WASHINGTON - The Labor Department's pension office may allow investment management arms of the largest corporate pension plan sponsors to swap securities among themselves, which could save millions in trading costs.
Approval could come this summer, and could prompt some corporations to set up separate investment management companies.
The Labor Department would issue a blanket exemption to the in-house investment units as well as to managers of managers acting on their behalf. Last year, the DOL's pension office approved allowing quantitative and passive money managers to swap securities among portfolios of pension fund clients.
Under a proposal by the Committee on Investment of Employee Benefit Assets, Bethesda, Md., the exemption would apply only to investment management affiliates or "in-house asset managers" representing plans with at least $250 million in assets and managing more than $50 million in plan assets either directly or acting as managers of managers on behalf of plans with at least $250 million in assets.
`Could be really valuable'
"If you're managing any large amount of assets in multiple plans, this could be really valuable for us (in lowering) our transaction costs," said Gary A. Glynn, president of the U.S. Steel & Carnegie Pension Fund, New York, which actively manages all of the approximately $8 billion in United States Steel Corp. pension assets.
"If a class trading exemption were to be issued by the (Labor) Department in anything approaching what CIEBA had proposed, you could see an increase in the number" of in-house asset management units, he said. Mr. Glynn chairs CIEBA.
Mr. Glynn said members of CIEBA's cross-trading taskforce interested in the exemption include AT&T Investment Management Corp., Basking Ridge, N.J.; General Motors Asset Management, New York; GE Asset Management Inc., Stamford, Conn.; International Business Machines Corp., Stamford, Conn.; Lucent Technologies Inc., Murray Hill, N.J.; Verizon Investment Management Corp., Stamford, Conn.; E.I. du Pont de Nemours & Co., Wilmington, Del.; and Qwest Asset Management, Englewood, Colo.
AT&T officials declined to comment; officials at GM were not available for comment; officials at GE did not return phone calls. Gail Dill, the executive assistant to Edward J. Basset, vice president at DuPont Capital Management, said the exemption would not really affect the firm.
Based on an informal survey CIEBA conducted among a few of its members, the application anticipates 14 firms would be affected. Collectively, they could have saved $65 million to $85 million in direct trading costs in 2000. The estimate is based on trading costs ranging from 14 basis points for domestic large-capitalization stocks to 45 basis points for trades in emerging market equities, and from 0.3 basis points for Treasury bonds to 25 basis points for high-yield bonds, said Judy Schub, managing director of pension and investment policy at CIEBA.
Exemption is necessary
In a February 2000 hearing on cross-trading, Britton Harris, then president of GTE Investment Management (now part of Verizon), said the inability to cross-trade cost all CIEBA members close to $500 million annually on equities alone. Mr. Harris' testimony was based on average trading costs - including commissions, market impact and opportunity costs - from Plexus Group Inc., a Los Angeles research firm.
The exemption is needed because the Employee Retirement Income Security Act prohibits pension funds and managers acting on their behalf to represent both buyer and seller in a securities transaction.
When CIEBA went to the DOL in October 2001, one concern raised by department officials was whether the party at the receiving end might get a better price in the transaction than the plan or manager seeking the trade.
"The Labor Department has asked if there's a proxy for measuring motivation of the parties, and we have said that's an invalid question" because the motivation can't be measured, said Rick Matta, a partner with the Groom Law Group in Washington, which represents CIEBA.
Labor Department officials declined to comment.
The cross-trades would be permitted between the plan sponsor's defined benefit plans and defined contribution retirement plans.
Additionally, under the proposal submitted by CIEBA, the cross-trades can only be conducted between portfolios of which at least 50% is in ERISA assets. And, at least 75% of the portfolios participating in a cross-trade must consist of in-house pension assets, or assets of affiliated private foundations.
As part of the elaborate cross-trading policies and procedures they would need to maintain, the in-house investment managers - or managers under their supervision - would have to conduct annual independent audits, as well as sample cross-trades. The written policies would include a description of pricing policies, procedures for allocating cross-trades among different plans (or clients) and a statement forbidding preferential pricing to any party in a cross-trade.
Moreover, the managers would need to ensure their decision to buy and sell securities was independent of the availability of cross-trading opportunities, although having made the investment decision, they could then use cross-trading opportunities to execute the orders.
Study notes savings
Securities in a cross-trade would be priced in accordance with existing securities rules, and illiquid securities would be priced at either the last sale price or the at the average of the bid and asked price, in accordance with SEC regulations.
Finally, the firm couldn't collect any brokerage fees or commissions as a result of the cross-trade.
Separately, the Labor Department's employee benefits security administration is expected to release a study conducted by Tom McInish, head of the Department of Finance at the University of Memphis, that supports the cross-trading proposal.
In his study, Mr. McInish found that large pension plans would save more by cross-trading than smaller plans. That's because larger plans, which would typically place bigger buy and sell orders for stocks and bonds, would save more because trading costs increase disproportionately for larger orders.
Mr. McInish estimates transaction costs range from 1% to 4% of an order, depending on the type of asset (stocks vs. bonds for example), daily trading volume of the asset, size of the order, time of day the order is executed, and market conditions.
Larger plans, which typically have many money managers with disparate investment styles resulting in one wanting to sell the same security that another wants to buy, also would have more opportunities to cross-trade, Mr. McInish's study noted.