[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





              CREATING GREATER TRANSPARENCY FOR PENSIONERS

=======================================================================

                                HEARING

                               before the

                        SUBCOMMITTEE ON HEALTH,
                     EMPLOYMENT, LABOR AND PENSIONS

                              COMMITTEE ON
                          EDUCATION AND LABOR

                     U.S. House of Representatives

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

             HEARING HELD IN WASHINGTON, DC, JULY 20, 2010

                               __________

                           Serial No. 111-73

                               __________

      Printed for the use of the Committee on Education and Labor








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                    COMMITTEE ON EDUCATION AND LABOR

                  GEORGE MILLER, California, Chairman

Dale E. Kildee, Michigan, Vice       John Kline, Minnesota,
    Chairman                           Senior Republican Member
Donald M. Payne, New Jersey          Thomas E. Petri, Wisconsin
Robert E. Andrews, New Jersey        Howard P. ``Buck'' McKeon, 
Robert C. ``Bobby'' Scott, Virginia      California
Lynn C. Woolsey, California          Peter Hoekstra, Michigan
Ruben Hinojosa, Texas                Michael N. Castle, Delaware
Carolyn McCarthy, New York           Vernon J. Ehlers, Michigan
John F. Tierney, Massachusetts       Judy Biggert, Illinois
Dennis J. Kucinich, Ohio             Todd Russell Platts, Pennsylvania
David Wu, Oregon                     Joe Wilson, South Carolina
Rush D. Holt, New Jersey             Cathy McMorris Rodgers, Washington
Susan A. Davis, California           Tom Price, Georgia
Raul M. Grijalva, Arizona            Rob Bishop, Utah
Timothy H. Bishop, New York          Brett Guthrie, Kentucky
Joe Sestak, Pennsylvania             Bill Cassidy, Louisiana
David Loebsack, Iowa                 Tom McClintock, California
Mazie Hirono, Hawaii                 Duncan Hunter, California
Jason Altmire, Pennsylvania          David P. Roe, Tennessee
Phil Hare, Illinois                  Glenn Thompson, Pennsylvania
Yvette D. Clarke, New York           [Vacant]
Joe Courtney, Connecticut
Carol Shea-Porter, New Hampshire
Marcia L. Fudge, Ohio
Jared Polis, Colorado
Paul Tonko, New York
Pedro R. Pierluisi, Puerto Rico
Gregorio Kilili Camacho Sablan,
    Northern Mariana Islands
Dina Titus, Nevada
Judy Chu, California

                     Mark Zuckerman, Staff Director
                Barrett Karr, Republican Staff Director

         SUBCOMMITTEE ON HEALTH, EMPLOYMENT, LABOR AND PENSIONS

                ROBERT E. ANDREWS, New Jersey, Chairman

David Wu, Oregon                     Tom Price, Geogia,
Phil Hare, Illinois                    Ranking Minority Member
John F. Tierney, Massachusetts       John Kline, Minnesota
Dennis J. Kucinich, Ohio             Howard P. ``Buck'' McKeon, 
Marcia L. Fudge, Ohio                    California
Dale E. Kildee, Michigan             Joe Wilson, South Carolina
Carolyn McCarthy, New York           Brett Guthrie, Kentucky
Rush D. Holt, New Jersey             Tom McClintock, California
Joe Sestak, Pennsylvania             Duncan Hunter, California
David Loebsack, Iowa                 David P. Roe, Tennessee
Yvette D. Clarke, New York
Joe Courtney, Connecticut








                            C O N T E N T S

                              ----------                              
                                                                   Page

Hearing held on July 20, 2010....................................     1

Statement of Members:
    Andrews, Hon. Robert E., Chairman, Subcommittee on Health, 
      Employment, Labor and Pensions.............................     1
    Kucinich, Hon. Dennis J., a Representative in Congress from 
      the State of Ohio, prepared statement of...................     5
        Additional submission: ``A.I.G. to Pay $725 Million in 
          Ohio Case,'' article from the New York Times...........    41
    Price, Hon. Tom, Ranking Republican Member, Subcommittee on 
      Health, Employment, Labor and Pensions.....................     3
        Prepared statement of....................................     4
        Additional submissions:
            ``Congress Overhauls Your Portfolio,'' article from 
              the Wall Street Journal............................    34
            Baker, Richard H., president and chief executive 
              officer, Managed Funds Association, prepared 
              statement of.......................................    42

Statement of Witnesses:
    Bovbjerg, Barbara, Director of Education, Workforce, and 
      Income Security, U.S. Government Accountability Office.....    11
        Prepared statement of....................................    13
    Chambers, Robert Gordon, on behalf of McGuireWoods, LLP......    13
        Prepared statement of....................................    15
    Hutcheson, Matthew D., professional independent fiduciary....     7
        Prepared statement of....................................     8
    Marco, Jack, chairman, Marco Consulting Group................    18
        Prepared statement of....................................    21

 
                     CREATING GREATER TRANSPARENCY
                             FOR PENSIONERS

                              ----------                              


                         Tuesday, July 20, 2010

                     U.S. House of Representatives

         Subcommittee on Health, Employment, Labor and Pensions

                    Committee on Education and Labor

                             Washington, DC

                              ----------                              

    The subcommittee met, pursuant to call, at 10:00 a.m., in 
room 2175, Rayburn House Office Building, Hon. Robert Andrews 
[chairman of the subcommittee] presiding.
    Present: Representatives Andrews, Wu, Kucinich, Fudge, 
Kildee, Holt, Courtney, Price, Kline, Guthrie, and McClintock.
    Staff Present: Aaron Albright, Press Secretary; Tylease 
Alli, Hearing Clerk; Andra Belknap, Press Assistant; Jose 
Garza, Deputy General Counsel; David Hartzler, Systems 
Administrator; Ryan Holden, Senior Investigator; Sadie 
Marshall, Chief Clerk; Meredith Regine, Policy Associate, 
Labor; James Schroll, Junior Legislative Associate, Labor; 
Michele Varnhagen, Labor Policy Director; Matt Walker, Labor 
Counsel, Subcommittee on Health, Employment, Labor, and 
Pensions; Ed Gilroy, Minority Director of Workforce Policy; 
Ryan Kearney, Minority Legislative Assistant; Molly McLaughlin 
Salmi, Minority Deputy Director of Workforce Policy; Ken 
Serafin, Minority Workforce Policy Counsel; and Linda Stevens, 
Minority Chief Clerk/Assistant to the General Counsel.
    Chairman Andrews. Welcome to the subcommittee hearing on 
the issue of transparency and accounting for what are 
frequently called alternative assets in defined benefit plans.
    We are very happy to have an excellent panel. I want to 
thank my ranking member and friend, Dr. Price, for his 
cooperation and participation, and welcome the ladies and 
gentlemen of the public.
    Noting that a quorum is present, the hearing of the 
committee will come to order.
    Eighty-six million Americans depend on traditional defined 
benefit plans for their future income. As the great work of the 
Government Accountability Office has shown in 2008, led by Ms. 
Bovbjerg, who is with us this morning, the number of pension 
plans that are investing in hedge funds and private equity 
funds is growing rather precipitously. Upwards of about 91 
percent, I believe the GAO study says, are involved in hedge 
funds, and a slightly smaller number in private equity. I may 
have that reversed, but it is a growing--it is 91 in private 
equity and, I think, 70 in hedge funds, or a number close to 
that.
    And although one cannot be exact about the level of 
investment in those funds, it is certainly in the hundreds of 
billions of dollars. And, of course, similar choices are being 
made by individuals in defined contribution plans, as well.
    I want to say emphatically from the beginning, I think the 
most important principle governing fiduciary decision-making in 
defined benefit plans is diversification of assets. I think 
that a prudent fiduciary is someone who understands well the 
diversification of risk and reward.
    Given that principle, I am not in any way interested in any 
statutory or arbitrary limitation on investments in such assets 
for pension funds or anyone else. I don't think it is the job 
of elected officials to favor or disfavor any class of 
investments. I think we should be agnostic as to classes of 
investments. I think that we should write laws that impose high 
standards of fiduciary responsibility on those whose job it is 
to make those decisions. And I think we should then essentially 
get out of the way and let them exercise their fiduciary duty.
    In order for people to exercise their fiduciary duty in a 
proper way, transparency is needed. In other words, one cannot 
really understand the potential risks and rewards of an 
investment if the data which underlie the dynamics of that 
investment are not easily and readily understandable.
    In most cases, most classes of investments have a long 
history of regulatory disclosure and, frankly, have a measure 
of transparency that comes from the principle that, in a 
marketplace, people vote with their feet. So when one invests 
in a frequently traded public stock or public bond, market 
fluctuations, when one sees millions of shares traded or 
billions of transactions occur, will let one know what one's 
peers think about the value of an asset.
    That kind of information is not readily available when it 
comes to alternative investments. They are typically thinly 
traded. In many cases, they are illiquid. In many cases, there 
may be no market at all that would help one determine what the 
marketplace thinks about the value of an asset.
    Again, I emphatically believe that this phenomenon should 
not exclude these classes of assets from consideration by 
fiduciary trustees in defined benefit plans. I don't think that 
at all. But I certainly think that those fiduciaries ought to 
have ample information to real-time, relevant information so 
they can properly discharge their responsibilities as 
fiduciaries.
    This, I believe, is not an ideological or political 
question; it is an empirical and analytical one. And the 
purpose of this morning's hearing is to assemble four 
individuals of great experience in this area and, I believe, 
great expertise in this area. And we welcome them to the 
subcommittee.
    The questions we are interested in hearing about this 
morning are: What tools are presently available to pension plan 
fiduciaries in evaluating alternative investments? How complete 
or incomplete are these tools? How useful are these tools? What 
might supplement them and make them more useful?
    What rules and standards govern those who prepare these 
tools? When one relies on an audited financial statement from a 
hedge fund or private equity fund to make a fiduciary decision, 
what standards would govern the quality of that audited 
financial statement? What do we know about the competence and 
preparation of the preparer?
    If there were conflicts of interest, what standards or 
rules would at least disclose or hopefully prohibit such a 
conflict of interest?
    The purpose of this hearing is for those of us on the 
committee to get a sense of how those who are in the fiduciary 
world view the efficacy of the tools available to them and to 
evaluate whether, if at all, changes are necessary to public 
policy.
    I want to say from the outset, I believe public policy does 
not necessarily mean statutes or regulations. It can come in 
the form of guidance from the Department of Labor. It could 
come in other less formal iterations.
    But at the end of the day, here is what we are interested 
in achieving: We want to develop a body of knowledge that would 
give us a level of assurance that when fiduciaries are carrying 
out their fiduciary responsibility and making a decision to 
invest or not invest in pension funds, in a private equity 
fund, or hedge fund, that that decision is being made in full 
disclosure, that that decision is being made with the benefit 
of tools that would help one evaluate the true value of that 
asset, so that, in diversifying one's portfolio, the fiduciary 
can make the best decision for those who depend on that 
decision.
    Our interest here is obviously beyond the philosophical and 
academic. Our real agenda is to prevent from ever occurring a 
taxpayer-subsidized bailout of pension funds. Our concern here 
is that to some extent explicitly and to some extent implicitly 
the taxpayers of the United States stand behind defined benefit 
plans in our country. So we not only have an interest in 
fairness for those who depend on those funds for their income, 
but we certainly have an interest in protecting the taxpayers 
of the country against any sort of obligation that would 
require them to rescue a failed fund.
    The best defense against failure is diversification. The 
best principle of diversification is transparent understanding 
of the investments through which a fiduciary can invest or not 
invest. So that is the purpose of our hearing.
    I would like to proceed by turning to my friend, the senior 
Republican on the subcommittee, Dr. Price, for his opening 
comments, at which time we will then proceed to hear from the 
witnesses.
    Dr. Price. Thank you, Mr. Chairman. And I appreciate you 
holding this hearing.
    I want to thank also the members of the panel. We look 
forward to your comments today and appreciate you taking the 
time to share with us your expertise.
    This is a remarkably critical issue. Some pension plans are 
experiencing funding shortfalls after the economic downturn, 
and plan sponsors are trying to find greater returns to meet 
their obligations.
    However, I share with some of my colleagues the concern 
that today we will be hearing testimony and recommendations, 
some of which are based upon a government report that is almost 
2 years old. That is essentially before the financial crisis 
occurred and without any of the recent statutory changes made 
in the Dodd-Frank Act, which, candidly, will have huge 
consequences, many of which may not be helpful to the state of 
pensions.
    Nevertheless, we welcome the opportunity to look at this 
issue further in an effort to better understand any potential 
problems.
    The ERISA statute provides a longstanding framework to 
guide the activities of private pension plans and the people 
acting in a fiduciary capacity for those plans. Generally, a 
pension plan fiduciary, the person charged with running the 
plan and making those pivotal decisions, must act prudently in 
determining a pension plan's obligations and ensure that 
sufficient assets exist to meet those obligations.
    Part of that obligation includes making good investment 
decisions. Pension plans commonly spread their investments 
across a wide variety of investment vehicles: stocks, bonds, 
mutual funds. Diversification helps pension plans avoid 
catastrophic losses and helps secure reasonable rates of 
return.
    Congress has historically encouraged diversification of 
pension assets and has mostly avoided mandating how private 
pensions invest their assets, leaving many of those details to 
those financial professionals responsible for the pension 
plans.
    As we will hear today, there are many different ways to 
invest pension assets, including some nontraditional vehicles, 
such as hedge funds and private equity. We will learn about 
different types of alternative products, how they operate and 
help pension plans achieve their objectives, whether our 
witnesses believe that new regulations are advisable, how 
different States may enable or curtail pension plan investment 
in alternative products, and whether the new financial services 
law might shed some light on the operations of certain funds 
like hedge funds.
    When looking at the bigger picture, though, it is important 
to note that our economic system generally provides greater 
rewards and potentially greater losses for those who take 
greater risks. While the vast majority of pension investments 
are made by highly sophisticated financial advisors investing 
in good faith in legitimate private investments funds, this 
ultimately helps all pensioners receive their promised 
benefits.
    Have there been some bad actors? Absolutely. However, we 
should be careful at this hearing not to implicate an entire 
industry due to the conduct of a small number of unscrupulous 
individuals. These issues are too important and consequential 
to the majority of Americans to rush to action or draw 
incorrect conclusions that might limit the choices for 
pensioners or flexibility in their decision-making.
    Mr. Chairman, I thank you. And I look forward to our 
hearing and hearing from the witnesses and the questions that 
will follow.
    [The statement of Dr. Price follows:]

