Jim and Bruce discuss the elections, inflation and government spending.
North Pier Fiduciary PIERspective – Brant Griffin (October 19th, 2011)
DOL Withdraws Regulations to Change Fiduciary Rule
The DOL has withdrawn a proposed regulation that would have expanded the definition of fiduciary under ERISA § 3(21) after falling to pressure from Congressand Wall Street (and some believe the White House). The proposed regulations would have amended ERISA and expanded the conditions under which consultants, advisors and others who provide investment advice would be considered fiduciaries.
The current fiduciary standard was developed shortly after the passage of ERISA in 1974. 35 years later, today’s retirement plan landscape makes the current rules seem remarkably antiquated. Many organizations have historically evaded fiduciary responsibility to the the sponsor retirement plans and to the America’s workers that rely on them. By maintaining conflicted business practices that are not consistent with a fiduciary stance, the current regulatory framework can permit advisors to subordinate their client’s interest to their own financial gains when advising plan sponsors and their participants. The proposal’s goal was to ensure that potential conflicts of interest among advisers are not allowed to compromise the quality of their advice.
The promise of regulations to define a new fiduciary standard has caused quite a stir in the advisor community. Wall Street brokerage houses, large consulting organizations, advisory firms and other interested parties would be greatly affected by this new rule, causing many organizations to restructure their ERISA services or be consigned to a non-fiduciary role. In the 10 months since the proposed rules were issued, the DOL received numerous public comments and heard testimony from many interested parties attempting to alter the outcome of this plan. As pressure mounted, calls for a withdrawal of these regulations finally succeeded.
In explaining the DOLs grounds for the withdraw, EBSA Assistant Secretary Phyllis C. Borzi commented, “We have said all along that we will take the time to get this right to ensure that we provide the strongest possible protections to business owners and retirement savers in plans and IRAs.” Secretary Borzi went on the say, “Investment advisers shouldn’t be able to steer retirees, workers, small businesses and others into investments that benefit the advisers at the expense of their clients. The consumer’s retirement security must come first.”
An area of controversy has been the application of these regulations on IRA accounts. DOL representatives have made it clear that IRA protections will be included in the new proposed regulations. The regulations will also address concerns on routine appraisals (such as for ESOPs) and certain commercial transactions, as performed in the management of stable value investments.
Critics of the initial proposal regarding IRA accounts allege that the proposed regulations would have subjected IRA brokers to a fiduciary duty when they are merely playing a sales role. Opponents further claim these new rules would reduce commissions, increase compliance costs and even force some broker-dealers out of the market. To date, the DOL has rejected these claims, and appears ready to address these concerns. If included in the final regulations, these changes will ultimately serve to clean up many of the questionable business practices that plague the servicing of the IRA market.
The DOL has stated a new version of the proposed regulations will be issued by early 2012. If the revised version is found to be a watered down rendering of its predecessor, this withdraw may prove to be a victory for those interested parties those who fiercely objected to them.
Regardless of this setback, plan sponsors are advised to be keenly aware on the distinctions that exist in the advisor arena. Properly exercised due diligence on the fiduciary role of their advice providers should yield a clear, accountable, higher value service – free from tainted advice. Mandated provider disclosures from the upcoming 408(b)(2) regulations (effective March 31, 2012) should make such due diligence easier.
Perhaps the best way to sum up the current marketplace for fiduciary services is by a revealing comment made by the EBSA’s Michael Davis, when he said, “I see a very short line of people in front of our building saying they want to be a fiduciary.” The simple truth of this statement ensures further battles to come. Today’s battle may have been lost, but the war wages on.
Legal Update: Appellate Court Rejects Allegations of Excessive Plan Fees
The last several years have seen heightened activity of ERISA suits stemming from investment related claims in defined contribution plans. In Loomis v. Exelon, the US Court of Appeals for the Seventh Circuit has ruled in favor of the defendants, marking a noteworthy decision for plan sponsors. Exelon Corporation’s (Exelon) employees argued that the company breached its fiduciary duties by providing investment options with excessive fees in its defined contribution plan.
Exelon’s plan offered 32 investments, 24 of them were mutual funds which were open to the public with expense ratios ranging from 0.03% to 0.96%. The plaintiffs asserted that the plan administrators violated their fiduciary duties by offering retail mutual funds when they should have offered lower cost options (such as institutional funds). The plaintiffs also claimed that requiring participants to absorb the costs of the plan’s funds rather than having the plan cover the costs, was in violation of the plan administrator’s fiduciary duty.
The plaintiffs’ arguments were not persuasive to the court. The court remarked that the same investments were offered in the retail marketplace and therefore their expense ratios were established to be competitive when measured against other fund alternatives. The court also noted that participants were given a wide range of investment choices from which to invest. Additionally, literature and education seminars were provided to inform plan participants on how their investment choices differed, including how to identify low cost alternatives.
The Seventh Circuit ultimately decided that there was no evidence to suggest that Exelon benefited from the funds at the expense of its plan participants. Exelon had every reason to choose the most cost effective funds in order to drive down participant expenses, as this would have resulted in better overall plan performance. Furthermore, the court remarked that there is nothing in ERISA that requires a fiduciary to look for the cheapest funds in the market.
