Ted Ballantine | Pension360

Chevron Beats 401(k) Fee Lawsuit

A federal judge threw out a class action suit challenging allegedly excessive fees in Chevron’s 401(k) plan this week.

[Read the complaint here.]

The ruling is noteworthy because of the influx of fee-related lawsuits that have hit 401(k) plans in recent months.

Bloomberg BNA breaks down the ruling:

In addition to challenging aspects of Chevron’s 401(k) plan under ERISA’s fiduciary duty of prudence—a common claim in ERISA litigation—the lawsuit also contended that the Chevron plan fiduciaries violated the statute’s duty of loyalty. Judge Phyllis J. Hamilton of the U.S. District Court for the Northern District of California rejected this alternative theory of liability after finding no allegations that any fiduciary actions were aimed at benefiting parties other than the plan’s participants.

Hamilton also dismissed the idea that a 401(k) plan can face liability for failing to offer a stable value fund—as opposed to a money market fund—as an option for preserving capital. According to Hamilton, offering a money market fund “as one of an array of mainstream investment options along the risk/reward spectrum” satisfies ERISA’s prudence requirement.

The lawsuit also accused Chevron of offering high-fee investments when it should have used its leverage as a $19 billion plan to negotiate lower fees and investigate alternative arrangements such as collective trusts and separate accounts. Hamilton disagreed, saying that ERISA plan fiduciaries “have latitude to value investment features other than price.” Further, allegations of high fees, without accompanying allegations of a flawed investment selection process, don’t state a claim for fiduciary breach, the judge wrote.

Does the ruling “raise the bar” for plaintiffs in these cases? BenefitsPro discusses implications:

Typically, there is a “low bar” for plaintiffs’ claims to survive a motion to have a case dismissed, noted Carol Buckmann in a blog post, an ERISA attorney that counsels plan sponsors and a founding partner of New York City-based Cohen and Buckmann.

But in the Chevron decision, Judge Hamilton seems to have raised that low bar. On the issue of whether plan participants paid unreasonable recordkeeping fees via revenue-sharing agreements, she ruled that that “are no facts alleged showing what recordkeeping fees Vanguard charges, so it is not clear on what basis plaintiffs are asserting that the fees were excessive,” according to the decision.

Regarding the bar that plaintiffs’ allegations must exceed to survive a motion to dismiss, Hamilton wrote: “A complaint that lacks allegations relating directly to the methods employed by the ERISA fiduciary may survive a motion to dismiss only ‘if the court, based on circumstantial factual allegations, may reasonably infer from what is alleged that the process was flawed’.” Hamilton was quoting a 2012 appellate decision in St. Vincent v. Morgan Stanley Investment Management Co.

Illinois Teachers’ Lower Rate A “Positive”, Says Moody’s

Credit rating agency Moody’s said on Wednesday it positively viewed the Illinois Teachers’ Retirement System’s decision to lower its assumed rate of return from 7.5 percent to 7 percent.

The lower rate will be tough for the state to stomach in the near-term as it raises annual contributions by hundreds of millions of dollars. But it also forces the state to pay up, and makes the System less reliant on out-sized investment returns.

From the Chicago Tribune:

A key ratings agency said the decision by the Illinois Teachers’ Retirement System to lower its expected rate of return was “a positive,” even though it means the cash-strapped state will have to find hundreds of millions of dollars more to pay into the pension program for teachers who live outside of Chicago.

The decision by the system’s board to alter the rate of return on investments from 7.5 percent to 7 percent was made despite opposition from Gov. Bruce Rauner, who characterized it as a rushed decision that puts taxpayers on the hook. It was an odd position for the Republican governor, who has long criticized state and city government for kicking the can down the road on financial issues.

But Moody’s Investors Service said the change was “a positive” despite increasing financial pressure on the state in the near term, saying the move would “lower exposure to volatile investment performance.” Moody’s estimated that if the new, lower rate had been in effect for the budget year that began July 1, the state’s required employer contribution would have been $4.3 billion, roughly $421 million more than if the assumed rate of return stayed at 7.5 percent.

Still, Moody’s said even under the lower rate the state remains roughly $1.5 billion below their “tread water indicator,” meaning the system’s unfunded liabilities will continue to grow.

The Disparity That’s Driving 401(k) Fee Lawsuits

The country’s top universities have been hit with an onslaught of lawsuits the last 30 days over excessive fees related to the schools’ 401(k) plans.

