Confero Spring 2014: Leadership & Stewardship Issue

confero A quarterly publication of Westminster Consulting

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ISSUE NO. 6

LEADERSHIP & STEWARDSHIP ISSUE

MERELYFIDUCIARY

ALSO:

The Government’s Role In The Pension System Stable Value Funds Today

Circular Reasoning In Due Diligience

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ISSUE NO. 5

EDUCATION VS. ADVICE

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Features Spring Issue 2014 • Issue no. 6

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MERELY FIDUCIARY

FAIRNESS FOR DEFINED CONTRIBUTION FEES

UNDERSTANDING STEWARDSHIP

In this article, Don Trone discusses the “Merely Fiduciary” standard of care and how one needs to stop wanting to be viewed as a fiduciary and begin to start wanting to be viewed as a leaders.

Plan fiduciaries have already adopted a deep responsibility, whether they fully understand it or not.

Understanding investments is a good first step to becoming a fiduciary. However, investments are the easy part. It is the other parts – the legal and ethical aspects to being a fiduciary – which are more difficult to manage.

22 THE GOVERNMENT’S ROLE IN THE PENSION SYSTEM: WHO IS IT HELPING? In the context of the US pension plan system, what started out as a framework for the provision and funding of retirement benefits, has evolved most recently into a pattern of government assistance – but to what end? Is it intended to benefit the employees, the plan sponsors or the government itself?

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Contents Spring Issue 2014 • Issue no. 6

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ONE PAGE MAGAZINE

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91/2 QUESTIONS

A brief overview of some recent events and notable discussions within the industry.

An Interview with Carlos Panskep — Carlos, the managing director from CEFEX discusses the benefits of good stewardship.

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RES IPSA LOQUITOR

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The New York Non-Profit Revitalization Act of 2013 — A brief overview.

IN EVERY ISSUE:

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DEFINED CONTRIBUTION

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ON TOPIC

Stable Value Funds Today — What are they and how should performance expecations be managed?

Circular Reasoning in Due Diligence— The archer missed the bull’s-eye because he didn’t hit the target.”

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2 PUBLISHERS LETTER 3 CONTRIBUTORS 4 UPCOMING EVENTS

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Chief Investment Office Summit April 10-11, 2014 The Harvard Club of NYC | New York The fifth installment of the CIO Summit New York will delve into the most effective strategies being used by the world’s most successful pension funds, sovereign wealth funds, endowments, and foundations. We hope you can join us. www.ai-cio.com/event/CIOSummit2014/

European Innovation Awards May 15, 2014 The Savoy | London On 15 May, aiCIO will host its second annual European Innovation Awards—a gathering of Europe’s most sophisticated institutional investors and those that serve them. www.ai-cio.com/event/EIA2014/

PLANSPONSOR National Conference June 2-4, 2014 Fairmont Hotel | Chicago Now in its ninth year, the PLANSPONSOR National Conference (PSNC) continues to deliver the most productive three days of conversation among plan sponsors, retirement plan advisers and their providers regarding the most innovative investment options, successful employee education and engagement ideas, and cutting-edge plan design solutions. www.plansponsor.com/event/psnc2014/

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Publisher’s Letter

confero A quarterly publication by Westminster Consulting

A quarterly publication of fiduciary ideas by various contributors within the industry.

Publisher Westminster Consulting, LLC. Editor-In-Chief Gabriella Martinez Contributing Editors Sean Patton, AIF® Thomas Zamiara, AIFA® Creative Director

W

elcome to our sixth issue of it means to be fiduciaries—whether you Confero, which is dedicated are an investment fiduciary or an advisor to the idea of Leadership and to fiduciaries.

Stewardship for investment fiduciaries.

Dan Sharpe, Esq. delves into a topic that Our last issue focused on Education is getting a great deal of attention lately— v. Advice for the participants of defined defined contribution plan fees. Dan outlines contribution plans. This is an incredibly what plan fiduciaries must be doing in order important topic as the United States moves to minimize fiduciary risk and improve from a pension based system to a defined participant outcomes. contribution retirement system. Trillions of dollars are now in the hands of individuals Gabriel Potter encourages fiduciaries to that may not be educated enough to make do more than just examine investments. decisions on their own. If you missed this Stewardship refers to the appropriate issue, please visit www.conferomag.com management of resources which do not belong to you. Gabe reviews what it means to view this and other past issues. to be a good steward.

This Leadership & Stewardship issue examines how those that oversee the assets Enjoy this issue, we welcome your feedback, of others should behave and the impact and consider contributing to a future edition. that this can have on organizations and Thanks so much for your continued support. individuals.

Don Trone provides us with something to think about; should we merely attempt to be good fiduciaries or strive to be seen as a leader. This is a thoughtful article from the man that brought us the idea of what

4 | SPRING 2014

Tom & Sean

Gabriella Martinez Contributors Gabriella Martinez Gabriel Potter, AIF® Diana K. Powell, Esq. Daniel R. Sharpe Cathe Tocher Donald B. Trone Thomas Zamiara, AIFA®

Questions or Comments? email us at info@conferomag.com

The information contained in this on-line magazine is for general information purposes only. The information is provided by Westminster Consulting and while every effort is made to provide information which is both current and correct, Westminster Consulting makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the on-line magazine or the information, products, services, or related graphics contained within the on-line magazine for any purpose. Any reliance you place on such information is therefore strictly at your own risk.

In no event will Westminster Consulting be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of, or in connection with, the use of this on-line magazine.

Contributors

Gabriella A. Martinez Editor

Cathe Tocher Contributing Writer

Gabriella is a marketing professional with over seven years of experience. She currently holds a Bachelor of Science in Multidisciplinary Studies with concentrations in Marketing, Printing & Publishing, Photographic Arts & Sciences and Psychology from Rochester Institute of Technology. She has been a featured writer and editor in several publications including Rochester Woman Magazine and Pup Culture.

Cathe Tocher has been with the Great-West Family of Companies since 1986. She was appointed senior vice president and chief investment officer, separate accounts, of Great-West Financial® in 2013.