It was also cited by the court that a prior U.S. Supreme Court case found that ERISA does not impose a duty on employers to contribute to employee benefit plans at a certain level. In determining its plan cost payment levels, employers “may act in their own interests.” Regarding the plaintiffs’ arguments that Exelon should have contributed more to the participants’ accounts by covering mutual fund expenses, the court ruled that ERISA did not support this claim.
It is important to note that the Loomis decision may be inconsistent with another well known district court decision in 2010, Tibble v. Edison International (appeal pending). In Tibble, the court held that Edison was in violation of ERISA’s fiduciary duty of prudence with the plan’s selection of certain retail mutual fund investment options. The court found that by not negotiating economies of scale discounts on behalf of the plan, or offering the option of less expensive “institutional” funds, the administrator violated its fiduciary duty. It will be interesting to see how the Ninth Circuit ultimately rules on Tibble.
Social Security COLA Increase Likely Rise projected at 3 percent or more
After two years without an increase, Social Security recipients appear likely to receive a cost-of-living adjustment (COLA) in 2012 reaching as high as a 3.5 % increase. Tens of millions of Social Security recipients across the US have not seen their benefits increase since January 2009, when beneficiaries received an adjustment of 5.8% due to rising energy prices. Given the general increase in the cost of goods, a COLA will be a welcome change for more than 58 million Social Security beneficiaries.
COLAs are based on overall average price indexes throughout the year and usually remain in line with inflation. The Bureau of Labor Statistics is responsible for the data. COLA adjustments are determined by comparing the third-quarter consumer price index with the previous year’s third quarter. If September’s index remains unchanged from August, then recipients can look for a 3.5 % increase in 2012.
North Pier Market PIERspective – Jim Scheinberg (October 19th, 2011)
“The only thing we have to fear is fear itself.”
Sentiment turned nearly to hysterics as Q3 unfolded. It was a quarter that saw volatile selloffs steadily mount in the face of a barrage of pessimistic conjecture, innuendo and uncertainty. Congress rattled nerves by playing a fiscal game of ‘chicken‘ with the U.S. debt ceiling. Then the Eurozone debt-boogieman raised his scary head almost daily in September. Wedge a downgrade of U.S. credit worthiness by S&P in between and you’ve got a saga that could have been written by the Brothers Grimm. In fact, I propose that it was.
I was astounded by the lopsidedness of the reporting being done by the talking heads of the financial press (where so many people flock to in order to get “informed”). Viewers were fed a constant flow of interviews with pessimists and doomsayers as the markets declined, exacerbating the weakness. Most sound bites were prefaced with “ifs” and “believes” and “expects” and very few “is”, “data” and “reported.” And no wonder. The actual data never depicted the “falling into the abyss” scenario painted by the emotionally driven sentiment gauges. At best, real measures of the economy showed that the pace of growth slowed from robust to moderate. Now don’t get me wrong, we are certainly not out of the woods. As a friend of mine put it a few weeks ago, “I don’t see us heading into a double dip, but we could talk ourselves into it.” If fear based sentiment sticks around long enough, it may solidify into action. But then again, now I’m speaking in “ifs.”
How the Markets Fared
Equity Markets across the globe sold off aggressively in the last week of July and the first week of August. The quarter began with both parties in Congress clashing over a routine periodic raising of the U.S. debt ceiling. Predictions of a massive global selloff in the U.S. Treasury that could ensue if an agreement was not reached had equity investors sitting on the edge of their seats. As the August 2nd deadline approached, nervous investors started selling equities to insure against a stalemate. Even though an eleventh hour deal was eventually reached, no relief was provided to equity investors. Two days later, S&P downgraded the credit rating of the United States anyway, sending markets reeling. All in all, global equity markets sold off nearly 20% in the two-week period. The remainder of the quarter was spent skipping off the new cycle lows as European debt fears and domestic economic uncertainties were debated.
For the quarter, most global equity markets suffered their worst quarterly loss since the dark days of the financial crisis. Domestic stocks were down from thelow teens to low twenty percents. Growth led more economically sensitive value stocks and large caps proved to be more defensive than their less liquid small cap brethren. International stocks moved in tandem with those in the United States during the decline but were then dealt an additional blow as European debt concerns pushed indexes even lower in September. At the same time, declines in the Euro and the Pound made matters worse for European equities when measured in Dollar-terms.
Investors fleeing stocks turned to the perceived safety of Treasuries in August, pushing yields down a dramatic 120 basis points on the 10-Year to finish the quarter at a near record low, 1.95%. (Yields had amazingly pulled back below 1.75% on the bellwether just a week prior, a rate not seen even during the mania of the financial crisis.) This run on Treasuries helped propel returns of the BarCap Aggregate Bond Index up nearly 4% for the quarter. Investors in long-term U.S. Government bonds saw returns exceeding 20%. At the same time, investors piled back into TIPS for protection against future inflation. Concerns over the health of the domestic economy, however, sent yield spreads widening on less credit worthy paper. High yield bonds saw declines of six percent net of interest during the quarter.
