a number of areas, and specifically opposed its use for private
sector pensions in a June, 2005 staff report prepared pursuant to
the Sarbanes-Oxley Act of 2002. Most recently, James Kroeker, SEC
acting chief accountant, said in May that the Commission will look “very
skeptically” at pension funds that change accounting methods
to “smooth out” losses incurred in the current financial
crisis. Kroeker reportedly said at the 28th annual SEC Financial
Reporting Institute Conference that the SEC would be scrutinizing
any attempt to reduce the transparency of a pension fund's assets
by changing amortization schedules.
It is therefore essential that the SEC and its Division of Enforcement
gain a better understanding of the differences between private sector
pensions, with which they are familiar, and the public sector plans,
before their inquiries and the work of their new unit goes any further.
It is also important for them to understand the typical structure
of public plans and the independence of the plan from its sponsor,
notwithstanding their experience with San Diego. NCTR will be working
with other national organizations representing the public sector
to help ensure that this educational process is effectively and expeditiously
undertaken.
City of San Diego Cease and Desist Order
SEC Report on Investigation Concerning Retirement Systems of
Alabama
FBAR
Update: Confusion Over Filing Requirement Continues
Despite repeated requests from numerous groups to the Internal
Revenue Service (IRS) for clarification, it is still unclear as
to whether or not public pension plans and their employees could
be required to file a “Report of Foreign Bank and Financial
Accounts" (Form TD F 90-22.1), commonly referred to as "FBAR." While
the issue is being sorted out, the IRS has extended until June
30, 2010, the FBAR filing deadlines for the 2008 and earlier calendar
years for certain persons. The issue of whether or not foreign
hedge funds or foreign private equity accounts constitute a financial
account subject to FBAR reporting obligations is also still unclear,
at least in the minds of some.
Many things may be unclear regarding FBAR filings, but one thing
is not: the IRS is definitely increasing enforcement of FBAR filing
requirements. While these reports have generally been required
for almost 40 years for persons with a financial interest in, or "signature
or other authority" over, a foreign "financial account" of
more than $10,000, enforcement has been relatively lax. However,
since the law was amended in 2001 by the International Money Laundering
Abatement and Financial Anti-Terrorism Act of 2001 (an act within
the USA Patriot Act of 2001), and given the IRS need for enhanced
revenue sources, such as taxpayers with undisclosed foreign bank
accounts, things are heating up.
In the past, since the original purpose of the law that created
the FBAR filings (The Bank Secrecy Act of 1970) was to detect and
prevent taxpayers from hiding assets offshore to avoid income taxes
or launder money, it was generally thought that pension funds and
other tax exempt entities were not intended to be subject to the
filing requirements. Furthermore, under the Bank Secrecy Act language,
unless the Treasury Secretary decides otherwise, it appears that
governmental entities are essentially exempt from coverage. Finally,
foreign financial accounts subject to FBAR reporting were generally
thought to exclude foreign hedge funds and foreign private equity
funds.
But all that began to change in October of 2008, when the IRS made
modifications to the FBAR. Under these changes, the definition
of “financial account” was clarified to include “any
accounts in which the assets are held in a commingled fund, and
the account owner holds an equity interest in the fund (including
mutual funds).” There were soon rumblings that this clarification
could mean that private offshore funds could be subject to FBAR.
However, things came to a head on June 12th of this year, when
IRS representatives on a panel discussing FBAR stated that an offshore
hedge fund is a “foreign financial account” for FBAR
purposes, and, accordingly, every U.S. investor in such a fund
must file an FBAR for 2008 and the preceding five years. They also
reportedly said that any foreign partnership or foreign corporation
that was used to commingle funds for investment would also be covered.
Since the FBAR reports were due June 30th, there was much confusion
and concern raised, as hedge funds began notifying pension clients
of this filing obligation.
The IRS has provided a number of responses. First, an IRS spokesperson
reportedly confirmed to the press that the IRS’ position
was that investments in foreign hedge funds and private equity
funds were indeed reportable under FBAR. The IRS also announced
that filers would be given until September 23, 2009, to file FBAR
for the 2008 calendar year if they have (1) only recently learned
of their obligation to file FBAR; (2) insufficient time to gather
the necessary information; and (3) reported and paid all 2008 taxable
income, if any. Even though such FBAR filings made after June 30
will still be viewed as delinquent, and are required to be filed
with a statement explaining the delinquency, the IRS said it will
not impose “failure to file” penalties in such cases.
Most recently, the IRS issued a notice on August 7th announcing
an extended filing date for (i) persons with signature authority
over, but no financial interest in, a foreign financial account,
and (ii) persons with a financial interest in, or signature authority
over, a foreign commingled fund, such as offshore private equity
funds and hedge funds. These persons now have until June 30, 2010,
to file an FBAR for the 2008 and earlier calendar years. The IRS
has also announced that the Department of the Treasury has requested
public comments regarding the FBAR filing requirement for both
groups.
A number of law firms and others have already filed comments with
both the Treasury Department and the IRS arguing that governmental
pension plans are not subject to FBAR requirements. For example,
on July 16th, Ice Miller wrote the Treasury Department arguing
that the rule under the Bank Secrecy Act is that, unless the Secretary
of the Treasury promulgates rules expressly including governmental
entities, “there is no reporting requirement imposed on the
States and their subdivisions” and that this would prevail
over any argument that pension funds are covered under the general
trust inclusion. “Our review of the Treasury Regulations
and other guidance does not reveal that the Secretary of Treasury
has taken the action necessary to cover governmental entities,
including governmental plans, with the FBAR reporting requirements,” their
letter concludes.
