Prosecutor & Judge Miss The Beat

My son is graduating from college in May, just a few weeks away, and is looking for a job.  I want to be helpful, if I can. He’s a good kid. I’m proud of his accomplishments and I want to see his career launched in the best way possible.

My yearnings, I suspect, are not unique.  In fact, I think that it is genetic and part of human nature.

I also suspect that Daniel O’Donnell feels the same way about his son, John O’Donnell.  His fatherly inclination is to help him. This is not a criticism, but rather a statement of the obvious.

The challenge, however, is that Daniel O’Donnell was until recently the chief operating officer of Guidepost Solutions, a compliance and security firm which has been hired to oversee John O’Donnell’s employer, Point72 Asset Management, the successor firm to SAC Capital. As reported by the New  York Times on Wednesday, it is unclear what Daniel’s O’Donnell’s new role will be.  Presumably, however, he has not retired from the firm

Yes, the father’s firm is overseeing his son’s employer.   This just doesn’t feel right.

And yet yesterday, Judge Laura Taylor Swain approved the SEC’s settlement with SAC Capital on insider trading charges, including a $1.2 billion penalty to be paid by SAC, which also included this father/son compliance arrangement.

No doubt that Guidepost Solutions will impose “firewalls” and other procedural impediments to limit the senior O’Donnell’s activities as relates to junior O’Donnell’s employer.   Lawyers are adept at devising structures which eliminate per se conflicts.

In fact, over the years, I too engaged in crafting these very lawyerly type structures.

However, I would think that after Enron, Lehman Brothers and the Financial Crisis of 2009 that the players in the financial markets would have learned the lesson that not only should per se conflicts be avoided, but that all appearances of impropriety should be avoided.

As a fiduciary for retirement plans, I want to emphasize that all real conflicts and “appearances” of conflicts should be avoided… at all times. The plan participants and beneficiaries on whose behalf I work, deserve no less.

I do not want to be misunderstood here.  I have no doubt that Guidepost Solutions and Daniel O’Donnell possess impeccable credentials and abide by the highest ethical standards. It is simply that these inter-twined relationships do not pass the smell test.

Given the significance of the SAC settlement, along with the symbolism of the victory for the SEC, is Guidepost really the only firm available to provide these oversight services?  Wouldn’t the entire system be better off had another firm been selected?

To a certain extent, the primary responsibility for this imbroglio rests not with Guidepost, Point72 Asset Management, nor the O’Donnells.  Instead, it behooves Preet Bharara, the United States attorney, and Judge Swain to explain their thinking.   If well respected prosecutors and jurists have a tin ear for conflicts, then what can we expect from the ambitious young masters of the universe who drive our capital markets?

Lawyers get out your pens (I date myself).  Opaque clever structuring seems to be back in style.





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Emphasize Quality Over Quantity

Retirement plan fiduciaries are hiring independent fiduciaries with greater frequency.  Structured properly, the plan fiduciaries and senior management, should be insulated from liability for the actions of the Independent Fiduciary, provided that the process of selecting and hiring the Independent Fiduciary is prudent.

The process need not be tedious or cumbersome.  Furthermore, it should not be delegated to junior professionals with a mere rubber stamp approval provided by senior management.   A robust process, conducted with integrity, serves as an important foundation for fiduciary decision-making.

1.  Meet and interview the Independent Fiduciary candidate.

There is nothing more important than meeting with the potential Independent Fiduciary.   Most advisors, I suspect, would say that compiling data through an RFP process is the most important part of the process.  I disagree.

Data is important, but it does not take the place of a face to face meeting. Serving in a fiduciary capacity is a position of trust.   While technical skills can be assessed through an RFP response, trust can not.   Trust should be determine through a face to face meeting in which the hiring fiduciary attempts to gauge the way in which the Independent Fiduciary will analyze problems and execute fiduciary decisions.

2.  Assess the Fiduciary’s Independence.

The best laid plans of fiduciary protection will fail if the fiduciary is not independent.

The industry serving the retirement plans is vast and interconnected, a veritable spider web of relationships.  Hiring fiduciaries must be assured that the Independent Fiduciary does not have any relationships with the plans that could give rise to a prohibited transaction.  Focus on the receipt and payment of fees among the plans sponsor, the plan, the Independent Fiduciary and any affiliates of the above.