Gabriel Potter, AIF ® Contributing Writer Gabriel is a Senior Investment Research Associate of Westminster Consulting where he designs strategic asset allocations and conducts proprietary market research.

He earned a B.A. in Economics and a Certificate of Business Management from the University of Rochester and an M.B.A. with concentrations in Corporate Finance and Computers & Information Systems from the University of Rochester’s William E. Simon School of Business. He also holds an Accredited Investment Fiduciary Analyst (AIF®) designation and has been quoted in Human Resources Executive Magazine and his articles have been published through fi360 and AdvisorOne.

Donald B.Trone, 3ethos Contributing Writer Donald B. Trone, GFS™ is the president of the Leadership Center for Investment Stewards, and is the founder and CEO/Chief Ethos Officer of 3ethos. He is the former Director of the Institute for Leadership at the U.S. Coast Guard Academy; founder of the Foundation for Fiduciary Studies; and, principal founder of fi360.

Daniel R. Sharpe, Bond, Schoneck and King Contributing Writer Daniel Sharpe is a member of the law firm of Bond, Schoeneck and King, PLLC and works principally out of its Buffalo, NY office. Bond’s 200+ lawyers include its Employee Benefits and Executive Compensation Practice Group of 9 full-time ERISA attorneys. Daniel is a graduate of the University of Rochester and The Ohio State University College of Law. Since his admission to the bar in 1976, Daniel has specialized in all aspects of employee benefits law, representing primarily employers, plan sponsors and fiduciaries. He has recently devoted substantial time to providing advice and guidance on investment policies, fiduciary risk management and in reviewing fees and service agreements for retirement plans.

Under Tocher’s leadership, the company’s fixed separate accounts have grown to $14 billion under management. Within the general account, Tocher oversees portfolio management and manages the trading desk and the quantitative analyst team. She oversees money markets and works closely with risk management, product development and sales teams across markets. Tocher was recently named head of global portfolio management, working under the direction of Mark Corbett, executive vice president and chief investment officer of parent company, GreatWest Lifeco Inc. Tocher attended the Universite de Poitiers, where she received a French diploma, and the University of Manitoba, where she received a Bachelor of Commerce degree with honors. She is a Chartered Financial Analyst. Tocher is a board member of the Denver Metropolitan Affiliate, Susan G. Komen for the Cure, and is involved in CASA (Court Appointed Special Advocates for Children) and Urban Peak, Denver.

Eric Harper, Harper Danesh Contributing Writer Erica is one of the founding partners of Harper Danesh LLC. Prior to that, she was a Principal with Mercer, having worked in its Boston, New York and Rochester, NY offices. She has considerable experience consulting on both defined benefit and defined contribution plans to a wide range of clients, including healthcare, financial services, manufacturing and educational institutions.

She also writes on a variety of topics focusing on retirement industry trends. Erica is a graduate of Mount Holyoke College with a Bachelor of Arts degree in Economics and French. She is an Associate of the Society of Actuaries, a Member of the American Academy of Actuaries, and an Enrolled Actuary.

Diana K. Powell, Esq. Contributing Writer Diana K. Powell, Esq. is a Senior Legal Advisor with over 20 years of experience. She was a sole practitioner who advised educational organizations, government bodies and private corporations. Diana is a graduate of the University of Rochester with a B.A. in Political Science and Albany Law School of Union University, J.D. She holds a Certificate of International Law from the University of Notre Dame, London Law Center and has studied negotiations, mediation and arbitration at the University of Cornell’s School of Industrial Labor Relations, as well as Statistics and International Studies, specializing in the Republic of China, and Educational Policy and Research Methods at the Warner School of Education at the University of Rochester.

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SPRING 2014

THE ONE PAGE MAGAZINE Company Pension Plans Are Healthier, But They Are Still Dying.

Defined Contribution Plans In The Public Sector: An Update

Pension plans finished 2013 in their best shape last year since the financial crisis of 2008. Their funded status are finally at a point where corporations have enough assets on hand, in some cases, to pay their projected obligations to beneficiaries.

A new issue brief from the Center for State and Local Government Excellence, Defined Contribution Plans in the Public Sector: An Update, finds that while there has been much discussion of shifting from defined benefit to defined contribution plans, relatively few governments have actually done so.

That being said, corporations have no appetite to continue to excercise this particular risk and are making steps to convert over to 401(k) plans.

To read the article on Reuters visit: www.reuters.com/article/2014/04/01/column-millerpensions-idUSL1N0MS11U20140401

—BenefitsPro, 4/1/14

The brief finds that defined benefit plans still dominate and only about 11 percent of public sector workers have a primary defined contribution plan.

Other key findings include: •

DC Participants Stay the Course with Saving and Investing A report, “Defined Contribution Plan Participants’ Activities, 2013” released by the Investment Company Institure (ICI), finds the majority of paticipants continued contributing to their plans in 2013 with only 2.7% stopping contributions, compared with 2.6% in 2012. The report notes some of these participants may have stopped contributing simply because they had reached their annual contribution limit.

•

•

Post-2008 changes have been to establish either hybrid plans or cash balance plans, rather than stand-alone defined contribution plans.

The changes appear driven by a desire to avoid future unfunded liabilities, to reduce investment and mortality risk, and to help short-tenure workers.

Such changes transfer risk to participants, but if the new plans enhance the likelihood of responsible funding, they could also offer some increased security.

Read the full brief at: slge.org/publications/definedcontribution-plans-in-the-public-sector-an-update.

—PRNewsWire, 4/24/14

Health Care Reform Spurs Move To Defined Contribution Benefits Model Full implementation of the AfforableCare Act by 2015 is prompting employers to rethink the way they offer benefits, with many increasingly eyeing a transition to defined contribution (DC) benefit models. According to Group Benefits and the Defined Contribution Model, the second in a series of five research briefs based on the Prudential Insurance Company of America’s (Prudential’s) Eighth Annual Study of Employee Benefits: Today and Beyond, nearly half (47%) of employers report they are moving or have moved to a DC model.

For the full release click here: www.marketwatch. com/story/health-care-reform-spurs-move-to-definedcontribution-benefits-model-2014-04-14

—Marketwatch

The report also found: •

• •

Plan withdrawals in 2013 remained low and stayed in line with activity in 2012. Only 3.5% of DC plan participants took withdrawals in 2013, compared with 3.4% in 2012. Only 1.7% took hardship withdrawals during 2013, same as in 2012.

