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Federal
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October 2007
GAO Report on Public Retirement Benefits Released The Government Accountability Office (GAO) has finally released its long-awaited report on State and local government retiree benefits, and it is much better than was initially feared. The report finds that, in general, public pensions are well-funded and well-managed, and that state and local governments are likely to need to raise their contribution rates only slightly to meet future pension costs. With regard to retiree health care costs, the report confirmed that these were only now really beginning to be addressed, and that these future costs will likely more than double as a percentage of salaries between 2006 and 2050, assuming retiree health care costs continue to be funded on a pay-as-you-go basis. The GAO study was requested in July of 2006 by the leaders of the Senate Finance Committee, Senators Chuck Grassley (R-IA) and Max Baucus (D-MT). (See August 2006 NCTR Federal e-News) The two powerful Senators claimed that the study was needed in order to "help public employees avoid the benefit losses and reduced accruals experienced by their private sector counterparts." They asked the GAO to provide an overview of state and local government retiree benefits, including (1) the types of benefits provided and how they are structured, (2) how retiree benefits are protected and managed, and (3) the fiscal outlook for retiree benefits and what governments are doing to ensure they can meet their future commitments. The Grassley/Baucus letter contained a number of troublesome characterizations of public sector funding that led some to believe that they were looking for a study that would serve as the basis for Federal intervention in this area. However, the GAO’s report is hardly a condemnation of the public sector’s pre-funding of retiree benefits, finding instead that “Across our site visit locations, we found that state and local governments employ a variety of strategies to keep the funding status of their pension plans on track.” The GAO also found that public pension benefits, once accrued, are generally protected, and that public pensions systems are typically managed as trust funds with board oversight – despite many recent media reports to the contrary! A model GAO developed to simulate the fiscal outlook for state and local governments indicates that, for the sector as a whole, estimated future pension costs (currently about 9 percent of employee pay) would require an increase in annual government contribution rates of less than a half percent, assuming future rates of return are more or less in line with historic experience. (The GAO simulation based its expected real yield on actual returns on various investment instruments over the last 40 years as well as the disposition of the portfolio of assets held by the sector over the last 10 years, generating a real yield of 5 percent.) However, the GAO also cautioned that while strategies are being used to keep the funding of most plans “on track,” it also found some “notable exceptions where the failure to use such strategies caused the funding status to drop significantly.” In the GAO’s view, “continued diligence will be necessary to ensure that funding is adequate in the future.” The report specifically points out “When state and local governments take breaks from their regular contribution schedules, such as when investment returns are high, they may be putting their ability to pay future retiree benefits at risk.” Finally, the GAO conditioned its rosy pension scenario by noting that “our long-term projections indicate that if future returns turn out lower than expected, governments may need to ratchet up their contributions substantially.” While much of this seems obvious to NCTR members, it is nevertheless good to have the well-respected GAO clearly state the impact of these variables, over which system administrators and boards often have little or no control. Turning to retiree health care, the GAO said that long-term strategies to address escalating health care costs for retirees are “generally lacking.” Based on its study, the GAO found that public officials are just beginning to estimate the amount of their unfunded liability for retiree health care costs in response to the GASB accounting standards, and that they had not yet developed strategies to manage them. The GAO report did a good job in separating retiree health care obligations from pensions. For example, it noted that retiree health benefits are less likely to have statutory protections applicable to them, and to the extent that any such legal protections exist, “they more frequently stem from the negotiated agreements between unions and government employers.” The GAO also underscored that the cost of annual retiree health benefits typically have been treated as an operating expense for that year’s costs on a pay-as-you-go basis. “State and local governments typically do not set aside funds while employees are working to pay their future retiree health benefits,” the GAO stressed. According to the GAO’s simulation studies, projected costs for retiree health benefits, “while not as large a component of state and local government budgets as pensions, will more than double as a percentage of salaries over the next several decades, if these costs continue to be funded on a pay-as-you-go basis.” In 2006, the GAO report notes, these costs amounted to approximately 2.0 percent of salaries, but by 2050, they will grow to 5.0 percent of salaries, representing a 150 percent increase. “The key reason for this substantial increase is the more general rise in health care costs, which, if left unconstrained, will continue to cause costs to rise as a percentage of salaries,” GAO said. The study also points out that in addition to the costs associated with providing health care benefits for their active and retired workers, “states also must contend with rising costs for their uninsured residents and federal changes to Medicaid.” On balance, the GAO report should prove to be an important, objective source of positive information concerning public pension funding, as well as a good primer for the media and others in distinguishing between pensions and retiree health care costs. Furthermore, the GAO report may also serve to provide important ammunition in the debate over “financial economics,” whose proponents argue that only “riskless returns” should be considered – that is, all pension funds should be invested in very safe financial instruments such as government bonds. When the GAO estimated the necessary steady level of employer contributions holding all elements in its model stable except the real expected yield, and used a 3 percent real yield which GAO said is a reasonable proxy for a riskless rate of return, the GAO found that the necessary contribution rates would need to be much higher—nearly 18.6 percent of wages. Thus, financial economics would result in more than a doubling of the annual government contribution rates, currently about 9 percent of employee pay, as compared to the expected increase of less than a half percent (assuming only a 5 percent yield) under the current approach used by public plans. GAO
Report on State and Local Government Retiree Benefits In mid-October, following hearings on the issue at which the Bush Administration strongly opposed divestment efforts at the state and local level, the Senate Banking Committee unanimously approved Sudan divestment legislation. The Senate bill endorses divestment by state and local governments, but it does not call for lists of so-called “bad actors” to be developed by the Federal government for use in such efforts. Furthermore, it would impose certain new requirements on those who choose to divest. Although the action clears the measure for consideration by the full Senate, nothing has yet to be scheduled. However, given the strong bipartisan support for the bill in Committee, it should easily pass the Senate when it is brought up for consideration. On October 17, the Senate Committee on Banking, Housing and Urban Affairs ordered reported the Sudan Accountability and Divestment Act (S. 2271). Before approving the legislation, the Committee held a hearing on the subject on October 3 at which the Bush Administration raised serious concerns with the issue of divestiture in general and the specifics of proposed legislation, including the House-passed bill (See July/August 2007 NCTR Federal e-News) in particular. The general theme sounded by Administration officials was that the new sanctions imposed by the United States in May are beginning to work and that it is therefore important to avoid any action – including legislative measures – that might set back the progress that has been made thus far. “We are also concerned that some initiatives to increase economic pressure on Sudan will damage our relationship with our key partners rather than increase pressure in Khartoum,” warned the U.S. Assistant Secretary of State for African Affairs. Specifically with regard to divestiture, the Administration witnesses argued that they had no position on private independent action by individual investors based on private-sector research and analysis, but that the President opposed Federal legislation to explicitly authorize divestment campaigns at the state and local level. Such divestment efforts were wrong, according to the State Department witnesses, for a number of reasons: · State and local divestment efforts create the appearance of a “multiplicity of foreign policies,” which undercuts the flexibility and the clarity of the President’s foreign policy messages, thereby “undermin[ing] the President’s Constitutional responsibilities to conduct foreign affairs for the Nation.” · Required divestment will be seen by allies as a U.S. government action targeting their companies and could affect America’s ability to obtain cooperation on mutual action with respect to Sudan. Furthermore, in what was characterized as “a broader spillover effect,” such Sudan measures “could also jeopardize the cooperation of these key partners on other countries of concern such as Iran, North Korea, and Burma.” · Divestment will compound Southern Sudan’s problems in attracting U.S. and foreign investors, and could even interfere with development assistance projects.
