DOL rule could raise pension funds' costs

The price tag for determining the value of pension fund investments in alternatives and other illiquid assets could go up dramatically, thanks to a proposed regulation from the Department of Labor.

That's because firms that appraise assets of retirement plans would be among the companies considered as fiduciaries under the DOL proposal, ERISA attorneys said.

“It will either drive up the costs (of providing valuations) dramatically or drive creditworthy institutions out of the business,” A. Richard “Brick” Susko, an ERISA attorney with Cleary Gottlieb Steen & Hamilton LLP, New York, said.

The proposed regulations, which also would extend the fiduciary standards to investment consultants and proxy advisory firms (Pensions & Investments, Nov. 1), are also wreaking havoc for firms that appraise employee stock ownership plans.

“This proposal, if adopted, is likely to have a dramatic impact on the ERISA appraisal industry,” said Norman Goldberg, managing director of independent fiduciary Evercore Trust Co., New York, which relies on appraisal companies to offer valuations for a variety of ERISA transactions.

“The bottom line is there may be a lot of people who look at this (proposed rule) and say they don't want to be in this business any more,” added Elyse Bluth, managing director and head of the ESOP and ERISA advisory services practice at Duff & Phelps LLC, Chicago.

Duff & Phelps is not abandoning the business yet. “It's way too early” to start thinking about that, Ms. Bluth said. But she added that the proposal was an important factor for people in the business to consider going forward.

Along with appraising the value of stock held by ESOPs, Duff & Phelps evaluates hard-to-value assets — including those held in hedge funds, private equity firms and other alternative investments — for ERISA plans, Ms. Bluth said.

Asset valuations are important for both defined benefit and defined contribution plans, according to retirement industry consultants and attorneys, because fiduciaries need to include the values of assets in their annual Form 5500 financial reports to the federal government.

Many retirement plans now rely exclusively on the valuations provided by the general partners in their alternative investment partnerships, even though DOL officials have expressed concern about this practice.

Virginia C. Smith, director of enforcement for the DOL's Employee Benefits Security Administration, confirmed in a September 2008 hearing before the ERISA Advisory Council that the DOL was investigating how corporate pension plan fiduciaries were valuing alternative investments.

She said it would be “difficult, if not impossible,” for a plan fiduciary to fulfill its prudence obligations if it lacked accurate information about the value of its alternative investments (Pensions & Investments, Sept. 29, 2008).

A July 2008 investigatory letter from the DOL's Boston regional office also said plan executives should be independently valuing alternatives instead of relying solely on valuations offered by an investment partnership's general partners.

“Many plans still rely on the valuation of the fund's general partners, though there have been issues raised about whether the fiduciary should look behind those evaluations,” said Ted Scallet, an ERISA attorney with the Groom Law Group, Washington.

“The larger plans currently use independent valuation professionals to review the (alternative investment) fund's own evaluation,” Mr. Scallet continued.

Extending the fiduciary obligations to independent appraisal firms would raise the costs for the firms because it would expose them to additional legal liability, ERISA attorneys said.

“I would anticipate that the increase in costs to the plans would be material here,” said Kent Mason, an ERISA attorney with the law firm Davis & Harman LLP, Washington.

Groom Law's Mr. Scallet said that although an appraisal company's costs would rise if it is required to assume ERISA fiduciary obligations, it's unclear whether market conditions would permit the firm to pass along the increase to the plan or the plan's fiduciary.

Yet an additional concern, according to Mr. Scallet: “There is currently no fiduciary liability insurance for evaluation professionals because there's been no need for it.”

Phyllis Borzi, current assistant secretary of labor for the EBSA, had not returned telephone calls seeking comment by press time.

Executives for the hedge fund industry's Managed Funds Association, the Private Equity Council and The Real Estate Roundtable, all in Washington, all declined to comment, according to spokesmen for the three lobbying groups.

But Mr. Mason said the problem for the appraisers of alternative investments is that the proposed rule, as drafted, applies to “substantially all” plan asset evaluations.

“At a minimum, some line-drawing needs to be made to distinguish between valuations that should give rise to fiduciary obligations and those that do not,” Mr. Mason said.