Harrison Fiduciary

Does Anyone Really Know?

Everyone takes money market funds for granted.  Don’t know where to invest idle cash?   Stick it in a money market fund, right?  Our entire financial system treats money market funds as safe and secure investments.

And, they are safe.  Until they are not.

Today’s NYT, Hopeful, but Wary at Money Markets, prudently identifies the fault lines and risks associated with money market funds.   Fortunately, Edward Wyatt’s reporting is not a Chicken Little,  the-sky-is falling rendition of risks inherent in the financial markets.  [The press and blogosphere are filled with too many of these.]  Instead, Wyatt effectively outlines and explains the risks inherent in money market funds in the context of extreme volatility in treasury securities.

Money market funds exist solely by virtue of a vastly complicated regulatory structure.  Anyone interested in the risks associated with money market funds must be familiar both with the regulations as well as with the investment securities.  One without the other is simply half-the-story.

And, as the Wyatt’s article points out, money market funds are not free from risk.  During the financial crisis of ’08-’09 one of the largest money-market funds, Reserve Primary Money Market Fund, “broke the buck”.  That is, investors lost money.

Plan Sponsors often are not familiar with all of the intricacies surrounding money market funds.  As fiduciaries, however, they should understand the general parameters of the risks.  And, more importantly they should make sure that the experts they have hired are in fact experts on every intricacy and beyond.  The hired experts, however, do not take the plan fiduciaries off the hook.  Everyone needs to be doing their job.

Wyatt, quoting an executive from Fidelity Investments, reports that Fidelity, which manages $440 billion in money market assets, has had “a contingency team focused on this since the end of May.”  Fidelity recognizes that “we have to be prepared to respond to the unthinkable”.

In light of the Reserve Primary Fund’s experiences just a few short years ago, the previously unthinkable is not so unthinkable.

If Fidelity is engaged in contingency planning, prudent dictates that all plan fiduciaries should be engaged in similar contingency planning.  In the financial world, the unthinkable can happen.  Plan sponsors must plan accordingly.

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Confusing Times  — Simple Measures

The headlines may change, but the theme is the same — too much debt.

Weather it is the never-ending saga of European debt (Greece, Portugal, Spain), or the debt-ceiling gridlock here in the US, policy makers, politicians, economist, investors — everyone is trying to make sense of out the debt.

No one has any answers, just best guesses.  In the midst of all of this confusion, however, fiduciaries still must act prudently.  What’s the best course of action?

First, and foremost, fiduciaries do not need to be economic or investment experts or savants.  They do not need to look into their crystal balls and predict the outcome or even the best course of action.

Instead, they must act prudently.  The following actions will advance their fiduciary obligations:

1.  Review investment policy statements and investment accounts

Simply identify the investment accounts or strategies which might be effected by the debt issues.  One could say that all investment portfolios could be effected.  However, it would not be difficult to prioritize the accounts.  No doubt cash,  money market, stable value, and other fixed income portfolios should be at the top of the list.

2.  Meet with your consultants and advisors

Pick and the phone and request a meeting with your advisors — either in person or via teleconference.  Don’t worry if it isn’t time of a quarterly or half-yearly portfolio review.

3.  Obtain their analysis of the market environment and their recommendations

Remember, while a fiduciary does not have to be an expert on these issues, your investment advisors do.   They are paid to be experts.   Therefore, they should have cogent positions and explanations for the current market environment.

4. Question their assumptions

Don’t blindly accept their responses.  Questions their assumptions.  Explore alternative options in the event that their predictions don’t materialize.

5.  Inquire if they have conducted stress tests on the portfolio

Simulating various market conditions has become a standard tool for monitoring investment portfolios.  Require  your managers to provide you with the results of these various tests.  And, most importantly, determine if you are comfortable with the results.

6.  Get recommendations in writing

Don’t be bashful.  Ask your advisors for their advice in writing.  If they hesitate, explore their motivations.  But, continue to press.

7.  Document, Document, Document

Document your process.   This cannot be stressed enough.  Contemporaneous written records of your process and the results of the process are critical to fiduciary prudence.

The issues are daunting.  The landscape changes daily.  Nobel prizing winning economists line up on every side of the issue.