Then there is the matter of whether or not interests in hedge funds
and private equity funds are in fact subject to FBAR reporting.
The latest IRS notice does not specifically address this issue;
however, by relieving persons with interests in such funds from
filing until next June, the IRS has clearly given itself time to
provide clearer guidance in this regard. On this point, the New
York State Bar Association has already filed lengthy comments with
the Treasury and the IRS, along with its criticism of the manner
in which the application of FBAR to such funds has been handled
to date and its request for a one year moratorium in filings which
the IRS has now effectively granted.
Therefore, the application of FBAR to governmental plans appears
to still be very much up in the air, as is the issue of its application
to hedge funds. The answers that the Treasury Department and the
IRS will hopefully provide during this filing extension are of
major importance. While governmental plans clearly do not want
to be perceived in any way as trying to avoid transparency with
regard to their investments – nor as unwilling to cooperate
with regulatory schemes that are aimed, in part, at the fight against
terrorism -- the FBAR requirement, particularly as it could apply
to persons with signature authority, could be a very heavy burden.
Furthermore, non-compliance could be costly: non-willful violations
can result in a $10,000 penalty, while willful violations can trigger
a penalty of the greater of $100,000 or 50% of the balance of the
account at the time of the violation. There are also criminal penalties
for willful violations.
The deadline for filing comments with the Treasury Department in
connection with questions raised in the latest IRS extension is
October 6, 2009.
IRS Notice of FBAR Filing Extension
NY State Bar Association Letter
Credit
Rating Agency Reforms Proposed by Obama Administration
The Obama Administration has now forwarded its ideas for the reform
of credit rating agencies to Capitol Hill. While the Treasury Department
proposal would ban credit rating agencies (also known as Nationally
Recognized Statistical Rating Organization, or NRSROs) from providing
other services, such as consulting, to any company that they also
rate, it would not change the current compensation structure for
the industry. Nor does the proposal deal directly with the current
limitations on the liability of credit rating agencies. Nevertheless,
this so-called immunity from lawsuits has not prevented the filing
of a major lawsuit against the industry by the nation’s largest
public pension plan.
On July 21st, the Treasury Department released its proposals to
reform the credit rating industry, which has been severely criticized
by many, both in Congress and within the public pension plan community
and elsewhere, for its role in the current economic crisis. According
to a “Fact Sheet” released by the Obama Administration,
the proposal would “tighten oversight of credit rating agencies,
protect investors from inappropriate rating agency practices, and
bring increased transparency to the credit rating process.”
In subsequent testimony before the Senate Banking Committee on
August 5th, Michael S. Barr, Treasury Assistant Secretary for Financial
Institutions, explained the proposal in more detail. Barr began
by noting that credit ratings “played an enabling role in
the buildup of risk and contributed to the deep fragility that
was exposed in the past two years.”
However, Barr went on to note that “[w]hile there were clear
failures in credit rating agency methodologies,” the Obama
Administration’s proposals “continue to endorse the
divide established by this Committee in 2006: The government should
not be in the business of regulating or evaluating the methodologies
themselves, or the performance of ratings.” Barr said that
to do so “would put the government in the position of validating
private sector actors and would likely exacerbate over-reliance
on ratings.” Nevertheless, Barr acknowledged that the government “should
make sure that rating agencies perform the services that they claim
to perform” and that the Administration proposal authorizes
the SEC to audit the rating agencies “to make sure that they
are complying with their own stated procedures.”
Barr described the Obama Administration’s legislative proposal as addressing
three primary problems in the role of credit rating agencies: lack of transparency,
ratings shopping, and conflicts of interest.
Transparency:
Require that each rating be supported by a public report containing
assessments of data reliability, the probability of default,
the estimated severity of loss in the event of default, and the
sensitivity of a rating to changes in assumptions.
Require that rating agencies use ratings symbols that distinguish
between structured and unstructured financial products in order
to address the need to consider the different risks posed by
these new financial instruments.
Ratings Shopping (where an issuer may attempt to “shop” among
rating agencies by soliciting “preliminary ratings” from
multiple agencies and enlisting the agency that provides the
highest preliminary rating):
Require an issuer to disclose all of the preliminary ratings
it had received from different credit rating agencies so that
investors could see how much the issuer had “shopped” and
whether the final rating exceeded one or more preliminary ratings.
Require issuers to provide the same data they provide to one
credit rating agency as the basis of a contracted rating to all
other credit rating agencies, thus allowing other credit rating
agencies to provide additional, independent analyses of the issuer
to the market based on the same information as the fully contracted
ratings, which is especially important for structured products
that are often complex and require detailed information to assess.
Conflicts of Interest:
Ban rating agencies from providing consulting services to issuers
that they also rate.
Prohibit or require the management and disclosure of conflicts
arising from the way a rating agency is paid, its business relationships,
its affiliations, or other sources.
Require a rating to include a disclosure of the fees paid for
the particular rating, as well as the total fees paid to the
rating agency by the issuer in the previous two years.
Require credit rating agencies to designate a compliance officer,
with explicit requirements that this officer report directly
to the board or the senior officer, and that the compliance officer
have the authority to address any conflicts that arise within
the agency.
Require credit rating agencies to institute reviews of ratings
in cases where their employees go work for issuers, to reduce
potential conflicts from a “revolving door.”
The Administration proposal also would support the SEC’s
efforts to establish a branch of examiners dedicated specifically
to conducting examination oversight of credit rating agencies,
and create a dedicated office for supervision of rating agencies
within the Commission. The Administration would also make registration
mandatory for all credit rating agencies.
The Administration’s proposal has come under fire in two
main areas. First, critics complain that there is no proposal to
specifically reform credit rating agency compensation practices.