Loan activity remained about the same throughout 2013 although it continues to remain elevated compared with five years ago.

As of the fourth quarter of 2013, 401(k) plans and other DC plans made up $5.9 trillion, of overall retirement assets.

To read the article on planadviser and download a copy of the report visit: www.planadviser.com/ NewsArticle.aspx?id=10737423031

­—Kevin McGuinness PlanAdviser.com, 4/23/14

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More Philanthropists Give Away Their Foundation’s Assets in Their Lifetimes.

More philanthropists are choosing to donate all of their foundations’ assets within their lifetimes.

About 50 years ago, only 5% of the total assets of America’s largest 50 foundations were held by spend-downs. In 2010, that number had risen to 24%, according to Bridgespan Group in Boston.

For the full article click here: online.wsj.com/news/articles/SB10001424052702304017604579447562412564966

— Veronica Dagher Wall Street Journal, 4/13/14

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9 1/2 QUESTIONS

An Interview with Carlos Panksep Managing Director of CEFEX

By Gabriel Potter, AIF®

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In this issue, Carlos Panskep of CEFEX talks to Confero about the benefits of good stewardship.

As a term, “stewardship” can seem like a vague, corporate buzzword that lacks solid meaning. For the benefit of our readers, how would you define stewardship?

We have a fairly well-defined definition of stewardship. We specifically go into the investment stewardship aspect as opposed to the broader definition of stewardship.

We define an investment steward as the person who has the legal responsibility for managing investment decisions, so that would include the plan sponsors, trustees and investment committee members. Typically, the investment steward isn’t an investment professional themselves, but they are responsible for selecting and overseeing the investment professionals to act as the experts for a plan or foundation and endowment or any other entity like that.

Hopefully, the principal who underlie their role are those of loyalty and care, those two principals provide the basis for the trustworthy conduct of the stewards who are entrusted with other people’s money.

For a eleemosynary – a foundation or endowment – what is the key benefit of good stewardship?

For a foundation or endowment, we think the key benefit is that good investment stewardship maximizes the return on the 18| SPRING 8 | SUMMER 2014 2013

donated assets. So as a steward you are responsible to ensure the donor’s assets, or the investment of those assets, are maximized.

When the donor organization hands over the funds, they place an enormous amount of trust that the funds are going to be utilized as prudently and effectively as possible. And that starts with just the basic stewardship of the funds: “Where do we put the funds and how are they invested until they are used.” And that could have a material effect on the longevity of the foundation and its need to continually get more funds. The better the funds are used the less need to continually get more assets. That is a key benefit, the investment benefit.

For a defined benefit plan – like a pension – what is the key benefit of good stewardship?

One key statistic for a defined benefit plan is its funding level—stewards must maintain the funding of a defined benefit plan so it can meet its obligations in the long term. A key benefit of good stewardship would be that cost and investment decisions are managed.

In other words, if you have high costs or imprudent investment decisions, that will negatively affect the plan’s ability to meet its future obligations and its liabilities. So, a good steward of a defined benefit plan is going to manage things like that—costs and investment decisions—very carefully so that the funding of the plan is maintained at its highest possible level. A good steward can’t necessarily change the liabilities, but they can have a direct impact of how well the plan is funded to meet those liabilities.

For a defined contribution plan – like a 401(k) –what is the key benefit of good stewardship?

Well, in this case we are talking about a plan naturally, where the participants are making their own decisions. But what the key benefit of good stewardship here would be that that steward has established a very good investment lineup, a selection of investment decisions that the participant can make that are prudent. What the outcome here is that the participant can trust that the steward has established an investment climate which is going to be in their best interest and that it’s provided at a reasonable cost to them. It’s like the steward has taken the first stop of doing the investment shopping and making sure that everything in the shopping basket is a good quality product at a reasonable cost and prudently selected so that the participant now has a universal selection that are a good starting point. As in the case of defined benefit plans, I think the performances and costs again will have a direct impact on the participants’ ultimate retirement nest egg. So it’s equally important to get those investment decisions made prudently to start with.

There are some external standards for stewardship. For example, charitable donors can investigate foundations and endowments on various sites like Charity Navigator. This site shows how much a donation will support a cause and how much supports other costs (staffing, fundraising, and so on). Furthermore, it will give donors an accountability

An Inter view with Carlos Panksep and transparency score. Are there any stewardship standards for other types of institutions?

In Canada, the Imagine Canada Standards program offers accreditation to charities and nonprofits that demonstrate excellence in board governance, financial transparency, fundraising, staff management and volunteer involvement. In the UK, the Pension Quality Mark, run by the National Association of Pension Funds Limited, is for firms which have Defined Contribution plans and want to demonstrate their value to staff through an independent standard.

How can institutions demonstrate their commitment to stewardship? What principles should they be espousing?

What certifications might they aim for?

Any kind of steward, the first step they need to do undertake is a fiduciary assessment.

And so there are many different styles of fiduciary assessments that we can offer— simple ones right through to the complex and comprehensive assessment. We also have an assessment which zeros in on service provider disclosures, so that’s another commitment to good stewardship, making sure that all of the disclosures are in place. And even another one which focuses on participant disclosures, so is the steward, who is ultimately responsible for participant disclosures according to regulation… what do they do to ensure that the participants are getting all the disclosures they should be getting. So, that’s a pretty big demonstration of a commitment to stewardship, to undertake any one of those assessments. The principals that we are espousing, of course, are the 21 prudent practices for investment stewards, codified in a handbook which can be downloaded and made available. As far as certifications, they should be shooting for their own CEFEX certification. If you are working with a CEFEX advisor, you can get your plan certified as well. You can find more information here: www.cefex.org/steward What’s the best success story you know related to improvement in stewardship?