For fiduciaries, be diligent about your process.  This will ensure that you are acting in the best interests of plan participants.

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Fiduciaries Really Need to be Experts

Plan sponsors need to re-calibrate their fiduciary obligations with respect to their retirement plans.  They have to ask hard questions. Do they have the relevant expertise to fulfill these roles?  Do they understand the “business” of maintaining and administering plans?  And, finally, do they want to devote time and resources to this responsibility?

In reality, most plan sponsors are too busy executing on their business strategy to worry about fiduciary matters. And, this is the way it should be.  Typically, HR and finance staff members oversee the plans and identify policies, procedures and vendors — all to be rubber-stamped by  high-level corporate committees.

This model is old-school, is broken, and must be fixed.  A recent appellate court case, in the 7^th Circuit, is bringing these issues into sharp focus.  Plan Sponsors need to pay attention.

The volume and sophistication of ERISA class action lawsuits has grown significantly over the past decade.  Until this April, however, plan sponsors and retirement plan service providers have largely successfully defended against this onslaught.  This has been good news for fiduciaries.

In April, however, the 7^th Circuit, previously a defendant-friendly court, handed plan sponsors and fiduciaries, a very serious set back.  In a class action suit against Kraft Foods, the court did not dismiss the case, but instead sent it back to the district court to determine whether the plan sponsor, Kraft, breached its fiduciary duty to the participants.

This holding is a nightmare for plans sponsors and corporate fiduciaries. No fiduciary wants a trial court to determine whether it’s acts or omissions satisfied the fiduciary standards of ERISA.  Likely the insurance companies will settle.

Nonetheless, this case goes to the heart of the critical importance of fiduciary processes.  With respect to a company stock fund, the court questioned whether the fiduciaries ever examined the operational structure of the fund and balanced the relative merits and drawbacks of different structures.  Furthermore, a question was raised as to whether Kraft ever reached an affirmative decision supporting one structure over another.  Surprisingly, no documentation was submitted which would support that a decision had, in fact, been made.

In addition, the court was not comfortable with Kraft’s 10 year relationship with its record-keeper.  Although consultants had advised that the recordkeeping fees were reasonable, the court was critical that third party bids were not obtained and used for comparison purposes.  Maybe the court just thought that the relationship was too cozy.

At a minimum, this case indicates that fiduciaries must develop a sophisticated understanding of the technical intricacies of the mutual fund, recordkeeping, and fund administration businesses.  Relying on consultants is not good enough.  Instead, fiduciaries must dig into the weeds, compare and assess the merits, deficiencies and costs of various service delivery models.

Plan Sponsors need to focus on capturing their own target markets, developing products, satisfying customer needs and growing their earnings. Why should they be bothered with this stuff?  It can be a nuisance.

As stated in the title of this posting, fiduciary oversight is not a part time job.  There is significant subject matter and procedural expertise required in discharging fiduciary responsibilities.  Plan Sponsors should recognize the professional skill set required to serve as a fiduciary, and acknowledge that it is not in their interest to develop or maintain this expertise in house.  Plan Sponsors, as well as participants and beneficiaries would be best served by hiring expert Independent fiduciaries to oversee the plans.

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BlackRock Solutions Needs to Shed Light on Valuation Methods

Today’s Wall Street Journal, BlackRock’s “Geeky-Guys” Business, focuses a spot light on BlackRocks Solutions — a small business unit tucked away in the bowels of BlackRock, complete with its own elevator entrances, computers and separate office floors.  If nothing else, haven’t we learned from the ’08-’09 financial crisis, that “Geeky-Guys” hidden away from view have the potential to inflict great harm on our financial system.

Let’s give BlackRock Solutions (BRS) the benefit of the doubt — they have some really smart people who work really hard.  And, during the height of the financial crisis BRS assisted with the management of portfolios which held a lot of funky assets.  The system and US government (including the taxpayers) needed BRS.

As the WSJ reports, BRS provides various risk management services, including asset allocation, to major pension plans — both public and private.  As part of these services, BRS also values hard to value assets according to its own proprietary algorithms and processes.  These valuation process are secret — according to the WSJ.