At the heart of the trend is an interesting disparity, writes Stephen Mihm for Bloomberg:

On one hand, 401(k)s and their ilk would seem to shift the burden of making investment decisions onto employees, limiting the fiduciary duty of the employer. On the other, the regulatory apparatus that applies to 401(k)s derives from ERISA, whose ideas of trusts and equity law imposes some serious duties for sponsors of defined-contribution plans — ideas at odds with the notion that individuals have to take responsibility for their investment decisions.

This disparity informs the lawsuits over excessive fees. Schlichter is pushing courts to recognize that 401(k) and 403(b) sponsors are trustees with grave responsibilities toward their plan participants. Implicit in this line of argument is the idea employers can’t simply shove some investment brochures in front of their employees and let them choose. Rather, the employer needs to get the absolute best possible deal for their employees — the lowest fees for example — and select investments that yield an average or above-average rate of return (index funds are the obvious choice).

And in the past few years, courts have started to agree, counter to the ethos that informed the creation of the 401(k). In May, the Supreme Court overturned a lower-court ruling that would have let defined-contribution sponsors off the hook for monitoring the quality of the investment choices on an ongoing basis. In a rare unanimous opinion, the court declared that “under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones.”

This may well be true. But the ambiguity remains. We are caught between two very different philosophies of individual responsibility. On the one hand, workers are still expected to navigate the confusing world of retirement investments on their own. But much of the law governing those investments relieves employees of that responsibility.

Which is it? It may be time for Congress to wade into this mess and clarify, once and for all, the respective duties of employer and employee on the vexed question of retirement benefits.

States’ “Weak” Pension Contributions Continue to Hurt Pension Funding, Says Fitch

A new commentary from Fitch Ratings lambasts states for their pension funding practices.

Even as contributions rise, Fitch writes, the sustainability of pension systems is not improving.

Fitch acknowledges that states are paying more in recent years:

Actual pension contributions have risen rapidly in recent years as governments have attempted to stem the erosion of their systems’ funded ratios and catch up with rising ARCs, the contribution benchmark calculated by actuaries as necessary to eliminate the unfunded pension liability over time. The average actual contribution in fiscal 2014 is roughly 89% greater than in 2008, the year the global financial crisis began, while the ARC has risen an average of 72% since then.

But, the credit rating agency contends, it’s not enough:

Actual contributions remain inadequate relative to the ARC. Based on Fitch’s last state pension update, a little more than half of major state-wide systems received an annual contribution in fiscal 2014 at or above their ARC. The remaining systems received lower contributions. A shortfall in actual contributions, relative to the ARC, deprives a system of investable resources, increases its unfunded liability and elevates the future ARC that will be calculated at subsequent funding valuations.

In many cases, a system’s ARC itself is a poor benchmark of contribution adequacy.

[…]

Under a 30-year rolling amortization, the ARC is an inadequate measure of contribution sufficiency because at each successive annual funding valuation the ARC is recalculated based on a new 30-year open period, much like refinancing a home mortgage loan year after year. The resulting ARC is likely to provide a higher degree of contribution stability at a lower cost than if it were calculated based on more conservative, alternative methods, such as a consistently fixed, closed-period amortization, various layered amortization approaches, or even a shorter rolling period, such as over 20-years.

For systems using a 30-year rolling amortization, the resulting ARC may too low to cover the cost of new benefits each year plus the accrued interest on the pre-existing unfunded liability — hence the unfunded liability can rise each year, even when the full ARC is paid and other assumptions are achieved. Many governments using 30-year rolling amortization while consistently paying their full ARC each year have still seen their funded ratios languish well below prerecession levels.

California Lawmakers Pass Divisive Private Equity Transparency Bill

The California state legislature has passed a controversial bill, formally called AB 2833, which aims to improve reporting and disclosure of fees paid by public pension funds to private equity firms and hedge funds.

The bill awaits Gov. Jerry Brown’s signature.

The bill has been championed for months by State Treasurer John Chiang; but observers have raised questions about the effectiveness of the bill, and whether it was “gutted” from its original form.

The Wall Street Journal describes the bill:

Once the bill is signed into law, California pensions must report all fees and expenses they pay to new private-equity funds they invest with from 2017 onward. They will be required to disclose the costs borne by portfolio companies that are then passed on to private-equity fund investors, charges often hidden from view. They also will have to report the share of deal profits—also known as carried interest—collected by each private-equity fund manager.

[…]

As the bill wound through the California state legislature over the past year, it drew mixed responses from pensions and raised questions about whether investors are ready to reckon with private equity’s full costs. Even as pensions try to get a handle on investment fees and expenses, some fear being too demanding would drive top managers away.