· These divestment efforts politicize capital markets. Turning to the specifics of the House-passed legislation and other similar proposals, the Administration criticized the “safe harbor” provisions exempting private sector fiduciaries from their ERISA duties of prudence and loyalty when divesting the plan from investments or avoiding investing plan assets. “By removing these essential protections, such a measure could harm workers, retirees and their families, allowing them no recourse for their losses,” according to the Principal Deputy Assistant Secretary of State for International Finance and Development. However, as expected, the provision that drew the most detailed opposition from the Administration was that requiring the development by the Federal government of a list of companies who could be appropriate subjects of divestiture. The State Department referred to them as “blacklists” that would target our allies and impair multilateral efforts to aid the Darfur peace process. The Treasury Department went further, underscoring how any such list “will necessarily be incomplete because it would not identify those companies whose involvement in Sudan is not sufficiently established or is known only through classified information;” would create “difficult issues in determining what type and amount of evidence would suffice to include a company on the list;” and would impose an “ongoing, burdensome requirement on the agency tasked with its creation,” diverting resources from other important government functions. Presumably such difficulties and related costs would not be too much to expect others to struggle with. But, take heart: Treasury also notes that there are “relevant lists already available from non-governmental sources” that you can use! The Senate Baking Committee’s subsequent action reflected many of the concerns raised by the Administration with the House-passed approach. For example, while the Committee’s bill authorizes State/local divestment, it does not contain a requirement that the Treasury Department establish a list of companies operating in the Sudan to be used for such purpose. Instead, the legislation simply requires the use of “credible information available to the public” by State and local governments in identifying candidates for divestment. In addition, with regard to Federal contracting restrictions, the Senate approach would be to require that companies, in order to obtain a Federal contract, would have to certify that they do not conduct business operations in Sudan that include power production activities, mineral extraction activities, oil-related activities, or the production of military equipment. Perhaps the most significant change for State and local governments would be new requirements that must be met in order to enjoy the authority (and protections) the legislation offers. Specifically, these new requirements would be:
2. There must be a 90-day period after the written notice is provided before the actual divestment measure is “applied;” and 3. The U.S. Department of Justice must be notified within 30 days after the State or local government “adopts” such a measure. The Banking Committee explains these requirements as follows: “In order to ensure reasonable consistency and uniformity, the
Committee sets forth specific standards by which States and localities
may divest, and requires that a State or local government provide notice
to the Department of Justice when it enacts a Sudan-related divestment
law under the authority provided in this section. The standards for
divestment to be observed include targeting companies that conduct business
operations in Sudan's power production, mineral extraction, oil, and
military equipment sectors. Furthermore, to avoid hampering positive
development in Sudan, this section explicitly excludes companies whose
business in Sudan only involves: investments in the regional government
of Southern Sudan; legal transactions under a license from the Office
of Foreign Assets Control (OFAC) or other U.S. authorization; delivery
of goods and services for marginalized populations or internationally
recognized humanitarian organizations, and other similar investments.
In addition, companies that have voluntarily suspended operations are
to be excluded from targeted divestment. The Committee recognizes that
it may take up to a year, or possibly longer, for a company to fully
suspend its operations once it has initiated such a process. Therefore,
those agencies implementing measures adopted pursuant to this section
should review all credible information provided to demonstrate voluntary
suspension. In order to facilitate this process, the Committee has required
that companies be informed in writing by the State or local government
before divestment. Companies then have at least 90 days to comment on
that decision.” What happens next? It is still unclear if the White House feels satisfied with the Senate Committee’s action and whether it believes the Senate can prevail in conference with the House on this measure. Assuming that the legislation does not get a “hold” placed on it by a Senator, it should easily pass the Senate once it reaches the floor of that chamber. However, given the differences in approach between the House and Senate versions, it may still be some time yet before a final measure is cleared for President Bush’s signature – or veto? S.