While I obviously am not privy to the contracts between BRS and its clients, I have strong suspicions that BRS is hired as a fiduciary to provide these services.  Furthermore, the people at the pension plans who hire BRS are likely fiduciaries themselves.

Based upon these two assumptions, I have 2 simple questions:

1) If valuation processes are secret, how do the fiduciaries which hire BRS know that they are prudent processes?

2) Are the fees which BRS charge dependent upon these secret valuations?

These are not sophisticated questions.  But, the answers go to the heart of our pension system.

ERISA is very clear.   Plan fiduciaries are able to hire and delegate responsibilities to other fiduciaries.  If they do so, the decision to hire and delegate these responsibilities must be a prudent decision.  Furthermore, the plan fiduciaries must continue to monitor the hired fiduciaries.  How can the decision to hire BRS be prudent if the valuation methods are secret?  Furthermore, how can anyone monitor whether BRS is discharging its responsibilities in the face of secret valuation methods.

Finally, I also strongly suspect that BRS  charges a fee based upon the assets under management.  If this is the case, then the secret valuations placed upon the assets can directly effect BRS’s compensation.  This is a problem under ERISA.

Yes, the professionals at BRS are smart, and we should trust them.  But, that is besides the point.  Assuming that they are fiduciaries, secrets can’t be permitted.

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Simple & Risk Free?  Hardly.

Plan participants have flocked to Stable Value programs to the tune of $700+ billion. As the name implies,  and most investors believe, these programs are touted as safe investment options for plan participants.  Maybe yes, maybe no.

Offering investment yields greater than money market funds, without the volatility of bond funds, Stable Value programs are hybrid investment and insurance products.  An investment manager manages the underlying cash portfolio, and an insurance company or bank then guarantees (or wraps) the book value of the program.  In essence, the value of the fund is not suppose to go below $1/share.

Hybrid products, however,  offer complexity, and complexity presents risks.

In the current low interest rate environment, unique risks confront plan fiduciaries.

To date, stable value plans have generated a higher investment return than money market funds because they can invest in securities with longer durations, paying higher interest rates.  When interest rates turn higher, however, this benefit becomes a drag.  Money market funds are more nimble and can take advantage of the higher rates in a rising rate environment.

Since most Stable Value funds are “marketed” as higher return investment options, plan participants will be very surprised to learn that their Stable Value options may be paying returns less than money market funds.  Employees must be educated on the true risks and mechanics of Stable Value Funds.  Failure to educate employees properly can bring sizable fiduciary risks on the plan sponsor.

With interest rates so low, Fiduciaries must not only monitor an upturn in rates, but they must also track withdrawals from Stable Value programs.   If interest rates do not increase, participants undoubtedly will begin switching into investment options generating higher returns.  Whether this makes investment sense is irrelevant.

The wrap contracts (which guarantee the value of the stable value program) often contain covenants that require the Program to maintain a minimum number of participants or assets in the Program.  Falling below this threshold constitutes a breach of the wrap agreement, and would allow an insurance company to walk away from the guarantee.   This is a total disaster from the perspective of the plan fiduciaries.

The very name “Stable Value” lulls everyone — participants and fiduciaries, alike – into a false sense of security.   These are highly technical and complicated investment options that should be monitored, evaluated and negotiated by Stable Value experts.

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Credit-Related Strategies Warrant Heightened Scrutiny

It’s called the Great Liquidation.  As reported in today’s NYT, The Haggling for Troubled Assets Begins, “hundreds of billions of dollars of bad investments …are going up for sale”.  Fiduciaries must ensure that these bad investments do not end up in retirement plans.

Notwithstanding TARP, QE1 and QE2, financial institutions still hold impaired or “bad” assets.  This simply means that the assets are still held by institutions at values that are likely far in excess of their fair market value.

And so, the Great Liquidation begins.  The term — coined by Fortress Investment Group — refers to the prediction that “you’re going to see in the next five years, more financial asset liquidations than you’ve seen in the sum total of the past 100 hundred years.”  An exaggeration?  Ok, let’s assume it’s simply more than in the pat 50 years – that’s still a lot of assets being put up for sale.

