[House Hearing, 111 Congress]
[From the U.S. Government Printing Office]
CREATING GREATER TRANSPARENCY FOR PENSIONERS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON HEALTH,
EMPLOYMENT, LABOR AND PENSIONS
COMMITTEE ON
EDUCATION AND LABOR
U.S. House of Representatives
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
__________
HEARING HELD IN WASHINGTON, DC, JULY 20, 2010
__________
Serial No. 111-73
__________
Printed for the use of the Committee on Education and Labor
Available on the Internet:
http://www.gpoaccess.gov/congress/house/education/index.html
_____
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COMMITTEE ON EDUCATION AND LABOR
GEORGE MILLER, California, Chairman
Dale E. Kildee, Michigan, Vice John Kline, Minnesota,
Chairman Senior Republican Member
Donald M. Payne, New Jersey Thomas E. Petri, Wisconsin
Robert E. Andrews, New Jersey Howard P. ``Buck'' McKeon,
Robert C. ``Bobby'' Scott, Virginia California
Lynn C. Woolsey, California Peter Hoekstra, Michigan
Ruben Hinojosa, Texas Michael N. Castle, Delaware
Carolyn McCarthy, New York Vernon J. Ehlers, Michigan
John F. Tierney, Massachusetts Judy Biggert, Illinois
Dennis J. Kucinich, Ohio Todd Russell Platts, Pennsylvania
David Wu, Oregon Joe Wilson, South Carolina
Rush D. Holt, New Jersey Cathy McMorris Rodgers, Washington
Susan A. Davis, California Tom Price, Georgia
Raul M. Grijalva, Arizona Rob Bishop, Utah
Timothy H. Bishop, New York Brett Guthrie, Kentucky
Joe Sestak, Pennsylvania Bill Cassidy, Louisiana
David Loebsack, Iowa Tom McClintock, California
Mazie Hirono, Hawaii Duncan Hunter, California
Jason Altmire, Pennsylvania David P. Roe, Tennessee
Phil Hare, Illinois Glenn Thompson, Pennsylvania
Yvette D. Clarke, New York [Vacant]
Joe Courtney, Connecticut
Carol Shea-Porter, New Hampshire
Marcia L. Fudge, Ohio
Jared Polis, Colorado
Paul Tonko, New York
Pedro R. Pierluisi, Puerto Rico
Gregorio Kilili Camacho Sablan,
Northern Mariana Islands
Dina Titus, Nevada
Judy Chu, California
Mark Zuckerman, Staff Director
Barrett Karr, Republican Staff Director
SUBCOMMITTEE ON HEALTH, EMPLOYMENT, LABOR AND PENSIONS
ROBERT E. ANDREWS, New Jersey, Chairman
David Wu, Oregon Tom Price, Geogia,
Phil Hare, Illinois Ranking Minority Member
John F. Tierney, Massachusetts John Kline, Minnesota
Dennis J. Kucinich, Ohio Howard P. ``Buck'' McKeon,
Marcia L. Fudge, Ohio California
Dale E. Kildee, Michigan Joe Wilson, South Carolina
Carolyn McCarthy, New York Brett Guthrie, Kentucky
Rush D. Holt, New Jersey Tom McClintock, California
Joe Sestak, Pennsylvania Duncan Hunter, California
David Loebsack, Iowa David P. Roe, Tennessee
Yvette D. Clarke, New York
Joe Courtney, Connecticut
C O N T E N T S
----------
Page
Hearing held on July 20, 2010.................................... 1
Statement of Members:
Andrews, Hon. Robert E., Chairman, Subcommittee on Health,
Employment, Labor and Pensions............................. 1
Kucinich, Hon. Dennis J., a Representative in Congress from
the State of Ohio, prepared statement of................... 5
Additional submission: ``A.I.G. to Pay $725 Million in
Ohio Case,'' article from the New York Times........... 41
Price, Hon. Tom, Ranking Republican Member, Subcommittee on
Health, Employment, Labor and Pensions..................... 3
Prepared statement of.................................... 4
Additional submissions:
``Congress Overhauls Your Portfolio,'' article from
the Wall Street Journal............................ 34
Baker, Richard H., president and chief executive
officer, Managed Funds Association, prepared
statement of....................................... 42
Statement of Witnesses:
Bovbjerg, Barbara, Director of Education, Workforce, and
Income Security, U.S. Government Accountability Office..... 11
Prepared statement of.................................... 13
Chambers, Robert Gordon, on behalf of McGuireWoods, LLP...... 13
Prepared statement of.................................... 15
Hutcheson, Matthew D., professional independent fiduciary.... 7
Prepared statement of.................................... 8
Marco, Jack, chairman, Marco Consulting Group................ 18
Prepared statement of.................................... 21
CREATING GREATER TRANSPARENCY
FOR PENSIONERS
----------
Tuesday, July 20, 2010
U.S. House of Representatives
Subcommittee on Health, Employment, Labor and Pensions
Committee on Education and Labor
Washington, DC
----------
The subcommittee met, pursuant to call, at 10:00 a.m., in
room 2175, Rayburn House Office Building, Hon. Robert Andrews
[chairman of the subcommittee] presiding.
Present: Representatives Andrews, Wu, Kucinich, Fudge,
Kildee, Holt, Courtney, Price, Kline, Guthrie, and McClintock.
Staff Present: Aaron Albright, Press Secretary; Tylease
Alli, Hearing Clerk; Andra Belknap, Press Assistant; Jose
Garza, Deputy General Counsel; David Hartzler, Systems
Administrator; Ryan Holden, Senior Investigator; Sadie
Marshall, Chief Clerk; Meredith Regine, Policy Associate,
Labor; James Schroll, Junior Legislative Associate, Labor;
Michele Varnhagen, Labor Policy Director; Matt Walker, Labor
Counsel, Subcommittee on Health, Employment, Labor, and
Pensions; Ed Gilroy, Minority Director of Workforce Policy;
Ryan Kearney, Minority Legislative Assistant; Molly McLaughlin
Salmi, Minority Deputy Director of Workforce Policy; Ken
Serafin, Minority Workforce Policy Counsel; and Linda Stevens,
Minority Chief Clerk/Assistant to the General Counsel.
Chairman Andrews. Welcome to the subcommittee hearing on
the issue of transparency and accounting for what are
frequently called alternative assets in defined benefit plans.
We are very happy to have an excellent panel. I want to
thank my ranking member and friend, Dr. Price, for his
cooperation and participation, and welcome the ladies and
gentlemen of the public.
Noting that a quorum is present, the hearing of the
committee will come to order.
Eighty-six million Americans depend on traditional defined
benefit plans for their future income. As the great work of the
Government Accountability Office has shown in 2008, led by Ms.
Bovbjerg, who is with us this morning, the number of pension
plans that are investing in hedge funds and private equity
funds is growing rather precipitously. Upwards of about 91
percent, I believe the GAO study says, are involved in hedge
funds, and a slightly smaller number in private equity. I may
have that reversed, but it is a growing--it is 91 in private
equity and, I think, 70 in hedge funds, or a number close to
that.
And although one cannot be exact about the level of
investment in those funds, it is certainly in the hundreds of
billions of dollars. And, of course, similar choices are being
made by individuals in defined contribution plans, as well.
I want to say emphatically from the beginning, I think the
most important principle governing fiduciary decision-making in
defined benefit plans is diversification of assets. I think
that a prudent fiduciary is someone who understands well the
diversification of risk and reward.
Given that principle, I am not in any way interested in any
statutory or arbitrary limitation on investments in such assets
for pension funds or anyone else. I don't think it is the job
of elected officials to favor or disfavor any class of
investments. I think we should be agnostic as to classes of
investments. I think that we should write laws that impose high
standards of fiduciary responsibility on those whose job it is
to make those decisions. And I think we should then essentially
get out of the way and let them exercise their fiduciary duty.
In order for people to exercise their fiduciary duty in a
proper way, transparency is needed. In other words, one cannot
really understand the potential risks and rewards of an
investment if the data which underlie the dynamics of that
investment are not easily and readily understandable.
In most cases, most classes of investments have a long
history of regulatory disclosure and, frankly, have a measure
of transparency that comes from the principle that, in a
marketplace, people vote with their feet. So when one invests
in a frequently traded public stock or public bond, market
fluctuations, when one sees millions of shares traded or
billions of transactions occur, will let one know what one's
peers think about the value of an asset.
That kind of information is not readily available when it
comes to alternative investments. They are typically thinly
traded. In many cases, they are illiquid. In many cases, there
may be no market at all that would help one determine what the
marketplace thinks about the value of an asset.
Again, I emphatically believe that this phenomenon should
not exclude these classes of assets from consideration by
fiduciary trustees in defined benefit plans. I don't think that
at all. But I certainly think that those fiduciaries ought to
have ample information to real-time, relevant information so
they can properly discharge their responsibilities as
fiduciaries.
This, I believe, is not an ideological or political
question; it is an empirical and analytical one. And the
purpose of this morning's hearing is to assemble four
individuals of great experience in this area and, I believe,
great expertise in this area. And we welcome them to the
subcommittee.
The questions we are interested in hearing about this
morning are: What tools are presently available to pension plan
fiduciaries in evaluating alternative investments? How complete
or incomplete are these tools? How useful are these tools? What
might supplement them and make them more useful?
What rules and standards govern those who prepare these
tools? When one relies on an audited financial statement from a
hedge fund or private equity fund to make a fiduciary decision,
what standards would govern the quality of that audited
financial statement? What do we know about the competence and
preparation of the preparer?
If there were conflicts of interest, what standards or
rules would at least disclose or hopefully prohibit such a
conflict of interest?
The purpose of this hearing is for those of us on the
committee to get a sense of how those who are in the fiduciary
world view the efficacy of the tools available to them and to
evaluate whether, if at all, changes are necessary to public
policy.
I want to say from the outset, I believe public policy does
not necessarily mean statutes or regulations. It can come in
the form of guidance from the Department of Labor. It could
come in other less formal iterations.
But at the end of the day, here is what we are interested
in achieving: We want to develop a body of knowledge that would
give us a level of assurance that when fiduciaries are carrying
out their fiduciary responsibility and making a decision to
invest or not invest in pension funds, in a private equity
fund, or hedge fund, that that decision is being made in full
disclosure, that that decision is being made with the benefit
of tools that would help one evaluate the true value of that
asset, so that, in diversifying one's portfolio, the fiduciary
can make the best decision for those who depend on that
decision.
Our interest here is obviously beyond the philosophical and
academic. Our real agenda is to prevent from ever occurring a
taxpayer-subsidized bailout of pension funds. Our concern here
is that to some extent explicitly and to some extent implicitly
the taxpayers of the United States stand behind defined benefit
plans in our country. So we not only have an interest in
fairness for those who depend on those funds for their income,
but we certainly have an interest in protecting the taxpayers
of the country against any sort of obligation that would
require them to rescue a failed fund.
The best defense against failure is diversification. The
best principle of diversification is transparent understanding
of the investments through which a fiduciary can invest or not
invest. So that is the purpose of our hearing.
I would like to proceed by turning to my friend, the senior
Republican on the subcommittee, Dr. Price, for his opening
comments, at which time we will then proceed to hear from the
witnesses.
Dr. Price. Thank you, Mr. Chairman. And I appreciate you
holding this hearing.
I want to thank also the members of the panel. We look
forward to your comments today and appreciate you taking the
time to share with us your expertise.
This is a remarkably critical issue. Some pension plans are
experiencing funding shortfalls after the economic downturn,
and plan sponsors are trying to find greater returns to meet
their obligations.
However, I share with some of my colleagues the concern
that today we will be hearing testimony and recommendations,
some of which are based upon a government report that is almost
2 years old. That is essentially before the financial crisis
occurred and without any of the recent statutory changes made
in the Dodd-Frank Act, which, candidly, will have huge
consequences, many of which may not be helpful to the state of
pensions.
Nevertheless, we welcome the opportunity to look at this
issue further in an effort to better understand any potential
problems.
The ERISA statute provides a longstanding framework to
guide the activities of private pension plans and the people
acting in a fiduciary capacity for those plans. Generally, a
pension plan fiduciary, the person charged with running the
plan and making those pivotal decisions, must act prudently in
determining a pension plan's obligations and ensure that
sufficient assets exist to meet those obligations.
Part of that obligation includes making good investment
decisions. Pension plans commonly spread their investments
across a wide variety of investment vehicles: stocks, bonds,
mutual funds. Diversification helps pension plans avoid
catastrophic losses and helps secure reasonable rates of
return.
Congress has historically encouraged diversification of
pension assets and has mostly avoided mandating how private
pensions invest their assets, leaving many of those details to
those financial professionals responsible for the pension
plans.
As we will hear today, there are many different ways to
invest pension assets, including some nontraditional vehicles,
such as hedge funds and private equity. We will learn about
different types of alternative products, how they operate and
help pension plans achieve their objectives, whether our
witnesses believe that new regulations are advisable, how
different States may enable or curtail pension plan investment
in alternative products, and whether the new financial services
law might shed some light on the operations of certain funds
like hedge funds.
When looking at the bigger picture, though, it is important
to note that our economic system generally provides greater
rewards and potentially greater losses for those who take
greater risks. While the vast majority of pension investments
are made by highly sophisticated financial advisors investing
in good faith in legitimate private investments funds, this
ultimately helps all pensioners receive their promised
benefits.
Have there been some bad actors? Absolutely. However, we
should be careful at this hearing not to implicate an entire
industry due to the conduct of a small number of unscrupulous
individuals. These issues are too important and consequential
to the majority of Americans to rush to action or draw
incorrect conclusions that might limit the choices for
pensioners or flexibility in their decision-making.
Mr. Chairman, I thank you. And I look forward to our
hearing and hearing from the witnesses and the questions that
will follow.
[The statement of Dr. Price follows:]
Prepared Statement of Hon. Tom Price, Ranking Republican Member,
Subcommittee on Health, Employment, Labor, and Pensions
Good morning and thank you, Chairman Andrews. I would like to begin
by thanking our distinguished panel for appearing today. We appreciate
that they have taken time out of their busy schedules to share their
experiences and expertise with us.
This is a critical issue. Some pension plans are experiencing
funding shortfalls after the economic downturn, and plan sponsors are
trying to find greater returns to meet obligations. However, I am
somewhat concerned that we will be hearing testimony and
recommendations today based on a government report that's almost two
years old. That's essentially before the financial crisis occurred and
without any of the recent statutory changes made by the Dodd-Frank
Act--which, candidly, will have huge consequences, many not helpful, to
the state of pensions. Nevertheless, we are open to examining this
issue in an effort to better understand any potential problems.
The ERISA statute provides a longstanding framework to guide the
activities of private pension plans and the people acting in a
fiduciary capacity for those plans. Generally, a pension plan
fiduciary, the person charged with running the plan and making those
pivotal decisions, must act prudently in determining a pension plan's
obligations and ensure that sufficient assets exist to meet those
obligations. Part of that obligation includes making good investment
decisions.
Pension plans commonly spread their investments across a wide
variety of vehicles, including stocks, bonds and mutual funds.
Diversification appears to help pension plans avoid catastrophic losses
and helps secure reasonable rates of return. Congress historically has
encouraged diversification of pension assets and has mostly avoided
mandating how private pensions invest their assets, leaving many of the
details to those financial professionals responsible for pension plans.
As we'll hear today, there are many different ways to invest
pension assets--including some non-traditional vehicles such as hedge
funds and private equity. We'll learn about different types of
alternative products, how they operate and help pension plans achieve
their objectives, whether our witnesses believe that new regulations
are advisable, how different states may enable or curtail pension plan
investment in alternative products, and whether the new financial
services law might shed some light on the operations of certain funds,
like hedge funds.