   Prepared Statement of Hon. Tom Price, Ranking Republican Member, 
        Subcommittee on Health, Employment, Labor, and Pensions

    Good morning and thank you, Chairman Andrews. I would like to begin 
by thanking our distinguished panel for appearing today. We appreciate 
that they have taken time out of their busy schedules to share their 
experiences and expertise with us.
    This is a critical issue. Some pension plans are experiencing 
funding shortfalls after the economic downturn, and plan sponsors are 
trying to find greater returns to meet obligations. However, I am 
somewhat concerned that we will be hearing testimony and 
recommendations today based on a government report that's almost two 
years old. That's essentially before the financial crisis occurred and 
without any of the recent statutory changes made by the Dodd-Frank 
Act--which, candidly, will have huge consequences, many not helpful, to 
the state of pensions. Nevertheless, we are open to examining this 
issue in an effort to better understand any potential problems.
    The ERISA statute provides a longstanding framework to guide the 
activities of private pension plans and the people acting in a 
fiduciary capacity for those plans. Generally, a pension plan 
fiduciary, the person charged with running the plan and making those 
pivotal decisions, must act prudently in determining a pension plan's 
obligations and ensure that sufficient assets exist to meet those 
obligations. Part of that obligation includes making good investment 
decisions.
    Pension plans commonly spread their investments across a wide 
variety of vehicles, including stocks, bonds and mutual funds. 
Diversification appears to help pension plans avoid catastrophic losses 
and helps secure reasonable rates of return. Congress historically has 
encouraged diversification of pension assets and has mostly avoided 
mandating how private pensions invest their assets, leaving many of the 
details to those financial professionals responsible for pension plans.
    As we'll hear today, there are many different ways to invest 
pension assets--including some non-traditional vehicles such as hedge 
funds and private equity. We'll learn about different types of 
alternative products, how they operate and help pension plans achieve 
their objectives, whether our witnesses believe that new regulations 
are advisable, how different states may enable or curtail pension plan 
investment in alternative products, and whether the new financial 
services law might shed some light on the operations of certain funds, 
like hedge funds.
    When looking at the bigger picture, it is important to note that 
our economic system generally provides greater rewards, and potentially 
greater losses, to those who take greater risks. Now, the vast majority 
of pension investments are made by highly sophisticated financial 
advisors investing in good faith in legitimate private investment 
funds. This ultimately helps all pensioners receive their promised 
benefits. Have there been some bad actors? You bet. However, we should 
be careful at this hearing not to implicate an entire industry due to 
the conduct of a small number of unscrupulous individuals.
    These issues are much too important and consequential to the 
majority of Americans to rush to action or draw incorrect conclusions 
that might limit the choices for pensioners or flexibility in their 
decision-making.
    Thank you, Mr. Chairman. I look forward to hearing from our 
witnesses and exploring these matters further in the questioning 
period.
                                 ______
                                 
    Chairman Andrews. I thank my friend.
    And, without objection, opening statements from any other 
member of the subcommittee will be entered in the record at 
this point.
    [The statement of Mr. Kucinich follows:]

  Prepared Statement of Hon. Dennis J. Kucinich, a Representative in 
                    Congress From the State of Ohio

    I would like to thank Chairman Andrews for holding this hearing and 
for his continued commitment to protecting the retirement security of 
workers.
    Pensions are predicated on trust. They are agreements between 
employees and their employers to provide for the retirement of the 
employees after they have fulfilled their service. When that trust is 
violated, it is the workers, through no fault of their own, who are 
left holding the bag.
    Case in point:
    In Ohio, our Attorney General has been fighting AIG for years to 
get back public pension funds lost due to bid rigging, accounting 
fraud, and market manipulation. Ohio was the lead plaintiff in a class 
action suit that attempted to recover millions of dollars for the 
pension plans of teachers, firefighters, and police officers.
    AIG recently settled the lawsuit for $725 million, which means that 
the people who teach our children and protect our communities will 
finally have received the compensation for crimes perpetrated against 
them.
    I am pleased that AIG finally decided to negotiate in good faith 
with Attorney General Richard Cordray after years of stalling, and 
after being called to account publicly in Congressional hearings.
    But we all know that cases like this are only the tip of the 
iceberg, and for the thousands of Ohioans who have been made whole by 
this decision, there are millions of Americans out there whose 
retirement security has been compromised by questionable investments or 
outright washed down the drain by fraud and lies.
    I look forward to working with Chairman Andrews to make sure that 
Congress does its part to make sure that pensioners are protected and 
that plan sponsors have the information they need to make responsible 
decisions.
    Our constituents deserve better than what many of them have 
received in the past. They choose pension plans precisely because of 
the security that defined benefits offer in retirement. We must do 
everything in our power to make sure that the rug cannot be pulled out 
from underneath them.
                                 ______
                                 
    Chairman Andrews. We will now proceed to introduce the 
witnesses. I am going to read a brief biography for each of 
you.
    You should know that your written statements, which we have 
received in advance and appreciate, will be entered, without 
objection, into the record of the hearing. We ask you to 
provide us with an approximately 5-minute oral summary of that 
written statement so that we can then proceed to the question 
and answer session with the members of the committee.
    So I am going to read the biographies in order of the 
witnesses' testimony, and then we will proceed.
    Mr. Matthew D. Hutcheson is an independent pension 
fiduciary. His clients include the plans of Fortune 100, 500, 
and 1,000 companies, mid- and small-sized companies, government 
and legal accounting firms. Mr. Hutcheson received his MS from 
the Institute of Business and Finance and earned further 
accreditation from the University of Pittsburgh, Texas Tech 
University, and the American Academy of Financial Management.
    Mr. Hutcheson, welcome to the committee.
    We are pleased to welcome back Ms. Barbara D. Bovbjerg, who 
is the director of education, workforce, and income security 
issues at the United States Government Accountability Office. 
At the GAO, she oversees evaluative studies on age and 
retirement income policy issues, including Social Security, 
private pension programs, and other issues. Ms. Bovbjerg holds 
a master's degree in public policy from Cornell University, an 
outstanding school, and a BA from Oberlin College.
    You can guess that both Mr. Walker and myself are graduates 
of Cornell Law School--not the only reason that you are here.
    We are pleased to welcome back to the committee Mr. Robert 
Chambers, a partner at McGuireWoods, LLP. Mr. Chambers counsels 
employers and executives in connection with tax-qualified 
retirement plans, including 401(k) plans, cash balance and 
pension equity plans, and ESOPs. He received his JD from 
Villanova University Law School and a BA from Princeton 
University, located in the finest State in America, New Jersey.
    We appreciate that, Mr. Chambers. Mr. Holt, I am sure, 
would appreciate that, as well, since he represents Princeton.
    And, finally, Mr. John Marco is chairman of the Marco 
Consulting Group. He began his career as an investment 
consultant in 1977, when he joined A.G. Becker, Incorporated. 
Mr. Marco received his BS in mathematics from Lewis University 
and continued his graduate studies at Purdue, Northwestern, and 
Northern Illinois Universities.
    To each of our witnesses, welcome to the subcommittee.
    Three of you, I know, have been here before. I think, Mr. 
Hutcheson, this is your rookie appearance here, is that right?
    The way the rules work is that, in front of you, you see a 
box. When you begin your testimony, the green light will go on. 
When you have 1 minute left in your 5, the yellow light will go 
on. And the red light signifies the end of the 5 minutes, and 
we would ask you to summarize so we can get to questions.
    And so, Mr. Hutcheson, if you would turn your microphone 
on, we will begin with you. We welcome you to the committee.

               STATEMENT OF MATTHEW D. HUTCHESON,
               PROFESSIONAL INDEPENDENT FIDUCIARY

    Mr. Hutcheson. Thank you. I appreciate the opportunity to 
be here.
    Chairman Andrews, Congressman Price, and members of the 
subcommittee, my name is Matthew Hutcheson. I am a professional 
independent fiduciary. Retirement plan sponsors may appoint me 
to serve as the responsible decision-maker for their plans to 
fulfill those often complex and time-consuming obligations. In 
my role as fiduciary, I have made decisions directly affecting 
the lives of hundreds of thousands of plan participants, of 
hopeful retirees expecting to receive many billions' worth of 
future benefits.
    We live in an increasingly volatile and uncertain business 
world. As a result, many plan fiduciaries are exploring 
alternative investments to improve portfolio performance and 
reduce risks. It is likely that interest in alternative 
investments will continue to spread, not only for the potential 
merit of the alternative investment alone, but particularly due 
to concerns about the economy and Wall Street's integrity, even 
in the face of sweeping legislative reform. There is 
significant financial industry fatigue, and alternative 
investments offer a sense of hope for some.
    Generally speaking, an alternative investment means any 
investment vehicle except stocks, bonds, mutual funds or 
similar funds comparable to mutual funds, cash, or properties. 
Examples of alternative investments may include tangible assets 
such as gold or art, commodities, private equity funds, hedge 
funds, and closely held stocks.
    Other examples of alternative investments, although not 
usually referred to as such, are derivatives and guru 
portfolios. Derivatives are those speculative instruments that 
brought down Lehman Brothers and Bear Stearns and nearly 
destroyed our financial system. Guru portfolios are so-called 
investment strategies based on special knowledge and expertise 
the guru is purported to have. That is how the guru claims it 
can outperform its competitors.
    Gurus play to the investor's ego, making the investor feel 
special and smart for knowing the guru and for being permitted 
to invest with him or her. Many times the guru is falsifying 
accounting records to make the investment performance appear 
better than it is. Investors' attention becomes focused on 
short-term gains instead of long-term values. Bernie Madoff is 
the most famous example.
    The due diligence burden retirement plan fiduciaries have 
when investigating alternative investments is significantly 
higher than it is for publicly traded securities, for obvious 
reasons. It requires greater knowledge and insight into 
relevant issues. Most fiduciaries of employer-sponsored plans 
are ill-prepared to perform an appropriate level of due 
diligence. While the plan itself is considered to be an 
accredited investor, individual fiduciaries might not otherwise 
be. The participants in a plan are vulnerable to the decisions 
made by that fiduciary.
    There are several reasons that performing due diligence and 
proper monitoring of alternative investments is so difficult. 
First, the fair value of the investment may be difficult to 
determine. Even when a fair value is assigned to an investment, 
its validity may be subject to debate. For example, the 
reported fair value of an investment could reasonably change by 
changing one or more unobservable inputs that could have a 
reasonably material impact on calculating the fair value under 
those circumstances.
    Unobservable inputs are assumptions the investment manager 
makes based on what he or she believes potential investors will 
pay for an interest in that investment. Those assumptions are 
based upon the best information available at the time given 
specific circumstances affecting that investment. However, 
there may be multiple unobservable inputs that are equally 
valid that materially change the calculated fair market value.
    There are other reasons why performing due diligence on 
alternative investments is tricky for fiduciaries. One is 
limited historical information. The second is the difficulty in 
obtaining an expected return, which is the basis of capital 
markets. Without an expected return, fiduciaries are unable to 
determine the merit of a particular investment. In order to 
properly govern a retirement plan, the portfolio must be 
structured in such a way as to produce that expected return in 
a diversified portfolio.
    So there are four practical ways to protect retirement plan 
participants from the inherent accounting valuation and due 
diligence challenges provided within the alternative investment 
framework.
    First, require audit of internal controls that are normally 
required for publicly traded companies; require them for hedge 
funds and private equity funds. Number two, require 
understandable financial statements. We receive financial 
statements that are frequently difficult to understand. Number 
three, ensure that managers of alternative investments have 
solid enterprise risk management skills. And, finally, 
improving fair value measurement methods.
    And I will explore all of these in greater detail 
throughout the hearing.
    [The statement of Mr. Hutcheson follows:]

              Prepared Statement of Matthew D. Hutcheson,
                   Professional Independent Fiduciary

