[Senate Hearing 109-144]
[From the U.S. Government Publishing Office]
S. Hrg. 109-144
PROTECTING AMERICA'S PENSION PLANS FROM FRAUD: WILL YOUR SAVINGS RETIRE
BEFORE YOU DO?
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HEARING
OF THE
COMMITTEE ON HEALTH, EDUCATION,
LABOR, AND PENSIONS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
EXAMINING PROTECTING AMERICA'S PENSION PLANS FROM FRAUD, FOCUSING ON
THE DEPARTMENT OF LABOR'S EMPLOYEE BENEFITS SECURITY ADMINISTRATION'S
ENFORCEMENT STRATEGY, EFFORTS TO ADDRESS WEAKNESS IN ITS ENFORCEMENT
PROGRAM ALONG WITH THE CHALLENGES THAT REMAIN
__________
JUNE 9, 2005
__________
Printed for the use of the Committee on Health, Education, Labor, and
Pensions
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21-846 WASHINGTON : 2005
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COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS
MICHAEL B. ENZI, Wyoming, Chairman
JUDD GREGG, New Hampshire EDWARD M. KENNEDY, Massachusetts
BILL FRIST, Tennessee CHRISTOPHER J. DODD, Connecticut
LAMAR ALEXANDER, Tennessee TOM HARKIN, Iowa
RICHARD BURR, North Carolina BARBARA A. MIKULSKI, Maryland
JOHNNY ISAKSON, Georgia JAMES M. JEFFORDS (I), Vermont
MIKE DeWINE, Ohio JEFF BINGAMAN, New Mexico
JOHN ENSIGN, Nevada PATTY MURRAY, Washington
ORRIN G. HATCH, Utah JACK REED, Rhode Island
JEFF SESSIONS, Alabama HILLARY RODHAM CLINTON, New York
PAT ROBERTS, Kansas
Katherine Brunett McGuire, Staff Director
J. Michael Myers, Minority Staff Director and Chief Counsel
(ii)
C O N T E N T S
__________
STATEMENTS
THURSDAY, JUNE 9, 2005
Page
Enzi, Hon. Michael B., Chairman, Committee on Health, Education,
Labor, and Pensions, opening statement......................... 1
Kennedy, Hon. Edward M., a U.S. Senator from the State of
Massachusetts, opening statement............................... 2
Lebowitz, Alan D., Deputy Assistant Secretary for Program
Operations, Employee Benefits Security Administration, U.S.
Department of Labor, Washington, DC.; and Barbara D. BovbJerg,
Director, Education, Workforce, and Income Security Issues,
U.S. Government Accountability Office, Washington, DC.......... 4
Prepared statements of:
Mr. Lebowitz............................................. 7
Ms. Bovbjerg............................................. 22
Endicott, John, Business Manager and Trustee, Local Union 290,
Plumbers, Steamfitters and Marine Fitters, Tualatin, Oregon;
Barclay Grayson, Former Chief Executive Officer, Capital
Consultants, Portland, Oregon; Stephen F. English, Bullivant
Houser Bailey, Portland, Oregon; and James S. Ray, Law Offices
of James S. Ray, Alexandria, Virginia.......................... 40
Prepared statements of:
Mr. Endicott............................................. 43
Mr. Grayson.............................................. 47
Mr. English.............................................. 51
Mr. Ray.................................................. 54
ADDITIONAL MATERIAL
Statements, articles, publications, letters, etc.:
Response to questions of Senators Enzi, Kennedy, Hatch, and
Bingaman by Alan Lebowitz.................................. 67
Response to questions of Senator Hatch by John Endicott...... 82
Response to questions of Senators Kennedy and Hatch by
Stephen English............................................ 83
Response to questions of Senators Kennedy and Bingaman by GAO 84
Response to a question of Senator Hatch by Barclay Grayson... 86
Response to questions of Senators Kennedy and Hatch by James
S. Ray..................................................... 87
Michael J. Esler............................................. 89
(iii)
PROTECTING AMERICA'S PENSION PLANS FROM FRAUD: WILL YOUR SAVINGS RETIRE
BEFORE YOU DO?
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THURSDAY, JUNE 9, 2005
U.S. Senate,
Committee on Health, Education, Labor, and Pensions,
Washington, DC.
The committee met, pursuant to notice, at 9:58 a.m., in
Room 430, Dirksen Senate Office Building, Hon. Mike Enzi,
chairman of the committee, presiding.
Present: Senators Enzi, Kennedy, and Bingaman.
Opening Statement of Chairman Enzi
The Chairman. We are a couple of minutes early, but we are
here and ready to go, so we will go ahead and start the train.
Senator Kennedy. This is the on-time chairman.
[Laughter.]
I was a little intimidated, even after 43 years, I still
remember back in the 4th grade, getting to my teacher's
classes--
[Laughter.]
The Chairman. I will go ahead and call the hearing to
order. I want to thank you for coming to today's investigative
hearing, our first investigative hearing.
Before we begin, I would like to thank the committee's
ranking member, Senator Kennedy, for his support throughout the
investigation of these issues and the other ones that we are
working on.
I would also like to thank the witnesses who will testify
before us today for taking time out of their schedules to be
here. Your testimony will provide the committee with the
direction, the detail, and the guidance that we need if we are
to effectively address the vital issues that will be raised
during this important hearing.
At present, approximately 90 million workers are enrolled
in 700,000 pensions and retirement savings plans. In addition,
there are 60 million workers who are part of a network of
almost 6 million health and welfare plans. Many of these
workers face some prospects of risk in their retirement and
benefit funds from a host of potential predators. These threats
arise from weaknesses in oversight by Federal Agencies,
trustees who lack investment expertise and whose better
judgment can be influenced by gifts and gratuities, and by
administrators and other professional advisors who fail to
perform their duties effectively.
Today, we will be considering these and other issues as we
take a closer look at the largest pension fraud in U.S.
history. It is a complicated story that involves the investment
firm of Capital Consultants LLC and its efforts to elude the
detection of the Department of Labor. It includes a cast of
people across the country that had no idea that their pension
funds were in jeopardy until it was too late. By then, through
a complex Ponzi scheme, Capital Consultants defrauded
approximately 300,000 pension plan participants and their
families out of more than $500 million. Our witnesses will
describe how the fraud was perpetrated, how the loss of these
funded affected lives, and what the Federal Government is
prepared to do to prevent these kinds of pension frauds in the
future.
As we take a look at the details of the case, we will be
looking to our witnesses for their insights on the following
issues. Are the Department of Labor and other relevant agencies
prepared to prevent future pension frauds so that workers will
receive all of their vested benefits? Do employers and
employees have the financial literacy to understand the pension
system and to recognize the signs of pension fraud? Will the
Federal Government use the successful recovery of more than 70
percent of the funds taken in this fraudulent scheme as a model
that the Federal Government and the States can use to address
future pension fraud cases? Finally, what can we in Congress
legislatively, through our hearings and oversights, do that
will aid in addressing and preventing pension fraud?
The Department of Labor and the Securities and Exchange
Commission can be very proud of their participation in
uncovering this scheme, the complexity of which underscores the
difficulty of identifying pension fraud schemes in general. The
size of the fraud in the Capital Consultants case highlights
the importance of examining the lessons learned, and its
potential to destroy the future earnings of our retirees makes
it essential for the committee to determine the extent to which
the Department of Labor is prepared to prevent future pension
fraud.
To assist in examining the Ponzi scheme, I asked my staff
to prepare a chart that clearly illustrates how the pension
funds were used to cover losses due to risky investments and
conceal them through a complex web of corporations created for
that purpose, and we have a chart over here that illustrates
that.
In addition, the staff prepared a chart that lists some of
the responsibilities of those entrusted with the fiduciary
responsibility for the pension funds, and that chart is over
there.
Before introducing the witnesses, I would like to introduce
Senator Kennedy for any opening remarks he might have.
Opening Statement of Senator Kennedy
Senator Kennedy. Thank you very much, Mr. Chairman. As we
know, our committee and the Finance Committee have jurisdiction
over these pension funds and we have all been enormously
concerned by the headlines of recent times as well as long and
continuing interest in the protection of pension funds. We
recognize that we have some very, very important
responsibilities in terms of oversight, in terms of
legislating, and I commend the chair for the extensive series
of hearings that he has had in terms of looking at all aspects
of the pension issue and also for doing the oversight work that
is so important for us as a committee and for us in the Senate.
He was talking about how he asked his staff to present
these charts so it would clearly explain what happened. I am
looking at that chart, and it is all so clear to me now.
[Laughter.]
We will come back to that.
The unethical practices of executives of Enron and Global
Crossing and Tyco and Worldcom have undermined the financial
security of tens of thousands of hard-working men and women and
shattered the trust of millions of other Americans. Now, with
this greedy, dishonest, and irresponsible handling of $1
billion in retirement and other funds, the executives of
Capital Consultants have joined that shameful list.
Capital Consultants' record of mismanagement and lies is
appalling. The company operated a private investment portfolio
of risky loans that were inadequately underwritten and poorly
documented, charged clients excessive fees. As long ago as
1995, the Department of Labor ordered the firm to repay $2
million in fees that it overcharged to a pension fund in
Oregon.
Yet Capital Consultants continued to pull the wool over the
eyes of its clients with a sophisticated scam. When one of its
biggest debtors went bankrupt, Capital Consultants began a
complex Ponzi scheme rather than disclosing the truth to its
clients. The fraud involved placing the resources of employees'
pension funds and health care funds into shell companies to
pass the money back to Capital Consultants. Clients who asked
questions were lied to and deceived and the devious practice
continued until 2000.
This Congress has ushered in new tax cuts for the wealthy
and has passed a bankruptcy bill that I believe caters to the
credit companies and a class action reform measure that shields
corporate defendants when the obvious need is for reform that
will restore trust in our financial markets. We know that
employees across the country are still overinvested in company
stock and we need to deal with kickbacks and conflicts of
interest by managers and financial service companies that
oversee people's hard-earned pensions. We need to ensure that
cases like Capital Consultants do not happen again.
I look forward to the testimony of our witnesses and to
working with my colleagues in Congress to curb the abuses that
have left far too many hard-working Americans without the
financial security which they worked so hard for and rightfully
deserve.
Thank you, Mr. Chairman.
The Chairman. Thank you very much, and I appreciate the
excellent explanation you did of the chart.
[Laughter.]
Your testimony covered that well.
Our first panel today on ``Protecting America's Pension
Plans from Fraud: Will Your Savings Retire Before You Do?'' is
the government panel, and the first witness on the panel is
Alan Lebowitz, who is the Deputy Assistant Secretary for
Program Operations at the Department of Labor. The second
witness is Barbara Bovbjerg from the Government Accountability
Office. We appreciate your being with us today.
Mr. Lebowitz?
Incidentally, your entire statement will be a part of the
record, as well as any additional opening statements by members
of the committee. So any effort you can make to condense the
testimony so that we can do questions will be appreciated. Mr.
Lebowitz?
STATEMENTS OF ALAN D. LEBOWITZ, DEPUTY ASSISTANT SECRETARY FOR
PROGRAM OPERATIONS, EMPLOYEE BENEFITS SECURITY ADMINISTRATION,
U.S. DEPARTMENT OF LABOR, WASHINGTON, DC.; AND BARBARA D.
BOVBJERG, DIRECTOR, EDUCATION, WORKFORCE, AND INCOME SECURITY
ISSUES, U.S. GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, DC.
Mr. Lebowitz. Good morning, Chairman Enzi, Senator Kennedy,
and members of the committee. Thank you for inviting me here
today to share information about the Department's enforcement
role under the Employee Retirement Income Security Act, ERISA.
I am Alan Lebowitz, Deputy Assistant Secretary for Program
Operations at the Employee Benefit Security Administration at
the Labor Department. My testimony will discuss EBSA's
enforcement program and our investigation of Capital
Consultants LLC, its principals, and numerous related
investigations.
Under ERISA, the Secretary is responsible for protecting
the rights and financial security of more than 730,000 private
pension plans and 6 million private health and welfare plans,
which together hold more than $4 trillion in assets and cover
more than 150 million Americans. EBSA is responsible for
administering and enforcing the fiduciary and reporting and
disclosure provisions of Title I of ERISA. Our enforcement
activities are conducted through 10 regional offices throughout
the United States.
We have a total staff of 887, including 470 field
investigators. The Office of the Solicitor, which estimates
that it expends about 75 FTE annually on our behalf, provides
legal support for us. Our investigative staff has varied
professional backgrounds, including law, accounting, and
business, which are complemented by our own specialized
training programs.
We conduct a wide range of civil and criminal
investigations to determine whether ERISA and the related
Federal Criminal Code have been violated. Investigations are
opened based on a variety of sources, including complaints from
participants, referrals from the national office or other
government agencies, and reviews of the annual report Form
5500.
We regularly work in coordination with other Federal and
State enforcement agencies, including the Department's Office
of the Inspector General, the Internal Revenue Service, the
Securities and Exchange Commission, and the Justice Department,
as well as Federal banking agencies.
The amount of time it takes to complete an investigation
will, of course, vary, from a few weeks to several years,
depending on its complexity, the cooperation of the parties,
and whether the investigation is resolved through voluntary
compliance or through contested litigation. Our goal in each
investigation is to restore any money to the plan that was lost
as a result of fiduciary breaches and to ensure the safety of
the plan in the future.
In fiscal year 2004, EBSA closed 4,399 civil cases, over 60
percent of which found and corrected ERISA violations. Total
monetary results from these cases exceeded $3 billion. In the
criminal area, 152 cases were closed, 121 individuals were
indicted, and 62 cases resulted in convictions or guilty pleas.
We also have very active compliance assistance and educational
programs designed to help plan officials understand their
responsibilities and identify and correct problems.
We opened our first investigation of CCL in March 1992
based on information indicating that CCL engaged in prohibited
transactions and self-dealing. The investigations were
completed in March 1993 and revealed violations of ERISA,
because under CCL's fee arrangement, it could use its
investment discretion to increase its own compensation. Along
with an annual management fee, an extra transaction-based fee
was charged each time CCL made a real estate investment for a
client plan.
The case was resolved with a complaint and consent order in
December 1995, under which CCL paid $2 million to its plan
client and a civil penalty to the Government of $182,000. The
order also permanently enjoined CCL and Jeffrey Grayson from
entering into fee arrangements of this type.
Our Seattle office opened its second investigation of CCL
in October 1997, based upon the receipt of a complaint filed
against Jeffrey Grayson and CCL by one of its plan clients. The
investigation involved CCL's investment of plan assets in loans
called collateralized notes, or loans for which the collateral
consisted largely of the borrower's potential revenues.
A series of loans totaling $160 million of their clients'
assets was made to Wilshire Credit Corporation from July 1995
to October 1998. When Wilshire defaulted on these loans, CCL
did not report or acknowledge or the resulting losses to its
clients. Instead, it engaged in a series of transactions with
other entities to facilitate paper sales of all or a portion of
the Wilshire loans at an artificially high price.
In reality, CCL carried out a Ponzi scheme under which it
loaned an additional $72 million of plan funds during 1999 and
2000 to those entities that in turn used the funds to make
purported interest payments on the original $160 million loans.
Keep in mind that during this period, CCL continued to charge
its clients a 3 percent annual management fee based on the full
$160 million valuation.
In the summer of 2000, our investigative findings were
shared with the SEC. The Commission and the Department decided
to proceed jointly against CCL. The Department had an indepth
knowledge of the underlying facts while the SEC could more
readily have a receiver appointed over the entire business of
CCL, which included nonERISA clients as well as ERISA plans.
Pursuant to complaints filed by us and the SEC on September
21, 2000, the U.S. District Court in Oregon entered court
orders appointing the receiver to make an accounting, and to
protect the interest of CCL's ERISA plan clients and other
investors, the court froze the defendants' personal assets and
enjoined them from doing business with ERISA plans. The
receiver estimates that the total amount of litigation
settlements and marshaled assets accumulated in the
receivership to date is $291 million, of which $193 million has
already been distributed to CCL's private placement clients,
including ERISA plans.
In addition to the investigation of CCL, we opened 58
related investigations and filed 19 lawsuits against trustees
of 34 plans in Oregon, Idaho, California, Nevada, Utah,
Arizona, Colorado, Minnesota, and Ohio. In these lawsuits, the
Department alleged that the trustees of those plans imprudently
authorized CCL to invest in high-risk investments, failed to
adequately investigate the merits of the investments, and
failed to adequately monitor the investments. We also found
that a number of trustees violated ERISA's self-dealing
provisions by accepting gratuities from CCL, including free
hunting trips, rifles, and tickets to football games.
The resolution of these cases resulted in the recovery of
an additional $9.2 million, $1.8 million in civil penalties,
and called for the retirement or resignation of 51 trustees and
permanent injunctions barring 31 plan trustees and one
investment advisor from serving as ERISA fiduciaries or service
providers.
Just as important, the consent order imposed significant
internal reforms on the affected employee benefit plans.
Our work on the task force that conducted related criminal
investigations that included the FBI, the IRS, the Inspector
General's office, and the Office of Labor Management Standards,
resulted in the Justice Department indicting 11 individuals for
various crimes for their participation in the CCL debacle.
Seven of these individuals pleaded guilty. One was convicted
and two were acquitted following a bench trial, and one case
was dismissed. Four defendants served prison time, ranging from
15 to 24 months.
The scheme created by CCL and its principals was a very
sophisticated fraud that had a veneer of respectability
provided with the cooperation of its many professionals,
including attorneys, accountants, and investment advisors.
ERISA clearly places the ultimate responsibility for the
governance of plans on individual plan fiduciaries. CCL was
able to find fiduciaries who completely failed to responsibly
oversee the assets of the plans for which they were
responsible. These fiduciaries, in league with CCL, failed to
live up to their solemn obligation to protect and preserve the
hard-earned benefits of the workers in their plan.
All too often, these trustees, supported by their
professional advisors, failed to understand the nature of CCL's
investments, to review the investments, or even adhere to the
plan's own investment guideline. Indeed, as late as June 2000,
counsel for several plans was disputing that his clients had
even experienced a loss.
Mr. Chairman, for some now who try to excuse their own
illegal behavior by pointing fingers at others, including the
Department, is to us incredible.
This concludes my testimony, Mr. Chairman, and I would be
pleased to answer any questions that you may have.
The Chairman. Thank you very much.
[The prepared statement of Mr. Lebowitz follows:]
Prepared Statement of Alan D. Lebowitz
EXECUTIVE SUMMARY
Background
EBSA is responsible for administering and enforcing the fiduciary,
reporting, and disclosure provisions of Title I of ERISA. EBSA conducts
both civil and criminal investigations relating to employee benefit
plans. Its enforcement activities are conducted through 10 regional and
5 district offices throughout the United States. The Agency's
investigative staff has various backgrounds including law, business and
accounting. EBSA also complements these backgrounds with specialized
training.
Enforcement Results
In fiscal year 2004, EBSA closed 4,399 civil cases, achieving more
than $3 billion in monetary results. In the criminal area, EBSA
obtained 121 indictments during the fiscal year and closed 152 cases
with 62 convictions and guilty pleas.
Capital Consultants Investigations
CCI (later renamed CCL) was an investment management firm located
in Portland, Oregon, that managed more than $900 million for
approximately 340 clients, many of which were employee benefit plans.
The firm was owned and controlled by Jeffrey Grayson, who was its chief
executive officer, and his son, Barclay Grayson, who was its president.
EBSA's first investigation of CCI was opened in March 1992, and
completed in March 1993. The investigation disclosed that CCI and
Jeffrey Grayson entered into prohibited fee arrangements with client
plans that allowed them to increase their own compensation. This case
was resolved by a consent order that required CCI to pay an ERISA plan
$2 million along with other injunctive relief and penalties.
The second investigation was opened in October 1997 and disclosed
that CCL placed its clients' funds into high-risk private loans and
equities, including a $160 million loan to Wilshire Credit Corp. When
this loan failed, CCL carried out a complex ponzi-like scheme to hide
the default by agreeing to loan an additional $100 million of clients'
funds during 1999 and 2000 to shell entities to make the purported
interest payments on the Wilshire loan.
Government Legal Actions
On September 21, 2000, the Department and the SEC filed
simultaneous complaints and consent orders against CCL, shutting it
down and placing it into receivership. The Receiver estimates that the
total amount of settlements and marshaled assets accumulated in the
receivership to date is $291 million of which about $193 million was
already distributed to CCL's private placement clients, including the
ERISA plans.
The Department filed 19 additional lawsuits against fiduciaries of
34 employee benefit plans. In addition to money collected by the
Receiver and through the mediation in third party litigation, the
Department obtained substantial restitution, civil penalties and other
injunctive relief. Criminally, the Department of Justice charged 11
individuals with various criminal counts, of which eight were convicted
or pled guilty.
______
INTRODUCTORY REMARKS
Good morning, Chairman Enzi and members of the committee. Thank you
for inviting me here today to share information about the Department's
role in enforcing the provisions of the Employee Retirement Income
Security Act of 1974 (ERISA). I am Alan D. Lebowitz, the Deputy
Assistant Secretary for Program Operations of the Employee Benefits
Security Administration. I am here today representing the Employee
Benefits Security Administration (EBSA),\1\ and its employees, who work
diligently to protect the interests of plan participants and support
the growth of our private benefits system.
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\1\ Prior to its name change in February 2003, EBSA was known as
the Pension and Welfare Benefits Administration.
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My testimony will discuss EBSA's investigation of Capital
Consultants, LLC, its principals, Jeffrey and Barclay Grayson, and
numerous related investigations. Additionally, I will describe the
structure of EBSA's enforcement program and the process we follow to
conduct investigations of potential pension fraud.
Background
EBSA is responsible for administering and enforcing the fiduciary,
reporting and disclosure provisions of Title I of ERISA. Under ERISA,
the Secretary of Labor is responsible for protecting the rights and
financial security of more than 730,000 private pension plans and 6
million private health and welfare plans, which together hold
approximately $4.5 trillion in assets and cover more than 150 million
Americans.
EBSA headquarters are located in Washington, D.C., and its
enforcement activities are conducted in 10 regional offices and 5
district offices throughout the United States. EBSA's staff has the
highest average educational attainment of any agency in the Department
of Labor. EBSA has a total authorized staff of 887, including the 470
investigative staff members that work out of the field offices.
Our investigators have expertise in a wide variety of fields
including law, accounting, banking, securities, and business. We
recruit entry-level investigators and auditors who have specialized
experience in such areas as accounting, finance, economics, business,
insurance, securities, and banking, or who have graduated with advanced
degrees. For other than entry-level investigative positions, EBSA
requires specialized experience relevant to conducting complex
financial investigations, such as past work experience in government, a
law firm, a pension plan administration firm, or a bank trust
department.
Our Agency has an active training program for its employees. EBSA
provides a basic training course on the fiduciary provisions of ERISA,
as well as courses on investigative techniques, and criminal
enforcement to all investigative staff. Individuals without an
accounting background attend EBSA's Employee Benefit Plan Accounting
training. These courses are all residential programs of at least 2
weeks in length, and offer academic and practical instruction led by
EBSA staff and guests from government and the benefits field. In
addition, EBSA's Office of Enforcement provides annual field office
training on topics determined by enforcement priorities, regulatory and
legal developments, and industry trends. Also, some of our
investigators attend such courses as Financial Forensic Techniques at
the Federal Law Enforcement Training Center when training slots are
available. EBSA encourages on-board staff to acquire additional
training, and agency funding has enabled individuals to attain the
Certified Employee Benefits Specialist designation and other
credentials.
DOL shares responsibility and closely coordinates with the Internal
Revenue Service and the Pension Benefit Guaranty Corporation in its
administration and enforcement of the provisions of ERISA, which are
designed to protect participants and beneficiaries in employee benefit
plans sponsored by private-sector employers.
Investigative authority is vested in the Secretary of Labor by
Section 504 of ERISA, 29 U.S.C. 1134, which states in part:
``The Secretary shall have the power, in order to determine
whether any person has violated or is about to violate any
provision of this title or any regulation or order thereunder .
. . to make an investigation, and in connection therewith to
require the submission of reports, books, and records, and the
filing of data in support of any information required to be
filed with the Secretary under this title . . .''
In addition, the Comprehensive Crime Control Act of 1984 amended
ERISA Section 506(b) to give the Secretary explicit authority to
investigate criminal violations of Title 18 of the United States Code
insofar as they relate to employee benefit plans.
The broad provisions in Title I protect not only retirement and
health benefits, but other employee benefits as well. The core of Title
I of ERISA consists of provisions that address the conduct of persons
(fiduciaries) who are responsible for operating pension and welfare
benefit plans (including group health plans, life insurance,
disability, dental plans, etc.). Fiduciaries are required to discharge
their duties solely in the interest of plan participants and
beneficiaries for the exclusive purpose of providing benefits and
defraying reasonable expenses of plan administration. In discharging
their duties, fiduciaries must act prudently and in accordance with the
documents governing the plan, to the extent such documents are
consistent with ERISA. Certain transactions between an employee benefit
plan and ``parties in interest,'' including fiduciaries and others who
may be in a position to exercise improper influence over the plan, are
prohibited by ERISA. If a fiduciary's conduct fails to meet ERISA's
standards, the fiduciary is personally liable for any resulting losses
to the plan.
Subpoena Authority
Under section 504 of ERISA, the Secretary of Labor has authority to
issue administrative subpoenas for testimony and for the production of
documents. The Secretary does not need to show reasonable cause to
believe that a violation may exist unless the Secretary is seeking to
require a plan to submit books and records more than once in a 12-month
period or unless the Secretary is seeking to enter a place and inspect
books and records and question persons.
Typically, the subject of an EBSA subpoena complies by submitting
the requested documents or testimony. In cases where the subject fails
to respond adequately to the subpoena, the Department may enforce the
subpoena by bringing an enforcement action in Federal District Court.
The court may compel compliance with the subpoena by imposing
appropriate sanctions, including incarceration in cases of civil
contempt.
Investigative Process
Under the leadership of its Regional Director, the investigative
staff in each of EBSA's field offices conducts investigations to detect
and correct violations of Title I of ERISA and related criminal laws.
The Regional Directors report to EBSA's Deputy Assistant Secretary for
Program Operations through the Office of Enforcement in Washington,
which is responsible for coordinating the Agency's enforcement
activities. The Solicitor's Office, a separate Agency within the
Department of Labor that provides legal representation for the entire
Department, provides litigation and other legal support through their
National and Regional offices. The Solicitor's Office has about 75
attorneys devoted to ERISA in the National Office and the Regions at
this time.
In carrying out its enforcement responsibilities, EBSA conducts a
wide range of activities, including civil and criminal investigations,
to determine whether the provisions of ERISA and sections of Title 18
of the United States Code, as they relate to employee benefit plans,
have been violated. EBSA regularly works in coordination with other
Federal and State enforcement agencies, including the Department's
Office of Inspector General, the Internal Revenue Service, the
Department of Justice, the Federal Bureau of Investigation, the
Securities and Exchange Commission, the PBGC, the Federal banking
agencies, State insurance commissioners, and State attorneys general.
EBSA field offices manage their investigative activity within broad
guidelines identified by the Agency's long-term Strategic Enforcement
Plan (StEP), which was published in the Federal Register on April 6,
2000. The StEP establishes a general framework by which EBSA's
enforcement resources are focused to achieve the Agency's policy and
operational objectives as established by the Secretary and Assistant
Secretary. Short-term enforcement priorities are established annually,
through the Program Operating Plan (POP) Guidance issued by the
national office. Preparation of the POP Guidance begins with the
identification of recent enforcement trends, an analysis of particular
areas of noncompliance, and a review of current policy considerations.
In this manner EBSA shifts its enforcement resources to respond quickly
when new and emerging issues are spotted while staying within the long-
term framework established by the StEP.
It is through the POP Guidance that EBSA establishes each fiscal
year's national enforcement projects, provides guidance for choosing
regional enforcement projects, identifies any other specific policy
priorities that will require investigative resources, integrates the
Agency's GPRA goals into the planning process, and provides general
guidance with regard to the selection of investigations. EBSA has
currently identified five national enforcement projects. Each region is
required to make sufficient investigative resources available to
perform necessary investigative functions in connection with these
designated national projects. The national enforcement initiatives are
Health Fraud/Multiple Employer Welfare Arrangements (MEWAs), Employee
Contributions Project, Rapid ERISA Action Team (REACT), Orphan Plan
Project, and Employee Stock Ownership Plans (ESOPs). In addition, each
region is encouraged to develop regional enforcement projects to target
issues within its geographic jurisdiction.
EBSA field offices open investigations based on a variety of
considerations, including complaints from participants or other people,
referrals from the National Office or other government agencies,
computer targeting, and Form 5500 reviews (annual reports which contain
detailed information on the financial condition of plans). Our goal in
each investigation is to restore any money to the plan that was lost as
a result of fiduciary breaches, and ensure the safety of the plan in
the future.
Generally, a field investigator examines a plan to determine
whether it is operated in accordance with its terms and the rules set
forth in Title I of ERISA. The ERISA Enforcement Manual guides the
conduct of EBSA investigations. Of particular concern in most
investigations is whether the fiduciaries are carrying out their
fiduciary duties appropriately, especially with regard to monitoring
service providers; prudent investment of plan assets; the payment of
plan expenses; proper diversification of investments; avoidance of
self-dealing and prohibited transactions; the timely collection of
contributions; and adherence to required claims procedures.
The type of records examined during the investigation varies
depending on the nature of the case and the issues identified. Records
are requested at the outset of the investigation and are generally
identified in a letter sent to the Plan Administrator. All plan records
relating to the maintenance of the plan are reviewed, including the
plan document, trust agreement, collective bargaining agreement (if
any), summary plan description, summary annual report, Form 5500,
fidelity bond, and plan financial records. In addition, depending on
the type of plan and the reason for the case opening, written and
electronic records specific to a particular issue are requested. EBSA
has broad authority to issue administrative subpoenas to compel the
production of documents or testimony.
The amount of time it takes to complete an investigation varies
from a few weeks to several years depending on the complexity of the
issues involved, the cooperation of the parties in complying with
document requests and subpoenas, and whether the investigation is
resolved through voluntary compliance or through contested litigation.
Procedurally, an investigation is closed when no violations are found
and the Regional Director issues a no action letter. When violations
are detected, the Regional Director will determine whether to pursue
corrective action through voluntary compliance (VC). If so, the
Regional Director will issue a VC notice letter which advises plan
fiduciaries or other responsible parties of the results of the
investigation and the sections of ERISA violated and invites the
recipients to discuss how the violation(s) will be corrected and losses
restored to the plan. In cases where VC efforts failed or that involve
issues for which VC is not appropriate, the investigation may be
referred to the local Regional Solicitor's Office or the Plan Benefits
Security Division of the Solicitor's Office (SOL) in Washington, DC,
with a recommendation that litigation be initiated. If criminal
violations are found, the case is referred to the U.S. Attorney's
Office for consideration of prosecution.
Compliance and Participant Assistance
EBSA conducts numerous educational and outreach activities to
ensure fiduciaries understand and comply with their responsibilities
under the law. Our newest Campaign, ``Getting It Right--Know Your
Fiduciary Responsibilities,'' includes nationwide educational seminars
to help plan sponsors understand the law. The program teaches plan
sponsors steps for avoiding the most common problems EBSA encounters in
its enforcement activities, emphasizing the obligation of fiduciaries
to:
Understand the terms of their plans;
Select and monitor service providers carefully;
Make timely contributions to fund benefits;
Avoid prohibited transactions; and
Make timely disclosures to workers and reports to the
Government.
Nine seminars have been held to date and two more have been
scheduled.
EBSA has established the Voluntary Fiduciary Correction Program
(VFCP). The VFCP is a voluntary enforcement program that encourages
plan sponsors and their advisors to self-identify and correct many
types of violations of Title I of ERISA. The program allows plan
officials to identify and fully correct certain transactions such as
prohibited purchases, sales and exchanges, improper loans, delinquent
participant contributions, and improper plan expenses. The program
includes 18 specific transactions and their acceptable means of
correction, eligibility requirements, and application procedures. If an
eligible party documents the acceptable correction of a specified
transaction, EBSA will issue a no-action letter.
EBSA also provides assistance to plan participants and
beneficiaries regarding their plan benefits through Benefits Advisors.
The Benefits Advisors provide direct technical assistance to plan
participants and beneficiaries by responding to more than 163,000
inquiries and complaints to EBSA's toll free number and Web site in
fiscal year 2004 alone. They recovered over $76.4 million in benefits
for participants that were improperly denied through an informal
resolution process with the employer. Benefits Advisors explain how the
relevant statutes apply to the participant or beneficiary and inform
the employer about his or her responsibilities under the law. The
Benefit Advisors facilitate resolution of complaints without formal
investigation or litigation when possible. If the Benefits Advisors
determine that a complaint is valid but are unable to resolve it
informally, the complaint is referred for investigation. In 2004, EBSA
restored over $307.97 million from 1,236 investigations opened as a
result of referrals from Benefits Advisors. EBSA has a total of 111
Benefits Advisors in the national and field offices.
The Agency's Web site hosted 1.73 million unique Web visitors in
fiscal year 2004, giving them access to numerous FAQs, publications and
other useful compliance and consumer information. EBSA now has 63
publications in print; over 800,000 hard copies were distributed last
year, and the publications are posted on the Agency's Web site.
EBSA's Fiscal Year 2004 Enforcement Results
In fiscal year 2004, EBSA opened 4,131 civil cases and closed 4,399
civil cases. Over 60 percent of the civil cases closed (or 2,642 civil
cases) were closed with fiduciary results. This means that violations
of ERISA's fiduciary duties and prohibited transaction provisions were
found and corrected. During that year, EBSA referred 310 investigations
to the SOL for litigation. Often these referrals were resolved through
voluntary compliance rather than contested litigation. In fiscal year
2004, SOL filed litigation in 125 cases, an increase of 16 filings over
the prior fiscal year.
In fiscal year 2004, EBSA opened 205 criminal cases and closed 152
criminal cases. One hundred twenty-one individuals were indicted in
connection with EBSA's criminal investigations during the fiscal year.
Sixty-two criminal cases were closed with convictions or guilty pleas
during fiscal year 2004.
EBSA's investigations and compliance assistance efforts have a
large financial impact on plans and their participants. Total monetary
results for fiscal year 2004 were over $3 billion. These recoveries
include the value of actions which EBSA obtained to correct prohibited
transactions ($2.4 billion), money restored to the plan or plan
participants to correct losses resulting from fiduciary breaches
($199.7 million), assets which were protected from significant risk by
EBSA intervention that secured appropriate safeguards to protect the
plan assets and reduce the risk of future losses ($141.6 million), and
benefits recovered on behalf of individual plan participants ($76.4
million). Additionally, $264.6 million in corrections were achieved
through the VFCP.
Criminal Enforcement
Under the Comprehensive Crime Control Act of 1984, the Secretary of
Labor is given responsibility to investigate violations of the criminal
provisions of ERISA and Title 18 of the U.S. Code that relate to
employee benefit plans. To fulfill that responsibility, EBSA conducts
criminal investigations as part of its enforcement program. Field
managers consult with local U.S. Attorneys as early as possible in a
criminal investigation to determine whether there is prosecutorial
interest in the case and to receive any necessary direction.
EBSA's investigators evaluate the facts of every case for possible
criminal violations. A civil investigation may turn into a criminal
investigation when facts indicating possible criminal misconduct are
uncovered and the case is referred to the appropriate U.S. Attorney for
consideration of criminal prosecution. In some instances, civil and
criminal investigations will be conducted at the same time using
separate field investigators and supervisory oversight in order to
avoid the illegal disclosure of grand jury information as well as to
avoid the appearance of using the civil process to conduct a criminal
investigation. In other instances, the investigation will be conducted
as a criminal investigation only.
EBSA dedicates approximately 15 percent of its investigative
resources to criminal cases. EBSA's criminal investigations are often
worked jointly with agents from the Department of Labor's OIG, the
Office of Labor Management Standards in the Department's Employment
Standards Administration; the FBI; the IRS; and the Postal Inspection
Service. Criminal investigations cover a wide variety of pension and
welfare plans, including 401(k) plans and Multiple Employer Welfare
Arrangements (MEWAs), as well as service providers such as investment
managers and third party administrators.
Reporting and Disclosure
ERISA section 103 requires employee benefit plans to file an annual
report (Form 5500) with the Secretary of Labor. The Secretary has
authority under section 502(c)(2) of ERISA to assess civil penalties of
up to $1,100 per day against plan administrators who fail or refuse to
file complete and timely annual reports. EBSA identifies deficient,
late or non-filers by reviewing and maintaining the ERISA Form 5500
Database. Non-filers are usually identified through referrals from
other EBSA offices, the Internal Revenue Service, or computer
targeting.
Our primary objective is to obtain compliance with ERISA's
reporting and disclosure requirements. As a result, civil monetary
penalties are usually significantly abated, once compliance is
achieved. In fiscal year 2004, EBSA resolved 3,282 deficient filer
cases, assessing $3,058,000 in penalties. In fiscal year 2004, EBSA
also pursued 360 non-filer cases, assessing $829,500 in related
penalties and the Agency closed 276 late filer cases with $172,000 in
civil penalties.
EBSA's Delinquent Filer Voluntary Compliance (DFVC) program was
established to assist filers in correcting situations involving the
late filing or non-filing of Form 5500 annual reports. This program,
which began in 1995 and was significantly revised in 2002, encourages
delinquent filers to come forward and correct violations by offering
significantly reduced civil monetary penalties. Participation in this
program also protects plan filers from potential Internal Revenue
Service late filing penalties. Since the 2002 revision, the DFVC
program has received over 37,000 filings and $25.6 million in reduced
civil penalty payments. The DFVC program has been enormously successful
in getting these plans on our ``radar screen'' so they can be
effectively monitored.
When Congress enacted ERISA in 1974, it included a requirement that
a plan's annual report must include an audit opinion issued by an
independent qualified public accountant (IQPA) stating whether the
plan's financial statements (and other schedules required to be
included in the annual report) are presented fairly in conformity with
generally accepted accounting principles (GAAP). The audit requirement
is intended to ensure the integrity of financial information that is
incorporated in the annual reports. While ERISA's auditing provisions
have worked to provide DOL and plan participants and beneficiaries with
information about the safety of plan operations, experience has shown
that IQPA audits do not consistently meet professional standards. The
Department's Office of Inspector General separately identified this as
a high-risk area.