We had one situation where one of our certified stewards (this was a couple years ago) had a set of service providers and they made some changes to the service providers. They made some changes to the services providers –sometimes these things happen for any host of reasons—and when the steward came in to do the renewal fiduciary assessment, we collectively looked at the stewards and we found some areas where the stewards could have improved the disclosures they were receiving from the service providers. I guess how did this turned into a success story is that through a fiduciary assessment, they were able to work with the service providers to significantly improve the disclosure of the services that were being provided and ultimately bring a much better definition on around what the service provided was to deliver on a regular basis to them. Poor stewardship would mean that you wouldn’t have this defined, and there would be a very poor definition on what was supposed to be delivered and how you monitor that. So, the outcome of this was that the stewards, following a fiduciary assessment, they identified what was deficient were able to succinctly turn that around into a program for monitoring the new services being provided by the service providers.

What has been the biggest failure you’ve seen in terms of stewardship? What went wrong and, ideally, what lessons can others learn?

We had a case of a steward, now this was steward as a service provider, where they were trying to achieve certification—and they did not, they just failed, they just couldn’t get certified. And the reason they couldn’t get certified was because while their intentions were good, they did not have documented processes in terms of performing the stewardship function. They ultimately got fined and ultimately put out of business. The lessons to learn is that you may have good intentions, however it’s absolutely necessary as a steward to have defined processes in place. It’s not because they didn’t have defined processes that they went out of business, however it was indicative of the immaturity of the

firm that ultimately, I’m sure was a factor in them going out of business. That I think is a failure, if you are going to be a steward—whether it’s as a steward of a plan or as a service providing steward—you must, you have absolute responsibility, of having a very defined set of processes and ultimately what that means for example, is that if you personally were to leave then someone else could just walk in and do the steward job so that it establishes a much more robust framework for being that steward.

Imagine you sit on a board of a regional foundation and you have the authority to adopt a single measure to improve stewardship. A commitment to good stewardship is an enduring and continuous process, and nobody expects your single action to fix every problem. With that caveat aside, what small action might you recommend to have the greatest positive impact?

I think the most important thing would be the to ensure that the Investment Policy Statement of the plan, foundation, endowment, etc. is as solid as it can be—that IPS is the single most relevant piece of documentation that a steward could establish—to make sure that it contains the several different elements we describe in our standard and to make sure that it is used on a regular basis when the plan or foundation meets with service providers and amongst themselves to look at the ultimate performance of the plan.

There are many cases good IPSs are not in place at all and even when they are in place, how often we still see that some improvements could be made to the IPS. 1/2 Question: What was your favorite Olympic highlight from Sochi?)

I’m not sure you are going to want to print this, but I’m a Canadian and I had two events which brought enormous pleasure and gratitude: both the men’s gold and the women’s gold. But the highlight has to be unfortunately for the US women’s team that were up 2-0 in the gold medal game that they eventually fell to the Canadian team, 3-2. n www.conferomag.com | 9

Feature

| SPRING 2014 14 10 | January-March 2012

Merely Fiduciar y

MERELY FIDUCIARY

By Donald B. Trone, GFS

I

’d like to propose the following exercise: Consider the following five words which we often associate with a fiduciary standard of care: Stewardship, Loyalty, Leadership, Governance and Trust.

Like the steps to a building, how would you arrange these words in ascending order? Which word would you put at the base, the top, and in between? What is the hierarchy of these five terms?

Not an easy task, is it?

Before I give you my answer to the hierarchy, a little background: I credit the origins of this article to John Taft. John is the great grandson of President William www.conferomag.com | 11

Feature

Howard Taft (27th President) and author of the book, Stewardship – a must read, by the way. John and I have had a number of intellectual discussions about leadership and stewardship, specifically how the terms impact our understanding of a fiduciary standard of care.

It was during one of these discussions that John talked about the “merely fiduciary” standard of care. The first time I heard him make the reference I remember chuckling – it was like someone saying that Peyton Manning is merely a quarterback. However, after consideration I began to see his point. The role of regulators is to define the minimum standard of care a trustee or plan sponsor must meet in order to manage a qualified retirement plan. It is not the role of regulators to define the gold-standard, merely what is acceptable.

To begin, let me offer my definition for each of the five terms: Stewardship is the passion and discipline to protect the long-term interests of others – it is what you are willing to go to the mat for. My favorite quote to illustrate this point is from Ken Melrose: What does the organization, my stakeholders, need me to be today: a coach, a teacher, a decision-maker, a supporter, a listener, a pilgrim, a servant, someone who makes waves?

Loyalty is to be faithful and steadfast to principles and commitments.

Leadership is the ability to inspire and the capacity to serve, others. I credit my coach, Lance Secretan, with introducing me to the concept that leadership is the ability to inspire others. Lance talks about the importance of understanding the differences between inspiration and motivation. Inspiration is a positive source of energy; motivation is almost always negative. This is certainly 12 | SPRING 2014

true when we talk about a fiduciary standard of care – it is negative motivation which is laced with responsibility, liability and risk.

Governance is communicating and exercising your policies and procedures – what one must do be in compliance. I define Governance as: Doing the right thing, with the right people; At the right time, at the right place; With the right resources, with the right processes; For the right intentions, and for the right reasons.

Trust is defined as the alignment of principles with policies and procedures which, in turn, nurtures reliability and builds confidence. Stephen M.R. Covey, the author of The Speed of Trust and the son of Stephen R. Covey who is credited with writing 7 Habits of Highly Effective People, defines trust as a new currency: The ability to establish, grow, extend, and restore trust with all stakeholders - customers, business partners, investors, and coworkers - is the key leadership competency of the new global economy.

With each term now defined, how would you complete the hierarchy? This is my answer:

Merely Fiduciar y

... if we define fiduciary as the alignment of Governance with Trust, then Stewardship, Loyalty and Leadership actually define a higher professional standard of care. ”

It starts with good Governance; with your ability to clearly communicate your procedural prudence – the details of your decision-making process.

Trust is the next step which will likely be out of sequence for many of you. You might actually have put Trust at the top of the hierarchy. After all, isn’t our primary objective to be the trusted plan sponsor? True, but what you’ll discover is that the remaining terms all build on Trust. If there is no Trust, there can be no sense of Stewardship, Loyalty or Leadership. Think of Trust as the cornerstone – remove the stone and the rest of the structure will fail.