If this appears daunting, don’t worry.   Fortress already has $12.7 billion of assets devoted to credit-related private equity and hedge funds.  No doubt the entire spectrum of the Wall Street herd — investment banks, commercial banks, hedge funds and private equity firms — will be bulking up in this area, if they haven’t already.

Just imagine a 2% management fee and 20% of profits on “hundreds of billions of dollars”.  Now that’s a nice bonus pool!

Before the Great Liquidation Orgy (my term) begins, however, Wall Street is going to need to raise money to indulge in this financial bacchanalia.  Certainly there will be private investors, wealthy individuals, sovereign wealth funds.  But the $16 trillion pool of pension assets is the granddaddy of all funding sources.

I can just see the entire pension investment consulting industry working itself into a frenzy cranking out their graphic laden presentations recommending Credit Related investment strategies and firms.  The graphs and the statistics, no doubt will be very impressive – worthy of PhDs.  But Beware.  “Its déjà vu all over again”.

Think back to the early 90’s.   Who had heard of hedge funds?   Private equity firms were still referred to as LBO firms.  In terms of financial markets and products it was a different era.  As the new century dawned, however, investment strategies and products exploded in complexity.  Simultaneously, in order to remain relevant, the pension consultants began touting these new products.

In time, consultants were recommending significant shifts in allocations to “Alternative Investment Classes”.  It was not surprising to see allocation recommendations of 8%, 10%, 15% or more to alternative asset classes.  In fact, in the summer of 2008, I had lunch with the Chief Investment Officer of a university endowment who said that they had allocated 45% of the endowment to hedge funds.

We all know the outcome of this story.  In the end, the investment returns of many plans were negatively affected by these allocations.  No one knows yet, if in the long run the plans were better off or worse for these significant allocations to Alternative Asset Classes.

We do know one thing, however.   Consultants merely make recommendations.  Plan fiduciaries hold the real power in making allocations to asset classes and to specific managers.

Without a doubt fortunes will be made in the course of the Great Liquidation.  The question is whether retirement plans need to venture into this arena.  Fiduciaries must invest assets prudently.   When a new asset class emerges, such as credit-related investments, how is a manager evaluated?  What’s the track record?  How is risk measured?  How are projected returns evaluated against the risks that are assumed?  What about due diligence on investments?

The list goes on and on.

The Media is going to feature the newly minted credit-related billionaires.  Investment returns may likely be huge.  The allure of jumping into these investments will be strong.  The consultants will be putting on a hard press.

Plan fiduciaries must be very wary.  For those who do decide to play in this game, make sure you do your homework.  Remember, you are investing other people’s hard earned retirement dollars.  Keep the financial debacle of 2007-2009 at the forefront of your mind.  And, tread carefully.

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Securities Lending Pays for Custody

Louise Story’s original article was the subject of an editorial in Friday’s New York Times, The Bank Wins.  Both the original article and the editorial use the opportunity to engage in the popular and easy task of bank bashing.   However, jumping onto this bandwagon simplifies and overlooks otherwise complicated dynamics underlying our financial system.

Securities Lending– typically knows as Sec Lending — most often is tied to the custody services provided by banks. In fact, in the early days of Sec Lending, the Sec Lending units of banks were often housed within the custody area of banks. And custody sales people often sold Sec Lending relationships.  It wasn’t until the explosive growth area of the late 1990’s when they were granted status as separate divisions or areas within a financial firm.

Sec Lending became a very hot “valued-added” service for the custody banks.   First, pension plans hate paying custody fees.  But they have no choice because ERISA requires that plan assets be held by a custodian (either a bank or an insurance company).  Second, from the bank’s perspective there is little sexy or exciting in the realm of custody other than various accounting and record-keepping services — essentially commodity type products.  Sec Lending, however, holds out the prospect of significant fees.

Pension plans which engage in  Sec Lending can net the revenue generated by Sec Lending against custody fees.  The tight relationship between custody and Sec Lending is reflected in  Mercer consultant, Jay Love’s statement that,”Whenever we say no Securities Lending,” then they say ‘well, we need to talk to you about your custodial fees.'”

Ms. Story also states that “Banks often pressure pension funds to participate in securities lending, pensions consultants say.”   Yes, banks clearly want to sell Sec Lending services, but focusing on “pressure”  seriously mischaracterizes the relationships between banks and pension fund decision-makers.

