Our Time Has Come

At the next cocktail party, trying mentioning that your firm does “fiduciary work” for qualified retirement plans.  Immediately, people’s eyes glaze over, they bolt to re-fill their drinks, and those who remain simply give a quizzical nod desperately trying to be polite.

Fiduciaries, fear not!  Our moment in the spotlight has arrived.

Yesterday’s New York Times editorial, Successful Investing for the Long Haul, highlights a long simmering regulatory battle between Washington and Wall Street.  Shortly after the financial crisis of ’08-’09, the Department of Labor issued proposed new regulations pertaining to the definition of fiduciary under ERISA.

Wall Street fought back hard, and the regulation wallowed in the backwater of rule making.

Until late February, that is, when President Obama, with Senator Elizabeth Warren (my Senator) at his side, announced in a speech made at the national headquarters of AARP, that he wanted the DOL to move forward with the fiduciary regulation project.

Subjecting brokers and financial advisers to a fiduciary standard captured the headlines.   Brokers must put client interests first — not simply as an advertising tagline, but rather in reality.

Digging beneath the headlines, however, uncovers a potential massive re-structuring of Wall Street firms.  $24 trillion of retirement assets (as reported in the ICI 2014 Annual Report) currently flow through the financial system and Wall Street .  10 basis points here, 10 basis point there, suddenly becomes a lot of money.  These financial firms have a lot at stake.

Once brokers are “deemed” fiduciaries, all related revenue streams will have to be examined and analyzed to determine if there are prohibited transactions or conflicts of interest.  Financial firms are going to have to under take a through review of their business models.

Wall Street will not look the same afterward.  Stay tuned.

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Dark pools remind me of revenue sharing.  Not much good can come from business practices or products with descriptive titles of this nature.

Whereas an avalanche of class action litigation has shed light on the practice known as revenue-sharing, New York Attorney General Eric Schneiderman, Barclays Faces New York Lawsuit Over Dark Pool and High-Frequency Trading, has focused the spot light on dark pools by filing a law suit against Barclays over its private stock trading platform… otherwise known as dark pools.

The law suit essentially claims that certain high-frequency traders were favored over other participants in the pool and that various practices were not properly disclosed.

Many of the other banks and financial services firms run similar “platforms”, so the entire financial industry has a stake in the litigation.  Schneiderman is not the only regulator involved, the SEC, charged with maintaining integrity in the financial markets, is also a key player.

And so … here goes another financial services industry free-for-all.   Mind you, these dark pools are big revenue producers, so the stakes are high.

The issues are serious and complex for Wall Street, however, I am much more interested in the fiduciary issues at stake.

Make no mistake about it, plan fiduciaries have oversight responsibility for the trading of securities held by the plan.  At a minimum, the trading practices must be reasonable, prudent and, generally, managers are required to seek “best execution.”  And, of course, this analysis must includes a review of trading costs and expenses.

The challenge and tension revolves around the fact that fiduciaries require transparency, whereas the name dark pools suggests the opposite — opacity.

At the outset, Fiduciaries need to determine whether plan assets were traded through these dark pools.  If the answer is yes, then a whole series of questions follow:

Did the plan assets get best execution?

Are other pool participants advantaged over the plan assets?

What fees are charged for trading in the pools?

Are these fees reasonable?

Are the fiduciaries assured that trading via the pools did not constitute a prohibited transaction?

How are pool operators compensated?

Are there any conflicts of interest?

Has the fiduciary been monitoring these trading practices on a regular basis?

This is merely an initial list of questions.  But, posing the questions is the easy part.  Understanding the answers is far more challenging.  In my many years of serving as the General Counsel of a global investment management firm, no area was more confusing or harder to get my arms around than the issues related to the trading desk.  Traders use a lingo and jargon that is all their own.  Sometimes getting satisfactory answers in this area requires the best of prosecutorial skills.  It can be tough going.

If they haven’t already, Fiduciaries are best advised that they begin asking these questions.  If they do not, certainly class action lawyers and the Department of Labor, most certainly will.

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Is Anyone Paying Attention?