Shaken but Not Deterred
One need look no further than to the consumer to see the duality going on between behavior and sentiment which took place during the Third Quarter. The August Consumer Confidence Index plunged from 59.2 in July to 44.5 in August (before leveling out in September). This slide was dominated by the Future Expectations component plummeting to 51.9 for August, from 74.9 in July. These were the lowest readings in over two years. The ‘current conditions’ reading for that same period was only down a notch from 35.7 to 33.3 the month prior. Shockingly, during the same month, retail sales unexpectedly advanced by three percent month-over-month and a whopping nine percent year-over-year. Clearly the pessimism that was being reported did not change actual spending patterns.
Not a Home-Run but Maybe a Home-Base-Hit
Although moderating from their March highs, the latest readings for pending home sales are running nearly eight percent ahead of the same month last year. People are clearly continuing to take advantage of the most affordable housing market seen in generations. JP Morgan calculates that the average new mortgage now costs less than 11% of average personal income. This represents nearly a 50% reduction from the 2007 peaks. Low interest rates and greatly deflated values in most markets make purchases very reasonable for those who qualify. But therein lies the rub. Take it from someone who was one of those homebuyers in Q3, qualifying is an arduous task, even for those with strong credit. The good news is that cash buyers continue to step in, now accounting for 30% of purchases (up from 12% just two years ago). With rents rising nationally, it appears that values are so compelling, that cash investors see a floor near these levels. The Case Shiller 20 City Index seems to support this notion, with July representing the fourth monthly home values gain in a row. Housing Starts for September confirm this notion, rising a surprising 15% from August and 110% year-over-year.
Business to Business Still in Business
I have asserted numerous times that the economic recovery has largely been lead by business-to-business activity. Most all indications point to this crucial engine of the recovery still maintaining forward progress, albeit at a less robust pace. The Conference Board’s Leading Economic Index® (LEI) for the U.S. increased 0.3 percent in August, following a 0.6 percent increase in July. Ataman Ozyildirim, an economist at The Conference Board commented, “The August increase in the U.S. LEI was driven by components measuring financial and monetary conditions which offset substantially weaker components measuring expectations.” Again, as we see with the consumer, sentiment has weakened but activity has not. We see the same pattern in corporate capital expenditures which also moderated during the quarter but are continuing to show modest growth.
At North Pier, the most accurate gauges we have monitored since the crisis first hit have been the Institute of Supply Management’s Purchasing Manager’s Indexes. As with last summer’s temporary moderation, the PMI has retreated from robust growth readings earlier this year, to more modest economic progress this summer. However, even in the wake of all the negative events previously discussed, these indicators have not dipped into ranges forecasting contraction. Through September, both the Manufacturing and Services sectors continue to show better readings than 50, indicating continued expansion. Manufacturing has shown the biggest pullback with new orders and backlogs posing more troublesome indicators. However, the Non-manufacturing indexes actually exhibited improvements in new orders and backlogs in September. In the very least, it appears that those on the front lines of business are not battening down the hatches for an economic storm. If the pattern of last year repeats itself, expect large advances in both of these indexes for the remaining months of the year.
The Labor Department reported that the economy added 103,000 new jobs in September. Although this number is still weaker than the 150,000-200,000 a month needed to begin reducing unemployment, it does not appear to be indicating that conditions have materially worsened either. However, there seems to be a bonus beneath the headline September number that was released in the latest report. The Bureau of Labor Statistics also revised gains in nonfarm payrolls for July and August up 42,000 and 57,000 respectively. This means that as of the latest report, 202,000 new jobs were actually reported. If this trend of report and upward revision holds, the labor market may in fact also be poised for a comeback.
I often found myself asking this question during the Third Quarter, “What’s new about this that we didn’t already know a couple of months ago?” We all had anticipated a short-term pause in global growth in the aftermath of the Japanese earthquake, which happened just two short quarters ago. The well examined European debt situation revealed no new systemic vulnerabilities, just speculative concerns over the political response that would be needed to address it. And domestically, fears of soaring interest rates that might result from a failure to raise the debt ceiling and/or a U.S. credit downgrade turned out to ill-founded. In fact, the antithesis happened, as interest rates plummeted immediately following the S&P downgrade. Sorry folks, I just didn’t see what the mania was all about.
And I still don’t. Business activity is healthy. Labor, although lackluster, is not deteriorating, and in fact is showing promising signs of stability. Housing prices and activity appear to be bottoming…finally. The consumer, despite what they say they feel like, is spending again (after paying down debt and increasing savings rates). Corporations’ earnings continue to climb, now matching all time record levels. They too, have much improved their balance sheets these last few years, holding over three Trillion in cash that they are beginning to deploy. BRIC nations continue to emerge, adding tens of millions of new consumers to the global market each year. This rise continues to benefit multinational corporations both domestically and abroad alike. Add to the equation U.S. stock market valuations that are near historic lows (<11x forward S&P 500 earnings estimates), while profits are growing at a robust rate and it becomes hard for me to accept the pessimistic case being made by the naysayers whose arguments begin with “I feel.” But that’s just my PIERspective.