[…]

In the end, the bill was adjusted to become less heavy handed, with later versions of the bill giving each California investor the flexibility to seek the data in any format.

Some observers, like Naked Capitalism’s Yves Smith, aren’t happy with the bill’s “adjustments”. Smith writes:

AB 2833 has gaping holes that will allow general partners to structure related party payments to escape reporting. The bill, which you can read here, has a very long and complicated definition of what constitutes a related party. It is inferior to shorter and more comprehensive definitions in earlier drafts.

[…]

AB 2833’s definition of “portfolio company” allows payment to be routed through other entities. The definition of “portfolio company” is more obviously deficient than that of “related party” and again allows the bill to be circumvented:

“Portfolio companies” means individual portfolio investments made by the alternative investment vehicle.

Huh? What does “individual portfolio investments” mean? This language does not map onto legal entities or contractual relationships. But by saying “individual,” that would appear to set up the argument that the portfolio company is only “individual” meaning the senior-most legal entity that owns fund assets. But private equity funds seldom invest directly in a portfolio company. For tax and other reasons, there are often “blocker” legal vehicles and other legal entities that sit between the private equity fund and the investee business. It thus appears that general partners could launder the former portfolio company fees through legal vehicles that sit above the portfolio company. For instance, Portfolio Company contracts with Intermediate Co. which has a mirror contract with the general partner or a related party.

Reporting is at far too high a level of abstraction to allow for verification or cross-checks. Another major flaw in the bill is that it fails to report fees quarterly, as the unhappy 13 major trustees had called for, and is nowhere near granular enough to allow them to map the fees back to either portfolio company activities or limited partnership agreements. It simply calls for an aggregate of fees and costs, reported on a pro-rata basis for the fund and also by the portfolio companies.

Bear in mind that the previous version of the bill required that all related party transactions be reported. The current version calls only for providing each CA public fund with its pro rata share of those fees.

John Chiang wrote a letter to the New York Times defending the bill against its detractors, which include Times writer Gretchen Morgenson. From his letter:

Should Assembly Bill 2833 become law, it would impose the most robust transparency requirements in the nation on private equity firms. For the first time, California public pension funds will be allowed behind the curtain to view previously hidden fees and charges that are paid to general partners and related parties.

Ms. Morgenson cites the concern of a former Calpers board member that my measure presents “less than a full picture” because it discloses only the related-party costs allocated to California public pension funds. I am open to sponsoring future legislation requiring broader disclosure of related-party transactions affecting private sector or non-California investors.

However, today, I am more concerned that our pension fund members and taxpayers are given a full picture of their share of total investment costs. A.B. 2833 does that. This type of disclosure is crucial given that every dollar paid in fees is one less dollar available for promised benefits.

Photo by TaxRebate.org.uk

Illinois Teachers’ Pension Lowers Return Assumption

The Illinois Teachers’ Retirement System on Friday voted to lower its assumed rate of return for the second time in three years.

The board voted to lower the rate from 7.5 percent to 7 percent, much to the dismay of various government officials who are wary of the extra cost it will bring to the state.

The news of the vote triggered more shade from the Rauner administration on Friday. From Reuters:

“Illinois taxpayers including our social service providers and small business owners were just handed a bill for nearly a half-billion dollars,” Rauner spokesman Lance Trover said in a statement.

He added that “questions remain about the legality of today’s action,” alluding to concerns raised by Rauner’s deputy general counsel that TRS’ revised meeting agenda containing the rate change as a voting measure did not comply with the state’s open meetings act’s 48-hour posting requirement.

TRS Executive Director Dick Ingram disputed there was any violation. He said the board has a fiduciary obligation to do “what is best for the financial sustainability” of the fund and that its action to lower the rate can be overridden by the Illinois Legislature.

Illinois’ total fiscal 2017 pension payment to its five retirement systems was pegged at $7.9 billion, up from $7.617 billion in fiscal 2016 and $6.9 billion in fiscal 2015, according to a March bipartisan legislative commission report.

Brexit The Culprit for $52 Billion Loss At World’s Largest Pension, Official Says

The Government Pension Investment Fund lost $52 billion (or, -4 percent) in the 2^nd quarter of 2016.

This week, GPIF’s President talked about the two factors he believes contributed most to the market conditions leading to the loss.

From the Financial Times via CNBC:

Norihiro Takahashi, the GPIF’s president, said that markets during the quarter had seen the dollar-yen exchange rate “developing without a clear sense of direction”. In June, he said, two main factors produced especially high market volatility that strengthened the yen and caused stocks to tumble.