The current practice is for issuers to pay for the ratings of the
products they are going to be selling, which in the eyes of many
poses a clear conflict of interest for the rating agencies. Many
think that this practice places the rating agencies under pressure
to give their clients a favorable rating, or else the issuer will
choose another rating agency. In the past, Senator Jim Bunning
(R-KY) said the process was “like a film production company
paying a critic to review a movie, and then using that review in
its advertising."
As Professor John C. Coffee, Jr. with the Columbia University Law
School, testified before the Senate Banking Committee’s August
5th hearing, “Because the ratings agencies receive an estimated
90% of their revenues from issuers who are paying for their ratings,
the agencies will predictably continue to have a strong desire
to please the client who pays them.” “Moreover,” he
warned, “the market for ratings has become more competitive,
and the latest empirical research finds that, with greater competition,
there has come an increased tendency to inflate ratings.”
One alternative that has been suggested is a subscriber/investor-pays
model. Congressman Paul Kanjorski (D-PA), Chairman of the House
Financial Services Committee’s Subcommittee on Capital Markets,
Insurance and Government Sponsored Enterprises thinks that this
alternative model is “worthy of our consideration,” noting
that at one time, all rating agencies received their revenue from
subscribers.
However, in a recent “white paper” issued by the Council
of Institutional Investors (CII) in April of this year, entitled “Rethinking
Regulation of Credit Rating Agencies: An Institutional Investor
Perspective,” it was pointed out that investor-pay credit
rating agencies “are subject to potential pressure from clients
to slide ratings one way or another.” For example, institutions
that can only invest in highly rated instruments “might pressure
a rater to guarantee a particular security gets an investment-grade
rating,” while other “might press the rating agencies
for lower ratings in hopes of receiving higher returns.”
The Administration defends its approach by arguing that they want “to
solve these problems within the current framework rather than prohibiting
specific models of rating agency compensation.” Barr told
the Senate Banking Committee that “we do not believe it is
the place of government to prescribe allowable business models
in the free market,” and that under the Administration’s
approach, it will be “simple for investors to understand
the conflicts in any rating that they read and allow them to make
their own judgment of its relevance to their investment decision.”
The second area where disappointment has been expressed concerning
the Obama approach deals with its lack of a response to the issue
of rating agency liability. Professor Coffee called it “the
most serious failing” in the proposed legislation.
Currently, credit rating agencies are effectively exempt from civil
liability. They are statutorily exempt from liability under Section
11 of the Securities Act of 1933, and are further protected from
private rights of action under the Credit Rating Agency Reform
Act of 2006. According to Professor Coffee, they have even argued
that the 2006 law preempted state tort law and thus they are protected
from common law fraud actions as well. Finally, credit rating agencies
have been successful before the courts in claiming that their ratings
are “opinions,” and therefore, under the First Amendment,
they are protected speech and deserve the same safeguards as those
given to opinions of publishers.
However, many take an opposing view. For example, Barbara Roeper,
president of the Consumer Federation of America, has been quoted
as saying that if credit rating agencies were legally liable, “if
they knew they could be sued for being reckless and issuing ratings
of which they have inadequate basis, then they might be more careful...
or to say 'I don't know' about risks they don't understand.” “At
the very least,” Ms. Roeper argues, “if they were liable,
they might have reexamined their methodologies."
Congressman Kanjorski also has a problem with this exemption from
liability. At a May 19th hearing before his House Subcommittee
entitled “Approaches to Improving Credit Rating Agency Regulation,” he
said that the view that the agencies are “mere publishers
issuing opinions bears little resemblance to reality, and the threat
of civil liability would force the industry to issue more accurate
ratings.” The Congressman went on to suggest that, “[m]uch
like the other gatekeepers to our markets, namely lawyers and auditors,
we could choose to impose some degree of public accountability
for rating agencies via statute.”
At the Kanjorski hearing, Gregory Smith, General Counsel of the
Colorado Public Employees’ Retirement Association, testified
and recommended just such an imposition of accountability by:
Removing credit rating agencies’ exemption from liability
for forward looking statements in Section 21E of the Securities
Exchange Act of 1934;
Removing the agencies’ exemption from misstatements in
registration statements in Section 11 of the Securities Act of
1933;
Removing their exemption from liability as experts under Securities
Act Rule 436; and
Adopting legislation indicating that credit rating agencies
are subject to private rights of action under specified statutory
criteria, including the failure to conduct a reasonable investigation
into the accuracy of the information used to rate a security
or to have obtained reasonable verification from other sources
independent of the issuer.
As Mr. Smith explained to the Subcommittee, “Legislation
clarifying the accountability of credit rating agencies certified
as NRSROs will effectively, and correctly, elevate the standards
of quality required of NRSROs to the same level as the market and
regulators have set for other vital financial gatekeepers.”
Senator Jack Reed (D-RI), Chairman of the Senate Banking Committee’s
Securities, Insurance, and Investment Subcommittee, also thinks
that some degree of liability may be appropriate, and has introduced
a bill, the Rating Accountability and Transparency Enhancement
(RATE) Act of 2009 (S.1073) , that would hold credit rating agencies
liable when it can be proved that they knowingly failed to review
factual elements for determining a rating based on their methodology
or failed to reasonably verify that factual information. "Credit
rating firms like any other industry should be held accountable
if they knowingly or recklessly mislead investors," said Senator
Reed.
And speaking of liability, despite the limitations noted above,
the California Public Employees Retirement System (CalPERS) has
just sued the major credit rating agencies in connection with their
conduct leading up to the current economic downturn. The suit was
filed on July 9th in California Superior Court in San Francisco
against Moody's Corp.'s Moody's Investors Service, the Standard & Poor's
unit of McGraw-Hill Cos. and Fimalac SA's Fitch Ratings.