Stewardship is on the next step. To be a good steward, you must be trusted. No one is going to believe that you are passionate about protecting their long-term interests if they don’t trust you.

Loyalty follows Stewardship – it’s demonstrating that you are being faithful and steadfast to your stewardship principles. Again, if people don’t trust you, they will not be loyal to you.

Finally, at the top, is Leadership. To have a successful plan, to produce positive retirement outcomes, plan participants must view you as a leader.

So where does a fiduciary standard fall within this hierarchy? Fiduciary is the alignment of Governance with Trust. A fiduciary’s procedural prudence is defined

by Governance, and the principle of the “best interests of the participant” forms the basis for Trust.

Note that if we define fiduciary as the alignment of Governance with Trust, then Stewardship, Loyalty and Leadership actually define a higher professional standard of care. Remember one of my opening comments: It is not the function of regulators to define the gold standard; their function is to define the minimum standard one has to meet in order to maintain the qualifications of a retirement plan.

Through the eyes of your participants, you should not want to be viewed merely as a fiduciary; you should want to be viewed as a leader. n Donald B. Trone, GFS® is the President of the Leadership Center for Investment Stewards and the CEO/Chief Ethos Officer of the 3ethos. Don was the first Director of the newly established Institute for Leadership at the U.S. Coast Guard Academy; founder and past President of the Foundation for Fiduciary Studies; and, principal founder and former CEO of fi360.

www.conferomag.com | 13

Res Ipsa Loquitor

RES IPSA

LOQUITOR The New York Non-Profit Revitalization Act of 2013

“It is not only what we do, but also what we do not do, for which we are accountable.”

—Moliere

DIANA K. POWELL, ESQ. 14 | SPRING 2014

T

he New York Non-Profit Revitalization Act of 2013 was signed into law by New York State Governor Andrew Cuomo last December and will take effect on July 1, 2014. This Act resulted from the culmination of efforts put forth

by New York State Attorney General Eric Schneiderman and the Leadership Committee for Nonprofit Revitalization.

The Leadership Committee was convened in 2011 by AG Schneiderman and consisted of members made up of experts, who worked together on the legislation to produce the first significant changes since 1969.

Investopedia defines a nonprofit organization as “a business entity that is granted tax-exempt status by the Internal Revenue Service. Donations to a nonprofit organization are often tax deductible to the individuals and businesses making the contributions.

Nonprofit organizations must disclose a great deal of financial and operating information to the public, so that donors can ensure their contributions are used effectively.” The individual state’s laws within which they reside govern nonprofit organizations. Therefore, each state passes its own legislation with regard to nonprofit organizations.

The New York Non-Profit Revitalization Act of 2013

The Act contains significant updates to the existing New York State laws, which govern nonprofit organizations within the state, “requiring that nonprofits enhance their oversight efforts and tighten governance measures.” (Root, Cooney, Pelletier)

According to experts, one of the major purposes of the Act is to revitalize the not-for-profit industry within New York State. It does this by simplifying, modernizing and more clearly and succinctly defining internal procedures with regard to nonprofit organizations.”

According to experts, one of the major purposes of the Act is to revitalize the not-for-profit industry within New York State. (Carter, Fortgang) It does this by simplifying, modernizing and more clearly and succinctly defining internal procedures with regard to nonprofit organizations. (Carter, Fortgang) The end goal is to make nonprofit organizations existing within New York State more accountable and their procedures ultimately more transparent.

Some of the highlights of the Act include: •

The Act will require every nonprofit to adopt a conflict of interest policy.

•

The Act will require nonprofits with 20 or more employees and more than $1 million in annual revenues to adopt a whistleblower policy.

•

•

The Act will raise the gross revenue thresholds that trigger both an independent CPA audit and an independent CPA’s review of a nonprofit’s financial statements.

While significant corporate events (such as exchanges, mergers and changes of purpose) currently require

court approval followed by attorney general review, under the Act these events will require only attorney general review.

•

•

•

Depending on the number of directors in the nonprofit, the Act may change the vote required to approve certain real estate transactions from a twothirds vote to a majority vote.

The Act will expand the disclosure requirement in related-party transactions to include “key employees” in addition to officers and directors. In addition, the Act will require the board to consider alternatives to any related-party transaction.

The Act will prohibit employees from serving as chair of the board of directors (or in any officer position with similar authority, regardless of title).

This provision will not take effect until July 1, 2015.

•

The Act will allow board members to meet board procedures via electronic means such as facsimile or e-mail, and for board members to attend meetings via videoconference or Skype.

•

The Act will prohibit an employee from being present during the discussion and decision-making process concerning his or her own compensation. (Pollak)

Another goal of the legislation is to help Board members of nonprofit organizations to act more responsibly and more efficiently while furthering the principles of their organizations. Careful consideration and implementation of the provisions of the Act need to be made by nonprofit organizations, in order to be compliant by the effective date of July 1, 2014. n

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Feature

FAIRNESS FOR DEFINED CONTRIBUTION FEES

By Daniel Sharpe, Bond, Schoeneck and King, PLLC

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here has been a tremendous amount of focus on participantassessed fees in 401(k) and 403(b) plans over the last couple of years.

This has come about, in part, because of lawsuits and the Department of Labor (DOL) regulations that require greater fee disclosures to both plan administrators and participants. While it has been slow to develop, the focus on fees is a natural progression from traditional pension and profit sharing plans, where employers paid most of the expenses, to 401(k) plans as the primary source of retirement benefits where participant accounts and plan assets pay the lion’s share of administrative costs.

Plan administrative committees who ignore these issues could find themselves busy as defendants in excessive fee lawsuits. It’s far better to respond to the emphasis on fees in several ways that will reduce fiduciary risk. In 2012, 16 | SPRING SUMMER 2014 2013

the effective date arrived for service providers to deliver fee information to plan administrators. These “408(b) (2) fee disclosures” were part of the DOL regulations which established the proposition that if the fees charged against plan assets are not reasonable, the plan administrator has breached its fiduciary responsibilities and committed a prohibited transaction. Thus, plan administrators who have allowed more than reasonable expenses to be charged against participant accounts are not only accountable to the participants for the excess, but are also subject to sanctions by the DOL for a prohibited transaction.