The custody and Sec Lending business is highly competitive.  Banks don’t like to lose customers … especially to competitors.  Fees and relationship are highly negotiable.

Pension plans have enormous leverage.  They do not have to accept the terms foisted upon them by banks.  And, they have the ability to shop terms around the various banks.  This happens all the time.  There are few secrets in custody/Sec Lending marketplace.   Remember, the pension plans always have the option of saying “no”.  Nothing requires Sec Lending.  This is a powerful position from which to negotiate.

Ms. Story, and the Times editorial, paint a picture of hapless powerless pension plans who are manipulated and at the mercy of the big bad banks.

This simply isn’t the case.  Pension plans must simply exert their fiduciary powers.  Plan fiduciaries must assess  the various risks posed by financial products and accept those risks when they are being adequately compensated.  In order to assess risks, however,  the risks have to be understood.  And this is the rub.  If Mr. Davis (see, Part I) of the New Orleans municipal employees fund is representative of pension decision makers, then assessing risk will be a daunting task.  Clearly, he never understood Sec Lending and therefore was in no position to assess the risk.

To be fair, there were abuses by the banks in Sec Lending.  Investment guidelines with respect to the investment of cash collateral were violated and if many of the facts set out by Ms. Story are corroborated then serious conflicts of interest arose.  Absent these abuses, however, Sec Lending works.  Plan fiduciaries simply have to exercise their fiduciary duties and decide whether they are adequately compensated for these risks.

In light of the abuses, Ms. Story and others suggest that further regulations might prevent future abuses.  No new regulation is needed. Both ERISA and the current Securities Laws are very effective regulatory schemes.  Instead, we need a system in which fiduciaries pose a force as strong as Wall Street’s. http://harrisonfiduciary.com/about/

Attention should be focused on the thousands of plan fiduciaries –many of whom are no different than Mr. Davis.  As Ms. Story states, “no one would take Jerry Davis for a financial hotshot.”  This is a difficult statement to parse.  For it suggests an element of ridicule or even a patronizing attitude.  No, Mr. Davis isn’t a financial hot shot.  But, this isn’t a joke.  He is in the position of making fiduciary decisions on behalf of thousands of workers.  This is not about being a hotshot.  This is about the prudent investment of hard earned retirement dollars.

With over $16 trillion held in retirement plans, it is not surprising that Wall Street devotes significant resources to developing products and services for this market.  The people on Wall Street are both smart and aggressive.   It’s not enough to state that Mr. Davis isn’t a financial hot shot.  Plan participants deserve fiduciaries who are as well versed in investment products as the salesman of Wall Street.

Ms. Story has focused attention on a little understood, but highly profitable product for Wall Street.   This spotlight is critically important.  However, she should follow up her efforts by digging into the qualifications and competence of the fiduciaries overseeing America’s retirement plans.  My prediction is that many would be shocked at what passes for fiduciary oversight. Strong, well trained investment fiduciaries could effect significant financial reform without a single new statute or regulation.

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Securities Lending Was Much Misunderstood

On the front page of yesterday’s New York Times, Louise Story unravels the complicated and profitable securities lending product offered by many banks.  Notwithstanding the slightly biased or misleading headline, Banks Shared Clients’ Profits, But Not Losses, Ms. Story does an excellent job of explaining the complex and somewhat arcane details of securities lending.

However, she misses a critical point  —  no one forced pension plans to engage in these transactions.  While she tends to focus on the missteps or questionable activities by the banks, there seems to be little attention paid to the investors — many of whom simply didn’t understand the basics of securities lending.

Without outlining the intricacies of a securities lending transaction in this space (see the above story and diagram), suffice it to say that securities lending entails leverage and a sophisticated investment management strategy.  Unfortunately, Jerry D. Davis, Chairman of the municipal employee pension fund of New Orleans,  explained that “fund officials did not consider securities lending to be risky.”  Furthermore, “It was, he said, ‘almost like free money'”.

