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“All the News That’s Fit to Print” and More

Who doesn’t love a deal, especially in today’s economic environment?  This past Sunday’s NY Times, 23 October 2011, not only offered an update on global current events, but also serves as a virtual handbook for retirement plan fiduciaries.  [Go fish it out of the re-cycling bin ... yes, I still read the physical newspaper; one of life's daily pleasures.]

Starting with a bold graphic representation of the European credit crisis sprawling across two pages of the Sunday Review, Bill Miller’s,  It’s all Connected: An Overview of the Euro Crisis is clearly worth more than 1000 words.   At first blush, it seems too confusing … just too much to get one’s head around.  It’s much easier to turn the page.  Better yet, flip to the Travel or Arts & Leisure Section.

Retirement plan fiduciaries, however, don’t have that luxury.  Ignoring the financial issues brewing in Europe would be irresponsible and imprudent.

And yet, even for a responsible fiduciary, where does one begin?  If only there were a true sage, who had all the answers and could predict the outsome.

Fiduciaries don’t have to be sages.  They simply need to be prudent and responsible.  At the very least, every fiduciary committee, whether for state & local plans or for corporate plans, should be exploring the impact of the European issues on their plans and on their investment policies.

A daunting proposition, but plan fiduciaries don’t have to operate in a vacuum.  Instead, they should turn to each of their investment fiduciaries and pose the following questions:

  1. What is your analysis of the European debt crisis?
  2. Does this analysis have any impact on your investment strategy and our portfolio?
  3. What’s the weakest link in your analysis?
  4. Have you constructed contingency plans?

No doubt, every investment advisor will have a different answer, and fiduciaries will need to piece together conflicting data points.  But, in the end, plan fiduciaires must make sure that their investment fiduciaries are themselves being prudent.  Fiduciaries can’t predict investment results, but they can, and must, ensure prudent processes and decision making.

If the above advice seems too general, and therefore too simplistic, and maybe even worthless, then let’s turn to the front page.  Gretchen Morgenson and Louise Story’s, Bank’s Collapse in Europe Points to Global Risks, examines the bailout of  Dexia Bank whose problems, in part, stem from gorging on too much sovereign debt.  Using Dexia as an example, Morgenson and Story extrapolate various scenarios, and related policy issues, raised by potential rounds of bailouts of banks and their trading counter-parties.

I’d supplement their analysis by drilling down to an equally ominous set of challenges to which they allude: repos, securities lending and short-term commercial paper.  Most all banks (domestic and foreign) fund their operations, in large part, through repos and other forms of commercial paper.  Remember what happend to Lehman when no one would fund their short term paper?  And, what about securities lending pools stuck with rapidly declining collateral?  Just ask plan fiduciaries who were unable to terminate investment managers becaus securities were tied up in frozen securities lending pools.

Need more questions to ask?

Let’s not forget about money market funds.  Gretchen Morgenson, in the Business Section,  How Mr. Volker Would Fix It, also wrote about Paul Volker’s blunt recommendations about reforming the financial system; starting with money market funds and the residential mortgage market. Money market funds are huge purchasers of sovereign and bank debt.  As has also been previously reported, many of these funds have been paring back their European exposure.  Plan fiduciaries overseeing 401(k) plans holding money market funds need to be questioning their managers about strategies for addressing these global banking issues.

Plan fiduciaries, however, also have to ask about STIF’s (short-term investment funds).   Every custodial bank runs $ Billions in STIF’s, unregulated funds which no doubt are also chock full of sovereign and bank debt. Fiduciaries, are you asking your custodian banks about their STIFs?

If Miller’s graphics and Morgenson”s and Story’s articles don’t arm fiduciaries with sufficient questions, then turn to The Little State With the Big Mess, an eye opening article about Rhode Island.  The tiniest state, but the biggest pension woes.  Hard to know where to begin asking questions about the Rhode Island mess, but how about starting with the newly revised investment return assumption of 7.5%, down from 8.25%?  Is that a prudent decision?  Where did that number come from?  An easy question to ask, but maybe the answer is not so simple.

Finally, turning from the newsprint to the magazine, Daniel Kahneman, Nobel prize winner in Economics, Don’t Blink! The Hazards of Confidence, writes about the behavioral phenomena that confidence in our own judgments creates a bias that can lead us to ignore hard facts which contradict our judgments.  Focusing on investment performance, Kahneman explains that notwithstanding quantitative proof that certain investment managers added zero value to the investment process, these managers were nonetheless awarded bonuses on the assumptions that they “added value.”  Assumptions die hard.

By the way, maybe someone should forward a copy of Kahneman’s article to the fiduciaries of the Rhode Island state and local pension plans.  I’m still struggling with 7.5%.

Fiduciaries beware.  Don’t be so confident.  Ask lots of questions and work hard not to be so confident in your assumptions.  You are not just investing your own assets … instead, you are investing on behalf of hard working plan participants and retirees.

And I thought that I’d relax with a cup of coffee and a leisurely read of the Sunday paper.

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Not In-House Lawyers

Any lawyer who has worked in-house in a financial services firm, no doubt, is not surprised about the mortgage documentation mess.  Articles abound in the newspapers:  Gretchen Morgenson, One Mess That Can’t be Papered Over; Joe Nocera, Big Problems for Banks: Due Process; and a NYTimes editorial, More on the Mortgage Mess.

As I have experienced, and many, many friends and colleagues have confirmed, few issues command less respect than properly documenting a transaction, a process or a meeting.  Everyone on Wall Street, and throughout the financial services industry views themselves as a deal-maker, a trader, a big-picture gal or guy.  Documentation is clearly beneath them.  (Yes, this condition crosses gender lines).

I will never forget in the early 90’s when equity swaps and other over –the –counter trades were gaining in popularity.  We were wrestling with the documentation process … executing confirms as well as master agreements.  Admittedly, it is a tedious process.

The Wall Street model had junior associates who worked directly on the trading desks who were responsible for completing first drafts of trading documents.  Deals were only kicked up to the legal department in the event that negotiations broke down over issues like indemnification or other liability limiting provisions.

Not so in our organization.  Notwithstanding my otherwise well-honed skills of persuasion, no one on the trading desk wanted anything to do with documentation.  Any piece of paper with more than 2 paragraphs of written English clearly was a “legal document” and belonged with “Legal”.

I tried to explain that understanding the legal documentation between two parties provided a junior person with valuable training.  Certainly someone who aspired to be an equity or fixed income trader would gain insight into their roles if they understood the contractual nature of the obligations they were creating.

I might as well have been from Mars.   Everyone just wanted to “do deals”.  Very few people were interested in “dotting the ‘I’s’ or crossing the ‘T’s’”.  In the excitement of wracking up large bonuses over the last decade, few people wanted to be bogged down by the careful, detail-oriented work of getting the documentation right.

And throughout Wall Street and beyond, the very people who were disdainful  of documentation, eventually assumed leadership of their firms.  Everyone knows, that the tone is set at the top.

Tens of thousands of mortgages, middlemen, issuers of securities, underwriters and sales people —the fact that there is a mess, does not surprise me.

Go take a poll of in-house lawyers.  I’m sure they read the various accounts of the mortgage mess simply shaking their heads with a profound sense of understanding.

As a lawyer, and as a fiduciary, I know in my gut (in my kishkes) that documentation is crucial.  For when the dust settles, all that is left are the documents.  Lawyers know that, and so do judges.

Fiduciaries have an obligation to act prudently on behalf of their clients.  There is no excuse and no tolerance for the lack of diligence in assuring that all documentation is perfect.  That is our duty.

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