When looking at the bigger picture, it is important to note that
our economic system generally provides greater rewards, and potentially
greater losses, to those who take greater risks. Now, the vast majority
of pension investments are made by highly sophisticated financial
advisors investing in good faith in legitimate private investment
funds. This ultimately helps all pensioners receive their promised
benefits. Have there been some bad actors? You bet. However, we should
be careful at this hearing not to implicate an entire industry due to
the conduct of a small number of unscrupulous individuals.
These issues are much too important and consequential to the
majority of Americans to rush to action or draw incorrect conclusions
that might limit the choices for pensioners or flexibility in their
decision-making.
Thank you, Mr. Chairman. I look forward to hearing from our
witnesses and exploring these matters further in the questioning
period.
______
Chairman Andrews. I thank my friend.
And, without objection, opening statements from any other
member of the subcommittee will be entered in the record at
this point.
[The statement of Mr. Kucinich follows:]
Prepared Statement of Hon. Dennis J. Kucinich, a Representative in
Congress From the State of Ohio
I would like to thank Chairman Andrews for holding this hearing and
for his continued commitment to protecting the retirement security of
workers.
Pensions are predicated on trust. They are agreements between
employees and their employers to provide for the retirement of the
employees after they have fulfilled their service. When that trust is
violated, it is the workers, through no fault of their own, who are
left holding the bag.
Case in point:
In Ohio, our Attorney General has been fighting AIG for years to
get back public pension funds lost due to bid rigging, accounting
fraud, and market manipulation. Ohio was the lead plaintiff in a class
action suit that attempted to recover millions of dollars for the
pension plans of teachers, firefighters, and police officers.
AIG recently settled the lawsuit for $725 million, which means that
the people who teach our children and protect our communities will
finally have received the compensation for crimes perpetrated against
them.
I am pleased that AIG finally decided to negotiate in good faith
with Attorney General Richard Cordray after years of stalling, and
after being called to account publicly in Congressional hearings.
But we all know that cases like this are only the tip of the
iceberg, and for the thousands of Ohioans who have been made whole by
this decision, there are millions of Americans out there whose
retirement security has been compromised by questionable investments or
outright washed down the drain by fraud and lies.
I look forward to working with Chairman Andrews to make sure that
Congress does its part to make sure that pensioners are protected and
that plan sponsors have the information they need to make responsible
decisions.
Our constituents deserve better than what many of them have
received in the past. They choose pension plans precisely because of
the security that defined benefits offer in retirement. We must do
everything in our power to make sure that the rug cannot be pulled out
from underneath them.
______
Chairman Andrews. We will now proceed to introduce the
witnesses. I am going to read a brief biography for each of
you.
You should know that your written statements, which we have
received in advance and appreciate, will be entered, without
objection, into the record of the hearing. We ask you to
provide us with an approximately 5-minute oral summary of that
written statement so that we can then proceed to the question
and answer session with the members of the committee.
So I am going to read the biographies in order of the
witnesses' testimony, and then we will proceed.
Mr. Matthew D. Hutcheson is an independent pension
fiduciary. His clients include the plans of Fortune 100, 500,
and 1,000 companies, mid- and small-sized companies, government
and legal accounting firms. Mr. Hutcheson received his MS from
the Institute of Business and Finance and earned further
accreditation from the University of Pittsburgh, Texas Tech
University, and the American Academy of Financial Management.
Mr. Hutcheson, welcome to the committee.
We are pleased to welcome back Ms. Barbara D. Bovbjerg, who
is the director of education, workforce, and income security
issues at the United States Government Accountability Office.
At the GAO, she oversees evaluative studies on age and
retirement income policy issues, including Social Security,
private pension programs, and other issues. Ms. Bovbjerg holds
a master's degree in public policy from Cornell University, an
outstanding school, and a BA from Oberlin College.
You can guess that both Mr. Walker and myself are graduates
of Cornell Law School--not the only reason that you are here.
We are pleased to welcome back to the committee Mr. Robert
Chambers, a partner at McGuireWoods, LLP. Mr. Chambers counsels
employers and executives in connection with tax-qualified
retirement plans, including 401(k) plans, cash balance and
pension equity plans, and ESOPs. He received his JD from
Villanova University Law School and a BA from Princeton
University, located in the finest State in America, New Jersey.
We appreciate that, Mr. Chambers. Mr. Holt, I am sure,
would appreciate that, as well, since he represents Princeton.
And, finally, Mr. John Marco is chairman of the Marco
Consulting Group. He began his career as an investment
consultant in 1977, when he joined A.G. Becker, Incorporated.
Mr. Marco received his BS in mathematics from Lewis University
and continued his graduate studies at Purdue, Northwestern, and
Northern Illinois Universities.
To each of our witnesses, welcome to the subcommittee.
Three of you, I know, have been here before. I think, Mr.
Hutcheson, this is your rookie appearance here, is that right?
The way the rules work is that, in front of you, you see a
box. When you begin your testimony, the green light will go on.
When you have 1 minute left in your 5, the yellow light will go
on. And the red light signifies the end of the 5 minutes, and
we would ask you to summarize so we can get to questions.
And so, Mr. Hutcheson, if you would turn your microphone
on, we will begin with you. We welcome you to the committee.
STATEMENT OF MATTHEW D. HUTCHESON,
PROFESSIONAL INDEPENDENT FIDUCIARY
Mr. Hutcheson. Thank you. I appreciate the opportunity to
be here.
Chairman Andrews, Congressman Price, and members of the
subcommittee, my name is Matthew Hutcheson. I am a professional
independent fiduciary. Retirement plan sponsors may appoint me
to serve as the responsible decision-maker for their plans to
fulfill those often complex and time-consuming obligations. In
my role as fiduciary, I have made decisions directly affecting
the lives of hundreds of thousands of plan participants, of
hopeful retirees expecting to receive many billions' worth of
future benefits.
We live in an increasingly volatile and uncertain business
world. As a result, many plan fiduciaries are exploring
alternative investments to improve portfolio performance and
reduce risks. It is likely that interest in alternative
investments will continue to spread, not only for the potential
merit of the alternative investment alone, but particularly due
to concerns about the economy and Wall Street's integrity, even
in the face of sweeping legislative reform. There is
significant financial industry fatigue, and alternative
investments offer a sense of hope for some.
Generally speaking, an alternative investment means any
investment vehicle except stocks, bonds, mutual funds or
similar funds comparable to mutual funds, cash, or properties.
Examples of alternative investments may include tangible assets
such as gold or art, commodities, private equity funds, hedge
funds, and closely held stocks.
Other examples of alternative investments, although not
usually referred to as such, are derivatives and guru
portfolios. Derivatives are those speculative instruments that
brought down Lehman Brothers and Bear Stearns and nearly
destroyed our financial system. Guru portfolios are so-called
investment strategies based on special knowledge and expertise
the guru is purported to have. That is how the guru claims it
can outperform its competitors.
Gurus play to the investor's ego, making the investor feel
special and smart for knowing the guru and for being permitted
to invest with him or her. Many times the guru is falsifying
accounting records to make the investment performance appear
better than it is. Investors' attention becomes focused on
short-term gains instead of long-term values. Bernie Madoff is
the most famous example.
The due diligence burden retirement plan fiduciaries have
when investigating alternative investments is significantly
higher than it is for publicly traded securities, for obvious
reasons. It requires greater knowledge and insight into
relevant issues. Most fiduciaries of employer-sponsored plans
are ill-prepared to perform an appropriate level of due
diligence. While the plan itself is considered to be an
accredited investor, individual fiduciaries might not otherwise
be. The participants in a plan are vulnerable to the decisions
made by that fiduciary.
There are several reasons that performing due diligence and
proper monitoring of alternative investments is so difficult.
First, the fair value of the investment may be difficult to
determine. Even when a fair value is assigned to an investment,
its validity may be subject to debate. For example, the
reported fair value of an investment could reasonably change by
changing one or more unobservable inputs that could have a
reasonably material impact on calculating the fair value under
those circumstances.
Unobservable inputs are assumptions the investment manager
makes based on what he or she believes potential investors will
pay for an interest in that investment. Those assumptions are
based upon the best information available at the time given
specific circumstances affecting that investment. However,
there may be multiple unobservable inputs that are equally
valid that materially change the calculated fair market value.
There are other reasons why performing due diligence on
alternative investments is tricky for fiduciaries. One is
limited historical information. The second is the difficulty in
obtaining an expected return, which is the basis of capital
markets. Without an expected return, fiduciaries are unable to
determine the merit of a particular investment. In order to
properly govern a retirement plan, the portfolio must be
structured in such a way as to produce that expected return in
a diversified portfolio.
So there are four practical ways to protect retirement plan
participants from the inherent accounting valuation and due
diligence challenges provided within the alternative investment
framework.
First, require audit of internal controls that are normally
required for publicly traded companies; require them for hedge
funds and private equity funds. Number two, require
understandable financial statements. We receive financial
statements that are frequently difficult to understand. Number
three, ensure that managers of alternative investments have
solid enterprise risk management skills. And, finally,
improving fair value measurement methods.
And I will explore all of these in greater detail
throughout the hearing.
[The statement of Mr. Hutcheson follows:]
Prepared Statement of Matthew D. Hutcheson,
Professional Independent Fiduciary
Chairman Andrews, Congressman Price, and members of the Committee.
My name is Matthew Hutcheson. I am a professional independent
fiduciary. Retirement plan sponsors may appoint me to serve as the
responsible decision maker for their plans to fulfill those often
complex and time consuming obligations. In my role as fiduciary, I have
made decisions directly affecting the lives of hundreds of thousands of
hopeful retirees expecting to receive many billions worth of future
benefits.
We live in an increasingly volatile and uncertain business world.
As a result, many plan fiduciaries are exploring alternative
investments to improve portfolio performance and reduce risks.
It is likely that interest in alternative investments will continue
to spread, not only for the potential merit of the alternative
investments alone, but particularly due to concerns about the economy
and Wall Street's integrity, even in the face of sweeping legislative
reform. There is significant ``financial industry fatigue,'' and
alternative investments offer a sense of hope for some.
Generally speaking, an alternative investment means any investment
vehicle other than stocks, bonds, mutual funds, cash or real estate.
Examples of alternative investments may include tangible assets (i.e.
gold or art), commodities, private equity funds, hedge funds, and
closely held stocks.
Other examples of alternative investments, although not usually
referred to as such, are derivatives and ``guru portfolios.''
Derivatives are those speculative instruments that brought Lehman
Brothers and Bear Sterns down, and nearly destroyed our financial
system.
Guru portfolios are so-called investment strategies based on
special knowledge and expertise the guru is purported to have. That is
how the guru claims it is able to outperform its competitors.
``Gurus'' play to the investor's ego; making the investor feel
special and smart for knowing the guru, and being ``permitted'' to
invest with him or her. Many times, the guru is falsifying accounting
records to make the investment performance appear better than it is.
Investor's attention becomes focused on short term gains instead of
long term values. Bernie Madoff is the most famous example.
The due diligence burden retirement plan fiduciaries have when
investigating alternative investments is significantly higher than it
is for publicly traded securities, for obvious reasons. It requires
greater knowledge and insight into relevant issues. Most fiduciaries of
employer sponsored retirement plans are ill prepared to perform an
appropriate level of due diligence. While the plan itself is considered
to be an ``accredited investor,'' \1\ individual fiduciaries might not
otherwise be. The participants in the plan are vulnerable to the
decisions made by the fiduciary.
There are several reasons that performing due diligence and proper
monitoring of alternative investments is so difficult. First, the fair
value of the investment may be difficult to determine. Even when a fair
value is assigned to an investment, its validity may be subject to
debate. For example, the reported fair value of an investment could
reasonably change by ``changing one or more unobservable inputs that
could have reasonably been used to measure fair value in the
circumstances.'' \2\
``Unobservable inputs,'' \3\ are assumptions the investment manager
makes based upon what he or she believes potential investors will pay
for an interest in the investment. Those assumptions are to be based
upon the best information available at the time, and given the specific
circumstances affecting the investment. However, there may be multiple
unobservable inputs that are equally valid, but that materially change
the calculated fair market value.
Unobservable inputs are not transparent to potential investors.
That's why they are called ``unobservable.'' They can lead investors to
incorrect conclusions and even significant investment losses, even when
all parties are otherwise acting in good faith.
There is another reason performing due diligence on alternative
investments is tricky for fiduciaries. Often, only limited historical
information is available on the investment. The historical behavior of
an investment is the basis for return on capital expectations, and also
expected levels of risk and volatility. It also makes monitoring
against a benchmark virtually impossible.
``Expected return'' \4\ is the foundation of capital markets. If
investors are unable to expect something favorable in return for the
investment of their capital, the market system would cease to function
properly. The flow of investment dollars would dry up, and the capital
markets would freeze.
Assets in a retirement plan are held in trust for the future
retirement income of plan participants and beneficiaries. Creating and
securing retirement income is the overarching objective of ERISA. In
order to properly govern a retirement plan, the portfolio must be
structured in such a way to produce an expected return over a defined
investment time horizon. If a fiduciary does not know what to expect in
return for the investment of trust assets, it is in the realm of
speculation. A fiduciary would also be unable to fairly compare two or
more alternative investments.
Fiduciaries are obligated under current regulation\5\ to avoid
imprudent speculation by applying proper principles of economics and
finance to portfolio construction and management. Thus, a lack of
historical information can pose a significant challenge, if not a road
block altogether, for fiduciaries considering a particular alternative
investment.
Finally, the cost of buying and selling alternative investments can
be very high. Those costs can be difficult to quantify, and are not
frequently disclosed in an easy to understand format.
There are four practical ways to protect retirement plan
participant's future retirement income from the inherent accounting,
valuation, due diligence, and trading challenges presented by
alternative investments.
1. Require audit of internal controls: Require that alternative
funds have an independent auditor sign off on internal controls based
upon the Committee of Sponsoring Organizations' (``COSO'') definition
of what it means to effectively evaluate internal controls.\6\ Auditing
internal controls today isn't as time-consuming or as costly as it was
when large public companies first began complying with one of the most
onerous requirements of the 2002 Sarbanes-Oxley Act, known as Section
404. Although the Sarbanes-Oxley Act is directed at public companies,
many privately owned companies and nonprofit organizations are electing
to evaluate their systems of internal control using COSO's
framework.\7\ Alternative investment managers can too.
2. Require understandable financial statements: President Obama is
quoted as saying, ``I think we have to restore a sense of trust,
transparency and openness in our financial system.'' \8\ It is urgent
that we do so. It starts with creating financial statements that
retirement plan fiduciaries can actually understand. Retirement plan
fiduciaries want a ``plain English'' executive summary to an
investment's annual report and more complete disclosures.\9\
Indentifying a reasonable expected return on capital will otherwise be
difficult at a minimum and perhaps even impossible based on what those
familiar with such matters would otherwise require before proceeding
with an investment.
3. Enterprise risk management skills: Strong enterprise risk
management skills should be the hallmark of every alternative
investment management team. Fiduciaries considering alternative
investments must possess sufficient knowledge themselves to investigate
whether alternative investments are being managed by individuals with
such skills. There must be a common, standardized language between all
alternative investment managers, auditors, and plan fiduciaries. Key
principles, concepts, and guidance must be conveyed under a common
framework.\10\ A fiduciary's ability to accurately compare two or more
competing alternative investments depends on it. That will restore
investor confidence and give retirement plan participants and retirees
the protections they deserve.
4. Fair Valuation Standards: The Financial Accounting Standards
Board recently published proposed amendments to its fair value
measurement and disclosure rules. An explanation can be found on the
Board's website.\11\ The proposed amendments enhance and standardize
the method of valuing alternative investments by the U.S. based
Generally Accepted Accounting Principles (GAPP) and the International
Financial Reporting Standards (IFRSs). It focuses on standardizing how
elements of uncertainty that may affect a fair market value are
disclosed. For example, disclosure of the use of one unobservable input
over another in a fair market valuation, and how it might have affected
the resulting value. This is particularly important for plan
fiduciaries investigating the merits of international alternative
investments. Legislation could augment those rules with respect to
employer sponsored retirement plans. That would enhance confidence that
the integrity of valuation method being applied to several considered
alternative investments is sound.
