Because pension plan money has become one of the largest sources of capital in the world, many people seek ways of eroding the principles of ERISA to allow riskier pension plan investments and more party-in-interest transactions. Theodore R. Groom, in a July 10 Other Views commentary ("ERISA should be based on SEC model"), proposes eliminating the prohibited transaction restrictions contained in ERISA. This would be a mistake.
The role of prohibited transaction rules is to inhibit the ability of pension plan trustees, investment managers and other fiduciaries to make investments where there is the possibility of a conflict of interest.
The Employee Retirement Incomes Security Act dictates that the role of process is at least as important as investment results. The the role of process was developed, as we all know, because acting as a fiduciary mandates that an inherently greater level of care should be applied to pension assets than other financial assets.
Mr. Groom evokes the ghosts of the 1950s era Teamsters and, with the Washington Hilton Hotel example, presents an early extreme application of the difficulties of complying with ERISA. With these examples, Mr. Groom trivializes the application of the prohibited transaction restrictions and implies that the restrictions are antiquated. In reality, ERISA and the prohibited transaction restrictions are more workable in today's investment market than they were when originally passed in 1974.
Small and large pension funds, with trustees who may or may not have sophisticated financial market experience or knowledge of ERISA requirements, are extremely vulnerable to abuse and fraud. Although Mr. Groom implies that prohibited transaction rules are an anachronism, abuse and fraud in this area are more likely because our capital markets have become more sophisticated and global.
Today, pension plan trustees are under even more pressure to make investments in which complex financial structures are used and where parties-in-interest may be involved. Because of political desirability or other market pressures, investment managers are being asked to invest in assets or investments that do not necessarily make economic sense. Investment managers also are no less tempted today than in the past to self-deal. For trustees and investment managers, nothing has changed in the capital markets when it comes to the temptation to misuse a pool of capital that now totals $12 trillion. Mr. Groom argues that prohibited transactions are not inherently dangerous and should not require guidelines within a regulatory framework with "set" absolutes. He contends that prior or subsequent disclosure of these transactions will provide adequate protection for the pension beneficiaries.
The truth is far different for two important reasons:
* The defined prohibited transactions are in most cases inherently dangerous and the beneficiaries of the pension plans could sustain significant damage if these transactions were not in and of themselves considered inappropriate and, thus, prohibited.
* Today's investment markets are fast-paced, and significant abuse could occur before the "real" disclosure of the impact of a party-in-interest could be effective or even understood by a trustee or beneficiary.
We all know that information about an investment or transaction can be included in a disclosure document without most people realizing what they are reading. In the capital markets today, even the most sophisticated investors and investment managers may not fully understand what is written in a disclosure document. A trustee who has limited experience with these matters is even less suited to understand them. It is unrealistic to assume that a working or retired beneficiary who is untrained in investments would understand these disclosures.
Retirement benefits are even more sacrosanct than the investment dollars of individuals and companies in the United States, because of the inherent nature of their social consequence. The law, through ERISA, sets a much higher standard for culpability than federal securities laws. The investment duties of ERISA serve a much larger social and economic goal -- one that should be supported at all costs, even if it inhibits a few investment opportunities.
Mr. Groom argues that current ERISA restrictions stifle innovation and impede investment. This may be a factual statement as it applies to non-pension fund investors, as they may take risks that a pension plan should not take. ERISA serves as a clear boundary that investment managers should not cross, and to make this boundary less clear invites behavior that quickly will erode faith in our pension system.
The standard ERISA has established does not stifle innovation and competition for those investment managers who understand how to work within it, and understand how those laws protect the interests of pension plan beneficiaries. As a practical matter, if an investment manager is seeking to make investments that may violate ERISA under its current standard, which may indirectly stifle competition and innovation, this would then imply that the investment might not be necessarily appropriate or prudent for the pension plan in question. Not every investment option is a good one, and certain investments should be prohibited simply because of the appearance, real or imagined, of conflicts of interest.
Pension plan beneficiaries deserve the highest standard of care for their investments to ensure that the expected returns are there in the long run. ERISA is, and was, intended as a stop sign for investment managers as well as trustees in order to preserve the trust corpus.
Opposition to the elimination of prohibited transaction restrictions is not, as Mr. Groom states, limited to the AFL-CIO and those with self-interests in the current system. The current system does not significantly affect legitimate investment activities or all investment structures where potential conflicts may occur. Certain class exemptions have been approved by the Department of Labor, allowing pension plans to enter into transactions that otherwise would be prohibited.
For example, Prohibited Transaction Class Exemption 84-14, also known as the QPAM exemption, allows an investment manager to pass on certain party-in-interest transactions that otherwise may be prohibited. Therefore, there is little opposition to the current system from investment managers, pension plans and their beneficiaries who understand the role of process and how to operate within the process-driven mandates of ERISA.
The purpose of ERISA is to set clear standards requiring investment managers to think about how an investment will be perceived by a court or the beneficiaries in the future, should a problem arise, and not to promote creative ways of working around conflicts, real or perceived, that do not serve the interest of the pension plan.
The fiduciary standards created by ERISA should be further amplified to ensure the sacrosanct nature of pension plan assets, rather than diluted. It is an insufficient remedy to allow a pension plan beneficiary to file a civil law suit, which he can ill afford, to enjoin an investment activity after receiving disclosure -- or even worse, to seek recovery of losses from an investment manager or trustee that does not have sufficient funds to pay off any judgment. All too often the reality is that the guilty parties are judgment-proof or lack the wherewithal to compensate for the losses incurred.
Stanley L. Iezman is president and chief executive officer of American Realty Advisors, Glendale, Calif.