2271 GPO/WEP To Be Subject of Senate Hearing; Mandatory Social Security Could be In Play Following intense pressure from retired Massachusetts public employees, Senator John Kerry (D-MA) has agreed to hold hearings on the Government Pension Offset (GPO) and the Windfall Elimination Provision (WEP). According to the Committee to Preserve Retirement Security (CPRS), the subject of mandatory Social Security coverage for all public employees is expected to be raised at the hearing as one possible solution to the problems posed by the two controversial provisions of Federal law – and a way to pay for the costs associated with their repeal. The Senate Finance Committee's Subcommittee on Social Security, Pensions and Family Policy has announced a hearing on “GPO and WEP: Policies Affecting Pensions from Work Not Covered by Social Security” for November 6. The Subcommittee’s Chairman, John Kerry, (D-MA), has been under increasing pressure to hold a hearing since earlier this year, when he announced that “I personally believe that the best way to address this legislation is in the context of an overhaul to the Social Security Program.” Kerry also said that he feared a hearing on the subject of repeal of GPO and WEP “has the potential to reopen the debate on private accounts and actually move us backwards in terms of finding a solution." The GPO cuts Social Security spousal or survivor benefits by two-thirds of the amount of an individual's public pension. According to the NEA, nationwide, more than one-third of teachers and education employees, and more than one-fifth of other public employees, are subject to the Government Pension Offset. The WEP reduces the earned Social Security benefits of an individual who also receives a public pension from a job not covered by Social Security. Senator Kerry has cosponsored reform of GPO and WEP in the past. For example, he introduced legislation in the 107th and 108th Congresses exempting retirees whose combined Social Security and public pension benefits are less than $2,000 a month from WEP. Under his bill, WEP would gradually phase in for those receiving combined benefits between $2,000 and $3,000 per month, while those receiving more than $3,000 per month would still be fully affected by WEP. He is currently a cosponsor of S. 206, legislation introduced by Senator Dianne Feinstein (D-CA) to repeal both the GPO and WEP, which currently has 33 other cosponsors. Witnesses are expected to include a retired teacher from Massachusetts who will discuss the personal impact the GPO/WEP has had on her and on her fellow retired teachers; a representative of AFSCME who will discuss GPO/WEP and universal coverage from a national perspective; and a representative of the Government Accountability Office (GAO), who will present GAO and Social Security Administration data regarding the issue. In addition, according to CPRS, there are also reports that a representative of the Urban Institute has also been invited to discuss universal Social Security coverage as a possible solution to the current GPO/WEP problem, possibly at the request of the Republican members of the subcommittee. The Urban Institute has previously released a paper by Peter Orzag and Peter Diamond that suggests possible reforms for GPO and WEP and suggests that mandating coverage for all new hires of state and local workers would eventually make the complications associated with GPO and WEP disappear. CPRS will be filing a statement for the record. Any individual or organization wanting to present their views for inclusion in the hearing record should submit a typewritten, single-spaced statement, not exceeding 10 pages in length. The title and date of the hearing, and the full name and address of the individual or organization must appear on the first page of the statement. Statements must be received no later than two weeks following the conclusion of the hearing, and should be mailed (not faxed) to the Senate Committee on Finance, Attn. Editorial and Document Section, Rm. SD-203, Dirksen Senate Office Bldg., Washington, DC 20510-6200b Reforming
the GPO and WEP in Social Security By Peter A. Diamond and Peter R.
Orszag As Focus on Fees Increases, New Legislation to Regulate DC Plans Introduced
The House Ways and Means Committee held a hearing on 401(k), 457, and 403(b) fees on October 30, continuing the trend of increased Congressional interest in the fees associated with DC plans that began in the House of Representatives soon after the 2006 elections. (See December 2006 NCTR Federal e-News). While earlier examinations of the issue and proposed legislative responses have taken place in the House Committee on Education and Labor, with jurisdiction over only ERISA plans, interest has now spread to the Ways and Means Committee, which has jurisdiction over all plans. Congressman George Miller (D-CA), Chairman of the Education and Labor Committee, kicked off the month with a hearing in his Committee on legislation he has introduced called the “401(k) Fair Disclosure for Retirement Security Act” (H.R. 3185). Mr. Miller held hearings earlier in the year on the impact of hidden fees for 401(k) plan participants (see March 2007 NCTR Federal e-News) and has decided that while some fees may be reasonable and necessary, the overall situation has grown untenable. At the October 4 hearing, Congressman Miller complained about what he refers to as a “dizzying array” of fees, including revenue sharing fees; wrap fees; finders’ fees; shelf space fees; surrender charges; and 12(b)(1) fees, to name a few. “I’m sure that many workers, if they knew about these fees, would not be willing to pay them,” the Congressman has concluded. His legislation would therefore require plan administrators to disclose all fees charged to plan participants each year in easily-understood language; provide participants with more detailed information on investment strategies, risks, and returns when they sign up for a 401(k) plan; and ensure that all fees and conflicts of interest are disclosed annually to employers who sponsor 401(k) plans. Perhaps the most controversial aspect of his legislation is the requirement that employers offer at least one low-cost index fund as an investment option for employees participating in 401(k) plans. As he explains, “Studies have shown that index funds outperform an overwhelming majority of actively managed, often higher-cost funds.” Congressman Miller believes “Plan participants don’t have to choose to invest in the index fund if they don't want to, but they should be able to make that choice for themselves.” Now the Ways and Means Committee has taken up the cause, with Chairman Charles Rangel (D-NY) expressing his concerns that as DC plans have grown, they have produced “a shift of the burden of saving for retirement” from employers to employees. Individuals’ ability to make wise investment choices and monitor account activity to ensure efficient use of funds has become critical, as these DC funds can be easily eroded through what he referred to as “excessive investment costs.” As an example of this, the Congressional Research Service (CRS) released a new report on October 17 that examined the effect of expenses ranging from 0.4% to 2.0% of assets on the amounts accumulated in retirement accounts over a thirty-year period by married couples and single persons with high, median, and low earnings. CRS found that expenses paid by plan participants can “substantially reduce” their retirement account balances. For example, a median-earning couple who contribute 6% of family earnings each year for 30 years to a retirement account with annual expenses equal to 2.0% of plan assets (invested two-thirds in stocks and one-third in