In conclusion, perhaps the most important participant-protecting
skill is application of the fiduciary standard. For example, in my
capacity of a professional fiduciary, I have never permitted trust
assets to be invested with Madoff, Bear Sterns, or any other
alternative investment that failed to meet a fiduciary smell test.
While many sophisticated institutional and high net-worth investors
lost billions with Madoff, not one participant under my fiduciary
jurisdiction has ever been exposed to Madoff, Bear Stearns, failed
hedge funds, or other investments such as those. The fiduciary standard
of care, coupled with clear evidence of risk management skills,
internal controls, and demanded transparency protected my participants.
This committee can develop policy intended to help all other
fiduciaries apply the same due diligence expertise of alternative
investments.
Thank you.
endnotes
\1\ http://www.sec.gov/answers/accred.htm
\2\ FASB Issues Proposed Update on Amendments for Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. CAQ
Alert #2010-41--July 14, 2010
\3\ CPA Journal. http://www.nysscpa.org/cpajournal/2006/1106/
infocus/p14.htm
\4\ http://www.investorwords.com/1840/expected--return.html
\5\ Application of modern investment principles in qualified
retirement plans. [Labor Reg. Sec. 2550.404a-1 (42 FR 54122, 1977)],
[ERISA Reg. Sec. 2550.404a-1], ERISA Interpretive Bulletin 94-1, etc.
\6\ http://mcgladreypullen.com/Resource--Center/Audit/Articles/
WhatIsCOSO.html
\7\ ``Turbo Charge Your SOX Program With the New COSO Monitoring
Guidance.'' July 8, 2010 by Stephen Austin, CPA, MBA. www.cpa2biz.com.
\8\ http://wallstreetpit.com/2430-improving-transparency-regaining-
investors-trust
\9\ ``A number of dialogue tour participants proposed adding a
``plain English'' executive summary to annual reports. Others suggested
that ``click-down'' online technology could let users control how
deeply they delve into a particular company's public reports. We also
found considerable support for more complete and understandable
disclosures on executive compensation. In short, investors have made it
clear that they want more transparency.'' http://www.icahnreport.com/
report/2009/01/improving-transparency-regaining-investors-trust.html
\10\ http://www.coso.org/Publications/ERM/COSO--ERM--
ExecutiveSummary.pdf
\11\ http://www.fasb.org/cs/ContentServer?c=FASBContent--
C&pagename;=FASB%2FFASBContent--C%2FNewsPage&cid;=1176156961430
______
Chairman Andrews. Mr. Hutcheson, thank you.
You should be aware that Members have had your written
testimony and had ample time to read it. I read it, and so you
can assume that we have had the opportunity to read your
complete statement. Thank you.
Ms. Bovbjerg, welcome back to the committee. Thank you
again for the outstanding work the GAO does on a range of
issues across the country and across the issues. I am always
impressed by the thoroughness and dedication you and your
colleagues show to every question you confront. It is good to
have you back.
STATEMENT OF BARBARA BOVBJERG, DIRECTOR OF EDUCATION,
WORKFORCE, AND INCOME SECURITY, U.S. GOVERNMENT ACCOUNTABILITY
OFFICE
Ms. Bovbjerg. Thank you so much, Mr. Chairman. I will
report back on your kind remarks.
I am particularly pleased to be here today to speak about
pension plan investment in hedge funds and private equity. It
is such an important issue. Millions of Americans rely on
defined benefit plans for their financial wellbeing in
retirement. And it is particularly important that plan
fiduciaries choose wisely in investing plan assets, to ensure
that plans are adequately funded today and in the future.
My testimony focuses on the extent to which plans have
invested in hedge funds and private equity, the challenges they
face in making such investments, steps sponsors can take to
address the challenges, and measures government can take. My
statement updates our 2008 report on this topic.
First, the extent of these investments. The frequency of DB
plan investment in hedge funds has grown dramatically, with 51
percent of large plans holding hedge funds in their portfolios
today, up from 11 percent in 2001. Yet the vast majority of
these plans invest less than 10 percent of their assets this
way.
The picture is a little different for private equity
investment. Although 90 percent of large plans invest in
private equity today, over 70 percent of them did this in 2001.
So this type of investment has been consistently fairly common,
at least among large plans. But as with hedge funds, most plans
do not concentrate their assets in this form of investment.
Let me turn now to the challenges these investments
present. Although plan fiduciaries have told us that they
invest this way to diversify while gaining potentially
significant returns, they face several major challenges:
foremost, the uncertainty over the current value of their
investment.
Unlike stocks and bonds, which have a readily determined
market price, hedge fund and private equity investments are
more opaque to investors. Hedge funds generally do not provide
information on either the nature of the underlying holdings or
the aggregate value on a day-to-day basis. Hedge fund managers
may decline to disclose information on asset holdings and their
value if they believe the disclosure could compromise their
trading strategy.
Similarly, private equity investment valuation is often
uncertain during the fund's cycle, which can be up to 10 years
or more. Plan fiduciaries often won't know the value of the
underlying investment until the holdings are sold.
Investment risks are also greater than from more
traditional investments. For example, hedge fund and private
equity managers may make relatively unrestricted use of
leverage. While leverage can magnify profits, it can also
magnify losses.
Further, the success or failure of these funds can by
greatly affected by their managers. Obviously, a managerial
investment mistake can cause losses, but there are also
operational risks of mismanagement, such as internal control
weaknesses that open the door to fraud. And this underlines the
importance of annual audits, which encourage robust operational
and internal control processes.
Finally, these investments are generally illiquid, making
it difficult, if not impossible, for plans to cut their losses
in the event of mishap. While the DB plan sponsor is
responsible for assuring plan funding levels, not the
participant as with 401(k)s, a significant drop in funding
could ultimately affect the viability of the DB plan and, by
extension, the retirement benefits participants that have been
promised.
Plan fiduciaries told us they take measures to protect
themselves from these risks by making careful and deliberate
fund selection at the front end. But, of course, the success of
this approach depends on how good the fiduciaries are at such
decision-making and how much information they have going in.
Savvy fiduciaries negotiate key terms of investments with
these funds, specifying fee structure and conditions, valuation
procedures, redemption provisions, and degree of leverage to be
employed. Some told us they look to funds of funds to expand
their diversification, although these are often less
transparent than single hedge funds and can come with an
additional layer of fees.
So there is a lot to be considered as a plan fiduciary
seeking to invest in such funds, and we think the Federal
Government can help. In 2008, 2 years ago, we recommended the
Department of Labor provide guidance on the unique challenges
of these investments and outline prudent steps plan fiduciaries
could take. We felt this could help all plans that consider
such investments and, in fact, might warn smaller plans away if
they don't have the resources to carry out the oversight that
is needed. We still believe that this would be an important
contribution for the Department to make, but, although they
said they would consider the feasibility of our recommendation,
they have taken no action as of yet.
I would like to conclude by noting that plan sponsors are
facing tremendous financial pressures, both overall and in
maintaining funding levels in their DB plans. Congress has
provided temporary relief from ERISA funding rules, but the
pressure to achieve high returns on plan assets has got to be
significant, especially if a failure to achieve such returns
means higher required contributions from the sponsor.
It will be increasingly important to help fiduciaries do
the right thing by making them aware of the risks associated
with alternative investments as well as ways to manage their
stake in these investments. Guidance from Labor and better
information from the investment managers themselves cannot, of
course, protect plan assets from poor decision-making, but it
can better armor fiduciaries and, by extension, plan
participants against large losses resulting from a poor
understanding of what they are getting into.
And that concludes my statement, Mr. Chairman.
[The statement of Ms. Bovbjerg may be accessed at the
following Internet address:]
http://www.gao.gov/new.items/d10915t.pdf
______
Chairman Andrews. Thank you again, Ms. Bovbjerg.
Mr. Chambers, welcome back to the committee. It is a
pleasure to have you with us.
STATEMENT OF ROBERT CHAMBERS, PARTNER, MCGUIREWOODS, LLP
Mr. Chambers. Thank you, Chairman, and thank you, Dr. Price
and members of the committee.
First and foremost, let me express my profound appreciation
to the committee for an opportunity to spend a few hours
thinking about something other than health reform. It has been
terrific. But I also appreciate the opportunity to present
testimony with respect to the investment of DB plan assets in
hedge funds, private equity funds, and other alternative
investments.
DB plans must continue to provide participants with
promised retirement security despite these turbulent economic
times. Our national priority should be a DB plan system that
functions transparently, as you indicated, Mr. Chairman, and
provides promised benefits, but without nonessential
administrative burdens and unnecessary costs that would
undermine their essential purpose.
So I am going to make a few points, if I may. The first
relates to the GAO report from 2008 on the investment of DB
plan assets in these kinds of investments.
I think that the GAO report itself was something of a
hedge. And I think that it was an important position for them
to take, and I think that it was actually pretty smart. The
report took great care, as did Ms. Bovbjerg just now, to
describe both the challenges and the unique opportunities
presented by these types of investments. So, for example, she
indicated and the report indicated that a growing number of
plans have begun to invest in hedge funds and private equity,
but virtually all of them have invested only a small portion of
their total plan assets.
Similarly, while many hedge fund and private equity
investments may carry increased risks, virtually all the
fiduciaries interviewed indicated that they were generally
pleased with the overall results of those investments and that
they were willing to devote the necessary time and energy to
vet those investments in order to increase overall asset
returns and, of course, to reduce volatility.
The GAO report did not suggest that any restrictions be
placed on nontraditional investments by DB plans or that
additional protective legislation would be required. Instead,
it recommended that DOL apprise plan fiduciaries of the risks
of such investments and the need for increased due diligence,
negotiations, and monitoring in accordance with ERISA's
existing fiduciary rules.
Which leads to my second point, and that is that the
guidance that the GAO has suggested is generally available
currently from other sources. The DOL expressed concern that
providing this guidance would be difficult in light of the lack
of uniformity in those investments. But I think that help is on
the way. First, the SEC is likely to provide help as it issues
regulations and other guidance under the Dodd-Frank financial
reform bill. And in the interim, the DOL could easily make
available to plan fiduciaries the existing work of, frankly,
many sophisticated nonpartisan groups that have developed
excellent tools for handling the due diligence and contract
negotiations for these kinds of investments. And I have
referred to one of these reports in my written testimony.
My third point is that the Dodd-Frank bill will require
many plan advisors to register with the SEC and to provide
information regarding their funds. The bill will give the SEC
broad new powers with respect to managers of many hedge funds
and possibly private equity funds, and the SEC and FSOC and
other regulators will provide guidance on definitions,
registration requirements, and the periodic filing of
confidential information for many of these funds.
In light of the recent passage of the bill, neither
Congress nor the DOL should act at this time, in my view, to
restrict DB plans from investing in these kinds of funds.
And next are the valuation issues that others have already
addressed. And I think that these valuation issues are, in
fact, being addressed. Form 5500 and plan actuaries require an
annual determination of the fair market value of DB plan
assets. So all investments for which there is no public market
or reported unit sales, including hedge funds and private
equity funds, present valuation challenges that I think are
manageable, albeit somewhat thorny.
Other groups are working on the issue. Again, the SEC is
likely to develop valuation techniques as part of its guidance
under the Dodd-Frank bill. And, also, the Financial Accounting
Standards Board and the accounting industry are developing a
systematized approach to the valuation of downstream
investments for which there is no public market.
My last point is that plan participants do not need
additional information on any of these kinds of investments
either. Again, the Pension Protection Act requires defined
benefit plan administrators to provide annual funding notices
to participants that include a year-end market valuation of the
plan's assets and liabilities as well as information regarding
funding and investment policies. The DOL has already issued a
model notice that is relatively short and easy, I think, for
participants to understand. I don't believe that there is any
need to provide even more information that could render the
existing disclosure regime completely meaningless.
And one last thought, if I may. The DOL has consistently
advised plan sponsors and other fiduciaries of the importance
of process. You are supposed to create appropriate procedures,
follow the procedures, review the procedures from time to time
to determine that they remain best practices, and then document
your compliance and review. Fiduciaries are to be judged
primarily on their adherence to this process rather than on the
result of their individual decisions. And the decision whether
to invest DB assets in hedge funds or other alternative
investments, as well as the monitoring of those investments,
should not be held to a different standard.
Thank you.
[The statement of Mr. Chambers follows:]
Prepared Statement of Robert Gordon Chambers,
on Behalf of McGuireWoods, LLP
My name is Robert Chambers, and I am a partner in the international
law firm of McGuireWoods LLP. I have advised clients with respect to
defined benefit plan issues since shortly after ERISA became effective.
In that regard, my clients have included both large and small employers
that sponsor defined benefit plans as well as financial institutions
and other organizations that provide services to such plans. I am also
a past chair of the Board of Directors of the American Benefits
Council.
I appreciate the opportunity to present testimony with respect to
the investment of defined benefit plan assets in hedge funds and
private equity funds. Despite the general decline of the defined
benefit (``DB'') plan system, the investment of assets and funding of
those DB plans that remain in effect have taken on increased importance
for millions of Americans during difficult economic times. It is more
important than ever to ensure that DB plans provide their participants
with the retirement security that they promise. Our national priority
should be an effective DB plan system that functions in a transparent
manner and provides promised benefits, but without nonessential
administrative burdens and unnecessary costs that would undermine the
paramount purpose of the plans.
Due to the breadth of this hearing's topic, I have tried to
anticipate several issues that may be discussed, and I apologize if I
have failed to cover any of the intended issues.
My testimony will relate to the following subjects:
The findings, conclusions, and recommendation reached in
the April, 2008 report of the Government Accountability Office
(``GAO'') on investment of DB plan assets in hedge funds and private
equity--GAO-08-692.
The existence of other reports that the Department of
Labor (``DOL'') may use to provide guidance to plan fiduciaries
regarding the decision-making process for such investments.
The provisions of the Dodd-Frank financial reform bill
that will require additional disclosure regarding hedge funds and
private equity.
The impact of such investments on other plan service
providers.
The existence of sufficient DB plan asset disclosure to
participants.
The GAO Report Generally Reaches Logical, But What Are Now Dated
Conclusions
The GAO necessarily hedged its view in developing the results and
conclusions in its August 2008 report. It determined that:
A growing number of plans have begun investing in hedge
funds and private equity, yet most of such plans only invested a small
portion of total assets in such investments.
Many hedge fund and private equity investments appear to
have more risk associated with them, yet virtually all of the
fiduciaries interviewed indicated that they were generally pleased with
the results of those investments.
Hedge fund and private equity investments often require
more due diligence to obtain necessary information and more negotiation
of contract terms in order to make an informed investment decision, yet
many fiduciaries are willing to devote this time and energy to the task
in order to achieve the overall returns and volatility reduction that
those investments can provide in accordance with a DB plan's funding
and investment policy.
Hedge fund and private equity investments often require
longer term commitment and less liquidity than other types of
investments, yet such fiduciaries deem those features to be less
problematic in the context of projected liquidity needs in DB plans,
especially in light of the opportunity for greater returns and less
volatility that those investments, many of which are uncorrelated to
traditional plan investments, may provide.
These GAO findings and conclusions certainly echo those of our
clients that have explored investments in hedge and private equity
funds.
The GAO report provides, correctly, that ERISA's fiduciary rules
apply equally to both large and small DB plans, but that smaller DB
plans may not have the resources to perform sufficient due diligence to
properly assess non-traditional investments such as hedge and private
equity funds. However, the report does not suggest that restrictions be
placed on smaller plans. Rather, the report recommends that smaller
plans should simply be apprised of the risks of such investments and
the need for increased due diligence, negotiations, and monitoring to
comply with ERISA's fiduciary rules.