One of these, he said, was the fact that the result of the British referendum on the EU had been different from market expectations — a shock that saw the yen soar against all major international currencies as investors turned to it as a safe haven.

The surging yen, whose rate against the dollar is correlated with the Japanese stock market, produced a 7 percent plunge in the Topix Index on the session immediately after the June 23 referendum results emerged.

The GPIF president also cited US May employment data, which came in lower than market forecasts, as a source of uncertainty during the quarter.

Takahashi sought to head-off a public backlash over the most recent results, saying in a statement: “Even if market prices fluctuate in the short term, it will not harm the pension beneficiaries…we invest from a long-term viewpoint.”

Largest Illinois Pension Could Lower Discount Rate, But Rauner Doesn’t Want to Pay Up

The Illinois Teachers Retirement System could vote at this week’s board meeting to lower its assumed rate of return – an action that spurred a panicked memo from Gov. Rauner’s office.

The discount rate, currently at 7.5 percent, could stand to be lowered to a more realistic number. But Rauner’s office doesn’t want to deal with the higher contributions that would result from the decision.

From Reuters:

A Monday memo from a top Rauner aide said the Teachers’ Retirement System (TRS) board could decide at its meeting this week to lower the assumed investment return rate, a move that would automatically boost Illinois’ annual pension payment.

“If the (TRS) board were to approve a lower assumed rate of return taxpayers will be automatically and immediately on the hook for potentially hundreds of millions of dollars in higher taxes or reduced services,” Michael Mahoney, Rauner’s senior advisor for revenue and pensions, wrote to the governor’s chief of staff, Richard Goldberg.

When TRS lowered the investment return rate to 7.5 percent from 8 percent in 2014 the state’s pension payment increased by more than $200 million, according to the memo.

[…]

Mahoney cautioned that “unforeseen and unknown automatic cost increases would have a devastating impact” on Illinois’ ability to fund social services and education.

One of Rauner’s top Republican legislative allies, Senate Minority Leader Christine Radogno, urged the TRS board to delay a vote Friday to give the public time to weigh in on its possible actions.

“This issue is important enough at the very least to put the TRS board on notice we don’t want them taking any action that could cost taxpayers $200 to $300 million without appropriate scrutiny,” she said.

CalPERS Adopts 5-Year ESG Plan; Aims for Private Equity Transparency

The CalPERS board this week adopted a 5-year Environmental, Social and Governance (ESG) Strategic Plan, which includes points on private equity reporting, sustainable investment research and board diversity of companies in which CalPERS is a shareholder.

Read the document here.

On the private equity front, the plan aims to eventually have all of CalPERS’ PE managers complete the fee template designed last year by the Institutional Limited Partners Association (ILPA). It’s unclear whether all of the general partners will sign onto that initiative; anyhow, they have 20 years to make up their minds.

More on the 5-year plan, from PlanSponsor:

The plan identifies six strategic initiatives that will direct staff’s work. The initiatives are data and corporate reporting standards; UN PRI Montreal Pledge company engagement; diversity and inclusion; manager expectations; sustainable investment research; and private equity fee and profit sharing transparency. These initiatives are cross-cutting issues which will have impacts on risk and return. Each initiative has specific objectives, key performance indicators, and a timeline.

The comprehensive plan is a result of more than a year’s worth of review by staff and the CalPERS Investment Committee. During this time, staff presented a thorough review of each channel—environmental, social and governance. Staff also reported on how each channel could use the approach of integration, engagement, advocacy and partnerships to move the strategy forward.

[…]

The strategic plan serves as the framework by which CalPERS executes its shareowner proxy voting responsibilities; engages public companies to achieve long-term, sustainable risk-adjusted returns; and works with internal and external investment managers to ensure their practices align with CalPERS’ Investment Beliefs.

The key performance indicators will serve as benchmarks to measure the success of efforts for each initiative. Staff will report to the board the status of the key performance indicators on a quarterly basis.

Columbia, Four Other Schools Latest To Be Hit With ERISA Suits; Could Signal “Race to Courthouse”

The wave of ERISA lawsuits against top schools’ 401(k) and 403(b) plans continued rolling this week.

The University of Pennsylvania, Johns Hopkins University, Vanderbilt University and Emory University were slapped with lawsuits early this week; more recently, Columbia University joined the fray on Wednesday.

The Columbia suit was, notably, brought by a different law firm than the rest. Observers say it could signal a “race to the courthouse” that could see others firms target new schools.

[Read the Columbia complaint here.]

All the lawsuits are targeting the fees associated with the schools’ 401(k) and 403(b) plan offerings.