The UK’s Pension Protection Fund, which covers insolvent UK pension funds, has published a Statement of Investment Principles that includes a 20% benchmark for equity investment. PPF’s restriction of equity investment echoes that of the PBGC during recent years, reflecting the goal of minimizing mismatch between assets and liabilities for the fixed annuities under trusteed pension plans.
Should on-going pension plans sponsored by companies, governmental employers, and other sponsors follow the pension insurers’ lead? The Administration, which has characterized currently prevalent pension fund investment policies as “hazardous,” presumably hopes so, although one supposes the hope is that such hazardous investments would then be bought up by individual retirement account holders enlightened by new investment education/marketing programs freed from fiduciary liability claims.
The ERISA §403 requirement that plan trustees exercise exclusive control over plan assets has an "implied exception" permitting participant investment direction for an individual account plan, according to a 7th Circuit decision affirming the district court. [Jenkins v. Yager, 04-4258] A plan participant had contended that a 401(k) plan's individual direction provision violated the ERISA by delegating trustee duties. Although the 401(k) plan did not meet the special conditions for participant-directed accounts under ERISA §404(c), since individual investment changes could only be made once annually instead of quarterly, the court recognized §404(c) as only a safe harbor, not the exclusive authorization for participant-directed accounts.
If a participant-directed plan does not meet the conditions set forth in 29 C.F.R. §2550.404c-1(b), the plan trustee and fiduciaries simply do not receive the benefits of section 404(c), and they are not shielded from liability for losses or breaches of duty which result from the plan participant's exercise of control. It does not necessarily mean that such a plan violates ERISA; instead, the actions of the plan trustee, when delegating decision-making authority to plan participants, must be evaluated to see if they violate the trustee's fiduciary duty.
In the case of the 401(k) plan involved in this case, the court then found that the trustee had not breached fiduciary duties in initial selection of available investments, in monitoring of the investments, or in the information provided to plan participants regarding investment choices. Although three of the four available investment alternatives suffered losses during 2000-2002, that in and of itself was insufficient to demonstrate a fiduciary violation.
However, the appellate court reversed the judgment of the district court favoring the trustee with respect to the profit-sharing portion of the plan, where the trustee retained authority to make the plan investments. Noting that the district court had not specifically addressed that particular claim, and finding sufficient evidence to suggest neglect, the case was remanded for further proceedings on that issue.
The Organization for Economic Co-operation and Development has published OECD Guidelines for Pension Fund Asset Management. Prepared by the organization’s Insurance and Private Pensions Committee and Working Party on Private Pensions, the guidelines mark an initiative by the world’s economic leaders to set international standards for pension fund investment management and oversight, complementing the OECD Council’s 2004 Core Principles of Occupational Pension Regulation. [OECD Website Release]
Endorsed by all 30 member governments, including the U.S., the guidelines enunciate best practices for pension fund investment regulation, centered on the basic premise that the regulatory framework should reflect the retirement income objective of the pension fund –
- Valuation of Pension Assets – Legal requirements should establish a transparent basis for valuing pension fund assets. [5.1] If market valuation is not required, then market values should be disclosed. [5.2] Where valuation methodologies differ for different purposes – such as accounting versus funding – the differences should be transparent. Smoothing methods are permissible for actuarial and funding purposes. [5.3]
- Quantitative Portfolio Limits – Maximum levels of investment allocation for particular investment categories may be prescribed to the extent consistent with prudential principles of security, profitability, and liquidity. Minimum levels should not be prescribed, except under exceptional temporary circumstances. [4.1] Where ceilings are required, a procedure for correcting excesses within specified time limits should be established. [4.3] Self-investment and investment in assets of the plan sponsor should be prohibited or strictly limited. [4.4] Foreign investments should not be prohibited. [4.6] Pension investment law should address the use of derivitives, in particular prohibiting or strictly limiting exposure to unlimited commitments. [4.7]
The OECD guidelines further encourage core principles for pension investment fund managers -
- Prudent Person Standard – Pension trustees should be subject to fiduciary standards, making investment decisions in the best interests of plan members and beneficiaries. [2.2] When the pension trustees lack sufficient expertise to fulfill investment responsibilities, the external assistance of an expert should be sought. [2.1]
- Identification of Investment Managers – Parties responsible for fund investment should be identified. If external investment managers are involved, an investment management agreement should be required. [3.6]
- Investment Policy – A pension fund should actively adhere to a written statement of investment policy [3.1, 2.3] that establishes clear investment objectives consistent with the retirement income objective of the fund. [3.2] At a minimum, the investment policy should identify the fund’s strategic allocation strategy, overall performance objectives, and monitoring methods. [3.3]
- Internal Controls – Criteria and procedures should be established for periodic review of the effectiveness of the fund’s investment policy. [3.7]
- Risk Management – Sound risk management concepts, such as diversification and asset-liability matching, should be established. [3.4]
- Participant Direction – Funds that permit individual investment selection should include an appropriate array of investment options, including a default option, and should ensure that participants have access to the information necessary to make sound investment decisions. [3.5]
OECD member countries are encouraged to disseminate the guidelines among pension funds and to invite their public authorities to ensure adequate regulation consistent with the recommended framework.