    Chairman Andrews, Congressman Price, and members of the Committee. 
My name is Matthew Hutcheson. I am a professional independent 
fiduciary. Retirement plan sponsors may appoint me to serve as the 
responsible decision maker for their plans to fulfill those often 
complex and time consuming obligations. In my role as fiduciary, I have 
made decisions directly affecting the lives of hundreds of thousands of 
hopeful retirees expecting to receive many billions worth of future 
benefits.
    We live in an increasingly volatile and uncertain business world. 
As a result, many plan fiduciaries are exploring alternative 
investments to improve portfolio performance and reduce risks.
    It is likely that interest in alternative investments will continue 
to spread, not only for the potential merit of the alternative 
investments alone, but particularly due to concerns about the economy 
and Wall Street's integrity, even in the face of sweeping legislative 
reform. There is significant ``financial industry fatigue,'' and 
alternative investments offer a sense of hope for some.
    Generally speaking, an alternative investment means any investment 
vehicle other than stocks, bonds, mutual funds, cash or real estate. 
Examples of alternative investments may include tangible assets (i.e. 
gold or art), commodities, private equity funds, hedge funds, and 
closely held stocks.
    Other examples of alternative investments, although not usually 
referred to as such, are derivatives and ``guru portfolios.''
    Derivatives are those speculative instruments that brought Lehman 
Brothers and Bear Sterns down, and nearly destroyed our financial 
system.
    Guru portfolios are so-called investment strategies based on 
special knowledge and expertise the guru is purported to have. That is 
how the guru claims it is able to outperform its competitors.
    ``Gurus'' play to the investor's ego; making the investor feel 
special and smart for knowing the guru, and being ``permitted'' to 
invest with him or her. Many times, the guru is falsifying accounting 
records to make the investment performance appear better than it is. 
Investor's attention becomes focused on short term gains instead of 
long term values. Bernie Madoff is the most famous example.
    The due diligence burden retirement plan fiduciaries have when 
investigating alternative investments is significantly higher than it 
is for publicly traded securities, for obvious reasons. It requires 
greater knowledge and insight into relevant issues. Most fiduciaries of 
employer sponsored retirement plans are ill prepared to perform an 
appropriate level of due diligence. While the plan itself is considered 
to be an ``accredited investor,'' \1\ individual fiduciaries might not 
otherwise be. The participants in the plan are vulnerable to the 
decisions made by the fiduciary.
    There are several reasons that performing due diligence and proper 
monitoring of alternative investments is so difficult. First, the fair 
value of the investment may be difficult to determine. Even when a fair 
value is assigned to an investment, its validity may be subject to 
debate. For example, the reported fair value of an investment could 
reasonably change by ``changing one or more unobservable inputs that 
could have reasonably been used to measure fair value in the 
circumstances.'' \2\
    ``Unobservable inputs,'' \3\ are assumptions the investment manager 
makes based upon what he or she believes potential investors will pay 
for an interest in the investment. Those assumptions are to be based 
upon the best information available at the time, and given the specific 
circumstances affecting the investment. However, there may be multiple 
unobservable inputs that are equally valid, but that materially change 
the calculated fair market value.
    Unobservable inputs are not transparent to potential investors. 
That's why they are called ``unobservable.'' They can lead investors to 
incorrect conclusions and even significant investment losses, even when 
all parties are otherwise acting in good faith.
    There is another reason performing due diligence on alternative 
investments is tricky for fiduciaries. Often, only limited historical 
information is available on the investment. The historical behavior of 
an investment is the basis for return on capital expectations, and also 
expected levels of risk and volatility. It also makes monitoring 
against a benchmark virtually impossible.
    ``Expected return'' \4\ is the foundation of capital markets. If 
investors are unable to expect something favorable in return for the 
investment of their capital, the market system would cease to function 
properly. The flow of investment dollars would dry up, and the capital 
markets would freeze.
    Assets in a retirement plan are held in trust for the future 
retirement income of plan participants and beneficiaries. Creating and 
securing retirement income is the overarching objective of ERISA. In 
order to properly govern a retirement plan, the portfolio must be 
structured in such a way to produce an expected return over a defined 
investment time horizon. If a fiduciary does not know what to expect in 
return for the investment of trust assets, it is in the realm of 
speculation. A fiduciary would also be unable to fairly compare two or 
more alternative investments.
    Fiduciaries are obligated under current regulation\5\ to avoid 
imprudent speculation by applying proper principles of economics and 
finance to portfolio construction and management. Thus, a lack of 
historical information can pose a significant challenge, if not a road 
block altogether, for fiduciaries considering a particular alternative 
investment.
    Finally, the cost of buying and selling alternative investments can 
be very high. Those costs can be difficult to quantify, and are not 
frequently disclosed in an easy to understand format.
    There are four practical ways to protect retirement plan 
participant's future retirement income from the inherent accounting, 
valuation, due diligence, and trading challenges presented by 
alternative investments.
    1. Require audit of internal controls: Require that alternative 
funds have an independent auditor sign off on internal controls based 
upon the Committee of Sponsoring Organizations' (``COSO'') definition 
of what it means to effectively evaluate internal controls.\6\ Auditing 
internal controls today isn't as time-consuming or as costly as it was 
when large public companies first began complying with one of the most 
onerous requirements of the 2002 Sarbanes-Oxley Act, known as Section 
404. Although the Sarbanes-Oxley Act is directed at public companies, 
many privately owned companies and nonprofit organizations are electing 
to evaluate their systems of internal control using COSO's 
framework.\7\ Alternative investment managers can too.
    2. Require understandable financial statements: President Obama is 
quoted as saying, ``I think we have to restore a sense of trust, 
transparency and openness in our financial system.'' \8\ It is urgent 
that we do so. It starts with creating financial statements that 
retirement plan fiduciaries can actually understand. Retirement plan 
fiduciaries want a ``plain English'' executive summary to an 
investment's annual report and more complete disclosures.\9\ 
Indentifying a reasonable expected return on capital will otherwise be 
difficult at a minimum and perhaps even impossible based on what those 
familiar with such matters would otherwise require before proceeding 
with an investment.
    3. Enterprise risk management skills: Strong enterprise risk 
management skills should be the hallmark of every alternative 
investment management team. Fiduciaries considering alternative 
investments must possess sufficient knowledge themselves to investigate 
whether alternative investments are being managed by individuals with 
such skills. There must be a common, standardized language between all 
alternative investment managers, auditors, and plan fiduciaries. Key 
principles, concepts, and guidance must be conveyed under a common 
framework.\10\ A fiduciary's ability to accurately compare two or more 
competing alternative investments depends on it. That will restore 
investor confidence and give retirement plan participants and retirees 
the protections they deserve.
    4. Fair Valuation Standards: The Financial Accounting Standards 
Board recently published proposed amendments to its fair value 
measurement and disclosure rules. An explanation can be found on the 
Board's website.\11\ The proposed amendments enhance and standardize 
the method of valuing alternative investments by the U.S. based 
Generally Accepted Accounting Principles (GAPP) and the International 
Financial Reporting Standards (IFRSs). It focuses on standardizing how 
elements of uncertainty that may affect a fair market value are 
disclosed. For example, disclosure of the use of one unobservable input 
over another in a fair market valuation, and how it might have affected 
the resulting value. This is particularly important for plan 
fiduciaries investigating the merits of international alternative 
investments. Legislation could augment those rules with respect to 
employer sponsored retirement plans. That would enhance confidence that 
the integrity of valuation method being applied to several considered 
alternative investments is sound.
    In conclusion, perhaps the most important participant-protecting 
skill is application of the fiduciary standard. For example, in my 
capacity of a professional fiduciary, I have never permitted trust 
assets to be invested with Madoff, Bear Sterns, or any other 
alternative investment that failed to meet a fiduciary smell test. 
While many sophisticated institutional and high net-worth investors 
lost billions with Madoff, not one participant under my fiduciary 
jurisdiction has ever been exposed to Madoff, Bear Stearns, failed 
hedge funds, or other investments such as those. The fiduciary standard 
of care, coupled with clear evidence of risk management skills, 
internal controls, and demanded transparency protected my participants. 
This committee can develop policy intended to help all other 
fiduciaries apply the same due diligence expertise of alternative 
investments.
    Thank you.
                                endnotes
    \1\ http://www.sec.gov/answers/accred.htm
    \2\ FASB Issues Proposed Update on Amendments for Common Fair Value 
Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. CAQ 
Alert #2010-41--July 14, 2010
    \3\ CPA Journal. http://www.nysscpa.org/cpajournal/2006/1106/
infocus/p14.htm
    \4\ http://www.investorwords.com/1840/expected--return.html
    \5\ Application of modern investment principles in qualified 
retirement plans. [Labor Reg. Sec.  2550.404a-1 (42 FR 54122, 1977)], 
[ERISA Reg. Sec.  2550.404a-1], ERISA Interpretive Bulletin 94-1, etc.
    \6\ http://mcgladreypullen.com/Resource--Center/Audit/Articles/
WhatIsCOSO.html
    \7\ ``Turbo Charge Your SOX Program With the New COSO Monitoring 
Guidance.'' July 8, 2010 by Stephen Austin, CPA, MBA. www.cpa2biz.com.
    \8\ http://wallstreetpit.com/2430-improving-transparency-regaining-
investors-trust
    \9\ ``A number of dialogue tour participants proposed adding a 
``plain English'' executive summary to annual reports. Others suggested 
that ``click-down'' online technology could let users control how 
deeply they delve into a particular company's public reports. We also 
found considerable support for more complete and understandable 
disclosures on executive compensation. In short, investors have made it 
clear that they want more transparency.'' http://www.icahnreport.com/
report/2009/01/improving-transparency-regaining-investors-trust.html
    \10\ http://www.coso.org/Publications/ERM/COSO--ERM--
ExecutiveSummary.pdf
    \11\ http://www.fasb.org/cs/ContentServer?c=FASBContent--
C&pagename=FASB%2FFASBContent--C%2FNewsPage&cid=1176156961430
                                 ______
                                 
    Chairman Andrews. Mr. Hutcheson, thank you.
    You should be aware that Members have had your written 
testimony and had ample time to read it. I read it, and so you 
can assume that we have had the opportunity to read your 
complete statement. Thank you.
    Ms. Bovbjerg, welcome back to the committee. Thank you 
again for the outstanding work the GAO does on a range of 
issues across the country and across the issues. I am always 
impressed by the thoroughness and dedication you and your 
colleagues show to every question you confront. It is good to 
have you back.

     STATEMENT OF BARBARA BOVBJERG, DIRECTOR OF EDUCATION, 
WORKFORCE, AND INCOME SECURITY, U.S. GOVERNMENT ACCOUNTABILITY 
                             OFFICE

    Ms. Bovbjerg. Thank you so much, Mr. Chairman. I will 
report back on your kind remarks.
    I am particularly pleased to be here today to speak about 
pension plan investment in hedge funds and private equity. It 
is such an important issue. Millions of Americans rely on 
defined benefit plans for their financial wellbeing in 
retirement. And it is particularly important that plan 
fiduciaries choose wisely in investing plan assets, to ensure 
that plans are adequately funded today and in the future.
    My testimony focuses on the extent to which plans have 
invested in hedge funds and private equity, the challenges they 
face in making such investments, steps sponsors can take to 
address the challenges, and measures government can take. My 
statement updates our 2008 report on this topic.
    First, the extent of these investments. The frequency of DB 
plan investment in hedge funds has grown dramatically, with 51 
percent of large plans holding hedge funds in their portfolios 
today, up from 11 percent in 2001. Yet the vast majority of 
these plans invest less than 10 percent of their assets this 
way.
    The picture is a little different for private equity 
investment. Although 90 percent of large plans invest in 
private equity today, over 70 percent of them did this in 2001. 
So this type of investment has been consistently fairly common, 
at least among large plans. But as with hedge funds, most plans 
do not concentrate their assets in this form of investment.
    Let me turn now to the challenges these investments 
present. Although plan fiduciaries have told us that they 
invest this way to diversify while gaining potentially 
significant returns, they face several major challenges: 
foremost, the uncertainty over the current value of their 
investment.
    Unlike stocks and bonds, which have a readily determined 
market price, hedge fund and private equity investments are 
more opaque to investors. Hedge funds generally do not provide 
information on either the nature of the underlying holdings or 
the aggregate value on a day-to-day basis. Hedge fund managers 
may decline to disclose information on asset holdings and their 
value if they believe the disclosure could compromise their 
trading strategy.
    Similarly, private equity investment valuation is often 
uncertain during the fund's cycle, which can be up to 10 years 
or more. Plan fiduciaries often won't know the value of the 
underlying investment until the holdings are sold.
    Investment risks are also greater than from more 
traditional investments. For example, hedge fund and private 
equity managers may make relatively unrestricted use of 
leverage. While leverage can magnify profits, it can also 
magnify losses.
    Further, the success or failure of these funds can by 
greatly affected by their managers. Obviously, a managerial 
investment mistake can cause losses, but there are also 
operational risks of mismanagement, such as internal control 
weaknesses that open the door to fraud. And this underlines the 
importance of annual audits, which encourage robust operational 
and internal control processes.
    Finally, these investments are generally illiquid, making 
it difficult, if not impossible, for plans to cut their losses 
in the event of mishap. While the DB plan sponsor is 
responsible for assuring plan funding levels, not the 
participant as with 401(k)s, a significant drop in funding 
could ultimately affect the viability of the DB plan and, by 
extension, the retirement benefits participants that have been 
promised.
    Plan fiduciaries told us they take measures to protect 
themselves from these risks by making careful and deliberate 
fund selection at the front end. But, of course, the success of 
this approach depends on how good the fiduciaries are at such 
decision-making and how much information they have going in.
    Savvy fiduciaries negotiate key terms of investments with 
these funds, specifying fee structure and conditions, valuation 
procedures, redemption provisions, and degree of leverage to be 
employed. Some told us they look to funds of funds to expand 
their diversification, although these are often less 
transparent than single hedge funds and can come with an 
additional layer of fees.
    So there is a lot to be considered as a plan fiduciary 
seeking to invest in such funds, and we think the Federal 
Government can help. In 2008, 2 years ago, we recommended the 
Department of Labor provide guidance on the unique challenges 
of these investments and outline prudent steps plan fiduciaries 
could take. We felt this could help all plans that consider 
such investments and, in fact, might warn smaller plans away if 
they don't have the resources to carry out the oversight that 
is needed. We still believe that this would be an important 
contribution for the Department to make, but, although they 
said they would consider the feasibility of our recommendation, 
they have taken no action as of yet.
    I would like to conclude by noting that plan sponsors are 
facing tremendous financial pressures, both overall and in 
maintaining funding levels in their DB plans. Congress has 
provided temporary relief from ERISA funding rules, but the 
pressure to achieve high returns on plan assets has got to be 
significant, especially if a failure to achieve such returns 
means higher required contributions from the sponsor.
    It will be increasingly important to help fiduciaries do 
the right thing by making them aware of the risks associated 
with alternative investments as well as ways to manage their 
stake in these investments. Guidance from Labor and better 
information from the investment managers themselves cannot, of 
course, protect plan assets from poor decision-making, but it 
can better armor fiduciaries and, by extension, plan 
participants against large losses resulting from a poor 
understanding of what they are getting into.
    And that concludes my statement, Mr. Chairman.
    [The statement of Ms. Bovbjerg may be accessed at the 
following Internet address:]

                http://www.gao.gov/new.items/d10915t.pdf

                                 ______
                                 
    Chairman Andrews. Thank you again, Ms. Bovbjerg.
    Mr. Chambers, welcome back to the committee. It is a 
pleasure to have you with us.