Having received the 408(b)(2) fee disclosures, plan committees were urged to review them carefully. Is the disclosure complete? Are the fees reasonable? A conclusion that the disclosure met the regulatory requirement was only step 1. Deciding that the fees are reasonable

is a bit more difficult. Often the service providers themselves had a description and comparison for their clients that accompanied the disclosures to show their fees, in comparison to industry averages or some other standard, were reasonable.

One approach has been to add up all the fees and show the cost as an “all in” amount, expressed as a percentage of plan assets. Because many plans cover administrative and other costs largely out of asset-based fees, an expression of total costs as a percentage of assets (or as so many basis points) is consistent with much of the media coverage of 401(k) plan costs. For example, a recent Wall Street Journal article published median fee levels for 401(k) plans based on the size of plan assets and expressed them as a percentage of those assets.

The second part of the DOL regulations is the fee disclosure to participants.

Having to make these more detailed

Fairness for Defined Contribution Fees

disclosures to participants has increased the likelihood that participants will be asking questions and increases the risk of fiduciary exposure if participants are not pleased with the answers.

Paying plan administrative costs with asset-based fees presents issues of fairness and can be problematic if not followed carefully over time.

On timing, consider the 401(k) plan with 100 participants at the end of 2012 and total plan assets of $4 million.

Assume the plan has about $300,000 in net contributions for 2013, with plan assets growing by 20% from investment performance, yielding plan assets at the end of 2013 of $5.1 million.

If this plan had a stable workforce and experienced no more than average plan activity (retirements, new hires, etc.), it might be concluded that administrative costs would remain fairly constant. The recent trend, in fact, has been to see administrative costs go down as the result of improved technology. If this plan paid administrative fees strictly on an asset-based model, however, its fees would go up by over 25% simply as a result of the growth in plan assets.

What was reasonable for the 2012 fees may have become unreasonable in 2013.

This problem can be addressed with thoughtfulness and creativity in working with the service provider. Suggestions include capping asset-based fees at a dollar amount per participant, or agreeing on a flat administrative cost per year.

Investment fund fees that may come to a service provider (sub-advisor, 12b-1, and other fees), can be reallocated to participants through an ERISA account

in the plan. An “ERISA account” is a plan account that is not held in the name of an individual, but rather it is a temporary holding account for the asset-based fees paid from the plan’s investment funds. An ERISA account is generally reallocated in some manner on an annual basis.

A second issue of fairness among participants arises in many plans because the asset-based fees generated by plan investments are not spread equally over all investment funds. Employer stock funds, for example, typically generate no asset-based fees that can be used for administrative purposes. Among mutual fund choices, some funds may generate 40 basis points (0.40%) to a service provider while others generate nothing.

It is not fair on an individual participant level if one participant’s investment choice provides 40 basis points toward the cost of administration, and another participant, due to different investment choices, “contributes” nothing toward overall plan costs.

Again, this potential disparity among participants, even if overall plan costs are reasonable, can be addressed through the plan’s service agreement and fee structure, as well as the use of an ERISA account.

starting out with a zero account balance, the same administrative amount as a participant with a $500,000 account balance. Some blending of per capita flat fees and asset-fees, therefore, may be appropriate.

The principal point here is that individual account plan service agreements and fee structures should not be once-negotiated and left on auto-pilot. Fairness, as well as fiduciary responsibility, demand that these agreements be reviewed annually.

In addition, an annual fee and service agreement review may be far more beneficial to participants than time spent going over a review of global markets, prognostications on interest rates, and projections of economic trends in the U.S., Japan, Europe, and China.

Attention to plan fee structures and overall costs will minimize fiduciary risk and improve participant retirement prospects. n Daniel Sharpe is a Member of Bond, Schoeneck & King, PLLC, a law firm. Dan and his colleagues in the Employment Benefits and Executive Compensation Practice Group have been exposed to most legal issues affecting employee benefit plans since the original effective dates of the Employee Retirement Income Security Act of 1974. Dan’s practice recently has focused increasingly on the fiduciary aspects of managing retirement plans.

The concept of “fairness,” however, can be elusive. While it might be argued that total plan costs can be accurately expressed as a flat dollar amount per participant, the truth is more complex.

Different participants utilize plan resources, such as a website, daily trading, etc., at different rates. Even if resource utilization is relatively equal, it may not seem quite right to charge a newly hired participant, www.conferomag.com www.conferomag.com || 17 17

Defined Contribution

Stable Value Funds Today What are They and How Should Performance Expectations be Managed?

By Catherine Tocher

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table value funds (SVF) are typically short- to intermediateterm, high-quality, fixed income bond funds. They represent a low-risk source of diversification in a fund lineup for retirement plans and are considered a fixed income alternative to money market funds and bond mutual funds.

SVF are deemed a good alternative to bond mutual funds because of their investment objective to seek stable returns across various economic and interest rate environments. They are an alternative to money market funds because they typically offer higher credited rates and relatively lower risk compared with other investments generally.

How can the returns be stable AND be higher than money market fund yields through rate cycles?

18 | SPRING 2014

The “funds” are “wrapped” with contracts issued by banks or insurance companies that help smooth out the returns of the underlying portfolio of bonds. Losses and gains of the underlying investments are spread over the duration of the fund. The investment objective of SVF is to provide capital preservation and predictable, steady returns via the credited rate smoothing mechanism.

Today, investors may be hesitant to allocate to SVF relative to equities.

It’s not surprising following a year when the S&P 500 returned in excess of 30%, the Barclay’s Aggregate Index returned negative -2.0 percent, and SVF credited rates ranged between 0.3 percent and 2.1 percent. However, this is comparing apples to oranges.

What’s relevant is comparing SVF

to money market and bond mutual funds. It is equally important to remain committed to the principles and benefits of diversification, being mindful of unique age and income-based needs.

Most investors should diversify across a broad range of asset classes, holding portfolios that include stocks and bonds as well as low-risk investment choices like SVF. Quantifying the impact of diversification through market cycles highlights the potential benefits, with 2008 representing a worst-case scenario for many portfolios that held a significant equity concentration.