Let’s run through this one again.  Mr. Davis and his colleagues, in their capacity as fiduciaries, agreed to implement a leveraged investment strategy by the pension plan because it was “almost like free money”.  While Ms. Story highlights various allegations against the Banks, she doesn’t point out that Mr. Davis didn’t have a clue as to what he was approving.  No doubt, in light of all of the litigation, there are scores of fiduciaries throughout the pension system who were equally ignorant of the risks posed by Securities Lending.

To truly appreciate this financial narrative, a little history, or context is needed. We’ve seen this movie before. The recent financial crisis was not the first time the Securities Lending industry hit a proverbial bump in the road.

Way back in the spring of 1994 when interest rates reversed a long decline, the uptick in rates generated havoc in the Securities Lending Collateral pools.  The culprits were not sub-prime mortgages, but instruments known as “reverse floaters”.  As the name implies, these products of financial wizardly fluctuated in the reverse direction of interest rates.  Not surprisingly, in a long-term falling interest rate environment, Securities Lending collateral pools were chock full of reverse floaters.

Surprise, surprise.  Interest rates tick up and reverse floaters plummeted.  Securities Lending collateral pools collapsed in values.  In fact, the Boston Company supported it’s collateral pools so that they did not “break a buck”.

Investors were outraged and claimed the investment risk of loss on the collateral pools lay with the banks.  Claims were made, negotiations ensued and various settlements were reached.

In light of some of the ambiguities which surfaced in the 1994 Securities Lending crisis, banks systematically clarified in their documentation that the risk of loss with respect to the investment performance of the collateral resided with the pension fund/client.

The specific allocation of investment risk to the pension fund/client is a key element of the securities lending process.  In fact, many banks offer investment pools with varying degrees of investment risk, and require the pension plan to select a collateral pool which reflects the pension plan’s risk tolerance.

The principle is very simple :  the securities belong to the plan.  If the plan chooses to lend out the securities, then the plan needs to invest the collateral in order to earn a return.  At all times, the securities remain assets of the plans and the plans retain the investment risk.  This risk is never transferred to the Banks.

Finally, the Banks are paid a fee usually a percentage of the investment return generated by the collateral pool.

Now, as Story’s article points out, the Banks run their own risks — they can breach investment guidelines or they can engage in activities which might give rise to conflicts of interest.   But these are risks separate and apart from the investment risk on the collateral.

Far from “free money”, anyone familiar with Securities Lending understands that it is a levered investment strategy with various inter-connecting components.  The documentation reflecting these transactions is dense and very technical.  However, for a fiduciary, complexity is not an excuse for ignorance.  Whether it is securities lending, investing in a hedge fund or commodity ETF’s, Fiduciaries have an obligation and a duty to understand the investments they authorize on behalf of plan participants.

In 1994 it was inverse floaters, in 2007/8 it was sub-prime mortgages, in 2013, who knows what?   But, it is safe to say that Wall Street will invent new products.  Fiduciaries must stay on top of these developments.

(Next Post will be on the relationship between Custody Services and Securities Lending)

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Pension Plans Must be Overseen by Real Investment Fiduciaries

Jeannie Kaplan, a member of the board of education of the City of Denver, explains that when she reviewed and approved a complicated financial transaction on behalf of the Denver teachers’ pension plan, “I sat there wanting to believe what they (Mssrs Bennet and Boasberg, respecitively, the superintendent and chief operation officer of the school system) were saying”.  This was Ms. Kaplan’s way of addressing a $400 million hole in the pension plan and assessing JP Morgan Chase’s proposed solution.

In retrospect she concludes, “The board probably should have had their own financial consultant.”

This revelation is buried deep in Gretchen Morgenson’s article, Exotic Deals Put Denver Schools Deeper in Debt, on the front page of today’s NY Times.  In great detail, Morgenson outlines the deal which the Denver public school system entered into with JP Morgan in order to address the $400 million dollar underfunding of the system’s pension plan. Not surprisingly the terms of the deal (for Denver) have turned south and are going to be costly.  Again, not surprisingly, it will likely turn out to be a rich deal for JP Morgan Chase.

Ms. Kaplan’s statements reveal a dark secret about the $ trillions held by private and public pension funds.  Many (and I would venture the vast majority) are overseen by people with little investment experience and knowledge.  In all likelihood, a review of the transaction by financial consultants would not have produced a different result.  My suspicion is that Ms. Kaplan and her colleagues would have rubber stamped the recommendations made by a consultant in the same way they rubber stamped the recommendations of Bennet and Boasberg.