    STATEMENT OF ROBERT CHAMBERS, PARTNER, MCGUIREWOODS, LLP

    Mr. Chambers. Thank you, Chairman, and thank you, Dr. Price 
and members of the committee.
    First and foremost, let me express my profound appreciation 
to the committee for an opportunity to spend a few hours 
thinking about something other than health reform. It has been 
terrific. But I also appreciate the opportunity to present 
testimony with respect to the investment of DB plan assets in 
hedge funds, private equity funds, and other alternative 
investments.
    DB plans must continue to provide participants with 
promised retirement security despite these turbulent economic 
times. Our national priority should be a DB plan system that 
functions transparently, as you indicated, Mr. Chairman, and 
provides promised benefits, but without nonessential 
administrative burdens and unnecessary costs that would 
undermine their essential purpose.
    So I am going to make a few points, if I may. The first 
relates to the GAO report from 2008 on the investment of DB 
plan assets in these kinds of investments.
    I think that the GAO report itself was something of a 
hedge. And I think that it was an important position for them 
to take, and I think that it was actually pretty smart. The 
report took great care, as did Ms. Bovbjerg just now, to 
describe both the challenges and the unique opportunities 
presented by these types of investments. So, for example, she 
indicated and the report indicated that a growing number of 
plans have begun to invest in hedge funds and private equity, 
but virtually all of them have invested only a small portion of 
their total plan assets.
    Similarly, while many hedge fund and private equity 
investments may carry increased risks, virtually all the 
fiduciaries interviewed indicated that they were generally 
pleased with the overall results of those investments and that 
they were willing to devote the necessary time and energy to 
vet those investments in order to increase overall asset 
returns and, of course, to reduce volatility.
    The GAO report did not suggest that any restrictions be 
placed on nontraditional investments by DB plans or that 
additional protective legislation would be required. Instead, 
it recommended that DOL apprise plan fiduciaries of the risks 
of such investments and the need for increased due diligence, 
negotiations, and monitoring in accordance with ERISA's 
existing fiduciary rules.
    Which leads to my second point, and that is that the 
guidance that the GAO has suggested is generally available 
currently from other sources. The DOL expressed concern that 
providing this guidance would be difficult in light of the lack 
of uniformity in those investments. But I think that help is on 
the way. First, the SEC is likely to provide help as it issues 
regulations and other guidance under the Dodd-Frank financial 
reform bill. And in the interim, the DOL could easily make 
available to plan fiduciaries the existing work of, frankly, 
many sophisticated nonpartisan groups that have developed 
excellent tools for handling the due diligence and contract 
negotiations for these kinds of investments. And I have 
referred to one of these reports in my written testimony.
    My third point is that the Dodd-Frank bill will require 
many plan advisors to register with the SEC and to provide 
information regarding their funds. The bill will give the SEC 
broad new powers with respect to managers of many hedge funds 
and possibly private equity funds, and the SEC and FSOC and 
other regulators will provide guidance on definitions, 
registration requirements, and the periodic filing of 
confidential information for many of these funds.
    In light of the recent passage of the bill, neither 
Congress nor the DOL should act at this time, in my view, to 
restrict DB plans from investing in these kinds of funds.
    And next are the valuation issues that others have already 
addressed. And I think that these valuation issues are, in 
fact, being addressed. Form 5500 and plan actuaries require an 
annual determination of the fair market value of DB plan 
assets. So all investments for which there is no public market 
or reported unit sales, including hedge funds and private 
equity funds, present valuation challenges that I think are 
manageable, albeit somewhat thorny.
    Other groups are working on the issue. Again, the SEC is 
likely to develop valuation techniques as part of its guidance 
under the Dodd-Frank bill. And, also, the Financial Accounting 
Standards Board and the accounting industry are developing a 
systematized approach to the valuation of downstream 
investments for which there is no public market.
    My last point is that plan participants do not need 
additional information on any of these kinds of investments 
either. Again, the Pension Protection Act requires defined 
benefit plan administrators to provide annual funding notices 
to participants that include a year-end market valuation of the 
plan's assets and liabilities as well as information regarding 
funding and investment policies. The DOL has already issued a 
model notice that is relatively short and easy, I think, for 
participants to understand. I don't believe that there is any 
need to provide even more information that could render the 
existing disclosure regime completely meaningless.
    And one last thought, if I may. The DOL has consistently 
advised plan sponsors and other fiduciaries of the importance 
of process. You are supposed to create appropriate procedures, 
follow the procedures, review the procedures from time to time 
to determine that they remain best practices, and then document 
your compliance and review. Fiduciaries are to be judged 
primarily on their adherence to this process rather than on the 
result of their individual decisions. And the decision whether 
to invest DB assets in hedge funds or other alternative 
investments, as well as the monitoring of those investments, 
should not be held to a different standard.
    Thank you.
    [The statement of Mr. Chambers follows:]

             Prepared Statement of Robert Gordon Chambers,
                     on Behalf of McGuireWoods, LLP

    My name is Robert Chambers, and I am a partner in the international 
law firm of McGuireWoods LLP. I have advised clients with respect to 
defined benefit plan issues since shortly after ERISA became effective. 
In that regard, my clients have included both large and small employers 
that sponsor defined benefit plans as well as financial institutions 
and other organizations that provide services to such plans. I am also 
a past chair of the Board of Directors of the American Benefits 
Council.
    I appreciate the opportunity to present testimony with respect to 
the investment of defined benefit plan assets in hedge funds and 
private equity funds. Despite the general decline of the defined 
benefit (``DB'') plan system, the investment of assets and funding of 
those DB plans that remain in effect have taken on increased importance 
for millions of Americans during difficult economic times. It is more 
important than ever to ensure that DB plans provide their participants 
with the retirement security that they promise. Our national priority 
should be an effective DB plan system that functions in a transparent 
manner and provides promised benefits, but without nonessential 
administrative burdens and unnecessary costs that would undermine the 
paramount purpose of the plans.
    Due to the breadth of this hearing's topic, I have tried to 
anticipate several issues that may be discussed, and I apologize if I 
have failed to cover any of the intended issues.
    My testimony will relate to the following subjects:
     The findings, conclusions, and recommendation reached in 
the April, 2008 report of the Government Accountability Office 
(``GAO'') on investment of DB plan assets in hedge funds and private 
equity--GAO-08-692.
     The existence of other reports that the Department of 
Labor (``DOL'') may use to provide guidance to plan fiduciaries 
regarding the decision-making process for such investments.
     The provisions of the Dodd-Frank financial reform bill 
that will require additional disclosure regarding hedge funds and 
private equity.
     The impact of such investments on other plan service 
providers.
     The existence of sufficient DB plan asset disclosure to 
participants.
The GAO Report Generally Reaches Logical, But What Are Now Dated 
        Conclusions
    The GAO necessarily hedged its view in developing the results and 
conclusions in its August 2008 report. It determined that:
     A growing number of plans have begun investing in hedge 
funds and private equity, yet most of such plans only invested a small 
portion of total assets in such investments.
     Many hedge fund and private equity investments appear to 
have more risk associated with them, yet virtually all of the 
fiduciaries interviewed indicated that they were generally pleased with 
the results of those investments.
     Hedge fund and private equity investments often require 
more due diligence to obtain necessary information and more negotiation 
of contract terms in order to make an informed investment decision, yet 
many fiduciaries are willing to devote this time and energy to the task 
in order to achieve the overall returns and volatility reduction that 
those investments can provide in accordance with a DB plan's funding 
and investment policy.
     Hedge fund and private equity investments often require 
longer term commitment and less liquidity than other types of 
investments, yet such fiduciaries deem those features to be less 
problematic in the context of projected liquidity needs in DB plans, 
especially in light of the opportunity for greater returns and less 
volatility that those investments, many of which are uncorrelated to 
traditional plan investments, may provide.
    These GAO findings and conclusions certainly echo those of our 
clients that have explored investments in hedge and private equity 
funds.
    The GAO report provides, correctly, that ERISA's fiduciary rules 
apply equally to both large and small DB plans, but that smaller DB 
plans may not have the resources to perform sufficient due diligence to 
properly assess non-traditional investments such as hedge and private 
equity funds. However, the report does not suggest that restrictions be 
placed on smaller plans. Rather, the report recommends that smaller 
plans should simply be apprised of the risks of such investments and 
the need for increased due diligence, negotiations, and monitoring to 
comply with ERISA's fiduciary rules.
If the DOL Decides to Provide Guidance to Plan Fiduciaries Regarding 
        the Decision-Making Process for Investments in Hedge and 
        Private Equity Funds, That Guidance Is Now Generally Available 
        From Other Sources
    The GAO Report concludes with a recommendation that the DOL provide 
guidance for plan fiduciaries that covers the special challenges 
relating to investments in hedge funds and private equity and the due 
diligence and other procedures that fiduciaries should undertake to 
address these challenges. The report also suggests that the DOL provide 
additional information on these investments for small DB plans.
    The DOL was provided an advance copy of a draft of the GAO report 
and responded that it foresaw a number of problems with satisfying the 
GAO's suggestion. The DOL's foremost concern was that providing such 
guidance would be extremely difficult in light of the lack of a uniform 
definition of such investments and the lack of uniformity of such funds 
and their underlying investments.
    This concern may be put to rest in part because we can expect the 
SEC to provide definitional help as it issues regulations and other 
guidance under the Dodd-Frank financial reform bill discussed below. 
Further, as we await the issuance of this guidance, I believe that the 
DOL may make available the guidance suggested by the GAO without 
needing to reinvent the wheel and becoming entangled in a definitional 
morass. There are a number of existing, recent publications containing 
guidance on investing in hedge funds and private equity, several of 
which were drafted in connection with public sector initiatives.
    For example, I draw your attention to Principles and Best Practices 
for Hedge Fund Investors, the Report of the Investors' Committee to the 
President's Working Group on Financial Markets. The report is dated, 
January 15, 2009. This document is available, among other places, on 
the Treasury Department's website.
    This report includes a Fiduciary's Guide and an Investor's Guide. 
The Fiduciary's Guide provides recommendations to individuals charged 
with evaluating the appropriateness of hedge funds as a component of an 
investment portfolio. The Investor's Guide provides recommendations to 
those charged with executing and administering a hedge fund program 
once a hedge fund has been added to the investment portfolio. The 
principles and best practices are applied uniformly to both large and 
small investors.
    The membership of the Investors' Committee included representatives 
of private and university endowments, large governmental and private 
pension funds, unions, and asset management firms.
    My point simply is that the DOL could easily and quickly make 
available to plan fiduciaries the existing work of sophisticated, non-
partisan groups that have developed excellent tools for handling the 
due diligence and contract negotiations for investments in hedge and 
private equity funds.
The Dodd-Frank Wall Street Reform and Consumer Protection Act Will 
        Require Many Advisers To Hedge and Private Equity Funds to 
        Register With the SEC and Provide Information Regarding the 
        Funds
    The Dodd-Frank Wall Street Reform and Consumer Protection Act (the 
``Dodd-Frank bill'', which has not been signed by the President at the 
time that this testimony has been prepared), imposes registration and 
other disclosure requirements on many hedge funds and possibly on 
private equity funds. The Dodd-Frank bill gives the Securities and 
Exchange Commission (``SEC'') broad new powers with respect to managers 
of hedge and private equity funds. My firm expects that the SEC, the 
Financial Stability Oversight Council, and other regulators will 
provide needed guidance on definitions, registration requirements for 
larger advisors, the provision of required confidential data for 
virtually all of these funds, and methods of determining whether such 
funds are undertaking undue risk. Those agencies are authorized to take 
action against those advisers that are determined to have undertaken 
too much risk. This will assist the agencies in their attempts to 
monitor the hedge funds and private equity industries that grown so 
exponentially in the past few years.
    Neither Congress nor the DOL should act at this time to restrict or 
prohibit DB plans from investing in any type of hedge or private equity 
funds. Plan sponsors are concerned such action would:
     Substitute Congress' current judgment regarding 
investments for the judgment of plan fiduciaries, who are familiar with 
their workforce and DB plan investment policies, liability management, 
funding issues, and administration;
     Establish an investment rule based on today's thinking 
that does not take into account future investment trends and 
principles;
     Lead to controversy and confusion (especially in the case 
of hedge funds), regarding whether a particular series of investments 
creates a restricted or prohibited hedge fund;
     Send a signal to fiduciaries that particular investment 
options should be preferred over others; and
     Undercut consideration of a plan's funding and investment 
goals, risk tolerance, and interest in volatility reduction and 
investment diversification.
There Are Valuation Issues That Must Be Addressed for Some Investments 
        in Hedge and Private Equity Funds
    The administrators of all DB plans must make an annual filing of 
Form 5500 and its related schedules, which require a determination of 
the fair market value of all plan assets. Further, plan actuaries must 
obtain a valuation of all plan assets in order to complete their 
actuarial valuations. Similar to many other types of investments for 
which there is no public market or reported units sales, hedge funds 
and private equity investments present valuation challenges that can be 
difficult but are manageable.
    The GAO report also noted the challenges DB plans face in valuing 
certain investments in hedge and private equity funds.
    I expect that the SEC will develop additional valuation techniques 
as part of the guidance that it issues under the Dodd-Frank bill. I 
also understand that the Financial Accounting Standards Board and the 
accounting industry are developing a systemized approach to the 
valuation of downstream investments for which there is no public 
market.
    More generally, in the United States, the valuation of assets and 
liabilities of DB plans has never been required to be an exact science. 
For example, real estate and stock in privately held companies can be 
appraised, but the valuation cannot be precise. This is not a problem 
that renders such investments inappropriate for plans, rather it is an 
issue that plan fiduciaries must consider along with all other factors 
in deciding to invest in such an asset.
No Additional Information on Hedge and Private Equity Funds Needs To Be 
        Provided To Plan Participants
    Congress and the DOL have just reviewed the issue of disclosure of 
specific information regarding individual investments of a DB plan. The 
Pension Protection Act amended Section 101 of ERISA to require DB plan 
administrators to provide annual funding notices to participants that 
include a year-end market valuation of the plan's assets and 
liabilities and information regarding the plan's funding and investment 
policy, among other information. The DOL has issued a model notice that 
includes a chart illustrating the plan's year-end asset allocation by 
percentage of plan assets invested in up to 17 categories. To the 
credit of the DOL, this part of the model notice is relatively short, 
simple, and easy to understand.
    It would be very unhelpful to revisit that issue. I have heard from 
numerous clients and colleagues that the amount of information being 
provided to participants has grown so great that participants have on 
the whole simply stopping looking at the disclosures. To add a set of 
complex new disclosures would simply reduce the number of participants 
who actually read what they receive.
    The key is enabling plan fiduciaries to make informed decisions on 
behalf of the participants. That should be our focus, rather than so 
overwhelming participants with complex information that the disclosure 
regime becomes meaningless.
    It is also important to remember that hedge funds, in particular, 
are not a separate asset class. Rather, they are a compilation of 
assets from one or more asset classes. Reforming existing rules to draw 
participants' attention to specific investments, whether in hedge 
funds, private equity, or other asset classes (such as real estate), 
invariably will be more confusing than enlightening.
    The DOL has consistently advised plan sponsors and other 
fiduciaries of the importance of creating appropriate procedures, 
following those procedures, reviewing the procedures from time to time 
in light of changes to best practices, and documenting such compliance 
and review. Fiduciaries will be judged primarily on their adherence to 
this process, rather than on the results of their decisions. The 
decision of whether to invest DB plan assets in hedge funds, private 
equity, and other non-traditional assets, and the monitoring of those 
investments, should not be held to different standards. Nonetheless, I 
agree with the GAO report that the DOL would perform a valid public 
service by providing or making available guidance on specific issues 
that such investments generate. That guidance, which is already 
available, will need to be reviewed and updated in the future to take 
into consideration accounting developments and guidance issued by other 
agencies as they implement recent legislation.
                                 ______
                                 
    Chairman Andrews. Mr. Chambers, thank you very much for 
your testimony.
    Mr. Marco, welcome to the committee. We are happy that you 
are with us.

