WASHINGTON - The SEC intends to challenge corporations with pension funds that assume long-term rates of return of 9% or higher.
The SEC's pronouncement could force some companies to redo their annual filings if the regulator is not satisfied with their disclosures. It is unlikely, however, to result in enforcement action unless there is a blatant attempt to manipulate the company's bottom line by stretching the pension fund assumptions, experts said.
In a speech to accounting professionals, Todd Hardiman, associate chief accountant in the Securities and Exchange Commission's division of corporation finance, said the action is prompted by investor concerns about companies using artificially high return assumptions on their pension assets.
Many companies have reported earnings based on earning 9%, 10% and even 11% average annual returns on their pension assets, while actually hemorrhaging billions of dollars from their pension funds since the stock market's collapse in March 2000.
Indeed, 87 of the 100 largest corporate defined benefit plans had return assumptions of 9% or higher, according to a Pensions & Investments survey published last summer. Since then, some have lowered their assumptions, including General Motors Corp., Ford Motor Co., Unisys Corp., Citigroup and IBM Corp.
The SEC pronouncement could cause companies to report smaller pension surpluses - or even cause those to disappear altogether - and to report lower earnings.
Investment experts predict the SEC's directive will result in companies dropping their assumptions below 9%.
"The SEC's pronouncement effectively puts a ceiling" on return assumptions, said Jeremy Gold, a New York-based actuary who runs an eponymous consulting firm.
Many already dropped
Michael Peskin, principal in the global pensions group of Morgan Stanley, New York, noted that many clients have already dropped their assumptions to 9% or lower, "whether that was because they expected the SEC action, or because anything above 9% looks highly dubious at this juncture." Mr. Peskin said he thinks even 9% might be too high: "I would be more comfortable with 7%."
Watson Wyatt Worldwide, the Washington-based consulting firm, is reporting that companies have dropped the average expected long-term return assumption on their pension funds to 8.81% for the fiscal year ended Dec. 31, based on the firm's latest survey of 123 corporate plan sponsors. It also predicts that companies will further lower the return assumption on pension assets, to 8.64%, in 2003.
Weyerhaeuser Co., which assumed it would earn 11% on its pension assets in 2001 - the highest among companies in the S&P 500 - lowered its assumption to 10.5% for 2002, and further to 9.5% for 2003, a spokesman said.
Under the SEC's latest pronouncement, companies will be expected to justify long-term return assumptions of 9% or higher, rather than simply disclosing the assumptions in footnotes of their financial reports.
"We understand that most plans are not 100% invested in stocks, so if you have an assumed rate of return in excess of 9% and the (management's discussion and analysis section of the financial statement) doesn't explain why, then you are probably a candidate for a comment," Mr. Hardiman said.
In his speech, he said the SEC arrived at the 9% figure by examining historical returns on large-cap domestic stocks and corporate bonds between 1926 and the first three quarters of 2002. In that period, stocks have earned average returns of 10% and bonds, 6%.
As SEC officials review annual corporate securities filings over the next few months, they will also be checking whether the rates of return companies assume on their pension assets are consistent with the historical compound average returns on portfolios with similar asset allocations. Companies will be expected to explain if the historical returns are based on the actual experience of their pension funds or on market data, or a blend of both. And, for the first time, companies will be expected to provide details about the asset allocations from which the return assumptions were derived.
Companies can also expect questions if the return assumptions on their pension funds are below 9%, but inconsistent with historical returns for that asset allocation.
Meanwhile, the steep decline in interest rates in high-grade corporate bonds could force companies to report higher pension liabilities as their pension assets are shrinking.
Because lower interest rates translate into higher pension liabilities, the decline in interest rates on AA-rated corporate securities - from 7.54% at the end of 2001 to 6.63% at the end of 2002 - could force companies to report higher pension liabilities in their 2002 annual reports in upcoming weeks.