In fiscal year 2005, EBSA is placing special emphasis on reviewing
the audit practices of the 37 CPA firms that audit plans holding the
overwhelming majority of reported assets. This review will include
examining policies and procedures that these firms employ to assure the
quality and completeness of their audit work. As part of reviewing each
CPA firm, a sample of plan audit engagements will be selected for more
detailed review and analysis. In addition to reviewing these firms'
overall employee benefit plan audit practices, our Office of the Chief
Accountant will review audit workpapers of these and other firms to
assess the quality of the underlying audit work. As in the past,
deficient plan auditors will be referred to the AICPA's Professional
Ethics Division or to the appropriate State board of accountancy.
The accounting profession has also taken steps to improve the
quality of plan audits. In October 2003, the American Institute of
Certified Public Accountants (AICPA) created an Employee Benefit Plan
Audit Quality Center (Center) with the goal of improving the quality of
employee benefit plan audits. The Center is composed of CPA firms who,
through voluntary membership, made a commitment to audit quality by
adhering to the Center's membership requirements affecting their
management practices, including the designation of a partner-in-charge
of the quality of the firm's employee benefit plan audit practice. The
Center's membership requirements also include obtaining employee
benefit plan specific training; establishing and maintaining quality
control practices and procedures specific to the firm's employee
benefit plan audit practice; self monitoring of adherence to policies
and procedures; and making the results of their external peer review of
their audit practice publicly available. Over 900 firms joined the
Center in its first year of operation.
EBSA's First Investigation of Capital Consultants
Capital Consultants, Inc. (CCI) was an investment management firm
located in Portland, Oregon, that managed more than $900 million for
approximately 340 clients, many of which were employee benefit plans.
More than 60 of these employee benefit plans were jointly administered
union pension and welfare benefits plans located primarily in the
Pacific Northwest. In addition, CCI provided investment services to
numerous private trusts and individual clients.
The firm was owned and controlled by Jeffrey Grayson, who was its
chief executive officer, and his son, Barclay Grayson, who was its
president. Effective June 30, 1999, Capital Consultants underwent a
corporate restructuring and was renamed Capital Consultants, LLC.
Therefore, the company is sometimes referred to as CCI and sometimes
CCL, depending on the time frame, but its ownership, officers, and line
of business remained the same.
EBSA opened its first investigation of CCI in March 1992, based on
information indicating that CCI engaged in prohibited transactions and
self-dealing. In addition to the investigation of CCI, EBSA opened
three other investigations of plans that entered into investments
through CCI. They were the Oregon Laborers-Employers Pension Trust,
Northern Alaska Carpenters Retirement Fund, and the Morse Brothers,
Inc. Profit Sharing Plan.
The investigations were completed in March 1993 and referred to
SOL. The investigations revealed that CCI and Jeffrey Grayson violated
ERISA by entering into a fee arrangement with the Oregon Laborers-
Employers Pension Trust (Oregon Laborers Trust) that enabled them to
increase their own compensation. Investment managers usually charge
their clients a fee based on a percentage of assets under management.
Under CCI's fee arrangement with the Oregon Laborers Trust, CCI and
Grayson charged the usual fee based on assets under management and
charged an extra fee for real estate related investments. This extra
fee, which they called an ``acquisition fee,'' was charged each time
CCI made a real estate related investment for a plan. This was a one-
time fee based on a percentage of the gross asset value of the
transaction.
As investment manager, CCI and Jeffrey Grayson had the discretion
to determine the amount and frequency of the Oregon Laborers Trust's
real estate-related investments. Therefore, this fee arrangement placed
them in the position of being able to affect their own compensation.
Each time CCI and Jeffrey Grayson invested the Oregon Laborers Trust's
assets in another real estate-related investment; CCI and Jeffrey
Grayson would receive an additional fee.
The investigation did not, however, establish any evidence that CCI
and Jeffrey Grayson increased the Trust's real estate investments with
the motive of increasing their fees, and a number of trustees stated
that they specifically authorized the real estate related investments.
Nevertheless, under ERISA, a fiduciary cannot set its own compensation,
regardless of whether that fee is reasonable. To the extent CCI set its
fees, rather than a fiduciary independent of CCI, it violated ERISA.
The investigations also revealed that CCI invested more than $100
million of its clients' assets, including almost $90 million in loans
and $13 million in stock purchases, in Crown Pacific, Ltd. (Crown),
from which CCI received $5.2 million in fees as its consultant. This
allegation related not only to the Oregon Laborers Trust but also to
the other two plans under investigation, the Northern Alaska Carpenters
Retirement Fund and the Morse Brothers Profit Sharing Plan. The timing
of the transactions suggested that CCI and Jeffrey Grayson might have
invested their client plans' assets in Crown in return for consulting
fees from Crown. If true, this too would violate the self-dealing
provisions of ERISA. However, there was no direct evidence of a
relationship between CCI's consulting agreements with Crown and the
investments that CCI caused the Plans to make in Crown. Neither was
there direct evidence that CCI had invested plan assets in Crown
specifically because CCI was being paid the consulting fees. Jeffrey
Grayson actually performed consulting services for Crown, and there was
only one instance of a simultaneous correlation between CCI's loans to
Crown and Crown's payment of consulting fees to Jeffrey Grayson.
Moreover, the loans, which were secured by land, personal guaranties,
and stock did not appear to cause any losses to the plans. Therefore,
the decision was made to proceed solely on the fee arrangement issue.
As is its usual practice, pursuant to Executive Order 12778, SOL
engaged in settlement negotiations before filing the complaint and
reached agreement on a consent order, which was filed simultaneously
with the complaint in December 1995 in the U.S. District Court for the
District of Oregon. The consent order provided that CCI would pay the
Oregon Laborers Trust $2 million, and permanently enjoined CCI and
Jeffrey Grayson from operating and collecting fees under any fee
arrangement which would permit them to use their discretion over the
assets of ERISA-covered plans to affect the amount of their fees from
such plans. In February 1996, the Secretary of Labor assessed a 502(l)
civil penalty \2\ of $182,000 against Jeffrey Grayson and CCI. All of
the payments required by the consent order and civil penalty assessment
were made.
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\2\ Under Section 502(l) of ERISA, the Secretary of Labor must
assess a penalty against any recoveries obtained pursuant to settlement
or court order. In effect, the penalty, which is payable to the
Treasury, acts as a tax on settlements with the Secretary, creates a
disincentive to settlement, and makes it more difficult for the
Secretary to intervene in private actions without making settlement
much more difficult for private litigants. Moreover, because the assets
available to fund settlements are typically limited, the penalty often
comes from amounts that could otherwise have been paid to reduce plan
losses or enhance future benefits. Because of these problems, the
Department has, for many years, urged Congress to amend section 502(l)
of ERISA to make the penalties discretionary, rather than mandatory.
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EBSA's Second Investigation of Capital Consultants
EBSA's Seattle District Office opened its second investigation of
CCL in October 1997, based upon the receipt of a complaint filed
against Jeffrey Grayson and CCL by one of its plan clients, the A.G.C.
International Union of Operating Engineers Local 701 Pension Trust
Fund. The complaint's principal allegation was that CCL made imprudent
real estate investments for the plan, contrary to the Plan's investment
guidelines and without the approval of the trustees. Although the
Operating Engineers Fund settled its lawsuit in March 1998, EBSA's
investigations continued. The breadth of the fiduciary misconduct which
was uncovered in EBSA's second investigation was astonishing,
ultimately causing EBSA to open 58 investigations, devote over 13 civil
and criminal investigative staff years to date, collect and review
hundreds of thousands of pages of documents covering dozens of private
loans and equity investments, and institute 19 separate lawsuits
against plan trustees.
This second investigation of CCL involved CCL's investment of plan
assets in loans called ``collateralized notes,'' which were loans for
which the collateral consisted largely of the borrower's potential
revenues. These loans were unlike the loans to Crown, which were
secured by land, personal guaranties and stock. The bulk of the loans
were first made to Wilshire Credit Corporation (WCC) beginning in July
1995, more than 2 years after EBSA's first investigation had ended.
Subsequent loans were made largely to shell corporations and entities
that did not exist at the time of the first investigation. Thus, EBSA's
second CCL investigation did not involve the same loans, the same
borrowers, or the same type of collateral as the first case.
WCC was an Oregon S-Corporation, which acquired and serviced
performing and non-performing consumer loans. CCL and Jeffrey and
Barclay Grayson invested $160 million of their clients' assets in a
series of loans to WCC from July 1995 through October 1998. The loans
were ``interest only'' with a stipulated maturity date but no periodic
payments of principal. The collateral for the loans was cash amounting
to only 15 percent of the loan amount and WCC's expected revenues from
loan servicing contracts with third parties, primarily Wilshire
Financial Services Group (``WFSG''), a publicly traded corporation
managed by the principals of WCC. WCC's expected revenues were not
guaranteed, and if WCC's business volume declined, the fees from third
parties would not sufficiently collateralize the loan. The WCC loan
agreements were amended several times to allow for increased principal,
reduced collateral, extended maturity dates and lower interest rates.
This made the terms of the loans even less favorable to the investors
and increased the risk of nonperformance.
Shortly after the final loan was made to WCC, WFSG experienced
severe financial problems. As a result, WFSG was no longer an income
source for WCC, and WCC defaulted on the loans. In fact, WFSG filed for
Chapter 11 bankruptcy in March 1999, and its Reorganization Plan
indicated that the $160 million in loans from CCL clients to WCC,
consolidated into ``the Wilshire Loan,'' was valued at only $6.45
million on a liquidation basis.
Rather than report or acknowledge investors' losses on the WCC
investment, CCL and Jeffrey and Barclay Grayson engaged in a series of
transactions with other companies (Sterling Capital, LLC; Oxbow Capital
Partners, LLC; Brooks Financial, LLC and Beacon Financial Group, LLC)
to facilitate ``paper sales'' of all or a portion of the Wilshire Loan
at an inflated price. This concealment is what some have referred to as
the ``ponzi scheme.'' Essentially, CCL was able to continue to make
interest payments on the loans.
First, in November 1998, Daniel Dyer, a prior recipient of CCL
loans, created Sterling Capital LLC (Sterling). Sterling was a shell
company with no assets or revenues, yet it entered into an agreement
with CCL to purchase the Wilshire Loan for $160 million plus interest.
Sterling retained the right to terminate payments under the agreement
at any time and without further liability.
Subsequently, in January 1999, Dyer created Oxbow Fund I, a venture
capital fund which was to raise funds from investors through a private
offering and use the funds to pay for Sterling's purchase of the
Wilshire Loan. Oxbow Fund I was to be marketed by Dyer through his
ownership of a broker/dealer firm, CJM Planning Corporation. Dyer's
purchase of CJM Planning had been funded in 1998 through loans from
CCL's clients. Also, CCL assured its clients by letter that the
Wilshire Loan was being sold to Sterling for $160 million plus interest
at prime + 3.75 percent. CCL continued to value the Wilshire Loan at
$160 million and charged its clients a fee of 3 percent per annum on
the face value.
The Oxbow Fund I offering failed to attract any significant
investors. As a consequence, Dyer told CCL that Sterling could not make
the Wilshire Loan payments and he wanted to terminate the agreement.
Instead, Sterling entered into an agreement with CCL and another
company, Brooks Financial LLC (Brooks), whereby Brooks agreed to take
over two thirds of Sterling's loan obligation.
Brooks was a shell company formed by the owner of Florida
Automobile Finance Corporation, a sub-prime automobile finance company.
Brooks' agreement to purchase two-thirds of the Wilshire Loan was
specifically conditioned on receiving a $50 million loan from CCL. On
that same day, CCL entered into a loan agreement with Brooks,
committing CCL's clients to loan Brooks up to $50 million. Pursuant to
the agreement, CCL loaned $38.1 million to Brooks. CCL used $7.843
million from its clients' escrow account to make ``interest payments''
on the Wilshire Loan. CCL reported to its clients throughout this
period that Brooks was making timely interest payments and the clients'
investment in the Wilshire Loan was still worth a total of $160
million.
Then, in January 2000, CCL entered into a second loan agreement
committing its clients' funds to loaning up to another $50 million to
Beacon Financial LLC (Beacon), a newly created shell company under
common ownership with Brooks. CCL loaned approximately $33.88 million
to Beacon. Again, CCL retained another $7.37 million in escrow and used
this money to make monthly interest payments on the Wilshire Loan. CCL
repeatedly assured its clients that both Brooks and Beacon were
performing on their respective loans and were making the interest
payments on the Wilshire Loan. As a consequence, CCL continued to
report the Wilshire Loan at its original value of $160 million.
Throughout this period, CCL billed its clients 3 percent per annum
for investment management fees on the Wilshire Loan and the Brooks and
Beacon loans.
This not only caused their clients to pay fees in excess of those
amounts to which CCL and Jeffrey and Barclay Grayson were entitled, but
also concealed from their clients the declining value of their
investments. A diagram of the scheme is attached as Appendix A to the
written statement.
In February 2000, after completing its investigation of CCL and its
principals, EBSA referred the case to SOL for litigation. In July 2000,
per the SEC's request, a copy of the EBSA Report of Investigation,
along with voluminous exhibits, was provided to the SEC in Los Angeles.
The SEC and the Department decided to proceed against CCL jointly. This
litigation strategy was advantageous because the Department had an
indepth knowledge of the underlying facts and the SEC could more
readily have a receiver appointed over the entire business of CCL,
which included non-ERISA clients as well as the ERISA plans.
On September 20, 2000, SOL and SEC attorneys jointly met with
counsel for CCL and its principals in Oregon. Counsel for CCL and its
principals represented that their clients agreed to the receivership.
SOL and SEC attorneys negotiated the language of their respective
consent orders. The consent orders were presented to the U.S. District
Court and were entered by the Court on September 21, 2000. The court
orders appointed a receiver to make an accounting and to protect the
interests of CCL's ERISA plan clients and other investors. Through the
consent orders, the SEC was able to freeze the defendants' personal
assets and EBSA was able to enjoin them from doing business with ERISA
plans.
CCL has been in receivership since the suit was filed in September
2000. Settlements totaling more than $101 million have been reached in
private litigation, resolving claims brought by the court-appointed
receiver, trustees of ERISA plans and other investors against plan
fiduciaries and other parties who provided services to or had business
relationships with CCL.\3\ These settlement amounts were made a part of
the receivership estate. To date, the receiver has marshaled estate
assets of more than $189 million in part by collecting on outstanding
loans and selling CCL's assets. The receiver estimates that the total
amount of settlements and marshaled assets accumulated in the
receivership to date is $291 million of which about $193 million was
already distributed to CCL's private placement clients, including the
ERISA plans.
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\3\ Over $42 million was paid as a result of additional litigation
by the Department and others against plan fiduciaries and service
providers. This number is not included in the receivership assets.
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Barclay Grayson settled with the receiver and private plaintiffs
for $500,000, but the Department did not agree to the settlement. The
Department is currently in settlement negotiations with him to obtain
injunctive relief. Barclay Grayson is bankrupt and the Bankruptcy Court
has discharged all of his debts. Jeffrey Grayson suffered a stroke and
is currently in a nursing home. The receiver has sold Jeffrey Grayson's
property. His remaining assets have been frozen and he is currently
drawing a monthly stipend to cover his living and medical expenses.
The receiver has approximately $76.36 million remaining for
distribution. It will be distributed in accordance with the court-
approved distribution plan, minus the remaining receivership fees and
expenses, which are approximately $1 million. The total cost of the
receivership is $8.5 million. Overall, the employee benefit plans
recovered well over 70 percent of their losses through the
receivership, and many plans have recovered additional losses through
settlements of litigation resulting in at least $42 million.
Related Litigation Against Trustees
In addition to the investigation of CCL, EBSA's Seattle, San
Francisco, Cincinnati, Detroit, Kansas City, and Los Angeles offices
opened investigations of plans that invested in private placements
through CCL. In total, EBSA opened 58 related investigations and filed
19 lawsuits against trustees of 34 plans in Oregon, Idaho, California,
Nevada, Utah, Arizona, Colorado, Minnesota and Ohio. In these lawsuits,
the Department alleged that the trustees imprudently authorized CCL to
invest in high-risk investments (the collateralized notes), failed
adequately to investigate the merits of the investments, and failed
adequately to monitor the investments. In some cases, the complaints
also alleged that the investments violated the plans' own investment
guidelines, and that a number of trustees violated ERISA's self-dealing
provisions by accepting gratuities from CCL, including free hunting
trips, rifles, and tickets to football games.
In April 2002, the Department entered into consent orders with 10
plans and their trustees in the District of Oregon. The consent orders
provided for the resignation of a number of trustees and permanently
enjoined others from serving as ERISA fiduciaries or service providers.
The consent orders also provided for significant plan reforms,
including internal controls and procedures relating to plan
investments, contracts with service providers, written investment
guidelines, communication procedures, quarterly meetings, reviewing and
monitoring plan fiduciaries, the pursuit of litigation, and the
retention of experts to serve as investment monitors, managers,
auditors, and attorneys. The plan reforms are binding on the plans'
current trustees as well as successor trustees.
Contemporaneously with the filing of the consent orders, private
plaintiffs settled their class action lawsuits against the same plan
fiduciaries as a result of court-ordered mediation in which the
Department participated. In the mediation, the private litigants
obtained settlements totaling $15.8 million. Of that amount, $9.5
million was to be paid by Legion Insurance Company, which is currently
in liquidation in Pennsylvania. It is expected, however, that much or
all of that money eventually will be recovered as a result of private
negotiated settlements with the State insurance guaranty funds and
through the liquidation of Legion by the Pennsylvania State Insurance
Commission.
After the April 2002 settlements, the Department continued to
monitor the receivership and to pursue cases against other trustees. In
March 2004, the Department obtained consent orders providing for
restitution of $4.875 million to 12 employee benefit plans in
California, Nevada and Utah. The consent orders also required payment
of $975,000 in civil penalties to the Government. In addition, the
consent orders provided for plan reforms, including internal controls
and procedures relating to plan investments similar to those contained
in the earlier settlements. The consent orders resolved five lawsuits
and covered more than 17,000 participants and beneficiaries.
In January 2005, the Department obtained additional consent orders
providing for restitution of $4.31 million to 10 employee benefit plans
in Arizona, Colorado, Minnesota and Ohio that invested plan assets
through CCL. The consent orders also required payment of $862,413 in
civil penalties to the Government. In addition, the consent orders
provided for plan reforms similar to those in the other cases. The
consent orders resolved eight lawsuits and covered more than 25,000
participants and beneficiaries.
In total, the Department filed 19 lawsuits against plan trustees,
covering 34 employee benefit plans. The consent orders issued in these
cases called for the retirement or resignation of 51 plan trustees, and
permanent injunctions barring 31 plan trustees and one investment
advisor and his firm from serving as ERISA fiduciaries or service
providers. The orders also imposed significant internal reforms on the
34 affected plans to help prevent future fiduciary breaches. In
addition to the money collected by the Receiver, and the $15.8 million
recovery from the Oregon mediation (subject to Legion's insolvency
proceedings), the Department obtained $9.2 million to date in these
cases against trustees, and assessed and received a total of
$1,837,427.86 in civil penalties.
Criminal Investigations of CCL and Related Entities
In December 1999, in coordination with the U.S. Attorney's Office
for the District of Oregon in Portland, Oregon, EBSA and other law
enforcement agencies began the criminal investigation of the CCL
matter. By the summer of 2000, under the direction of the U.S.
Attorney's Office, the investigation had developed into a task force
which included EBSA, the Internal Revenue Service, the Department of
Labor's Office of Inspector General and the Office of Labor Management
Standards, as well as the Federal Bureau of Investigation.
The criminal investigations of Jeffrey and Barclay Grayson led to
other investigations surrounding the CCL debacle. By December 2000,
under the direction of the U.S. Attorney's Office, the task force
opened an investigation of Lawrence Mendelsohn and Andrew Wiederhorn,
owners of Wilshire Credit Corporation. In June 2001, the investigations
into CCL and its officers and employees expanded to Dean Kirkland, the
principal salesperson for CCL. These investigations revealed that CCL
had engaged in a practice of paying gratuities to trustees of union
sponsored employee benefit plans which invested funds through CCL.
From May 2002 to July 2002, the task force conducted a number of
criminal cases on various trustees of union sponsored benefit plans. As
a result of a task force investigation guilty verdicts and pleas were
obtained from Barclay Grayson and Dean Kirkland of CCL; plan trustees
John Abbott, Robert Mayhew, John Lontine, and Dennis Talbot; and Andrew
Wiederhorn and Larry Mendelsohn of Wilshire. Two other trustees Gary
Kirkland and Robert Legino were acquitted of gratuities charges after a
lengthy trial. The charges against Jeffrey Grayson were dismissed due
to Grayson's mental and physical impairment. An attorney from the
Department of Justice's Criminal Division participated in the
prosecution of the plan trustees and Dean Kirkland.
Conclusion
CCL owed a duty of undivided loyalty to its benefit plan investors
under ERISA. It breached that duty on an almost unprecedented scale
causing hundreds of millions of dollars in losses to both ERISA plans
and non-ERISA investors. It took an extraordinary effort to uncover
CCL's misconduct and to remedy the violation because the transactions
were extraordinarily complex and CCL consistently misled its investors
about the nature of the transactions and the existence and magnitude of
the resulting losses. There simply were no easy shortcuts available to
the Agency to uncover and remedy CCL's violations.
As a result of EBSA's efforts, in tandem with the work of the SEC
and private litigants, the participants of the ERISA-covered plans will
recover well over 70 percent of their losses. The Department and the
SEC had a receiver appointed to marshal CCL's assets and protect the
interest of CCL's investors. The Department also enjoined Jeffrey and
Barclay Grayson from doing business with ERISA plans. In total, the
Department filed 19 lawsuits against the plan trustees of 34 employee
benefit plans and obtained consent orders calling for the resignation
and retirement of 51 trustees and permanent injunctions barring 31
additional trustees (as well as one investment manager) from ever
serving as ERISA fiduciaries or service providers. The additional
injunctive relief obtained by the Department included significant plan
reforms, including internal controls and procedures relating to plan
investments that will provide long-term protections for plan
participants and beneficiaries. In addition to the money collected by
the receiver and through the mediation in the third party litigation,
the Department obtained restitution of $9.2 million to date in cases
against plan trustees. A total of $1,837,427.86 in civil penalties were
assessed and paid. A chart that describes the results of the civil
investigations is attached as Appendix B to the written statement.
EBSA's work also resulted in the Justice Department indicting 11
individuals for various crimes resulting from their participation in
the CCL debacle. Seven of these individuals pleaded guilty. One case
was dismissed, while two individuals were acquitted in a bench trial
and one was convicted. Four defendants served prison time ranging from
15 to 24 months, for a total of 81 months served, while others served
probation. A chart that describes the results of the criminal
investigations is attached as Appendix C to the written statement.
The scheme was of great sophistication and had a veneer of
respectability provided by the cooperation of so many professionals
including attorneys, accountants, and investment advisors. EBSA's
investigation uncovered a complex scheme to defraud investors through
the unprecedented use of newly created shell companies, paper
transactions, and false reports.
Finally, ERISA places the ultimate responsibility for the
governance of plans on individual plan fiduciaries. CCL was able to
find fiduciaries that failed to responsibly oversee the retirement
assets of the plans' participants and beneficiaries. These fiduciaries,
as well as CCL, failed to prudently discharge their obligations to the
plans' participants. All too often, the trustees (and their advisors)
failed to understand the nature of CCL's investments, to review the
investments, or even adhere to the plans' own investment guidelines.
Mr. Chairman and members of the committee, thank you again for the
opportunity to appear before you to discuss EBSA's enforcement program
and this very important case. This concludes my testimony. I would be
pleased to answer any questions you may have.
APPENDIX C
----------------------------------------------------------------------------------------------------------------
Name Date Jail Probation Fines Restitution Charges
----------------------------------------------------------------------------------------------------------------
Barclay Grayson.................. 11/20/01 24 36 (mo) $100 -0- Guilty Plea
18 U.S.C. 1341
John Abbott...................... 11/21/01 15 12 (mo) $200 $194,400 Guilty Plea
18 U.S.C. 1954;
26 U.S.C. 7206(1)
Larry Mendelsohn................. 5/24/04 -0- 18 (mo) $100 $105,454 Guilty Plea
26 U.S.C. 7206(1)
Jeffrey Grayson.................. 5/26/04 -0- -0- -0- -0- Dismissed
Andrew Wiederhorn................ 6/03/04 18 -0- $25,200 $2,000,000 Guilty Plea
18 U.S.C. 1954;
26 U.S.C. 7206(1)
Gary Kirkland.................... 6/15/04 -0- -0- -0- -0- Acquitted
Robert Legino.................... 6/15/04 -0- -0- -0- -0- Acquitted
Robert Mayhew.................... 7/01/04 -0- 12 (mo) $1,000 -0- Guilty Plea
29 U.S.C. 1131;
18 U.S.C. 2
John Lontine..................... 7/01/04 -0- 12 (mo) $1,000 -0- Guilty Plea
29 U.S.C. 1131;
18 U.S.C. 2
Dennis Talbott................... 7/15/04 -0- 36 (mo) $1,000 -0- Guilty Plea
18 U.S.C. 1954
Dean Kirkland.................... 2/10/05 24 24 (mo) $5,000 $15,756 Conviction
18 U.S.C. 1954;
18 U.S.C. 1343;
18 U.S.C. 1503(a)
----------------------------------------------------------------------------------------------------------------
Key
Title 18 U.S.C. 2 Principals.
Title 18 U.S.C. 1341 Frauds and Swindles.
Title 18 U.S.C. 1343 Fraud by wire, radio, or television.
Title 18 U.S.C. 1503(a) Influencing or injuring officer or juror generally.
Title 18 U.S.C. 1954 Offer, acceptance, or soliciation to influence operations of employee benefit plan.
Title 26 U.S.C. 7206(1) Making and subscribing a false return, statement or other document.
Title 29 U.S.C. 1131 Willful violation of Part I of ERISA.
The Chairman. Ms. Bovbjerg?
Ms. Bovbjerg. Thank you, Mr. Chairman, Senator Bingaman.
Thank you for inviting me here today to discuss past GAO work
on the Department of Labor's enforcement of ERISA.
Labor's Employee Benefit Security Administration, EBSA, is
charged with safeguarding the economic interests of the more
than 150 million people who participate in employee benefit
plans. Recent abuses by plan fiduciaries, trading scandals in
mutual funds, and the bankruptcy of companies like United
Airlines and Enron have exposed vulnerabilities in our
country's pension system. They also underscore the importance
of legal protections for workers and the vigorous enforcement
of such protections.
Today, I will discuss three things. First, the ways in
which EBSA enforces ERISA. Second, the measures EBSA has taken
to improve. And finally, the challenges that remain. My remarks
are based on a body of GAO work on pension vulnerabilities and
ERISA enforcement.
First, EBSA's enforcement practices. EBSA's enforcement
program is conducted by its regional offices and focuses
primarily on investigations. Investigations result mainly from
participant complaints, but are also initiated as part of a
coordinated national enforcement effort. For example, one of
EBSA's current national priorities focuses on employee
contributions to defined benefit plans, which is a type of
retirement saving that has grown dramatically in recent years.
In an effort to leverage its enforcement resources, EBSA
also carries out education programs for plan participants,
sponsors, and service providers. For participants, EBSA seeks
to establish an environment where individual law workers can
recognize potential legal violations and report them. For
sponsors and service providers, EBSA has launched campaigns to
explain and publicize fiduciary responsibilities under ERISA.
In addition, EBSA has initiated the voluntary fiduciary
correction program, which encourages plan officials to identify
and correct ERISA violations on their own. EBSA's
investigations, education, and voluntary corrections are
intended to comprise a multifaceted approach to enforcement.
Let me now turn to recent improvements in EBSA's
enforcement. In the past, most recently in 2002, we reported
weaknesses in this program that we felt affected its efficiency
and effectiveness. Since then, EBSA has taken a number of steps
to improve. For example, we observed that EBSA knew little
about the levels of compliance with different aspects of the
law, making it difficult, if not impossible, to really target
enforcement resources at the areas of greatest need.
In response, EBSA has completed a compliance study on large
multiemployer health plans and is currently conducting a study
to determine the level of timely employee contribution
transmission. Although these studies are more limited than the
broader survey we believe is needed, they represent important
steps toward better targeting of resources.
And such improvement, as Mr. Lebowitz says, has borne
fruit. Prohibited transactions corrected and plan assets
restored rose from $566 million in 2002 to $2.5 billion in
2004.
But despite these improvements, of course, challenges
remain, and some have their roots in the law. The primary
source of pension information, for example, the Form 5500, is
not timely and it hinders its utility as an enforcement tool.
Statutory deadlines allow sponsors 285 days to file information
and, as we reported last week in our report on this topic,
processing adds more time. As a result, EBSA today is using
2003 Form 5500 data for enforcement targeting, which does
little to help identify compliance problems as they emerge.
EBSA is also hobbled by ERISA in assessing penalties. Work
we did last year for Senator Kennedy highlighted EBSA's
inability to assess penalties in certain circumstances. As a
consequence, EBSA has fewer enforcement tools than other
regulatory agencies like the SEC.
But not all enforcement shortcomings stem from legal
restrictions. Some would benefit from managerial changes. For
example, recent evidence of abusive trading practices in mutual
funds and conflicts of interest by pension consultants
highlight the need for EBSA to work even more closely with the
SEC, as they did with Capital Consultants. Last year, these
agencies each acted separately to address mutual fund issues,
but some of the actions originally proposed by the SEC could
have had adverse effects on pension funds as investors. These
two agencies should have worked more closely together on these
issues, as pension plans invest about one-fifth of their
capital in mutual funds. Certainly limited enforcement
resources could be better utilized if the agencies better
coordinated in areas of mutual interest.
To conclude, EBSA is a relatively small agency with a
crucially important responsibility of protecting retirement
income savings at a time when private pensions and Social
Security are increasingly under fiscal pressure. Although the
agency strengthened its enforcement program, pension fraud
continues to harm working Americans and threaten their
standards of living in retirement. Better law and continuous
improvement in enforcement will be necessary to assure workers
that pension promises made will be retirement income promises
delivered.
That concludes my statement, Mr. Chairman. I would be happy
to answer any questions you have.
The Chairman. Thank you very much.
[The prepared statement of Ms. Bovbjerg follows:]
Prepared Statement of Barbara D. Bovbjerg
EMPLOYEE BENEFITS SECURITY ADMINISTRATION
IMPROVEMENTS HAVE BEEN MADE TO PENSION ENFORCEMENT PROGRAM BUT
SIGNIFICANT CHALLENGES REMAIN
Why GAO Did This Study
Congress passed the Employee Retirement Income Security Act 1874
(ERISA) to address public concerns over the mismanagement and abuse of
private sector employee benefit plans by some plant sponsors and
administrators. The Department of Labor's Employee Benefits Security
Administration (EBSA) shares responsibility with the Internal Revenue
Service and the Pension Benefit Guaranty Corporation for enforcing
ERISA. EBSA Works to safeguard the economic interest of more than 150
million people who participate in an estimated 6 million employee
benefit plans with assets in excess of $4.4 trillion. EBSA plays a
primary role in ensuring that employee benefit plans operate in the
interests of plan participants, and the effective management of its
enforcement program is pivotal to ensuring the economic security of
workers and retirees.
Recent scandals involving abuses by pension plan fiduciaries
service providers, as well as trading scandals in mutual funds that
affected plan participants and other investors highlight the importance
of ensuring that EBSA has an effective and efficient enforcement
program. Accordingly, this testimony focuses on describing EBSA's
enforcement strategy, EBSA's efforts to address weaknesses in its
enforcement program along with the challenges that remain.
What GAO Found
EBSA's enforcement strategy is a multifaceted approach of targeted
plan investigations. To leverage its enforcement resources, EBSA
provides education to plan participants and plan sponsors. EBSA allows
its regional offices the flexibility to tailor their investigations to
address the unique issues in the regions, within a framework
established by EBSA's Office of Enforcement. The regional offices then
have a significant degree of autonomy in developing and carrying out
investigations using a mixture of approaches and techniques they deem
most appropriate. Participant leads are still the major source of
investigations. EBSA officials told us that they open about 4,000
investigations into actual and potential violations of ERISA annually.
To supplement their investigations, the regions conduct outreach
activities to educate both plan participants and sponsors. The purpose
of these efforts is to gain participants' help in identifying potential
violations and to educate sponsors in properly managing their plans and
avoiding violations. Finally, EBSA maintains a Voluntary Fiduciary
Correction Program through which plan officials can voluntarily report
and correct some violations without penalty.
EBSA has taken steps to address many of the recommendations we have
made over the years to improve its enforcement program, including
assessing the level and types of noncompliance with ERISA, improving
sharing of best investigative practices, and developing a human capital
strategy to better respond changes in its workforce. EBSA reported a
significant increase in enforcement results for fiscal year 2004,
including $3.1 billion in total monetary results and closing about
4,400 investigations, with nearly 70 percent of those cases resulting
in corrections of ERISA violations. Despite this progress, EBSA
continues to face a number of significant challenges to its enforcement
program, including (1) the lack of timely and reliable plan
information, which is highlighted by the fact that EBSA is currently
using plan year 2002 and 2003 plan information for its computer
targeting, (2) restrictive statutory requirements that limit its
ability to assess certain penalties, and (3) the need to better
coordinate enforcement strategies with the Securities and Exchange
Commission, which is highlighted by recent scandals involving the
trading practices and market timing in mutual funds and conflicts of
interest by pension consultants.
Mr. Chairman and members of the committee, I am pleased to be here
today to provide an overview of our past work reviewing the Department
of Labor's Employee Benefits Security Administration (EBSA) enforcement
program. EBSA works to safeguard the economic interest of more than 150
million people who participate in an estimated 6 million employee
benefit plans with assets in excess of $4.4 trillion. EBSA plays a
primary role in ensuring that employee benefit plans operate in the
interests of plan participants, and the effective management of its
enforcement program is pivotal to ensuring the economic security of
workers and retirees.
Congress passed the Employee Retirement Income Security Act of 1974
(ERISA) to address public concerns over the mismanagement and abuse of
private sector employee benefit plans by some plan sponsors and
administrators. ERISA is designed to protect the rights and interests
of participants and beneficiaries of employee benefit plans and
outlines the responsibilities of the employers and administrators who
sponsor and manage these plans. The recent bankruptcies of some large
corporations and the effects on employees' retirement savings and the
Federal pension insurance program expose certain vulnerabilities in our
private pension system. Such problems point out the need for
comprehensive pension reform. Also, recent scandals involving abuses by
pension plan fiduciaries and service providers, as well as trading
scandals in mutual funds that affected plan participants and other
investors highlight the importance of ensuring that EBSA has an
effective and efficient enforcement program.
Today, I would like to discuss the evolution of EBSA's enforcement
program and the challenges that remain. GAO has conducted several
studies of ERISA enforcement issues, and my statement is largely based
on that work.
In summary, EBSA's enforcement strategy is a multifaceted approach
of targeted plan investigations supplemented by outreach and education.
To leverage its enforcement resources to prevent and detect violations
and promote overall compliance with ERISA, EBSA provides education to
plan participants and sponsors and allows the voluntary self-correction
of certain transactions without penalty. EBSA's education program for
plan participants aims to increase their knowledge of their rights and
benefits under ERISA. EBSA has taken steps to address many of the
recommendations we have made over a number of years to improve its
enforcement program, including assessing the level and types of
noncompliance with ERISA, improving sharing of best investigative
practices, analyzing the sources of cases, and developing a human
capital strategy to better respond changes in its workforce. EBSA
reported a significant increase in enforcement results for fiscal year
2004, including $3.1 billion in total monetary results and closing
nearly 4,400 investigations, with nearly 70 percent of those cases
resulting in corrections of ERISA violations. Despite this progress,
EBSA continues to face a number of significant challenges to its
enforcement program. Such challenges include lack of timely and
reliable plan information, restrictive statutory requirements that
limit its ability to assess certain penalties, and the need to better
coordinate enforcement strategies with the Securities and Exchange
Commission. As we have previously reported, legislative changes will be
required to address some of these issues. Furthermore, the Congress
should consider providing EBSA with additional enforcement tools, such
as enhanced penalty authority, to meet these challenges. Finally, EBSA
needs to continue to look for ways to better target investigations to
leverage its limited resources.
Background
Three agencies share responsibility for enforcing ERISA: the
Department of Labor (EBSA), the Department of the Treasury's Internal
Revenue Service (IRS), and the Pension Benefit Guaranty Corporation
(PBGC). EBSA enforces fiduciary standards for plan fiduciaries of
privately sponsored employee benefit plans to ensure that plans are
operated in the best interests of plan participants. EBSA also enforces
reporting and disclosure requirements covering the type and extent of
information provided to the Federal Government and plan participants,
and seeks to ensure that specific transactions prohibited by ERISA are
not conducted by plans.\1\ Under Title I of ERISA, EBSA conducts
investigations of plans and seeks appropriate remedies to correct
violations of the law, including litigation when necessary.\2\ IRS
enforces the Internal Revenue Code (IRC) and provisions that must be
met which give pension plans tax-qualified status, including
participation, vesting, and funding requirements. The IRS also audits
plans to ensure compliance and can levy tax penalties or revoke the
tax-qualified status of a plan as appropriate. PBGC, under Title IV of
ERISA, provides insurance for participants and beneficiaries of certain
types of tax-qualified pension plans, called defined benefit plans,
that terminate with insufficient assets to pay promised benefits.
Recent terminations of large, underfunded plans have threatened the
long-term solvency of PBGC. As a result, we placed PBGC's single-
employer insurance program on our high-risk list of programs needing
further attention and congressional action.\3\
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\1\ Certain transactions are prohibited under the law to prevent
dealings with parties who may be in a position to exercise improper
influence over the plan. In addition, fiduciaries are prohibited from
engaging in self-dealing and must avoid conflicts of interest that
could harm the plan.
\2\ Prior to 1979, there was overlapping responsibility for
administration of the parallel provisions of Title I of ERISA and the
Internal Revenue Code (IRC) by the Department of Labor and IRS,
respectively.
\3\ See GAO, Pension Benefit Guaranty Corporation Single-Employer
Program: Long-Term Vulnerabilities Warrant High-Risk Designation, GAO-
03-1050SP (Washington, D.C.: Jul. 23, 2003).