The debt-ceiling crisis has been momentarily addressed and the financial markets are continuing to tremble.  In my past few blogs, I’ve raised topics which Plan Sponsors should address with their various plan fiduciaries.   It’s all about being prudent.  Today, the focus is on Securities Lending.

In the 2008-2009 financial crisis, Securities Lending programs froze.  Collateral pools experienced huge liquidity issues and loans could not be unwound.  Pension plan portfolios suffered significant loses.

The last time around the culprits were mortgaged-backed securities and all the various related derivatives.  This time, it could be sovereign debt.  Today, the NYT reports Large Banks in Europe Struggle with Weak Bonds.  The main thrust of the article is that sovereign prices for certain European countries are weakening dramatically thereby affecting the capitalization of some large European banks.

However, tucked deep in the article are references to repo transactions and the posting of collateral.  Sovereign debt is often used in these trascations.   This is where Securities Lending (the “reverse” side of a repo transaction) comes into play, and where Plan Sponsors should be focusing their questions.

Plan Sponsors should examine two separate, but very closely related, potential risk related to European debt and the European banks:

Short-Term Bank Paper Held by Collateral Pools — Remember Lehman Bros?  It’s paper was held by many investors, including pension funds.  As the paper became worthless, securities lending collateral pools lost values.  Plan Sponsors are on the hook for the investment losses related to collateral pools.  Many plan sponsors were not happy.

Collateral Posted by Broker/Dealers — When broker/dealers borrow securities to facilitate short sales by their clients, the broker/dealer must post collateral.  Often, Sovereign Debt offered as collateral qualifies for better terms than other forms of collateral.  Therefore, there is a huge incentive for broker/dealers to offer Sovereign Debt for these purposes.  However, to the extent that debt from any of the troubled European countries was used as collateral, and as prices continue to deteriorate, the broker/dealers will have to post more collateral as the value of this debt deteriorates.  Watch the capitalizations of the broker/dealers.

Don’t dismiss the role of broker/dealers in the stability of our financial system.  As Lehman as entered in bankruptcy, all the others teetered on the edge of the abyss.

Few areas are more technical, “nichey”, or esoteric than Securities Lending.  If Plan Sponsors want to partake of the benefits of Securities Lending, then they must really understand the risk.  They must dive into the details which I outlined above.

If these questions are too “geeky” for Plan Sponsors to develop in-house expertise, then they should delegate oversight to true experts.  Ignoring complicated issues can never be prudent.

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Harrison Fiduciary Group — Our Pledge

As anticipated, the SEC issued it’s report, Study on Investment Advisers and Broker-Dealers, and recommends a new Unified Fiduciary Standard for broker/dealers and investment advisors.  Uniformity can be applauded, as well as a higher standard applicable to broker/dealers ….but, let’s not kid ourselves, as I discussed in my prior Post, it is a diluted fiduciary standard allowing for the payment of commissions, the sale of proprietary products and other accommodations to Wall Street.

At Harrison Fiduciary Group we will always rise above the morals of the market place and we pledge as follows:

  1. We will not receive commission income;
  2. No conflicts will be tolerated;
  3. We will not promote proprietary products; and
  4. All actions that we take, and decisions which we make, will be solely in the interests of participants and beneficiaries.

Regulators and Congress may be compromised by political interests, but at HFG we are not subject to these pressures.  Instead, we are guided by our core corporate values which shall remain undiluted.  Our responsibility is to put the interests of plan participants ahead of our own.

Our flat fee schedule goes to the heart of our business model, and reflects our core fiduciary values.  For each assignment we will be paid a flat fee and not a basis point fee on the size of assets under management.  The “basis point” model has become endemic to the pension industrial complex.  Many service providers attempt to hitch their revenue streams to the ever growing pool of pension assets –investment managers, custodians, record-keepers and consultants.  We aim to break this link.

As a fiduciary we will be paid a fee in exchange for our fiduciary services.  This fee will reflect the fiduciary risk we assume, the complexity of an engagement and the amount of resources which will need to be devoted to the engagement.

Overseeing and managing the hard earned retirement assets of plan participants is a position of trust.  At Harrison Fiduciary Group we will earn and safeguard that trust zealously.

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