If the DOL Decides to Provide Guidance to Plan Fiduciaries Regarding
the Decision-Making Process for Investments in Hedge and
Private Equity Funds, That Guidance Is Now Generally Available
From Other Sources
The GAO Report concludes with a recommendation that the DOL provide
guidance for plan fiduciaries that covers the special challenges
relating to investments in hedge funds and private equity and the due
diligence and other procedures that fiduciaries should undertake to
address these challenges. The report also suggests that the DOL provide
additional information on these investments for small DB plans.
The DOL was provided an advance copy of a draft of the GAO report
and responded that it foresaw a number of problems with satisfying the
GAO's suggestion. The DOL's foremost concern was that providing such
guidance would be extremely difficult in light of the lack of a uniform
definition of such investments and the lack of uniformity of such funds
and their underlying investments.
This concern may be put to rest in part because we can expect the
SEC to provide definitional help as it issues regulations and other
guidance under the Dodd-Frank financial reform bill discussed below.
Further, as we await the issuance of this guidance, I believe that the
DOL may make available the guidance suggested by the GAO without
needing to reinvent the wheel and becoming entangled in a definitional
morass. There are a number of existing, recent publications containing
guidance on investing in hedge funds and private equity, several of
which were drafted in connection with public sector initiatives.
For example, I draw your attention to Principles and Best Practices
for Hedge Fund Investors, the Report of the Investors' Committee to the
President's Working Group on Financial Markets. The report is dated,
January 15, 2009. This document is available, among other places, on
the Treasury Department's website.
This report includes a Fiduciary's Guide and an Investor's Guide.
The Fiduciary's Guide provides recommendations to individuals charged
with evaluating the appropriateness of hedge funds as a component of an
investment portfolio. The Investor's Guide provides recommendations to
those charged with executing and administering a hedge fund program
once a hedge fund has been added to the investment portfolio. The
principles and best practices are applied uniformly to both large and
small investors.
The membership of the Investors' Committee included representatives
of private and university endowments, large governmental and private
pension funds, unions, and asset management firms.
My point simply is that the DOL could easily and quickly make
available to plan fiduciaries the existing work of sophisticated, non-
partisan groups that have developed excellent tools for handling the
due diligence and contract negotiations for investments in hedge and
private equity funds.
The Dodd-Frank Wall Street Reform and Consumer Protection Act Will
Require Many Advisers To Hedge and Private Equity Funds to
Register With the SEC and Provide Information Regarding the
Funds
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
``Dodd-Frank bill'', which has not been signed by the President at the
time that this testimony has been prepared), imposes registration and
other disclosure requirements on many hedge funds and possibly on
private equity funds. The Dodd-Frank bill gives the Securities and
Exchange Commission (``SEC'') broad new powers with respect to managers
of hedge and private equity funds. My firm expects that the SEC, the
Financial Stability Oversight Council, and other regulators will
provide needed guidance on definitions, registration requirements for
larger advisors, the provision of required confidential data for
virtually all of these funds, and methods of determining whether such
funds are undertaking undue risk. Those agencies are authorized to take
action against those advisers that are determined to have undertaken
too much risk. This will assist the agencies in their attempts to
monitor the hedge funds and private equity industries that grown so
exponentially in the past few years.
Neither Congress nor the DOL should act at this time to restrict or
prohibit DB plans from investing in any type of hedge or private equity
funds. Plan sponsors are concerned such action would:
Substitute Congress' current judgment regarding
investments for the judgment of plan fiduciaries, who are familiar with
their workforce and DB plan investment policies, liability management,
funding issues, and administration;
Establish an investment rule based on today's thinking
that does not take into account future investment trends and
principles;
Lead to controversy and confusion (especially in the case
of hedge funds), regarding whether a particular series of investments
creates a restricted or prohibited hedge fund;
Send a signal to fiduciaries that particular investment
options should be preferred over others; and
Undercut consideration of a plan's funding and investment
goals, risk tolerance, and interest in volatility reduction and
investment diversification.
There Are Valuation Issues That Must Be Addressed for Some Investments
in Hedge and Private Equity Funds
The administrators of all DB plans must make an annual filing of
Form 5500 and its related schedules, which require a determination of
the fair market value of all plan assets. Further, plan actuaries must
obtain a valuation of all plan assets in order to complete their
actuarial valuations. Similar to many other types of investments for
which there is no public market or reported units sales, hedge funds
and private equity investments present valuation challenges that can be
difficult but are manageable.
The GAO report also noted the challenges DB plans face in valuing
certain investments in hedge and private equity funds.
I expect that the SEC will develop additional valuation techniques
as part of the guidance that it issues under the Dodd-Frank bill. I
also understand that the Financial Accounting Standards Board and the
accounting industry are developing a systemized approach to the
valuation of downstream investments for which there is no public
market.
More generally, in the United States, the valuation of assets and
liabilities of DB plans has never been required to be an exact science.
For example, real estate and stock in privately held companies can be
appraised, but the valuation cannot be precise. This is not a problem
that renders such investments inappropriate for plans, rather it is an
issue that plan fiduciaries must consider along with all other factors
in deciding to invest in such an asset.
No Additional Information on Hedge and Private Equity Funds Needs To Be
Provided To Plan Participants
Congress and the DOL have just reviewed the issue of disclosure of
specific information regarding individual investments of a DB plan. The
Pension Protection Act amended Section 101 of ERISA to require DB plan
administrators to provide annual funding notices to participants that
include a year-end market valuation of the plan's assets and
liabilities and information regarding the plan's funding and investment
policy, among other information. The DOL has issued a model notice that
includes a chart illustrating the plan's year-end asset allocation by
percentage of plan assets invested in up to 17 categories. To the
credit of the DOL, this part of the model notice is relatively short,
simple, and easy to understand.
It would be very unhelpful to revisit that issue. I have heard from
numerous clients and colleagues that the amount of information being
provided to participants has grown so great that participants have on
the whole simply stopping looking at the disclosures. To add a set of
complex new disclosures would simply reduce the number of participants
who actually read what they receive.
The key is enabling plan fiduciaries to make informed decisions on
behalf of the participants. That should be our focus, rather than so
overwhelming participants with complex information that the disclosure
regime becomes meaningless.
It is also important to remember that hedge funds, in particular,
are not a separate asset class. Rather, they are a compilation of
assets from one or more asset classes. Reforming existing rules to draw
participants' attention to specific investments, whether in hedge
funds, private equity, or other asset classes (such as real estate),
invariably will be more confusing than enlightening.
The DOL has consistently advised plan sponsors and other
fiduciaries of the importance of creating appropriate procedures,
following those procedures, reviewing the procedures from time to time
in light of changes to best practices, and documenting such compliance
and review. Fiduciaries will be judged primarily on their adherence to
this process, rather than on the results of their decisions. The
decision of whether to invest DB plan assets in hedge funds, private
equity, and other non-traditional assets, and the monitoring of those
investments, should not be held to different standards. Nonetheless, I
agree with the GAO report that the DOL would perform a valid public
service by providing or making available guidance on specific issues
that such investments generate. That guidance, which is already
available, will need to be reviewed and updated in the future to take
into consideration accounting developments and guidance issued by other
agencies as they implement recent legislation.
______
Chairman Andrews. Mr. Chambers, thank you very much for
your testimony.
Mr. Marco, welcome to the committee. We are happy that you
are with us.
STATEMENT OF JOHN MARCO, CHAIRMAN,
MARCO CONSULTING GROUP
Mr. Marco. Good morning, Mr. Chairman, Dr. Price, and
members of the committee.
My name is Jack Marco. I am the chairman of the Marco
Consulting Group, an investment consulting firm I founded in
1988. We serve about 400 defined benefit plans as clients. Most
are multi-employer, jointly trusteed plans organized under the
Taft-Hartley Act and subject to ERISA. In most cases, we serve
as an investment consultant, but in many situations we serve as
a named fiduciary, where we make the decisions on asset
allocation and select investment managers. Our clients'
aggregate value is approximately $90 billion.
The employee trustees of the Taft-Hartley plans are
electricians and bakers, bricklayers and nurses, janitors and
plumbers. They work in our grocery stores and hotels and
hospitals. They drive trucks and make clothes and care for the
sick. They are the very best our Nation has for building
complex construction projects and providing necessary and
sometimes critical services.
The employer trustees represent small business and large.
They are contractors, HR specialists, labor relation
specialists, and representatives of trade associations. While
they are not investment professionals, as leaders in their
unions and businesses they are smart, successful, accomplished
individuals. As trustees, they work tirelessly to provide a
solid retirement benefit for their members and their employees,
and they accept all of the liabilities of a fiduciary and
receive no compensation.
When I first started providing investment consulting
services to Taft-Hartley plans in 1977, their investments were
overwhelmingly in traditional assets of stocks, bonds, and
insurance contracts. I was hired as an investment consultant to
help them select and monitor investment firms which would
manage their assets. Their investments in publicly traded
stocks and bonds were held at a custodian bank and
independently valued by them. There was little debate about
what they owned, what it was worth, and the risks they were
taking.
Today, our clients still own stocks and bonds held in many
of the same custodial banks. However, these assets represent
about 75 percent of their funds. The remainder are in real
estate partnerships and commingled funds, private equity
partnerships, LLCs, and hedge funds.
On the positive side, these assets have added important
diversification to the portfolios and improved returns. On the
negative side, many of these strategies have become very
complex, with little regulation and government oversight. The
trustees are expected to be prudent experts when selecting
investments which use these strategies. More than ever, they
rely on independent investment consulting firms, such as ours,
to educate them on the risks and returns of these approaches,
bring them the best managers, and help them avoid the poor
ones. That is becoming more challenging every day.
I would like to focus on two of these investment
approaches: private equity and hedge funds.
In private equity, the definition of ``private'' means
making investments in companies that are not registered with
the SEC as publicly traded securities. They are not generally
followed by Wall Street. One of the advantages of private
equity is that little is known about these startup companies or
privately held institutions; therefore, investors who seek out
these companies have greater opportunities for superior return.
It is also true that this same lack of information creates risk
to investors.
While a manager of a publicly traded equity may hold 50
securities, some private equity managers will hold less than 10
investments. These private equity investments are typically
partnerships, the investment manager being the general partner
and the pension fund being the limited partner. At the time of
investment, there are no investments made yet, and the manager
begins the process of looking for companies in which to invest.
The investor has to rely on his own due diligence and
information provided by the general partner to provide some
confidence that the general partner will do well.
Our clients typically meet four times a year to conduct all
of the business of the pension fund. They have no capacity and
no investment staff to perform that due diligence. Most often,
they look to an investment consultant to provide that due
diligence for them.
Our process examines private equity managers in great
detail--everything from SEC registration, third-party
providers, offering memorandums, marketing materials, and the
like. We require this information to proceed. However, the
general partners are not required to provide it. If they
refuse, we move on to another candidate. The general partner
moves on to another investor who may not demand these
disclosures.
The best general partners provide all that is asked of them
and more. The worst general partners rely on slick
presentations without appropriate disclosure. The same can be
said about disclosures after the pension fund has become an
investor.
Again, all of these requirements we place on any
partnership we recommend to our clients. Where it is not
demanded by the investor, it may not be provided because it is
not required by law.
Our preference is for our clients to use private equity
fund of funds instead of individual private equity funds. The
fund-of-funds structure provides diversification of strategy,
geography, and industry. The fund-of-funds manager brings
expertise, access and oversight, and resources to the
investment process and bears full responsibility for the
evaluation, selection, and timing of all of these investments.
We believe this due diligence structure and the use of fund
of funds is a very effective tool for Taft-Hartley trustees.
However, requiring general partners to provide these
disclosures would ensure that all investors have the
information they need to make intelligent, informed decisions.
On hedge funds, there are over 9,000 hedge funds available
for pension fund investors. They include a multitude of
strategies: long/short equity, merger arbitrage, relative
value, distressed debt, fixed-income arbitrage, and the list
goes on.
These are some of the most sophisticated strategies
executed in the industry. Consequently, it requires equally
sophisticated supervision. That is why we prefer funds of hedge
funds for our clients. These are typically partnerships or LLCs
that select a group of hedge funds and move in and out of them
over time. The investor then owns shares in 30 to 50 hedge
funds in a diversified portfolio rather than just a few they
would select on their own.
As a result, we focus our analyzing and monitoring on funds
of hedge funds. We have developed a list of best practices for
funds of hedge funds. Generally, we do not recommend funds of
hedge funds that do not adhere to the majority of the best
practices.
We also expect fund-of-hedge-fund managers to follow
certain best practices in their due diligence and monitoring of
underlying hedge funds. Our best practices are divided into
four categories: people, investment, operational, and business.
Let me just mention that one of the key things about
people: Background checks, history and experience, and
operational risk is something that is very key to us. We think
that the funds need to hire third-party firms to manage
custody, audit, and administration responsibility. We want to
also measure the business risk of these institutions.
Let me make clear that these are best practices we believe
are appropriate and that we follow. They are not required by
law or in regulation.
Finally, we believe the SEC registration should be required
for all hedge funds and funds of hedge funds. And, thus, we
welcome Congress's passage of the financial reform bill,
requiring registration of those funds with $150 million or more
under management, as an important step towards that goal.
In conclusion, I would like to say the investment
environment that Taft-Hartley fund trustees face today is
exponentially more complex than it was when I joined the
industry three decades ago. It is very difficult to expect
trustees to understand the many investment strategies, but
without full and complete disclosure by the investment
community, it is nearly impossible for these trustees to do
their job of protecting the retirement security of millions of
American workers.
From the professional advisor and fiduciary's perspective,
I know requiring these disclosures would help us do a better
job of scrutinizing these investments. I have also provided the
committee with a list of these best practices on private equity
and hedge funds on the Web site provided to the committee.
Thank you very much, and I am happy to answer any
questions.
[The statement of Mr. Marco follows:]
Prepared Statement of Jack Marco, Chairman,
Marco Consulting Group
Good morning Mr. Chairman and Members of the Committee. My name is
Jack Marco. I am the Chairman of the Marco Consulting Group, an
investment consulting firm I co-founded in 1988. We have nearly 400
benefit plans as clients; most are multi-employer, jointly-trusteed
plans organized under the Taft-Hartley Act and subject to ERISA. In
most cases we serve as investment consultant but in many situations we
serve as a named fiduciary where we make the decisions on asset
allocation and select the investment managers. Our clients' aggregate
asset value is approximately $90 billion. In terms of assets, we are
the largest investment consultant to Taft-Hartley plans in the country.
I have been an investment consultant for 33 years.
The employee trustees of Taft-Hartley plans are electricians and
bakers, bricklayers and nurses, janitors and plumbers. They work in our
grocery stores and hotels and hospitals. They drive trucks and make
clothes and care for the sick. They are the very best our nation has
for building complex construction projects and providing necessary--in
some cases critical--services. The employer trustees represent small
business and large. They are contractors, HR specialists, labor
relation specialists and representatives of trade associations. While
they are not investment professionals, as leaders in their unions and
businesses, they are smart, successful and accomplished individuals. As
trustees they work tirelessly to provide a solid retirement benefit for
their members and their employees. And for this they accept all of the
liabilities of a fiduciary and receive no compensation.
When I first started providing investment consulting services to
Taft-Hartley plans in 1977, their investments were overwhelmingly in
the traditional asset classes of stock, bonds and insurance contracts.
I was hired as an investment consultant to help them select and monitor
investment firms which would manage their assets. Their investments in
publicly traded stocks and bonds were held at custodian banks and
independently valued by them. There was little debate about what they
owned, what it was worth and the risks they were taking.
Today our clients still own stocks and bonds held in custody by
many of these same banks and reported on accordingly. However, these
assets now represent about 75% of their funds. The remainder is in real
estate partnerships and commingled funds, private equity partnerships,
LLC's and hedge funds. On the positive side, these asset classes have
added important diversification to the portfolios and improved returns.