CalPERS asserts two causes of action: negligent misrepresentation
and negligent interference with prospective economic advantage.
The case focuses on the three credit rating agencies’ giving
their highest credit ratings to three structured investment vehicles
(SIVs) – Cheyne Finance LLC, Stanfield Victoria Funding LLC
and Sigma Finance, Inc. – in which CalPERS invested a total
of $1.3 billion and which collapsed in 2007 and 2008, defaulting
on their payment obligations and costing CalPERS “perhaps
more than $1 billion of investment losses.”
CalPERS alleges that these credit ratings “ultimately proved
to be wildly inaccurate and unreasonably high,” and that
the credit rating agencies, which by ratings represented the SIVs
as most likely able to withstand an economic depression, “were
structured with Rating Agency participation in a manner that used
certain flawed assumptions which ended up ensuring SIV’s
collapse when a recession actually occurred.” According to
CalPERS, the rating agencies “no longer played a passive
role, but would help the arrangers structure their deals so that
they could rate them as highly as possible.” CalPERS quotes
former CEO of Moody’s, Brian Clarkson, as saying “You
start with a rating and build a deal around a rating.”
CalPERS says that it relied on the agencies’ representations
made in connection with their ratings of these SIVs, but they proved
to be “untrue because the ratings were inaccurate and unjustifiable.” “Without
the high credit ratings there would have been no market for SIVs,” and
CalPERS claims that it “would never have come to invest in
them.” Furthermore, according to the pension plan, "no
amount of due diligence" by its own analysts could have given
CalPERS "actual knowledge" of how conflicts of interest
at the ratings agencies affected the agencies’ assessment
of SIVs.
CalPERS will have its work cut out for it if the past record of
the credit rating industry is any indication. As Professor Coffee
noted in his Senate testimony, while it is not possible to be aware
of every possible settlement in Federal or state court, recent
surveys by legal scholars suggest that ratings agencies appear
never to have been held liable. As he notes, even in the case of
Enron, “a proceeding in which underwriters paid over $7 billion
in settlements, the credit rating agencies escaped liability.”
As for the Administration’s proposal, it is likely to eventually
be considered as part of a larger package of financial markets
reforms when the Congress returns from its August recess. Whether
it will have some of the above-noted deficiencies addressed remains
to be seen.
Fact Sheet on Obama Adminstration Credit Rating Agency Reform
Proposal
Senate Banking Committee Hearing on Administration Proposal
Testimony of COPERA General Counsel Smith before House Financial
Services Committee
Senator Reed's Credit Rating Reform Legislation
CalPERS Lawsuit
Institutional Investors
Once Again Under the Microscope for Being Oil "Speculators" -
and Possibly Under the Gun, as Congress and the Administration
Consider New Restrictions on Commodities
Trading
Institutional investors, including public pension plans, are once
again being seen by some as speculators, responsible for driving
up oil prices – and therefore the price of gas at the pump.
The Commodity Futures Trading Commission (CFTC) has just finished
a series of hearings on the subject of speculation in energy markets
and is considering whether to issue new rules to limit such. The
new CFTC Chairman thinks it would be a good idea, and some members
of Congress agree with him, while others have their own ideas about
ways to reduce speculation in the energy markets that are aimed
directly at pension plans. In the meantime, it appears that an
agreement may have been reached in principal on the regulation
of over-the-counter (OTC) derivatives, which has been a major bone
of contention between the CFTC, and its Congressional overseers,
and the Securities and Exchange Commission (SEC). Finally, the
Obama Administration has also weighed in with its legislative suggestions
regarding derivatives regulation, which will become part of the
overall reform of the financial markets that Congress will finally
attempt to undertake when it returns from its August recess.
The CFTC held three hearings during July and early August to address
the current application of position limits and the exemptions from
position limits in energy markets. The new CFTC Chairman, Gary
Gensler, wants to consider having the CFTC set Federal “speculative” limits” for
commodities of “finite supply,” in particular energy
commodities, such as crude oil, heating oil, natural gas, gasoline
and other energy products.
Currently, the CFTC sets and enforces position limits on certain
agriculture products, but does not do so for energy markets. Instead,
futures exchanges set position limits and accountability levels
for energy commodities, and they are not required to set and enforce
position limits to address excessive speculation. Gensler wants
to review this difference in treatment, and the hearings explored
several ideas, such as applying position limits consistently across
all markets and participants, including index traders and managers
of Exchange Traded Funds. Another area, which the CFTC is currently
reviewing, is whether the bona fide hedge exemption should continue
to apply to persons using the futures markets to hedge risks other
than risks arising from the actual use of a commodity.
Last year, when gasoline prices soared above $4 a gallon during
the summer, many Members of Congress were ready to blame the sky
high prices on excessive speculation in the oil futures market,
and public pension funds were specifically named as among the chief
culprits. Senator Joseph Lieberman (I-CT) was even contemplating
introducing legislation that would include a prohibition on institutional
investments in commodity futures altogether, and in late July,
a prohibition on institutional investor “speculation” in
the commodities markets was proposed as part of a comprehensive
bill dealing with the CFTC in the House. In effect, it would have
amounted to a ban on pension fund investments in commodities, and
it was only narrowly defeated in Committee.
This year, gasoline prices have once again risen over the summer
months. As the Washington Post observed in a July 14th story, given
that demand was low, “the global economy was sagging, and
the world's oil consumers and producers were brimming with excess
supply,” you would think that prices would be down. However, “the
monthly average price of crude oil jumped $10 a barrel from February
to April, another $10 in May and again in June,” according
to the newspaper, while gasoline prices in the United States “rose
54 days in a row, and AAA called the increases through May "the
largest five-month retail advance this century."