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ERISA and the IRC require plan administrators to file annual
reports concerning, among other things, the financial condition and
operation of plans. EBSA, IRS, and PBGC jointly developed the Form 5500
so that plan administrators can satisfy this annual reporting
requirement. Additionally, ERISA and the IRC provide for the assessment
or imposition of penalties for plan sponsors not submitting the
required information when due.
About one-fifth of Americans' retirement wealth is invested in
mutual funds, which are regulated by the Securities and Exchange
Commission (SEC), primarily under the Investment Company Act of 1940.
The primary mission of the SEC is to protect investors, including
pension plan participants investing in securities markets, and maintain
the integrity of the securities markets through extensive disclosure,
enforcement, and education. In addition, some pension plans use
investment managers to oversee plan assets, and these managers may be
subject to other securities laws.
EBSA Uses a Multifaceted Enforcement Strategy
EBSA's enforcement strategy is a multifaceted approach of targeted
plan investigations supplemented by providing education to plan
participants and plan sponsors. EBSA allows its regions the flexibility
to tailor their investigations to address the unique issues in their
regions, within a framework established by EBSA's Office of
Enforcement. The regional offices then have a significant degree of
autonomy in developing and carrying out investigations using a mixture
of approaches and techniques they deem most appropriate. Participant
leads are still the major source of investigations. To supplement their
investigations, the regions conduct outreach activities to educate both
plan participants and sponsors. The purpose of these efforts is to gain
participants' help in identifying potential violations and to educate
sponsors in properly managing their plans and avoiding violations. The
regions also process applications for the Voluntary Fiduciary
Correction Program (VFCP) through which plan officials can voluntarily
report and correct some violations without penalty.
EBSA Enforces ERISA Primarily Through Targeted Investigations
EBSA attempts to maximize the effectiveness of its enforcement
efforts to detect and correct ERISA violations by targeting specific
cases for review. In doing so, the Office of Enforcement provides
assistance to the regional offices in the form of broad program policy
guidance, program oversight, and technical support. The regional
offices then focus their investigative workloads to address the needs
specific to their region. Investigative staff also have some
responsibility for selecting cases.
The Office of Enforcement identifies national priorities--areas
critical to the well-being of employee benefit plan participants and
beneficiaries nationwide--in which all regions must target a portion of
their investigative efforts. Currently, EBSA's national priorities
involve, among other things, investigating defined contribution pension
plan and health plan fraud. Officials in the Office of Enforcement said
that national priorities are periodically re-evaluated and are changed
to reflect trends in the area of pensions and other benefits.
On the basis of its national investigative priorities, the Office
of Enforcement has established a number of national projects.
Currently, there are five national projects pertaining to a variety of
issues including employee contributions to defined contribution plans,
employee stock ownership plans (ESOP), and health plan fraud. EBSA's
increasing emphasis on defined contribution pension plans reflects the
rapid growth of this segment of the pension plan universe. In fiscal
year 2004, EBSA had monetary results of over $31 million and obtained
10 criminal indictments under its employee contributions project.
EBSA's most recent national enforcement project involves investigating
violations pertaining to ESOPs, such as the incorrect valuation of
employer securities and the failure to provide participants with the
specific benefits required or allowed under ESOPs, such as voting
rights, the ability to diversify their account balances at certain
times, and the right to sell their shares of stock.\4\ Likewise, more
attention is being given to health plan fraud, such as fraudulent
multiple employer welfare arrangements (MEWAs).\5\ In this instance,
EBSA's emphasis is on abusive and fraudulent MEWAs created by promoters
that attempt to evade State insurance regulations and sell the promise
of inexpensive health benefit insurance but typically default on their
benefit obligations.\6\
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\4\ In 2002, we reported that the financial collapse of the Enron
Corporation and other large firms and the effects on workers and
retirees had raised questions about retirement funds being invested in
employer securities and the laws governing such investments. We
recommended that the Congress consider amending ERISA to require plan
sponsors to provide defined contribution plan participants with an
investment education notice that includes information on the risks of
certain investments such as employer securities and the benefits of
diversification. See GAO, Private Pensions: Participants Need
Information on the Risks of Investing in Employer Securities and the
Benefits of Diversification, GAO-02-943 (Washington, DC: Sept. 6,
2002).
\5\ A MEWA is a welfare benefit plan or any other arrangement
(other than an employee welfare benefit plan), which is established or
maintained for the purpose of offering or providing a welfare benefit
to employees of two or more employers. Typically, such arrangements
often involve small employers that are either unable to find or cannot
afford the cost of health care coverage for their employees.
\6\ See GAO, Employee Benefits: States Need Labor's Help Regulating
Multiple Employer Welfare Arrangements, GAO/HRD-92-40 (Washington,
D.C.: Mar. 10, 1992).
---------------------------------------------------------------------------
EBSA regional offices determine the focus of their investigative
workloads based on their evaluation of the employee benefit plans in
their jurisdiction and guidance from the Office of Enforcement. For
example, each region is expected to conduct investigations that cover
their entire geographic jurisdiction and attain a balance among the
different types and sizes of plans investigated. In addition, each
regional office is expected to dedicate some percentage of its staff
resources to national and to regional projects--those developed within
their own region that focus on local concerns. In developing regional
projects, each regional office uses its knowledge of the unique
activities and types of plans in its jurisdiction. For example, a
region that has a heavy banking industry concentration may develop a
project aimed at a particular type of transaction commonly performed by
banks. We previously reported that the regional offices spend an
average of about 40 percent of their investigative time conducting
investigations in support of national projects and almost 25 percentage
of their investigative time on regional projects.
EBSA officials said that their most effective source of leads on
violations of ERISA is from complaints from plan participants. Case
openings also originate from news articles or other publications on a
particular industry or company as well as tips from colleagues in other
enforcement agencies. Computer searches and targeting of Form 5500
information on specific types of plans account for only 25 percent of
case openings. In 1994, we reported that EBSA had done little to test
the effectiveness of the computerized targeting runs it was using to
select cases. Since then, EBSA has scaled down both the number of
computerized runs available to staff and its reliance on these runs as
a means of selecting cases.\7\ Investigative staff are also responsible
for identifying a portion of their cases on their own to complete their
workloads and address other potentially vulnerable areas.
---------------------------------------------------------------------------
\7\ See GAO, Pension Plans: Stronger Labor ERISA Enforcement Should
Better Protect Plan Participants, GAO/HEHS-94-157 (Washington, D.C.:
August 8, 1994).
---------------------------------------------------------------------------
As shown in figure 1, EBSA's investigative process generally
follows a pattern of selecting, developing, resolving, and reviewing
cases. EBSA officials told us that they open about 4,000 investigations
into actual and potential violations of ERISA annually. According to
EBSA, its primary goal in resolving a case is to ensure that a plan's
assets, and therefore its participants and beneficiaries, are
protected. EBSA's decision to litigate a case is made jointly with the
Department of Labor's Regional Solicitors' Offices. Although EBSA
settles most cases without going to court, both the Agency and the
Solicitor's Office recognize the need to litigate some cases for their
deterrent effect on other providers.
As part of its enforcement program, EBSA also detects and
investigates criminal violations of ERISA. From fiscal years 2000
through 2004, criminal investigations resulted in an average of 54
cases closed with convictions or guilty pleas annually. Part of EBSA's
enforcement strategy includes routinely publicizing the results of its
litigation efforts in both the civil and criminal areas as a deterrent
factor.
EBSA Uses Education, Outreach, and a Voluntary Fiduciary Correction
Program to Supplement Its Investigations
To further leverage its enforcement resources, EBSA provides
education to plan participants, sponsors, and service providers and
allows the voluntary self-correction of certain transactions without
penalty. EBSA's education program for plan participants aims to
increase their knowledge of their rights and benefits under ERISA. For
example, EBSA anticipates that educating participants will establish an
environment in which individuals can help protect their own benefits by
recognizing potential problems and notifying EBSA when issues arise.
The Agency also conducts outreach to plan sponsors and service
providers about their ongoing fiduciary responsibilities and
obligations under ERISA.
At the national level, EBSA's Office of Participant Assistance
develops, implements, and evaluates agencywide participant assistance
and outreach programs. It also provides policies and guidance to other
EBSA national and regional offices involved in outreach activities.
EBSA's nationwide education campaigns include a fiduciary education
campaign, launched in May 2004, to educate plan sponsors and service
providers about their fiduciary responsibilities under ERISA. This
campaign also includes educational material on understanding fees and
selecting an auditor.
EBSA's regional offices also assist in implementing national
education initiatives and conduct their own outreach to address local
concerns. The regional offices' benefit advisers provide written and
telephone responses to participants. Benefit advisers and investigative
staff also speak at conferences and seminars sponsored by trade and
professional groups and participate in outreach and educational efforts
in conjunction with other Federal or State Agencies. At the national
level, several EBSA offices direct specialized outreach activities. As
with EBSA's participant-directed outreach activities, its efforts to
educate plan sponsors and service providers also rely upon Office of
Enforcement staff and the regional offices for implementation. For
example, these staff make presentations to employer groups and service
provider organizations about their ERISA obligations and any new
requirements under the law, such as reporting and disclosure
provisions.
To supplement its investigative programs, EBSA is promoting the
self-disclosure and self-correction of possible ERISA violations by
plan officials through its Voluntary Fiduciary Correction Program.\8\
The purpose of the VFCP is to protect the financial security of workers
by encouraging plan officials to identify and correct ERISA violations
on their own. Specifically, the VFCP allows plan officials to identify
and correct 18 transactions, such as delinquent participant
contributions and participant loan repayments to pension plans. Under
the VFCP, plan officials follow a process whereby they (1) correct the
violation using EBSA's written guidance; (2) restore any losses or
profits to the plan; (3) notify participants and beneficiaries of the
correction; and (4) file a VFCP application, which includes evidence of
the corrected transaction, with the EBSA regional office in whose
jurisdiction it resides. If the regional office determines that the
plan has met the program's terms, it will issue a ``no action'' letter
to the applicant and will not initiate a civil investigation of the
violation, which could have resulted in a penalty being assessed
against the plan.
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\8\ In April 2005, the Department of labor published in the Federal
Register a revised VFCP that according to EBSA, simplified and expanded
the original program.
---------------------------------------------------------------------------
EBSA Has Taken Steps to Address Weaknesses in Its Enforcement Program,
but Significant Challenges Remain
EBSA has taken steps to address many of the recommendations we have
made over a number of years to improve its enforcement program,
including assessing the level and types of noncompliance with ERISA,
improving sharing of best investigative practices, and developing a
human capital strategy to better respond changes in its workforce. EBSA
reported a significant increase in enforcement results for fiscal year
2004, including $3.1 billion in total monetary results and closing
nearly 4,400 investigations, with nearly 70 percent of those cases
resulting in corrections of ERISA violations. Despite this progress,
EBSA continues to face a number of significant challenges to its
enforcement program, including the lack of timely and reliable plan
information, restrictive statutory requirements that limit its ability
to assess certain penalties, and the need to better coordinate
enforcement strategies with the SEC.
EBSA Has Made Progress in Improving Its Enforcement Program
EBSA has taken a number of steps, including addressing
recommendations from our prior reports that have improved its
enforcement efforts across a number of areas. For example, EBSA has
continued to refine its enforcement strategy to meet changing
priorities and provided additional flexibility to its regional office
to target areas of investigations. More recently, EBSA implemented a
series of recommendations from our 2002 enforcement report that helped
it strategically manage its enforcement program, including conducting
studies to determine the level of and type of noncompliance with ERISA
and developing a Human Capital Strategic Management Plan (see table
1).\9\
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\9\ See GAO, Pension and Welfare Benefits Administration:
Opportunities Exist for Improving Management of the Enforcement
Program, GAO-02-232 (Washington, DC: March 15, 2002).
Table 1: Examples of EBSA's Actions in Response to GAO Recommendations
to Improve its Enforcement Program
------------------------------------------------------------------------
GAO recommendation Examples of EBSA
GAO observation to EBSA Actions
------------------------------------------------------------------------
EBSA had not adequately Develop a cost- In fiscal year
estimated the nature of effective 2001 conducted
employee benefit plans' strategy for national
noncompliance with ERISA assessing the compliance study
provisions. level and type of of group health
ERISA plans' compliance
noncompliance with new health
among employee care laws in
benefit plans. ERISA.
In 2003 conducted
compliance study
focusing on large
multiemployer
health plans.
Currently
conducting
baseline study to
determine the
level of
compliance with
ERISA
requirements on
timely
transmission of
employee
contributions to
pension plans.
EBSA had not routinely analyzed Conduct regular Conducted analysis
the full range of cases reviews of the on cases closed
investigated to determine which sources of cases in fiscal years
sources were the most effective that lead to 2001, 2002, and
in terms of detecting and investigations. 2003.
correcting violations. Agreed to perform
reviews of the
sources of cases
that lead to
investigations on
an annual basis
as long as
resources permit.
EBSA did not coordinate the Coordinate the Established a Best
sharing of best practices sharing of best Practices Sharing
information among its regions practices Team composed of
regarding case selection and information among enforcement staff
investigative techniques. regions relating and regional
to the optimum representatives.
and most Developed an
productive intranet site to
techniques for allow EBSA
selecting and investigators to
conducting share best
investigations. practices, such
as investigative
plans, subpoenas,
letters, and
investigative
guides.
EBSA lacked a centrally Develop a closed In fiscal year
coordinated quality review case quality 2003, an EBSA
process to ensure that its review process team composed of
investigations are conducted in that ensures the Office of
accordance with its independence of Enforcement and
investigative procedures.. reviewers and field managers
sufficiently developed a
focuses on closed case
substantive quality review
technical issues. program that
focuses on
substantive
technical case
issues and is
reported
centrally. The
program also
includes
procedures to
ensure the
independence of
the case
reviewer.
Certain requirements, such as Analyze barriers EBSA modified key
notifying plan participants of to participation features of the
potential violations and in the VFCP and program
levying excise taxes on explore ways to eliminating
prohibited transactions, may reduce them. notice
hinder participation in the requirements to
VFCP.. participants, and
provided a
limited excise
tax exemption for
those who
participate in
the program.
EBSA gave limited attention to Conduct a EBSA conducted an
human capital management comprehensive employee
despite anticipated workforce review of its workforce
and enforcement workload future human analysis and an
changes. For example, the capital needs, employee training
Agency had not considered including the needs assessment.
succession planning and size of its In 2003, EBSA
workforce retention, which workforce; the issued its Human
could undermine the continuity skills and Capital Strategic
and effectiveness of its abilities needed; Management Plan.
enforcement program.. succession The plan
planning identified
challenges; and strategies that
staff deployment address current
issues. and project
skills shortages,
anticipated
future staffing
needs, competency
requirements to
ensure that
employees possess
or acquire the
critical skills
needed to
accomplish
program mission
and functions,
and the
recognition and
reward of quality
performance.
------------------------------------------------------------------------
Source: GAO summary and analysis of EBSA documents.
EBSA has reported a substantial increase in results from its
enforcement efforts since our last review. For fiscal year 2004, EBSA
closed 4,399 civil investigations and reported $3.1 billion in total
results, including $2.53 billion in prohibited transactions corrected
and plan assets protected, up from $566 million in fiscal year 2002.
Likewise, the percentage of civil investigations closed with results
rose from 58 percent to 69 percent. Also, applications received for the
VFCP increased from 55 in fiscal year 2002 to 474 in 2004. EBSA has
been able to achieve such results with relatively small recent
increases in staff. Full-time equivalent (fte) authorized staff levels
increased from 850 in fiscal year 2001 to 887 ftes in fiscal year 2005.
The President's budget for fiscal year 2006 requests no additional
ftes.
Untimely and Incomplete Plan Information Continues to Hinder
Enforcement Efforts
Previously, we and others have reported that ERISA enforcement was
hindered by incomplete, inaccurate, and untimely plan data.\10\ We
recently reported that the lack of timely and complete Form 5500 data
affects EBSA's use of the information for enforcement purposes, such as
computer targeting and identifying troubled plans.\11\ EBSA uses Form
5500 information as a compliance tool to identify actual and potential
violations of ERISA. Although EBSA has access to Form 5500 information
sooner than the general public, the Agency is affected by the statutory
filing deadlines, which can be up to 285 days after plan year end, and
long processing times for paper filings submitted to the ERISA Filing
Acceptance System. EBSA receives processed Form 5500 information on
individual filings on a regular basis once a form is completely
processed. However, Agency officials told us that as they still have to
wait for a sufficiently complete universe of plan filings from any
given plan year to be processed in order to begin their compliance
targeting programs. As a result, EBSA officials told us that they are
currently using plan year 2002 and 2003 Form 5500 information for
computer targeting. They also said that in some cases untimely Form
5500 information affects their ability to identify financially troubled
plans whose sponsors may be on the verge of going out of business and
abandoning their pension plans, because these plans may no longer exist
by the time that Labor receives the processed filing or is able to
determine that no Form 5500 was filed by those sponsors.
---------------------------------------------------------------------------
\10\ See, GAO, Employee Benefit Plans: Efforts to Streamline
Reporting Requirements and Improve Processing of Annual Plan Data, GAO/
HEHS-98-45R (Washington, DC: Nov. 14, 1997).
\11\ See GAO, Private Pensions: Government Actions Could Improve
the Timeliness and Content of Form 5500 Pension Information, GAO-05-491
(Washington, DC: June 3, 2005).
---------------------------------------------------------------------------
The Form 5500 also lacks key information that could better assist
EBSA, IRS, and PBGC in monitoring plans and ensuring that they are in
compliance with ERISA. EBSA, IRS and PBGC officials said that they have
experienced difficulties when relying on Form 5500 information to
identify and track all plans across years. Although EBSA has a process
in place to identify and track plans filing a Form 5500 from year to
year, problems still arise when plans change employer identification
numbers (EIN) and/or plan numbers. Identifying plans is further
complicated when plan sponsors are acquired, sold, or merged. In these
cases, Agency officials said that there is an increased possibility of
mismatching of EINs, plans, and their identifying information. As a
result, EBSA officials said they are unable to (1) verify if all
required employers are meeting the statutory requirement to file a Form
5500 annually, (2) identity all late filers, and (3) assess and collect
penalties from all plans that fail to file or are late. Likewise, PBGC
officials said that they must spend additional time each year trying to
identify and track certain defined benefit plans so that they can
conduct compliance and research activities. EBSA officials said they
are considering measures to better track and identify plans but have
not reached any conclusions. Our recent report makes a number of
recommendations aimed at improving the timeliness and content of Form
5500 that will likely assist EBSA's enforcement efforts.\12\
---------------------------------------------------------------------------
\12\ See GAO-05-491.
---------------------------------------------------------------------------
In addition to problems with Form 5500 information, concerns remain
about the quality of annual audits of plans' financial statements by
independent public accountants. For many years, we, as well as the
Department of Labor's Office of Inspector General (OIG), have reported
that a significant number of these audits have not met ERISA
requirements. For example, in 1992 we found that over a third of the 25
plan audits we reviewed had audit weaknesses so serious that their
reliability and usefulness were questionable. We recommended that the
Congress amend ERISA to require full-scope audits of employee benefit
plans and to require plan administrators and independent public
accountants to report on how effective an employee benefit plan's
internal controls are in protecting plan assets.\13\ Although such
changes were subsequently proposed, they were not enacted. In 2004,
Labor's OIG reported that although EBSA had reviewed a significant
number of employee benefit plan audits and made efforts to correct
substandard audits, a significant number of substandard audits remain
uncorrected. Furthermore, plan auditors performing substandard work
generally continue to audit employee benefit plans without being
required to improve the quality of the audits.\14\ As a result, these
audits have not provided participants and beneficiaries the protections
envisioned by Congress. Labor's OIG recommended, among other things,
that EBSA propose changes to ERISA so that EBSA has greater enforcement
authority over employee benefit plan auditors.
---------------------------------------------------------------------------
\13\ Under ERISA, investments held by certain regulated
institutions, such as banks and insurance companies, may be excluded
from the scope of a plan audit The resulting lack of audit work can
result in an auditor disclaiming an opinion on the plan's financial
statements. See GAO, Employee Benefits: Improved Plan Reporting and CPA
Audits Can Increase Protection under ERISA, GAO/AFMD-92-l4 (Washington,
D.C.: April 9, 1992) and Employee Benefits: Limited Scope Audit
Exemption Should Be Repealed, GAO/T-AIMD-98-75 (Washington, D.C.:
February 12, 1998).
\14\ See U.S. Department of Labor Office of Inspector General--
Office of Audit, EBSA Needs Additional Authority to Improve the Quality
of Employee Benefit Plan Audits. (Washington, D.C.: Sept. 30, 2004).
---------------------------------------------------------------------------
Restrictive Statutory Requirements Limit Assessment of Fiduciary
Penalties
As we have previously reported, restrictive legal requirements have
limited EBSA's ability to assess penalties against fiduciaries or other
persons who knowingly participate in a fiduciary breach.\15\ Unlike the
SEC, which has the authority to impose a penalty without first
assessing and then securing monetary damages, EBSA does not have such
statutory authority and must assess penalties based on damages or, more
specifically, the restoration of plan assets.\16\ Under Section 502(1),
ERISA provides for a mandatory penalty against (1) a fiduciary who
breaches a fiduciary duty under, or commits a violation of, Part 4 of
Title I of ERISA or (2) against any other person who knowingly
participates in such a breach or violation. This penalty is equal to 20
percent of the ``applicable recovery amount,'' or any settlement agreed
upon by the Secretary or ordered by a court to be paid in a judicial
proceeding instituted by the Secretary. However, the applicable
recovery amount cannot be determined if damages have not been valued.
This penalty can be assessed only against fiduciaries or knowing
participants in a breach who, by court order or settlement agreement,
restore plan assets. Therefore, if (1) there is no settlement agreement
or court order or (2) someone other than a fiduciary or knowing
participant returns plan assets, the penalty may not be assessed. For
example, last year we reported that ERISA presented legal challenges
when developing cases related to proxy voting by plan fiduciaries,
particularly with regards to valuing monetary damages.\17\ As a result,
because EBSA has never found a violation that resulted in monetary
damages, it has never assessed a penalty or removed a fiduciary because
of a proxy voting investigation. Given the restrictive legal
requirements that have limited the use of penalties for violations of
ERISA's fiduciary requirements, we recommended that Congress consider
amending ERISA to give the Secretary of Labor additional authority with
respect to assessing monetary penalties against fiduciaries. We also
recommended other changes to ERISA to better protect plan participants
and increase the transparency of proxy voting practices by plan
fiduciaries.
---------------------------------------------------------------------------
\15\ See GAO/HEHS-94-157.
\16\ EBSA can also seek removal of a fiduciary for breaches of
fiduciary duty or seek other sanctions.
\17\ See GAO, Pension Plans: Additional Transparency and Other
Actions Needed in Connection with Proxy Voting, GAO-04-749 (Washington,
D.C.: August 10, 2004).
---------------------------------------------------------------------------
Recent Scandals Highlight the Need for Better Coordination With SEC
Recent events such as the abusive trading practices of late trading
and market timing in mutual funds and new revelations of conflicts of
interest by pension consultants highlight the need for EBSA to better
coordinate enforcement strategies with SEC. Last year we reported that
SEC and EBSA had separately taken steps to address abusive trading
practices in mutual funds.\18\ At the time we issued our report, SEC
had taken a number of actions to address the abuses including:
---------------------------------------------------------------------------
\18\ See GAO, Mutual Funds: SEC Should Modify Proposed Regulations
to Address Some Pension Plan Concerns, GAO-04-799 (Washington, D.C.:
July 9, 2004).
charging some fund companies with defrauding investors by
not enforcing their stated policies on market timing,
fining some institutions hundreds of millions of dollars
(some of this money was to be returned to long-term shareholders who
lost money due to abusive practices),
permanently barring some individuals from future work with
investment companies, and
proposing new regulations addressing late trading and
market timing.
Separate from SEC activities, EBSA began investigating possible
fiduciary violations at some large investment companies, including
those that sponsor mutual funds, and violations by plan fiduciaries.
EBSA also issued guidance suggesting that plan fiduciaries review their
relationships with mutual funds and other investment companies to
ensure they are meeting their responsibilities of acting reasonably,
prudently, and solely in the interest of plan participants. Although
SEC's proposed regulations on late trading and market timing could have
more adversely affected some plan participants than other mutual fund
investors, EBSA was not involved in drafting the regulations because it
does not regulate mutual funds.
In another example of how EBSA and SEC enforcement responsibilities
can intersect, SEC recently found that potential conflicts of interest
may affect the objectivity of advice pension consultants are providing
to their pension plan clients.\19\ The report also raised important
issues for plan fiduciaries who often rely on the advice of pension
consultants in operating their plans. Recently, EBSA and SEC issued
tips to help plan fiduciaries evaluate the objectivity of advice and
recommendations provided by pension consultants.
---------------------------------------------------------------------------
\19\ See SEC, Staff Report Concerning Examinations of Select
Pension Consultants, The Office of Compliance Inspections and
Examinations (Washington, D.C.: May 16, 2005).
---------------------------------------------------------------------------
Concluding Observations
Americans face numerous challenges to securing their economic
security in retirement, including the long-term fiscal challenges
facing Social Security; the uncertainty of promised pension benefits;
and the potential volatility of the investments held in their defined
contributions plans. Given these concerns, it is important that
employees' benefits are adequately protected. EBSA is a relatively
small Agency facing the daunting challenge of protecting over $4
trillion in assets of pension and welfare benefits for millions of
Americans. Over the years, EBSA has taken steps to strengthen its
enforcement program and leverage its limited resources. These actions
have helped better position EBSA to more effectively enforce ERISA.
EBSA, however, continues to face a number of significant challenges
to its enforcement program. Foremost, despite improvements in the
timeliness and content of the Form 5500, information currently
collected does not permit EBSA and the other ERISA regulatory agencies
to be in the best position to ensure compliance with Federal laws and
assess the financial condition of private pension plans. Given the
ever-changing complexities of employee benefit plans and how rapidly
the financial condition of pension plans can deteriorate, it is
imperative that policymakers, regulators, plan participants, and others
have more timely and accurate Form 5500 information. In addition, there
is a legitimate question as to whether information currently collected
on the Form 5500 can be used as an effective enforcement tool by EBSA
or whether different information might be needed. Without the right
information on plans in a timely manner, EBSA will continue to have to
rely on participant complaints as a primary source of investigations
rather than being able to proactively identify and target problem
areas. Second, in some instances, EBSA's enforcement efforts continue
to be hindered by ERISA, the very law it is charged with enforcing. For
example, because of restrictive legal requirements, EBSA continues to
be hindered in assessing penalties against fiduciaries or others who
knowingly participate in a fiduciary breach. Congress may want to amend
ERISA to address such limits on EBSA's enforcement authority. Finally,
the significant changes that have occurred in pension plans, the
growing complexity of financial transactions of such plans, and the
increasing role of mutual funds and other investment vehicles in
retirement savings plans require enhanced coordination of enforcement
efforts with SEC. Furthermore, such changes raise the fundamental
question of whether Congress should modify the current ERISA
enforcement framework. For example, it is important to consider whether
the current division of oversight responsibilities across several
agencies is the best way to ensure effective enforcement or whether
some type of consolidation or reallocation of responsibilities and
resources could result in more effective and efficient ERISA
enforcement. We look forward to working with Congress on such crucial
issues.
Mr. Chairman, this concludes my statement. I would be happy to
respond to any questions you or other members of the committee may
have.
Contact and Acknowledgments
For further information, please contact me at (202) 512-7215. Other
individuals making key contributions to this testimony included Joseph
Applebaum, Kimberley Granger, Raun Lazier, George Scott, and Roger
Thomas.
The Chairman. I appreciate the testimony by both of you. I
am just guessing, but I suspect that I am the only person in
Congress that has actually filled out Form 5500 and been
audited on them.
Ms. Bovbjerg. You likely are.
[Laughter.]
The Chairman. One of my pet peeves on it always was that
both pensions and health benefits use the same form, and the
questions do not apply to both. So I asked why there was the
same Form 5500 for two such different functions and I was told
it was the fault of the Paperwork Reduction Act. To do two
forms would penalize the agency. Pretty poor excuse, I think.
But at any rate, there are some problems and we need to
know how to find the answers to those problems a little bit
earlier. Mr. Lebowitz, can you elaborate on some of the
hardships and difficulties that members faced when they found
out their retirement savings had been lost?
Mr. Lebowitz. In the CCL--in connection with----
The Chairman. Yes, in CCL. We are going to confine it to
that.
Mr. Lebowitz. Well, it varied dramatically from plan to
plan. There were, as I said in my testimony, dozens of plans
that had invested some of its assets with CCL and some of these
plans invested a rather significant proportion of their assets,
one, if I am not mistaken, as much as 70 percent of its assets.
So for those plans, the consequence of CCL's collapse was
catastrophic. Others had invested smaller amounts, but
something in the order of the low 20s, plans had invested 10
percent or more of their total assets in these collateralized
notes through CCL. Some of these were health plans. Some of
them were 401(k) plans, where the losses directly translated to
losses to participants. And others were traditional defined
benefit plans where ultimately the employers contributing to
the plans had to make up those losses.
The Chairman. Over the past several years, EBSA has stepped
in many times to protect plan participants against these
effects of corporate fraud, but EBSA subjected Capital
Consultants to intense scrutiny for several years without
spotting these Ponzi-like schemes. When the SEC got involved,
they spotted the fraud in a few weeks and took action to close
Capital Consultants. Why didn't EBSA spot the Capital
Consultants' fraud sooner?
Mr. Lebowitz. Well, the Ponzi scheme really developed
rather late in the process. As I said in my oral testimony, our
investigation opened in October of 1997 and the scheme that is
described on the chart over there was really something that
came about in 1999 and 2000, after the collapse of Wilshire
Financial and its consequent effect on CCL.
When we--in the middle of 2000, sometime in June of 2000, I
believe, we began to communicate with the SEC about what we had
found. They were interested in knowing what we knew and we were
certainly interested in bringing them into it. So we made
available to the Commission our entire investigative record.
Now, as far as I know, up to that point, they had not
undertaken any formal investigation. So everything they knew
about CCL which formed the basis for their ability to bring the
action that they and we brought in September was based on our
investigation.
So I think that, in fairness, one needs to look back and
see that the Commission was able to take advantage of all the
work that our investigators had done in putting the case
together over the 2 or 3 years prior to their becoming involved
in it. Then, of course, they moved very quickly and were very
effective in what they did.
The Chairman. For either of you, since they had to do Form
5500s on this and the Form 5500s, if you have more than 100
employees, have to be audited, why didn't the accounting firm
that did the auditing find some of this?
Mr. Lebowitz. That is a question we have asked many times,
many auditors. CCL, of course, is itself not a plan. It was an
investment advisor, investment manager that held plan assets,
and as such, it is a plan fiduciary and, therefore, subject to
ERISA's rules. The 5500s are filed by the individual plans that
invested in CCL, the 60 or so that I described earlier. It is
those plans' auditors who have a responsibility under ERISA's
audit rules to opine on the fairness of the financial
statements that are prepared by the plan administrator.
We looked--our Chief Accountant's Office looked very
closely at the 20 plans that had invested material amounts, 10
percent or more of their assets, in CCL over a period of years,
and what we found was, unfortunately, not surprising based on
our history of reviewing the quality of ERISA audits over the
years. So what we found was that, for the most part, plan
auditors were more than willing to just accept the valuations
that CCL and its service providers, its auditors and
evaluators, attached to these assets and rarely raised any
question about it.
There were a couple of instances where the auditors did
raise questions, and a couple of instances where plan
investment advisors made very strong comments to their clients
about their concerns about CCL investments, and those plans
were able to get out without any harm. So it was capable of
being detected by careful auditing and by careful review, but
for the most part, plans' auditors failed in their
responsibility to do that.
The Chairman. My time has expired in the first round, so I
will go to Senator Bingaman.
Senator Bingaman. Thank you very much. Thanks for having
this hearing, Mr. Chairman. I think you are uniquely qualified
to be helping Congress do some oversight on this important
issue.
From the little I know about this--I don't claim any great
expertise--it sounds to me like the Department of Labor is
really not geared up to do effective monitoring or enforcement
in this area. I read the report from GAO and they say that we
are using plan year 2002 and 2003 plan information in your
computer targeting, and you lack timely and reliable plan
information. Is that an accurate criticism, as you understand
it, Mr. Lebowitz?
Mr. Lebowitz. It is accurate. The Form 5500, as Ms.
Bovbjerg said in her testimony, the Form 5500 does not have to
be filed until seven-and-a-half months after the close of the
plan year to which it applies. And then there is obviously a
period of time for review and processing. There is an enormous
amount of paper. There are about 1.4 million 5500 series
returns that are filed with us. It is a joint form that
contains information for us, the Internal Revenue Service, and
the Pension Benefit Guaranty Corporation. As the chairman
noted, it is a very complex form. It is very difficult, very
technical. And then there is information that comes--that has
to be presented on the form but comes from other parties, from
the plan's auditors, from the plan's actuaries, all of which
adds to the time and to the complexity of it.
And our system for receiving and processing these 1.4
million forms which contain somewhere on the order of 25 or 30
million pages is one that is rapidly coming to the end of its
life. We have been spending a good bit of time developing
approaches that would streamline that process, take advantage
of modern technologies, and move us away from this enormous
amount of paper which is----
Senator Bingaman. Is there a plan to do that, to
essentially change this system and come up with a new
streamlined, more timely system?
Mr. Lebowitz. There are a variety of options that are being
considered now----
Senator Bingaman. But there is nothing proposed yet?
Mr. Lebowitz. There is nothing that the Department has
proposed at this point, that is right.
Ms. Bovbjerg. We have made recommendations that they move
to an electronic filing system.
Senator Bingaman. Right.
Ms. Bovbjerg. It seems absolutely essential to speed things
up in the processing side and to have better access to the
information. But the deadline for getting the information in
and the 285 days is statutory.
I know that one of the things that we certainly talked
about is whether, if you were going to alter that statutory
deadline, whether it would be appropriate to treat everyone the
same, which it probably is not, or whether you would try to
look at a shorter deadline for riskier plans.
Senator Bingaman. Getting to this issue of riskier plans,
does the Department of Labor currently have open investigations
going against investment advisors? This was a case where you
had about a half-billion dollars in fraud that was perpetrated
by this Capital Consultants group, as I understand it. Does the
Department of Labor have other cases like that that are
currently being investigated that are coming to a head, or what
is the status?
Mr. Lebowitz. We have--over the years, we have had
investigations, or undertaken investigations of financial
services companies that provide investment management and other
fiduciary services to plans and have found violations of
various sorts. I don't know that we found anything quite like
what we ultimately found in the CCL matter, but review of
investment managers is a part of our enforcement program.
Senator Bingaman. But you do have cases currently under
investigation of investment advisors?
Mr. Lebowitz. Yes. Yes, we do.
Senator Bingaman. OK. There is a suggestion in here, in the
GAO report, that there is a need for the restrictive statutory
requirements that limit the ability of the Department of Labor
to assess certain penalties. Are you of the view that we should
stiffen those penalties or change those statutory provisions?
Mr. Lebowitz, is this something that you considered asking
Congress to do, or do you request that we do this, or----
Mr. Lebowitz. At this point, there is no--the Department
has not made a request of that sort with regard to ERISA's
penalties. There are a variety of penalties, civil money
penalties, in the statute now, most of which relate to late
filing and matters that--documents that have to be made
available to the Department. And then there is a civil penalty
under Section 502(l) of ERISA, which is sort of an add-on to
amounts that are recovered in the course of litigation or in
settlement agreements.
The SEC, for example, has some additional penalties that it
uses rather effectively in the course of undertaking its
investigations. There are other models to look at, but we have
not made any formal request at this point.
Senator Bingaman. My time is up, Mr. Chairman. Go ahead.
The Chairman. Thank you. To return to the question I was
asking earlier, Mr. Lebowitz, the commercial bank regulators
visit every bank regularly to make sure it is being managed in
a safe and sound manner. By contrast, EBSA has, I thought it
was about 400 investigators, I think you said 867, to
investigate 700,000 private pension plans and 6 million health
and welfare plans. That is almost 17,000 plans per
investigator. How do you proactively target the troubled plans
to investigate?
Mr. Lebowitz. Well, it is a challenge, Mr. Chairman. Just
to clarify the number, our total staff for the entire agency,
authorized staff, is 887 FTE, and our investigative staff is
470.
At that level, we obviously have to be very careful and
very analytical in terms of the cases that we select for
targeting. We use a variety of sources. We traditionally have
not done random reviews of plans or of service providers, but
rather have opened cases based on indicators from the annual
report, from complaints filed by participants, from referrals
from other agencies, and we have--we measure our performance,
or GIPRA goal, our principal GIPRA goal in the enforcement area
is one that measures how well we do at targeting. It basically
looks to see what proportion of the cases that we open actually
end up finding violations and correcting those violations. The
percentage--and that is how we define success in terms of our
Agency's performance objectives.
It is a process that involves very careful analysis of the
information that comes to us and we have been improving that
percentage every year. But it is a challenge to make sure that
we are--that we have a presence across the board, not just in
one segment of this very large plan universe and service
provider universe, but that we are seen as being involved in
investigations in connection with small plans, large plans, and
service providers of various sorts, as well as geographically.
Ms. Bovbjerg. If I could break in for a minute----
The Chairman. Sure.
Ms. Bovbjerg. We had recommended that EBSA do a little
compliance survey of a sample of plans that would be
projectable so you would have some sense of what really are the
problems out there. This is something that the IRS has done
with pension plans for their responsibilities under the IRC to
review funding, investing, and some of those elements of
pension plans. They pulled the sample and audited the plans.
This is a way to really know where the compliance problems are
out there, a projectable way, and another way that you could
target resources.
I think that EBSA has done some of these things in sort of
different pieces of their plan responsibilities, but I think a
more comprehensive look at it would be warranted.
The Chairman. OK. I also have--it is a little more into
some technical things on what that percentage of success is and
how it is determined that we will follow up on in writing.
Ms. Bovbjerg, for 20 years, GAO has consistently
recommended stronger enforcement of ERISA by the Department of
Labor. In your assessment, does the Department of Labor have
the latitude to strengthen its enforcement strategies or is
legislative action needed to empower that kind of change?