bonds) could expect to accumulate $263,333, which is 26.0% less than the $356,434 they could accumulate if they had been in a low-cost plan with annual expenses equal to 0.4% of plan assets. Chairman Rangel also points out that “As assets in DC plans grow, so does the Federal subsidy for the savings held in these plans.” For example, he notes that the “tax expenditure” – that is, the revenue forgone by the Federal government to support policies through tax preferences, deductions, and credits – is $40 billion annually for 401(k)’s, while 403(b)’s and 457’s combined cost the government $52 billion. The five-year grand total “cost” for these three DC plans is $561 billion in otherwise collectible taxes. Rangel argues that if employees are going to be expected to “shoulder the cost of saving adequately for their retirement,” and the Federal government is going to subsidize these efforts to the tune of hundreds of billions of dollars, then “we have a duty to make sure that our Federal dollars are efficiently and effectively working for the benefit of our workers.” Rangel says that “We need to make sure that these subsidies are being reflected in the account balances of these workers.” The Ways and Means Committee hearing did not focus on specific legislative proposals, but witnesses let it be know of their concerns with several bills that have been introduced, including the Miller proposal as well as a recent measure by Congressman Richard Neal (D-MA), Chairman of the Ways and Means Subcommittee on Select Revenue Measures. Neal’s bill, the “Defined Contribution Plan Fee Transparency Act of 2007” (H.R. 3765), would require employers to provide two separate disclosures regarding plan investments and fees – at enrollment and annually. It would also require service providers to provide various fee information to plan administrators in advance of a contract for plan services. The Department of Labor expressed its concerns with proposals that would mandate specific investment options, such as George Miller’s approach, saying that they would limit “the ability of employers and workers together to design plans that best serve their mutual needs.” The Labor Department also expressed its worry about other proposals that would mandate lengthy, detailed disclosures to participants. “Participants are most likely to benefit from concise disclosures that allow them to meaningfully compare the investment options in their plans,” the Labor Department insisted. The Government Accountability Office (GAO) also talked about the “voluminous
amount of information that could be disclosed,” and warned that
determining what information is truly relevant “is key.”
GAO believes that at a minimum, information such as expense ratios or
other investment-specific fee information should be included, but also
stresses that the information must be “accessible” in terms
of the language, layout, length, comparability, and distribution so
that that participants can actually use it. In addition to NAGDCA, other testimony referring to public plans also came from the American Society of Pension Professionals & Actuaries (AAPPA), and the Council of Independent 401(k) Recordkeepers (CIKR). They noted that while much of the conversation about the fee disclosure issue focuses on 401(k) plans, “the issues are identical for 403(b) and 457 plans.” They recognized that technical details would differ to some degree in applying disclosure of fees and expenses rules to these plans. However, they stressed “the need for these rules is every bit as acute for 403(b) and 457 plans as it is for 401(k) plans,” and that “ASPPA and CIKR recommend that fee disclosure legislation apply to all self-directed account pension plans.” Finally, and perhaps most surprisingly for some, W. Thomas Reeder, Esq., Benefits Tax Counsel with the Treasury Department’s Office of Tax Policy, spoke approvingly of the present structure of State and local government supervision of their DC plans, and said that no additional Federal laws were necessary, at least when it came to fiduciary standards. Speaking specifically to what he called “recent reports of undisclosed fees, penalties, and restrictions in defined contribution plans sponsored by State and local governmental entities,” he noted that the exception from regulation and disclosure rules under ERISA and the Labor Department “was a conscious decision by Congress in enacting ERISA,” and that “we do not propose to apply Federal fiduciary rules to those plans.” Furthermore, in cases where certain excessive or hidden fee arrangements under which fees are paid with plan assets and are not used for the exclusive benefit of employees and their beneficiaries might be occurring in public plans, Reeder noted that “plan disqualification would adversely affect innocent participants,” and that “State enforcement mechanisms are more effective than the Internal Revenue Code at appropriately addressing these issues.” How refreshing! Do you think we could have this attitude apply to public plans generally? We might want to have this statement laminated on cards that can be handed out when next the IRS comes calling! Ways
and Means Hearing on Appropriateness of Retirement Plan Fees SEC Appears Ready to Roll Back Shareowner Rights to Proxy Access
From every indication, SEC Chairman Chris Cox appears committed to scheduling a vote on the so-called “short rule” affecting proxy access by the end of November. This proposal – one of two contradictory rules the SEC advanced in July (see July/August 2007 NCTR Federal e-News http://www.nctr.org/federal/07JulyAugfederaleNews.html#10) – would effectively roll back last year’s court ruling which has permitted shareowners to offer corporate bylaw amendments that would establish procedures permitting shareowners to include in the corporate proxy materials their nominees for the board of directors. Such SEC action would mean that corporations, under the SEC’s Rule 14a-8, could once again exclude shareowner proposals of this nature as relating to an election for membership on the company’s board of directors, and the SEC would start issuing "no-action” letters giving the green light for corporations to do so. Furthermore, with only one Democrat remaining on the SEC following the recent departure of Roel Campos, there would not be sufficient votes to approve the so-called “long rule,” which would provide an override mechanism for shareowners to offer such proposals -- but under such onerous and unrealistic circumstances as to be effectively meaningless. Clearly then, such an action by the SEC would represent a major diminution in existing shareowner rights afforded by the AFSCME v. AIG decision. In a letter to Chairman Cox on October 12, House Financial Services Committee Chairman Barney Frank (D-MA) and ten other members of his Committee urged that the SEC not take action on either rule proposal before the next proxy season, “but instead to use the opportunity to learn more from the limited access for proposals on director election rules currently available” as a result of the court ruling. More recently, Senator Chris Dodd (D-CT), the Chairman of the Senate Banking Committee, and eight members of his Committee also wrote Chairman Cox. Their November 1 letter specifically says that the “short rule” would eliminate shareholder access. “This proposal would strip shareholders of their rights as the company owners to propose amendments concerning the process for shareholder nomination of directors,” according to the Senate letter. It would “undermine legitimate efforts by long-term investors who seek to have meaningful elections of corporate directors charged with protecting their interests and investments” in the view of