Therefore, once again it should come as no surprise that there
are calls for something to be done about speculators. While pension
funds are not featured as prominently as they were in 2008 as being
to blame, they still get mentioned, but much more of the wrath
seems to be focused on Wall Street – for now. Nevertheless,
if the CFTC were to classify all bank holding companies and hedge
funds engaged in energy futures trading as noncommercial participants
and subject them to strict position limits -- as some are suggesting,
including Senator Bernard Sanders (I-VT) -- institutional investors
would clearly feel the impact. Whether, at the end of the day,
this kind of action or other restrictions could have the same practical
effect as an outright ban remains to be seen, but the point is,
changes appear to be clearly in the works that could have a significant
impact on legitimate hedging activities of pension funds.
While Gensler seems ready to impose some restrictions, it is still
not clear if the CFTC as a body is ready to go as far as he may
want to go. However, a new report by the CFTC is expected any day
that will look at the types of firms, such as banks and hedge funds,
and the positions they hold in energy investments. While CFTC officials
reportedly insist that this new report will not directly address
whether speculation is influencing oil prices, it could serve to
document that the market is dominated by a few players.
This, in turn, could be seen as evidence of the need for restrictions
on speculation. In fact, CFTC Commissioner Bart Chilton (D) is
already quoted as calling this new report a “better report” and
that he thinks people “will have a greater degree of confidence
in it -- especially when compared to the report we issued last
year." In 2008, the CFTC issued a report, over his objections,
that found that supply and demand, not speculation, was to blame
for last year’s gasoline price spikes.
While the CFTC appears poised to act in this area, there are some
in Congress who have other ideas to help address undesirable speculation.
For example, Senator Ron Wyden (D-OR) has recently introduced legislation
that would require pension funds and other tax-exempt entities
to pay taxes on their investment returns from oil and gas futures.
His legislation, the “Stop Tax-breaks for Oil Profiteering
(STOP) Act of 2009,” would require tax-exempt entities, including
pension funds, to pay “unrelated-business-income tax” (UBTI)
on these profits. Wyden says UBTI already exists as a well-established
tax obligation for income that is not directly related to the tax
exempt purpose of the organization. “UBTI was created precisely
to keep tax exempt organizations from competing unfairly with taxpaying
businesses, which is what they are doing when they enter the commodity
markets solely for investment income purposes,” Senator Wyden
argues. His legislation would also prevent tax exempt organizations
from investing in off-shore funds to try to avoid the new UBTI
tax.
The Oregon Democrat says he is troubled that commercial traders
(who have a commercial need to buy, sell and hedge their purchases
of oil) pay taxes on whatever profits they make on trading at the
same rates as ordinary income, while speculators “get a much
better deal from the tax code,” either paying capital gains
taxes or, in the case of pension funds or endowments, no tax whatsoever.
While Wyden supports closing trading loopholes, he says his bill
is aimed at “the giant financial bubble that’s been
created by people who are simply chasing speculative profits in
the commodities markets and creating artificial demand that is
driving up prices.” The Senator claims that his bill “will
let some of the air out of this speculative balloon and help create
a level playing field among companies participating in the commodity
markets.”
In the meantime, in another sensitive area involving the CFTC,
progress appears to have been made concerning the regulation of
over-the-counter (OTC) derivatives. House Financial Services Committee
Chairman Barney Frank (D-MA), whose Committee has jurisdiction
over the SEC, and House Agriculture Committee Chairman Collin Peterson
(D-MN), whose Committee has jurisdiction over the CFTC, have apparently
reached an agreement in principle that will serve as a guide for
their two Committees as they work to develop legislation to regulate
derivatives.
The two Chairmen aimed at finding a middle ground between those
who wanted to completely eliminate the over-the-counter market
and those who thought that increased transparency would be sufficient. “The
fundamental purpose here is to improve the regulation of derivatives
so that they continue to perform their important market function
but are less likely to contribute to a kind of irresponsibility
that can cause a crisis,” Chairman Frank was quoted as saying.
Depending on the underlying asset on which a derivative is based,
either the SEC or the CFTC, or potentially both, will oversee the
regulation of OTC derivative dealers, exchanges and clearinghouses.
Each agency would have enforcement authority over products under
its jurisdiction, with joint enforcement authority for any products
subject to joint jurisdiction. Until this agreement, there had
been an intense struggle between the two Committees as to who and
how derivatives would be handled, which was further complicated
by initial rumors that the CFTC and the SEC would be merged as
part of the general overhaul of the financial markets.
The principles also include mandatory clearing of OTC derivatives;
the strengthening of capital and margin requirements; the protection
of U.S. financial institutions from lesser regulatory standards
in other countries; and the settlement of any disputes between
the SEC and CFTC over authority over new products given to a new
Financial Services Oversight Council.
As for the issue of speculation, there are at least two options
that will be considered:
A limitation on speculation involving a prohibition on any purchase
of credit protection using a credit-default swaps (CDS) contract
unless the party owns the referenced security or (one or more)
of the securities in an index of securities; the party has a
bona fide economic interest that will be protected by the contract;
or the party is a bona fide market maker. Regulators would have
authority to monitor market activity and impose position limit
where necessary; or
Enhanced oversight of speculative positions, which will require
confidential reporting to the appropriate regulator of all short
interest in CDS contracts by OTC derivatives dealers, investment
advisers that manage in excess of $100 million;, and other entities
that are deemed “major market participants.”