               STATEMENT OF JOHN MARCO, CHAIRMAN,
                     MARCO CONSULTING GROUP

    Mr. Marco. Good morning, Mr. Chairman, Dr. Price, and 
members of the committee.
    My name is Jack Marco. I am the chairman of the Marco 
Consulting Group, an investment consulting firm I founded in 
1988. We serve about 400 defined benefit plans as clients. Most 
are multi-employer, jointly trusteed plans organized under the 
Taft-Hartley Act and subject to ERISA. In most cases, we serve 
as an investment consultant, but in many situations we serve as 
a named fiduciary, where we make the decisions on asset 
allocation and select investment managers. Our clients' 
aggregate value is approximately $90 billion.
    The employee trustees of the Taft-Hartley plans are 
electricians and bakers, bricklayers and nurses, janitors and 
plumbers. They work in our grocery stores and hotels and 
hospitals. They drive trucks and make clothes and care for the 
sick. They are the very best our Nation has for building 
complex construction projects and providing necessary and 
sometimes critical services.
    The employer trustees represent small business and large. 
They are contractors, HR specialists, labor relation 
specialists, and representatives of trade associations. While 
they are not investment professionals, as leaders in their 
unions and businesses they are smart, successful, accomplished 
individuals. As trustees, they work tirelessly to provide a 
solid retirement benefit for their members and their employees, 
and they accept all of the liabilities of a fiduciary and 
receive no compensation.
    When I first started providing investment consulting 
services to Taft-Hartley plans in 1977, their investments were 
overwhelmingly in traditional assets of stocks, bonds, and 
insurance contracts. I was hired as an investment consultant to 
help them select and monitor investment firms which would 
manage their assets. Their investments in publicly traded 
stocks and bonds were held at a custodian bank and 
independently valued by them. There was little debate about 
what they owned, what it was worth, and the risks they were 
taking.
    Today, our clients still own stocks and bonds held in many 
of the same custodial banks. However, these assets represent 
about 75 percent of their funds. The remainder are in real 
estate partnerships and commingled funds, private equity 
partnerships, LLCs, and hedge funds.
    On the positive side, these assets have added important 
diversification to the portfolios and improved returns. On the 
negative side, many of these strategies have become very 
complex, with little regulation and government oversight. The 
trustees are expected to be prudent experts when selecting 
investments which use these strategies. More than ever, they 
rely on independent investment consulting firms, such as ours, 
to educate them on the risks and returns of these approaches, 
bring them the best managers, and help them avoid the poor 
ones. That is becoming more challenging every day.
    I would like to focus on two of these investment 
approaches: private equity and hedge funds.
    In private equity, the definition of ``private'' means 
making investments in companies that are not registered with 
the SEC as publicly traded securities. They are not generally 
followed by Wall Street. One of the advantages of private 
equity is that little is known about these startup companies or 
privately held institutions; therefore, investors who seek out 
these companies have greater opportunities for superior return. 
It is also true that this same lack of information creates risk 
to investors.
    While a manager of a publicly traded equity may hold 50 
securities, some private equity managers will hold less than 10 
investments. These private equity investments are typically 
partnerships, the investment manager being the general partner 
and the pension fund being the limited partner. At the time of 
investment, there are no investments made yet, and the manager 
begins the process of looking for companies in which to invest. 
The investor has to rely on his own due diligence and 
information provided by the general partner to provide some 
confidence that the general partner will do well.
    Our clients typically meet four times a year to conduct all 
of the business of the pension fund. They have no capacity and 
no investment staff to perform that due diligence. Most often, 
they look to an investment consultant to provide that due 
diligence for them.
    Our process examines private equity managers in great 
detail--everything from SEC registration, third-party 
providers, offering memorandums, marketing materials, and the 
like. We require this information to proceed. However, the 
general partners are not required to provide it. If they 
refuse, we move on to another candidate. The general partner 
moves on to another investor who may not demand these 
disclosures.
    The best general partners provide all that is asked of them 
and more. The worst general partners rely on slick 
presentations without appropriate disclosure. The same can be 
said about disclosures after the pension fund has become an 
investor.
    Again, all of these requirements we place on any 
partnership we recommend to our clients. Where it is not 
demanded by the investor, it may not be provided because it is 
not required by law.
    Our preference is for our clients to use private equity 
fund of funds instead of individual private equity funds. The 
fund-of-funds structure provides diversification of strategy, 
geography, and industry. The fund-of-funds manager brings 
expertise, access and oversight, and resources to the 
investment process and bears full responsibility for the 
evaluation, selection, and timing of all of these investments.
    We believe this due diligence structure and the use of fund 
of funds is a very effective tool for Taft-Hartley trustees. 
However, requiring general partners to provide these 
disclosures would ensure that all investors have the 
information they need to make intelligent, informed decisions.
    On hedge funds, there are over 9,000 hedge funds available 
for pension fund investors. They include a multitude of 
strategies: long/short equity, merger arbitrage, relative 
value, distressed debt, fixed-income arbitrage, and the list 
goes on.
    These are some of the most sophisticated strategies 
executed in the industry. Consequently, it requires equally 
sophisticated supervision. That is why we prefer funds of hedge 
funds for our clients. These are typically partnerships or LLCs 
that select a group of hedge funds and move in and out of them 
over time. The investor then owns shares in 30 to 50 hedge 
funds in a diversified portfolio rather than just a few they 
would select on their own.
    As a result, we focus our analyzing and monitoring on funds 
of hedge funds. We have developed a list of best practices for 
funds of hedge funds. Generally, we do not recommend funds of 
hedge funds that do not adhere to the majority of the best 
practices.
    We also expect fund-of-hedge-fund managers to follow 
certain best practices in their due diligence and monitoring of 
underlying hedge funds. Our best practices are divided into 
four categories: people, investment, operational, and business.
    Let me just mention that one of the key things about 
people: Background checks, history and experience, and 
operational risk is something that is very key to us. We think 
that the funds need to hire third-party firms to manage 
custody, audit, and administration responsibility. We want to 
also measure the business risk of these institutions.
    Let me make clear that these are best practices we believe 
are appropriate and that we follow. They are not required by 
law or in regulation.
    Finally, we believe the SEC registration should be required 
for all hedge funds and funds of hedge funds. And, thus, we 
welcome Congress's passage of the financial reform bill, 
requiring registration of those funds with $150 million or more 
under management, as an important step towards that goal.
    In conclusion, I would like to say the investment 
environment that Taft-Hartley fund trustees face today is 
exponentially more complex than it was when I joined the 
industry three decades ago. It is very difficult to expect 
trustees to understand the many investment strategies, but 
without full and complete disclosure by the investment 
community, it is nearly impossible for these trustees to do 
their job of protecting the retirement security of millions of 
American workers.
    From the professional advisor and fiduciary's perspective, 
I know requiring these disclosures would help us do a better 
job of scrutinizing these investments. I have also provided the 
committee with a list of these best practices on private equity 
and hedge funds on the Web site provided to the committee.
    Thank you very much, and I am happy to answer any 
questions.
    [The statement of Mr. Marco follows:]

              Prepared Statement of Jack Marco, Chairman,
                         Marco Consulting Group

    Good morning Mr. Chairman and Members of the Committee. My name is 
Jack Marco. I am the Chairman of the Marco Consulting Group, an 
investment consulting firm I co-founded in 1988. We have nearly 400 
benefit plans as clients; most are multi-employer, jointly-trusteed 
plans organized under the Taft-Hartley Act and subject to ERISA. In 
most cases we serve as investment consultant but in many situations we 
serve as a named fiduciary where we make the decisions on asset 
allocation and select the investment managers. Our clients' aggregate 
asset value is approximately $90 billion. In terms of assets, we are 
the largest investment consultant to Taft-Hartley plans in the country. 
I have been an investment consultant for 33 years.
    The employee trustees of Taft-Hartley plans are electricians and 
bakers, bricklayers and nurses, janitors and plumbers. They work in our 
grocery stores and hotels and hospitals. They drive trucks and make 
clothes and care for the sick. They are the very best our nation has 
for building complex construction projects and providing necessary--in 
some cases critical--services. The employer trustees represent small 
business and large. They are contractors, HR specialists, labor 
relation specialists and representatives of trade associations. While 
they are not investment professionals, as leaders in their unions and 
businesses, they are smart, successful and accomplished individuals. As 
trustees they work tirelessly to provide a solid retirement benefit for 
their members and their employees. And for this they accept all of the 
liabilities of a fiduciary and receive no compensation.
    When I first started providing investment consulting services to 
Taft-Hartley plans in 1977, their investments were overwhelmingly in 
the traditional asset classes of stock, bonds and insurance contracts. 
I was hired as an investment consultant to help them select and monitor 
investment firms which would manage their assets. Their investments in 
publicly traded stocks and bonds were held at custodian banks and 
independently valued by them. There was little debate about what they 
owned, what it was worth and the risks they were taking.
    Today our clients still own stocks and bonds held in custody by 
many of these same banks and reported on accordingly. However, these 
assets now represent about 75% of their funds. The remainder is in real 
estate partnerships and commingled funds, private equity partnerships, 
LLC's and hedge funds. On the positive side, these asset classes have 
added important diversification to the portfolios and improved returns. 
On the negative side, many of these strategies have become very complex 
with little regulation and government oversight. The trustees are 
expected to be ``prudent experts'' when selecting investment firms 
which use these strategies. More than ever they rely on independent 
investment consulting firms such as ours to educate them on the risks 
and returns of these approaches, bring them the best managers and help 
them avoid the poor ones. That is becoming a more challenging task 
every day. I would like to focus today on two of these investment 
approaches: Private Equity and Hedge Funds.
Private Equity
    By definition, ``private'' equity means making investments in 
companies that are not registered with the Securities and Exchange 
Commission (``SEC'') as publicly traded securities. They are not 
generally followed by Wall Street analysts. Much has been written about 
the ``Efficient Market Theory'' which says there is so much information 
available about publicly traded companies that there is little 
opportunity for a money manager to provide above market returns. One of 
the advantages of Private Equity is that little is known about these 
privately held or startup companies, therefore the investor who seeks 
out these companies has greater opportunity to provide superior 
returns. It is also true that this same lack of information creates a 
risk to investors. Furthermore, because private equity managers may 
have a specialized industry or niche that they invest in, they may hold 
concentrated positions that are not well-diversified--this presents a 
greater opportunity for significant loss. While a manager of publicly 
traded equity may hold 50 securities, some Private Equity managers will 
make less than 10 investments.
    These private equity investments are typically partnerships, the 
investment manager being the General Partner and the pension fund 
investors being the Limited Partners. At the time of the investment 
(commitment) there are no investments made yet and the manager begins 
the process of looking for companies in which to invest. The investor 
has to rely on his own due diligence and the information provided by 
the General Partner to provide some confidence that the General Partner 
will do well. The need to perform proper due diligence is further 
heightened by one of the unique aspects of Private Equity--contractual 
agreements that lock up investor capital for more than a decade after 
the initial commitment. Our clients typically meet four times a year to 
conduct all of the business of the pension fund. They have no capacity 
and no investment staff to perform that due diligence. Most often they 
look to an investment consultant to provide due diligence for them.
    Our process examines the private equity manager's: Form ADV (if it 
is registered with the SEC); insurance; audited financial statements, 
valuation procedures; third-party service providers; offering 
memorandum, and marketing materials; personnel; biographies of key 
employees; client references; complete historical returns for all prior 
funds; and a history of all limited partnership investments, total 
capital managed and strategy for all prior products. We require this 
information to proceed; however the General Partners are not required 
to provide it. If they refuse, we move on to another candidate. The 
General Partner moves on to another investor who may not demand these 
disclosures. The best General Partners provide all that is asked of 
them and more. The worst General Partners rely on slick presentations 
without appropriate disclosure.
    The same can be said about disclosures after the pension fund has 
become an investor. We require quarterly detailed reporting on each 
investment including asset values, capital flows, and business plans. 
Of the General Partner, we continue to require reporting on their 
investment strategies, current market conditions and organizational 
issues. On an annual basis we collect and review Form ADVs where 
possible, insurance, audited financial statements and valuation 
procedures. Again all of this is a requirement we place on any 
partnership we recommend to our clients. Where this is not demanded by 
the investor it may not be provided because it is not required by law.
    Our preference is for our clients to use private equity fund of 
funds instead of individual private equity funds. The fund of funds 
structure provides diversification of strategy, geography and industry. 
The fund of funds manager brings expertise, access, oversight and 
resources to the investment process and bears full responsibility for 
the evaluation, selection and timing of all investments in the fund. A 
good fund of funds manager demands all of the disclosures we listed and 
also has a good track record of discovering successful partnerships.
    We believe this due diligence structure and the use of fund of 
funds are very effective tools for Taft-Hartley trustees. However 
requiring General Partners to provide these disclosures would ensure 
that all investors have the information they need to make intelligent, 
informed decisions.
Hedge Funds
    There are over 9,000 hedge funds available to pension fund 
investors. They cover a multitude of strategies and approaches: Long/
Short Equity, Merger Arbitrage, Relative Value, Distressed Debt, Fixed 
Income Arbitrage, Global Macro, CTA's and the list goes on. While the 
traditional manager invests in a stock or a bond in a long position, 
the hedge fund manager will also take that long position and then hedge 
it with a short position (short sale). This is done with publicly 
traded stocks, domestic and foreign, currencies, commodities, and bonds 
to name a few. These are some of the most sophisticated strategies 
executed in the industry. Consequently, it requires equally 
sophisticated supervision. That is why we prefer Funds of Hedge Funds 
for our clients. These are typically partnerships or LLC's that select 
a group of hedge funds and move in and out of them over time. The 
investor then owns shares of 30 to 50 hedge funds in a diversified 
portfolio rather than just a few they could select on their own. As a 
result, we focus on analyzing and monitoring the Funds of Hedge Funds.
    We have developed a list of best practices for Funds of Hedge 
Funds. Generally, we will not recommend a fund of hedge funds that does 
not adhere to the majority of these best practices. We also expect the 
Fund of Hedge Funds managers to follow certain best practices in its 
due diligence and monitoring of underlying hedge funds.
    Our best practices are divided into four categories of risk at the 
fund of hedge funds and underlying hedge fund level--people, 
investment, operational and business.
    For people risk, we want a fund of hedge funds to provide client 
references and underlying manager references. We expect the underlying 
hedge funds to provide client references and to agree to background 
checks on their key investment and operations staff to the fund of 
hedge funds manager.
    For investment risk, we want fund of hedge funds to agree to be an 
ERISA fiduciary, to provide the number of underlying funds and to 
report fund and client performance on a monthly and quarterly basis and 
aggregate strategy exposures on a quarterly basis. We expect the 
underlying hedge funds to provide the number of their underlying 
positions and to report on at least a quarterly basis to the fund of 
hedge funds. We want both fund of hedge funds and hedge funds to 
provide: monthly returns; strategy and geographic allocations; and 
portfolio terms for liquidity and fees.
    For operational risk, we want both fund of hedge funds and hedge 
funds to hire third party firms to manage custody, audit and 
administration responsibilities.
    For business risk, we want both fund of hedge funds and hedge funds 
to provide general firm information regarding their inception, assets 
under management and number of accounts for both institutions and non-
institutions. We also want them to provide general fund information 
regarding inception, assets under management (strategy and fund level), 
number of accounts and minimum investment amount.
    Let me make it clear that these are the best practices we believe 
are appropriate and that we follow. They are not required in the law or 
in regulation.
    Finally, we believe SEC registration should be required for all 
hedge funds and Funds of Hedge Funds, and thus we welcome Congress' 
passage of the Financial Reform Bill requiring registration of those 
funds with $150 million or more under management as an important step 
towards that goal.
Conclusion
    The investment environment that Taft-Hartley Fund trustees face 
today is exponentially more complex than it was when I joined this 
industry three decades ago. It is difficult enough to expect trustees 
to understand the many investment strategies, but without full and 
complete disclosure by the investment community, it is nearly 
impossible for these trustees to do their job in protecting the 
retirement security of millions of American workers. From the 
professional advisor and fiduciary's perspective, I know requiring 
these disclosures would certainly help us do a better job of 
scrutinizing these investments.
    I have also provided the Committee with our list of best practices 
for Private Equity and Hedge Fund investing as well as background 
documents on them and model principles and valuation procedures. They 
can be viewed at http://www.marcoconsulting.com/cexhibits.html.
    I welcome any questions you may have.
                                 ______
                                 