3. Review the Independent Fiduciary’s Procedures.

Every fiduciary should have a set of written procedures that it follows for a fiduciary engagement.  Request a copy of these procedures and evaluate them.  Ask the candidate whether they certify that the Procedures were followed.  Be assured that the  procedures are specifically tailored to the particular engagement and that they are not simply boiler-plate lists of tasks.

4. Inquire about Fiduciary Litigation.

Explore the candidate’s litigation experience.   The plaintiff’s bar is very active.  Qualified fiduciary candidates may have both been sued for breach of fiduciary duty and have won the case based on the facts; that is, a finding of the court that the fiduciary acted prudently.   Specifically, question whether the fiduciary’s procedures withstood the scrutiny of litigation.

5.  Is the Fiduciary an Expert?

Fiduciaries must be prudent experts.  Under take the requisite due diligence to determine that the fiduciary is both an expert with respect to the specific engagement and with respect to ERISA principles.   Investment/financial skills as well as fiduciary expertise are critical.  Compilation of data through an RFP can be helpful in this process.

Most importantly maintain a detailed written record of the selection and hiring process.  This documentation could be valuable if the process ever needs to be defended.


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An Independent Fiduciary Protects All Parties

With rising interest rates and CEO’s tired of pension-related balance sheet surprises, the volume and size of annuity transactions is bound to explode.

Experience teaches that exuberance in financial markets and products can lead to some very painful losses.  The Department of Labor is concerned.  It has seen this movie more than once.

Multiple factors go into the corporate decision to “de-risk” the balance sheet by purchasing annuity contracts.  Months of work go into this decision.  One key factor is the cost of the annuity, as well as the cost of executing the transaction.  While these transactions can be expensive to execute, senior corporate managers are also incentivized, and have a duty of loyalty to the company, to minimize these expenses.  Lower expenses enhance earnings.

However, annuity pricing is efficiently correlated to the credit quality of the issuer of the annuity.   In other words, lower credit-quality issuers charge less for their products.  The corollary is also true; higher credit-quality annuities are more expensive.

Left to their own devices, corporate managers are incentivized to purchase the cheapest annuity available even if it reduces the credit quality of the issuer.  This pressure is very strong.

Plan fiduciaries and participants, however, have a different view.  They are interested in the strongest credit quality issuer available, price be damned.  Remember, prior to the annuity purchase, the pension plan is funded by a diversified pool of assets, thereby mitigating investment risk.

An annuity purchase,however, substitutes a single issuer for this diversified pool.   The pensions of thousands of plan participants are dependent on this single issuer.  The issuer goes bankrupt, the pensions are lost… forever.

The conflicts for senior managers (some of whom are plan fiduciaries) in executing these transactions are real.  Should they pay up for higher credit quality; or, should they sacrifice credit to enhance earnings.

ERISA provides a single answer.  Fiduciaries must act in the interests of participants.

In the early 1990’s the bankruptcy of Executive Life Insurance Co. provided a huge wake-up call.   Many plans were invested in Exec Life products and they absorbed huge losses.

In response,  the DOL issued guidelines in IB 95-1 setting forth numerous requirements regarding the purchase of annuity contracts.  Post-Executive Life,  the DOL requires that a plan purchases the “safest available annuity”.   In reaching this determination, the DOL requires that 6 six factors be analyzed, price of the annuity is not one of the factors.

Recognizing the potential conflicts of interest and the competing pressures of corporate managers, these IB 95-1 suggests that an independent fiduciary be hired to make the the “safest available annuity” determination.

Unfortunately, plan sponsors don’t like hiring Independent Fiduciaries. They don’t like paying the fees and they don’t like a second set of eyes reviewing their judgments.  If corporate managers want to purchase an annuity from XYZ Insurance Co, they don’t want a third party telling them that they should purchase the annuity from DEF Insurance Co.  And, they really don’t like that an Independent Fiduciary will retain its own lawyers and advisors for the transaction.