Ms. Bovbjerg. Some of both. I think the Department has been
responsive to many of our recommendations for manager changes
of enforcement and I applaud them for that. I think there is
still more to be done. Some of it would be legislative, and one
of the points about penalties, you can't assess penalties
against fiduciaries for violation of fiduciary duty unless you
have an estimate of monetary damage. If it is a proxy voting
issue, you may not ever be able to estimate monetary damage. So
they can't assess a penalty. That is statutory. That would
require a change to the law.
There are a number of legal changes that we have
recommended over the years to ERISA, both to strengthen the law
and to provide additional tools for EBSA to use. I think that
they have made a lot of progress in this area, but we are
particularly concerned about targeting. We think that they need
to be more proactive and less reactive to complaints. Certainly
following up on complaints is important, but it should not be
the primary approach.
The Chairman. Thank you. My time has expired again.
Senator Bingaman?
Senator Bingaman. Thank you, Mr. Chairman. I will ask a
couple more questions, if I could here.
The Securities and Exchange Commission has come out with
this study which has been referred to a few times, I think, and
as I understand it, they have basically concluded that after
their review of some of these investment advisors, registered
investment advisors, they have concluded that maybe half of
them or more have some kind of a conflict, I mean, that they
basically have a financial deal with some financial company
that they are then recommending to their clients they invest in
these firms.
Is this something that--what is the Department of Labor
doing about that? First, do you agree with their conclusion? Do
you think they are right? This sounds like something that would
violate ERISA. Am I wrong about that?
Mr. Lebowitz. It could, and we consulted with the
Commission staff over the course of the period during which
they did that study, and shortly afterwards, we jointly issued
guidance for plan fiduciaries to follow----
Senator Bingaman. Yes, but what if they don't?
Mr. Lebowitz. I think it is probably useful to take a half-
step back here and think about what the Commission said. The
Commission is the regulator of investment advisors under
various securities laws. We don't regulate investment advisors,
per se. We regulate plan fiduciaries. So the first part of any
investigation that we do----
Senator Bingaman. What is that distinction again, now? I
thought investment advisors had some kind of a fiduciary
responsibility. Do they not?
Mr. Lebowitz. They do under the securities laws. They are,
as I understand it, they are considered to be fiduciaries for
purposes of the Investment Advisors Act. But the ERISA
definition of fiduciary is more of a functional thing. It
doesn't really matter what you are called. It matters what you
do. So an investigation by us to determine whether a fiduciary
has violated ERISA first has to determine whether the party is
a fiduciary, which means going in and looking very carefully at
the kinds of services that that entity is providing and
determine whether it fits under ERISA's rather technical
definition of fiduciary, meaning do they have discretion and
control over plan administration or management. That is what we
have to find.
In the Commission's case, the investment advisor is, by
virtue of filing a Form ADV, it is--and registering--it is a
fiduciary with respect to----
Senator Bingaman. So are you saying that the SEC, by virtue
of their authority, is better positioned to deal with this
problem of conflict of interest on the part of investment
advisors than you are?
Mr. Lebowitz. They are certainly--I would think--I would
agree that they are in a better position to deal with the issue
of these kinds of conflicts by investment advisors whom they
regulate. Now, their concern is whether the potential conflicts
or the actual conflicts that they found were adequately
disclosed. Adequate disclosure may or may not be enough under
ERISA if there are real--if there is real self-dealing going
on. It doesn't necessarily cure the ERISA problem. It might
cure the securities law problem.
Senator Bingaman. Well, it would seem to me that it would
be worthwhile for us to have a clear definition of the
responsibility to ensure that not only that disclosure occur,
but that conflict of interest or self-dealing kinds of
arrangements be prohibited, and you are basically saying that
you are unable to do that because of your limited authority.
SEC is unable to do that because they are really more
interested in disclosure than they are with the problem of
self-dealing. So are you saying there is a gap in there? There
is no one whose job it is to prevent this self-dealing from
occurring?
Mr. Lebowitz. No, and I certainly wouldn't want to speak
for the Commission and can't speak for the Commission in terms
of what they are interested in. But the nature of this study
that they did focused on whether these potential conflicts were
adequately disclosed to the plan clients of these investment
advisors.
I don't know that there is a gap necessarily, Senator, but
it is a complex area and it highlights the fact that while we
operate in the same general area as the SEC, we have a
different law and the people who are subject to our law are not
necessarily the same ones or subject in the same way that they
are to the securities laws, and it is difficult sometimes to
parse through all of that to make sure that everything that
should be covered is covered.
Ms. Bovbjerg. Could I jump in 1 second?
Senator Bingaman. Yes, please. Go ahead.
Ms. Bovbjerg. I think that from what I understand of the
back and forth, these investment advisors could be fiduciaries
under ERISA. We don't know. And if the SEC has pulled a sample,
which is what I understand they did, and they found that about
half of them had conflicts, it bears looking at. It bears
looking at----
Senator Bingaman. Bears looking at by whom?
Ms. Bovbjerg. From the two agencies together. This is one
of those areas where we really think that they need to continue
to try to have a more collaborative enforcement process.
Senator Bingaman. So you are saying that if this survey by
the SEC turned out half of 1,700 people they surveyed, 1,700
investment advisors that they surveyed have conflicts, you are
saying the Department of Labor ought to get the information
from the SEC as to which investment advisors they believe have
conflicts and run that to ground?
Ms. Bovbjerg. What I think I--the question it makes me ask
is, well, how many--might some of these investment advisors be
fiduciaries under ERISA, and as an analyst, I would want to
pull a representative sample and just take a look at a few of
them to see what the incidence might be. Maybe none of them
are, but we don't know.
Mr. Lebowitz. If I might just clarify a couple of the
numbers here, as I understand it, there are 1,700 registered
investment advisors who indicate that they provide pension
consulting services. That is the total number. And the
Commission looked at something on the order of 25 of them, I
think. They did not look at all 1,700.
Senator Bingaman. I see.
Mr. Lebowitz. And they have provided us with the
information that we have asked for with regard to the identity
some of the advisors that they looked at where they found
problems.
Senator Bingaman. And are you taking action with regard to
those?
Mr. Lebowitz. We will certainly look very carefully at what
they give us.
Senator Bingaman. Thank you, Mr. Chairman.
The Chairman. Thank you.
Ms. Bovbjerg, in the past, GAO reports have highlighted
some confusion over the ability of individual States to
regulate the employer-based health plans. Given the existing
ERISA framework, what more can individual States do to help
combat pension fraud? What role can States play?
Ms. Bovbjerg. We did that work a really long time ago and I
am concerned that things have changed substantially since then
with regard to health plans and with regard to Labor's
responsibility for health plans under HEPA that I am really
afraid to go there. We could get back to you for the record,
though.
The Chairman. I will submit a written question to you on
that, then, so that we can do that.
Mr. Lebowitz, the sophisticated financial instruments today
can provide high rates of return, but usually that means high
rates of risk, as well, and as we found in this situation, they
can also mask fraud, as in Enron, Capital Consultants, some of
the other corporate scandals. Now, the riskiest transactions
were hard for investigators and regulators to spot. They were
footnoted or otherwise obscured. How are your investigators
trained to recognize the suspicious financial activity? Is that
where some of the targeting comes in?
Mr. Lebowitz. I might just note that many of these frauds
were not detected by lots of people in the financial markets,
not just government agencies, but other investors, very large,
sophisticated financial institutions themselves were fooled by
them. So they are very difficult to find.
Our investigators are very determined and very highly
skilled people. They work methodically, as the investigative
team that worked on the CCL case did, to go through the
elements of the proof that are necessary to develop an ERISA
case, which, as I said, starts with the notion of whether--the
idea of whether the entity is a fiduciary under ERISA, then to
determine whether what that entity did constituted a breach of
their fiduciary responsibilities, and then to determine whether
that breach actually caused any losses.
It is a complicated and difficult process. I have great
confidence in our investigators. I think they are very
dedicated, highly skilled people, and work very hard at what
they do and very determined to get to the bottom of things.
Sometimes, just by the nature of what they are looking at, it
takes a long time.
The Chairman. I appreciate all the responses. I do have a
few questions that get into more technical detail of numbers
and things, which I really enjoy, but I won't subject everybody
to those.
Senator Kennedy was called to the Judiciary Committee over
a nominee, so he won't be here for questions on this, but for
all members of the committee, we leave the record open for 10
days so that they can submit questions immediately, not 10 days
from now, and then we can get a response from you that will be
a part of building this record.
Of course, what we really need to know is what sorts of
legislative things can be done to make a change, make things
easier for the investigators, but still fair for everybody
involved and not overburden people with paperwork. I will be
concentrating on the Form 5500 a little bit, but I have been
doing that for 8 years and it hasn't done any good, so----
Mr. Lebowitz. Well, we have a booklet called ``A
Troubleshooter's Guide to the 5500.'' We will be happy to send
you one, Senator.
The Chairman. I used to subscribe to a special service that
put out a notebook that was about that thick that helped me to
determine what each line meant, regardless of what it said.
[Laughter.]
Ms. Bovbjerg. We encourage you to submit it electronically.
The Chairman. Electronically might help. It would help if
the instructions were embedded in the electronic work so that a
person didn't have to have a number of references to go to
and--actually, it would really help again if they divided it so
that health was different than pensions, which are completely
different animals, in my opinion, and the questions never
applied, which is why you had to have the huge manual to
understand what the question meant. So it might be time to redo
it so that there are two forms, but that they are easier to
fill out.
Of course, I once suggested to the IRS that if they put a
little bit more instruction in their forms, that it would be
easier to fill out, as well, and that is where I learned about
the Paperwork Reduction Act. They can add to the manual as much
as they want without being penalized, but to add to the form
has a pretty strong Congressional penalty. So we will see if we
can't get a few more accountants so we can help people to
understand that.
Thank you very much for your testimony today and we will
move to the second panel. I would appreciate it if the two of
you would listen to the testimony in the second panel, which
may give some insight to the questions that we will be asking
based on their testimony, asking of you based on their
testimony.
As is traditional, while they are getting settled, I will
introduce the panel and then we will call on them individually
to give their statements.
The first witness on the second panel is Mr. John Endicott
from Oregon. He is the Business Manager and Financial Secretary
of Local 290 of the Plumbers, Steamfitters and Marine Fitters
Union.
The next witness will be Mr. Barclay Grayson from Portland,
Oregon, and served as the former Vice President and CEO of
Capital Consultants before operations were closed.
The next witness is the attorney Stephen English with the
law firm of Bullivant Houser Bailey in Portland, Oregon, and
Mr. English served as the lead attorney for the successful
recovery effort.
And the final witness is attorney James S. Ray from the Law
Offices of James S. Ray in Alexandria, Virginia.
We appreciate your taking the time from your busy schedules
to provide us with some information. Again, your complete text
will be a part of the record. You will also have a chance to
expand on that after the hearing if you wish to do that. We
just appreciate any information you can give that will make
sure that our pension is intact.
Mr. Endicott?
STATEMENTS OF JOHN ENDICOTT, BUSINESS MANAGER AND TRUSTEE,
LOCAL UNION 290, PLUMBERS, STEAMFITTERS AND MARINE FITTERS,
TUALATIN, OREGON; BARCLAY GRAYSON, FORMER CHIEF EXECUTIVE
OFFICER, CAPITAL CONSULTANTS, PORTLAND, OREGON; STEPHEN F.
ENGLISH, BULLIVANT HOUSER BAILEY, PORTLAND, OREGON; AND JAMES
S. RAY, LAW OFFICES OF JAMES S. RAY, ALEXANDRIA, VIRGINIA
Mr. Grayson. Chairman Enzi, first, I would like to thank
you very much for the opportunity to come and share with you
the stories of the hard-working members of Plumbers and Pipe
Fitters Local 290.
My name is John Endicott. I am from Gresham, Oregon. I have
been a steamfitter for over 30 years and have been a member of
the United Association Local 290 Plumber and Steamfitter and
Marine Fitter Union since 1972. I am the Business Manager of UA
Local 290, which is located in Tualatin, Oregon. I have been a
union trustee since March 2002, and I currently serve as
Secretary of the UA Local 290 pension plan and trust 401(k)
plan, health and welfare plan, pre-funded retiree health trust,
educational reimbursement trust, Local 290 training trust, and
the Local 290 scholarship trust, among other local trust funds.
In my current position as Business Manager, I represent
approximately 4,300 steamfitters and plumbers. Virtually all of
the membership participates in one or more of the trusts. Most
of those members have families who are also beneficiaries of
the trusts. In the aggregate, our trusts administer pension,
health and welfare, and other benefits for over 22,000
participants and beneficiaries, recognizing there is a
substantial overlap where members and their families
participate in one or more of the trusts.
A census of the membership in 2004 shows that members of my
local and participants and beneficiaries of my local's trust
live in 30 of the 50 States in this country, including Alabama,
Georgia, Wyoming, Iowa, Maryland, Nevada, New Mexico, North
Carolina, and Washington. The majority of our active members
live and work in Oregon, Washington, and Northern California.
I want to tell you about the serious impact that the
collapse of Capital Consultants had on me and my fellow union
members and the debacle that we faced when we first heard that
much of our hard-earned pension, health, and other benefits had
been stolen, misappropriated, or lost through reckless and
fraudulent schemes concocted by corrupt money managers we had
entrusted to handle our funds.
In addition, Mr. Chairman, I want to mention some things I
think the Federal Government needs to do in order to protect
workers' pensions and benefit trust funds. This is money that
our members have spent a lifetime accumulating and need to
depend upon to pay for their retirement, medical, and other
benefits in sickness and old age.
Mr. Chairman, the members of my local are all hard-working
men and women. Many of us have labored for decades with our
hands and our backs. We know a lot about plumbing and
pipefitting. When it comes to investing our trust fund assets,
we turn to professionals to give us advice. We rely on
investment managers, pension consultants, lawyers, accountants,
and insurance agents when it comes to the decisions about
investments in stock funds, real estate, trusts, hedge funds,
or collateralized notes. To help us make the kinds of prudent
decisions we need to be making with our members' money,
trustees like me depend upon the advice of those professionals
that we hire.
Beginning in approximately 1975, my local began to invest
through the Capital Consultants firm in Portland, Oregon. By
June of 2000, the UA Local 290 trust had entrusted more than
$159 million of our workers' pension and other trust fund money
with that firm. This was all the money the trust was trying to
safeguard for our members, money that they would require for
their retirement and for their medical bills and the like.
Those funds represented much of the safety net our members were
depending upon.
Capital Consultants knew that they had an obligation to
invest that money prudently and in the best interest of our
participants and beneficiaries. However, in a blink of an eye,
much of that money evaporated into thin air, almost like a
cloud of steam, along with all the hopes and dreams of most of
our members. I, like our 4,300 members and their families, were
shocked and devastated to discover that we had lost more than
$75 million, most of that in what Capital Consultants described
as insured collateralized note program. Unbeknownst to us, the
notes were neither insured nor collateralized. Our 401(k)s were
frozen, which meant that we could not move our investments.
Mr. Chairman, we had hired professionals to guide and
advise us, and those professionals had all assured us that
Capital Consultants was doing a good job and our money was
safe. Unfortunately, as we were later to discover, many of
those professionals we had paid were dead wrong. The
professionals we depended upon had simply failed us. They just
didn't do the kind of work or exercise the due diligence that
we have a right to expect. They didn't provide the level of
oversight that we depended upon. We were fooled, and as a
result, our members lost.
How could this have happened to us? Equally important, how
can we protect others from experiencing this type of loss in
the future?
First, the representatives of Capital Consultants lied to
us. As we later learned, Capital Consultants never told us the
true nature of their investments in private placement loans.
For example, they represented that our investments through
Capital Consultants' collateralized note program were secured
by collateral and that the notes were insured. Neither was
true.
What we later learned was that when the loans failed or
when investigators sought to terminate the relationship with
Capital Consultants, Capital Consultants simply sought out more
pension money to prop up the failed loans or to liquidate
clients who wanted to terminate Capital Consultants. In the
most egregious case, Capital Consultants had loaned more than
$157 million of mostly union trust fund money, and when those
loans were discharged in bankruptcy, Capital Consultants hid
that fact by lying to the trust and representing that it had a
new investor who had assumed those loans. What Capital
Consultants did not tell us was that it had pumped an
additional $80 million through entities functionally controlled
to create an appearance that the failed loans were actually
performing.
Second, the Government entities charged with oversight of
investment managers for employee benefit plans subject to ERISA
should have more clearly defined authority to act on the local
level. I understand that Capital Consultants was under scrutiny
and investigation by the Department of Labor through most of
the 1990s. At the local level, we had little, if any,
information from the Department of Labor that Capital
Consultants was under investigation.
In addition to having clear authority to act at the local
level, the Department of Labor should employ personnel
specifically trained to understand the investment money
managers make with employee benefit plan assets. Alternatively,
the Labor Department should work closely with the Securities
and Exchange Commission to enforce compliance regarding
investments made by investment managers.
Third, clarify civil laws and regulations that apply to
pension consultants, investment managers, and other
professionals who advertise the ability to monitor employee
benefit plan investment managers. These financial professionals
place themselves between the trustees and the investment
managers and their credentials suggest that they are in the
best position to warn of improprieties in an investment
manager's operations.
Finally, enforce the criminal law. A man who robs a store
of a few hundred dollars at gunpoint might be sentenced to 10
years in prison. The sentences in this case seem very light in
comparison to the losses.
Thank you for giving me the opportunity to share with you
my concerns and those of the members of my local union. Thank
you, Mr. Chairman.
The Chairman. Thank you very much.
[The prepared statement of Mr. Endicott follows:]
Prepared Statement of John Endicott
Mr. Chairman and members of the committee, my name is John
Endicott. I am from Gresham, Oregon. I have been a steamfitter for over
30 years and have been a member of the United Association Local 290
Plumber, Steamfitter and Marine Fitter union since 1972. I am the
Business Manager of U.A. Local 290, which is located in Tualatin,
Oregon.
I have been a union trustee since March 2002, and I currently serve
as Secretary of the U.A. Local No. 290 Plumber, Steamfitter, and
Shipfitter Industry Pension Plan and Trust; the U.A. Local No. 290
Plumber, Steamfitter, and Shipfitter Industry 401(k) Plan and Trust;
the U.A. Local No. 290 Plumber, Steamfitter, and Shipfitter Industry
Health and Welfare Plan and Trust; the U.A. Local No. 290 Pre-Funded
Retiree Health Trust; U.A. Local No. 290 Educational Reimbursement
Trust; U.A. Local No. 290 Training Trust; and the U.A. Local No. 290
Scholarship Trust, among other Local trust funds.
In my current position as Business Manager I represent
approximately 4,300 steamfitters and plumbers. Virtually all of the
membership participates in one or more of the Trusts. Most of those
members have families who are also beneficiaries of the Trusts. In the
aggregate, our Trusts administer pension, health, and welfare, and
other benefits for over 22,000 participants and beneficiaries,
recognizing that there is substantial overlap where members and their
families participate in more than one Trust. A census of the membership
in 2004 shows that members of my Local, and participants and
beneficiaries in my Local's Trusts, live in 30 of the 50 States in this
country, including Alabama, Georgia, Wyoming, Iowa, Maryland, Nevada,
New Mexico, North Carolina, and Washington.\1\ The majority of our
active members live and work in Oregon, Washington, and Northern
California.
---------------------------------------------------------------------------
\1\ The remaining States with members, participants or
beneficiaries include Arkansas, Arizona, California, Colorado,
Delaware, Florida, Hawaii, Idaho, Louisiana, Minnesota, Missouri,
Mississippi, Montana, North Carolina, North Dakota, Oklahoma, Oregon,
Pennsylvania, South Dakota, Texas, and Wisconsin.
---------------------------------------------------------------------------
I want to tell you about the serious impact that the collapse of
Capital Consultants had on me and on my fellow union members and the
debacle that we all faced when we first heard that much of our hard-
earned pension, health and other benefits had been stolen,
misappropriated or lost through reckless and fraudulent schemes
concocted by corrupt money managers who we had entrusted to handle our
funds. In addition, Mr. Chairman, I want to mention some things that I
think the Federal Government needs to do in order to protect workers'
pension and benefit trust funds. This is money that our members have
spent a lifetime accumulating and need to depend upon to pay for their
retirement, medical and other benefits in sickness and old age.
Mr. Chairman, the members of my Local are all hard-working men and
women. Many of us have labored for decades with our hands and our
backs. We know a lot about plumbing and pipefitting. When it comes to
investing our Trust Fund assets, we turn to professionals to give us
advice. We rely on investment managers, pension consultants, lawyers,
accountants, and insurance agents when it comes to decisions about
investments in stock funds, real estate trusts, hedge funds or
collateralized notes. To help us make the kinds of prudent decisions we
need to be making with our members' money, trustees like me depend upon
the advice of those professionals that we hire.
Beginning in approximately 1975, my Local began to invest through
the Capital Consultants firm in Portland, Oregon. By June of 2000, the
U.A. 290 Trusts had entrusted more than $159 million of our workers'
pension and other Trust fund money with that firm. This was all money
that the Trusts were trying to safeguard for our members--money that
they would require for their retirement and for their medical bills and
the like. Those funds represented much of the safety net our members
were depending upon. Capital Consultants knew that and they had an
obligation to invest that money prudently and in the best interests of
our participants and beneficiaries. However, in just a blink of an eye,
much of that money evaporated into thin air--almost like a cloud of
steam--along with all of the hopes and dreams of most of our members.
I, like our 4,300 members and their families, was shocked and
devastated to discover that we had lost more than $75 million, most of
that in what Capital Consultants described as an insured,
collateralized note program. Unbeknownst to us, the notes were neither
insured nor collateralized. Our 401(k)s were frozen, which meant that
we could not move our investments.
Mr. Chairman, we had hired professionals to guide and advise us,
and those professionals had all assured us that Capital Consultants was
doing a good job and our money was safe. Unfortunately--as we were
later to discover--many of those professionals we had paid were dead
wrong. The professionals we depended upon had simply failed us. They
just didn't do the kind of work or exercise the due diligence that we
have a right to expect. They didn't provide the level of oversight that
we depended upon. We were fooled and--as a result--our members lost.
How could this have happened to us and, equally important, how can
we protect others from experiencing this type of loss in the future?
First, the representatives of Capital Consultants lied to us. As we
later learned, Capital Consultants never told us the true nature of
their investments in private placement loans. For example, they
represented that our investments through Capital Consultants
Collateralized Note Program were secured by collateral and that the
Notes were insured. Neither was true. What we later learned was that
when loans failed or when investors sought to terminate their
relationship with Capital Consultants, Capital Consultants simply
sought out more pension money to prop up the failed loans or to
liquidate clients who wanted to terminate Capital Consultants. In the
most egregious case, Capital Consultants had loaned more than $157
million of mostly union trust fund money and when those loans were
discharged in bankruptcy Capital Consultants hid that fact by lying to
the Trusts and representing that it had a new investor who had assumed
the loans. What Capital Consultants did not tell us was that it pumped
an additional $80 million through entities it functionally controlled
to create an appearance that the failed loans were actually performing.
Second, the governmental entities charged with oversight of
investment managers for employee benefit plans subject to ERISA should
have more clearly defined authority to act on the local level. I
understand that Capital Consultants was under scrutiny and
investigation by the Department of Labor through most of the 1990s. At
the local level, we had little if any information from the Department
of Labor that Capital Consultants was under investigation. In addition
to having clear authority to act at the local level, the Department of
Labor should employ personnel specifically trained to understand the
investments money managers make with employee benefit plan assets.
Alternatively, the Department of Labor should work closely with the
Securities and Exchange Commission to enforce compliance regarding
investments made by investment mangers.
Third, clarify civil laws and regulations that apply to pension
consultants, investment managers and other professionals who advertise
the ability to monitor employee benefit plan investment managers. These
financial professionals place themselves between the Trustees and the
investment managers and their credentials suggest that they are in the
best position to warn of improprieties in an investment manager's
operations.
Finally, enforce the criminal law. A man who robs a store of a few
hundred dollars at gun point might be sentenced to 10 years in prison.
The sentences in this case seem very light in comparison to the losses.
Thank you for giving me the opportunity to share with you my
concerns and those of the members of my Local.
The Chairman. Mr. Grayson?
Mr. Grayson. Good morning. My name is Barclay Grayson. I am
35 years old. I have a wife and three young children. I
obtained my undergraduate business degree from the University
of Oregon in 1992 and I obtained my MBA from Colombia Business
School with an emphasis in finance and real estate in 1996. I
am currently Senior Vice President of BDC Advisors based in
Portland, Oregon, where I facilitate senior housing real estate
acquisitions.
In 1996, I joined my father's registered investment
advisory firm which he founded in 1968. At its height, Capital
managed assets in excess of $1 billion. Approximately 75
percent of these assets were Taft-Hartley regulated funds, of
which half were derived from my father and the other half from
Dean Kirkland, who was my father's primary union salesman. The
company invested about half of its finance capital in privately
originated loans and investments.
One of Capital's private borrowers was named Wilshire
Credit Corporation, led by Andrew Wiederhorn. Over a period of
9 years, Wilshire borrowed over $150 million from Capital,
which it used to acquire high-risk, sub-performing loans. These
loans represented nearly 15 percent of Capital's total assets.
Two years after I joined the firm, Wilshire defaulted on
its loans and effectively failed. Instead of closing Wilshire's
default and shutting down the borrower, Capital advised its
clients that it was undertaking a ``workout.'' This workout
first involved maximizing what little was left following the
collapse of Wilshire. It next involved the formation of three
new shell entities that then collectively borrowed in excess of
$80 million of additional funds from Capital's clients. The
majority of these funds were used to make high-risk used car
and credit card loans. The balance was used to keep the
original Wilshire loans current.
As a result of these complex transactions, the company's
clients largely had no idea that their ongoing contributions
were effectively being circulated through each of these shell
borrowers to keep their Wilshire investments current. This gave
the false impression that all the firm's loans were fully
performing, fully secured, and of limited risk.
At the end of 1999, a year following the effective loss of
the Wilshire assets, my father appointed me President of the
company. In mid-2000, the SEC determined that the initial
Wilshire loans were likely worthless and that the loans being
made going forward were highly risky and the disclosures to
clients were insufficient. This resulted in Capital being
placed into court-ordered receivership on September 21, 2000.
I immediately cooperated with all parties to maximize the
recovery of client assets following being placed into
receivership and assisted in the ensuing Department of Justice
investigation. It quickly became clear to me that I had failed
to live up to my fiduciary disclosure duties as President
relative to what is required on behalf of the firm's clients.
In 2001, I therefore pled guilty to one count of mail
fraud. I thereafter entered into a global settlement with all
the company's clients and the SEC. Due to my extensive
cooperation, the prosecution ultimately recommended that I be
sentenced to 1 year of home detention. However, due to public
accountability issues, I received a sentence of 18 months and a
3-year term of subsequent probation.
After spending 14 months at FPC Sheridan, I returned home
and started over. Due to my conduct and extraordinary
assistance, the sentencing judge terminated my probation 2
years early. She explained this was a very rare occurrence, but
was warranted.
There are three natural questions that would follow after
hearing this story. The first question that arises is why did
Capital loan so much money to Mr. Wiederhorn. These reasons
include, one, my father received improper personal loans from
Mr. Wiederhorn. Two, Capital received a management fee of 3
percent of promptly invested assets. Three, Mr. Wiederhorn
acquired earlier failed investments at face value from the
company. And four, Capital's excessive concentration with Mr.
Wiederhorn resulted in a loss of control.
The second question is why did the union clients invest so
much money into Capital's private investment program initially
and why did the money keep flowing in for so long after
Wilshire's failure? There were several reasons. One, gifts and
gratuities provided by my father and Dean Kirkland to the
firm's trustees were extensive. They included extensive
dinners, golf trips, club memberships, lavish parties, sporting
events, fishing and hunting trips, foundations, hiring of union
members, donations to causes, raffles, loans, and employment of
trustees postunion employment. Second, we had established
relationships with service providers associated with
recommending which investment advisors were selected for
management.
The third question is whether there was any regulatory
oversight of us. Due to complaints dating back to the early
1990s, the DOL reviewed many of Capital's private investments.
No specific issues were found to exist with Wilshire, but the
DOL did determine that Capital was charging excessive fees
relative to one investment on behalf of one client which
resulted in a $2 million fine that was, in fact, returned to
one of the affected clients. There was little detailed follow-
through to ensure that the funds Capital used to pay this fine
were derived from legitimate sources, of which they were not.
Although the DOL opened another investigation into
Capital's private investments, including Wilshire, in 1997, the
company continued to be allowed to operate for almost 3 more
years until the SEC announced the receivership proceedings. All
told, the DOL effectively witnessed over 8 years of abuses
without taking significant action to close the firm.
Based on my observations, the DOL has a limited
understanding of private investments and a general lack of
accounting skills. This results in the DOL having long open
files, which makes them largely ineffective. In this case, the
DOL were largely reactionary as opposed to being proactive.
The SEC began its core investigation in 2000. They first
spoke to past employees and existing borrowers of Capital. They
then came in hard and fast with a team of forensic accountants.
They looked at every private investment in the portfolio and
they met with all members of the private investment management
team at Capital. Within very short order, they were working
toward placing Capital into receivership.
The last question relates to what recommendations I would
make to you to better check pension assets going forward.
First, we need to educate. Courses and licensing should be
required for all parties associated with Taft-Hartley regulated
funds. No such requirements exist. Trustees would particularly
benefit. And second, courses and licensing should be required
for all parties investing in privately-held loans and
investments. Many are ill-prepared to properly analyze private
investments.
Second, we need to strengthen regulatory oversight. The DOL
needs to employ highly-trained accountants and business experts
like the SEC who will audit pension investments at least once
every 2 years, as well as all the service providers providing
services to the unions themselves to ensure that no conflicts
of interest exist. Second, the DOL needs to implement more
strict Taft-Hartley investment guideline requirements that set
real limits on investment alternatives and investment
concentration.
Third, we need to expand the laws regulating Taft-Hartley
assets. No. 1, limiting receipt of gifts and gratuities by
trustees and service providers associated with the trust, in my
opinion, to no more than $100 per item or event and no more
than $500 annually would be satisfactory. The law should be
clear that if a trustee or service provider accepts a gift or
gratuity over a stated level, regardless of whether influence
can be proven, it is a violation of the law. Second, any
trustees or service providers desiring to accept gifts or
gratuities within legal limits should be required to disclose
said items to the trustees--the rest of the trustees--prior to
taking receipt. And third, to help mitigate future pension
losses, there should be a minimum level of E&O insurance
coverage required for all investment advisors. This minimum
should be tied to each manager's total assets, in my opinion,
under management so as to provide additional coverage, but yet
still be cost effective for providers.
That is my testimony. Thank you.
The Chairman. Thank you, and especially for your
willingness to testify and your specific suggestions.
[The prepared statement of Mr. Grayson follows:]
Prepared Statement of Barclay Grayson
Good afternoon, my name is Barclay Grayson. I am 35 years old. I
have a wife and three young children. I obtained my undergraduate
business degree from the University of Oregon in 1992 and I obtained an
MBA from Colombia Business School with an emphasis in Finance and Real
Estate in 1996. I am currently Senior Vice President of BDC Advisors,
LLC, based in Portland, OR, where I facilitate senior housing real
estate acquisitions.
In 1996, I joined my father's registered investment advisory firm
which he founded in 1968. At its height, Capital managed assets in
excess of $1 billion. Approximately 75 percent were Taft-Hartley
regulated funds, of which half were derived from my father and the
other half from Dean Kirkland who was my father's primary union
salesman. The company invested about half of its clients' capital in
privately originated loans and investments.
One of Capital's private borrowers was named Wilshire Credit
Corporation, led by Andrew Wiederhorn. Over a period of 9 years,
Wilshire borrowed over $150 million which it used to acquire high risk,
sub-performing loans. These loans represented nearly 15 percent of
Capital's total assets. Two years after I joined the firm, Wilshire
defaulted on its loans and effectively failed.
Instead of disclosing Wilshire's default and shutting down the
borrower, Capital advised its clients that it was undertaking a ``work-
out.'' This work-out first involved maximizing what little was left
following the collapse of Wilshire. It next involved the formation of
three new shell entities that then collectively borrowed $80 million of
additional funds from Capital's clients. The majority of these funds
were used to make high risk car and credit card loans. The balance was
used to keep the original Wilshire loans current. As a result of these
complex transactions, the Company's clients largely had no idea that
their ongoing contributions were effectively being circulated through
each of these shell borrowers to keep their Wilshire investments
current. This gave the false impression that all of the firm's loans
were fully performing, fully secured and of limited risk.
At the end of 1999, a year following the effective loss of the
Wilshire assets, my father appointed me president of the company. In
mid-2000 the SEC determined that the initial Wilshire loans were likely
worthless, that the loans being made going forward were highly risky
and that the disclosures to clients were insufficient. This resulted in
Capital being placed into court-ordered receivership on September 21,
2000. I immediately cooperated with all parties to maximize the
recovery of client assets and assist in the ensuing DOJ investigation.
It quickly became clear to me that I had failed to live up to my
fiduciary duties as President relative to required disclosures to the
firm's clients. In 2001, I therefore pled guilty to one count of mail
fraud. I thereafter entered into a global settlement with all of the
company's clients and the SEC.
Due to my extensive cooperation, the prosecution ultimately
recommended that I be sentenced to 1 year of home detention. However,
due to public accountability issues, I received a sentence of 18 months
and a 3 year term of subsequent probation. After spending 14 months at
FPC Sheridan, I returned home and started over. Due to my conduct and
extraordinary assistance, the sentencing Judge terminated my probation
2 years early. She explained that this was a very rare occurrence but
was warranted.
There are three natural questions that would follow after hearing
this story:
The first question that arises is why did Capital loan so much
money to Mr. Wiederhorn.
The reasons include:
1. My father received improper personal loans from Mr. Wiederhorn;
2. Capital received management fees of 3 percent from clients on
promptly invested assets;
3. Mr. Wiederhorn acquired earlier failed investments at face
value;
4. Capital's excessive concentration with Mr. Wiederhorn resulted
in a loss of control.
The second question is why did the union client's invest so much
money into Capital's private investment program initially and why did
the money keep flowing in for so long after Wilshire's failure?
1. Gifts and gratuities provided by my father and Dean Kirkland to
the firm's union trustees including:
a. Expensive Dinners & Golf Trips;
b. Club Memberships;
c. Lavish parties/transportation/travel, etc.(trustees and
families);
d. Sporting Events (Football/Basketball/Golf);
e. Very Expensive Fishing/Hunting Trips;
f. Establishment and funding of Foundations;
g. Hiring relatives of Union members;
h. Donations to causes/raffles of trustees/family;
i. Investments in directed investments benefiting trustees
(labor only investments, relatives, friends, etc.);
j. Loans (trustees and family) and Cash or equivalents;
k. Employment of trustees post union employment. Big
compensation.
2. Established relationships with service providers associated with
recommending which investment advisors are selected for management.
The third question is whether there was any regulatory oversight?
Due to complaints dating back to the early 1990's, the DOL reviewed
many of Capital's private investments. No specific issues were found to
exist with Wilshire, but the DOL did determine that Capital was
charging excessive fees. This resulted in a $2 million fine. There was
little detailed follow-through to ensure that the funds Capital used to
pay this fine were derived from legitimate sources; of which they were
not. Although the DOL opened another investigation into Capital's
private investments (including Wilshire) in 1997, the company continued
to be allowed to operate for almost 3 years until the SEC announced the
receivership proceedings. All told, the DOL effectively witnessed
almost 10 years of abuses without taking significant action to close
the firm.
Based on my observations, the DOL has a limited understanding of
private investments and a general lack of accounting skills. This
results in the DOL having long ``open files'' which makes them largely
ineffective. In this case, the DOL were largely reactionary as opposed
to being pro-active.
2. The SEC began its core investigation in 2000. They first spoke
to past employees and existing borrowers of Capital. Then they came in
hard and fast with a team of forensic accountants. They looked at every
private investment in the portfolio and met with all members of the
private investment management team at Capital. Within very short order
they were working towards placing Capital into receivership.
The last question relates to what recommendations would I make to
Congress to better protect pension assets:
First, we need to educate:
1. Courses and licensing should be required for all parties
associating with Taft-Hartley regulated funds. No such requirements
exist. Trustees would particularly benefit.
2. Courses and licensing should be required for all parties
investing in privately held loans/investments. Many are ill-prepared to
properly analyze private investments.
Second, we need to strengthen regulatory oversight:
1. The DOL needs to employ highly trained accountants and business
experts like the SEC who will audit pension investments at least once
every 2 years, as well as all of the service providers providing
services to the unions themselves to ensure that no conflicts of
interest exists.
2. The DOL needs to implement more strict Taft-Hartley investment
guideline requirements that set real limits on investment alternatives
and investment concentration.
Third, we need to expand the laws regulating Taft-Hartley assets:
1. Limit receipt of gifts and gratuities by trustees and service
providers associated with a Trust to no more than $100 per item or
event and no more than $500 per year. The law should be clear that if a
trustee or service provider accepts a gift or gratuity over stated
level, regardless of whether influence can be proven, that it is a
violation of the law.
2. Any trustees or service providers desiring to accept gifts or
gratuities within legal limits should be required to disclose said
items to the Trust prior to taking receipt.
3. To help mitigate future pension losses there should be a minimum
level of E&O insurance coverage required for all investment advisors.
This minimum should be tied to each manager's total assets under
management, so as to provide additional coverage, but yet still be cost
effective for providers.
The Chairman. Mr. English?
Mr. English. Good morning, Mr. Chairman. I am pleased to be
here today to discuss an area of concern to all of us,
protection of retirement funds, and to share my experience
prosecuting a fraud against ERISA benefit plans.
The fraud was perpetrated by Capital Consultants and
others. As you heard, it affected over 300,000 participants and
beneficiaries from all 50 States, putting at risk the
retirement dollars and health insurance of hard-working
plumbers, laborers, office workers, and other private investors
and workers.
I am an attorney with Bullivant Houser Bailey in its
Portland, Oregon, office. Bullivant represented several of the
Taft-Hartley plans which were defrauded. I was asked to be lead
counsel in a plaintiffs' consortium, which ultimately
represented all potential claimants. This plaintiffs'
consortium consisted of attorneys from Nevada, Oregon,
Washington, California, Ohio, and several other States.
Altogether, there were 97 attorneys representing plaintiffs and
defendants.