On the negative side, many of these strategies have become very complex
with little regulation and government oversight. The trustees are
expected to be ``prudent experts'' when selecting investment firms
which use these strategies. More than ever they rely on independent
investment consulting firms such as ours to educate them on the risks
and returns of these approaches, bring them the best managers and help
them avoid the poor ones. That is becoming a more challenging task
every day. I would like to focus today on two of these investment
approaches: Private Equity and Hedge Funds.
Private Equity
By definition, ``private'' equity means making investments in
companies that are not registered with the Securities and Exchange
Commission (``SEC'') as publicly traded securities. They are not
generally followed by Wall Street analysts. Much has been written about
the ``Efficient Market Theory'' which says there is so much information
available about publicly traded companies that there is little
opportunity for a money manager to provide above market returns. One of
the advantages of Private Equity is that little is known about these
privately held or startup companies, therefore the investor who seeks
out these companies has greater opportunity to provide superior
returns. It is also true that this same lack of information creates a
risk to investors. Furthermore, because private equity managers may
have a specialized industry or niche that they invest in, they may hold
concentrated positions that are not well-diversified--this presents a
greater opportunity for significant loss. While a manager of publicly
traded equity may hold 50 securities, some Private Equity managers will
make less than 10 investments.
These private equity investments are typically partnerships, the
investment manager being the General Partner and the pension fund
investors being the Limited Partners. At the time of the investment
(commitment) there are no investments made yet and the manager begins
the process of looking for companies in which to invest. The investor
has to rely on his own due diligence and the information provided by
the General Partner to provide some confidence that the General Partner
will do well. The need to perform proper due diligence is further
heightened by one of the unique aspects of Private Equity--contractual
agreements that lock up investor capital for more than a decade after
the initial commitment. Our clients typically meet four times a year to
conduct all of the business of the pension fund. They have no capacity
and no investment staff to perform that due diligence. Most often they
look to an investment consultant to provide due diligence for them.
Our process examines the private equity manager's: Form ADV (if it
is registered with the SEC); insurance; audited financial statements,
valuation procedures; third-party service providers; offering
memorandum, and marketing materials; personnel; biographies of key
employees; client references; complete historical returns for all prior
funds; and a history of all limited partnership investments, total
capital managed and strategy for all prior products. We require this
information to proceed; however the General Partners are not required
to provide it. If they refuse, we move on to another candidate. The
General Partner moves on to another investor who may not demand these
disclosures. The best General Partners provide all that is asked of
them and more. The worst General Partners rely on slick presentations
without appropriate disclosure.
The same can be said about disclosures after the pension fund has
become an investor. We require quarterly detailed reporting on each
investment including asset values, capital flows, and business plans.
Of the General Partner, we continue to require reporting on their
investment strategies, current market conditions and organizational
issues. On an annual basis we collect and review Form ADVs where
possible, insurance, audited financial statements and valuation
procedures. Again all of this is a requirement we place on any
partnership we recommend to our clients. Where this is not demanded by
the investor it may not be provided because it is not required by law.
Our preference is for our clients to use private equity fund of
funds instead of individual private equity funds. The fund of funds
structure provides diversification of strategy, geography and industry.
The fund of funds manager brings expertise, access, oversight and
resources to the investment process and bears full responsibility for
the evaluation, selection and timing of all investments in the fund. A
good fund of funds manager demands all of the disclosures we listed and
also has a good track record of discovering successful partnerships.
We believe this due diligence structure and the use of fund of
funds are very effective tools for Taft-Hartley trustees. However
requiring General Partners to provide these disclosures would ensure
that all investors have the information they need to make intelligent,
informed decisions.
Hedge Funds
There are over 9,000 hedge funds available to pension fund
investors. They cover a multitude of strategies and approaches: Long/
Short Equity, Merger Arbitrage, Relative Value, Distressed Debt, Fixed
Income Arbitrage, Global Macro, CTA's and the list goes on. While the
traditional manager invests in a stock or a bond in a long position,
the hedge fund manager will also take that long position and then hedge
it with a short position (short sale). This is done with publicly
traded stocks, domestic and foreign, currencies, commodities, and bonds
to name a few. These are some of the most sophisticated strategies
executed in the industry. Consequently, it requires equally
sophisticated supervision. That is why we prefer Funds of Hedge Funds
for our clients. These are typically partnerships or LLC's that select
a group of hedge funds and move in and out of them over time. The
investor then owns shares of 30 to 50 hedge funds in a diversified
portfolio rather than just a few they could select on their own. As a
result, we focus on analyzing and monitoring the Funds of Hedge Funds.
We have developed a list of best practices for Funds of Hedge
Funds. Generally, we will not recommend a fund of hedge funds that does
not adhere to the majority of these best practices. We also expect the
Fund of Hedge Funds managers to follow certain best practices in its
due diligence and monitoring of underlying hedge funds.
Our best practices are divided into four categories of risk at the
fund of hedge funds and underlying hedge fund level--people,
investment, operational and business.
For people risk, we want a fund of hedge funds to provide client
references and underlying manager references. We expect the underlying
hedge funds to provide client references and to agree to background
checks on their key investment and operations staff to the fund of
hedge funds manager.
For investment risk, we want fund of hedge funds to agree to be an
ERISA fiduciary, to provide the number of underlying funds and to
report fund and client performance on a monthly and quarterly basis and
aggregate strategy exposures on a quarterly basis. We expect the
underlying hedge funds to provide the number of their underlying
positions and to report on at least a quarterly basis to the fund of
hedge funds. We want both fund of hedge funds and hedge funds to
provide: monthly returns; strategy and geographic allocations; and
portfolio terms for liquidity and fees.
For operational risk, we want both fund of hedge funds and hedge
funds to hire third party firms to manage custody, audit and
administration responsibilities.
For business risk, we want both fund of hedge funds and hedge funds
to provide general firm information regarding their inception, assets
under management and number of accounts for both institutions and non-
institutions. We also want them to provide general fund information
regarding inception, assets under management (strategy and fund level),
number of accounts and minimum investment amount.
Let me make it clear that these are the best practices we believe
are appropriate and that we follow. They are not required in the law or
in regulation.
Finally, we believe SEC registration should be required for all
hedge funds and Funds of Hedge Funds, and thus we welcome Congress'
passage of the Financial Reform Bill requiring registration of those
funds with $150 million or more under management as an important step
towards that goal.
Conclusion
The investment environment that Taft-Hartley Fund trustees face
today is exponentially more complex than it was when I joined this
industry three decades ago. It is difficult enough to expect trustees
to understand the many investment strategies, but without full and
complete disclosure by the investment community, it is nearly
impossible for these trustees to do their job in protecting the
retirement security of millions of American workers. From the
professional advisor and fiduciary's perspective, I know requiring
these disclosures would certainly help us do a better job of
scrutinizing these investments.
I have also provided the Committee with our list of best practices
for Private Equity and Hedge Fund investing as well as background
documents on them and model principles and valuation procedures. They
can be viewed at http://www.marcoconsulting.com/cexhibits.html.
I welcome any questions you may have.
______
Chairman Andrews. Thank you, Mr. Marco.
We would like to thank each of our witnesses for their
preparation and excellent presentations this morning. We will
now get to the questions from the Members.
Mr. Hutcheson, let's assume that I am a fiduciary of a
defined benefit plan, and I am thinking about making an
investment with my fellow trustees in a private equity fund
that buys bad debt. The business principle of the private
equity fund is that they think that people have undervalued
this bad debt, that it is worth more than they were able to buy
it for, and they are going to make a profit off of that.
Let me just walk through some of the resources available
now for me to help make the decision as to whether or not that
is a good or bad decision for the people to whom I have a
fiduciary duty.
First of all, I assume that, on the basic level, if someone
were stealing from that fund, that a competent accountant would
find that; is that correct?
Mr. Hutcheson. Most of the time, embezzlement would be
discovered.
Chairman Andrews. Okay. Now, let's get beyond that to the
more common sort of problem. When I look at the financial
statement of this private equity fund, it is going to list on
it assets of the debts owned by, right? The debts owned by the
private equity fund are going to be listed as assets.
Who would do the valuation of those assets on that
financial statement?
Mr. Hutcheson. Well, there should be an independent audit
performed of the fund, and there could be depending on the
nature, where the debt came from. If the debt is from publicly
traded companies, which it could be in the underlying private
equity fund, you know, there should be a Sarbanes-Oxley----
Chairman Andrews. Let's assume it is bad real estate loans
that the fund has bought from banks.
Mr. Hutcheson. Well, the fund will hire an auditor--they
call them internal auditors--to perform an audit and to put
together the financial statement. We may not know what the
probability is----
Chairman Andrews. Would we know--and I don't ask this as an
accusatory question--if the auditor who did that audit, if it
was the first time he or she had ever evaluated bad debt, would
we know that?
Mr. Hutcheson. No. No, you would not know that.
Chairman Andrews. If they had done it a thousand times,
would we know that?
Mr. Hutcheson. No.
Chairman Andrews. Yeah. As my friend suggests, if we
asked--either you or Mr. Marco could answer this question--is
that the type of information that would typically be made
available if you asked for it?
Mr. Hutcheson. If it occurs to the fiduciary to ask that
question, which it should, they might share that with you. But
that is a question that most fiduciaries wouldn't--it wouldn't
occur to them to ask that question.
Chairman Andrews. What other documents might the fiduciary
rely upon to determine whether to buy into that fund, besides
the audited financial statement?
Mr. Hutcheson. Well, drilling down a little bit in greater
detail, the probability that the debts are actually going to be
paid off, and why they think that. There needs to be some type
of risk measurement tied to each one of the debt obligations,
so they are understanding what the nature of the debt is, what
the payment terms are, what the interest rates are. There is a
large variety of things that go into investigating such a
portfolio.
Chairman Andrews. Mr. Marco, in your work both acting as a
fiduciary and advising fiduciaries, if you were presented with
the hypothetical that I gave, what kind of due diligence would
you perform in order to either make the decision or give advice
about making the decision about that bad debt fund?
Mr. Marco. The first step is before it starts when you
evaluate whether you want to hire that investment manager to
manage those assets. The due diligence requires, what is the
process that you use to price the securities? Is there a
methodology? Are there outside independent auditors? Are you
applying FASB standards? All of these are questions you have to
ask before you start the investment.
And if the answers are to your satisfaction, if they are
complete, then afterwards it is asking the question when the
assets are--checking to make sure they are continuing to follow
their practices.
But it is the first step, requiring those things. And those
are the things I described as best practices. That is what a
good firm would do. And if they are doing it, then that is
fine. My view is that it ought to be required. It ought not to
be just someone saying--because, again, my argument is that if
we follow those and we recommend or select those funds that do
that kind of appropriate due diligence, we are comfortable. But
those that don't, that we don't recommend or don't use, they
move on to the next investor and they get their money because
they didn't ask the question, they didn't pursue it.
It is much more satisfactory--if they are required to
provide it right up front, then you will know. Because once the
investment is made, once you have given the money to the
investment manager and have that, you own it; now it is a
problem you have to deal with. So you avoid it up front if you
have the right procedure.
Chairman Andrews. Mr. Chambers, one of the problems you
noted in your testimony was about the date of the GAO report we
are talking about this morning. And in fairness to GAO,
obviously we haven't asked them to do anything since that time.
They were asked at that time to issue their report.
And I would want the record to show that, yeah, I think
that before any decisions could be made based on that report,
it would need to be updated rather considerably, given what has
happened since the report was written.
If we were to look at areas of inquiry that we think the
GAO should do to follow up on the work it did in 2008, what
kinds of questions do you think that we should ask them to look
at?
Mr. Chambers. Well, I think, to some extent, they have
updated their report. And I think that the result of the update
of their report is that, at least as I have glanced through it
last night, it had the--the recommendations and the findings
had not changed materially since the report in 2008.
I think that what they were doing is they were looking at,
again, process. They are not suggesting regulation, they are
not suggesting legislation. They are looking at process. They
are focusing on perhaps the Department of Labor coming out with
guidance, rather than regulation, on what types of best
practices are out there.
What I would suggest to Mr. Marco, in connection with his
last response, is what he perceives to be a best practice in
conjunction with a particular type of investment fund, it is
going to be very different, perhaps, than what Mr. Hutcheson's
best practice would be----
Chairman Andrews. Or yours.
Mr. Chambers [continuing]. Or mine, because, of course, I
don't have any. I am just a lawyer.
But I do think that the best practices are going to be very
complicated to create a definite, finite group of best
practices, because it is going to differ from investment to
investment. Some of them, of course, will overlap.
Chairman Andrews. Ms. Bovbjerg, what--and this will be my
last question--what do you think the logical next series of
questions we might ask would be that you could build on the
work that you have done?
Ms. Bovbjerg. I think it would be really useful to know
what is going on in the small plan universe, and that is a much
harder thing to uncover.
The concern that we had in doing this report, when we
talked with representatives of large plans, they had a strategy
and they understood what they needed to do and talked about the
challenges and how they were dealing with them--very competent
people who had thought about this a great deal.
What we see is an increase in plans of the large and medium
sizes going into hedge funds and private equity. What that
suggests is, likely, smaller plans will follow. And I don't
mean this in a pejorative way, but there is sort of a herd
mentality among plan investors. They don't want to be the
outlier, necessarily. And you could imagine a smaller plan
coming to the conclusion that they are not being a very good
fiduciary and they are not getting the returns that they should
be getting because they are not doing this, too. And they
really may not be capable of providing the kind of oversight
that is needed. So that was a concern we had.
And the work we did in the last couple of weeks, looking
forward to this hearing, looking at the data, suggested that
the trend continues. And work we have under way in another way
that touches on this doesn't, in any way, suggest that things
are materially different.
Chairman Andrews. I appreciate that.
I thank each of you.
And I would turn to Dr. Price for his questions.
Dr. Price. Thank you, Mr. Chairman.
I want to pick up where that discussion was leaving off.
Mr. Marco, the GAO report talks about some States that had
limited small plans to investment categories, small plans under
$250 million, for example, unable to invest in hedge funds or
private equity at a State level.
Is there merit to considering that at the Federal level?
Mr. Marco. I do think there is some merit in that.
The issue is this: Very small plans, it is a question of if
they have the wherewithal to hire the professionals to help
them do the work. Small plans, almost by definition, don't have
internal investment staff. So they don't have people, but they
can go outside and hire investment consulting firms to that
work for them.
Very small plans can't afford to do that, so they are left,
then, with individuals who may not be investment professionals
but fiduciaries of these plans to go out and make decisions on
very complex information, as I said, where disclosure is not
required, and even if it was, their level of handling it can be
very difficult.
Dr. Price. Mr. Hutcheson, do you agree with that, that
there is merit to having the Federal Government consider
limiting what small plans can do?
Mr. Hutcheson. I agree with Chairman Andrews that the
Federal Government probably should not go there, with respect
to limiting.
I think that the--Mr. Chambers said that perhaps some
guidance from the government on what would be required for
alternative investments would be appropriate. In the current
small-plan world, we have investment fiduciaries who get paid a
percentage of assets, so there is a small percentage that is
paid off the top that can be easily liquidated and paid to an
investment advisor. In the small-plan world, it becomes
difficult to have an investment advisor involved to monitor
because you can't just liquidate the alternative investment to
pay a fee. The small plan sponsor has to pay it out of their
own pocket. And so it becomes problematic to, number one, get
expertise in monitoring and evaluating.
However, I don't think that they should be limited. I think
that fiduciaries simply need to understand that the burden, the
due diligence burden and the monitoring burden, is significant
and it requires true expertise.
Dr. Price. Ms. Bovbjerg, you commented in response to the
chairman's question about what you might want to consider for a
new report. Given the recent passage of the reg reform bill and
the regulations that will certainly be forthcoming from the SEC
and elsewhere, would it not be wise for Congress and the
Department of Labor to wait until we see what other arms of the
Federal Government are going to do and require before issuing
any recommendations?