Senator Dodd and his colleagues. In the view of Senator Dodd and his colleagues, the exclusion contained in Rule 14a-8(i)(8) should be limited to proposals that relate to a particular election of particular candidates. The Senators therefore tell the SEC “It is our judgment that the securities markets and investors would best be served by adopting no new rule at this time; the Commission should not adopt either of the proposals.” Chairman Cox, however, feels that the SEC’s rules and standards are now at best unclear in this area. He is concerned that the effect of the court ruling has been to create uncertainty about the application of Rule 14a-8 in the Second Circuit, on the one hand, and in the other 11 judicial circuits in America, on the other hand. He also believes that the effect of applying the court's decision as a rule of general application would be to permit director election contests without the disclosures required by the election contest rules. Therefore, he believes that the SEC has an obligation to provide a clear standard of conduct to avoid the chaos and confusion that could result. Finally, Mr. Cox has committed to start the proxy access process over again next year in order to provide a new and better access rule. As he explained when the two rules were considered in July, the idea that access to a company's proxy materials should under all circumstances be inaccessible to the shareowner when it comes to nominating directors “would seem to stand the principle of ‘fair corporate suffrage’ on its head.” He firmly believes that this “new and improved” access rule can be done in time for the 2008/09 proxy season. However, as the Senate letter points out, in 1976, when the SEC last actually amended the substance of Rule 14a-8, it was clear that the rule permitted shareholder proposals regarding the process for electing directors. “We believe this is the appropriate interpretation of the rule,” the Senators assert. Furthermore, they note that the Second Circuit Court of Appeals, in its review of this rule, said that the 1976 interpretation “clearly reflects the view that the election exclusion is limited to shareholder proposals used to oppose solicitations dealing with an identified board seat in an upcoming election and rejects the somewhat broader interpretation that the election exclusion applies to shareholder proposals that would institute procedures making such election contests more likely.” Therefore, how can there be any uncertainty or doubt as to the meaning of this 1976 interpretation? It is also clear that this interpretation now stands until and unless the SEC provides reasons for any changed position regarding the excludability of proxy access bylaw proposals (such as the shift that began in 1990 and that was the subject of the AFSCME lawsuit). As SEC Commissioner Annette Nazareth said in a recent speech on the issue of proxy access, “The non-access proposal [the short rule] would eliminate confusion. It would make certain that there would be no shareholder access to the corporate proxy. I do not see a principled reason to provide certainty by excluding rather than including such bylaw amendments.” As for concerns with disclosure, Commissioner Nazareth points out that the short rule does not consider, address, or even solicit comments on ways to ensure proper disclosure, such as applying existing disclosure requirements and prohibitions on false and misleading statements to nominations done through bylaw procedures. “ If the problem is one of disclosure,” she argues, “the solution is to address the disclosure directly, not to eliminate this bylaw avenue altogether.” There are also problems with the Cox “rosy scenario” for change in 2008. First, it assumes that there will be two new Democratic SEC Commissioners in place (one to replace the already-departed Campos and another to replace Commissioner Annette Nazareth, who is expected to be gone by the end of the year). This is necessary in order to provide Cox with the votes he needs to advance any access proposal. After all, GOP Commissioners Atkins and Casey would not even support the access proposal currently pending that has received no support from the investor community; why would Cox believe either of them would support a more pro-investor access proposal? Once the short rule is adopted, it will probably be their view that proxy access has been dealt with. Period. Furthermore, in order to get two replacement Democrats on the Commission by the spring of 2008, a number of very tricky hurdles have to be jumped. First, Democratic Senators have to agree among themselves as to who the nominees for such posts should be. This, in and of itself, is already proving to be a very difficult task. Then, assuming agreement, there is the little matter of getting the White House interested in appointing them. After all, the SEC can operate with just the 3 Republican members it should still have by next spring. Why would the President want to go to the trouble of filling two Democratic vacancies? More importantly, why would the Business Roundtable (BRT) and other opponents of proxy access want to allow him to do so? At the end of every year, there is usually a flurry of deal-making involving other appointments that are bottled up, so it is true that some horse-trading could take place that would make it worth the President’s while to nominate replacements Democrats for the SEC in return for getting some of his nominations approved for other positions. But there is then the matter of the clearance process that must be undertaken, and the hearings that are required for Senate confirmation. Finally, there is always the possibility of a “hold” being placed on a nomination by one Senator before it can actually make it to the Senate floor. The BRT is certainly capable of that. Thus, at so very many stages in the process, there are any number of places where delays can occur. And none of this takes into account the fact that next year will be an election year -- and a Presidential election year at that. This fact alone increases the possibilities for mischief exponentially. In short, a very many number of planets must be carefully aligned if Chairman Cox is to have the opportunity next year to begin again the process of a new proxy access rule. Finally, the Senate letter also raises other concerns with this two-step approach: “Some have speculated that the Commission will adopt a new rule for the 2008 proxy season and reconsider other proposals next year. We think such a course of action would be disruptive, could lead to having public companies comply with three different regulatory schemes in two years, and is not advisable.” Notwithstanding this reasoning and despite the letters from Congress urging no action until there is a full Commission seated and able to look at a renewed proxy access effort, it looks like Cox will soon schedule the short rule as the subject of SEC consideration and almost certain approval before the end of November. Increasing pressure from investors telling Cox that adoption of the short rule will represent a serious diminution of shareholder rights by a Chairman purportedly committed to expanding them has also apparently fallen on deaf ears. Can anything be done, then, to stop this course of action? Some believe that a media campaign targeted at Chairman Cox’s
desire for a pro-investor legacy could make a difference. But there
are others who believe that as a former 8-term Congressman from California,
Cox knows that bad press comes – and bad press goes. Furthermore,
he will still have almost a year left in the Bush Administration to
restore any damaged pro-investor reputation, especially if, as promised,