    Chairman Andrews. Thank you, Mr. Marco.
    We would like to thank each of our witnesses for their 
preparation and excellent presentations this morning. We will 
now get to the questions from the Members.
    Mr. Hutcheson, let's assume that I am a fiduciary of a 
defined benefit plan, and I am thinking about making an 
investment with my fellow trustees in a private equity fund 
that buys bad debt. The business principle of the private 
equity fund is that they think that people have undervalued 
this bad debt, that it is worth more than they were able to buy 
it for, and they are going to make a profit off of that.
    Let me just walk through some of the resources available 
now for me to help make the decision as to whether or not that 
is a good or bad decision for the people to whom I have a 
fiduciary duty.
    First of all, I assume that, on the basic level, if someone 
were stealing from that fund, that a competent accountant would 
find that; is that correct?
    Mr. Hutcheson. Most of the time, embezzlement would be 
discovered.
    Chairman Andrews. Okay. Now, let's get beyond that to the 
more common sort of problem. When I look at the financial 
statement of this private equity fund, it is going to list on 
it assets of the debts owned by, right? The debts owned by the 
private equity fund are going to be listed as assets.
    Who would do the valuation of those assets on that 
financial statement?
    Mr. Hutcheson. Well, there should be an independent audit 
performed of the fund, and there could be depending on the 
nature, where the debt came from. If the debt is from publicly 
traded companies, which it could be in the underlying private 
equity fund, you know, there should be a Sarbanes-Oxley----
    Chairman Andrews. Let's assume it is bad real estate loans 
that the fund has bought from banks.
    Mr. Hutcheson. Well, the fund will hire an auditor--they 
call them internal auditors--to perform an audit and to put 
together the financial statement. We may not know what the 
probability is----
    Chairman Andrews. Would we know--and I don't ask this as an 
accusatory question--if the auditor who did that audit, if it 
was the first time he or she had ever evaluated bad debt, would 
we know that?
    Mr. Hutcheson. No. No, you would not know that.
    Chairman Andrews. If they had done it a thousand times, 
would we know that?
    Mr. Hutcheson. No.
    Chairman Andrews. Yeah. As my friend suggests, if we 
asked--either you or Mr. Marco could answer this question--is 
that the type of information that would typically be made 
available if you asked for it?
    Mr. Hutcheson. If it occurs to the fiduciary to ask that 
question, which it should, they might share that with you. But 
that is a question that most fiduciaries wouldn't--it wouldn't 
occur to them to ask that question.
    Chairman Andrews. What other documents might the fiduciary 
rely upon to determine whether to buy into that fund, besides 
the audited financial statement?
    Mr. Hutcheson. Well, drilling down a little bit in greater 
detail, the probability that the debts are actually going to be 
paid off, and why they think that. There needs to be some type 
of risk measurement tied to each one of the debt obligations, 
so they are understanding what the nature of the debt is, what 
the payment terms are, what the interest rates are. There is a 
large variety of things that go into investigating such a 
portfolio.
    Chairman Andrews. Mr. Marco, in your work both acting as a 
fiduciary and advising fiduciaries, if you were presented with 
the hypothetical that I gave, what kind of due diligence would 
you perform in order to either make the decision or give advice 
about making the decision about that bad debt fund?
    Mr. Marco. The first step is before it starts when you 
evaluate whether you want to hire that investment manager to 
manage those assets. The due diligence requires, what is the 
process that you use to price the securities? Is there a 
methodology? Are there outside independent auditors? Are you 
applying FASB standards? All of these are questions you have to 
ask before you start the investment.
    And if the answers are to your satisfaction, if they are 
complete, then afterwards it is asking the question when the 
assets are--checking to make sure they are continuing to follow 
their practices.
    But it is the first step, requiring those things. And those 
are the things I described as best practices. That is what a 
good firm would do. And if they are doing it, then that is 
fine. My view is that it ought to be required. It ought not to 
be just someone saying--because, again, my argument is that if 
we follow those and we recommend or select those funds that do 
that kind of appropriate due diligence, we are comfortable. But 
those that don't, that we don't recommend or don't use, they 
move on to the next investor and they get their money because 
they didn't ask the question, they didn't pursue it.
    It is much more satisfactory--if they are required to 
provide it right up front, then you will know. Because once the 
investment is made, once you have given the money to the 
investment manager and have that, you own it; now it is a 
problem you have to deal with. So you avoid it up front if you 
have the right procedure.
    Chairman Andrews. Mr. Chambers, one of the problems you 
noted in your testimony was about the date of the GAO report we 
are talking about this morning. And in fairness to GAO, 
obviously we haven't asked them to do anything since that time. 
They were asked at that time to issue their report.
    And I would want the record to show that, yeah, I think 
that before any decisions could be made based on that report, 
it would need to be updated rather considerably, given what has 
happened since the report was written.
    If we were to look at areas of inquiry that we think the 
GAO should do to follow up on the work it did in 2008, what 
kinds of questions do you think that we should ask them to look 
at?
    Mr. Chambers. Well, I think, to some extent, they have 
updated their report. And I think that the result of the update 
of their report is that, at least as I have glanced through it 
last night, it had the--the recommendations and the findings 
had not changed materially since the report in 2008.
    I think that what they were doing is they were looking at, 
again, process. They are not suggesting regulation, they are 
not suggesting legislation. They are looking at process. They 
are focusing on perhaps the Department of Labor coming out with 
guidance, rather than regulation, on what types of best 
practices are out there.
    What I would suggest to Mr. Marco, in connection with his 
last response, is what he perceives to be a best practice in 
conjunction with a particular type of investment fund, it is 
going to be very different, perhaps, than what Mr. Hutcheson's 
best practice would be----
    Chairman Andrews. Or yours.
    Mr. Chambers [continuing]. Or mine, because, of course, I 
don't have any. I am just a lawyer.
    But I do think that the best practices are going to be very 
complicated to create a definite, finite group of best 
practices, because it is going to differ from investment to 
investment. Some of them, of course, will overlap.
    Chairman Andrews. Ms. Bovbjerg, what--and this will be my 
last question--what do you think the logical next series of 
questions we might ask would be that you could build on the 
work that you have done?
    Ms. Bovbjerg. I think it would be really useful to know 
what is going on in the small plan universe, and that is a much 
harder thing to uncover.
    The concern that we had in doing this report, when we 
talked with representatives of large plans, they had a strategy 
and they understood what they needed to do and talked about the 
challenges and how they were dealing with them--very competent 
people who had thought about this a great deal.
    What we see is an increase in plans of the large and medium 
sizes going into hedge funds and private equity. What that 
suggests is, likely, smaller plans will follow. And I don't 
mean this in a pejorative way, but there is sort of a herd 
mentality among plan investors. They don't want to be the 
outlier, necessarily. And you could imagine a smaller plan 
coming to the conclusion that they are not being a very good 
fiduciary and they are not getting the returns that they should 
be getting because they are not doing this, too. And they 
really may not be capable of providing the kind of oversight 
that is needed. So that was a concern we had.
    And the work we did in the last couple of weeks, looking 
forward to this hearing, looking at the data, suggested that 
the trend continues. And work we have under way in another way 
that touches on this doesn't, in any way, suggest that things 
are materially different.
    Chairman Andrews. I appreciate that.
    I thank each of you.
    And I would turn to Dr. Price for his questions.
    Dr. Price. Thank you, Mr. Chairman.
    I want to pick up where that discussion was leaving off.
    Mr. Marco, the GAO report talks about some States that had 
limited small plans to investment categories, small plans under 
$250 million, for example, unable to invest in hedge funds or 
private equity at a State level.
    Is there merit to considering that at the Federal level?
    Mr. Marco. I do think there is some merit in that.
    The issue is this: Very small plans, it is a question of if 
they have the wherewithal to hire the professionals to help 
them do the work. Small plans, almost by definition, don't have 
internal investment staff. So they don't have people, but they 
can go outside and hire investment consulting firms to that 
work for them.
    Very small plans can't afford to do that, so they are left, 
then, with individuals who may not be investment professionals 
but fiduciaries of these plans to go out and make decisions on 
very complex information, as I said, where disclosure is not 
required, and even if it was, their level of handling it can be 
very difficult.
    Dr. Price. Mr. Hutcheson, do you agree with that, that 
there is merit to having the Federal Government consider 
limiting what small plans can do?
    Mr. Hutcheson. I agree with Chairman Andrews that the 
Federal Government probably should not go there, with respect 
to limiting.
    I think that the--Mr. Chambers said that perhaps some 
guidance from the government on what would be required for 
alternative investments would be appropriate. In the current 
small-plan world, we have investment fiduciaries who get paid a 
percentage of assets, so there is a small percentage that is 
paid off the top that can be easily liquidated and paid to an 
investment advisor. In the small-plan world, it becomes 
difficult to have an investment advisor involved to monitor 
because you can't just liquidate the alternative investment to 
pay a fee. The small plan sponsor has to pay it out of their 
own pocket. And so it becomes problematic to, number one, get 
expertise in monitoring and evaluating.
    However, I don't think that they should be limited. I think 
that fiduciaries simply need to understand that the burden, the 
due diligence burden and the monitoring burden, is significant 
and it requires true expertise.
    Dr. Price. Ms. Bovbjerg, you commented in response to the 
chairman's question about what you might want to consider for a 
new report. Given the recent passage of the reg reform bill and 
the regulations that will certainly be forthcoming from the SEC 
and elsewhere, would it not be wise for Congress and the 
Department of Labor to wait until we see what other arms of the 
Federal Government are going to do and require before issuing 
any recommendations?
    Ms. Bovbjerg. Well, we have never called for a requirement 
that would limit the types of investments.
    Dr. Price. No, I am just talking in, kind of, a different 
umbrella. Just in terms of your report--the chairman asked you 
about your report. Would it not be appropriate for us to wait 
until we see what the SEC and others are doing in response to 
the reg reform bill?
    Ms. Bovbjerg. It is our hope that Labor and SEC will work 
together as they consider these things. There is always that 
difficulty of who is the investor. I mean, SEC is protecting 
investors; Labor is protecting plan participants and sponsors.
    We still believe that the Department of Labor should get 
some guidance up there. In fact, I think that what Mr. Chambers 
said about guidance that is available elsewhere could certainly 
help them decide what to put on their Web site. It shouldn't be 
that hard.
    Dr. Price. Mr. Chambers, I would like to follow up with you 
on the concerns about limiting investments and your thoughts on 
Congress or the Federal Government, through a rule or 
regulation, limiting the ability for funds to invest.
    Mr. Chambers. Well, I would point out first that it seems 
that Mr. Marco probably just precluded his own defined benefit 
plan, if he has one, from investing in alternative investments, 
from what he was saying, because I suspect it would not have, 
at least in that example, $250 million.
    And that is the point. It seems to me that there needs to 
be individual choice that is to be exercised by fiduciaries. We 
have a strategy for fiduciary rules that has been in existence 
for quite some time. It continues to get tweaked periodically 
through litigation and through court decisions.
    But the reality is that there needs to be choice. And I 
think that it is incumbent upon the Department of Labor to 
provide guidance so that people understand what they are 
getting into if they decide to embark on an investment regimen 
that includes these types of investments.
    I don't see that there is any basis whatsoever for 
additional regulation or legislation in this field, 
particularly as you were just asking, I think, Ms. Bovbjerg 
about the fact that we are going to have a slew of information 
that is coming out in conjunction with the Dodd-Frank bill.
    And just one other point about that, which is that--and I 
don't pretend to be a guru in conjunction with the Dodd-Frank 
bill--but I would point out that, as I understand the 
registration requirements in that bill, it is the advisor, not 
the fund, that would be registered. There would certainly be 
fund information that would need to be provided by those 
registered advisors, as well as perhaps, if the SEC finds the 
need, other advisors that are not registered.
    But the most important thing is that that information is 
supposed to be held confidential. And it seems to me that 
Congress has just acted--well, shortly, when the ink dries, if 
it is ever applied--has acted in a fashion that says, ``We 
think that imparting this information is very important, but it 
is to be imparted to the government for purposes of determining 
risk. We understand that there is proprietary information that 
we are probably going to be requesting. And if that proprietary 
information is then handed out to the general public, we, 
Congress, do not believe that that is the best way to handle 
it.''
    And I think what Mr. Marco and, to some extent, Mr. 
Hutcheson are suggesting in their written testimony is that 
there should be a requirement that a lot of that information, 
which is proprietary, which is private, in fact, should be 
disseminated to the general public. And that is contrary to 
what Congress just decided.
    Dr. Price. Thank you.
    Thank you, Mr. Chairman.
    Chairman Andrews. The chair recognizes Mr. Kildee for 5 
minutes.
    Mr. Kildee. Thank you, Mr. Chairman.
    Mr. Chairman, I have served on this subcommittee now for 34 
years. It was called a task force at the beginning, with Frank 
Thompson as the chairman, and then the task force was folded 
into the committee. And Frank used to say at that time that 
there was only one person in Washington who understood ERISA, 
and that was Phyllis Borzi. And I think probably the number has 
grown since then. But it was a very complex bill, and we were 
trying to address a problem that existed out there.
    I want to commend you, Mr. Chairman. I have served with a 
lot of chairmen, and I have found none better than you, both in 
head and heart, because you really believe in the importance of 
this bill.
    I would like to ask a question, address it to Ms. Bovbjerg, 
and if the others want to answer. It is a very generic 
question: If any, what is the most significant change or 