Ms. Bovbjerg. Well, we have never called for a requirement
that would limit the types of investments.
Dr. Price. No, I am just talking in, kind of, a different
umbrella. Just in terms of your report--the chairman asked you
about your report. Would it not be appropriate for us to wait
until we see what the SEC and others are doing in response to
the reg reform bill?
Ms. Bovbjerg. It is our hope that Labor and SEC will work
together as they consider these things. There is always that
difficulty of who is the investor. I mean, SEC is protecting
investors; Labor is protecting plan participants and sponsors.
We still believe that the Department of Labor should get
some guidance up there. In fact, I think that what Mr. Chambers
said about guidance that is available elsewhere could certainly
help them decide what to put on their Web site. It shouldn't be
that hard.
Dr. Price. Mr. Chambers, I would like to follow up with you
on the concerns about limiting investments and your thoughts on
Congress or the Federal Government, through a rule or
regulation, limiting the ability for funds to invest.
Mr. Chambers. Well, I would point out first that it seems
that Mr. Marco probably just precluded his own defined benefit
plan, if he has one, from investing in alternative investments,
from what he was saying, because I suspect it would not have,
at least in that example, $250 million.
And that is the point. It seems to me that there needs to
be individual choice that is to be exercised by fiduciaries. We
have a strategy for fiduciary rules that has been in existence
for quite some time. It continues to get tweaked periodically
through litigation and through court decisions.
But the reality is that there needs to be choice. And I
think that it is incumbent upon the Department of Labor to
provide guidance so that people understand what they are
getting into if they decide to embark on an investment regimen
that includes these types of investments.
I don't see that there is any basis whatsoever for
additional regulation or legislation in this field,
particularly as you were just asking, I think, Ms. Bovbjerg
about the fact that we are going to have a slew of information
that is coming out in conjunction with the Dodd-Frank bill.
And just one other point about that, which is that--and I
don't pretend to be a guru in conjunction with the Dodd-Frank
bill--but I would point out that, as I understand the
registration requirements in that bill, it is the advisor, not
the fund, that would be registered. There would certainly be
fund information that would need to be provided by those
registered advisors, as well as perhaps, if the SEC finds the
need, other advisors that are not registered.
But the most important thing is that that information is
supposed to be held confidential. And it seems to me that
Congress has just acted--well, shortly, when the ink dries, if
it is ever applied--has acted in a fashion that says, ``We
think that imparting this information is very important, but it
is to be imparted to the government for purposes of determining
risk. We understand that there is proprietary information that
we are probably going to be requesting. And if that proprietary
information is then handed out to the general public, we,
Congress, do not believe that that is the best way to handle
it.''
And I think what Mr. Marco and, to some extent, Mr.
Hutcheson are suggesting in their written testimony is that
there should be a requirement that a lot of that information,
which is proprietary, which is private, in fact, should be
disseminated to the general public. And that is contrary to
what Congress just decided.
Dr. Price. Thank you.
Thank you, Mr. Chairman.
Chairman Andrews. The chair recognizes Mr. Kildee for 5
minutes.
Mr. Kildee. Thank you, Mr. Chairman.
Mr. Chairman, I have served on this subcommittee now for 34
years. It was called a task force at the beginning, with Frank
Thompson as the chairman, and then the task force was folded
into the committee. And Frank used to say at that time that
there was only one person in Washington who understood ERISA,
and that was Phyllis Borzi. And I think probably the number has
grown since then. But it was a very complex bill, and we were
trying to address a problem that existed out there.
I want to commend you, Mr. Chairman. I have served with a
lot of chairmen, and I have found none better than you, both in
head and heart, because you really believe in the importance of
this bill.
I would like to ask a question, address it to Ms. Bovbjerg,
and if the others want to answer. It is a very generic
question: If any, what is the most significant change or
changes we could make to help improve accounting transparency
for pensions?
Ms. Bovbjerg. I am actually sitting before the subcommittee
and thinking about fees. It is difficult for me to think about
disclosure and pensions without thinking about 401(k) fees. I
know that is not really your question.
When I think about what fiduciaries need to deal with, it
is a very difficult job, and I salute you. I think they need
all the information they can get. That said, I think it is
important to try to balance the costs versus the benefits of
getting that information. So if there were to be, you know,
more audited information, you would have to think about what it
would take to get that.
I just did want to point out, though, that in our work, the
plans that we contacted--so these are medium and large plans--
virtually all dealt only with registered advisors for their
investments in hedge funds and private equity.
Mr. Kildee. Anyone else want to comment?
Mr. Hutcheson. Yes. Thank you very much.
In my written testimony, I think there are four practical
ways to enhance accounting transparency. The first one that I
mentioned is requiring audit of internal controls. And that is
normally associated with the Sarbanes auditing.
And, you know, early on, that was a significant burden to
publicly traded companies. But, you know, it has been 10 years
since--we are approaching 10 years since Sarbanes came into
effect. And it is a lot easier these days to get an audit of
internal controls. So, for example, a hedge fund could obtain a
Sarbanes-like audit of internal controls without it become a
burden to the hedge fund.
And I do agree with Mr. Chambers. You know, the allure of
the private equity and hedge funds is that there are some
proprietary methodologies and knowledge and systems that these
managers use. And if that got into the public, it would kind of
render their business model--it would injure it. And so I think
that there is a way to apply the audit of the internal controls
without it becoming public, like it is with publicly traded
companies.
So, you know, I am not opposed at all to that line of
thinking. That is the whole idea of having private equity and
hedge funds available, is their proprietary methods.
The second one is the financial statements. They are not
easy to understand. We need a summary in plain English that
says, ``This is what this financial statement means.''
Enterprise risk management skills, that should be the
hallmark of every hedge fund manager and private equity fund
manager. These are the risk-management skills that we are
trying to deploy here. If we can't avoid it, we need to reduce
it. If we can't reduce it, we need to spread it out and
diversify it, or perhaps accept it. But there needs to be
skills in managing that.
And the last one is the fair valuation standards. The
problem, currently, with the fair valuation standards and FASB
is trying to bring those into a more consolidated, tight
definition. But hedge fund managers and private equity managers
are able to give the CPA who is performing the audit internally
and preparing the financial statements variables, which are
called unobservable inputs.
These are the inputs that we believe will make sense to an
investor and give them the information they want to invest in
this fund, and then the auditor assigns the value of the fund.
Well, the problem with that is there could be three or four
different unobservable inputs that could materially change the
value. And so those unobservable inputs--they are unobservable,
hence they are not transparent to fiduciaries who need to make
the decisions. We need to know what those variables are. In
other words, if input A is used and the fair market value is X,
what would the impact be if we use input B or C? How would that
change the fair market value? I think we need to know those
things.
Mr. Kildee. Thank you.
Thank you very much, Mr. Chairman.
Chairman Andrews. I thank my friend for the very nice
compliment as well. The chair recognizes the ranking member of
the full committee, the organic farmer from Minnesota, Mr.
Kline.
Mr. Kline. Thank you, Mr. Chairman, and thank you to the
witnesses. And, Mr. Chairman, I want to congratulate you on yet
again finding a witness from Cornell Law School, thus
strengthening the bonds of the Cornell Law School Alumni
Association.
Chairman Andrews. I think she is actually not from the law
school. We are diversifying our witness list. She is from the
master's program. This is entirely different.
Mr. Kline. This is entirely different. I take it back. I
take my congratulations back.
I want to sort of pick up on some of the things that Mr.
Price was asking about and the chairman addressed, and that was
the issue of the timing of the 2008 GAO report, the subsequent
additions and modifications that Mr. Chambers was reading last
night, and the comments that a couple of you have made about
the financial reg bill, the Dodd-Frank bill. It is my
understanding that we are in for a blizzard of
rulemakings--some hundreds and hundreds from the health
care bill that still aren't done yet, and I have been told over
300 from the Dodd-Frank bill.
And so the sort of general question is--and it is to
anybody who--Mr. Chambers said he is not the guru of this
legislation--but anybody who has some idea of what the impact
will be in this very area. I mean we have been calling for the
Department of Labor to put up guidance and not regulations, as
I understand the discussion here. But, nevertheless, it seems
to me, and that is what I am asking you, that there could be
some serious changes that come into effect when this rulemaking
process moves toward its conclusion, and it might affect
guidance and regulation and everything else.
So anybody, guru or not, who has an opinion on this, I
would like to hear from you.
Mr. Marco. I am not sure what rules will be covered but I
think the issue of disclosure--and I would like to differ with
some of the comments that were made earlier--I think the idea
of saying to an investor, ``Invest in this fund of hedge funds.
I can't tell you what I am doing and I can't tell you what I am
holding, because that is proprietary. Just trust me. But you
invest in this and that is fine. I am not going to tell you,
and I can't tell you.'' This is nonsense. No one would do that
in their right mind. There has to be some kind of supervision
of what it is you are buying, what it is you are investing in.
For us, it is not a problem. As the fiduciary for the clients
that we serve, we demand that disclosure, and we get it. We
also sign----
Mr. Kline. If I could interrupt, I take your point. But
what I am getting at is do we think Dodd-Frank, with its
hundreds of new rules and regulations, is going to affect any
of your practices or any of the processes that are underway now
that might affect whatever guidance the Department of Labor
would put out? And so that is what I am looking at.
Mr. Chambers.
Mr. Chambers. There is a tremendous amount of discretion
that has been afforded to the SEC under the bill, as I
understand it. And, therefore, I think it is somewhat difficult
to say, well, clearly we are going to have guidance on this
field or we are going to have--we are going to recognize a
requirement to provide this sort of information, but I do think
that some of the things that will happen as a result of this in
connection with hedge funds--and it is not even sure to the
extent to which they are going to cover private equity--but
with regard to hedge funds is that the larger hedge funds, of
course, will be providing a pretty significant amount of
information, I expect, to the government. The government will
be assessing that in conjunction with in particular the risk
element of what it is that those organizations are doing, as
well as working with outside accountants and things like that.
I personally believe that because a number of the
exemptions from registration that have existed in the past are
being changed or eliminated, I think a lot of this is going to
move offshore. I think that what you are going to find is that,
under this bill, there are a number of organizations that
provide access to investments like this which are going to try
to avoid the registration and other things. They are going to
limit the amount of assets they have under management and they
are going to move offshore. They are going to remain small.
I guess the one point that I would make tough to Mr. Marco
is that I think it is disingenuous to expect that there is
going to be a tremendous or that there could be a tremendous
amount of information regarding these private companies to be
disseminated and to be updated and to have those organizations
be able basically to afford to provide that kind of
information.
Finally, if I may, finally, there is a very simple
response: Don't invest in anything where you feel that there is
not sufficient information. This is the tail wagging the dog.
Don't invest in something if you feel that the information is
incorrect or that it is insufficient. That is what we do with
regard to investments in things where there is public
disclosure. Don't invest. That is what they are hiring you for.
Mr. Kline. Thank you. I see the red light is on. I think
that confirmed my suspicion that we have got a lot of rules
coming and we don't know what they are going to do. So thank
you very much.
I yield back, Mr. Chairman.
Chairman Andrews. The gentlelady from Ohio, Ms. Fudge, is
recognized for 5 minutes.
Ms. Fudge. Thank you all for being here. My first question
is initially directed to Mr. Chambers and anyone else is free
to answer. I just want to be clear or ask if you are suggesting
or if you believe that setting fiduciary standards for hedge
fund managers will impede their ability to manage their funds.
Mr. Chambers. I may have missed the middle part of your
question. If we create responsibilities for hedge fund
managers?
Ms. Fudge. If we create standards, which is what we are
talking about to some degree, do you believe that that is an
impediment for them to manage their funds, just by creating the
standard?
Mr. Chambers. I think in large part, yes.
Ms. Fudge. Why is that?
Mr. Chambers. As I have indicated, I think that a lot of
the information that could be requested and disseminated to the
public rather than kept at the government level, as it would be
under the Dodd-Frank bill, is information that could be
proprietary and it therefore could have an adverse impact on
how they run their fund.
Secondly, I think that depending upon how much information
is required, as anyone who has ever worked with a public
company or who has worked with a registered investment kind of
arrangement understands, there is a significant cost that is
going to be associated with creating that kind of information
and keeping it updated. Those are just two out of many reasons
why.
Ms. Fudge. So do you believe that there should not be
standards for hedge fund managers?
Mr. Chambers. I think that hedge fund managers, like people
who operate and own any private business, do have a certain
sense of standards that they need to owe to
shareholders, that they need to owe to their employees, and
we have existing laws that provide those standards. What I am
suggesting here is that with regard to--and that is with regard
to any organization that is not publicly--where there is no
public market. If an organization is going to have a public
market, if it is going to hold it itself out as being an
investment-grade opportunity for the general public, then yes,
there are additional standards that we as a government have
imposed over the years. Those standards have never in the past
been extended to private industry that is not out there seeking
public investment.
Ms. Fudge. My second question, and to any of the members of
the panel, but particularly for Mr. Hutcheson. Without
additional disclosure, do pension plan managers understand the
risks involved in investing in hedge funds and private equity
funds? And I guess probably maybe put a different way, is it
useful information or is it just more information?
Mr. Hutcheson. Excellent question. To clarify this
discussion about whether proprietary information should be
shared or whether the risks are understood, I think the key to
all of this, and I think it is very, very important, a
fiduciary has to know what is going on in the fund. So to
clarify my prior statement, I am not suggesting that
alternative investments need to have all their proprietary
information shared with the public. Does it need to be shared
with the fiduciaries? Absolutely. There is no question about
it.
I think Mr. Chambers isn't suggesting that information be
withheld from fiduciaries. Otherwise, they can't make a good
decision.
But the thing that is more important, the hallmark of any
investment, is the concept of expected return. A lot of people
get nervous when they hear that, but unless an investor, like a
trustee of a pension plan, can expect a favorable outcome from
the investment of their capital over a specific period of time
or a long time horizon, they can't really determine what the
merits are of that particular investment. And so we talk about
all the time: ``what are the risks, what are the risks, what
are the risks?'' Well, that is fine, but I need to know what
the expected outcome or expected return, which is really, truly
the hallmark of investing. If you can't expect a favorable
outcome, the markets, whether they be private or public, will
come to a screeching halt because the flow of capital will
stop.
I mean, are you going to give your capital to somebody if
you can't expect something favorable to happen? No. You won't
do it. Nobody else will either. So the real issue is what are
the expected returns. And then, when you evaluate the expected
returns, you have to balance that out with what are the
expected risks. And that requires a lot of information.
The four elements that I talked about earlier I believe are
the foundation for disclosing what a fiduciary needs to know
and understand about expected return and expected risks. And so
to tie all this together, at the end of the day it is the
fiduciary who has to make the decision. I don't think the
government needs to make those decisions. The fiduciary has to
make the decision. But they have to be informed and they have
to understand before they can make that decision. That requires
knowledge and disclosure. And so I envision that taking place
between a hedge fund manager and the fiduciary in an office.
They are talking about it. Things are disclosed to the
fiduciary and the fiduciary can consider it, but I am not
necessarily in favor of broad distribution of information. If
the fiduciary wants it, they can get it. And if they can't get
it, move on.
Ms. Fudge. Thank you very much, Mr. Chairman.
Chairman Andrews. Thank you. The gentleman from Oregon, Mr.
Wu, if he chooses to be recognized.
Very well.
We would like to thank the witnesses and the members of the
committee for their diligence today, and I would return to the
gentleman from Georgia for any concluding remarks he would like
to offer.
Dr. Price. Thank you, Mr. Chairman. I think this has been
helpful. The information that has been provided to the
committee I think will allow us to hopefully step back and take
a deep breath, wait on the SEC and, as my senior member Mr.