In order to prevent abuse, the appropriate regulator would have
authority to impose position limits on market participants and
ban the purchase of credit protection using CDS by any non-dealer
that is not hedging a risk.
The Obama Administration has also now submitted its formal legislative
proposals for the regulation of OTC derivatives. Much of it tracks
this Congressional agreement, but there are some significant differences
dealing with the role of the Federal Reserve in the clearing process.
These differences, and others, will have to be ironed out when
the Congress returns from its August recess and begins working
in earnest on the various market reform proposals that the Obama
Administration has now submitted for consideration.
In fact, the OTC derivatives package was the final piece in what
the Administration refers to as “a comprehensive package
of financial regulatory reform legislation” that has successfully
translated all of the proposals set out in the Administration’s
white paper, "Financial Regulatory Reform: A New Foundation," released
on June 17th, into detailed legislative text – “a remarkable
effort in both speed and scope,” if they do say so themselves
--and they do.
Will they feel as pleased with their “comprehensive package” when
Congress gets through chewing on it?
Gensler Statement
Senator Sanders Statement
Wyden "Stop Tax-breaks for Oil Profiteering (STOP) Act"
Obama Administration Proposal to Regulate OTC Derivatives Market
Snapshots
“Snapshots” is a new feature of the NCTR
Federal e-NEWS, intended to give you a very brief summary of
an issue,
event, or publication(s), and then provide links to appropriate
back-up materials. This is not intended to replace the more in-depth
analysis of issues which will continue to be the primary focus
of the e-News, but will allow coverage of a larger number of issues
of interest to NCTR members.
Will Lack of Social Security COLA Increase
Some Public Sector Medicare Part B Premiums?
Public Pension Plans Meet at White House
to Discuss Market Reforms
Congressman Pomeroy Proposes Incentives
for Annuitization of Retirement Savings
NCSL Updates Listing of State Legislative
Actions Affecting Pensions
New CRS Report on 401(K) Plans and Retirement Savings
Issues
New Report from State Legislator Group Blasts Public Pension
Actuarial Accounting Techniques
Society of Actuaries Seeking Models for New Retirement
Systems
GASB Issues First Ever Exposure Draft
on Chapter 9 Municipal Bankruptcies
SEC Creates New Investor Advisory Committee
NIRS Releases New Report on Costs of Failed Retirement
Will
Lack of Social Security COLA Increase Some Public Sector Medicare
Part B Premiums?
Recent declines in consumer prices and low expected inflation
during the next few years is expected to translate into no COLAs
in Social Security benefits until 2013. Because of the way the
Medicare Part B premium is funded, it is expected that approximately
one quarter of all Medicare beneficiaries will have to pay a higher
Medicare Part B premium than they would otherwise. Furthermore,
as a percentage of the current premium, the increases will be significant.
The reason for the increase is because most Medicare enrollees
have their Part B premium withheld from their monthly Social Security
benefit, and for those individuals, a “hold-harmless” provision
guarantees that a benefit check will not decrease as a result of
an increase in the Part B premium. That is, the dollar increase
in the Part B premium for a year is compared to the dollar increase
in the Social Security monthly benefit, and if the dollar increase
in the premium is larger than the dollar increase in the Social
Security benefit, then the increase in the Part B premium paid
by the beneficiary is limited to the dollar increase in the Social
Security benefit.
Thus, when there is no increase in the Social Security benefit
to offset the Medicare Part B premium increase, then the hold-harmless
means that these Social Security recipients are not required to
pay the Medicare Part B increase.
But this is not true for everyone. For example new enrollees in
Part B (because they did not have the premium withheld from their
Social Security benefit in the prior year), will not be covered
by the hold-harmless. Higher-income enrollees who are subject to
an income-related premium, as well as individuals who do not have
the Part B premium withheld from their Social Security benefit
(nearly all of whom have their premiums paid by Medicaid) will
also not receive the protection.
And what about public employees who are not covered by Social Security?
It would appear that they are also going to fall into this group
who will not receive the protection from the hold-harmless provision.
According to the “Director’s Blog” of Douglas
W. Elmendorf, the Director of the Congressional Budget Office (CBO),
because almost three-quarters of Part B enrollees will be subject
to the hold-harmless provision, the increase in Medicare Part B
premium revenue needed to draw matching contributions sufficient
to cover the growth in annual spending and maintain the contingency
reserve will have to be collected from the one-quarter of enrollees
who are not eligible for the protection of the hold-harmless provision. “As
a result, the current-law increase in the monthly Part B premium
for those individuals will be nearly four times the increase that
would be required if no enrollees were subject to the hold-harmless
provision,” Mr. Elmendorf estimates.
CBO estimates that the hold-harmless provision, in conjunction
with the zero COLAs projected for Social Security benefits, will
result in the monthly Part B premium for beneficiaries not subject
to the hold-harmless provision increasing to $119 in 2010, $123
in 2011, and $128 in 2012. “Without the hold-harmless provision,
CBO estimates that the monthly premium would be $103 in 2010 and
would grow to about $109 in 2012, so the interaction of the hold-harmless
provision and projected zero COLAs for Social Security will add
significantly to the increases called for under current law,” Mr.
Elmendorf says. There is no effect on Part D premiums because there
is no hold-harmless provision in Part D.
CBO Director's Blog Entry on the Medicare Part B Premium Increase
Public
Pension Plans Meet at White House to Discuss Market Reforms
Representatives of public and private sector pension funds, including
many NCTR members, were invited to meet with senior White House
and Treasury officials in August to discuss their thoughts and
concerns related to the Obama Administration market reform proposals.
Diana Farrell, deputy director of the National Economic Council,
and Michael Barr, Assistant Secretary for Financial Institutions
at the Treasury Department, led the one-hour meeting.