he is actually able to pull off a satisfactory override rule for proxy
access next year. One thing is certain, however: absent such an effort
by investor advocates, it will never be known if it could have made
a difference. So-called appropriations “riders” place restrictions on the use of funds to implement targeted programs. Technically these are legislating on an appropriations bill, which is typically opposed by both the authorizing and appropriating committees. However, there is talk that Chairman Frank is willing to entertain such an approach, which could freeze an SEC-adopted rule in its tracks – and the possibility of such could even be enough to deter action in the first place. Such a maneuver is difficult, particularly on the Senate side, where the Republican minority can easily slow down such an effort. Nevertheless, if attached to a must-pass bill, these kinds of riders can be successful. So, as for proxy access, as with other such “sporting” events, it ain’t over till it’s over. Congressman
Barney Frank Letter to Cox Bill to Change USERRA Advances in House; Imposes New Tax Qualification Standard Linked to Treatment of Survivor Benefits for Servicemembers Killed in Action
On November 1, the House Ways and Means Committee approved H.R. 3997, the “Heroes Earnings Assistance and Relief Tax (HEART) Act of 2007,” a measure designed to deliver tax relief for members of the military and their families. The bill contains a number of provisions of interest to public employers and retirement systems, including a change in USERRA advocated by Congressman Earl Pomeroy (D-ND) designed to address the treatment of employer-sponsored retirement benefits when a service member dies while on active duty. Mr. Pomeroy was the recipient of NCTR’s first award for “Outstanding Service to Public Pensions,” presented to him in October of 2006 (see August 2006 NCTR Federal e-News) In May, Congressman Pomeroy introduced H.R. 2540, his so-called HEROES
Act. Mr. Pomeroy’s action was prompted by the story of the widow
of a reservist originally from Jamestown, North Dakota and later of
Yakima, Washington, who discovered that her husband -- he was a Corrections
Department of Yakima County employee with 15 years service -- was treated
as a terminated employee for benefit purposes. Accordingly, she was
only eligible for a survivor benefit equal to a refund of his contributions. The new HEART legislation advanced by the Ways and Means Committee essentially includes this change in USERRA, except that a retirement plan would be permitted (not required) to treat, for benefit accrual purposes, an individual who leaves service with the plan's sponsoring employer for qualified military service and who cannot be reemployed on account of death or disability as if the individual had been rehired as of the day before death or disability (a “deemed rehired employee”) and then had terminated employment on the date of death or disability. The proposal would apply in the case of deaths and disabilities occurring on or after January 1, 2007. However, the new HEART legislation would also amend IRC Section 401(a), which sets forth the requirements necessary for a pension plan to be considered a tax-qualified plan. Under the new requirement, in order to retain tax-qualified status, a plan must provide that, in the case of a participant who dies (disability is not included) while performing qualified military service, the survivors of the participant must be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would be provided under the plan had the participant resumed employment with the employer maintaining the plan and then terminated employment on account of death. Furthermore, this new tax qualification requirement would also apply to 403(b) and 457 plans. Thus, as the explanation of the benefit by the Joint Committee on Taxation (JCT) puts it, “if a plan provides for accelerated vesting, ancillary life insurance benefits, or other survivor benefits that are contingent upon a participant’s termination of employment on account of death, the plan must provide such benefits to the beneficiary of a participant who dies during qualified military service.” In general, these changes must be incorporated in an amended plan on or before the last day of the plan year beginning on or after January 1, 2009. Governmental plans are given until 2011. With regard to the USERRA change, in the case of a “deemed rehired employee,” the plan would be permitted to comply fully or partially with the benefit accrual restoration provisions that would be required under Internal Revenue Code (IRC) section 414(u) had the individual actually been rehired. (Section 414(u) provides rules regarding the interaction of the USERRA protections, such as make-up contributions, with generally applicable rules that govern tax qualified retirement plans, such as contribution and deduction limits.) Subject to several conditions, if a plan complies fully or partially with the benefit accrual requirements of section 414(u), then the special section 414(u) rules regarding the interaction of USERRA with the otherwise applicable benefit limitation rules apply. The first condition is that all employees performing qualified military service of the employer maintaining the plan who die or become disabled must be credited with benefits on a reasonably equivalent basis. The second condition is that if the plan credits deemed rehired employees with benefits that are contingent on employee contributions or elective contributions, the plan must determine the rate of employee contributions or elective deferrals on the basis of the actual average contributions or deferrals made by the employee during the 12-month period prior to military service (or if less, the average for the actual period of service). Other provisions of the HEART legislation of particular interest to retirement systems would (1) include differential wages paid by an employer to an employee who becomes active duty military in the calculation of wages for retirement plan purposes and (2) make permanent the expiring IRC provision that permits active duty reservists to make penalty-free withdrawals from retirement plans. JCT
Description of HEART Act IRS Announces Annual Cost-of-Living
Adjustments for 2008 For example, the cap on the annual benefit paid under a defined benefit
plan is increased from $180,000 to $185,000. The limitation for defined
contribution plans is increased from $45,000 to $46,000. However, other
limits remain the same. For instance, the limitation on deferrals under
Section 457 plans stays unchanged at $15,500. NCTR/NASRA Public Fund Survey for FY 2006 Released The new Public Fund Survey documents that public pensions are in strong shape. According to Keith Brainard, NASRA research director and the author of the survey, “The combination of modest liability growth and strong investment earnings portends improving funding levels in FY 07 and subsequent years.” The Public Fund Survey for FY 2006 was released in October, and covered 92 public retirement systems, including 118 plans, although not all the data was available from all plans. Combined, systems in the Survey represent more than 85 percent of the entire state and local government retirement system community, and hold $2.46 trillion in assets. NCTR and NASRA jointly sponsor the survey. According to the findings, the median public pension fund had a 17.6% investment return for the year ended June 30, up from 11.8% the previous year. The aggregate funding level declined slightly to 85.6% of actuarial assets, down from 86.4% for the previous year. Median investment management expenses rose in the year ended June 30, 2006, to 23 basis points from 21 basis points the previous year. Other key findings are that combined unrecognized investment gains