Capital Consultants had more than 300 clients, including
ERISA retirement and medical benefit plans and private
investors. Their losses, as you have heard this morning, were
estimated at half-a-billion dollars. As a result of the efforts
of the plaintiffs' consortium, working with the court-appointed
receiver, we have been able to recover so far approximately
$350 million for the benefit of the claimants. We created a
model, which I believe should be replicated, to investigate and
maximize recovery of losses in this type of case.
We developed a plan to obtain the greatest net return,
factoring in time and cost. The plaintiffs' consortium gave a
complete release to any defendant who agreed to settle and
created a court-ordered claims bar to protect them from further
litigation. A summary of the specifics of this recovery plan is
contained in my written submission.
During our civil prosecution, we worked cooperatively with
a task force headed by Assistant U.S. Attorney Lance Caldwell
which included the FBI, IRS, Office of Labor Racketeering and
Fraud, OLMS, and EBSA. Our job was to recover assets. Theirs
was to prosecute wrongdoers. We were urged by our clients to
cooperate with Mr. Caldwell's team and any government
investigation fully, no matter where it led.
In August 2000, I led a small group of attorneys and former
Federal investigators to gather facts quickly to determine who
the potential defendants were. I would like to acknowledge the
presence here today of some members of that team, including my
partner, Robert Miller, and investigators Joe Gavalas and Norm
Transit with CTG and Associates. Several other members of the
consortium have submitted statements, including Mike Farnell,
another key member of the consortium who is here today, and
who, I might add, flew all night to get here.
One month later, based on the information we gathered, in
September 2000, we filed an 80-page lawsuit which included
claims for fraud, RICO, breach of fiduciary duty, securities
violations, and ERISA violations to address a Ponzi scheme
which had been in existence for several years and apparently
had been investigated for 3 years by the Department of Labor.
We made available to all potential plaintiffs the
information we had gathered in return for their agreement to
form a consortium that would create an efficient division of
labor, minimize overlapping of effort, and thereby maximize
recovery. We rejected a scorched earth approach, which could
have been financially beneficial to the attorneys but would
have been disastrous for our clients.
We then obtained a mandate from U.S. District Judge Garr M.
King requiring all parties to stay discovery and to enter into
a speedy mediation procedure. This allowed us to approach the
resolution of these claims as a business solution as opposed to
a legalistic fight between lawyers, thereby avoiding the cost
of trials and appeals. We were then able to utilize the
mediation services of senior Ninth Circuit Judge Edward Leavy,
who was brilliant in his ability to move the parties forward
toward settlement.
To conclude, the time from our initial investigation to the
court's approval of the settlements and entry of a claims bar
to depositing the settlement money in an escrow account took
under 2 years. Because of the coordination of effort, the legal
fees for the recovery amounted to under 10 percent of the total
recovery. To date, approximately $350 million has been
recovered for distribution to claimants. Under the court's
distribution plan, this equates to approximately 70 cents on
the dollar for every dollar invested by a retiree or investor
at a recovery cost of under 7 cents on a dollar. The success in
this Oregon formula could be repeated in similar cases
elsewhere.
Mr. Chairman, this concludes my prepared statement. I would
be happy to answer any questions you may have.
The Chairman. Thank you very much. The summary of your
successful recovery plan will be shared with the governors,
too, so that we can follow up on that.
[The prepared statement of Mr. English follows:]
Prepared Statement of Stephen F. English
Mr. Chairman and members of the committee, I am pleased to be here
today to discuss with you an area of concern to all of us, protection
of retirement funds.
I am an attorney in practice in Portland, Oregon with the regional
law firm of Bullivant Houser Bailey, PC. I have been a trial lawyer on
both sides of the bar for 32 years. Although much of my experience has
been as a defense attorney, I have taken the lead role as plaintiffs
attorney in a number of complex commercial and financial cases.
I have been asked to provide you with a description of the process
I worked to develop to investigate the claims against Capital
Consultants and related entities. As you know, the losses in this
scandal were estimated in the range of $350,000,000 to $470,000,000.
Capital Consultants had more than 300 clients, and over 150 of them
were employee benefit plans. Those plans had more than 300,000
participants and beneficiaries and they came from nearly every State in
the country. We built a business model that I think can be replicated
to investigate and recover losses in this type of case. We were
successful in putting together litigation settlements in excess of
$125,000,000 from the time I started working on the case in August of
2000. Subsequent recoveries are in the $35,000,000 range and the
Receiver was able to conserve approximately $170,000,000 in assets, all
for the benefit of the pensioners and others who were defrauded by
Capital Consultants and the players associated with the fraud.
In total, the litigators and the Receiver were able to return in
excess of $330,000,000 at a cost in legal fees, Receiver fees, and
investigation costs of less than 10 percent. I would like to give you
an overview of how we handled the litigation and mediation effort in an
efficient and expedient manner. The key to what we accomplished lies in
the fact that we developed a plan to engage in settlement negotiations
that would yield the greatest net return to the clients in exchange for
a complete release in favor of any defendant that agreed to settle, and
a mechanism to ensure that they would not be sued by any other claimant
or sued for contribution by any other potential defendant.
1. I led a small group of attorneys and investigators to identify
the scope of the legal and factual problem and obtain a sufficient
understanding of the problems and potential liability to be able to
speak knowledgeably and get the potential defendants' attention. We did
not expend unnecessary resources on any specific individual defendant,
but rather focused on developing a case against a number of potential
defendants so as to create a broader base from which recovery could be
sought. The initial case focused on approximately 10 of the major
entities responsible for the losses. The case focused on Capital
Consultants as the investment manager, the borrowers with the greatest
culpability, and the lawyers and accountants that worked with those
companies.
2. We purposely did not engage in an exhaustive scorched earth
approach at this stage for the simple reason that we did not know
whether there would be a recovery sufficient to make such efforts
worthwhile to our clients and because we felt time was of the essence
in any recovery.
3. We prepared a lawsuit based on a sufficient amount of
information to be able to tell our story to the defendants and give
other claimants an understanding of what we were doing.
4. We made available to all other potential plaintiffs all of the
information that we had obtained, as well as giving them full access to
our investigation. We based this on the condition that they agree to
cooperate with us in forming a united front so as to maximize recovery
and minimize overlapping of effort. We gave each group of claimants the
right to veto any settlement decision submitted to the group, and that
element proved to be one of the strengths in keeping the group together
and providing a unified front to the numerous defendants.
5. We negotiated an agreement among all plaintiffs to work together
and divide the work in such a way so that all lawyers involved could
have meaningful participation, but with a minimum of duplication of
efforts and costs. As a group, we understood and committed that the
approach would be one which would aim toward a speedy resolution as
opposed to an exhaustive, scorched earth approach. Such an exhaustive,
scorched earth approach would be financially beneficial to the
attorneys, but could be financial disaster to our clients. We then
sought a mandate from U.S. District Court Judge Garr M. King to require
defendants to enter into a mediation process which combined a
sufficient exchange of information so that a businesslike evaluation
could be made by the defendants of their potential exposure. Again, in
the interest of moving a resolution forward, we sought and obtained the
court's approval and guidance so as to freeze or limit the amount of
time spent on expensive, time consuming discovery tactics that could be
employed by defendants and plaintiffs in this type of case. Our
overriding goal in this regard was to approach the resolution as a
business solution as opposed to a legalistic or legal solution.
6. As we anticipated, at least a few of the defendants immediately
saw the value in this. As a part of the resolution we offered these
defendants, we first gathered authority from all potential plaintiffs
and obtained the court's authority to act on their behalf. By doing
this we were able to promise and make good on promises to defendants
that when they settled with us they resolved all claims by all
plaintiffs. As a further condition of this approach, we agreed that
once they resolved claims with us we would protect them from cross-
claims by other defendants. This essentially allowed us to go to a
defendant and say, settle with us and you can resolve everything. This
translated into a monetary value for not just the defendants, but their
insurance carriers, who understood the value of having finality
obtained quickly and efficiently on a case of this exposure.
7. Once it became clear that the court not only approved of this
process, but was fully supportive of it, were able to utilize the
mediation services of senior status Ninth Circuit Judge Edward Leavy,
who proved nothing short of brilliant in his ability to move the
parties forward. The process allowed for several weeks of mediation,
with each party generally mediating two to three times before
resolution was obtained satisfactory to both parties.
8. Once the settlements began, there occurred a ``tipping point''
at which it became apparent that no defendant wanted to remain as the
only holdout. In addition, the fact that many defendants paid less than
they might have had to pay if they had chosen to go through a trial
created a sufficient amount of money so that plaintiffs did not have to
have the maximum possible amount from any individual defendant. Again,
one of our overriding strategies was that a businesslike approach
required getting money quickly and at the least possible cost as
opposed to holding out to squeeze every last dime from entities or
individuals and risk the cost of trial and appeals.
9. The individual lawyers for various plaintiffs understood that in
order to maximize the overall recovery in the most efficient manner
possible, they had to sacrifice aggressive attempts on their part to
maximize their personal clients' recovery to the detriment of other
plaintiffs. In other words, it became apparent to the plaintiffs
attorneys that by following a strategy that would move the recovery
process forward in the most beneficial way for the plaintiffs as a
whole, they were actually acting in the best interest of their
individual clients.
10. The case was able to be concluded from initial investigation
through filing of the lawsuits, completion of the mediation of
defendants and the court approval of the full settlement and claims bar
in 22 months. All of the lawyers on the plaintiffs side meaningfully
participated, but because of the coordination of effort and
cooperation, the legal fees for the recovery amounted to under 10
percent of the total recovery. To date, approximately $330,000,000 has
been recovered for distribution to pensioners and others. Under the
calculation of losses in the distribution plan approved by the Court,
this equates to approximately $.70 on the dollar for every dollar paid
invested in a retirement account or investment account by a retiree or
investor at a cost of under $.07 on the dollar. We believe this formula
and its success should not be unique to Oregon.
The Chairman. Mr. Ray?
Mr. Ray. Thank you, Mr. Chairman. I am pleased and honored
to again appear before this distinguished committee. I welcome
this opportunity to discuss the protection of employee benefit
plans from fraud. My perspective is that of an employee
benefits lawyer who has been representing pension plans for
more than 25 years. Fortunately, none of my client plans were
investors in Capital Consultants.
I would like to focus my comments on a few critical points,
Mr. Chairman. First, we are discussing a dangerous intersection
between the ethics in the marketplace and fiduciary duty.
Capital Consultants is an example of a broader problem with the
investment services community. Pension plans offer investment
firms an opportunity to generate enormous fees and to make
investment professionals fabulously wealthy.
The competition for pension plan clients can be fierce. It
is not surprising that some investment people ignore or bend
the rules or intentionally remain ignorant. There is a sense
that the risk of getting caught is an acceptable business risk
and that the costs of being caught are manageable costs of
doing business.
Consider the financial industry scandals that have been
making headlines over just the past few years, scandals that
have cost investors millions of dollars: The mutual fund
trading abuses and overcharges; fraudulent investment
recommendations by brokers to attract investment banking
business; kickbacks or pay-to-play arrangements between the two
largest insurance brokers in this country and insurance
companies; and there are others, again, that have involved
billions of dollars of loss to investors.
Many of the leading names in the financial services
community, the cream of the crop of Wall Street, have been
required to pay restitution and fines in the hundreds of
millions of dollars. Does it make any difference to them? They
continue to do business.
The second point I would like to make is that it is
unreasonable to expect pension plans to ferret out fraud and
abuse by investment managers. As I explained in my written
statement, soundly administered pension plans use an array of
professionals to develop and oversee their investment programs
and to manage their investment assets. I might make a note that
it is the investment people, not the plan fiduciaries, who make
the money. The typical plan governing fiduciary, like a board
of trustees, they are typically unpaid volunteers. It is the
investment people who make the big money off pension plans.
However, no matter how many professionals a pension plan
hires to monitor other plan professionals, and no matter how
much expense a plan incurs to protect itself against fraud,
there is simply no way that a pension plan could be guaranteed
that it will not fall victim to investment fraud.
Deception is the hallmark of fraud. Investment fraud
typically involves sophisticated schemes involving complex
financial transactions and secret conspiracies conceived and
executed by smart people motivated by greed. Look at the
lengths to which Capital Consultants went to commit and conceal
its fraud against its client pension plans: Lies about the
investment managers bona fides; lies about the nature of the
complex multilevel collateralized note investment; lies about
the performance or nonperformance of the investment; the
creation of shell companies to conceal the collapse of the
investment; secret arrangements with people in the position to
make decisions.
Unfortunately, the nature and scope of this fraudulent
scheme became clear only in hindsight, after investigation by
the SEC and the Labor Department and extensive and expensive
private litigation. Capital Consultants managed to defraud some
very smart professional people, not merely layman trustees.
Only the government has the investigative authority and
resources to effectively deter and detect fraud. Only the
government has the power to compel production of internal
documents and testimony through subpoenas. In particular, this
is a responsibility of the Securities and Exchange Commission,
as the primary regulator of the investment industry. The SEC
has a program of examinations of investment firms, not merely
the authority to investigate when a problem arises. The SEC has
the specialized knowledge and expertise about how investment
firms operate and are supposed to operate.
But as recently noted in a speech by outgoing SEC Chairman
Donaldson, quote, ``There is a mindset that holds that
significant action is appropriate only in retrospect, only
after things have gotten so bad that the risk of investment
harm threatens to become an uncertainty,'' unquote. He went on
to explain in this May 2005 speech that efforts by the SEC to
initiate programs that anticipate investment industry abuses
and stop them before they occur have been actively resisted,
both within the SEC and by outside forces.
The committee might want to note in this regard that the
warnings by Chairman Donaldson and Federal Reserve Chairman
Greenspan lately about the hedge fund industry. Pension plans,
and other investors are scrambling now to find higher returns
than the modest returns being projected for traditional equity
and fixed-income portfolios. Plans are still trying to deal
with the consequences of the negative markets in 2000 through
2002. Hedge funds and other very complex, sophisticated
investment vehicles are being aggressively marketed to pension
plans as the path to higher returns. Pension plans and other
investors are counting on the SEC to protect them.
The third and last point I would like to make is that there
is no lack of laws to deal with the fraud committed by Capital
Consultants. It is a matter of finding out that the fraud is
taking place. The securities fraud laws, ERISA's fiduciary and
prohibited transaction standards, criminal laws, most notably
18 U.S.C. 1954 and 664, and yes, even the Racketeering
Influenced and Corrupt Organizations law provided ample
remedies to deal with the Capital Consultants fraud. The issue
was finding the fraud, and that is where pension plans are
counting on the SEC to do its job to regulate the investment
community.
When I say pension plans, Mr. Chairman, I want to
emphasize, I am not merely speaking about union trust funds, as
the chart indicates and prior testimony indicates. There are
far more corporate plans that are just as susceptible to
investment fraud and need the protection of the SEC and
Congress, as well.
Thank you, Mr. Chairman. I would be happy to answer any
questions.
The Chairman. Thank you very much.
[The prepared statement of Mr. Ray follows:]
Prepared Statement of James S. Ray
Chairman Enzi, Ranking Member Kennedy, and members of the
committee, I am pleased and honored to again appear before this
distinguished, storied committee. I welcome this opportunity to discuss
protecting employee pension plans from fraud, and applaud you for
having the discussion.
Overview
I bring to your discussion the perspective of an experienced
employee benefits law practitioner who has represented pension plans as
well as plan participants and plan sponsors for more than 25 years. I
have had the honor of serving two, three-year terms on the ERISA
Advisory Council of the Labor Department, most recently as Chair for
2002, in both Republican and Democratic administrations. I have also
held several positions with the American Bar Association, including
Chair of its Joint Employee Benefits Committee and as a member of the
governing Council of the Section on Labor and Employment Law. I am a
Charter Fellow in the College of Labor and Employment Lawyers as well
as a Charter Fellow of the American College of Employee Benefits
Counsel, both of which are peer-elected honorary organizations. Of
course, I am not speaking on behalf of any of these organizations.
My focus in this discussion is on the relationship between pension
plans and the investment services industries. That relationship is a
dangerous intersection between the ethics of the marketplace and
fiduciary duty to plan participants. The U.S. Supreme Court has made
the following observation about that intersection:
``Many forms of conduct permissible in a workaday world of
those acting at arms-length are forbidden to those bound by
fiduciary ties. A [fiduciary] is held to something stricter
than the morals of the marketplace. Not honesty alone, but the
punctilio of an honor the most sensitive, is then the standard
of behavior [for fiduciaries].'' Pegram v. Herdrich, 530 U.S.
211, 224-25 (2000).
Unfortunately, the opportunities to make enormous profits and the
competition for those opportunities have led too many in the investment
services community to abuse their fiduciary duties to pension plans and
other investors, and to entice other plan fiduciaries to violate their
duties. Too often the morals of the marketplace are that the risk of
being caught wrongdoing is an acceptable business risk, and the
restitution or penalty imposed if caught is a manageable cost of doing
business. The words ``everybody does it'' are too often uttered in
defense of wrongdoing. There is a certain arrogance that comes with the
investment community's strong influence over the Nation's economy.
The recent spate of investment community scandals, many involving
frauds on pension fund investors, suggests that the lessons of earlier
scandals have not been learned. And, signals from the Securities and
Exchange Commission (SEC), the Federal Reserve, and media reports
indicate that more scandals can be expected, particularly among hedge
funds, as pension funds and other institutional investors search for
higher investment returns than traditional investments in equities and
fixed income securities are expected to produce in the foreseeable
future.
The Capital Consultants fraud is but one illustration of a broader
problem of the investment community placing business interests ahead of
fiduciary duty.
There needs to be a change in the culture of the investment
community concerning dealings with employee pension plans. And, that
cultural change seems possible only if there is greater regulatory
oversight of investment services providers by the SEC. In this world of
an ever-increasing variety and complexity of investment vehicles, only
government has the resources and authority to deter and detect
sophisticated fraud; pension funds do not.
Will the SEC meet this challenge? Will Congress have the political
will to allow the SEC to meet this challenge?
Pension Plans Depend On Investment Community
Employee pension plans collectively constitute one of the largest
pools of domestic investment capital, especially if you include
``401(k) plans'' as pension plans. Pension plan investments are valued
in the trillions of dollars. Naturally, they receive a lot of attention
from the investment services industry, including investment managers,
investment consultants, brokers, banks, insurance companies, mutual
funds, hedge funds, other collective investment funds, and lots of
other organizations and individuals. Pension plans are a gold mine of
investment fees.
Pension plans depend on the investment services community. The
typical pension plan engages a collection of investment professionals
to perform services related to the plan's investments. Private sector
plans are, as a practical matter, compelled to do so by the Employee
Retirement Income Security Act (ERISA). ERISA's fiduciary standards of
conduct require, among many other things, that a plan's investment
program be prudent in structure and operation. Prudence is really a
process standard; whether an investment decision is prudent is measured
by the soundness of the decisionmaking process, not by the future
success or failure of the decision. Prudent investment decisionmaking
generally requires specialized knowledge and expertise that few laymen
possess. Indeed, many newly developed investment vehicles and financial
instruments have become so complex that few professionals, and even
fewer regulators, understand them.
An investment consultant (or consultants) is engaged: to develop
and monitor the plan's asset allocation; to develop and monitor
investment guidelines and policies; to recommend investment managers
and investment vehicles; and to monitor the performance of the
investment managers and investment vehicles. Generally the investment
consultant is an advisor to the plan's governing fiduciary (e.g., board
of trustees in a multiemployer plan setting, corporate officers in a
single employer plan setting). Nonetheless, the consultant is a
fiduciary within the meaning of ERISA because the consultant is giving
investment advice for a fee. In performing its services for the plan,
the consultant is subject to ERISA's fiduciary standards of conduct and
prohibited transactions rules.
An investment management firm (investment manager) generally is
engaged to assume discretionary, fiduciary responsibility to manage a
specified portion of the pension plan's investment portfolio (e.g.,
large cap equity, small cap equity, fixed income or balanced account).
The investment manager decides which specific investments to make, hold
and sell (e.g., buy or sell a particular company's stock or a
particular corporate bond). Typically, a plan engages more than one
investment manager, each with fiduciary responsibility for a portion of
the plan's portfolio, reflecting the plan's asset allocation decisions
and the need for investment diversification. Each investment manager is
an ERISA fiduciary with respect to the plan because it has
discretionary authority regarding the management of plan assets.
ERISA strongly encourages the engagement of investment managers
beyond the need for prudent investment decisionmaking. If a pension
plan's governing fiduciaries engage an investment manager, ERISA
generally shields the governing fiduciaries from liability for the
investment manager's investment decisions. For this statutory shield to
apply, the investment manager must be registered with the SEC or a
similar State agency, unless it is a regulated bank or insurance
company. The investment manager must also acknowledge in writing that
it is a fiduciary with respect to the pension plan under ERISA.
The governing fiduciaries continue to have a fiduciary obligation
to monitor the performance of the investment manager relative to the
pension plan's investment policies and guidelines as well as relative
to some established benchmarks, and decide whether to retain or
discharge the investment manager. This monitoring function, however, is
generally assigned to the investment consultant who advises the plan's
governing fiduciaries.
Investment brokers are engaged by the pension plan's investment
managers to execute the manager's decisions to buy and sell particular
securities for the plan's portfolio. The investment manager generally
selects the broker for each transaction and agrees to pay the broker a
commission for its trading services. The commission is paid to the
broker using the pension plan's assets, not the manager's own assets.
Often, a portion of the commission, or its value, is rebated to the
investment manager by the broker under so-called ``soft dollar''
arrangements. The investment manager personally benefits from these
soft dollar rebates by, at a minimum, reducing its own business
overhead costs. To some extent, SEC rules allow investment managers to
maintain soft dollar arrangements with brokers, despite their
questionable status under ERISA. (More about this later.) Some pension
plans try to preempt such soft dollar arrangements by participating in
so-called commission recapture programs under which one or more
brokerage firms agree to rebate a portion of the commissions to the
plan, rather than to the plan's investment managers.
Increasingly, pension plans are investing (buying units or shares)
in pooled investment vehicles managed by investment managers, rather
than engaging the investment manager to manage a separate portfolio for
the plan. Some investment managers are encouraging this shift,
asserting that pooled arrangements are most cost efficient (although I
suspect that the managers have their own motives as well).
For the governing fiduciaries of the plan, a decision to buy units
in a pooled investment fund presents a fundamentally different decision
than a decision to hire an investment manager to manage a separate
portfolio, viewed from ERISA's perspective. The governing fiduciaries
are the decisionmakers on the question of whether to invest in the
pooled fund; that is, whether to buy units in the fund. Once the
investment is made, the manager of the pooled fund has fiduciary
responsibility for the management of the fund's assets (including the
money invested by the pension plan) in accordance with the investment
fund's governing documents and applicable law. But, the decision to
make the investment in the fund is the responsibility of the pension
plan's governing fiduciaries, not the manager of the investment fund.
(Managers of pooled investment funds typically include such a
disclaimer in the investment documentation.) Well-advised pension plan
governing fiduciaries will rely on a qualified investment consultant to
conduct a prudent, due diligence review of the investment vehicle and
to advise them on whether the investment is appropriate for the pension
plan. Few governing fiduciaries of plans are qualified to make such an
investment decision without professional advice.
The amount of fees that investment managers earn from pension plan
investments is enormous. Generally management fees are based on a
percentage of the market value of the portfolio or fund being managed.
As the value of the portfolio or fund increases, the manager's fee
automatically increases. The value of the portfolio may increase
through investment growth or by the addition of investment capital
(e.g., new investors). With each new pension plan client, an investment
management firm typically gains an additional fee base (more assets to
manage) without much additional work because the firm applies
essentially the same strategies to all of its clients or to groups of
clients.
In contrast to the investment managers and other investment
professionals, the governing fiduciaries of pension plans are typically
unpaid volunteers. In a multiemployer plan setting, the governing
fiduciary is the board of trustees, consisting of labor and management
representatives in accordance with the Labor Management Relations
(``Taft-Hartley'') Act. ERISA prohibits the pension plan from
compensating these trustees for their services to the plan if they are
(as is usual) full-time employees of the sponsoring union and of
contributing employers. They can only be reimbursed for their actual
and reasonable expenses incurred in performing services for the plan.
In a single employer plan setting, the governing fiduciaries are
typically employees of the plan sponsor whose plan duties are part of
their corporate duties.
In short, pension plans are at the mercy of the investment services
community.
Investment Services Community Abuses and Corruption
Conflicts of interest, self-dealing and other abuses are no
strangers to the investment services community. Indeed, there seems to
be a continuing stream of major scandals in the community. Some recent
examples:
Mutual Fund Abuse Scandal (2003-04): Several large mutual
funds were found to have permitted favored customers to engage in
market-timing and late trading abuses to the detriment of other
investors. In addition, the SEC found that a large percentage of
brokerage firms were assisting the favored clients to engage in these
abuses. Several financial institutions were required to make
restitution and pay fines in the tens and hundreds of millions of
dollars (e.g., Bank of America--$675 million; Alliance Capital
Management--$600 million; Massachusetts Financial Services--$350
million; Canary Capital Partners--$40 million). The SEC belatedly took
action to prevent these types of abuses. Notably, in a March 2004
report, the SEC admitted that its review of mutual fund records ``did
not reveal the covert arrangements that fund executives had with select
shareholders'' prior to the abuses becoming public.
Mutual Fund Overcharges (2003): The SEC and NASD found
that more than 400 securities firms had overcharged investors for sales
charges on mutual fund investments by $86 million in 2001 and 2002.
Self-Dealing Investment Research (2002-03): Merrill Lynch
agreed to pay a $100 million fine and take other actions in response to
New York Attorney General's complaint that the Merrill Lynch analysts
were recommending questionable stocks to investors in the hope of
gaining the investment banking business of the companies whose stock
they were falsely promoting. Nine other ``Wall Street'' investment
firms entered into a private litigation settlement under which they
collectively agreed to pay $1.4 billion.
Insurance Broker Fraud (2005): Marsh & McLennan Companies,
the Nation's largest insurance broker, agreed to pay $850 million in
restitution to settle charges by the New York Attorney General that it
steered its brokerage clients to insurance companies that paid
kickbacks to Marsh & McLennan, and that it staged phony bidding among
insurance companies to conceal the ``pay to play'' kickback scheme from
clients. Even more recently, AON, the second largest insurance broker,
agreed to pay $190 million to settle the same charges. Other insurance
brokerage firms have been implicated as well.
Not so long ago hedge fund manager Long-Term Capital Management had
to be saved from collapse with a $3.6 billion bailout, that investment
firms were peddling inappropriate derivative investments and junk bonds
to pension plans.
Today, as pension plans and other institutional investors search
for higher returns in the face of predictions of low returns in
traditional equity and fixed income portfolios, the investment
community is developing and marketing even more complex and exotic
investment vehicles that are supposed to outperform traditional
investments. Some of these vehicles are so complex and multilayered
that they are not well-understood by professionals and regulators, much
less laymen.
Hedge funds are being aggressively marketed to pension plans as the
clear path to higher returns. The extraordinary management fees charged
by hedge funds (typically 2 percent of assets plus 20 percent of
capital gains and appreciation) have made hedge fund managers wealthy
beyond imagination. Yet, dire predictions are being made that the hedge
fund industry will produce the next major scandal. The SEC has reported
``an increasing incidence of fraud'' among hedge funds; 51 cases of
hedge fund theft, fraud and abuse caused a loss of more than $1 billion
to investors. In its 2003 report on hedge fund growth, the SEC stated:
``The Commission's inability to examine hedge fund advisers has the
direct effect of putting the Commission in a `wait and see' posture
vis-a-vis fraud and other misconduct.'' Federal Reserve Chairman
Greenspan opined earlier this week that many hedge funds are pursuing
high risk and complex trading strategies that could result in
significant losses.
Yet, the SEC's recent action to require the vast majority of hedge
funds to register with the SEC for the first time in 2006 was greeted
with condemnation in the investment community. Indeed, the SEC vote on
the new requirement was 3-2. In commenting on this controversy in a May
12, 2005 speech, outgoing SEC Chairman Donaldson made the following
observations about the difficulty of expanding regulatory oversight of
the investment community, and the difficulty of deterring and detecting
fraud:
``There is a certain mindset that holds that significant
regulatory action is appropriate only in retrospect, or only
after things have gotten so bad that the risk of investor harm
threatens to become a certainty. We have sought to launch the
Commission on a different course, an approach that anticipates
problems before they develop, and deals with areas of concern
that have perhaps lingered unattended for many years with their
pernicious consequences long unnoticed by the public at large .
. . .
``The controversy generated by these reforms [i.e., hedge fund
registration and market structure reforms] both within and
without the Commission also illustrates the practical
difficulties faced by the Commission when it seeks to take
action that is anticipatory in nature, as well as reactive . .
. .
``At the same time, there has been an increased number of
enforcement actions involving hedge funds, and it was difficult
to deter this fraud--or to discover it--without a compliance
regime and a program of examinations and inspections by our
staff . . .
``If history is any guide, it is just this sort of
[competitive] pressure that can lead otherwise well-intentioned
professionals to pursue practices that ultimately result in
disaster for the investors that they serve.''
Inherent Conflicts Of Interest Among Investment Firms
Conflicts of interest are inherent in some of the arrangements
among investment community members that have come to be accepted
practice (``everybody does it''). The most obvious of these practices
is the so-called ``soft dollar'' arrangement. Most investment
management firms have what are essentially kickback arrangements,
called ``soft dollar'' arrangements, with the securities broker
selected by the manager to execute trades for the investment manager's
client pension plan. Under these arrangements, the investment manager
pays a commission to the broker for the broker's services (using the
pension plan's assets), and the broker rebates a portion of the
commission to the investment manager in some form.
In other words, in addition to the investment management fee that
the manager receives directly from the client pension plan, the manager
receives a rebate of the plan-paid commission from the broker. This is
big business inasmuch as pension plans, mutual funds and other
institutional investors pay billions of dollars each year in brokerage
commissions ($12.7 billion in 2002, half of which was rebated in the
form of soft dollar goods and services according to the Wall Street
Journal).
The Security Act and SEC rules allow investment managers to use
soft dollar arrangements to obtain from brokers so-called ``research''
related products and services (e.g., securities research materials,
software, Bloomberg terminals, magazine subscriptions); in essence
allowing the use of commission rebates to offset what would normally be
business overhead costs. This is called the Section 28(e) soft dollar
safe harbor rule.
In a 1998 report on soft dollar practices, the SEC observed that
soft dollars have been used to benefit the investment managers in ways
that went well beyond the scope of ``research.'' An SEC survey found
that 35 percent of the brokers examined provided some clearly non-
research goods, services and other things of value to investment
managers, including office rent, office equipment and furnishings,
employee compensation, and personal travel and entertainment. The SEC
also found that the disclosure requirements for such arrangements were
widely ignored.
While both the SEC and the Labor Department have recognized that
soft dollar arrangements place a pension plan's investment manager in a
conflict of interest, they have not been prohibited because Section
28(e) remains on the books. The SEC has a Task Force on Soft Dollars
considering whether to narrow the scope of the ``research'' for which
soft dollars can be used under 28(e) and whether to require more
disclosure to pension plans and other investors about soft dollar
arrangements.
From the ERISA perspective, soft dollar arrangements would be
treated as prohibited transactions, essentially like kickbacks, but for
ERISA's deference to other Federal law, Section 28(e). So, the Labor
Department has accept that managers may have soft dollar arrangements.
However, according to Labor Department guidance, the plan's governing
fiduciaries must monitor each investment manager's soft dollar
arrangements to ensure that the manager is not being excessively
compensated by the plan (considering both the investment management fee
paid to the manager directly by the plan and the brokerage commissions
rebated to the manager by the brokers). This is a mission impossible
for most, if not all, pension plans. Pension plans do not have the
resources or investigative authority of the SEC or the Labor
Department.
Another example of conflicts of interest in the investment
community are investment consultants that have arrangements with
investment managers and investment funds to recommend the managers or
funds to the consultants' clients in exchange for payments or other
things of value to the consultant (so-called ``pay to play''
arrangements). Pension consultants' conflicts of interest was the
subject of a May 2005 SEC staff report. It reports that it is
commonplace for investment consulting firms to have arrangements with
investment managers and investment funds that compromise the
independence of the investment advice that the consultants give to
pension plan clients about the investment managers and funds.
In a joint guidance statement issued on June 1, 2005, the Labor
Department and the SEC placed responsibility for ferreting out
consultants' conflicts of interest on the pension plans' governing
fiduciaries. The statement is entitled: ``Selecting and Monitoring
Pension Consultants--Tips for Plan Fiduciaries.'' I've been asked by
clients how the government can expect them to discover such consultant
conflicts when it took the SEC so long to find them.
Capital Consultants Fraud
I understand that the committee is particularly interested in the
fraud perpetrated on various pension plans by Capital Consultants LLC
in the 1990s, and that other witnesses have recounted the facts and
circumstances of that matter to the committee.
To me, the Capital Consultants matter is yet another example of how
difficult it is to prevent and detect fraud by investment firms. In
hindsight, it all seems so clear. But, at the time, Capital Consultants
had the appearance of propriety: a large client base, good performance
figures, and some good references. Moreover, the collateral notes
investment pool being marketed by Capital Consultants was a complex
investment. Some of the pension plans' consultants blessed the plans'
investment with Capital Consultants, although it is unclear how deeply
they probed (or were capable of probing) into the complexities of the
investment and the undisclosed arrangements among the players.
It was not until after Capital Consultants' collapse--with the
benefit of aggressive and expensive private litigation and intervention
by the SEC and Labor Department--that the corrupt machinations among
Capital Consultants, Wilshire Financial, and various other firms and
individuals were uncovered. Few, if any, pension plans have the
wherewithal to engage in such an indepth investigation of sophisticated
conspiracies and complex financial instruments.
Much has been made of the fact that Capital Consultants salesman
Dean Kirkland provided free trips and other valuable gifts to some
trustees of some pension plans, and that one trustee was paid
substantial cash kickbacks. Needless to say, this conduct was improper
in an ERISA context. Kirkland and a trustee who received the cash
kickbacks were properly convicted of crimes under existing law. There
is no lack of law prohibiting such misconduct, or governmental
authority to investigate. Section 1954 of Title 18 of the United States
Code, under which Kirkland was convicted, makes it a crime for service
providers (and others) to offer or give a kickback to ERISA plan
fiduciaries, and makes it a crime for any ERISA plan fiduciary to
solicit or receive a kickback. In addition, ERISA itself treats such a
kickback as a prohibited transaction that subjects the giver and the
recipient to various civil remedies. And, in the context of labor-
management relations, the Taft-Hartley Act (Section 302 of Title 29 of
the United States Code) generally prohibits employer payments to union
representatives.
The Labor Department's Employee Benefits Security Administration
has broad authority (including subpoena powers) to investigate whether
such a criminal or civil violation has occurred. In the context of
multiemployer plans, the Labor Department's Inspector General also has
criminal investigative authority.
The fact is that many in the investment community consider ``travel
and entertainment'' for pension plan clients to be normal marketing;
the kind of thing that ``everybody does'' because if they don't their
competitors will. This is how business is conducted in the marketplace.
I've heard some investment firm representatives say that their firms
get upset if they don't spend their marketing budgets to get ``face
time'' with clients. There seems to be little understanding among
investment firms, or at least their representatives, that some
marketing practices that might be ``business as usual'' are simply
unlawful, even criminal, if used in the context of an ERISA-covered
pension plan. This needs to change, but will only change if the
investment firms realize that their business interests are better
served by compliance with ERISA's restrictions on payments to or for
plan fiduciaries. If investment firm representatives cease offering
gifts and gratuities to plan fiduciaries, there will be nothing for
plan fiduciaries to accept.
Conclusion
In sum, protecting pension plans from fraud requires a commitment
to greater regulatory oversight of the investment services community.
It is unrealistic to expect that pension plans can adequately protect
themselves against sophisticated schemes involving complex financial
transactions and secret conspiracies conceived and executed by smart
people who are motivated by unmitigated greed. Only the SEC has the
authority, expertise and other resources needed to deter and detect
investment fraud. The question of the day is whether the SEC has the
will and backing to more aggressively police the investment community.
Thank you again for this opportunity to participate in the committee's
discussion of this important issue. I would be pleased to answer your
questions.
The Chairman. A very interesting panel, probably more
specific suggestions than we usually get on any of the action
that we are contemplating, so I appreciate all the expertise
that is gathered here. I will ask a few questions to get a
little bit more information from you. And again, members of the
committee will be submitting questions in writing so that we
can add to the record today, too.
Mr. Grayson, again, I want to thank you for your
willingness to participate in the hearing today. The
information and insights that you provided go a long way toward
assisting in preventing future pension frauds.
Now, you stated that the Department of Labor had several
opportunities to uncover the Capital Consultants scheme but
that it was the SEC that more decisively uncovered this Ponzi-
like scheme and examined the collateralized note program. Can
you describe the instances in which the Department of Labor or
other government agencies reviewed the books and records of
Capital Consultants and your observation about the
effectiveness of those reviews? I am particularly interested in
your perspective on the difference in enforcement capability
between the Department of Labor and the SEC.
Mr. Grayson. Yes, sir. The Department of Labor reviewed
Capital's books and records actually consistently over many
years, the first of which was in 1992 when they opened their
file, and then the second of which was in 1997, all told,
almost--over 8 years of ongoing investigations by the
Department of Labor where they were looking in depth at all of
Capital's private investments.
Unfortunately, though, that review over both periods of
time was not to the point where individual details associated
with those private investments were really focused on. There
was not a real forensic accounting analysis done of the private
investments on either occasion. It was more kind of a general,
broad approach. They did look at them all, but instead of
focusing on the more complex transactions, like the Wilshire
investment, during both cases, it was really more of a focus on
the more simpler ones, easier to get their hands around, which
unfortunately, I think, resulted in missed opportunities.
The SEC, on the other hand, when they came in, they came in
with a team. I believe there were five forensic accountants
that came in. They interviewed everybody in our office. They
looked at every file, every single page, and they basically
camped at our office that entire time. They were very diligent.
They talked to clients. They looked at correspondence. They
pretty much did everything one could ever hope for from a true
audit. And then they reacted very quickly.
So I guess the real difference in perspective between the
two agencies, from my perspective, is that one resulted in
general conclusions about problems with specific private
investments but didn't result in any true uncovering of real
issues and took more of a legal approach, a general, simple
approach, whereas the other took a very detailed, focused look
at all of the assets in our management and uncovered wrongdoing
very quickly and then took immediate corrective action.