Topics discussed by the pension representatives included corporate
governance; systemic risk; disclosures related to OTC derivatives’ hedge
fund registration; regulation of credit rating agencies; resolution
authority for failed companies; and pension fund oversight.
Council of Institutional Investors Press Release
Congressman
Pomeroy Proposes Incentives for Annuitization of Retirement
Savings
Congressman Earl Pomeroy (D-ND), a strong supporter of public
pensions and the first recipient of NCTR’s “Award for
Outstanding Service to Public Pensions,” has introduced a
bipartisan bill along with Congresswoman Ginny Brown-Waite (R-FL)
that would encourage retirees to take a portion of their retirement
savings in the form of an annuity.
The “Retirement Security Needs Lifetime Pay Act,” H.R.
2748, would provide a 50 percent tax exclusion for up $10,000 of
lifetime annuity payments each year. In addition, the bill would
exclude from taxes, 25 percent of lifetime income payments from
Individual Retirement Accounts (IRAs), qualified plans and similar
employer-sponsored retirement savings plans other than defined
benefit plans. The bill also excludes the value of longevity insurance
from amounts subject to required minimum distributions and clarifies
the taxation of partial annuity payments.
The bill has been referred to the House Committee on Ways and Means,
of which both Pomeroy and Brown-Waite are members.
Pomeroy Press Release
H.R. 2748
NCSL Updates
Listing of State Legislative Actions Affecting Pensions
For an idea of what other states are doing regarding possible
changes to their pension plans in light of the current economic
downturn, you may want to check out the National Conference of
State Legislatures (NCSL) “State Pensions and Retirement
Legislation 2009.”
According to Ron Snell, who handles this posting of legislative
activity pertaining to public retirement systems for NCSL, the “principal
theme in pensions legislation in 2009 was the need to make future
pension costs manageable in the light of states' straitened fiscal
circumstances and the enormous losses most retirement trust funds
have experienced.” A number of tactics were pursued, including
revised benefit packages for future employees to require longer
service or higher ages for retirement, discourage early retirement
even with reduced benefits, limit future cost-of-living adjustments,
and tighten standards for disability retirement. However, no state
created a new defined contribution plan as its primary retirement
package for public employees, or as an option for existing or new
employees.
Mr. Snell reports that few benefit increases were enacted, and
reductions in various forms appeared in a number of states. Some
states also increased employer and employee contribution rates.
NCSL's 2009 State Pensions and Retirement Legislation Summary
New CRS
Report on 401(K) Plans and Retirement Savings Issues
The Congressional Research Service (CRS) released a report in
July that describes seven major policy issues with respect to defined
contribution plans. Here is how the CRS describes them:
1. ACCESS TO EMPLOYER-SPONSORED RETIREMENT PLANS. In 2007, only
61% of employees in the private sector were offered a retirement
plan of any kind at work. Fifty-five percent were offered a DC
plan. Only 45% of workers at establishments with fewer than 100
employees were offered a retirement plan of any kind in 2007. Forty-two
percent were offered a defined contribution plan.
2. PARTICIPATION IN EMPLOYER-SPONSORED PLANS. Between 20% and
25% of workers whose employer offers a DC plan do not participate.
Workers under age 35 are less likely than older workers to
participate.
3. CONTRIBUTION RATES. On average, participants in DC plans
contributed 6% of pay to the plan in 2007. The median contribution
by household
heads who participated in a DC plan in 2007 was $3,360. This
was just 22% of the maximum allowable contribution of $15,500
in that
year.
4. INVESTMENT CHOICES. At year-end 2007, 78% of all DC plan
assets were invested in stocks and stock mutual funds.
This ratio varied
little by age, indicating that many workers nearing retirement
were heavily invested in stocks and risked substantial
losses in a market downturn like that in 2008. Investment
education
and target
date funds could help workers make better investment decisions.
5. FEE DISCLOSURE. Retirement plans contract with service
providers to provide investment management, record-keeping,
and other
services. There can be many service providers, each charging
a fee that is
ultimately paid by participants in 401(k) plans. The arrangements
through which service providers are compensated can be
very complicated and fees are often not clearly disclosed.
6. LEAKAGE FROM RETIREMENT SAVINGS. Pre-retirement withdrawals
from retirement accounts are sometimes called leakages.
Current law represents a compromise between limiting leakages
from
retirement accounts and allowing people to have access
to their retirement
funds in times of great need. In general, borrowing from
a 401(k) plan poses less risk to retirement security than
a withdrawal.
Pre-retirement withdrawals can have adverse long-term effects
on
retirement income.
7. CONVERTING RETIREMENT SAVINGS INTO INCOME. Retirees
face many financial risks, including living longer than
they expected,
investment
losses, inflation, and possible large expenses for medical
care and long-term care. Annuities can protect retirees
from some of
these risks, but few retirees purchase them. Developing
polices that motivate retirees to convert assets into a
reliable
source of income will be a continuing challenge for Congress
and other
policymakers.
CRS works exclusively for the United States Congress, providing
policy and legal analysis to committees and Members of both the
House and Senate, regardless of party affiliation. As a legislative
branch agency within the Library of Congress, CRS has been a valued
and respected resource on Capitol Hill for nearly a century.
CRS 401(k) Report
New Report
from State Legislator Group Blasts Public Pension Actuarial Accounting
Technique
A new report from the American Legislative Exchange Council (ALEC)
entitled “Is There a Gorilla in Your Backyard?” finds
that, in the case of pension plans, many jurisdictions continue
to use actuarial accounting techniques that do not meet appropriate
standards. For example, the report notes that “some pension
plans use an infinite time horizon, rather than the recommended
30 year time frame. Many pension plans assume a rate of return
on assets that exceeds more prudent assumptions recommended by
actuaries.” The report says that these are “fatal flaws” that
overstate the funding ratio and do not provide an accurate picture
of the funding status of pension plans.