Kline said, the blizzard of regulations and rules that will be
forthcoming and see where we are at that point. But I think
this has been helpful. Transparency is important. There is no
doubt about it. However, limiting individuals' opportunities
and options in terms of investing the way that they believe to
be most appropriate for themselves is, I think, something that
is anathema to our system. If we move down that road, then I
fear that we continue to move down the road that changes the
very fabric of our Nation. And I am hopeful that we do not
continue in that vein.
So, Mr. Chairman, I appreciate the opportunity. I would ask
unanimous consent that included in this hearing record be an
article from the Wall Street Journal earlier this week,
Congress Overhauls Your Portfolio.
Chairman Andrews. Without objection.
[The information follows:]
[From the Wall Street Journal]
Congress Overhauls Your Portfolio
Hidden in Washington's Historic Finance Bill Are Major New Rules
Affecting Nearly Every Corner of the Investing World
By Eleanor Laise
With all the talk of ``systemic risk'' and ``too big to fail,''
small investors might assume that the landmark Dodd-Frank financial
overhaul bill has little bearing on their portfolios.
They would be wrong.
Buried in the bill's 800-odd pages are the most sweeping regulatory
changes for ordinary investors in decades, affecting everything from
mutual funds and retirement plans to single-stock investments and other
holdings.
The legislation has the potential to make brokers more accountable
to their clients, shine light on hedge funds and improve the
transparency of the complex derivatives on which many mutual funds and
pension plans rely to hedge their risks.
Several provisions promise to give investors a louder voice in
policy-making circles and corporate boardrooms. Within the Securities
and Exchange Commission, for example, the bill sets up an Office of the
Investor Advocate designed specifically to assist retail investors, and
the Investor Advisory Committee, which focuses on initiatives to
protect investors' interest. And the bill gives the SEC authority to
make it easier for shareholders to nominate directors for corporate
boards.
Taken as a whole, the legislation not only ``lays the groundwork
for significant improvements'' in investor protection and disclosure,
but also gives investors ``a greater voice in the policies that affect
their interests,'' says Barbara Roper, director of investor protection
at the Consumer Federation of America.
Yet despite its hefty dose of investor-protection provisions, the
legislation isn't a home run for small investors, analysts and investor
advocates say. So-called stable-value funds, popular investments among
the most conservative 401(k) participants because they are designed to
deliver smooth, steady returns, are left in limbo, awaiting regulatory
decisions that could affect their costs and availability in retirement
plans.
Likewise, while investor advocates had pushed aggressively for the
SEC to oversee ``equity-indexed annuities,'' these complex products
escaped the agency's purview.
What's more, the bill's full effects on small investors likely
won't be known for some time. Many provisions call for regulators
merely to study certain issues or give them the power, but not the
obligation, to make certain rule changes.
But in the meantime, investors can prepare for some significant
changes in their mutual funds, hedge funds, retirement plans, brokerage
accounts and single-stock holdings. Here are the important factors to
watch:
Mutual Funds
Though mutual funds are barely mentioned in the Dodd-Frank bill,
the legislation could affect everything from funds' bond and
derivatives holdings to how these products are advertised to investors.
For bond funds, the bill creates some uncertainty and could even
boost volatility in certain types of holdings, managers and analysts
say. That is because it gives the Federal Deposit Insurance Corp.,
which can seize troubled financial institutions, leeway to pay
investors holding identical bonds issued by that institution differing
amounts. If investors aren't sure how they will be treated in such a
scenario, they may demand higher yields, which means lower bond prices,
or dump the bonds at the first sign of trouble, money managers say.
The provision ``can have all sorts of unintended effects,'' says
Bob Auwaerter, head of fixed income at mutual-fund firm Vanguard Group.
If mutual funds are trying to sell bonds as the issuer tumbles toward
default, the potential for unequal treatment of bondholders ``will
reduce liquidity and lower the price,'' Mr. Auwaerter says.
One little-noticed provision in the bill could be critical for
mutual-fund investors prone to poor market-timing decisions. It calls
for the Comptroller General to study mutual-fund advertising, including
the use of past performance data, and recommend ways to improve
investor safeguards. Academic research suggests that ``short-term
performance ads really do drive investor dollars, and unfortunately not
in a good way,'' says Ryan Leggio, fund analyst at investment-research
firm Morningstar Inc. ``Those usually lead investors to the hot fund of
the month or the year.''
Retirement Plans
Stable-value funds, the most conservative investments in many
401(k) plans, are left in a regulatory gray zone.
These funds typically consist of a diversified bond portfolio and
bank or insurance-company ``wrap'' contracts, which allow investors to
trade in and out at a relatively steady value. As the bill was being
hammered out, the stable-value industry lobbied hard to keep these wrap
contracts from being categorized as ``swaps,'' a type of derivative
subject to a slew of new rules. Instead of making a final decision,
lawmakers called for regulators to study the issue within 15 months.
A swap designation would make stable-value wrap contracts more
complex to issue and more costly, stable-value experts say, ultimately
dragging down 401(k) participants' returns. That outcome ``would have
an immediate and very troubling effect on 401(k) plans across the
country,'' says Kent Mason, partner at Davis & Harman LLP and outside
counsel to the American Benefits Council. The regulatory uncertainty
itself could potentially make issuers more hesitant to offer the
contracts, he says.
Stable-value contracts are in short supply already, since issuers
became more reluctant to offer them in the wake of the financial
crisis. But since demand for the contracts remains strong, fees for
these wraps have increased significantly.
Hedge Funds and Other Private Investments
The Dodd-Frank legislation helps to push hedge funds out of the
shadows.
Funds with more than $150 million in assets generally must register
with the SEC as investment advisers. For registered firms, investors
can get some basic information about their business activities,
employees and disciplinary history through the public SEC website,
adviserinfo.sec.gov.
Some investor advocates hope that, with more firms registering,
regulators also will deliver a long-promised overhaul of registered
advisers' required public disclosures. In a May speech, SEC Chairman
Mary Schapiro said the Commission is preparing to require ``a plain
English narrative discussion of an adviser's conflicts, compensation,
business activities and disciplinary history.''
While many larger hedge funds already have registered with the SEC,
the new requirement will likely boost operating costs for smaller funds
not yet registered. Many of these funds are already struggling to raise
money, and may consider closing down or raising fees they charge
investors. ``Clearly there is a group of managers who will never get
off the ground,'' says Nathan Greene, a partner in the asset-management
group at law firm Shearman & Sterling LLP.
The bill also raises the bar for individuals to qualify as
``accredited investors,'' a basic threshold for buying private
investments. These investors must now have $1 million excluding the
value of their primary residence, whereas the old standard was simply a
$1 million net worth.
Individual Stocks
The Dodd-Frank bill will likely give shareholders, including small
investors and mutual funds, a louder voice in corporate boardrooms.
The bill confers authority on the SEC to allow shareholders access
to corporate proxies to nominate directors. ``Major shareholders with
long-term interests in the company are going to be able to hold
management accountable,'' the Consumer Federation's Ms. Roper says.
There isn't any guarantee, however, that larger shareholders will
make much use of this perk. ``I can't be bothered with trying to find
the right people to put on the board,'' says Albert Meyer, co-manager
of Mirzam Capital Appreciation Fund. ``Personally I would sell a
company's stock if I thought the board was inept.''
Under the bill, shareholders also get a ``say on pay,'' meaning a
nonbinding vote on public companies' executive compensation. Such a
vote ``is an important component of monitoring executive
compensation,'' says Jim Hamilton, an analyst at financial-information
provider Wolters Kluwer. Though the vote is nonbinding, a ``no'' vote
by shareholders would likely force management to respond in some way
and can still have a beneficial effect, he says.
Derivatives
While many small investors avoid dabbling directly in derivatives,
mutual funds, exchange-traded funds and pension plans use them
extensively. Money managers, for example, use these complex financial
contracts to boost exposure to particular market segments or hedge
risks such as interest-rate and currency changes.
The bill should help cut risks in funds holding derivatives. It
calls for many types of derivatives to be exchange-traded and
``cleared,'' meaning trades are routed through a central clearinghouse
that covers losses if a party to the trade blows up. It also requires
many derivatives traders to post ``margin,'' so they will have cash on
hand to pay other parties if their bet goes awry.
Funds, and their shareholders, may pay a price for such safeguards.
While exchange trading should improve pricing, all the new rules also
could boost some costs of derivatives trading, managers and analysts
say.
The upshot: Since derivatives are here to stay in mutual funds,
``portfolio managers will grin and bear it, and it will be some
incremental drag on the overall performance'' of funds, Mr. Greene
says.
What's more, it is doubtful the new provisions would have prevented
all the derivatives-related mutual-fund blow-ups of the financial
crisis, analysts say. Oppenheimer Champion Income, a high-yield bond
fund, dropped nearly 80% in 2008, partly because of derivatives tied to
commercial mortgage-backed securities. Exchange trading won't stop such
disasters.
Brokerage Accounts
The bill gives the SEC authority to impose the same standard of
``fiduciary'' duty on brokers that currently applies to investment
advisers. That would mean that brokers must provide advice that is in
clients' best interest, whereas currently they are required only to
recommend investments that are suitable for customers.
The SEC must first study the issue and deliver a report to
Congress. But given that Ms. Schapiro, the SEC chairman, has voiced
support for such a measure, investor advocates are optimistic that
regulators will follow through.
The bill also authorizes the SEC to limit or prohibit the mandatory
predispute arbitration clauses that apply to many brokerage accounts.
Such clauses force brokerage customers to take any disputes that might
arise with their broker before arbitration panels, which critics claim
often favor the brokerage industry, rather than taking their claims to
court.
Since taking your broker to court can be costly and time-consuming,
investor advocates say, the best outcome for investors would be to have
access to both arbitration and the courts. ``You need to give the party
with the least power, the investor, the right to choose,'' the Consumer
Federation's Ms. Roper says.
Gregory Zuckerman contributed to this article. Write to Eleanor
Laise at eleanor.laise@wsj.com.
______
Dr. Price. Thank you.
Chairman Andrews. The gentleman from Oregon said he would
like to ask a question. I am going to permit that. Frankly, Dr.
Price, if you would like to follow up on that, you will have
that opportunity before we close. The gentleman from Oregon is
recognized for 5 minutes.
Mr. Wu. Thank you very much, Mr. Chairman. I just have one
question. This hearing is focused on transparency. Most of our
Federal securities laws--most--are based on disclosure. There
are some substantive constraints in Federal securities law and
State blue sky laws are more based on substantive constraints.
I would like to hear the witnesses talk just for a second about
whether each of you feels that the disclosure and transparency
mechanisms are, in and of themselves, completely adequate, or
whether there is a significant role for some substantive
constraints. I would view, for example, margin limits as one
example. I am sort of remembering it as the uptick rule for
certain types of sales, whether some substantive constraints
are also necessary because it may be the case that transparency
alone is not enough; that the market may not be fast enough
and, quite frankly, there are some things that are so complex
that even a very sophisticated investor may not be able to
understand exactly what is going on even when fully disclosed
or certainly not in a sufficiently timely manner to react to
market conditions.
I would like, to the extent that you all have any comments
on that, I would be very interested in your comments.
Mr. Marco. First, I would say that disclosure does so much
of getting you along that path so that the investor knows what
it is and how risky and how much leverage is going to be an
investment. All of the things I have talked about today, to
correct some of the other comments, are being done today. They
are best practices of managers who are doing it. I am not
suggesting inventing something new. There is an organization
called Institution of Limited Partners Association with
hundreds of members who have agreed to these best practices. So
it is not like asking people to do something that is a burden--
this is what the best investment firms do.
Now, to your point when they disclose and the investor can
see the amount of risk taken, it will give people pause and
perhaps choose not to be invested in one of these things. If
they can get the information to know what it is they are doing,
they may choose not to.
I think down the road there may be some room to say that
there may be some limitations on the kind of things that these
investment vehicles can do. I sort of suspect that the reason
that the SEC hasn't done a lot in this area is because, to a
large extent, they don't understand them. They don't have the
staff of professionals that understand all the complex things
that are going on within these hedge funds, and as they start
to learn more, they may say, well, there is a limit to how much
leverage we can do--someone could put on something. But,
unfortunately, to deal with hedge funds is, by their nature,
they are very complex and they are trading in very complex ways
and leveraged, which makes them very risky, which says, first
of all, the investors ought to know what the heck they are
getting into when they purchase--when they use these investment
managers to make these bets. But then, for someone to come in
and say, okay, in doing these complex strategies, only 2
percent of this and 5 percent of that, gets to be pretty
difficult. I am not exactly sure how--I am sure there are some
areas that could be done, but I think you get much further down
the road by saying, explain what it is you are doing, give
detailed information to fiduciaries, not published in the
public record, but to the supervising fiduciary to say, this is
what we are doing, show us your position, show us your
leverage, so we can understand what you are doing, gets you a
long way to helping fiduciaries handle these kind of assets
rather than have to set borders on the individuals.
Mr. Wu. Just following up on that, there may be, in your
view, some mechanisms which are so inherently risky that once
understood by the SEC staff, that one may choose as a matter of
public policy to take that mechanism out of the tool box
because they are inherently too risky?
Mr. Marco. That is possible.
Mr. Hutcheson. If I may also just comment. One thing that
comes to mind is naked short selling. Not only--I think that
that shouldn't exist within qualified retirement plans, number
one, because of the risk that it creates not only for the plan
but also as a systemic risk. Failed naked short sales create a
systemic problem that affects other hedge funds, other pension
plans.
So when you said is there something of substance that you
would limit, I would say, if a plan is considering a hedge fund
or some type of investment philosophy, I would personally ban
naked short selling. I won't buy knowingly anything that has
exposure to failed short sales or other systemic risks like
that.
Mr. Chambers. May I just take one moment? Congressman, I
think that your question requires taking a step back because it
is not just a matter of deciding what needs to be restricted, I
think it is a question of weighing the rights of people who are
putting together a particular type of investment and the rights
of people who are thinking about investing in that investment.
And as I mentioned earlier, and I think you were not here at
the time, if you are going to be making public opportunities
available, then I think, as a matter of public policy, yes,
there is a lot of information that needs to be required. On the
other hand, most, not all, but most of these private equity
funds and certainly hedge funds are private arrangements. They
are contracts between investors who want to find out as much as
they can about those investments and the people who put the
investments together, the managers or the advisers, who decide
how much information they wish to provide and how much they do
not. And I think that the weighing of this now is: Are you
going to be taking what is now available only in conjunction or
required only in conjunction with public investments, publicly
traded investments, and are you going to be making some of that
required for private industry? And that is an enormous step.
And the question is, as I mentioned earlier, isn't the answer
to this that someone is willing to give this amount of
information, and if the person is not willing to make an
investment based upon that information, they don't have to make
the investment. Why is it that DB plan fiduciaries should have
a right that perhaps is greater than investors who are
investing for themselves or who are investing for college
endowments. These are willing buyers and willing sellers, and I
think that what you are asking is that we might be interested
in making some of these disclosure requirements much further
downstream than we have ever considered doing before.
Mr. Wu. Well, there are some open--there are some
transactions that folks might be openly going into that we
banned for other reasons. We don't permit someone to sell
themselves into slavery or to do a murder contract. Those are
extreme examples, but in all the market or the transactions
that you are talking about, whether in an open market or not,
they have, by their nature, some impact on folks who are not
parties.
Chairman Andrews. The gentleman's time has expired.
Dr. Price, if there is any closing.
I will, again, thank the witnesses and members of the
committee.
When the discussion that Mr. Hutcheson theorized takes
place in an office where a fiduciary for a defined benefit plan
or the representative of fiduciaries is meeting with the
representative of a hedge fund or private equity fund and
discussing whether or not to make an investment, obviously the
people who have received the pension from that fund have a
vital stake in that discussion. But there is also a silent
partner in any one of those discussions, and one way or another
it is the taxpayers of the United States because of the PBGC
and the role the taxpayers, I think, ultimately have in
standing behind the PBGC.