changes we could make to help improve accounting transparency 
for pensions?
    Ms. Bovbjerg. I am actually sitting before the subcommittee 
and thinking about fees. It is difficult for me to think about 
disclosure and pensions without thinking about 401(k) fees. I 
know that is not really your question.
    When I think about what fiduciaries need to deal with, it 
is a very difficult job, and I salute you. I think they need 
all the information they can get. That said, I think it is 
important to try to balance the costs versus the benefits of 
getting that information. So if there were to be, you know, 
more audited information, you would have to think about what it 
would take to get that.
    I just did want to point out, though, that in our work, the 
plans that we contacted--so these are medium and large plans--
virtually all dealt only with registered advisors for their 
investments in hedge funds and private equity.
    Mr. Kildee. Anyone else want to comment?
    Mr. Hutcheson. Yes. Thank you very much.
    In my written testimony, I think there are four practical 
ways to enhance accounting transparency. The first one that I 
mentioned is requiring audit of internal controls. And that is 
normally associated with the Sarbanes auditing.
    And, you know, early on, that was a significant burden to 
publicly traded companies. But, you know, it has been 10 years 
since--we are approaching 10 years since Sarbanes came into 
effect. And it is a lot easier these days to get an audit of 
internal controls. So, for example, a hedge fund could obtain a 
Sarbanes-like audit of internal controls without it become a 
burden to the hedge fund.
    And I do agree with Mr. Chambers. You know, the allure of 
the private equity and hedge funds is that there are some 
proprietary methodologies and knowledge and systems that these 
managers use. And if that got into the public, it would kind of 
render their business model--it would injure it. And so I think 
that there is a way to apply the audit of the internal controls 
without it becoming public, like it is with publicly traded 
companies.
    So, you know, I am not opposed at all to that line of 
thinking. That is the whole idea of having private equity and 
hedge funds available, is their proprietary methods.
    The second one is the financial statements. They are not 
easy to understand. We need a summary in plain English that 
says, ``This is what this financial statement means.''
    Enterprise risk management skills, that should be the 
hallmark of every hedge fund manager and private equity fund 
manager. These are the risk-management skills that we are 
trying to deploy here. If we can't avoid it, we need to reduce 
it. If we can't reduce it, we need to spread it out and 
diversify it, or perhaps accept it. But there needs to be 
skills in managing that.
    And the last one is the fair valuation standards. The 
problem, currently, with the fair valuation standards and FASB 
is trying to bring those into a more consolidated, tight 
definition. But hedge fund managers and private equity managers 
are able to give the CPA who is performing the audit internally 
and preparing the financial statements variables, which are 
called unobservable inputs.
    These are the inputs that we believe will make sense to an 
investor and give them the information they want to invest in 
this fund, and then the auditor assigns the value of the fund. 
Well, the problem with that is there could be three or four 
different unobservable inputs that could materially change the 
value. And so those unobservable inputs--they are unobservable, 
hence they are not transparent to fiduciaries who need to make 
the decisions. We need to know what those variables are. In 
other words, if input A is used and the fair market value is X, 
what would the impact be if we use input B or C? How would that 
change the fair market value? I think we need to know those 
things.
    Mr. Kildee. Thank you.
    Thank you very much, Mr. Chairman.
    Chairman Andrews. I thank my friend for the very nice 
compliment as well. The chair recognizes the ranking member of 
the full committee, the organic farmer from Minnesota, Mr. 
Kline.
    Mr. Kline. Thank you, Mr. Chairman, and thank you to the 
witnesses. And, Mr. Chairman, I want to congratulate you on yet 
again finding a witness from Cornell Law School, thus 
strengthening the bonds of the Cornell Law School Alumni 
Association.
    Chairman Andrews. I think she is actually not from the law 
school. We are diversifying our witness list. She is from the 
master's program. This is entirely different.
    Mr. Kline. This is entirely different. I take it back. I 
take my congratulations back.
    I want to sort of pick up on some of the things that Mr. 
Price was asking about and the chairman addressed, and that was 
the issue of the timing of the 2008 GAO report, the subsequent 
additions and modifications that Mr. Chambers was reading last 
night, and the comments that a couple of you have made about 
the financial reg bill, the Dodd-Frank bill. It is my 
understanding that we are in for a blizzard of
    rulemakings--some hundreds and hundreds from the health 
care bill that still aren't done yet, and I have been told over 
300 from the Dodd-Frank bill.
    And so the sort of general question is--and it is to 
anybody who--Mr. Chambers said he is not the guru of this 
legislation--but anybody who has some idea of what the impact 
will be in this very area. I mean we have been calling for the 
Department of Labor to put up guidance and not regulations, as 
I understand the discussion here. But, nevertheless, it seems 
to me, and that is what I am asking you, that there could be 
some serious changes that come into effect when this rulemaking 
process moves toward its conclusion, and it might affect 
guidance and regulation and everything else.
    So anybody, guru or not, who has an opinion on this, I 
would like to hear from you.
    Mr. Marco. I am not sure what rules will be covered but I 
think the issue of disclosure--and I would like to differ with 
some of the comments that were made earlier--I think the idea 
of saying to an investor, ``Invest in this fund of hedge funds. 
I can't tell you what I am doing and I can't tell you what I am 
holding, because that is proprietary. Just trust me. But you 
invest in this and that is fine. I am not going to tell you, 
and I can't tell you.'' This is nonsense. No one would do that 
in their right mind. There has to be some kind of supervision 
of what it is you are buying, what it is you are investing in. 
For us, it is not a problem. As the fiduciary for the clients 
that we serve, we demand that disclosure, and we get it. We 
also sign----
    Mr. Kline. If I could interrupt, I take your point. But 
what I am getting at is do we think Dodd-Frank, with its 
hundreds of new rules and regulations, is going to affect any 
of your practices or any of the processes that are underway now 
that might affect whatever guidance the Department of Labor 
would put out? And so that is what I am looking at.
    Mr. Chambers.
    Mr. Chambers. There is a tremendous amount of discretion 
that has been afforded to the SEC under the bill, as I 
understand it. And, therefore, I think it is somewhat difficult 
to say, well, clearly we are going to have guidance on this 
field or we are going to have--we are going to recognize a 
requirement to provide this sort of information, but I do think 
that some of the things that will happen as a result of this in 
connection with hedge funds--and it is not even sure to the 
extent to which they are going to cover private equity--but 
with regard to hedge funds is that the larger hedge funds, of 
course, will be providing a pretty significant amount of 
information, I expect, to the government. The government will 
be assessing that in conjunction with in particular the risk 
element of what it is that those organizations are doing, as 
well as working with outside accountants and things like that.
    I personally believe that because a number of the 
exemptions from registration that have existed in the past are 
being changed or eliminated, I think a lot of this is going to 
move offshore. I think that what you are going to find is that, 
under this bill, there are a number of organizations that 
provide access to investments like this which are going to try 
to avoid the registration and other things. They are going to 
limit the amount of assets they have under management and they 
are going to move offshore. They are going to remain small.
    I guess the one point that I would make tough to Mr. Marco 
is that I think it is disingenuous to expect that there is 
going to be a tremendous or that there could be a tremendous 
amount of information regarding these private companies to be 
disseminated and to be updated and to have those organizations 
be able basically to afford to provide that kind of 
information.
    Finally, if I may, finally, there is a very simple 
response: Don't invest in anything where you feel that there is 
not sufficient information. This is the tail wagging the dog. 
Don't invest in something if you feel that the information is 
incorrect or that it is insufficient. That is what we do with 
regard to investments in things where there is public 
disclosure. Don't invest. That is what they are hiring you for.
    Mr. Kline. Thank you. I see the red light is on. I think 
that confirmed my suspicion that we have got a lot of rules 
coming and we don't know what they are going to do. So thank 
you very much.
    I yield back, Mr. Chairman.
    Chairman Andrews. The gentlelady from Ohio, Ms. Fudge, is 
recognized for 5 minutes.
    Ms. Fudge. Thank you all for being here. My first question 
is initially directed to Mr. Chambers and anyone else is free 
to answer. I just want to be clear or ask if you are suggesting 
or if you believe that setting fiduciary standards for hedge 
fund managers will impede their ability to manage their funds.
    Mr. Chambers. I may have missed the middle part of your 
question. If we create responsibilities for hedge fund 
managers?
    Ms. Fudge. If we create standards, which is what we are 
talking about to some degree, do you believe that that is an 
impediment for them to manage their funds, just by creating the 
standard?
    Mr. Chambers. I think in large part, yes.
    Ms. Fudge. Why is that?
    Mr. Chambers. As I have indicated, I think that a lot of 
the information that could be requested and disseminated to the 
public rather than kept at the government level, as it would be 
under the Dodd-Frank bill, is information that could be 
proprietary and it therefore could have an adverse impact on 
how they run their fund.
    Secondly, I think that depending upon how much information 
is required, as anyone who has ever worked with a public 
company or who has worked with a registered investment kind of 
arrangement understands, there is a significant cost that is 
going to be associated with creating that kind of information 
and keeping it updated. Those are just two out of many reasons 
why.
    Ms. Fudge. So do you believe that there should not be 
standards for hedge fund managers?
    Mr. Chambers. I think that hedge fund managers, like people 
who operate and own any private business, do have a certain 
sense of standards that they need to owe to
    shareholders, that they need to owe to their employees, and 
we have existing laws that provide those standards. What I am 
suggesting here is that with regard to--and that is with regard 
to any organization that is not publicly--where there is no 
public market. If an organization is going to have a public 
market, if it is going to hold it itself out as being an 
investment-grade opportunity for the general public, then yes, 
there are additional standards that we as a government have 
imposed over the years. Those standards have never in the past 
been extended to private industry that is not out there seeking 
public investment.
    Ms. Fudge. My second question, and to any of the members of 
the panel, but particularly for Mr. Hutcheson. Without 
additional disclosure, do pension plan managers understand the 
risks involved in investing in hedge funds and private equity 
funds? And I guess probably maybe put a different way, is it 
useful information or is it just more information?
    Mr. Hutcheson. Excellent question. To clarify this 
discussion about whether proprietary information should be 
shared or whether the risks are understood, I think the key to 
all of this, and I think it is very, very important, a 
fiduciary has to know what is going on in the fund. So to 
clarify my prior statement, I am not suggesting that 
alternative investments need to have all their proprietary 
information shared with the public. Does it need to be shared 
with the fiduciaries? Absolutely. There is no question about 
it.
    I think Mr. Chambers isn't suggesting that information be 
withheld from fiduciaries. Otherwise, they can't make a good 
decision.
    But the thing that is more important, the hallmark of any 
investment, is the concept of expected return. A lot of people 
get nervous when they hear that, but unless an investor, like a 
trustee of a pension plan, can expect a favorable outcome from 
the investment of their capital over a specific period of time 
or a long time horizon, they can't really determine what the 
merits are of that particular investment. And so we talk about 
all the time: ``what are the risks, what are the risks, what 
are the risks?'' Well, that is fine, but I need to know what 
the expected outcome or expected return, which is really, truly 
the hallmark of investing. If you can't expect a favorable 
outcome, the markets, whether they be private or public, will 
come to a screeching halt because the flow of capital will 
stop.
    I mean, are you going to give your capital to somebody if 
you can't expect something favorable to happen? No. You won't 
do it. Nobody else will either. So the real issue is what are 
the expected returns. And then, when you evaluate the expected 
returns, you have to balance that out with what are the 
expected risks. And that requires a lot of information.
    The four elements that I talked about earlier I believe are 
the foundation for disclosing what a fiduciary needs to know 
and understand about expected return and expected risks. And so 
to tie all this together, at the end of the day it is the 
fiduciary who has to make the decision. I don't think the 
government needs to make those decisions. The fiduciary has to 
make the decision. But they have to be informed and they have 
to understand before they can make that decision. That requires 
knowledge and disclosure. And so I envision that taking place 
between a hedge fund manager and the fiduciary in an office. 
They are talking about it. Things are disclosed to the 
fiduciary and the fiduciary can consider it, but I am not 
necessarily in favor of broad distribution of information. If 
the fiduciary wants it, they can get it. And if they can't get 
it, move on.
    Ms. Fudge. Thank you very much, Mr. Chairman.
    Chairman Andrews. Thank you. The gentleman from Oregon, Mr. 
Wu, if he chooses to be recognized.
    Very well.
    We would like to thank the witnesses and the members of the 
committee for their diligence today, and I would return to the 
gentleman from Georgia for any concluding remarks he would like 
to offer.
    Dr. Price. Thank you, Mr. Chairman. I think this has been 
helpful. The information that has been provided to the 
committee I think will allow us to hopefully step back and take 
a deep breath, wait on the SEC and, as my senior member Mr. 
Kline said, the blizzard of regulations and rules that will be 
forthcoming and see where we are at that point. But I think 
this has been helpful. Transparency is important. There is no 
doubt about it. However, limiting individuals' opportunities 
and options in terms of investing the way that they believe to 
be most appropriate for themselves is, I think, something that 
is anathema to our system. If we move down that road, then I 
fear that we continue to move down the road that changes the 
very fabric of our Nation. And I am hopeful that we do not 
continue in that vein.
    So, Mr. Chairman, I appreciate the opportunity. I would ask 
unanimous consent that included in this hearing record be an 
article from the Wall Street Journal earlier this week, 
Congress Overhauls Your Portfolio.
    Chairman Andrews. Without objection.
    [The information follows:]