The Chairman. You mentioned forensic accountants coming in.
Were the others, were the Department of Labor folks accountants
or----
Mr. Grayson. They were attorneys, primarily, coming in.
They lacked an overall business skill set, and in fact, our
counsel even pointed that out to them on several occasions. To
understand private investments, it takes an extensive business
background, accounting background. As you are aware, numbers
can be adjusted and one has to truly know what the available
options are and how to understand the true basis for a lot of
these investments. Fortunately, the SEC had the staff and had
the capabilities and went in there hard and spent the time. It
is spending the time that is critical. You can't get by with
just a couple days on site. You need to really go in and talk
to everybody.
The Chairman. Thank you. Could you expand a little bit on
the nature of the collateralized note program and its
significance to Capital Consultants in this operation? I am
also interested in understanding how the private auditors and
the government investigators can improve their oversight of
these collateralized note programs.
Mr. Grayson. The collateralized note program is really just
a branding title that my father and Capital assigned to a
subprime lending program, a receivable basis program, which, by
the way, the receivables at the end of the day were effectively
straw receivables. So there were obviously deficiencies in the
program itself.
But in terms of the program, because it was defined as
effectively a high-income-producing fixed-income investment, it
provided a very high rate of return, which was desirable to a
lot of the Taft-Hartley regulated funds with which Capital was
marketing. As a result, when Capital would go into client
presentations for new money, they would be competing against
other money managers who had publicly traded debt instruments
as alternatives. The relative comparison is that the
collateralized note program would provide investment returns
typically 400 or 500 basis points higher than what the rest of
the market was available.
Obviously, that inherently means that there is higher risk,
collateral potential issues, a variety of other options. But in
the end, Capital was typically selected over other money
managers on a regular basis because nobody could compete with
that product.
That, as a result, resulted in a very continuing flow of
funds into the company. They were regular. They were coming in
monthly in large amounts, millions of dollars, and they would
come in and those dollars were the source of funds that allowed
the Wilshire investment and other collateralized notes to be
kept current, effectively. If the source of those dollars did
not continue, then what occurred could not have occurred.
In terms of what regulators could have done, from a
governmental standpoint, they have authority to come in at any
time and spend a significant amount, more amount of time. When
the initial red flags went up, in my opinion, there should have
been more analysis done. That was actually prior to my arrival
at the firm. But the analysis should have been more intense.
Just as an example, that $2 million fine that was imposed
by the Department of Labor, the source of those funds were
actually from Wilshire. Wilshire loaned my father the $2
million, which was then in turn paid to the clients. Then those
$2 million that were paid to the clients in turn were returned
to Capital to invest on their behalf, and then that $2 million
was, in turn, loaned back to Wilshire. So that circular nature
of funds could have been pretty easily identified by a forensic
accountant or somebody who went in within a very short period
of time and the Department of Labor instead just asked for a
letter from Capital confirming that they were, in fact,
Capital's own funds. So there is a pretty significant
difference.
The Chairman. Thank you.
Mr. English, in your testimony, you mentioned some other
people that are here with you, but we don't know who they are.
Would you mind re-introducing the----
Mr. English. Absolutely. I would be happy to, Mr. Chairman.
I mentioned my partner, Bob Miller.
Mr. Miller. Good morning, Mr. Chairman.
The Chairman. Good morning.
Mr. English. And Joe Gavalas and Norm Transit. And I
reluctantly admit that Mr. Transit is a forensic accountant--
[Laughter.]--although I think the lawyers had something to do
with this, also.
The Chairman. Oh, yes.
Mr. English. Mr. Farnell, Mike Farnell, he is another
attorney that was a member of the consortium.
The Chairman. Thank you. It is usually almost impossible
for accountants to operate without attorneys, but once in a
while, when there is something good said about them, I do like
to emphasize that.
[Laughter.]
Which I would do for attorneys, too.
[Laughter.]
Mr. English. Understood.
The Chairman. Now, it appears that the consortium of
attorneys and other professionals who pulled together to deal
with this matter were unusually successful in rapidly returning
the trust fund the hundreds of millions of dollars that the
workers lost in the pension and the benefit funds. In your
view, why was the consortium so successful at getting back so
much of the money in this particular case?
Mr. English. There are several reasons. No. 1, I think we
quickly got our arms around the facts in the case to create a
strong understanding of the facts as well as a variety of legal
theories that, frankly, went beyond the normal ERISA remedies.
Oregon is blessed with a Securities Act that creates liability
not just for the issuer of a security, but for those who
materially aid in a debt, and that was a tool that we were able
to use as a part of our claim.
In addition to having a strong case, we had an extremely
cooperative Federal judge, Judge Garr M. King, who shut down
discovery before it got rolling. That allowed us to take a more
business-like approach to gathering information quickly without
individuals having to go through the typical extremely
expensive scorched earth discovery process.
And we were able to share with the other plaintiffs or
potential plaintiffs all of our information that we had
gathered. We did this because we thought the most efficient way
to get this done was to have a united front of attorneys making
one claim so that a defendant could write one check and have
all of his claims resolved.
Typically, this doesn't occur. Typically, resolutions are
slowed because a defendant not only has to deal with a
particular plaintiff, but with cost claims by other defendants
or by claims that could exist for not yet identified
plaintiffs. We solved those problems through a mechanism that
allowed recovery and settlement by a defendant to resolve all
issues at once.
The Chairman. Thank you.
Mr. Grayson, from your statement, it sounds as though there
wasn't any limit under the pension laws on the gifts and
gratuities that firms can provide to pension fiduciaries. It
also sounds as though the gifts and gratuities were a major
part of Capital Consultants' method of conducting business.
Could you explain to the committee how much was set aside
annually for gifts and gratuities and describe a little bit
more about how the firm used those gifts and gratuities to
conduct business? I am particularly interested in the extent to
which you believe other firms across the country might be using
gifts and gratuities, as well.
Mr. Grayson. Yes, sir. Capital Consultants had an annual
budget for travel and entertainment of Taft-Hartley regulated
funds and also other trustees of $500,000. It was an annual T&E
budget that was exhausted each year.
The use of gifts and gratuities is very prevalent in this
industry. It is known as the wine-and-dine industry. There are
exceptions. You are one of them. But there are exceptions to
the rule, but it goes on quite often. Unfortunately, it is to
the point where it is almost expected.
When I talked about the expensive dinners and the trips
before, those are all regular events and those are things that
are experienced not only by ourselves but by our competition.
From my personal experience, I know that it was going on in
most of our competitors associated with the trustees. In our
industry, it is viewed that you have to maintain your
relationship with trustees, and therefore, wining and dining is
part of that.
Others, the general rule that we go by is that there is not
supposed to be anything taken of value away from a trustee
following some sort of entertainment. Obviously, Capital
historically did not follow that rule to the letter, and
unfortunately, in my personal opinion, I believe that that goes
on, as well. But that general rule of thumb of not taking away
anything of value is the kind of guideline that we deal with.
Of more difficulty in dealing with the current law, the
current law, as was witnessed in the recent trial associated
with this case of two trustees, unless it can be proven that
gifts and gratuities directly influenced their investment
decisions and behavior, it was determined that they were not
guilty, and that was the finding of the court. So if there is
no criminal conduct associated with the receipt of gifts and
gratuities unless you can prove, and that is very difficult to
prove, that it influenced decisions, it is going to continue
that way for quite a while because it is a normal course of
business.
Obviously, not everybody does this and there are some very
good standpoints, people who rest entirely on their performance
alone, but it is a regular event.
The Chairman. Thank you. I appreciated your comments and
your testimony on that, too.
Mr. English--and I will get to the other two here in a
minute--do you know what benefit plan service providers think
about current provisions and practices regarding gifts and
gratuities within the industry? In your opinion, does Congress
need to clarify or prescribe additional rules?
Mr. English. As to the first question, Mr. Chairman, I am
not a benefit plan service provider myself, but I have some
experience and have been exposed to them. I think it is
confusing, at the least. Marketing 101 for business in the
United States is that one wines and dines one's clients. I am
sure you are familiar with that from your experience in the
accounting industry and other industries. Taking a client to
lunch, taking a client to a game or whatever is considered
standard operating procedure.
To have that same kind of conduct be not just a basis for
civil but criminal liability makes it confusing, and as Mr.
Barclay Grayson just identified, the definition is one that is
somewhat confusing. It needs to be clarified. If Congress
really wants to prohibit any kind of influence, then they
should have it a broader-based law as opposed to what I
perceive right now to be a rifle shot.
The opinion of Judge Brown actually sets that out in some
detail. She was the judge that articulated some of the problems
with the current law.
The Chairman. And we will pay some particular attention to
the way that she expedited that. I appreciate that.
Mr. Ray, would you like to comment on that, gifts and
gratuities.
Mr. Ray. If I may, Mr. Chairman. This is that intersection
between market ethics and fiduciary duty that I was talking
about before. I agree with my colleague, Mr. English, that that
is the way business is done, and I think in the investment
community, they don't see the bright line between the way
business is normally done and when you are dealing with an
ERISA fiduciary, an ERISA plan. The rules are different. The
morals of the marketplace aren't enough, as I say in my written
statement. The U.S. Supreme Court has observed that, as well.
There has to be a change in culture in the investment
community. Either through education or other means, they have
to understand that it is not the right thing to do and they
have to understand that if they stop doing wrongdoing, they are
not going to have to worry about losing the business to some
competitors. There has to be some assurance, a safe harbor, if
you will, in the investment community as to not assure they are
going to lose business if they don't provide gifts and
gratuities.
Another quick point. Current law prohibits these things.
There isn't an absence of law, again, Mr. Chairman. They are
prohibited transactions under ERISA. They are breaches of
fiduciary duty under ERISA. And they can constitute criminal
violations of Section 1954.
Now, with regard to the District Court decision that has
been referenced by Mr. Grayson, I, frankly, think that the
District Court was wrong and I think her decision was
inconsistent with a whole collection of other Court of Appeals
cases in other Federal courts. It is no, I think, coincidence
that her opinion fails to mention any of these other 1954 cases
that have been decided before that have a different standard of
intent that is required. I think it is, frankly, one District
Court decision that is wrong. It is not some systematic problem
with the Federal statute.
The Chairman. Thank you. I paid particular attention when
you mentioned this under section of ethics and fiduciary
responsibility. I read a book by a friend of mine, Amitai
Etzioni, who is an economics professor at the George Washington
University. He taught ethics at Harvard Business School in the
1970s. It is an interesting chapter in his book about how black
and white the questions had to get before he could get them
away from the question of how does it affect the bottom line.
If you think about it, the ones from the 1970s would be the
corporate managers today.
I am not particularly picking on the Harvard School of
Business, but that is the only example that I had of somebody
that went to teach ethics that early. It was very distressing
to see what the schools might have been doing at that point in
time.
Mr. Endicott, what message would you want to send to the
Department of Labor, who is responsible for regulating the
pension fund fiduciaries?
Mr. Grayson. Well, I think in hindsight, if this would have
been discovered earlier, a little more attention made to it, it
would have saved millions and millions of dollars to our
participants of our trusts. Just the lack of getting to the
bottom of what was going on and not letting the prior trustees
know there was an investigation going on really harmed our
members. If you see something is wrong, you should go after it,
and the delay in time cost lots of money to our members.
The Chairman. Is there any particular message you would
like to send to the pension fund fiduciaries who were, you
know, making these investment decisions?
Mr. Grayson. It is just--you have got to look really hard
at the people's money you are investing. These are just hard-
working folks. They know how to put pipe in the ground and
build powerhouses and hospitals and schools and that is why we
hire those professionals, licensed professionals, to look out
for the best interest of our funds. That should be their prime
mission.
The Chairman. Thank you.
I have some other questions, but I will submit those in
writing to you. They, again, they get into more specific
accounting actions and a little bit more detail on some of the
shortcomings and limitations that each of you may have found as
you worked on it.
I really appreciate your outstanding testimony today and
this bank of expertise that we have. We will try and utilize it
so that problems like this don't happen in the future and make
sure that Congress does what it can do, which is not only
making laws, but also providing some oversight over the
agencies that are responsible for these sorts of things and
making sure that coordination happens. Obviously, from an
accounting standpoint, there are some things in coordination
that can be done that will help to disclose things a little bit
earlier.
I thank you all for being here. The record will stay open
for another 10 days so that others can submit questions and
also so that any of you can expand on your testimony, if you
wish to. Thank you.
The hearing is adjourned.
[Additional material follows.]
ADDITIONAL MATERIAL
Response to Questions of Senators Enzi, Kennedy, Hatch, and Bingaman by
Alan Lebowitz
SENATOR ENZI
Question 1. You testified that EBSA is regularly in contact with
the SEC regarding investment advisor and related fiduciary enforcement
matters. Excluding telephone calls and e-mails, how often and at what
level have EBSA officials met with the SEC during the past 6 months and
what matters were discussed at those meetings? Have EBSA and the SEC
formalized how often to meet and what their joint enforcement
priorities are?
Answer 1. EBSA works very closely with a number of Federal
Agencies, including the SEC, IRS, PBGC, the Department of the Treasury,
DOJ, and OCC on a wide variety of interpretative and enforcement
issues. For example, the Department and the SEC staff recently jointly
published ``Selecting and Monitoring Pension Consultants--Tips for Plan
Fiduciaries,'' following the release of an SEC staff report on
potential conflicts of interest by pension consultants. In addition, we
worked very closely with SEC staff in the development of our
regulations under the Sarbanes-Oxley Act and in the review of their
regulations. EBSA routinely seeks comment from SEC, IRS, and OCC and
routinely provides comments to these agencies on matters of mutual
interest and concern.
Some Agencies, such as the SEC, IRS, and Federal banking agencies,
require special procedures in order to share investigative information.
We find that these procedures provide a workable framework, and we have
no difficulty in coordinating and sharing investigative information
with these Agencies. Meetings between the SEC and EBSA are held as
needed, and there is frequent telephonic communication as well.
Meetings between EBSA and the SEC are summarized in Appendix 1.
Question 2. GAO indicated that ``targeting'' remains a ``big
concern'' and that, while improvement has been made, EBSA needs to be
more proactive and less reactive. You testified that EBSA does not
measure success based on the effectiveness of its targeting, but
instead measures success based on the aggregate results of opened
investigations. How do you determine which plans to investigate in the
first place? How is the EBSA targeting program proactive?
Answer 2. Broadly speaking, case selection is guided by EBSA's
Strategic Enforcement Plan (StEP), which sets forth our national long-
term investigative priorities and establishes a general framework by
which EBSA's enforcement resources are focused to achieve the Agency's
policy and operational objectives as established by the Secretary and
Assistant Secretary. Short-term enforcement priorities are established
annually, through the Program Operating Plan (POP) Guidance issued by
the national office. Preparation of the POP Guidance begins with the
identification of recent enforcement trends, an analysis of particular
areas of noncompliance, and a review of current policy considerations.
In this manner EBSA shifts its enforcement resources to respond quickly
when new and emerging issues are spotted while staying within the long-
term framework established by the StEP. It is through the POP Guidance
that EBSA establishes each fiscal year's national enforcement projects,
provides guidance for choosing regional enforcement projects,
identifies any other specific policy priorities that will require
investigative resources, integrates the Agency's GPRA goals into the
planning process, and provides general guidance with regard to the
selection of investigations.
EBSA's Regional Directors have discretion in the use of their
investigative resources as long as sufficient resources are made
available to perform necessary investigative functions in connection
with designated national projects and policy priorities. For fiscal
year 2005, EBSA has identified the following national enforcement
projects: Employee Contributions Project (delinquent employee
contributions); Health Fraud/Multiple Employer Welfare Arrangements;
Orphan Plans; Rapid ERISA Action Team (bankruptcy issues); and Employee
Stock Ownership Plans. In addition, regions are encouraged to develop
and implement regional projects, with national office review and
approval. Such regional projects focus on plans, investments, service
providers, and other arrangements that warrant concentrated attention
in a particular geographic jurisdiction. Through the use of this
format, which combines flexibility with oversight, EBSA has a proactive
targeting program.
Specific cases may be selected based on the analysis of the Form
5500 Annual Report database, computer targeting, referrals from the
national office or other Government Agencies, leads from bankruptcy
trustees and plan service providers, information reported in the media,
and complaints from participants or other people. The results of this
review are used to enhance EBSA's targeting program.
The Voluntary Fiduciary Correction Program (VFCP) is the
Department's correction program for fiduciary breaches. EBSA
implemented the VFCP in 2000 and enhanced the program in 2002 and 2005.
The VFCP enables plan officials and their service providers to self-
identify and correct certain violations of Title I of ERISA. If an
eligible party documents the acceptable correction of a specified
transaction in its application to EBSA, EBSA will issue a no-action
letter. EBSA is proactive in its efforts to reach out to fiduciaries to
self-identify and correct ERISA violations through VFCP conferences and
workshops, a comprehensive Web site and general education. In the last
fiscal year, EBSA verified $264 million in corrections under the VFCP
involving 436 plans.
Question 3. What percentage of fidelity bonds complies with ERISA?
What is the Department's process for assuring compliance? Does EBSA
either monitor individual ERISA plans to make sure the form of bond is
correct or monitor the largest insurers to verify their issuance of the
correct type of bond?
Answer 3. So far this fiscal year EBSA found that 79 percent of the
employee benefit plans investigated have fidelity bonds that comply
with ERISA. For the past 5 fiscal years (current year included) 81.6
percent of employee benefit plans investigated have fidelity bonds in
compliance with ERISA.
In every investigation, EBSA investigators determine plan
compliance with the fidelity bonding requirements under ERISA section
412. Section 412(a) of ERISA requires that every fiduciary and every
person who handles plan assets be covered by a fidelity bond in an
amount not less than 10 percent of the plan assets handled by such
person. Per the statute, the amount of the bond is required to be not
less than $1,000 but no more than $500,000. The surety on the bond must
be an acceptable surety on Federal bonds as approved by the Secretary
of the Treasury (listed in U.S. Treasury Circular 570). EBSA
investigators complete a bonding checklist and/or bonding calculation
spreadsheet for every investigation. Additionally, investigators cross-
reference the sureties used by the plans with the Treasury's Listing of
Approved Sureties located on the Treasury Web site.
EBSA seeks correction of ERISA section 412 violations by inquiring
whether fiduciaries and other persons that handle plan assets are
covered by the bond; the bond is for the appropriate dollar amount; the
bond pays from the first dollar loss (no deductibles are permitted);
and the bond names the plan or plans as the insured or has a rider or
separate agreement to make certain that any reimbursement collected
under the bond will be for the benefit and use of the plan suffering a
loss.
SENATOR KENNEDY
Question. Barclay Grayson testified that there were stark
differences between EBSA's investigations of Capital Consultants and
those of the SEC. Notably, he said that EBSA's personnel lacked the
necessary accounting skills. What is being done to recruit and retain
the personnel needed to detect violations?
Answer. EBSA actively recruits and retains highly qualified
personnel who have the professional skills necessary to root out the
sort of fraud that Mr. Grayson perpetrated against the innocent workers
and families whose retirement plan assets were invested with Capital
Consultants. EBSA played a central role in the criminal investigation
that led to Mr. Grayson's conviction and prison sentence. Our
investigators have expertise in a wide variety of fields including law,
accounting, banking, securities, and business. We recruit entry-level
investigators and auditors who have specialized experience in such
areas as accounting, finance, economics, business, insurance,
securities, and banking, or who have graduated with advanced degrees.
For other than entry-level investigative positions, EBSA requires
specialized experience relevant to conducting complex financial
investigations, such as past work experience in government, a law firm,
a pension plan administration firm, or a bank trust department.
Our Agency has an active training program for its employees. All
EBSA investigators attend a comprehensive basic training course on the
fiduciary responsibility provisions of ERISA that also covers civil and
criminal investigative techniques. EBSA's specialized criminal
enforcement training is provided to most investigative staff. The
criminal enforcement course includes guest speakers from the Department
of Justice, U.S. Probation Office, Federal Law Enforcement Training
Center (FLETC), local prosecutors and private sector attorneys
specializing in criminal defense. Individuals without a significant
accounting background also attend EBSA's Employee Benefit Plan
Accounting training. These courses are all residential programs of at
least 2 weeks in length, and offer academic and practical instruction
led by EBSA staff and guests from government and the employee benefits
field. In addition, EBSA's Office of Enforcement provides annual field
office training on topics determined by enforcement priorities,
regulatory and legal developments, and industry trends. Also, on a
space available basis, some of our investigators attend courses such as
Law Enforcement Advanced Interviewing Techniques and Financial Forensic
Techniques at the FLETC in Glenco, Georgia. EBSA encourages on-board
staff to acquire additional training, and agency funding has enabled
individuals to attain the Certified Employee Benefits Specialist and
Certified Fraud Examiner designations and other credentials as well as
maintain other professional certifications.
With respect to accounting skills, we would note that not only do
we provide training for our accountants and investigators, but we also
have an aggressive program to improve the skills of the accounting
profession generally with respect to employee benefit plan audit and
accounting issues. Since 1988, EBSA has worked closely with the
American Institute of Certified Public Accountants (AICPA) to update
the guidance and technical materials available to CPAs performing
employee benefit plan audits.
Without question, recruiting and retaining high quality people is a
challenge for every organization--public and private. We work in an
area for which there is great demand for experienced people in the
private sector as well as in government. Although we do experience
attrition as employees move to positions outside EBSA, we also have had
success in hiring people from other Federal regulatory agencies and the
private sector.
SENATOR HATCH
Question. Mr. Lebowitz, with respect to monitoring and enforcement,
what went wrong in the Capital Consultants case? What lessons has DOL
learned from this case?
Answer. Applying the measures that are traditionally used to judge
the success or failure of an investigation, the CCL case had a very
positive outcome. In the civil case, the cooperative actions of the
Department of Labor and the Securities and Exchange Commission resulted
in the appointment of a receiver and the recovery of approximately $291
million or 70 percent of the losses suffered by plans and other CCL
investors. The Department conducted 58 related investigations of the
actions of trustees of investing plans and filed 19 lawsuits against
the trustees of 34 plans. These cases resulted in the recovery of an
additional $9.2 million and called for important injunctive relief such
as the retirement or resignation of 51 plan trustees and the permanent
bar of 31 trustees and one investment adviser from further plan
service. The task force that conducted related criminal investigations,
which included EBSA, the FBI, IRS, OIG and OLMS, resulted in the
Justice Department indicting 11 individuals for various crimes. Seven
of these individuals pleaded guilty, and one was convicted. It is fair,
however, to ask why the investigation took as long as it did, and what
could have been done to prevent the fraud from occurring in the first
place.
To be successful in an ERISA action such as CCL, the Department
must prove that the offending party was a fiduciary under the statute's
functional definition, that the actions taken by the fiduciary were, in
fact, imprudent (which almost always requires sophisticated financial
analyses and the use of expert witnesses) or an act of fiduciary self-
dealing or other breach of a fiduciary's obligations under ERISA.
Finally, we must prove that the violation caused the losses that we
seek to recover. The scheme constructed by CCL was extraordinarily
complex and sophisticated. CCL consistently misled its investors about
the nature of the transactions and existence and magnitude of the
resulting losses. As Mr. Grayson acknowledged in his written testimony,
the Wilshire transactions were ``complex'' arrangements designed to
give ``the false impression that all of the firm's loans were fully
performing, fully secured, and of limited risk.'' CCL co-opted
attorneys, accountants, and investment advisers into putting their
stamps of approval on its Ponzi scheme. EBSA's investigators were able
to unravel the scheme despite Mr. Grayson's deliberate efforts to hide
the truth through a complex series of paper transactions, shell
companies, and false reports. Even with the benefit of hindsight, a
completed investigation, and the explanatory materials created by the
Government in connection with that investigation, it is no simple
matter to grasp all the elements of the fraud in which Mr. Grayson
participated.
No shortcuts were available to EBSA to uncover and remedy CCL's
violations, nor is it likely that additional investigative resources
would have allowed EBSA to stop the scheme much sooner. EBSA expended
significant resources on more than 60 CCL-related investigations,
sorting through the thousands of pages of documents, interviewing
numerous witnesses, and figuring out exactly what happened. As is our
practice, EBSA puts the resources on the investigations as they are
needed, and will continue to strategically deploy its investigative
resources to address the most egregious problems. The lawsuits and
recoveries, which followed EBSA's investigation, represent the work of
many people and organizations, public and private, but the results all
built upon the foundation laid by EBSA's investigation.
In our view, schemes like that presented in the CCL case can
succeed only when they are provided with a veneer of respectability by
the attorneys, accountants, investment advisers and other professionals
employed by the perpetrator. The failure of those directly responsible
for protecting plans, their trustees and their advisers, to understand
the true nature of CCL's investments or even adhere to their own
investment guidelines was a necessary ingredient in the success of the
scheme. As late as 3 months before we and the SEC shut down CCL,
counsel for several plans was disputing with us that a loss had even
been experienced.
SENATOR BINGAMAN
Question 1. In responding to my questions, you seemed to imply that
the majority of those people who provide investment advice to plans are
not fiduciaries. That is contrary to my understanding of recent case
law. Could you please elaborate on your answer to clarify your
position?
Answer 1. ERISA-covered plans and their fiduciaries rely upon many
consultants and service providers to assist them in plan administration
and asset management. Not all of these consultants and service
providers are fiduciaries. In general, ERISA takes a ``functional''
approach to fiduciary status--a person is a fiduciary to the extent he
engages in certain ``fiduciary'' activities, without regard to title or
position. Under ERISA, a person acts as a fiduciary when he or she (i)
exercises discretionary authority or control over the management of a
plan or exercises any authority or control over the management or
disposition of its assets, (ii) renders investment advice for a fee or
other compensation, direct or indirect, with respect to any moneys or
other property of a plan or has any authority or responsibility to do
so, or (iii) has discretionary authority or responsibility in the
administration of a plan.
ERISA 3(21)(A), 29 U.S.C. 1002(21)(A).
The term ``investment adviser'' is not defined under ERISA. The
Investment Advisers Act of 1940 defines ``investment adviser'' but only
for purposes of securities laws.\1\ All ``investment advisers'' under
the Investment Advisers Act are fiduciaries for purposes of the Federal
securities laws. Many persons who provide investment services to ERISA
plans call themselves investment advisers as well as consultants,
investment monitors or performance monitors. Investment advisers who
lack authority or control over plan assets are not fiduciaries under
ERISA unless they render investment advice for a fee or other
compensation with respect to plan assets, in a manner described in the
Department's regulations.
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\1\ Under the National Securities Markets Improvement Act of 1996
and SEC rules, investment advisers register with the SEC if they
provide continuous and regular supervisory or management services to
securities portfolios totaling at least $25 million, or if they act as
a pension consultant with respect to assets of plans having an
aggregate value of at least $50 million. Other investment advisers are
regulated by State securities administrators.
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Under the Department's regulations, a person renders investment
advice to a plan only if the person gives advice as to the value of
securities or other property or makes recommendations as to the
advisability of investing in, purchasing, or selling securities or
other property, and either (1) has discretionary authority or control
over purchasing or selling securities or other property for the plan,
or (2) renders the advice on a regular basis pursuant to a mutual
agreement or understanding that the advice will serve as a primary
basis for the plan's investment decisions, and that the advice will be
individualized to the plan based on the plan's particular needs. The
courts have consistently accepted these five requirements for finding
an investment adviser to be an ERISA fiduciary from the regulation's
promulgation in 1975 to the present. See, e.g., Dudley Supermarket,
Inc. v. Transamerica Life Ins. & Annuity Co., 302 F.3d 1 (1st Cir.
2002) (a financial services company was a fiduciary where it was
compensated as the primary, individualized and routine provider of
investment advice for the plan); Thomas, Head & Greisen Employees Trust
v. Buster, 24 F.3d 1114 (9th Cir. 1994), cert. denied, 513 U.S. 1127
(1995) (a mortgage broker who sold trust deeds to a plan was a
fiduciary where all five elements of the test were satisfied);
Schloegel v. Boswell, 994 F.2d 266 (5th Cir.), cert. denied, 510 U.S.
964 (1993) (insurance broker who advised the plan on insurance
purchases did not meet the five requirements and therefore was not a
fiduciary).
As the SEC noted in a recent staff report on pension consultants,
many consultants believe that they have structured their arrangements
with plans so that they are not ERISA fiduciaries. Even if a consultant
is an SEC-registered investment adviser and, consequently, owes a
fiduciary duty to its clients under the Advisers Act, the consultant is
an ERISA fiduciary only if it meets the five requirements set forth
above. If, for example, the consultant provides advice on an irregular
basis, or does not provide advice specific to the particular needs of
the plan, he is not an ERISA fiduciary. The consultant's status in any
particular case depends on the specific facts and circumstances of that
case.
Question 2. In responding to my questions, you stated that the
Department of Labor has not brought many cases or enforcement actions
against investment advisers. Could you please provide a brief summary
of all the cases/actions over the past 10 years or so that have been
brought against investment advisers, including the results? Also,
please provide how many cases/actions are currently pending.
Answer 2. Over the past 10 years, EBSA's civil investigations
involving investment advisers yielded monetary results totaling
approximately $1.7 billion, the correction of ERISA reporting and
disclosure violations, the appointment of independent fiduciaries, as
well as the imposition of internal controls. EBSA's criminal
investigations relating to investment advisers advisors led to the
indictment of 29 individuals. EBSA has 66 currently open criminal and
civil investigations involving investment advisers. All EBSA cases
conducted over the past 10 years involving civil litigation and
criminal prosecution are summarized in Appendix 2.
Question 3. In responding to my question, you stated that the SEC
was the primary Agency to monitor the actions of those who provide
investment advice to plans. What about those who provide investment
advice but are not registered investment advisors? Do you monitor their
activities? Does the DOL have the ability to provide adequate
enforcement if the SEC ceases these activities? Do you believe DOL
currently has the proper level of staffing to handle oversight of
investment advisors?
Answer 3. EBSA investigates ERISA plans, including their
fiduciaries and service providers, as discussed in the response to
Question 4 below. The agency investigates the activities of plans'
investment advisers and consultants, whether or not they are registered
under the Investment Advisers Act of 1940, if they provide services to
ERISA plans. ERISA provides for the direct recovery of losses only from
fiduciaries. If a consultant or adviser fails to meet the test for
fiduciary status set forth in the response to Question 1 above, the
Department could seek relief from the consultant only if he ``knowingly
participated'' in a fiduciary breach, and could obtain ``equitable''
relief, including injunctive relief and the disgorgement of fees. Under
ERISA, the Department could not recover any monetary losses caused by a
non-fiduciary consultant's misconduct.
If the SEC were to stop monitoring the actions of registered
investment advisers, EBSA would continue to investigate their
activities with respect to ERISA-covered plans.
We are confident that our existing resources are adequate to
fulfill our mandate under the law.
Question 4. Does ERISA provide an adequate remedy to deter the type
of fraud perpetrated in the Capital Consultants matter? If so, why was
the action brought, and effectively settled, based on Oregon securities
law?
Answer 4. The Department of Labor and the SEC brought the initial
lawsuits against CCL, Jeffrey Grayson, and Barclay Grayson. The
Department based its claims on ERISA, and the SEC filed suit based on
the Federal securities laws. The court appointed a receiver over CCL in
the Government's litigation, and the majority of the money recovered
for distribution--well over $180 million--has come from the receiver's
efforts. Additionally, the Department of Labor and private parties have
filed lawsuits against the trustees of 34 plans based upon ERISA,
resulting in more than $27 million in judgments and penalties, and
injunctive relief, including the removal of plan fiduciaries and the
imposition of plan reforms.
Private litigants, including the receiver, also recovered more than
$100 million from a variety of non-fiduciary defendants, such as
accountants, attorneys, consultants, and parties to the Wilshire
transactions based, in substantial part, on State law claims of
negligence, negligent misrepresentation, fraud, breach of contract,
fraudulent transfers, and securities laws, as well as other State and
Federal laws apart from ERISA. ERISA, as interpreted by the Supreme
Court, does not provide a damage remedy against non-fiduciary
defendants, even if they knowingly participated in a fiduciary breach.
At most, ERISA permits the recovery of ``equitable'' relief against
non-fiduciaries, which may include disgorgement of fees in certain
cases, but does not include recovery of the damages caused by the non-
fiduciary's misconduct. In the cases at issue, the recoveries available
from the State law claims were much larger than the amount of the non-
fiduciaries' fees, and the private litigants accordingly pursued those
claims, which the Department of Labor does not have standing to assert.
The Department did, however, file an amicus brief in opposition to
arguments by an accounting firm that the private litigants' State law
claims were preempted by ERISA.
ERISA primarily gives the Secretary standing to bring claims for
violations of its provisions in two remedial sections. First, under
Section 502(a)(2), participants, plan fiduciaries and the Secretary can
file suit seeking relief allowed under ERISA Section 409. Section 409
allows recoveries only against plan fiduciaries, and includes the
recovery of plan losses, as well as the restoration of profits made by
a fiduciary through the use of plan assets, and other ``equitable or
remedial relief'' as the court may deem appropriate including removal
of a breaching fiduciary. Recently, however, one Circuit Court has
held, incorrectly in the Department's view, that a loss recovery is not
available, even against fiduciaries, under Section 502(a)(2), where the
fiduciary breach harmed only some of the plan's participants and was
not targeted at the plan as a whole. Milofsky v. American Airlines,
Inc., 404 F.3d 338 (5th Cir. 2005).
Second, section 502(a)(5) of ERISA allows the Secretary to sue to
enjoin any act or practice that violates Title I of ERISA, and also
allows other appropriate equitable relief which courts have defined as
the relief that was ``typically'' available in courts of equity. The
Supreme Court has held, in cases involving non-fiduciaries, that
``equitable'' relief does not include the recovery of money damages
(Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204 (2002);
Mertens v. Hewitt Associates, 508 U.S. 248 (1993)), and a number of
lower courts have extended the Supreme Court's holding to fiduciaries
as well as non-fiduciaries, holding that no damages remedy is available
against any defendants under ERISA's authorization for ``equitable''
relief. By way of contrast, the State laws at issue in the private
litigation permitted a much broader range of recoveries and defendants.
For example, the Oregon securities law provides a loss remedy, not only
against the seller of a security, but against every person who directly
or indirectly controlled the seller and every person who participated
or materially aided the unlawful sale.
Appendix 1. Summary of Collaboration Between the U.S. Department of
Labor, Employee Benefits Security Administration and the U.S. Securities
and Exchange Commission
------------------------------------------------------------------------
Date Matters discussed
------------------------------------------------------------------------
March 2004
------------------------------------------------------------------------
3/3.................................... An EBSA Investigator and
District Supervisor met with
an SEC Enforcement Attorney
and two SEC Examiners to
discuss potential ERISA
violations uncovered during an
SEC investigation.
3/8.................................... An EBSA Investigator met with
two SEC Enforcement Attorneys,
an Assistant SEC Branch Chief,
and an SEC Assistant District
Administrator to discuss
conducting a joint
investigation into the
potential market timing
activity of a particular
investment management company.
3/12................................... Two EBSA Investigators and two
SEC Compliance Examiners
conducted a joint interview of
a witness in connection with
an enforcement matter.
3/17................................... The Associate Director of SEC's
Office of Compliance
Inspections and Examinations
provided a 2-hour training
presentation to EBSA managers
and senior investigators on
issues that included: SEC
organization and operation;
methods for identifying
improper trading practices in
mutual funds; and the SEC's
ongoing analysis of pension
consultants.
3/23................................... EBSA Assistant Secretary met
with officials from the SEC
and other Federal agencies to
discuss investigative
coordination.
------------------------------------------------------------------------
April 2004
------------------------------------------------------------------------
4/29................................... An EBSA Senior Investigator met
with an SEC staff attorney to
discuss the status of their
investigation into an
investment adviser. EBSA
opened an investigation into
the same subject as a result
of media reports. The SEC
granted EBSA access to SEC
files on their pending matter.
------------------------------------------------------------------------
May 2004
------------------------------------------------------------------------
5/3.................................... An EBSA Senior Investigator met
and began ongoing
collaboration with an SEC
Senior Attorney. Over the
course of several months, an
EBSA investigator met four
times (5/3, 5/24, 6/29, & 7/
16) to collaborate with the
SEC to set investigative
assignment report findings,
and develop investigative
strategy. On January 21, 2005
the SEC provided EBSA with a
copy of the complaint filed as
a result of their
collaborative effort.
5/17................................... An EBSA Supervisor, EBSA Senior
Investigator, and EBSA
Investigator met with an SEC
Assistant District
Administrator, an SEC Branch
Chief of Examinations, and an
SEC Branch Chief of
Enforcement to discuss the
status of parallel SEC and
EBSA investigations into the
same company and to arrange
for EBSA access to relevant
SEC files.
5/24................................... An EBSA Senior Investigator met
and continued ongoing
collaboration with an SEC
Senior Attorney to set
investigative assignment
report findings and develop
investigative strategy. On
January 21, 2005, the SEC
provided EBSA with a copy of
the complaint filed as a
result of their collaborative
effort.
June 2004
------------------------------------------------------------------------
6/16................................... An EBSA Investigator and three
SEC Compliance Examiners
conducted a joint interview of
a witness in connection with
an enforcement matter.
6/21................................... An EBSA Senior Investigator met
with an SEC Branch Chief to
discuss certain issues in a
prior SEC investigation, as
part of an EBSA investigation.
EBSA obtained documents from
the SEC.
6/25................................... An EBSA Regional Director, EBSA
Group Supervisor, and two EBSA
Investigators met with an SEC
Associate District
Administrator and an SEC
Branch Chief of Enforcement.
The SEC presented information
to EBSA with respect to
certain cases currently being
pursued by the SEC. As a
result, the SEC's Office of
Economic Analysis offered to
assist the Department of
Labor.
6/29................................... An EBSA Senior Investigator met
and continued ongoing
collaboration with an SEC
Senior Attorney to set
investigative assignment
report findings and develop
investigative strategy. On
January 21, 2005, the SEC
provided EBSA with a copy of
the complaint filed as a
result of their collaborative
effort.
------------------------------------------------------------------------
July 2004
------------------------------------------------------------------------
7/7.................................... An EBSA Group Supervisor, two
EBSA Senior Investigators, and
two EBSA Investigators
attended the 18th Annual Joint
Regulatory Conference held in
Los Angeles. Other
participating regulatory
agencies included: the Pacific
Regional Office of the SEC,
Public Company Account
Oversight Board (PCAOB), NASD,
NYSE, U.S. Attorney's Office
(California, Nevada, Oregon),
and North America Securities
Administrators Association.