What I get asked most often is, when are crediting rates going to increase … meaningfully?

We believe there may be a gradual upward movement in interest rates as

Stable Value Funds Today

the underlying strength developing in the U.S. economy flows into higher real growth this year. Household net worth has largely recovered, quality of consumer and corporate balance sheets has improved significantly, and gains in real GDP inputs are solid, so it is our opinion that real growth has upside potential relative to forecasts.

Because corporate balance sheets are healthy, because consumers have deleveraged, and because there is increasing access to credit, I believe real demand will support higher-thanexpected growth in 2014. Offsetting higher interest rates is a tighter spread environment, so that increasing earned rates in a portfolio will be a very gradual outcome of rising Treasury rates. The composition of SVF, as well as cash flow generated from the SVF that will

participate in a rising rate environment, are factors that also determine credited rate movements.

Why SVF today?

An investor nearing retirement or in retirement may want to preserve principal and minimize risk. SVF may be more appealing to this type of investor for several reasons. Management fees for SVF are typically less expensive than those of bond mutual funds, SVF can be used as a low-risk tool to diversify overall portfolio risk, and credited rates typically do not fall below 0 percent.

The SVF crediting rate smoothing formula relative to the actual return earned on a bond mutual fund, which can be negative in a rising interest rate environment, may also be more appealing for these types of investors.

In a rising rate environment, managing duration exposure and cash flow reinvestment is critical to performance.

With an improving economy as a backdrop, the Federal Reserve Board taper program underway and the Fed Funds rate expected to increase in 2015, opportunities to increase yield and SVF credited rates will grow. Current positioning is important so that cash and SVF cash flows can be targeted to these opportunities, participate in the higher rate environment, and grow asset balances over time. n Catharine Tocher is the Senior Vice President & Chief Investment Officer, Separate Accounts at Great-West Financial速

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Feature

UNDERSTANDING STEWARDSHIP

By Gabriel Potter, AIF®

Investments are the easy part When a person agrees to be a fiduciary, it is often based on a self-assessment of two criteria: first, I am trustworthy, and second, I understand investments. These facets are certainly important. If you sit on an investment committee for a charitable organization or corporate retirement plan, you should be trustworthy. Furthermore, a lot of the decisions you’ll be making involve hiring investment managers and allocating assets, so it would be helpful to know something about investments.

Understanding investments is a good first step to becoming a fiduciary. However, investments are the easy part. It is the other parts – the legal and ethical aspects to being a fiduciary – which are more difficult to manage. Why? For starters, there is a relative lack of understanding of legal issues relative to investment issues. After all, nearly everyone has a bank account and most everyone can manage their own finances. Most professionals will have some investments experience, either through their personal retirement assets, their children’s college fund, or other assets. On the other hand, the concepts which inspire confusion for investment committees and plan sponsors, lack this natural familiarity.

20 | SPRING 2014

Words like “stewardship”, “governance”, “prudence”, and “compliance” can feel like meaningless buzzwords with only hazy definitions.

Another problem with managing the legal aspects to being a fiduciary is there are simply fewer experts to draw upon.

There are thousands of people with substantial investment experience including old-fashioned stock brokers, daytraders, financial analysts, wealth managers, family offices, accountants, and so on. Conversely, there are very few professionals who tailor their investment recommendations to the legal requirements of a fiduciary relationship.

On the plus side, there is nothing inherently difficult about any of this. Everything fits inside the basis of commonsense. Still, nobody is born knowing all the details, so it takes a little education or training to fully acknowledge the duties a fiduciary accepts.

Understanding stewardship To begin facing this challenge, we will solidify these nebulous concepts into something meaningful. Today, we will start with “stewardship”. A fiduciary, almost by definition, manages the assets for the benefit of someone else. The

Understanding Stewardship

concept of stewardship refers to the appropriate management of resources which do not belong to you.

So, how does one demonstrate they are a good steward?

Consider a charitable organization like Habitat for Humanity.

In order to attract donations from the community, the charitable organization must show the money they raise goes to support the intended mission (in this case, affordable housing). To maintain their donors’ goodwill, they must show the success they have had supporting this mission. In short, they must demonstrate the goals of the organization are efficiently being served with the limited resources they have been entrusted with.

There are behavioral aspects to stewardship which must be accounted for, particularly in regards to the investment selection. At some level, every investor is risk-averse and must be compensated for adopting investment and market risk with commensurate returns. Risk aversion is a healthy and necessary component to investment behavior. However, a steward often exhibits a heightened sense of risk-aversion while directing the investments for other parties. This natural conservatism of stewards can manifest itself positively as a thoughtful and prudent investment lineup. For example,

good stewards avoid speculative or whimsical investments.

On the other hand, a steward’s cautious tendencies must be balanced against the ultimate goal – the mission – of the assets. Stewards are occasionally too conservative in their approach and end up constructing an investment portfolio which cannot reach the investment target returns even given ideal circumstances.

Please read our “9 ½ Questions” feature for additional perspective on good stewardship and how it applies to different pools of assets, like pension or defined contribution (i.e. 401(k)) retirement plans.

Moving forward Stewardship is only one element towards understanding fiduciary responsibility. Other elements - including duty of loyalty, governance, transparency, prudence, and diversification - should be discussed with your fiduciary consultant. In future editions of Confero, we will explore these concepts and provide more education and insight. n

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Feature

GOVERNMENT’S ROLE IN THE PENSION SYSTEM: WHO IS IT HELPING?

By Erica Harper, AASA, EA, MAAA

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veryone has their own perspective on government’s role in our daily lives. Is it there to provide aid and assistance or is meant to merely provide the framework for us to govern ourselves? In the context of the US pension plan system, what started out as a framework for the provision and funding of retirement benefits, has evolved most recently into a pattern of government assistance – but to what end?

Is it intended to benefit the employees, the plan sponsors or the government itself?

rules for determining the minimum and maximum tax deductibility of contributions, precluded discrimination in favor of highly compensated employees over rank-in-file, and prevented the misuse of plan assets for means other than the benefit of plan participants. At the same time, it established the Pension Benefit Guaranty Corporation (PBGC), a pension insurance system intended to protect participants’ benefits up to specified limits set by law. All-in-all, it provided some much-needed structure to an otherwise rudderless system.