In my mind, this leads to one conclusion and then a series
of questions. As I said at the outset of the hearing, I do not
embrace the proposition that protecting the taxpayers requires
precluding investment in these classes of assets. I think the
opposite is true. I think that a fiduciary who diversifies is a
more prudent fiduciary than one who doesn't. So I think making
these classes of assets fully available to defined benefit
plans ensured by the PBGC is entirely appropriate, and I would
not favor anything that restricts that.
The series of questions that are raised though are: Do
these decisions take place in a context of adequate or
desirable transparency? Do the fiduciaries have access to
comprehensive, relevant, real-time information to help them
make these decisions. I don't know the answer to that question.
I think that is a question that ought to be looked at.
To the extent that there is not; to the extent that there
is not access to relevant, adequate, real-time information,
what conditions might create the environment where that is the
case?
Clearly, a pension fund with a robust balance sheet is in a
market position to demand such access or not make the
investment. And I do think that is the most powerful way to
avoid this problem, the most powerful antiseptic to any toxin
that might exist. The question becomes what, if any, steps are
appropriate for us to take to create that environment. These
steps range from perhaps simply making more education more
available to more fiduciaries on a basis of education, ranging
all the way from there to legal changes that would require such
disclosures.
I find myself this morning in a position that is agnostic
on that question. I think before one answers the question of
whether the law should require more disclosure, we have to get
to the issue as to whether disclosure is adequate or inadequate
in the first place. I would hope that the committee would
pursue that question, again not so that we might necessarily
lead to a legislative proposal or a regulatory one, but so that
we can assure that the best quality of transparency is
available in every one of these transactions.
Sort of an implicit answer to Mr. Chambers' argument, which
I think he makes very persuasively, the reason that that
defined benefit plan trustee may have some right that is prior
to some of the other investors that you mentioned in your last
comments is that the taxpayers are underwriting that decision
in a way they are not in at least some of the others that you
mentioned. So there is a public interest here in trying to
prevent yet another bailout, yet another financial disaster the
taxpayers of this country would be called upon to address.
I think that the defined benefit system is a success, and I
think the record will show that investments in alternative
investments have been a success, by and large. I think that the
last thing in the world that we want to do is micromanage
fiduciary decisionmakers around this country. What we want to
do is create an environment where those fiduciary
decisionmakers have adequate access to adequate, relevant,
real-time information so they may do their job and be held to
the high standard to which the law holds them today.
You, ladies and gentlemen, have given us much food for
thought. You have given us a lot of excellent information. I am
sure that we will be calling upon you again as we deliberate on
this and other issues.
Without any further ado, without objection, the Members
will have 14 days to submit additional materials or questions
for the hearing record.
Without objection, the hearing is adjourned.
[Additional submission of Mr. Kucinich follows:]
[From the New York Times, July 17, 2010]
A.I.G. to Pay $725 Million in Ohio Case
By Michael Powell and Mary Williams Walsh
The American International Group, once the nation's largest
insurance group before it nearly collapsed in 2008, has agreed to pay
$725 million to three Ohio pension funds to settle six-year-old claims
of accounting fraud, stock manipulation and bid-rigging.
Taken together with earlier settlements, A.I.G. will ladle out more
than $1 billion to Ohio investors, money that will go to firefighters,
teachers, librarians and other pensioners. The state's attorney
general, Richard Cordray, said Friday, that it was the 10th largest
securities class-action settlement in United States history.
``No privileged few are entitled to play by different rules than
the rest of us,'' Mr. Cordray said during a news conference. ``Ohio is
determined to send a strong message to the marketplace that companies
who don't play by the rules will pay a steep price.''
A.I.G. disclosed the terms of the settlement in a filing with the
Securities and Exchange Commission.
How A.I.G. will pay for this settlement is an open question. It has
agreed to a two-step payment, in no small part to give it time to
figure out how to raise the money.
Executives are well aware that taxpayers and legislators would cry
foul if it paid the lawsuit with any portion of the $22 billion in
federal rescue money still available from the United States Treasury.
Instead, the company intends to pay $175 million within 10 days of
court approval of its settlement. It plans to raise $550 million
through a stock offering in the spring of 2011. That prospect struck
some market analysts as a long shot.
``There's still a lot of question marks hanging over A.I.G.,'' said
Chris Whalen, a co-founder of Institutional Risk Analytics, a research
firm. ``How would you write a prospectus for it?
``The document,'' he said, ``would be quite appalling when it
described the risks.''
A.I.G.'s former chief executive, Maurice R. Greenberg, and other
executives agreed to pay $115 million in an earlier settlement with
Ohio, which filed its lawsuit in 2004.
State attorneys general often have proved more aggressive than
federal regulators in going after financial houses in the wake of the
2008 crisis. And A.I.G. could face new legal headaches. For instance
New York's attorney general, Andrew M. Cuomo, has stepped up his
investigation of the company in the last few weeks, according to a
person with direct knowledge of the case.
The Ohio settlement allows ``A.I.G. to continue to focus its
efforts on paying back taxpayers and restoring the value of our
franchise,'' Mark Herr, a company spokesman, said in a news release.
The Ohio case was filed on behalf of pension funds in the state
that had suffered significant losses in their holdings of A.I.G. when
its share price plummeted after it restated results for years before
2004. Those restatements followed an investigation by Eliot L. Spitzer,
Mr. Cuomo's predecessor, into accounting irregularities at the company
and the subsequent resignation of Mr. Greenberg.
But the company faces a long and uncertain road, say Wall Street
analysts.
Its stock, after adjusting for a reverse split, once traded at
$1,446.80 a share; it stands now at $35.64.
A.I.G. has become the definition of turmoil. Its chairman resigned
this week after a fierce feud with the chief executive, who has
referred dismissively to ``all those crazies down in Washington.''
Those crazies presumably include the federal government, which over
the last two years gave A.I.G. the largest bailout in United States
history, making $182 billion available to the company.
And the company's proposed stock offering next year is rife with
uncertainties. Such an offering would by definition dilute the value of
the government's holdings.
A.I.G. has struggled of late to sell off subsidiaries to repay the
Federal Reserve Bank of New York. This year the company failed in its
attempts to turn its Asian life insurance subsidiary over to Prudential
of Britain. This week the company's directors voted to proceed with an
initial public offering of the same subsidiary, with the proceeds
intended for the Federal Reserve.
Should the company fail to raise the $550 million, Ohio has the
right to resume its litigation.
The fall of the world's largest insurance company began in the
autumn of 2008, when a sudden downgrade in its credit worthiness set
off something like a bank run. It turned out that the company had sold
questionable derivatives that were used to prop up the portfolios of
other financial institutions.
Federal officials moved quickly to bail out the company, fearing
that if A.I.G. toppled, dozens of financial institutions would quickly
fall as well. Havoc seemed in the offing.
Federal investigators have since examined many aspects of the
company's behavior, even convening a grand jury in New York. But they
have never brought charges against the company or its top officials.
``The states are too often the only ones to watch out for this
misconduct,'' Mr. Cordray said Friday. ``For years, people have been
asleep at the switch.''
______
[Additional submission of Dr. Price follows:]
Prepared Statement of Richard H. Baker, President and
Chief Executive Officer, Managed Funds Association
Managed Funds Association (``MFA'') is pleased to provide this
statement in connection with the House Subcommittee on Health,
Employment, Labor, and Pensions hearing, ``Creating Greater Accounting
Transparency for Pensioners'' held on July 20, 2010. MFA is the voice
of the global alternative investment industry. Its members are
professionals in hedge funds, funds of funds and managed futures funds,
as well as industry service providers. Established in 1991, MFA is the
primary source of information for policy makers and the media and the
leading advocate for sound business practices and industry growth. MFA
members include the vast majority of the largest hedge fund groups in
the world who manage a substantial portion of the approximately $1.5
trillion invested in absolute return strategies.
MFA appreciates the opportunity to express its views on the
benefits that hedge funds provide with respect to pension plans and the
beneficiaries of those plans and the legal requirements that must be
met before a pension plan can invest in hedge funds.
Before doing so, I believe it is important to underscore the
comprehensive and robust nature of the regulatory framework that
applies to hedge funds and their advisers now that the Dodd-Frank Wall
Street Reform and Consumer Protection Act has been enacted. All hedge
fund advisers of meaningful size must register with the SEC under the
Investment Advisers Act of 1940 (the ``Advisers Act''). The
responsibilities imposed on hedge fund advisers by the Advisers Act
entail significant disclosure and compliance requirements, including:
publicly available disclosure to the SEC regarding the adviser's
business; extensive systemic risk reporting to the SEC; detailed
disclosure to clients; policies and procedures to prevent insider
trading; maintaining extensive books and records; and periodic
inspections and examinations by SEC staff.
Benefits of investing in hedge funds
First and foremost, our industry consists of successful investment
managers. As noted in the chart on the following page, and the charts
included in Appendix A, the hedge fund industry has grown significantly
over the last two decades. This growth is due to the value we provide
our clients, which are predominantly institutional investors such as
corporate and public pension plans, insurers, and educational
endowments.
*Second quarter 2009. Estimates vary over the amount of assets and
the number of funds. Research companies use different definitions and
models to value hedge fund assets. Source: Hedge Fund Research, Inc.
Available by subscription at: www.hedgefundresearch.com.
Hedge funds and other alternative investment vehicles are a
valuable component of the investment portfolio for many pension plans.
The properly managed addition of hedge funds to a portfolio provides
diversification, risk management and returns that are not correlated to
traditional equity and fixed income markets. These are critical
benefits that help pension plan managers generate sufficient returns to
enable plans to meet their obligations to plan participants. These
benefits can be seen in the chart on the following page, which compares
the value of one dollar invested in the Hedge Fund Research, Inc.
Monthly Index (the ``HFRI''), compared to the S&P; 500 (with dividends
reinvested).\1\ The strong performance of the hedge fund industry can
further be seen in the charts in Appendix B, which compare the
performance returns of the HFRI versus the S&P; 500 over the past 20
years.
---------------------------------------------------------------------------
\1\ The HFRI is one of a series of benchmarks of hedge fund
industry performance created by Hedge Fund Research, Inc., which are
designed to achieve representative performance of a larger universe of
hedge fund strategies. More information about the HFRI, and the
methodology used to create the index is available at: https://
www.hedgefundresearch.com/index.php?fuse=indicesfaq&1280757789.
**1989-1990 HFRI approximated with samples of roughly 90 funds from
---------------------------------------------------------------------------
David Hsieh and William Goetzmann
The critical importance of hedge funds and other alternative
investments as part of a pension plan's diversified portfolio was noted
by Joseph A. Dear, Chief Investment Officer of the California Public
Employees' Retirement System, in his written testimony before the
Senate Banking Subcommittee on Securities, Insurance and Investment on
July 15, 2009.\2\ In that testimony, Mr. Dear stated that the
performance of alternative investments:
\2\ Available at http://banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore--id;=e83f7ca16f94-4854-8aa9-
ef0ac11b4bb0.
translates into substantial value added to the pension fund
over a sustained time period. It makes realization of our
target rate of return feasible. The consequences to our
beneficiaries, their government employers and taxpayers of our
not meeting this objective are substantial and real: lower
wages, higher contribution rates and higher taxes. Can these
performance benefits be delivered through other investment
---------------------------------------------------------------------------
products? No.
The value that hedge funds add to pension portfolios is also
demonstrated through the significant investments made by pensions and
endowments in hedge funds. Pensions and endowments in every state
invest in hedge funds because of the benefits to their investment
portfolios.
Finally, hedge funds are one of the best examples in the financial
community of alignment of interests. Because the typical fee structure
for a fund includes a performance fee whereby the manager receives a
percent of the total returns the fund generates, hedge funds are
motivated to perform for their clients. In addition, if hedge funds
experience losses, those same performance fees do not start again until
the fund earns enough in investment returns to get back to its earlier
levels. These ``high water marks'' as well as the performance fees, and
the lack of any government safety net, explain in large part the
excellent risk management practiced by the hedge fund industry.
Contrary to popular media portrayals, the ``hedge'' in hedge funds is
real.
Legal qualifications for pension plans to invest in hedge funds
In order for a pension plan to invest in a hedge fund, two legal
requirements must be met. First, the plan must qualify under the
Federal securities laws as a sophisticated investor, typically as a
``qualified purchaser'' under the Investment Company Act of 1940 or as
an ``accredited investor'' under Regulation D under the Securities Act
of 1933. Second, the person who makes the investment decision on behalf
of the pension plan must make such decisions consistent with his or her
obligations as a fiduciary to the plan under the Employee Retirement
Income Security Act of 1974 (``ERISA'').\3\
---------------------------------------------------------------------------
\3\ Section 3(21)(A) of ERISA provides that a person is a fiduciary
with respect to a plan to the extent he (i) exercises any discretionary
authority or discretionary control respecting management of such plan
or exercises any authority or control respecting management or
disposition of its assets, (ii) renders investment advice for a fee or
other compensation, direct or indirect, with respect to any moneys or
other property of such plan, or has any authority or responsibility to
do so, or (iii) he has any discretionary authority or discretionary
responsibility in the administration of such plan.
---------------------------------------------------------------------------
Hedge funds provide significant benefits when appropriately
incorporated into a pension fund's portfolio, however, as noted by the
President's Working Group on Financial Markets' Investors' Committee
noted in its 2009 report titled, Principles and Best Practices for
Hedge Fund Investors (the ``Investors' Committee Report''):
Thousands of institutional and individual investors meet the
legal requirements to invest in hedge funds, but it is not
always appropriate for them to do so. Prudent evaluation and
management of hedge fund investments may require specific
knowledge of a range of investment strategies, relevant risks,
legal and regulatory constraints, taxation, accounting,
valuation, liquidity, and reporting considerations. Fiduciaries
must take appropriate steps to determine whether an allocation
of assets to hedge funds contributes to an institution's
investment objectives, and whether internal staff or agents of
the institution have sufficient resources and expertise to
effectively manage a hedge fund component of an investment
portfolio.\4\
---------------------------------------------------------------------------
\4\ Available at: http://www.amaicmte.org/Public/
Investors%20Report%20-%20Final.pdf.
We fully agree with the Investors' Committee Report that pension
plan managers should consider not only whether the plans they manage
are eligible to invest in hedge funds under the securities laws, but
also whether an investment in hedge funds is consistent with the plan
manager's fiduciary duties to the plan. Included in those fiduciary
duties is the obligation on the plan manager, or the manager's
representative, to conduct appropriate due diligence on the hedge fund
and hedge fund's manager prior to making an investment, as well as
appropriate ongoing due diligence once an investment has been made.\5\
We believe that the combination of securities laws' thresholds and
ERISA fiduciary obligations together work well to ensure that only
pension plans with the appropriate sophistication and resources invest
in hedge funds.
---------------------------------------------------------------------------
\5\ Since 2000, MFA has been the leader in developing, enhancing
and promoting standards of excellence for hedge fund managers through
its document, Sound Practices for Hedge Fund Managers, which includes a
model due diligence questionnaire for use by investors when considering
an investment in a hedge fund. MFA's Sound Practices is available at:
http://www.managedfunds.org/mfas-sound-practices-for-hedge-fund-
managers.asp.
---------------------------------------------------------------------------
Conclusion
MFA appreciates the opportunity to express its views on the
benefits that hedge funds provide with respect to pension plans and the
beneficiaries of those plans and the legal requirements that must be
met before a pension plan can invest in hedge funds. We would welcome
the opportunity to elaborate on these points, or answer any questions
that Subcommittee members or staff may have regarding our views.
---------------------------------------------------------------------------
\6\ Source: Hedge Fund Research Inc.--copyright 2010 HFR Inc.
www.hedgefundresearch.com.
______
[Whereupon, at 11:25 a.m., the subcommittee was adjourned.]