State agencies included:
Hawaii Department of Commerce
and Consumer Affairs,
Washington Department of
Financial Institutions, Nevada
Secretary of State, Securities
Division, California
Department of Commerce,
Washington Department of
Financial Institutions,
Arizona Corporation
Commission, Oregon Division of
Finance and Corporate
Securities.
7/9.................................... The Assistant Secretary of EBSA
met with an SEC Commissioner
to discuss agency
coordination.
7/16................................... An EBSA Senior Investigator met
and continued ongoing
collaboration with an SEC
Senior Attorney to set
investigative assignment
report findings and develop
investigative strategy. On
January 21, 2005, the SEC
provided EBSA with a copy of
the complaint filed as a
result of their collaborative
effort.
7/21................................... An EBSA Regional Director, an
EBSA Deputy Regional Director,
an EBSA Supervisory
Investigator, an EBSA Acting
Group Supervisor, two EBSA
Senior Investigators, and an
EBSA Investigator met with an
SEC Assistant District
Administrator, and an SEC
Branch Chief, to discuss the
SEC's audit process with
respect to specific mutual
funds and common collective
investment trusts that were
the subject of parallel SEC
and EBSA investigations.
During the meeting, each
agency shared their regulatory
backgrounds and investigative
procedures, specifically with
respect to auditing this
particular entity for market
timing and late trading
issues.
7/22................................... An EBSA Regional Director and
an EBSA Senior Investigator
addressed the quarterly
meeting of the SEC Enforcement
and the SEC Examinations
sections. The EBSA staff
presented information
regarding EBSA enforcement
matters within the region.
7/26................................... An EBSA Senior Investigator and
an EBSA Investigator met with
an SEC Attorney and her
assistant to obtain documents
associated with an SEC
investigation as part of an
EBSA investigation into the
retirement plan of the same
company. The discussion
included details of the SEC's
and EBSA's respective
investigations, and yielded
documents obtained by the SEC
during its investigation that
were relevant to EBSA's
investigation.
7/30................................... The Assistant Secretary of EBSA
met with the SEC Director of
Compliance Inspections and
Examinations and the former
SEC Director of the Office of
Investment Management to
discuss agency coordination.
------------------------------------------------------------------------
August 2004
------------------------------------------------------------------------
8/3.................................... The Assistant Secretary of EBSA
met with the SEC Chief
Accountant to discuss Investor
Education.
8/4.................................... A Senior Investigator arranged
a meeting with SEC staff to
discuss the findings of an SEC
investigation of a plan
sponsor who is also the
subject of an EBSA
investigation. The initial
meeting led to a series of
subsequent meetings on October
18, 21, 22, 25, 26, 2004; and
December 1, 2004. During the
subsequent meetings, EBSA was
permitted to review documents
obtained by the SEC pursuant
to its investigation.
8/11................................... An SEC Assistant District
Administrator for Enforcement
and an SEC Assistant District
Administrator for Examination
addressed an EBSA quarterly
meeting for the Boston region.
The SEC staff presented
information regarding SEC
Enforcement efforts within the
region and changes made in
response to the market timing
cases brought in the fall of
2003.
8/30................................... An EBSA Senior Investigator
attended a corporate fraud
conference sponsored by the
FBI. During that conference,
the Senior Investigator
established a contact with an
SEC staff attorney regarding a
specific EBSA investigation,
and referred this attorney to
the appropriate regional
office that was conducting
this investigation. The Senior
Investigator also spoke with
another SEC staff attorney
regarding general provisions
of the Sarbanes-Oxley Act.
------------------------------------------------------------------------
September 2004
------------------------------------------------------------------------
9/10................................... Two EBSA Senior Investigators,
two EBSA Investigators, and an
EBSA Computer Specialist met
with an SEC Branch Chief of
Examinations regarding the
sharing of information of
interest to EBSA that was
collected during an SEC ``mini-
sweep'' of mutual funds.
9/15................................... An EBSA Senior Investigator and
an EBSA Investigator observed
an interview of a witness
conducted by an SEC Staff
Attorney and an SEC Branch
Chief.
9/16................................... The EBSA Director of
Enforcement and two EBSA Lead
Investigators met with the
SEC's Director of Compliance
Inspections and Examinations,
an SEC Associate Director,
Division of Enforcement, and
an SEC Associate Director,
Office of Compliance
Inspections and Examinations,
to address areas of concern
for EBSA. Among other things,
the meeting covered a GAO
report on proxy voting matters
and enhanced coordination with
the SEC.
9/17................................... An EBSA Investigator attended
the deposition of a witness to
an SEC enforcement matter. An
SEC Enforcement Attorney and
an SEC Examiner conducted the
deposition. The deposition
involved securities trades
that may have violated ERISA.
9/18................................... An EBSA Senior Investigator and
an EBSA Investigator met with
an SEC Staff Attorney and
Chief. The SEC updated EBSA
regarding the status of a
particular SEC enforcement
investigation that paralleled
an EBSA enforcement
investigation.
9/22................................... EBSA Assistant Secretary met
with officials from the SEC
and other Federal agencies to
discuss investigative
coordination.
9/23................................... The SEC Associate Regional
Director of the Midwest
Regional Office spoke at an
EBSA regional office quarterly
training session.
9/27................................... An EBSA Senior Investigator
observed witness interviews
conducted jointly by an SEC
Staff Attorney and an EBSA
Investigator. The interviews
were conducted to provide
information simultaneously for
an EBSA enforcement
investigation and its parallel
SEC enforcement investigation.
------------------------------------------------------------------------
October 2004
------------------------------------------------------------------------
10/18 and.............................. An EBSA Senior Investigator met
10/21-10/26............................ with SEC staff to discuss the
findings of an SEC
investigation of a plan
sponsor who is also the
subject of an EBSA
investigation. During the
meeting, EBSA was permitted to
review documents obtained by
the SEC pursuant to its
investigation.
------------------------------------------------------------------------
November 2004
------------------------------------------------------------------------
11/9................................... The Assistant Secretary of EBSA
met with the Chairman and
Executive Director of the
SEC's Investor Education Plan
to discuss investor education.
11/16.................................. An EBSA Senior Investigator met
an SEC Senior Enforcement
Investigator and an SEC
Assistant District
Administrator to discuss open
investigations of an
investment adviser. Several
subsequent meetings have
occurred to exchange
information on this matter.
EBSA's investigations were
launched as a result of the
SEC's suggestion that it had
uncovered indications of
potential ERISA violations
during the course of its
investigation.
------------------------------------------------------------------------
December 2004
------------------------------------------------------------------------
12/1................................... An EBSA Senior Investigator and
an SEC Staff Attorney jointly
convened a meeting with the
attorneys for the subject of
parallel SEC and EBSA
enforcement investigations to
discuss various issues.
12/1................................... An EBSA Senior Investigator met
with SEC staff to discuss the
findings of an SEC
investigation of a plan
sponsor who is also the
subject of an EBSA
investigation. During the
meeting, EBSA was permitted to
review documents obtained by
the SEC pursuant to its
investigation.
------------------------------------------------------------------------
January 2005
------------------------------------------------------------------------
1/11................................... An EBSA Senior Investigator and
an SEC Staff Attorney jointly
convened a meeting with the
attorneys for the subject of
SEC and EBSA enforcement
investigations to discuss
various issues.
1/25................................... Two EBSA Investigators met with
an SEC Enforcement Attorney
regarding the SEC's
investigation of an investment
adviser. The EBSA
investigators were briefed on
the SEC's case against the
investment adviser and they
requested documents pertaining
to affected employee benefit
plans.
------------------------------------------------------------------------
February 2005
------------------------------------------------------------------------
2/4.................................... Two EBSA Senior Investigators
met with an SEC Examiner at
his office to discuss late
trading and market timing
issues with respect to an EBSA
investigation.
2/18................................... EBSA staff from the Office of
the Chief Accountant met with
the Public Company Account
Oversight Board (PCAOB)
inspection staff to generally
discuss the PCAOB inspection
programs. EBSA's Office of the
Chief Accountant was
implementing a new inspection
program and sought this
meeting to learn from the
PCAOB's experience in
conducting similar
investigations.
------------------------------------------------------------------------
March 2005
------------------------------------------------------------------------
3/17................................... An EBSA Senior Investigator met
with two SEC Staff Attorneys.
The SEC provided EBSA with
access to records from an SEC
investigation of two ERISA-
covered funds.
3/21................................... An EBSA Senior Investigator met
with an SEC Staff Attorney.
The SEC provided EBSA with
access to records from an SEC
investigation of two ERISA-
covered funds.
3/21................................... An EBSA Regional Director, an
EBSA Deputy Regional Director,
and EBSA staff members who are
investigating corporate fraud
or market timing cases met
with an SEC Assistant District
Administrator of Enforcement.
The meeting served to
introduce the newly appointed
EBSA Regional Director to the
SEC Assistant District
Administrator of Enforcement.
The meeting reaffirmed EBSA's
interest in the continued
cooperative relationship
between the agencies. Items of
mutual interest discussed
included corporate fraud;
trading practices such as
market timing, late trading
and fee arrangements relating
to mutual funds; hedge funds;
criminal statutes as they
relate to ERISA and the SEC;
and the referral of cases
between the EBSA Regional
Office and the SEC. The SEC
Assistant District
Administrator of Enforcement
indicated that he is forming a
Regulatory Working Group for
Northern California law
enforcement agencies and
industry organizations in the
securities area and invited
the EBSA Regional Office to
participate. The EBSA Regional
Office accepted the invitation
and is participating.
3/31................................... Several members of EBSA's
Enforcement staff and Office
of Information Technology
staff met with Information
Technology staff at the SEC to
discuss avenues for electronic
sharing of information.
3/31................................... EBSA Deputy Assistant Secretary
for Program Operations, EBSA
Director of the Office of
Regulations and
Interpretations, EBSA Director
of Enforcement, and an EBSA
Lead Investigator met with the
Director of SEC's Office of
Compliance Inspections and
Examinations and an Associate
Director of the SEC's Office
of Compliance Inspections and
Examinations to discuss the
SEC's upcoming release of
their study of conflicts of
interest involving pension
consultants. The SEC provided
draft copies of the report. As
a result the two agencies
agreed to coordinate the
release report with guidance
for plan fiduciaries in the
selection and oversight of
pension consultants.
------------------------------------------------------------------------
April 2005
------------------------------------------------------------------------
4/7.................................... An EBSA Senior Investigator met
with an SEC Examiner to
discuss an EBSA investigation
into a defunct plan sponsor.
EBSA sought SEC views with
respect to certain issues that
had arisen in EBSA's
investigation. The meeting
included a discussion of SEC
disclosure requirements.
4/12................................... Two EBSA investigators met with
an SEC Branch Chief to examine
documents of interest to EBSA
that were collected by the SEC
during its ``mini-sweep'' of
mutual funds. The conversation
included a general discussion
of the SEC's findings.
4/26................................... An EBSA investigator visited
SEC offices to review
documents pertaining to an SEC
investigation. The
investigator was onsite from 4/
26 to 4/29. During the course
of the document review, the
Investigator met with an SEC
Branch Chief, an SEC Assistant
Regional Director, and an SEC
Group Supervisor. The
discussions included specific
questions relevant to the
investigation as well as a
general discussion of
information sharing.
4/28................................... An EBSA Regional Director,
members of his staff who are
investigating corporate fraud
and market timing cases, and
the Regional Special Agent In
Charge of the Department's
Office of Inspector General,
Office of Labor Racketeering
and Fraud Investigations,
attended the Northern
California Securities Fraud
Working Group. EBSA's
attendance was at the
invitation of an SEC Assistant
District Administrator of
Enforcement, who leads the
group. The group consists of
Federal law enforcement
agencies that investigate
corporate fraud cases. The
group meets quarterly to
explore areas of mutual
interests and to identify
cases that may lend themselves
to joint investigations.
4/29................................... The Chicago, Cincinnati, and
Kansas City offices of EBSA
and SEC hosted a regional
conference to discuss areas of
mutual interest and concern.
Employees of both SEC and EBSA
attended the meeting. An SEC
Examiner led the informal
discussion that sought to
inform each agency about the
nature of the other agency's
investigative and enforcement
activities. The purpose was to
foster an understanding of the
types of issues that might be
referred between the two
agencies and areas appropriate
for joint investigations.
------------------------------------------------------------------------
May 2005
------------------------------------------------------------------------
5/9.................................... An EBSA Investigator met with
two SEC Examiners to discuss
cross-trading issues that had
been cited in an SEC
investigation. EBSA was
reviewing the impact of these
issues on the benefit plans
connected to the subject of
the SEC's investigation.
5/9-5/20............................... An SEC attorney attended EBSA's
Basic Training Course.
5/11................................... An EBSA Senior Investigator and
EBSA District Supervisor met
with an SEC staff attorney.
The SEC was conducting a civil
investigation that paralleled
an EBSA investigation. The SEC
provided EBSA with an index of
records from their
investigation.
5/26................................... Assistant Secretary met with
officials from the SEC and
other Federal agencies to
discuss investigative
coordination.
------------------------------------------------------------------------
June 2005
------------------------------------------------------------------------
6/9.................................... The Assistant Secretary of EBSA
met with an SEC Commissioner
to discuss agency
coordination.
6/16................................... An EBSA Regional Director
participated in a panel
discussion at the Securities
and Exchange Commission,
Pacific Region's 19th Annual
Joint Regulatory Conference on
``Vulnerable Investors:
Current Issues Regarding
Pension Plans, 401(k)s and
IRAs.'' Staff from the SEC and
the California Department of
Corporations were also on the
panel. The EBSA Regional
Director provided a brief
overview of ERISA and
discussed how in regulating
employee benefit plans EBSA
often has concerns and
objectives in common with
securities regulators.
Approximately 120 people
attended this conference of
regulators. Attendees in
addition to the SEC included
representatives from the New
York Stock Exchange, NASD,
CFTC and the U.S. Attorney's
Office for the Central
District of California.
6/16................................... Two EBSA Investigators attended
the 19th Annual Joint
Regulatory Conference in Los
Angeles. The Securities and
Exchange Commission's Pacific
Region invited EBSA's San
Francisco Regional Office to
attend the general session.
The Conference is a closed,
regulators-only meeting to
discuss common enforcement and
regulatory concerns;
participants typically include
the SEC, State securities
regulators, self-regulatory
organizations, and Federal
white-collar crime agents and
prosecutors. Staff members
from EBSA's San Francisco
Regional Office regularly
attend this conference.
6/22................................... The EBSA Director of
Enforcement, the EBSA Chief of
the Division of Fiduciary
Interpretations, the EBSA
Chief, Division of Field
Operations, an EBSA Pension
Law Specialist, and an EBSA
Lead Investigator met with the
SEC Associate Director for the
Division of Enforcement and an
SEC Division of Enforcement
Assistant Litigation Counsel.
The purpose of the meeting was
to discuss potential ERISA
issues and concerns arising
from the distribution of
proceeds by Independent
Distribution Consultants
resulting from SEC's
settlements with mutual fund
companies for trading practice
violations including market
timing and late trading.
6/29................................... EBSA's Chief, Division of
Reporting Compliance, Office
of the Chief Accountant met
with the SEC Chief of Market
Surveillance to share
information regarding EBSA's
blackout notice rule
enforcement program. These
EBSA and SEC entities have an
ongoing relationship whereby
EBSA informs the SEC of any
blackout notice rule cases
involving SEC registrants for
possible enforcement action
under Federal securities laws.
------------------------------------------------------------------------
Appendix 2. EBSA Investment Adviser Investigations Resulting in Civil
Litigation or Criminal Prosecution
BOSTON REGION
Beaumont Nursing Home Pension Plan--Northbridge, MA
The investigation disclosed that the plan invested over 49 percent
of its assets in convertible securities rated below investment grade.
Under the direction of investment adviser Melvin Cutler, the plan
invested a high percentage of its assets in convertible securities that
were low investment grade.
The Department filed a complaint on May 3, 1989. On October 24,
1996, a consent order was reached resulting in $51,282 restored to the
plan. This amount was based upon the questionable investments in
convertible securities.
Blackstone Investment Advisors--Providence, RI
In the late 1980s and early 1990s George Kilborn, an investment
adviser with Blackstone Investment Advisors, invested assets on behalf
of approximately 27 employee benefit plans in investment vehicles
offered by Security Finance Group. These investment vehicles included
loan agreements, construction loans, and other real estate investments.
Security Finance Group filed bankruptcy and the investments became
virtually worthless. The investigation disclosed the failure of Kilborn
to properly evaluate the investments prior to investing employee
benefit plan assets.
The Department filed a complaint on January 22, 1999. The
Department recovered $210,000 from Blackstone Investment Advisors on
behalf of employee benefit plans.
Joseph Strutynski--Fayetteville, NY
Strutynski held himself out to be a professional financial planner
and investment adviser who advised a benefit plan participant to roll
over her account balance into an IRA account. Strutynski deposited the
rollover into an account controlled by him. The participant never
received a statement. A guilty plea was entered on January 17, 2003.
Strutynski was sentenced to 1 month in jail, with court-ordered
restitution of $42,000.
Shawmut Investment Advisors--Boston, MA
The investigation was related to a kickback scheme that involved
broker commission allocation and soft dollar practices. EBSA's
investigation revealed that Shawmut Investment Advisors (``SIA'')
allocated brokerage commissions to selected brokers by an SIA salesman
purportedly because these brokers were helpful to the sales efforts in
securing clients for SIA. This review further disclosed that the
alleged research that was received from selected brokers was
substandard or non-existent. In addition, SIA also used ``Sub-
Advisors'' and ``Interpositioning Brokers'' to direct trades to a
particular brokerage firm.
The investigation further revealed that the benefactors of the
directed trades wired large portions of the commissions to the Cayman
Islands. From the Cayman Islands, the funds were redirected back to
certain trustees in the United States.
The participants of the scheme were indicted on a number of charges
including Federal racketeering conspiracy, pension fund kickback, and
money laundering charges arising out of commission kickbacks paid to
two trustees of Chicago-based labor union pension funds. One investment
adviser pleaded guilty to an Information on one count of Offer,
Acceptance or Solicitation to Influence the Operation of an Employee
Benefit Plan/kickback statute, while a second investment adviser was
sentenced to 36 months imprisonment, 36 months supervised release,
asset forfeiture in the amount of $7,433,845, and a special assessment
of $2,350.
Todd J. LaScola--Providence, RI
Todd LaScola was the subject of a 55-count indictment returned
November 17, 2000, charging him with employee benefit plan
embezzlement, employee benefit plan kickbacks, and fraudulent financial
transactions that victimized individual investors, family trust funds,
and pension plans. Forty-two of the counts charged wire fraud
violations. On February 23, 2001, he pleaded guilty to three counts of
mail fraud, and one count of embezzlement from an employee benefit
plan. He was subsequently sentenced to 96 months in prison and ordered
to pay $8 million in restitution.
Between 1997 and 1998, LaScola invested approximately $6.3 million
of a $16 million pension fund belonging to IBEW LU 99 with a real
estate firm in a manner contrary to his management agreement with the
plan which forbade him from investing pension money in non-publicly
traded securities and from investing more than 5 percent of the plan's
monies in any one investment. In exchange for these investments,
LaScola allegedly received unlawful commissions of $241,000 from the
real estate even though he was compensated under a management agreement
by means of a fixed fee paid him by the plan based on the amount of
plan assets. When the investments went bad, he took $6 million from
private investor accounts to repay the union plan.
Investment Committee of IBEW LU 99--Cranston, RI
EBSA's civil investigation of the Investment Committee of
International Brotherhood of Electrical Workers Local Union 99 was
related to the criminal investigation of Todd J. LaScola (above). The
Department filed a complaint on January 29, 2001. Under the terms of a
default judgment entered July 24, 2001, the court ordered LaScola and
his company to repay $1.2 million to the plan.
Melvin Cutler, Investment Manager--Worcester, MA
This case involved the issue of imprudently investing a significant
percentage of plan assets in ``junk'' convertible securities. Cutler
served as an investment manager for a number of pension and profit
sharing plans. Cutler's investment philosophy was to invest nearly the
entire assets of the plans in preferred convertible bonds. A
significant percentage of these bonds were considered ``junk'' bonds by
Standard & Poor's rating service. The Department settled the case with
approximately $182,364 in losses being restored to several of the
affected plans.
CHICAGO REGION
Capital Financial Services, Inc. and Colonial Financial Services--
Buffalo Grove, IL
EBSA opened this investigation involving issues of fiduciary
imprudence associated with client plans' acquisition of three private
limited partnership investments. The Department filed a complaint in
Federal District Court in Chicago, Illinois on May 31, 1994. The
complaint alleged that the defendants realized considerable personal
gain when they exercised substantial influence over the plans and their
trustees to cause the plans to invest in the three limited
partnerships. One individual, Arthur McManus, entered into a consent
order with the Department whereby he was enjoined from serving as a
fiduciary, administrator, trustee, or service provider to any employee
benefit plan for 10 years.
Michael Daher--Englewood, CO
In 1994, the trustees of the International Longshoremen's
Association Local Union 1969 caused the plan to invest $1.4 million in
a joint venture with RODEVCO, a housing development company out of
Mesquite, Nevada. The investment served as construction financing. The
loan was secured by a mortgage on the undeveloped land, which was
appraised at $988,000. The trustees' loans to RODEVCO totaled $3.1
million. In 1995, the trustees caused the plan to purchase for $975,000
adjoining land to be developed for condominium housing. Also that year,
the trustees caused the plan to loan $1.3 million to a brewery in
Colorado. Of the $6,434,985 in plan assets at year ended 1995,
$4,391,986 was invested in RODEVCO and brewery loans.
The trustees alleged that their investment adviser, Mike Daher,
orchestrated a scheme to defraud the plan of its assets by causing it
to invest in the RODEVCO development. Mike Daher owned RODEVCO. On
January 22, 2003, a Federal Trial Court ordered Mr. Daher to restore
more than $1.6 million to the plan and permanently barred him from
serving ERISA-covered plans.
Strong Corneliuson Capital Management--Menomonee Falls, WI
EBSA opened this investigation based on a referral from the SEC.
This case involved the issue of cross-trading of securities between
client accounts that were under Strong Corneliuson's discretionary
control. Strong Corneliuson used plan assets in several of the cross-
trades to purchase assets owned by a limited partnership in which
Strong Corneliuson's management had investment interests. In addition,
many of the securities traded were considered to be junk bonds. Most of
the client accounts involved were ERISA-covered employee benefit plans.
The case was settled with Strong Corneliuson restoring losses of
$5,986,378 to the affected client plans.
Dallas Region--Christopher ``Puffer'' Haff--Dallas, TX
Haff was indicted on April 24, 2001, and entered a guilty plea on
May 17, 2001. Haff was the owner of Haff Financial Group. He obtained a
check for $46,699 from the Dallas law firm of McCathern, Mooty and
Buffington. The check was to be invested on behalf of the law firm's
pension plan and deposited for investment through Alliance Benefit
Group with the investments to be held by the Guardian. Instead, he
endorsed the check and deposited it in an account owned by Haff at a
related company. He subsequently used all but $1,400 of the funds for
personal expenses.
KANSAS CITY REGION
Arthur G. Stevenson III--St. Louis, MO
Between January 1996 and March 2002, Stevenson provided investment
management services to individuals and employee benefit plans. Instead
of depositing funds he received in bona fide investments, Stevenson
kept client funds for his own use. As a result of EBSA's joint
investigation with the FBI and the Postal Inspectors, on June 21, 2002,
Stevenson pleaded guilty to one count of mail fraud and one count of
embezzling from an employee benefit plan. On September 20, 2002,
Stevenson was sentenced to 87 months in prison, ordered to pay
restitution of over $4 million to over 50 victims and barred from
service to any employee benefit plan for 13 years.
B.K. Foster--Golden, CO
EBSA and the FBI conducted a joint investigation of B.K. Foster, an
investment adviser to an employee benefit plan. Foster pleaded guilty
to single counts of embezzlement of pension funds and wire fraud. On
May 26, 2000, he was sentenced to 5 months imprisonment, supervised
release for 3 years and ordered to make restitution of $2,318,024.
Frank L. Gazzola--Mankato, MN
From 1999 through 2002, through his investment company, Gazzola
obtained money from employee benefit plans and other investors by
promising high rates of return on supposedly secure investments. In
actuality, Gazzola was operating a $7 million ``Ponzi'' scheme.
As a result of the EBSA's joint investigation with the FBI and the
FDIC, Gazzola was indicted on December 1, 2003, on four counts of mail
fraud, nine counts of bank fraud, four counts of false statements, one
count of counterfeit security, two counts of theft from pension plans,
four counts of falsification of pension plan records and two counts of
bankruptcy fraud. On May 17, 2004, Gazzola pleaded guilty to one count
of mail fraud, one count of bank fraud, and two counts of theft from
employee pension plans. Gazzola died prior to sentencing.
Investment Advisors Inc.--Minneapolis, MN
Investment Advisors, Inc. (IAI) was a registered investment adviser
to the IAI mutual funds. IAI also entered into Investment Management
Agreements with ERISA plan clients, including the IAI Pension and
Profit Sharing Plans for its employees. From 1991 through April 1996,
IAI caused the employee benefit plans to invest plan assets in IAI
mutual funds that paid 12b-1 fees to IAI Securities, Inc. (IAIS), a
registered broker-dealer and affiliate of IAI. On March 21, 1996, the
shareholders of IAI funds voted to eliminate the 12b-1 fees payable to
IAIS.
On July 17, 1998, the Department obtained a consent judgment
requiring IAI to pay to its in-house plans and those plans containing
individually managed accounts invested in IAI mutual funds, the sum of
$376,815.59, which represented the amount of 12b-1 fees paid by IAI
mutual funds to IAIS plus an amount representing additional earnings
that would have accrued if the 12b-1 fees had not been paid. In
addition, IAI represented that it would not cause any employee benefit
plan to invest in IAI mutual funds that pay 12b-1 fees to IAI, its
affiliates, subsidiaries, or parties in interest except as permitted by
statutory exemption granted under ERISA.
Michael W. Heath D/B/A Gfc--Kansas City, MO
Heath was operating a ``Ponzi'' scheme to defraud investors,
including employee benefit plans. Heath promised returns of up to 30
percent on investments made for 30 to 45 days. He instead used the
investor money for his own business and personal expenses. He also
falsely represented to investors that his companies were registered to
sell securities in Missouri or Kansas and claimed he was a registered
investment adviser even though his only professional registration
allowed him to sell insurance.
As a result of a joint investigation with the U.S. Postal
Inspection Service, the Criminal Investigation Division of the Internal
Revenue Service, and the Office of the Securities Commissioner for the
State of Kansas, Heath pleaded guilty to single counts of mail fraud,
embezzlement of pension funds, and money laundering. The amount of
embezzlement from pension plans totaled $450,000. Heath was sentenced
to 35 months in prison and was ordered to pay $1,565,860 in restitution
to his victims.
Will Hoover--Cherry Creek, CO
Hoover's investment company was operating a ``Ponzi'' scheme.
Hoover and his company were alleged to have stolen over $8 million from
clients including employee benefit plans.
As a result of EBSA's joint investigation with the Denver District
Attorney's Office and the Colorado Securities Exchange Commission, on
June 3, 2004, Hoover was found guilty of 43 felony counts of securities
fraud and theft. On June 23, 2004, he was sentenced to 100 years in
jail, ordered to make restitution of $15,388,347 ($226,655 to employee
benefit plans), and barred from service to any employee benefit plan
for 13 years.
William H. Kautter--Leawood, KS
Kautter, a financial adviser, solicited funds from benefit plans by
selling investments that promised high rates of return on the
investments. After using his clients' assets for personal purposes,
Kautter filed for Chapter 7 bankruptcy.
Kautter was indicted on November 13, 2001, on 3 counts of mail
fraud, one count of making a false statement, and one count of
defrauding a financial institution. On May 23, 2002, he was sentenced
to 12 months and 1 day in prison with 3 years probation on one count of
mail fraud. The court required Kautter to pay restitution of $626,670--
$452,500 was identified as monies owing to ERISA covered plans.
LOS ANGELES REGION
3first Pension Corporation--Orange, CA
EBSA opened an investigation into 3first, a pension administrator
that offered investments in junior trust deeds to its clients. The
clients suffered more than $121 million in losses, including $66.7
million that was actually invested and an additional $54.8 million in
interest that purportedly accrued. The losses occurred after losses in
the underlying investments were hidden from investors, resulting in a
Ponzi scheme to hide the mounting losses. As a result of the joint
investigation by EBSA and the FBI, the three principals received
lengthy jail sentences.
Anthony G. Dipace--Latham, NY
Dipace, an investment consultant in Albany, New York, was indicted
on 11 counts of mail fraud for executing a scheme to defraud the Hotel
Union and Hotel Industry of Hawaii Pension Plan and Trust by lying
about his credentials in an effort to be hired by the pension plan as
its investment adviser. Had he been hired, he would have received more
than $300,000 in annual compensation and would have put plan assets of
more than $200 million at risk. He was found guilty on February 8,
2000. He was sentenced to 60 months imprisonment.
Cohen & Baizer--Santa Monica, CA
Cohen and Baizer served as the investment manager or adviser for
the company's defined benefit plan, which held $1.1 million in assets
as of December 1988, and performed a variety of services for several
other pension plans. EBSA opened this case based on participant
complaints of unsecured and unpaid loans and on the plan's imprudent
investment of $400,000 in a $1.1 million note receivable, which was
never paid. The Department's litigation resulted in $81,598 recovered
by the plan, the appointment of an independent appraiser, and $163,628
in distributions to participants.
Wm. Mason & Co., Inc.--Los Angeles, CA
Wm. Mason & Co. served as an investment manager or adviser for
ERISA-covered plans and invested in derivatives. The Department filed a
complaint against William Francis Mason on July 6, 1998, and obtained a
consent decree 2 days later permanently enjoining Mr. Mason from
providing services or controlling assets of ERISA covered plans.
philadelphia region
Advanced Investment Management--Pittsburgh, PA
The Philadelphia Regional Office opened its investigation of
Advanced Investment Management (AIM) based on media reports that AIM,
an investment manager, was terminated by two municipal employee pension
funds for alleged investment guideline violations. AIM is now defunct
and as of July 2003 had approximately 40 clients including 10 ERISA-
covered plans.
Between January 2001 and June 2002, AIM allegedly violated the risk
guidelines of its clients. AIM's clients lost more than $415 million.
The affected clients (including the ERISA covered plans) filed
individual lawsuits in 2002. Soon thereafter AIM went out of business.
AIM and its senior officers settled the lawsuits by distributing to the
plaintiffs a proportionate share of a settlement fund totaling $14.5
million. In 2003, all litigants executed an omnibus settlement
agreement/release.
On April 11, 2005, the Department obtained a consent judgment
permanently barring Jeff Thomas Allen, AIM's Chairman, President, CEO
and an investment manager to the ERISA-covered plans, from serving as a
fiduciary or service provider to any ERISA-covered plan.
LIUNA and Trust Fund Advisors--Washington, DC
EBSA opened its investigation of Laborers International Union of
North America (LIUNA) and its service provider Trust Fund Advisors
(TFA)/ULLICO to determine whether there were potential ERISA violations
involving two LIUNA pension funds (the Local Union and District Counsel
Pension Fund and the National Industrial Pension Fund).
On March 22, 2002, the Department sued Trust Fund Advisors (TFA),
an SEC-registered investment adviser, and ULLICO for imprudently
investing more than $10 million in assets of the two Laborers
International Union pension funds in 120 acres of raw land near Las
Vegas, NV. The land was bought for the purpose of developing it into
residential lots, without an accurate appraisal or adequate due
diligence. The funds suffered losses when the property was sold in 1999
for less than the money invested by the funds. The Department obtained
a consent judgment requiring TFA and ULLICO to pay $2.4 million in
restitution to the two Laborers International Union pension funds and
civil penalties to the Department.
SAN FRANCISCO REGION
Capital Consultants, Inc.--Portland, OR
On September 21, 2000, the Department filed a lawsuit against
Capital Consultants and its principals Jeffrey and Barclay Grayson.
Concurrently, the court entered a consent order that appointed a
receiver to make an accounting and protect the interests of CCL's ERISA
plan clients and other investors. Through the consent orders, the SEC
was able to freeze the defendants' personal assets and EBSA was able to
enjoin them from doing business with ERISA covered plans.
CCL has been in receivership since the suit was filed in September
2000. Settlements totaling more than $101 million have been reached in
private litigation, resolving claims brought by the court-appointed
receiver, trustees of ERISA plans and other investors against plan
fiduciaries and other parties who provided services to or had business
relationships with CCL.\2\ These settlement amounts were made a part of
the receivership estate. To date, the receiver has marshaled estate
assets of more than $189 million in part by collecting on outstanding
loans and selling CCL's assets. The receiver estimates that the total
amount of settlements and marshaled assets accumulated in the
receivership to date is $291 million of which about $193 million was
already distributed to CCL's private placement clients, including the
ERISA plans.
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\2\ Over $42 million was paid as a result of additional litigation
by the Department and others against plan fiduciaries and service
providers. This number is not included in the receivership assets.
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The receiver has approximately $76.36 million remaining for
distribution. Overall, the employee benefit plans recovered well over
70 percent of their losses through the receivership, and many plans
have recovered additional losses through settlements of litigation
resulting in at least $42 million.
Jeff Grayson--Portland, OR
On April 16, 2002, an Information was filed charging Jeffrey Lloyd
Grayson with one count of mail fraud in violation and one count of
assisting in the preparation of a false tax return. The Information
described an extensive fraud against employee benefit plans beginning
in about 1994 and continuing through September 2000. On April 23, 2002,
Jeffrey Grayson pleaded guilty to one count of mail fraud and one count
of assisting in the preparation of a false tax return. As part of his
plea, Grayson agreed to cooperate with the U.S. Attorney's Office in
the continuing criminal investigation of Capital Consultants' borrowers
and investors. The charges were dismissed due to Grayson's poor health.
Barclay Grayson--Portland, OR
Barclay Grayson pled guilty to mail fraud, a felony, admitting that
he engaged in a scheme to defraud pension plans by overstating the
value of certain investments made by Capital Consultants Inc. He agreed
to testify against his father, Jeffrey Grayson, and union officials in
exchange for a deal with Federal prosecutors that would tentatively
recommend 18 months in prison. Barclay Grayson was sentenced to 24
months in prison and 3 years probation. The AUSA and the court agreed
to restitution of $500,000 as negotiated in the civil class action
suit.
Andrew Wiederhorn and Lawrence Mendelsohn--Portland, OR
EBSA's criminal investigation of Andrew Wiederhorn and Lawrence
Mendelsohn, was opened as a spinoff of the Jeffrey and Barclay Grayson
criminal investigations (above). Andrew Wiederhorn and Lawrence
Mendelsohn are the primary owners and officers of Wilshire Credit
Corporation.
An Information was filed against Lawrence Mendelsohn on November
20, 2003. On November 24, 2003, he pleaded guilty to one count of
filing a false tax return. As part of his plea agreement, Lawrence
Mendelsohn agreed to cooperate with the Government in its continuing
investigation of CCL.
On June 4, 2004, Wiederhorn pleaded guilty to paying an illegal
gratuity to Jeffrey Grayson, and to filing a false tax return. Andrew
Wiederhorn agreed to pay $2 million in restitution, and pay a $25,000
fine. He was sentenced to 18 months in prison.
Dean Kirkland--Portland, OR
This investigation was a spinoff of the criminal investigations of
Jeffrey and Barclay Grayson, after it was alleged that Dean Kirkland
knowingly provided false information to employee benefit plan trustees
in his CCL sales presentations, as well as provided gratuities to plan
trustees.
On August 21, 2002, a 41 count Federal indictment was handed down
against Dean Kirkland. On September 5, 2002, he entered a not guilty
plea. On September 8, 2003, a 57 Second Superceding Indictment was
handed down by the grand jury, after the District Court dismissed the
41 count Superceding Indictment on July 11, 2003. Kirkland was charged
in the Second Superceding Indictment with 21 counts of violations of
Offer, acceptance, or solicitation to influence operations of employee
benefit plan by providing pension plan trustees with hunting and
fishing trips, sporting event tickets, and other gifts. Dean Kirkland
is also charged in the Indictment with 13 counts of wire fraud and with
obstruction of justice.
On February 10, 2005, Dean Kirkland was sentenced to 24 months in
Federal prison, ordered to pay restitution in the amount of $15,756.20,
and fined $5,000. Dean Kirkland is barred for 13 years from serving in
a fiduciary capacity or consultant to pension and other employee
benefit plans covered by ERISA. In addition, Kirkland is barred from
serving as an officer, employee, or representative of any labor
organization or in any capacity with decisionmaking authority
concerning labor union funds or assets for 13 years.
Response to Questions of Senator Hatch by John Endicott
Question 1. Mr. Endicott, you mentioned that beginning in 1975,
your Local began to invest its pension funds through Capital
Consultants, and that by June of 2000, Local 290 had invested more than
$159 million with that firm. What percentage of the total plan assets
did this represent?
Answer 1. By June of 2000, Local 290 had entrusted $159 million of
its pension and benefit trust funds to Capital Consultants for
management and investment. These investments through Capital
Consultants represented about 45 percent of our members' pension and
benefit trust funds. At the time it was closed, Capital had put
approximately $85 million in publicly traded investments and $74
million into private placements. It was the Local's $74 million that
had been invested in private placements that was lost.
Question 2. Did Local 290 have an investment advisor to give
overall advice as to where to invest its pension funds, and how to
allocate its investments?
Answer 2. Capital Consultants was a well-known and highly-regarded
Portland, Oregon investment management firm which was given the
discretion by the trustees of Local 290 to select investments which fit
within 290's investment portfolio, subject to the plan's overall
investment strategy, guidelines, and objectives. Local 290 hired a
pension consultant, Salomon Smith Barney, a registered investment
advisor, to monitor the performance of Capital Consultants in order to
determine whether Capital was doing a competent job in handling these
investments. Salomon Smith Barney was also hired to give the Trust
advice as to how to allocate its investments and how to define its
investment objectives. Local 290 is currently in litigation against
Salomon Smith Barney over its failure to properly monitor the
performance of Capital Consultants, among other things.