Dating back 40 years, the Employee Retirement Income Security Act of 1974 (ERISA) was enacted to give participants a better understanding of their eligibility and entitlements from their pension plans. It also defined the

In good times, when the market was strong, interest rates were high and plans were well-funded, these rules permitted plan sponsors to avoid contributions, despite the fact that participants continued to earn benefits each year. At the time, this

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was a win-win for companies and the government. Companies found “better” uses for their cash, and the government benefited from greater tax revenue when fewer deductions were taken.

However, it neglected to consider the future benefit security of participants should a downturn occur.

In the early 2000s, with the failure of several high profile companies putting a strain on the PBGC, it was time for new reform. So the government signed into law the Pension Protection Act of 2006 (PPA), the most significant pension legislation since ERISA. In a speech at the signing of the bill, President Bush read, “This bill establishes sound standards for pension funding, yet, in the end, the primary responsibility rests with employers to fund the pension promises as soon as

The Government’s Role in the Pension System

they can.” In fact, PPA funding rules accelerated the contributions sponsors were required to make in an attempt to shore up the funding of pension plans, taking pressure off the PBGC. Again, the government recognized a gap in the system and implemented a new framework to address the immediate concerns of plan participants while holding plan sponsors accountable.

The timing of PPA was unfortunate. Just as plan sponsors’ funding requirements were picking up, the market and interest rates were backing down – causing a “perfect storm.” In response to pleas from plan sponsors, the government stepped in again and offered temporary funding relief – most notably in 2012 with the signing of the act known as MAP-21, or Moving Ahead for Progress in the 21st

Century. From the sponsor’s perspective, it reduced immediate cash requirements by as much as 50% or more in 2012, with sustained assistance through 2016. From the government’s perspective, it again increased tax revenue by significantly reducing deductible contributions. But what did it do for participants?

A few weeks ago, an extension of MAP21 was introduced by the House which would further reduce the contribution requirements through 2018 and beyond.

In an April 17, 2014 letter from the American Academy of Actuaries (AAA) to the leaders of the House and Senate, the AAA Pension Finance Task Force writes, “The amount of benefits paid to plan participants would not be changed by these legislative proposals, but the security of promised benefits may be

reduced. Lower contribution requirements will very likely result in lower plan assets, providing less security for participants and increasing risk for the Pension Benefit Guaranty Corporation (PBGC). “ There is no doubt that without government intervention, many more plans would have wound up in the hands of the PBGC – likely resulting in reduced benefits to participants. But delaying contributions also puts these plans at risk. While the government’s involvement provides relief to companies in the most dire of situations, sponsors need to consider their responsibility in the future of these plans. Let’s fund these promises as soon as we can. n

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On Topic

Circular Reasoning In Due Diligence

By Gabriel Potter, AIF®

“The archer missed the bull’s-eye because he didn’t hit the target.”

T

his sentence, while true, doesn’t explain anything substantive about the situation’s cause and effect.

An improved sentence would be, “the archer missed the bulls-eye because his broken arm was impeding his aim.”

The improved sentence supplies a clear cause to the effect.

Why are we discussing logical arguments in an article about finance and investing?

The reason is because we have been disappointed with active managers using circular reasoning to defend their poor performance relative to their indices.

When we conduct due diligence on our

18 | SPRING 24 SUMMER 2014 2013

mangers, we try very hard to understand the causes of relative performance, both positive and negative. This understanding is blocked when active managers justify their underperformance with this excuse, “the market hasn’t favored active management.”

Let us consider that defense for a moment.

As long as individual security returns vary at all, there will be positions which outperform the index and positions which underperform the index. Naturally, active managers try to pick the winners— those securities which outperform the index. Conversely, an active manager will underperform their index, if their selections—in aggregate—underperform their index. Active managers are not required to buy or sell any particular type of position. Therefore, there is no market that inherently favors or disfavors active management.

It is true that the opportunity set for managers might be different depending on the strength of the market’s direction and the variance of returns among different securities. For example, Manager XYZ is a contrarian large cap value stock manager. A contrarian investor generally picks positions that have fallen in price, and they won’t pick stocks that have rallied recently. The underlying investment philosophy for contrarians suggests that stocks, once they’ve appreciated in price, are less likely to appreciate in the future. On the other hand, there are “momentum” market environments where they previous winners continue to win. In a momentum environment, a contrarian investor will likely underperform.

So, it is entirely fair to say a particular style of management was not favored.

Circular Reasoning in Due Diligence

For example, in the 3rd quarter of 2011, most active fixed income managers made the same bet. Specifically, most active managers bet that long duration treasuries and government bonds were overvalued relative to credit bonds. Thus, most active managers overweighted credit bonds and many of them underperformed the index when government bonds rallied.

In other words, there was a common bet that many active managers made which ended up underperforming the index; most active managers underperformed.

On the other hand, there was nothing to force active managers to make that bet. It simply is untrue to suggest that the market somehow disfavored active management.

It is also true that, collectively, active managers tend to make similar bets. For

example, we notice that active managers, in general, tend to pick higher quality names than the index. It would also be completely fair to notice that high quality names underperformed low quality stocks over the past few years and so, as a result, active managers have generally tended to underperform. However, it is not fair to infer that active management did not work or was somehow out-offavor because of the similar bet made by active managers generally.

There are investment styles that move and out of favor in the marketplace.

These style biases can be explained.

There are individual reasons for any specific manager to underperform.

These reasons can be supported with attribution analysis. However, when active managers try to excuse their

underperformance by claiming the market didn’t favor active management, what they are actually saying is that do not understand the causes for their relative underperformance.

In our July 2012 Article on Portfolio Construction, Westminster Consulting asserted a healthy skepticism over the superiority of either approach – passive or active. We detailed advantages and disadvantages of both active and passive management, and we even suggested there is room for both types within a portfolio.

We are not against active management.

However, active managers are not allowed to defend poor performance on circular reasoning. n

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WESTMINSTER CONSULTING

800.237.0076 www.Westminster-Consulting.com