exceed $125 billion, due to actuarial asset smoothing methods, and that
median plan liability growth in FY 06 was once again below seven percent
– for the fifth consecutive year. Of the 92 systems reporting
FY 06 data, the market value of assets grew by 9.2 percent from the
prior year. FY
06 Public Fund Survey Summary NCSL Summary of State Legislative Actions on Pensions, Benefits Available The National Conference of State Legislatures (NCSL) released its new report on “Pensions and Retirement Plan Enactments in 2007 State Legislatures” in October. According to the study, sustaining defined benefit plans for the long haul continued to be the major concern of public retirement policy in 2007. The NCSL report summarizes selected pensions and retirement legislation that state legislatures enacted in 2007 as well as some 2006 legislation not reported last year. It also includes some items that failed to pass or were vetoed, but were of particular interest nonetheless. No legislature significantly improved the benefit package for a large plan for public employees or teachers in 2007, according to the study. On the other hand, NCSL found that three states changed their benefit packages to reduce benefits for future employees, including adopting longer vesting requirements in some cases – a reversal of the trend to shorten vesting that has been the case for the last 25 years. OPEB was the focus of concern in some areas, with at least 13 states moving to create state trust funds or enabling local trust funds for retiree health care or other post-employment benefits. Divestiture was also a hot topic, according to NCSL, with divestment legislation or resolutions debated in at least 14 states in 2007; most dealt with companies operating in Sudan. NCSL
2007 Report on Pensions and Retirement Plan Enactments AMT Tax Reform Legislation Moving in the House; Hedge Funds, Private Equity Targeted Congressman Charles Rangel (D-NY), Chairman of the House Ways and Means Committee, has swiftly moved tax legislation out of his committee to provide a temporary fix for the Alternative Minimum Tax (AMT) problem. As expected, hedge funds and private equity are significant sources of new revenue to pay for it. However, final action on the overall package by the Congress may be difficult to obtain before the end of this year. As promised, the leader of the House tax-writing committee has proposed
legislation to temporarily tweak the tax code for one year in order
to spare tens of millions of middle-class Americans from the Alternative
Minimum Tax (AMT). His bill, H.R.3996, the “Temporary Tax Relief
Act of 2007,” would prevent taxpayers who must pay the AMT from
increasing to as many as 25 million in the 2007 tax year, as compared
to 4 million last year. The temporary fix will cost about $50 billion
over 10 years; total repeal would run up the 10-year bill to $800 billion.
Hedge fund managers would be the primary source of revenue with which
to pay for the fix. In addition to extending for one year AMT relief for nonrefundable personal credits and increasing the AMT exemption amount to $66,250 for joint filers and $44,350 for individuals, the bill would also increase the eligibility for the refundable child tax credit for 2008. The legislation would also provide an additional standard deduction for State and local real property taxes paid or accrued by taxpayers who claim the regular standard deduction. Only available in 2008, the maximum amount that may be claimed under this provision would be $700 for joint filers and $350 for individuals. In response to the current home mortgage crisis, the bill would also create a permanent exclusion from gross income of discharged home mortgage indebtedness of up to two million dollars of indebtedness (on or after January 1, 2007) which is secured by a principal residence and which is incurred in the acquisition, construction, or substantial improvement of the principal residence. There are also a number of tax credits that are set to expire next year that would receive a one-year extension, from the deduction of State and local general sales taxes for individuals to the R&D credit for businesses. Of particular interest to investors, the legislation also contains significant changes in the taxation of hedge fund managers and private equity partnerships. First, investment fund managers would be required to treat carried interest as ordinary income to the extent that it does not reflect a reasonable return on invested capital (in which case it could continue to be taxed at capital gains rates.) This proposal is estimated to raise $25.6 billion over 10 years. The bill also would change the treatment of deferred compensation from a “tax indifferent party.” It would effectively prevent hedge fund managers from deferring taxes on compensation received from investment services by using offshore tax haven corporations. This would raise an additional $23.8 billion over 10 years. AMT legislation is viewed as a “must-pass” bill. According to the IRS, which is now preparing forms for the 2008 tax filing season, any further delays in addressing the AMT could mean that the processing of returns for as many as 50 million taxpayers, and the issuance of approximately $75 billion in refunds, could be significantly delayed if these forms need to be revised. However, Congressional Republicans and the White House are strongly opposed to any tax increases. The AMT “patch” may therefore be the first real test of Democratic resolve to stay with their PAYGO approach to legislation, which requires losses in revenue, such as would result from the AMT fix, to be paid for by offsetting cuts in program spending or, as has been proposed by Chairman Rangel, increases in other taxes – namely on wealthy hedge fund managers in this case. How Democrats decide to deal with this temporary solution to the AMT for the 2007 tax year will probably provide an indication of the outlook for the major tax reform that Chairman Rangel has proposed for 2008. This bill (H.R. 3970) would attempt to repeal the AMT once and for all. The massive measure would pay for the repeal in large part by imposing a new “replacement tax” of 4% on those with income levels above $200,000, and another 4.6% on income in excess of $500,000 ($250,000 in the case of single taxpayers). However, the bill offers a bit of something for everyone. For example, corporate tax rates would fall to 30.5% from 35% and many of the changes appear to mostly track the recommendations of Bush Treasury Secretary Hank Paulson, who has also endorsed the “tighten and lower” approach to corporate taxes. On the individual tax front, the bill increases the standard deduction and earned income tax credit (an offset used by the working poor). Will Democrats be willing to forgo their PAYGO rules to achieve a temporary AMT fix now? If so, then why retain PAYGO in 2008 in an effort to come up with the $800 billion needed to repeal the AMT? If Democrats instead insist on paying for the current one-year patch, can they pay for the 2007 AMT relief on the backs of wealthy hedge fund managers, or will the private equity lobby be able to successfully fight them off? If not, and Democrats succeed, will the party also insist that complete repeal must be paid for in 2008? At the end of the day, the final answer will probably depend on whether or not Democrats are willing, in an election year, to wear such a massive “tax increase” label that Republicans are already preparing to pin on them. Summary