Response to Questions of Senators Kennedy and Hatch by Stephen English
SENATOR KENNEDY
Question 1. The DOL and SEC have recently issued ``tips for plan
fiduciaries'' to address potential conflicts of interest between
pension consultants and investment advisors. This guidance puts the
burden on fiduciaries to police complex financial transactions. Do you
believe this guidance will be effective at task, or is something more
needed?
Answer 1. In some instances, additional information offered by the
SEC and DOL may be helpful to trustees and other fiduciaries.
Nevertheless, the fact remains that the duties and responsibilities of
trustees are immense--especially when they have accountability for
multimillion dollar trust fund assets. As we saw with Capital
Consultants, it is probably not realistic to expect that most trustees
could ever effectively police the kinds of complex financial
transactions and potential conflicts of interest that can be involved
in today's larger investment portfolios. Even trained diligent experts
can fail to recognize fraudulent activity that is purposefully
disguised or hidden from the view.
By and large, most benefit plan trustees come from the ranks of
current or former members of their respective trade unions. As such,
their work experience mainly has been derived from the many years they
worked as electricians, plumbers, steam fitters, laborers and the like.
Their prior work experience simply does not arm them with the kinds of
knowledge and experience they would need to successfully ferret out
complex financial transactions or the types of conflicts of interest
that can arise. Apparently--at least in the case of Capital
Consultants--these activities even eluded the purview of accountants,
lawyers, plan monitors, and other professional advisors whom the
trustees had hired to advise them and to oversee their various
activities. Expecting trustees to perform the level of scrutiny or
oversight that would be required of them is perhaps ill-advised, and
may simply shift the Government's oversight burden onto working people
who are not well prepared to perform those tasks. It is unlikely that
preparing a ``tips for plan fiduciaries'' could ever do much to remedy
that situation very effectively.
Without specific legislative and regulatory action by the
Government, I do not see the situation improving to the degree that is
needed. What I believe is required are strengthened criminal sanctions
for violations of ERISA, including the clarification of prohibitions
against gifts and gratuities for trustees and plan officials. In
addition, the minimum fidelity bonds need to be increased to compensate
for decades of inflation and the huge growth in benefit plan assets.
Also, insurance must be required for fiduciaries so that the plans'
funds are better safeguarded from depletion or loss through non-
criminal conduct. All parties-in-interest need to submit annual
disclosures to the plan administrators regarding any financial dealings
or their receipt of anything of value relating to their benefit plan
responsibilities. Finally, conflicts of interest that plan advisors
have that keep them from performing their jobs solely on behalf of the
plan's beneficiaries should be identified and eliminated, or if they
cannot be eliminated, the plan advisors should be required to
voluntarily resign.
Question 2. Do you have any thoughts on how the SEC and DOL can
better coordinate their efforts to enforce existing laws and to
discover pension financial fraud?
Answer 2. Simply put, there needs to be more effective laws and/or
more oversight resources allocated to pension and benefit plan
protection. There simply are not enough resources currently arrayed by
the Government to protect the trillions of dollars in pension and
benefit funds that workers, retirees and their dependants count upon to
take care of their present and future benefit needs. Experience in the
Capital Consultants case and others has shown us that these funds are
ripe for loss through fraud or mismanagement caused by unscrupulous or
unskilled investment managers, or through the lack of trained oversight
by plan advisers whose job is to find out about such fraud or
mismanagement.
The extent of Federal oversight needs to be increased so that there
is a real likelihood that wrongdoing will be quickly detected and
stopped before losses to the funds become massive and jeopardize a
trust fund's ability to meet its obligations. In addition, criminal
sanctions need to be strengthened in order to provide a greater
deterrence to fraud and abuse. Finally, the bonding requirements for
fiduciaries need to be clarified and strengthened, so that in the event
of a loss or other event, there is an adequate safety net available to
protect a plan's participants and beneficiaries.
In the Capital Consultants case, the SEC demonstrated that it had
the skills to clearly recognize the extent of the problems that the DOL
investigator had first uncovered, as well as the will and the
wherewithal to move against Capital quickly and aggressively. Perhaps
SEC has some important skill sets and analytic abilities that DOL may
currently lack because of a shortage of manpower and training. By
working together with the SEC, I believe the DOL could become an even
more effective agency at safeguarding workers' pension and benefit
plans.
SENATOR HATCH
Question. Mr. English, the agreement you were able to negotiate
with the other plaintiff attorneys seems nothing short of remarkable.
How were you able to get such a large number of attorneys and their
clients to put their own self-interest aside in favor of increasing the
chances for everyone coming out better?
Answer. The short answer is that we (1) assessed the overall loss
to Capital Consultant's clients, (2) assessed the culpability of the
investment manager, its primary borrowers, and the accountants,
consultants and attorneys advising the manager and the borrowers, (3)
assessed the financial resources available to each of the parties, and
(4) set out a realistic estimate of the recovery we could expect from
each, based on our best estimate of the potential liability of each. We
discussed this assessment with all of the plaintiffs' lawyers within
120 days after filing the first Complaint in District Court, and
discussed probable distribution plans and the range of amounts each
trust or group of individuals might realize from a distribution based
on our assessment of the likely range of recovery. We then agreed to
act unanimously. Any single group of represented plaintiffs could veto
a settlement decision. Admittedly, the plaintiffs consortium worked
hard internally to resolve differences that often arose so that we
could maintain unanimity. However, this united front allowed us to move
against the defendants with tough but reasonable settlement proposals
that lead to a terrific result for the clients of Capital Consultants.
By way of background, it became quickly apparent to many of us that
the benefit losses incurred by the plans' participants would be massive
and devastating to participants and to their families. In fact the
number of individuals affected by the Capital Consultants debacle would
eventually total some 300,000, with losses of about a half billion
dollars.
Early on, I can vividly recall standing in front of some 1,000
desperate and angry union members whose lifetime accumulation of
pension and benefit trust funds had been lost. They needed help. We
realized that it would be vital for us to try to do everything that we
possibly could to recover and restore as much of their lost money as
quickly as possible. To best conserve assets, we realized we had to
work efficiently and cooperatively with the many other attorneys and
firms who were now involved in the case. Therefore, we developed a plan
to share the legal work among the various firms, recognizing the skills
that each firm could bring to the process. Our objective was to avoid
duplication of efforts and a lengthy and costly discovery process that
could greatly reduce the benefits funds that would be available.
We knew that this would not be an easy process, but we were willing
to do whatever was necessary to make it happen. We understood that we
had to make sound business decisions and were truly fortunate that so
many formidable attorneys were willing to set aside their egos and work
together. We were gratified that a real spirit of cooperation
eventually emerged among the plaintiffs' attorneys. By operating more
like businessmen than as typical litigators, we were able to keep the
recovery effort and the legal costs from spiraling out of control. I
believe the lessons we learned in handling this case can be instructive
in similar situations, thereby conserving plan assets for the benefit
of all of the plan participants.
Response to Questions of Senators Kennedy and Bingaman by GAO
SENATOR KENNEDY
Question. In your testimony, you discussed the need for EBSA to
supplement its targeted enforcement strategy with a survey of pension
plans and that EBSA has yet to perform a more detailed analysis along
the lines you have recommended. Please tell us what further steps you
believe the Department needs to take to better identify fraudulent
transactions and enforce ERISA protections.
Answer. In our testimony, we acknowledge the Department of Labor's
efforts to determine the level of noncompliance with ERISA provisions
among certain health and retirement savings plans. We continue to
believe that Labor can build upon these efforts to develop a cost-
effective and systematic approach to better assess the level and type
of ERISA noncompliance for the entire plan universe.
We have also made a number of recommendations to Labor that we
believe, if implemented, will enhance Labor's ERISA enforcement
efforts. For example, we recently reported on steps Labor can take to
further improve the timeliness and content of Form 5500 reports.\1\ In
2004, we recommended that the Congress take steps to improve the
transparency of proxy voting practices by plan fiduciaries.
Furthermore, we recommended that Labor take appropriate action to more
regularly assess the level of compliance with proxy voting requirements
and enhance coordination of enforcement strategies with the Securities
and Exchange Commission (SEC) in this area.\2\ We continue to believe
that additional transparency and an enhanced enforcement presence would
be beneficial in this area.
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\1\ See GAO, Private Pensions: Government Actions Could Improve the
Timeliness and Content of Form 5500 Pension Information, GAO-05-491
(Washington, DC: June 3, 2005).
\2\ See GAO, Pension Plans: Additional Transparency and Other
Actions Needed in Connection with Proxy Voting, GAO-04-749 (Washington,
DC: August 10, 2004).
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SENATOR BINGAMAN
Question 1. In responding to my questions, you indicated that you
had concerns about the lack of oversight of those who provide
investment advice to plans. Could you please elaborate and provide any
relevant information that you have compiled in this area? Do you
believe that DOL has the resources to provide this type of oversight?
Answer 1. We have previously testified that plan participants may
need more individualized investment advice and that such advice becomes
even more important as participation in 401(k) and other defined
contribution plans increases.\3\ Investment advice that is honest and
uncompromised by conflicts of interest could help employees better
understand their future retirement income needs as well as emphasize
the need for proper diversification. Previously, some legislative
proposals have been introduced that would address employers' concern
about fiduciary liability for making investment advice available to
plan participants and make it easier for fiduciary investment advisors
to provide investment advice to participants when they also provide
other services to the participants' plan. We have noted that concerns
remain that such proposals may not adequately protect plan participants
from conflicted advice. More recently, the SEC found that potential
conflicts of interest may affect the objectivity of advice pension
consultants are providing to their pension plan clients. Labor and SEC
issued guidance to assist plan fiduciaries in reviewing conflicts of
interests of pension consultants. Labor should also take appropriate
enforcement actions to determine to what extent ERISA violations may
have occurred in the instances the SEC identified and use this
information to better target enforcement activity.
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\3\ Private Pensions: Key Issues to Consider Following the Enron
Collapse, GAO-02-480T (Washington, DC: February 27, 2002).
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To better leverage limited enforcement resources, we believe that
Labor should coordinate enforcement strategies with the SEC in areas
where their oversight responsibilities intersect.
Question 2. If current rules were liberalized allowing investment
advisers with conflicts of interest to begin to provide advice to plan
participants in defined contributions, would DOL be able to provide
adequate oversight of this newer larger class of investment advisers?
Would such a change in ERISA cause you concern based on DOL's current
handling of oversight of investment advisers providing advice to
professional plan managers? Could these concerns be assuaged with a
significant increase in staff for oversight at DOL?
Answer 2. If current rules were changed to allow investment
advisers with conflicts of interest to provide advice to plan
participants, the Congress may also want to consider changes to ERISA
to ensure that adequate safeguards are in place to protect
participants. For example, requiring investment advisers to disclose
conflicts could be one safeguard, but would not by itself be
sufficient. Additional safeguards would be needed to ensure that plan
participants are not negatively affected by advice from investment
advisers with conflicts of interest. Thus, Congress may want to amend
ERISA to address limits on Labor's enforcement authority. For example,
Labor continues to be hindered by restrictive legal requirements in
assessing monetary penalties against those who knowingly participate in
a fiduciary breach.
As we noted above, Labor should coordinate enforcement strategies
with the SEC in areas where their oversight responsibilities intersect
such as the oversight of pension consultants and investment advisers.
Absent information on the level and extent of plans' noncompliance
with ERISA provisions, it is difficult to determine what effect a
significant increase in staff at Labor would have on ERISA enforcement.
Without such information, Labor cannot ensure that it is accurately
identifying the areas in which it needs to focus to most efficiently
and effectively allocate its limited resources.
Response to a Question of Senator Hatch by Barclay Grayson
Question. Mr. Grayson, do you believe you had the adequate
knowledge and training about ERISA requirements relating to fiduciary
responsibilities at the time your father appointed you president of
Capital Consultants? Do you believe that current law requirements as to
knowledge and training of investment managers are adequate?
Answer. The question posed is both insightful and extremely
relevant to the Capital Consultants case, as well as to the rest of the
investment advisory community at large. To my knowledge, there are
absolutely no specific ERISA training requirements of any registered
investment advisor by either current law requirements or regulatory
agency requirements. As a registered investment advisor who was selling
securities or otherwise providing investment advice to clients, I was
required to obtain a Series 7 and Series 63 securities license by the
Securities and Exchange Commission. These licenses required extensive
education and training relative to general National and State
securities laws. These licenses do not speak specifically to ERISA law
and there is little, if any, mention of there being any separate laws
or requirements associated with the management and administration of
ERISA related funds. Further, at no time during my 5 years at Capital
was I ever tested on my knowledge of ERISA law, required to attend
training or continuing education or otherwise learn any laws relative
to the management of ERISA regulated funds. The answer to your first
question is therefore that I absolutely do not believe that I had
adequate knowledge or training about ERISA requirements at the time my
father appointed me president of Capital Consultants (other than what
limited information my father told me based on his personal
interpretation of the law) relating to fiduciary responsibilities
associated with the management of ERISA regulated funds.
In terms of your second question, it is absolutely clear to me that
few salesmen and management personnel in the registered investment
advisory community have the legal training or knowledge required to
properly manage and invest ERISA regulated funds. As discussed, no
training or education of which I am aware, is required either by law or
regulatory agency in order to manage ERISA regulated funds. As far as I
am aware, if one works for a registered investment advisor and holds a
Series 63 and Series 7 license, I am not aware of anything that would
preclude a sales person from selling to or otherwise managing ERISA
funds. This results in most sales people only having knowledge of the
general securities laws as required by the SEC, rather than having an
understanding of ERISA law, which is entirely unique. I am not
personally aware of any investment advisors independently requiring
specific in-house ERISA law training for all sales staff. Obviously,
there may be firms that require such independent training, but I am
unaware of such programs based on personal experience.
I should note that many ERISA attorneys are hesitant to provide
concrete information relative to ERISA law as so much of that body of
law is considered to be grey or otherwise untested. Given a general
lack of clear instruction from the Department of Labor relative to the
proper management of ERISA regulated funds, most managers tend to
follow a general rule of acting prudently as required by fiduciary
standards. However, being a prudent fiduciary is in many cases not
enough when it comes to managing ERISA regulated funds as some behavior
that would normally be acceptable, is prohibited when it comes to the
management of ERISA funds. As an example, in the investment advisory
industry (and most other industries for that matter), it is common
course to entertain prospective clients. However, under ERISA law an
investment advisor is generally prohibited from providing a trustee
charged with overseeing ERISA regulated funds with anything of value.
Further, trustees are prohibited from receiving anything of value if
said entertainment will influence the trustees decision making relative
to ERISA regulated funds. Prior to Capital being placed into
receivership, the firm attempted to clarify with its attorneys whether
entertainment of trustees overseeing ERISA funds was prohibited. This
question was specifically asked of counsel that specializes in ERISA
law (and in one case to a past Department of Labor official). Only
after extensive research did Capital learn exactly what type of
behavior was prohibited according to ERISA. As it turned out, Capital
had improperly entertained clients, along with most of the investment
advisory industry as far as I can tell, for the last 30 years. This is
but one of several areas in the industry which currently does not
follow ERISA law primarily as a result of a lack of education and
training. Given the lack of mandatory training, it took Capital
extensive efforts to identify said prohibited acts. Capital also
conducted other improper behavior, but the fact of the matter is that
the industry as a whole is largely not following current ERISA law in
several areas given the lack of guidance from the Department of Labor
and a general lack of mandatory ERISA training and education.
Response to Questions of Senators Kennedy and Hatch by James S. Ray
The Law Offices of James S. Ray,
Alexandria, Virginia 22314-3679,
July 1, 2005.
Hon. Michael B. Enzi,
Chairman,
Committee on Health, Education, Labor, and Pensions,
U.S. Senate,
Washington, D.C. 20510-6300.
Re: Protecting America's Pension Plan From Fraud: Will Your Savings
Retire Before You Do?
Dear Chairman Enzi: Thank you for your letters of June 13 and June
24, 2005. I am pleased to submit the following responses to the
questions for the record included with your June 24th letter.
SENATOR KENNEDY
Question 1. The DOL and SEC have recently issued ``tips for plan
fiduciaries'' to address potential conflicts of interest between
pension consultants and investment advisers. This guidance puts the
burden on fiduciaries to police complex financial transactions. Do you
believe this guidance will be effective at that task, or is something
more needed?
Answer 1. The DOL and SEC issued a joint statement entitled
``Selecting and Monitoring Pension Consultants: Tips For Plan
Fiduciaries'' on June 1, 2005 in response to the SEC's staff report on
conflicts of interest between investment consultants and the pension
plans for which the consultants provide investment advice. This
guidance was nice. Certainly, a pension plan's governing fiduciaries
should require their plan's investment consultant(s) to answer the
conflict of interest questions included in the guidance. Honest
consultants will provide honest answers.
But, what if the pension consultant lies? The point is that the
pension plan's governing fiduciaries won't know that the consultant is
lying. Plans lack the authority, expertise and resources to ferret out
fraudulent conduct by investment firms, including their investment
consultants. The SEC, which regulates pension consultants as investment
management firms, was unaware of the extent of pension consultants'
conflicts of interest with investment managers until its staff
conducted the study that led to the report.
As stated in my testimony, it is the SEC's responsibility to
regulate investment firms; not only the investment consultants but also
the investment management firms that actually make the investment
decisions. The SEC has the authority to regularly examine the
operations of each firm to prevent and detect fraud and other
wrongdoing. The SEC has enforcement powers to quickly compel an
investment firm to cease and desist from wrongful conduct, or to place
a firm in receivership. The SEC is expected to have the expertise to
detect fraud and abuse by investment consultants and managers. The
sophistication of many of the investment vehicles and schemes being
marketed to pension plans today is beyond the understanding of the
plans' governing fiduciaries and, frankly, of many of the plans'
professional advisers. But for some unexpected problems in the
financial markets that caused the Capital Consultants' dominos to begin
falling, the Capital Consultants' fraud might have continued undetected
by plan fiduciaries and professionals.
A typical investment firm has many pension plan clients. By
preventing an investment firm from engaging in or continuing a fraud,
the SEC can protect multiple pension plans. This is sometimes referred
to as the hub-and-spokes approach to enforcement.
In short, the answer to the question is that more and better SEC
regulation of the investment services community is needed; not merely
the issuance of nice statements however helpful. The answer is not for
the SEC to ``privatize'' its enforcement responsibilities by shifting
the burden to pension plans. Pension plans and their participants and
beneficiaries are relying on the SEC to police the investment services
community.
Question 2. Do you have any thoughts on how the SEC and DOL can
better coordinate their efforts to enforce existing laws and to
discover pension financial fraud?
Answer 2. As noted in answer to the first question, the SEC has
primary responsibility and authority to regulate the investment
services community. The SEC needs to do a better regulatory job.
Moreover, the SEC should share with the DOL information about
investment firms that the SEC has under investigation for wrongdoing,
and about findings of wrongdoing. The DOL should be free to advise
pension plans' governing fiduciaries of an investment consulting or
investment management firm that has engaged in wrongdoing. It is
inexcusable if the SEC and/or the DOL knows of wrongdoing by an
investment firm, but fails to notify pension plans that are or may be
affected by the wrongdoing. If an agency is not going to protect a
plan, it should provide the plan's governing fiduciaries with the
information they need to protect the plan.
The SEC is unwilling to share enforcement information with pension
plans. Some years ago, I had occasion to ask the SEC for information
about an investment manager engaged by one of my client pension plans;
specifically, I asked whether the SEC knew if the manager had an
unlawful ``soft dollar'' (kickback) arrangement with brokers used by
the manager for securities transactions on behalf of the plan. The. SEC
had conducted a ``sweep'' of investment firms and found that many of
the firms had ``soft dollar'' arrangements with brokers that exceeded
the scope of the so-called ``research safe harbor'' permitted by law.
The SEC refused to respond to my inquiry.
With regard to the DOL, ERISA Section 504(a)(2) [29 U.S.C.
1134(a)(2)], provides that:
``. . . the Secretary may make available to any person actually
affected by any matter which is the subject of an investigation
under this section, and to any department or agency of the
United States, information concerning any matter which may be
the subject of such investigation; except that information
obtained by the Secretary pursuant to Section 6103(g) of the
Internal Revenue Code of 1954 shall be made available only in
accordance with regulations prescribed by the Secretary of the
Treasury.''
This ERISA provision gives the DOL authority to notify the
governing fiduciaries of pension plans about wrongdoing by investment
firms of which the DOL becomes aware. My experience has been that the
DOL is reluctant to exercise this authority and share information.
SENATOR HATCH
Question 1. Mr. Ray, you mentioned in your testimony that
typically, a plan engages in more than one investment manager, each
with fiduciary responsibility for a portion of the plan's portfolio,
and that one of the reasons for this is to increase investment
diversification. To your knowledge, was Capital Consultants the sole
investment manager for any of the pension plans that it served? In
other words, did any pension plan lose a major portion of its portfolio
because of the Capital Consultants fraud?
Answer 1. I am not aware of Capital Consultants being the only
investment manager engaged by any of its client pension plans. Based on
the reports of the receiver for Capital Consultants, Capital
Consultants had 301 clients in September 2000 (when it was placed in
receivership), the average client had $3.4 million under management by
Capital Consultants, and 50 percent of the clients had less than
$400,000 in assets under Capital Consultants' management. There were a
few plans that had much larger investments under management by Capital
Consultants, and some plans took multi-million dollar losses.
Fortunately, as described by DOL Deputy Assistant Secretary Lebowitz
and Stephen English, Esq. in their respective testimony to the
committee, the efforts of the receiver, the DOL, and the private
litigation have enabled the pension plans to recover 70 percent or more
of their losses.
Question 2. Are there ERISA rules governing the minimum number of
investment managers a pension plan must use? Would it be permissible
under ERISA for a pension plan to put all of its investments with one
investment manager?
Answer 2. ERISA does not expressly mandate that a pension plan
engage even a single investment manager. ERISA does expressly encourage
the governing fiduciaries of a pension plan to engage an investment
manager by providing a statutory shield against liability for acts or
omissions of an ``investment manager.'' See ERISA Sections 405(d) and
3(38) [29 U.S.C. 1105(d), 1002(38)].
But, the fiduciary standards of conduct, particularly the ``prudent
man'' standard of ERISA Section 404(a)(1)(B) [29 U.S.C.
1104(a)(1)(B)], have the effect of requiring governing fiduciaries of a
plan to engage a qualified investment professional to manage the plan's
investment if the plan fiduciaries themselves are not qualified to
manage the investments. Rarely are the governing fiduciaries themselves
qualified to manage their plan's investments.
How many investment managers a pension plan engages depends on many
variables, including the type of plan, the amount of its assets, its
asset allocation, its liquidity needs, the extent to which it prefers
passive versus active management, and whether it prefers balanced or
specialized managers. It is generally a ``facts and circumstances''
issue.
However, in the case of a medium or large size pension plan, it
would be highly unusual for the plan to engage only one investment
manager. Prudence, as well as the diversification rule of ERISA Section
404(a)(1)(C) [29 U.S.C. 1104(a)(1)(C)], would require diversifying
the plan's portfolio among different types of investments and it is
highly unlikely that one investment manager would be appropriate to
manage all types of investments. In this regard, the authoritative
ERISA Conference Report, states that:
``Ordinarily the fiduciary should not invest the whole or an
unduly large proportion of the trust property in one type of
security or in various types of securities dependent upon the
success of one enterprise. . . .'' [H. Rep. No. 1280, 93d Cong,
2d Sess. (1974) at 304, reprinted in 1974 U.S.C.C.A.N. 5085].
Placing all of the assets of a medium or large pension plan under
the management of one investment manager would be to make the success
of the plan's investment portfolio ``dependent upon the success of one
enterprise'': the investment manager.
I am aware of one case in which this argument, in essence, is being
advanced, and it happens to be a case in which I am involved. On behalf
of retirees of the Prudential Insurance Company of America, I, along
with the law firm of Leiff, Cabraser, Heimann & Bernstein LLP, am in
litigation against Prudential and its Board of Directors challenging
the investment of virtually all $8-9 billion of the Prudential
Employees' Pension Plan in investment products of Prudential that are
managed by Prudential and its affiliated companies. Senior Prudential
officers decide how all of the plan's assets are invested; they choose
all the investment vehicles without independent investigation or
negotiation over the terms. And, they almost always choose Prudential
products managed by Prudential managers. Indeed, on several occasions,
Prudential's officers decided to use the Pension Plan's assets to
provide ``seed capital'' for new Prudential investment products. The
Pension Plan pays Prudential millions of dollars each year for managing
the Plan's investments in Prudential products, at fee rates
unilaterally set by Prudential without negotiation or independent
investigation.
The plaintiff-retirees' lawsuit alleges that Prudential and its
Directors engaged in massive self-dealing, prohibited transactions and
breaches of fiduciary duty in violation of ERISA. The appointment of an
independent fiduciary for the Plan is among the remedies being demanded
by the retirees. This case went to trial in 2004, and is awaiting
decision by the trial judge. [Dupree, et al. v. Prudential Insurance
Company of America, et al., Civil Action No. 99-8337-CIV-JORDAN,
U.S.D.C. S.D. FL. (Miami Div.)].
I hope that you and the committee members, and particularly Senator
Kennedy and Senator Hatch, find these answers to be responsive and
helpful.
Respectfully,
James S. Ray.
______
Statement of Michael J. Esler
Esler, Stephens & Buckley,
Attorneys At Law,
Portland, Oregon 97204-2021,
May 25, 2005.
I have been practicing law in Northwest since 1971, when I
graduated from the University of Chicago Law School. My practice has
been focused on business litigation, with a heavy emphasis on
securities fraud and other business torts. I have spoken on the subject
to various bar associations and recently spoke at the 25th Annual
Northwest Securities Institute, a conference of State securities
regulators from Oregon, Washington, Idaho and British Columbia.
In the Capital Consultants Litigation, my firm and I prosecuted the
claims of most of the non-ERISA investors, including those who were
represented through the receiver. The total group of plaintiffs we
represented had lost about $100 million. One of our smallest clients
was the Intertribal Timber Council. However, their experience
underscores the need for reform in this area.
The Intertribal Timber Council (``Council'') is a nonprofit
501(c)(3) organization consisting of over 65 member Tribes and Alaska
Native Corporations that have timber or other natural resource
management interests. It operates under the direction of an elected
Board of Directors consisting of 11 Tribes. The Council was formed in
1976 to enhance communications with the Bureau of Indian Affairs by
providing a forum for Tribes to express collective concerns and to be
more actively involved in the management of Indian forestry services.
Among its many accomplishments and activities are its annual
scholarship awards to outstanding students for excellence in Indian
natural resource management.
After a strong sales presentation in Fall 1998 by Jeffrey Grayson,
head of Capital Consultants LLC (``CCL''), the Council changed its
investment adviser and placed approximately $200,000 of its Scholarship
Fund with CCL. Grayson told the Council that CCL could get a better
return on the Scholarship Fund than the Council's existing manager,
enabling the Council to fund three to four more scholarships a year. At
the time of this change, CCL and its cohorts were already insolvent and
deeply mired in the Ponzi scheme that led to its failure. Shortly
before CCL collapsed in September 2000, the Council had approximately
$480,000 invested in two accounts with CCL. This $480,000 on deposit
with CCL had taken 15 to 20 years to accumulate, since the organization
does not have a major emphasis on donations, even though it is a
501(c)(3) nonprofit organization. Its revenues come principally from
member dues, symposium fees and work shop fees. CCL was fully aware
that the funds in its care were for scholarship purposes.
On average, some 15 scholarships were awarded annually prior to the
collapse of CCL. Approximately $22,800 was awarded in 2000. With the
collapse of CCL, the Council estimated it would have available only
$15,000 to award in 2001, with far less in 2002, and that would involve
invading its principal to support the college students already
dependant on the stipend. Essentially, the collapse of CCL created an
immediate loss of five to six forestry scholarships to Native American
high school students and has jeopardized the entire program. As a
result of the Receiver's efforts and litigation under the Oregon
securities laws, the Council will recover about 55 percent of its
losses (which were virtually 100 percent of its CCL investments).
The partial recovery for the Council has enabled it to go forward
with a much reduced scholarship program. In large part, that recovery
was made possible by the Oregon Securities Laws, which, unlike ERISA
and Federal securities laws, give investors the right to pursue a broad
range of professionals who participate in this conduct. This included
professionals who were employed by CCL and the entities with whom CCL
had invested the Council's funds and who were participating in the
Ponzi scheme. Had the Council and other CCL investors been limited to
remedies under the existing Federal securities laws and ERISA, the
amount recovered for them would have been a small fraction of what has
been recovered to date, despite the efforts of the Department of Labor
and the SEC. There is a need for stronger laws to protect people like
the Council by extending full liability for losses to anyone who
materially aids or participates with an ERISA fiduciary in a scheme to
defraud them.
Yours truly,
Michael J. Esler.
______
What To Do When Your ERISA Fiduciary Screws Up--Lessons Learned From
the Capital Consultants Litigation
I. ERISA MAY PROVIDE ONLY LIMITED REMEDIES TO A PLAINTIFF INJURED BY AN
INVESTMENT ADVISOR'S MISCONDUCT
A. As Noted ERISA Does Provide for Remedies, But, as to Non-ERISA
Fiduciaries, These May be Limited. However, Common
Law and Other Statutory Bases for Recovery May Be
Available
Most recently in Harris Trust & Savings Bank v. Solomon Smith
Barney, Inc., 530 US 238 (2000), the Supreme Court made it clear that
the relief available under ERISA is limited to ``appropriate equitable
relief.'' ERISA 503(a)(3). Bast v. Prudential Insurance Co. of
America, 150 F3rd 1003 (9th Cir 1998), as amended. See, also, Toumajian
v. Frailey, 135 F3rd 648 (9th Cir 1998). In Toumajian, the court
summarized this confusing area of the law, stating: ``Once again the
mysteries of the ERISA--a statute intended to provide a system of
uniformity and simplicity in the complex regulatory field of employee
benefits--provided added complexity in this action.'' The question
faced in Toumajian was whether ERISA preempted run-of-the-mill
professional malpractice claims. (In Toumajian, the issue of limited
remedies under ERISA is discussed and becomes a part of the bases for
denying Federal jurisdiction.) See, also, Nieto v. Ecker, 845 F2d 868,
873 (9th Cir 1998) and Harris Trust, supra, 530 US at 240. The lesson
here is to avoid ERISA claims or triggering ERISA preemption by careful
pleading.
B. ERISA May Preempt Other Common Law and Statutory Claims
Pilot Life Ins. Co. v. Dedeaux, 481 US 41 (1987) (ERISA preempts
all common law and State law claims that relate to an employee benefit
plan). A cause of action relates to an employee benefit plan if it has
a connection with, or reference to, such a plan. New York State
Conference of BlueCross & BlueShield Plan v. Travelers Insurance Co.,
514 US 645 (1995). The Ninth Circuit has held that a complaint for
intentional mishandling of plan assets against accountants, actuaries
and attorneys, including nonfiduciaries, was preempted. Concha v.
London, 62 F3rd 1493 (9th Cir. 1995) (this case may be distinguishable
because the entire control and management of the plan was entrusted to
a CPA). In Rutledge v. Seyfarth, Shaw, Fairweather & Jaroldson, 201
F3rd 1212 (9th Cir 2000), the Ninth Circuit observed that Federal
preemption applied to a claim for excessive attorney compensation.
However, if the case had been for substandard performance, ERISA would
not have preempted the claims.
The Supreme Court has stated that courts must address claims of
preemption starting with the presumption that Congress did not intend
to supplant State law. Travelers, 514 US at 655. In Arizona State
Carpenters Pension Trust Fund v. Citibank, 125 F3rd 715 (9th Cir.
1997), the Ninth Circuit held that ERISA does not preempt State law
claims for breach of contract, breach of common law fiduciary duty,
breach of the implied covenant of good faith and fair dealing,
negligence or common law fraud against a service provider bank that
aided an investment manager's breaches of fiduciary duty by failing to
notify the trustees of defaults.
In Donrs v. KPMG Peat Marwick, 876 F Supp 1116 (CD Cal 1994), the
court held that ERISA does not preempt common law claims for accounting
malpractice.
There is a split of authority on the subject, and this is a highly
contested area of the law. If there is an ERISA cause of action, then
preemption may occur.
C. Common Law Remedies Are Probably Better--If Available
Assuming ERISA does not preempt common law causes of action, like
breach of fiduciary duty, common negligence, professional negligence,
negligent misrepresentation and fraud, these claims may provide a
better source of relief than ERISA or the Securities Act.
II. THE OREGON SECURITIES LAW PROVIDES BROAD REMEDIES AGAINST
PARTICIPANTS, IF APPLICABLE \1\
---------------------------------------------------------------------------
\1\ Note, in Central Bank of Denver v. First Interstate Bank, 511
US 164 (1994), aider and abettor liability under 10b of the
Securities Act of 1934 was essentially eliminated.
---------------------------------------------------------------------------
A. Federal Cases Interpreting Oregon Law Require a Liable Seller in
Order to State a Claim Under the Oregon Securities
Act
See, e.g., Nesbitt v. McNeal, 896 F2d 380 (9th Cir.) 1990).
B. Oregon Cases State Court Decisions Are Somewhat Ambiguous on the
Subject
Anderson v. Carden, 146 Or App 675, 683, 934 P2d 562 (1997) (``The
liability of the nonseller participant under ORS 59.115(3) is
predicated on the violation of the seller.''); Metaltech Corp. v. Metal
Teckniques, Inc., 74 Or App 297, 306, 703 P2d, 237 (1985); Towery v.
Lucas, 128 Or App 555, 562, 876 P2d 814 (1994)(the 1985 amendments
excluded from coverage offers to sell securities).
C. Investment Advisors Generally Act as the Agent of the Buyer and Not
the Agent of the Seller
Pool v. Frank, 1990 WL 267360, at 3-5 (D.Or. 1990) (holding that an
investment advisor acting as agent for its investing clients could not
be liable under Oregon Securities Law as a seller of securities because
it was agent for the purchaser); Rolex Employees Retirement Trust v.
Orgraphics Corp., 1990 WL 45714, at 4 (D.Or. 1991) (``The reference to
``offers'' in ORS 59.115(1) was expressly deleted from the statute
during legislative revisions in 1985 . . .'' and ``the language in ORS
59.115(1) provides no basis for this court to extend liability under
the statute beyond a person who actually passes title to a security.'')
D. Potential Responses
Potential responses to these arguments include the following: (i)
the term ``seller'' is not defined in the statue, and there is no
reason to interpret it to exclude a person who does the act of selling;
and, (ii) the investment program offered by the investment advisor
could, in and of itself, constitute a security. The definition of
``security'' is very broad and includes: ``Note, stock, treasury stock,
bond, debenture, evidence of indebtedness, collateral trust
certificate, investment contract, etc.'' Can the investment program be
re-cast as a mutual fund or an investment contract? Is the investment
advisor acting in a duel capacity?
III. COMMON LAW CLAIMS MAY BE AVAILABLE
A. The Existence of a Special Relationship
Common law claims are stronger because of the existence of a
special relationship. Onita Pacific Corp. v. Trustees of Bronson, 315
Or 149, 843 P2d 890 (1992) and Restatement (2nd) Torts, 552. Compare
with Conway v. Pacific University, 324 Or 231, 924 P2d 818 (1990). By
definition, an ERISA fiduciary should be acting for the benefit of the
plaintiff and a special relationship should exist. Professionals and
others hired by the ERISA fiduciary may be liable as sub-agents--agents
of an agent with fiduciary responsibilities.
B. Fiduciary Duties Include Duties of Undivided Loyalty, Full
Disclosure, Fair Dealing, Good Faith, and Due Care
The failure to exercise reasonable care in selecting investments
should be connected to losses when those investments flounder to
satisfy the causation requirement, but this is a common defense.
Soleberg v. Johnson, 306 Or 484, 760 P2d 867 (1988).
C. Duty of Disclosure
A duty of disclosure mandates that the investment advisor explains
risks and advise his client when he believes his client is embarking in
fool-hearty investments. See attached copies of a recent decision in
Moak v. Sloy.
D. Establishment of a Duty of Care
Establishment of a fiduciary duty makes an investment advisor
responsible for simple negligence. Stuart v. Jefferson Plywood Co., 255
Or 603, 469 P2d 783 (1970) (a person may be found negligent if he ought
reasonably to have foreseen that his conduct would expose another to an
unreasonable risk of harm); and Dodge v. Darrit Const. Co., 146 Or App
612, 934 P2d 591 (1997), rev denied, 326 Or 530 (1998).
E. Participant Liability is Available
Participant liability can be established by showing that the
participant either conspired with, or aided and abetted, the tortious
conduct of the investment advisor. Granewich v. Harding, 329 Or 47, 985
P2d 788 (1999) (incorporating Restatement (2nd) of Torts, 876 (1979).
The elements of conspiracy or aiding and abetting include either: (i) a
tortious act in concert with another or pursuant to a common design
with another; (ii) knowledge that the other person's conduct involved a
breach of duty and substantial assistance; or (iii) substantial
assistance to the other to accomplish tortious results when,
independently of the other, the conduct involved a breach of duty to
the third person. Acting in concert has been defined to mean the
performance of an action that is ``mutually contrived or planned,''
``agreed on,'' ``performed in unison or done together.'' Slegel v.
Hubbard, 176 Or App 1, 29 P3d 1195 (2001). Acting in concert only
requires that the tortious conduct be performed together. Sprinkle v.
Lemley, 243 Or 521, 414 P2d 797 (1966) (each of two doctors operating
together could be liable for the negligence of the other because they
acted in concert). An agreement to act together can be implied and
understood to exist from the conduct itself. Restatement (2nd) of
Torts, 876, comment a (``Agreement need not be expressed in words and
may be implied and understood to exist from the conduct itself.'') and
Slegel, supra, 29 P3rd at 1197 (Court inferred from the conduct of
defendant and third party that they had agreed to engage in tortious
conduct); and Granewich, supra, 329 Or at 59 (allocations that give
rise to an inference to an agreement are sufficient). Passive conduct,
such as a failure to disclose, can also constitute substantial
assistance where there is a duty to disclose. Gregory v. Novak, 121 Or
App 651, 855 P2d 1142 (1993) (``One who makes a representation that is
misleading because it is in the nature of a `half truth' assumes the
obligation to make a full and fair disclosure of the whole truth.'')
[Whereupon, at 11:45 a.m., the committee was adjourned.]