The solution to both the pension and OPEB funding problems, according
to this report, is to first adopt the private sector approach when
dealing with unfunded liabilities. “There is no reason,” the
report asserts, “why public pension and OPEB plans should
not be brought into line with similar private plans.” Is
this a reference to the use of MVL?
The second part of the solution is to replace defined benefit plans
with defined contribution plans. The model, the report says, should
be Alaska. However, the report fails to note that there is legislation
pending for Alaska to return to the DB plan model.
With more than 2,000 members, ALEC represents itself as the nation's
largest nonpartisan, individual membership association of state
legislators, with one-third of all state legislators belonging
to the organization. According to its website, ALEC traces its
origins back more than thirty years, when “a small group
of state legislators and conservative policy advocates met in Chicago
to implement a vision: A nonpartisan membership association for
conservative state lawmakers who shared a common belief in limited
government, free markets, federalism, and individual liberty.”
"Is there a Gorilla in your Backyard?"
Society of Actuaries Seeking Models
for New Retirement Systems
The Society of Actuaries (SOA) Pension Section Council is calling
for models to solicit ideas for new tier II retirement systems
that align with the principles outlined in its Retirement 20/20
initiative. Retirement 20/20 is a strategic initiative of the SOA
Pension Section “to find new retirement systems that meet
the needs of stakeholders better than the existing DB/DC models.” It
is intended to “generate a better understanding of how adequate
and affordable retirement income can be generated in North America
throughout the next century.”
The deadline for statements of intent has been extended to September
15, 2009. Submissions are encouraged either by individuals or organizations
for new tier II retirement systems that “fit within the context
of the social insurance system, culture, work patterns and social
values in Canada and/or the United States.” According to
the SOA, its Pension Section plans to support this call for models
by awarding cash prizes for the top qualified submissions.
Retirement 20/20 was launched, according to the SOA, “in
reaction to the shortcomings of both traditional defined benefit
(DB) plans and defined contribution (DC) plans, shortcomings which
have been further accentuated during the current financial crisis.”
Retirement 20/20 Calls for Models
GASB Issues
First Ever Exposure Draft on Chapter9 Municipal Bankruptcies
In a sign of the times, the Governmental Accounting Standards
Board (GASB) released its first ever Exposure Draft (ED) of a proposed
Statement on Accounting and Financial Reporting for Chapter 9 Bankruptcies
in late June. The ED contains proposals intended to improve consistency
in the financial reporting and the measurement of the effects of
Chapter 9 bankruptcy.
The proposed Statement on Chapter 9 bankruptcies would provide
guidance for state and local governments that have petitioned for
protection from creditors by filing for bankruptcy under Chapter
9 of the United States Bankruptcy Code. It would establish requirements
for recognizing and measuring the effects of the bankruptcy process
on assets and liabilities, and for classifying changes in those
items and related costs.
According to Robert Attmore, GASB chairman, “With the current economic
environment putting stress on state and local government resources, it became
necessary for the GASB to address the financial reporting issues associated with
local governments filing for bankruptcy protection under Chapter 9.”
Exposure Draft on Chapter 9 Bankruptcies Statement
SEC Creates
New Investor Advisory Committee
The Securities and Exchange Commission (SEC) has formed an Investor
Advisory Committee to give investors a greater voice in the Commission's
work. SEC Commissioner Luis A. Aguilar (D) will serve as the Commission's
primary sponsor of the Committee, and Ann Yerger, Executive Director
of the Council of Institutional Investors has been named as a member.
According to the SEC, the new group will advise the Commission
on matters of concern to investors in the securities markets; provide
investors' perspectives on current, non-enforcement, regulatory
issues; and serve as a source of information and recommendations
to the Commission regarding the SEC’s regulatory programs
from the point of view of investors.
The Advisory Committee will be co-chaired by Richard (Mac) Hisey,
President of AARP Financial Incorporated and AARP Funds, and Hye-Won
Choi, Senior Vice President and Head of Corporate Governance for
TIAA-CREF. Fred Joseph, President of the North American Securities
Administrators Association and Securities Administrator for the
State of Colorado, will be an ex officio participant.
SEC Press Release on Investor Advisory Committee
NIRS Releases New Report on Costs of Failed Retirement
The National Institute on Retirement Security (NIRS) has released
a new report entitled “The Pension Factor: Assessing the
Role in Defined Benefit Plans in Reducing Elder Hardships.” The
new report documents the critical role that defined benefit pension
income plays in reducing the risk of poverty and hardship for older
Americans. Poverty rates among older households lacking pension
income are about six times greater than those with such income,
according to the NIRS study.
The study also finds that pensions reduce – and in some cases
eliminate – the greater risk of poverty and public assistance
dependence that women and minority populations otherwise would
face.
Perhaps most significantly, the NIRS study documents $7.3 billion
in public assistance expenditures savings, representing about 8.5
percent of aggregate public assistance dollars received by all
American households for the same benefit programs. That is, but
for the success of the DB model, governments would have to pay
billions in public assistance costs.
In short, governments can either pay for the retirement security
of their employees “up front,” through contributions
to well-managed, cost-effective, efficient DB plans, or they can
pay later in the form of public assistance. Given the inefficiencies
often cited with such assistance programs, and the possibility
that retirees could be in worse shape than they would otherwise
have been, would the costs to government of the later approach
be even higher than they might otherwise have paid to a support
a DB plan?
The Pension Factor
|