of H.R.3996, the AMT Patch for 2007 The SCHIP program, viewed by some as the necessary next step in universal health care coverage, continues to struggle in the Congress, facing yet another Bush veto. In the meantime, some believe that the recent UAW deals on retiree medical trusts signal the death knell for employer-provided health care. While there appears to be growing interest in Washington in making major modifications to the employer-driven model, a recent EBRI survey found that there is still strong public support for a health care reform plan mandating all employers to provide and fund their workers' health coverage. As expected, Congress failed to override President Bush’s early-October veto of the State Children’s Health Insurance Program (SCHIP). Even though a new, revamped proposal intended to deal with Republican concerns has now once again cleared the Congress, it did not muster sufficient votes to overcome another expected Bush veto. SCHIP subsidizes coverage for lower income workers who do not qualify for Medicaid. The new bill caps eligibility at families of four making $62,000 or less, phases out adults now in the program, and clarifies that illegal aliens could not use the program – attempting to address major points of contention with GOP opponents. The new measure, like the old one, still relies on a 61-cent increase in Federal tobacco taxes as its main financing method. However, the Administration continues to oppose the bill, reiterating concerns that the legislation does not target the poorest of the working poor (families making $41,300 or less) and that the bill still encourages shifting from private coverage to government-subsidized coverage. Summing up the Republican leadership’s views, Congressman Sam Johnson (R-TX), a senior Republican on the Ways and Means Committee, called the new bill “nothing less than a bunch of baloney.'' While many think that a temporary extension of the program will eventually be worked out between the White House and the Democratic leadership, the problems that this legislation – once viewed as an easy, bi-partisan win in the health care reform process – has encountered underscores the lack of consensus on the overall direction that reform needs to take. Some believe that while Congress fiddles with high-level health policy issues, the reality on the ground will ultimately shape the final outcome. For example, there is still strong concern in some quarters that the UAW’s negotiations with GM and Ford have significantly damaged the future outlook for reform. By effectively shifting the burden of running a health care program to the union in the form of a retiree medical trust, the concern is that employers will have even less incentive to work for such goals as universal coverage. Will this be the model for other employers? Is employer-provided health care a thing of the past? An October 18 hearing before the House Budget Committee explored this subject, examining the tax code and health insurance coverage in detail. Testimony summarized the current tax treatment of health insurance, the effects of tax subsidies on coverage and health care costs, and discussed the ways that tax credits might affect health coverage. Employer-sponsored health insurance and the manner in which the tax code encouraged it was criticized as an “upside-down subsidy,” with the largest benefits going to high-income taxpayers who would be most likely to obtain insurance under almost any system. However, it was also pointed out that major changes in the way the tax code subsidizes employer-sponsored health insurance could significantly reduce insurance coverage. According to Leonard E. Burman, Director, Tax Policy Center and Senior Fellow at the Urban Institute, “While some young, healthy people might be induced to acquire coverage in the individual nongroup market under a different set of incentives, the loss of ESI [employer-sponsored health insurance] could be particularly devastating to old and unhealthy workers who would face prohibitively high health insurance premiums in the private nongroup market in the vast majority of states.” According to Burman, “The most cost-effective approach to expanding health insurance coverage may not be a tax subsidy at all, but expansion of an existing public program, such as Medicaid, S-CHIP, or Medicare.” The other witness at the hearing, Grace-Marie Turner, the President of the Galen Institute, also criticized the current employer-sponsored health insurance model and its subsidization through the tax code. According to her, a key element of the problem is visibility: “Deductions are visible, but exclusions are invisible.” Turner argues that employees who are demanding expensive health insurance seldom know the full cost of the policy – and the amount of compensation they are forgoing as a result – because its cost is excluded from their income. “Few employees are aware that an average of $12,000 a year of their compensation package is going to fund their family health insurance policy,” according to Turner. “Employees may be receiving smaller pay raises as a result of the rising cost of health insurance, but this is a less visible consequence,” she believes. “If employees saw health insurance as a more visible part of their pay package, they would likely make different choices than they do today about that spending,” Turner concludes. However, the 2007 Health Confidence Survey carried out by the Employee Benefit Research Institute (EBRI) and Mathew Greenwald & Associates, released in October, suggests otherwise. Their survey found that three-quarters of those with employer-provided health coverage (76%) said they would prefer $7,500 in employer-based health benefits to an additional $7,500 in taxable income. “When those preferring to keep their coverage were asked how much they would need in additional taxable income to willingly give it up, the median response was $12,000,” according to EBRI. In fact, the vast majority of workers with employment-based coverage were not very confident they could afford health insurance on their own, even if their employer gave them the money it currently spends on their insurance to help them pay for it. The EBRI study also found that there is still significant public support for the employer-sponsored system, with 42% saying they would back a reform plan mandating all employers to provide and fund their workers' health coverage. But is that enough to maintain the system as it exists today? Many members of Congress from both sides of the aisle have offered proposals that would change this approach. President Bush has also proposed replacing the current tax exclusion with a universal tax deduction (see January 2007 NCTR Federal e-News). Even Senator Hillary Clinton, in her recent health proposal, suggests limiting the current exclusion from taxes of employer-provided health premiums for those making over $250,000. Whatever the future holds for the current model of employer-provided healthcare subsidized through the tax code, the new EBRI study underscores the need for reform of some nature. For example, the survey found that 30% of respondents said that increased health care costs have resulted in a decrease in contributions to retirement, and 29% report that these increased costs have resulted in difficulty paying for basic necessities. According to Dallas Salisbury, EBRI president, while previous surveys showed rising health care costs were affecting household finances, “This year we learned that costs also are influencing how much individuals use the health care system, even to the point of delaying care when that could be harmful.” Salisbury said it therefore “should be no surprise that the overwhelming majority of Americans are not satisfied with the costs of health insurance."
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