The Securities Exchange Commission has proposed amendments to rule 22c-2 under the Investment Company Act relating to mutual fund redemption fees. [17 CFR 270, File No. S7-06-06] The proposed change is a technical rule modifying identification of intermediaries with whom information-sharing agreements must be established and clarifying operation of the rule governing those agreements.
Rule 22c-2 was originally adopted in March 2005 to address short-term trading abuses. [70 FR 13327] The rule requires a fund’s board to consider imposing a redemption fee of as much as 2 percent on the value of shares redeemed within 7 days. Funds are also required to establish agreements with intermediaries, such as broker-dealers, enabling identification of investors whose trading violates short-term trading restrictions. Compliance with rule 22c-2 is required by October 16, 2006. (See Benefitsblog for further discussion.)
The SEC’s proposed amendment addresses practical problems that had been raised with the rule on information-sharing agreements with intermediaries -
- Small Intermediaries – If a fund treats an entity as an individual for purposes of control of market-timing, then the entity would not be treated as an intermediary for purposes of the rule on information-sharing agreements. For example, if a fund applies a redemption fee or exchange limits to the transactions of a small retirement plan rather than separately to the transactions made by each plan participant, then the plan would not be treated as an intermediary, and the fund would not be required to establish an agreement with the plan.
- Intermediary Chains – Frequently an intermediary, such as a brokerage firm, may hold mutual fund shares on behalf of other intermediaries, such as pension plans. The SEC’s proposed amendment to the rule would require the fund to establish an agreement only with “first-tier intermediaries,” those that directly submit orders to purchase or redeem fund shares.
- Failure to Obtain Agreement – If a fund has obtained agreements with some of its intermediaries, but has been unable to obtain an agreement with one or more other intermediaries, then trading prohibitions would be required only with respect to any intermediary lacking an agreement, without adversely affecting those with agreements.
The proposed rule does not delay the original 10/16/06 compliance date. Although the SEC seeks further comment on other market-timing issues, the current proposal does not address uniform standards nor numerous additional matters of concern to retirement plan sponsors. Comments on the proposed rule should be submitted to the SEC by 4/10/2006.
Investment advice and asset management services provided by independent financial planners or advisors directly to participants of a participant-directed individual account plan are subject to ERISA fiduciary standards. However, other fiduciaries of the plan are not liable as fiduciaries for either the selection of the investment advisor or investment manager, nor for the results of decisions made by those other fiduciaries. [Advisory Opinion 2005-23A, 12/7/05] Thus, the established plan fiduciaries do not lose protection against liability under ERISA 404(c) for participant-directed accounts by making independent external investment advice and investment management available to participants, although those external advisors and managers themselves would be liable for any fiduciary violations arising from their own actions.
Also discussed in the same DOL advisory opinion -
- A recomendation to a participant to roll over an account balance to an individual retirement account (IRA) in order to take advantage of investement options that are not available under the plan does not constitue investment advice as defined for purposes of ERISA. However, a plan officer or fiduciary who responds to plan participant queries about distributions or investment of withdrawn amounts is exercising discretionary authority in plan management, and must act prudently and solely in the interest of the participant. Moreover, if withdrawn plan assets are invested in an IRA managed by the fiducary who has given advice to the participant, then the fiduciary may be using plan assets in self-interst in violation of ERISA 406(b)(1).
- An advisor who earns management or other investment fees with respect to an IRA is not engaging in a prohibited transaction by recommending that a participant withdraw plan assets to invest in the IRA, provided the advisor is not otherwise a plan fiduciary. However, as indicated above, such advice given by a plan fiduciary would be subject to ERISA’s fiduciary standards.
Post-Enron, some individuals have been hesitant to keep large portions of their 401(k) accounts invested in company stock, fearful of seeing their retirement security evaporate. An article in this month’s issue of AARP Magazine reminds us that if stock is transferred upon distribution, then income tax is owned only on the stock’s cost basis, and subsequent stock sales are subject to lower capital gains taxes. [AARP Magazine, Jan/Feb 2006, Karen Hube, p38]
Even that favorable capital gains treatment won’t protect the individual from a crash as severe as the one that brought Enron stock down. Diversification of investments would have been the prudent course there. But for any reasonable holdings of company stock, going the capital gains route will be better than cashing out the stock within the 401(k) plan itself, even if the stock price slips some moderate amount: you’re losing less to the market than you would lose to your Uncle Sam!
Realized and unrealized gains and losses attributable to each Division of an insurer’s pooled separate account are credited or charged to the assets invested within that Division, each of which has its own different investment objective or style. Accordingly, each Division is considered a “separate account” as defined by ERISA section 3(17), according to the Employee Benefits Security Administration. [Advisory Opinion 2005-22A, 12/7/05]