Ironically,  the intensity of the resistance by senior managers to hiring an Independent Fiduciary actually illustrates and proves the very conflicts of interest outlined above.

Corporate managers who forgo an Independent Fiduciary might one day be in the position of having to prove to the Department of Labor that they transcended these conflicts and acted in the interests of plan participants.  In the context of large losses (possibly $ billions) That will be a hard argument to make.  The DOL will be very suspicious.  Remember, there is personal liability for breaches of fiduciary duty.

In the end, an Independent Fiduciary will make decisions in the interest of the plan participants.  However, the corporate managers can take great comfort from knowing that the conflict of interest is significantly mitigated by the hiring of the Independent Fiduciary.  Whether they understand it or not, the Independent Fiduciary provider significant protections to the corporate managers.

Corporate managers should focus on executing their corporate strategies.  Let the Independent Fiduciaries wrestle with the complexities of purchasing annuity contracts.







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The Writing is on the Wall


Amazon upended retail and iTunes transformed the music business.  A new business model is now threatening the highly coveted super-sized bonuses earned by private equity and hedge fund managers.

The Institutional Investor’s Roundtable represents a consortium of public and sovereign wealth funds that are coordinating their investment activities, in large part, to exercise greater control of the investment of fund assets, and correspondingly reducing the fees paid to private equity and similar hedge fund managers. Public Funds Take Control of Assets, Dodging Wall Street.

Nathaniel Popper of the New York Times reports that Abu Dhabi Investment Authority,  Alberta Investment Management Corporation, Ontario Teacher’s Pension Plan,  China Investment Corporation, the Russian Direct Investment Fund, and the public pension funds for Oregon and Wisconsin have all been adopting methods which reduce the fees paid to investment managers.

Make no mistake, the names listed above are marquee names in the investment management business.   Investment managers fall over themselves to accommodate these clients.  So, it is bad news all around for investment professionals when these clients are so focused on fee reduction.

I’m not an economist.  However, I suspect that once the fee-reduction genie is out of the bottle it is very difficult to go back to the way the private equity and hedge fund game use to be played.

As a fiduciary, I applaud these efforts.  Since the advent of modern portfolio theory, back in the 1970’s, it has been axiomatic that a reduction in fees and expenses incurred by an investment portfolio increase the investment return of the portfolio.  Increased investment returns mean greater pools of assets to be distributed to plan participants and beneficiaries.

This trend is bound to continue.  Hopefully it will accelerate.  Detroit is in bankruptcy, countless municipalities and public funds are reporting significant pension shortfalls and yet the investment management masters of the universe continue to buy trophy properties in Aspen, Nantucket and Jackson Hole.

Something is terribly amiss with this scenario.  It is high time that fiduciaries begin to exert their responsibility to reduce the outsized fees paid to these managers.


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Goldman has gotten tangled up in a web of conflicts where it provided investment advice to a target company, El Paso Corporation, while holding an investment interest in the acquiring company, Kinder Morgan.  Andrew Ross Sorkin reports on the resulting litigation, As An Adviser, Goldman Guaranteed Its Payday.

Goldman apparently argues unsuccessfully that it had disclosed the conflict to El Paso and arranged for a second, independent bank, to advise El Paso.

In the current investment and business environment the concept of disclosure reigns supreme.  As investigators, lawyers and journalists pour through the all of the various claims generated out of the recent mortgage crisis, often the question is whether certain investments or processes were effectively disclosed.

Disclosure, however, is a securities law concept.  When it comes to fiduciary relationships and ERISA, disclosure doesn’t cut it.

ERISA is very clear.  Conflicts of interest are not tolerated. Fiduciaries are prohibited from acting on behalf of any party whose interests are adverse to the interests of a plan.  This rule is not some obscure or technical rule within ERISA.  Instead, it is the cornerstone of ERISA.

Violation of this principle constitutes a “prohibited transaction”  which can give rise to penalties and fines.

The economy may be gathering a little steam, and the banks may be on a more solid footing than they were a few years ago, however, trust in the “system” is sorely lacking.  Just watch the political news every night.

We need players in the financial and capital markets who understand that there is no justification for conflicts of interest.  The system needs professional who are trusted and who will act in the best interests of their clients.




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