Would Ms. Kaplan have asked a consultant penetrating questions about the assumptions, potential conflicts of interest or risks inherent in the transaction?  Probably not.  Because the chances are that Ms. Kaplan wouldn’t even know where to begin in asking these questions.

This is the shocking truth.  Many people serve as pension plan fiduciaries who do not even possess a rudimentary understanding of investment and financial principles.

Quite frankly, the participants in the Denver plan, along with the taxpayers deserve far better.  They deserve real fiduciary experts who understand the complexities of managing and overseeing pension plans.  Experts adept in assessing risk, prudent portfolio construction and monitoring various service providers to the plan.

Wall Street professionals are very smart and creative.  Probably much smarter on financial and investment matters than Ms. Kaplan and her colleagues.  Pension plans need fiduciaries who are an equal match to Wall Street.  I’m not suggesting, at all, that everyone on Wall Street is pedaling a scam transaction.  In fact, many Wall Street innovations have proven beneficial to markets and investors.

Instead, fiduciaries, acting on behalf of plan participants need to assess the risks they are assuming on behalf of the plans and assure that the plans are being properly compensated for these risks.  No doubt, any deal proposed by Wall Street, will be good for Wall Street.   Plan fiduciaries need to make sure that the deal is also good for the plan.

There is nothing to cause me to doubt Ms. Kaplan’s capabilities as an effective school board member.  However, she, and countless others, should recognize the limitations of the their skills and delegate their investment responsibilities to experts.  I’m not suggestion that they simply rely upon and rubber stamp recommendations by consultants, but rather delegate responsibility to those who will stand by the fiduciary decisions which they make on behalf of the plan participants.

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“Financial Innovation Boosts Economic Growth,” an Oxford-style debate — featuring Jeremy Grantham, a doyenne of investment management, and author Richard Bookstaber, author of A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation, opposing the proposition, and Myron Scholes, Noble Prize winner, and Robert Reynolds, CEO of Putnam Investments, in favor of the proposition — is summarized in an Appendix to Grantham’s January 2010 Quarterly Newsletter entitled, “What a Decade!”

In offering stinging criticism about the investment management industry, from which he admits he has profited handsomely, Grantham provides:

Clients can’t easily distinguish talent from luck or risk taking.  It’s an unfair contest [between clients and the investment management industry], nothing like the fair fight assumed by standard Economists.  As we add new products, options, futures, CDO’s, hedge funds, and private equity, aggregate fees per dollar rise.  As the layers of fees and layers of agents increase, so too products become more complicated and opaque, causing clients to need us more.

The ultimate industry insider acknowledges that the game is stacked against the clients in favor of the service providers.  Ironically, however, he includes that the high fees, complexity and opacity, create greater reliance upon the industry itself.

Au Contraire!!  The trifecta of high fees, complexity and opacity cries out for the role of professional fiduciaries to cut through the jargon, smokescreens and hype surrounding the investment of plan assets.

To focus momentarily just on fees, as fiduciaries, with respect to administrative expenses, we clearly have an obligation to “defray reasonable expenses.”  The explosion of fee litigation clearly bears this out.  However, with respect to investment management fees the directive is not as explicit, but nonetheless the obligation to monitor fees is critical.  Certainly there is an obligation to make sure that fees are reasonable, but the exclusive benefit language in ERISA also suggests that where possible, fiduciaries should work to reduce fees wherever possible.  Simply put, any reduction in fees is an increase in the assets available for plan participants and beneficiaries.

The current shock to the financial system, as well as to client portfolios across the board, provides a unique opportunity for fiduciaries to review all of their investment relationships not only with respect to investment performance, but also with respect to fees.  Fiduciaries must ask themselves a hard question; are the fees being charged by private equity, real estate, venture and hedge funds justified by the investment returns being generated and the risks assumed?

The current financial environment levels the playing field between the investment management industry on the one hand, and plan fiduciaries on the other.  Plan fiduciaries must jump at this opportunity to exercise responsibility to strike deals in the best interest of their plans. Negotiate, negotiate, negotiate!

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