                     [From the Wall Street Journal]

                   Congress Overhauls Your Portfolio

    Hidden in Washington's Historic Finance Bill Are Major New Rules
          Affecting Nearly Every Corner of the Investing World

                            By Eleanor Laise

    With all the talk of ``systemic risk'' and ``too big to fail,'' 
small investors might assume that the landmark Dodd-Frank financial 
overhaul bill has little bearing on their portfolios.
    They would be wrong.
    Buried in the bill's 800-odd pages are the most sweeping regulatory 
changes for ordinary investors in decades, affecting everything from 
mutual funds and retirement plans to single-stock investments and other 
holdings.
    The legislation has the potential to make brokers more accountable 
to their clients, shine light on hedge funds and improve the 
transparency of the complex derivatives on which many mutual funds and 
pension plans rely to hedge their risks.
    Several provisions promise to give investors a louder voice in 
policy-making circles and corporate boardrooms. Within the Securities 
and Exchange Commission, for example, the bill sets up an Office of the 
Investor Advocate designed specifically to assist retail investors, and 
the Investor Advisory Committee, which focuses on initiatives to 
protect investors' interest. And the bill gives the SEC authority to 
make it easier for shareholders to nominate directors for corporate 
boards.
    Taken as a whole, the legislation not only ``lays the groundwork 
for significant improvements'' in investor protection and disclosure, 
but also gives investors ``a greater voice in the policies that affect 
their interests,'' says Barbara Roper, director of investor protection 
at the Consumer Federation of America.
    Yet despite its hefty dose of investor-protection provisions, the 
legislation isn't a home run for small investors, analysts and investor 
advocates say. So-called stable-value funds, popular investments among 
the most conservative 401(k) participants because they are designed to 
deliver smooth, steady returns, are left in limbo, awaiting regulatory 
decisions that could affect their costs and availability in retirement 
plans.
    Likewise, while investor advocates had pushed aggressively for the 
SEC to oversee ``equity-indexed annuities,'' these complex products 
escaped the agency's purview.
    What's more, the bill's full effects on small investors likely 
won't be known for some time. Many provisions call for regulators 
merely to study certain issues or give them the power, but not the 
obligation, to make certain rule changes.
    But in the meantime, investors can prepare for some significant 
changes in their mutual funds, hedge funds, retirement plans, brokerage 
accounts and single-stock holdings. Here are the important factors to 
watch:
Mutual Funds
    Though mutual funds are barely mentioned in the Dodd-Frank bill, 
the legislation could affect everything from funds' bond and 
derivatives holdings to how these products are advertised to investors.
    For bond funds, the bill creates some uncertainty and could even 
boost volatility in certain types of holdings, managers and analysts 
say. That is because it gives the Federal Deposit Insurance Corp., 
which can seize troubled financial institutions, leeway to pay 
investors holding identical bonds issued by that institution differing 
amounts. If investors aren't sure how they will be treated in such a 
scenario, they may demand higher yields, which means lower bond prices, 
or dump the bonds at the first sign of trouble, money managers say.
    The provision ``can have all sorts of unintended effects,'' says 
Bob Auwaerter, head of fixed income at mutual-fund firm Vanguard Group. 
If mutual funds are trying to sell bonds as the issuer tumbles toward 
default, the potential for unequal treatment of bondholders ``will 
reduce liquidity and lower the price,'' Mr. Auwaerter says.
    One little-noticed provision in the bill could be critical for 
mutual-fund investors prone to poor market-timing decisions. It calls 
for the Comptroller General to study mutual-fund advertising, including 
the use of past performance data, and recommend ways to improve 
investor safeguards. Academic research suggests that ``short-term 
performance ads really do drive investor dollars, and unfortunately not 
in a good way,'' says Ryan Leggio, fund analyst at investment-research 
firm Morningstar Inc. ``Those usually lead investors to the hot fund of 
the month or the year.''
Retirement Plans
    Stable-value funds, the most conservative investments in many 
401(k) plans, are left in a regulatory gray zone.
    These funds typically consist of a diversified bond portfolio and 
bank or insurance-company ``wrap'' contracts, which allow investors to 
trade in and out at a relatively steady value. As the bill was being 
hammered out, the stable-value industry lobbied hard to keep these wrap 
contracts from being categorized as ``swaps,'' a type of derivative 
subject to a slew of new rules. Instead of making a final decision, 
lawmakers called for regulators to study the issue within 15 months.
    A swap designation would make stable-value wrap contracts more 
complex to issue and more costly, stable-value experts say, ultimately 
dragging down 401(k) participants' returns. That outcome ``would have 
an immediate and very troubling effect on 401(k) plans across the 
country,'' says Kent Mason, partner at Davis & Harman LLP and outside 
counsel to the American Benefits Council. The regulatory uncertainty 
itself could potentially make issuers more hesitant to offer the 
contracts, he says.
    Stable-value contracts are in short supply already, since issuers 
became more reluctant to offer them in the wake of the financial 
crisis. But since demand for the contracts remains strong, fees for 
these wraps have increased significantly.
Hedge Funds and Other Private Investments
    The Dodd-Frank legislation helps to push hedge funds out of the 
shadows.





    Funds with more than $150 million in assets generally must register 
with the SEC as investment advisers. For registered firms, investors 
can get some basic information about their business activities, 
employees and disciplinary history through the public SEC website, 
adviserinfo.sec.gov.
    Some investor advocates hope that, with more firms registering, 
regulators also will deliver a long-promised overhaul of registered 
advisers' required public disclosures. In a May speech, SEC Chairman 
Mary Schapiro said the Commission is preparing to require ``a plain 
English narrative discussion of an adviser's conflicts, compensation, 
business activities and disciplinary history.''
    While many larger hedge funds already have registered with the SEC, 
the new requirement will likely boost operating costs for smaller funds 
not yet registered. Many of these funds are already struggling to raise 
money, and may consider closing down or raising fees they charge 
investors. ``Clearly there is a group of managers who will never get 
off the ground,'' says Nathan Greene, a partner in the asset-management 
group at law firm Shearman & Sterling LLP.
    The bill also raises the bar for individuals to qualify as 
``accredited investors,'' a basic threshold for buying private 
investments. These investors must now have $1 million excluding the 
value of their primary residence, whereas the old standard was simply a 
$1 million net worth.
Individual Stocks
    The Dodd-Frank bill will likely give shareholders, including small 
investors and mutual funds, a louder voice in corporate boardrooms.
    The bill confers authority on the SEC to allow shareholders access 
to corporate proxies to nominate directors. ``Major shareholders with 
long-term interests in the company are going to be able to hold 
management accountable,'' the Consumer Federation's Ms. Roper says.
    There isn't any guarantee, however, that larger shareholders will 
make much use of this perk. ``I can't be bothered with trying to find 
the right people to put on the board,'' says Albert Meyer, co-manager 
of Mirzam Capital Appreciation Fund. ``Personally I would sell a 
company's stock if I thought the board was inept.''
    Under the bill, shareholders also get a ``say on pay,'' meaning a 
nonbinding vote on public companies' executive compensation. Such a 
vote ``is an important component of monitoring executive 
compensation,'' says Jim Hamilton, an analyst at financial-information 
provider Wolters Kluwer. Though the vote is nonbinding, a ``no'' vote 
by shareholders would likely force management to respond in some way 
and can still have a beneficial effect, he says.
Derivatives
    While many small investors avoid dabbling directly in derivatives, 
mutual funds, exchange-traded funds and pension plans use them 
extensively. Money managers, for example, use these complex financial 
contracts to boost exposure to particular market segments or hedge 
risks such as interest-rate and currency changes.
    The bill should help cut risks in funds holding derivatives. It 
calls for many types of derivatives to be exchange-traded and 
``cleared,'' meaning trades are routed through a central clearinghouse 
that covers losses if a party to the trade blows up. It also requires 
many derivatives traders to post ``margin,'' so they will have cash on 
hand to pay other parties if their bet goes awry.
    Funds, and their shareholders, may pay a price for such safeguards. 
While exchange trading should improve pricing, all the new rules also 
could boost some costs of derivatives trading, managers and analysts 
say.
    The upshot: Since derivatives are here to stay in mutual funds, 
``portfolio managers will grin and bear it, and it will be some 
incremental drag on the overall performance'' of funds, Mr. Greene 
says.
    What's more, it is doubtful the new provisions would have prevented 
all the derivatives-related mutual-fund blow-ups of the financial 
crisis, analysts say. Oppenheimer Champion Income, a high-yield bond 
fund, dropped nearly 80% in 2008, partly because of derivatives tied to 
commercial mortgage-backed securities. Exchange trading won't stop such 
disasters.
Brokerage Accounts
    The bill gives the SEC authority to impose the same standard of 
``fiduciary'' duty on brokers that currently applies to investment 
advisers. That would mean that brokers must provide advice that is in 
clients' best interest, whereas currently they are required only to 
recommend investments that are suitable for customers.



    The SEC must first study the issue and deliver a report to 
Congress. But given that Ms. Schapiro, the SEC chairman, has voiced 
support for such a measure, investor advocates are optimistic that 
regulators will follow through.
    The bill also authorizes the SEC to limit or prohibit the mandatory 
predispute arbitration clauses that apply to many brokerage accounts. 
Such clauses force brokerage customers to take any disputes that might 
arise with their broker before arbitration panels, which critics claim 
often favor the brokerage industry, rather than taking their claims to 
court.
    Since taking your broker to court can be costly and time-consuming, 
investor advocates say, the best outcome for investors would be to have 
access to both arbitration and the courts. ``You need to give the party 
with the least power, the investor, the right to choose,'' the Consumer 
Federation's Ms. Roper says.

    Gregory Zuckerman contributed to this article. Write to Eleanor 
Laise at [email protected].
                                 ______
                                 
    Dr. Price. Thank you.
    Chairman Andrews. The gentleman from Oregon said he would 
like to ask a question. I am going to permit that. Frankly, Dr. 
Price, if you would like to follow up on that, you will have 
that opportunity before we close. The gentleman from Oregon is 
recognized for 5 minutes.
    Mr. Wu. Thank you very much, Mr. Chairman. I just have one 
question. This hearing is focused on transparency. Most of our 
Federal securities laws--most--are based on disclosure. There 
are some substantive constraints in Federal securities law and 
State blue sky laws are more based on substantive constraints. 
I would like to hear the witnesses talk just for a second about 
whether each of you feels that the disclosure and transparency 
mechanisms are, in and of themselves, completely adequate, or 
whether there is a significant role for some substantive 
constraints. I would view, for example, margin limits as one 
example. I am sort of remembering it as the uptick rule for 
certain types of sales, whether some substantive constraints 
are also necessary because it may be the case that transparency 
alone is not enough; that the market may not be fast enough 
and, quite frankly, there are some things that are so complex 
that even a very sophisticated investor may not be able to 
understand exactly what is going on even when fully disclosed 
or certainly not in a sufficiently timely manner to react to 
market conditions.
    I would like, to the extent that you all have any comments 
on that, I would be very interested in your comments.
    Mr. Marco. First, I would say that disclosure does so much 
of getting you along that path so that the investor knows what 
it is and how risky and how much leverage is going to be an 
investment. All of the things I have talked about today, to 
correct some of the other comments, are being done today. They 
are best practices of managers who are doing it. I am not 
suggesting inventing something new. There is an organization 
called Institution of Limited Partners Association with 
hundreds of members who have agreed to these best practices. So 
it is not like asking people to do something that is a burden--
this is what the best investment firms do.
    Now, to your point when they disclose and the investor can 
see the amount of risk taken, it will give people pause and 
perhaps choose not to be invested in one of these things. If 
they can get the information to know what it is they are doing, 
they may choose not to.
    I think down the road there may be some room to say that 
there may be some limitations on the kind of things that these 
investment vehicles can do. I sort of suspect that the reason 
that the SEC hasn't done a lot in this area is because, to a 
large extent, they don't understand them. They don't have the 
staff of professionals that understand all the complex things 
that are going on within these hedge funds, and as they start 
to learn more, they may say, well, there is a limit to how much 
leverage we can do--someone could put on something. But, 
unfortunately, to deal with hedge funds is, by their nature, 
they are very complex and they are trading in very complex ways 
and leveraged, which makes them very risky, which says, first 
of all, the investors ought to know what the heck they are 
getting into when they purchase--when they use these investment 
managers to make these bets. But then, for someone to come in 
and say, okay, in doing these complex strategies, only 2 
percent of this and 5 percent of that, gets to be pretty 
difficult. I am not exactly sure how--I am sure there are some 
areas that could be done, but I think you get much further down 
the road by saying, explain what it is you are doing, give 
detailed information to fiduciaries, not published in the 
public record, but to the supervising fiduciary to say, this is 
what we are doing, show us your position, show us your 
leverage, so we can understand what you are doing, gets you a 
long way to helping fiduciaries handle these kind of assets 
rather than have to set borders on the individuals.
    Mr. Wu. Just following up on that, there may be, in your 
view, some mechanisms which are so inherently risky that once 
understood by the SEC staff, that one may choose as a matter of 
public policy to take that mechanism out of the tool box 
because they are inherently too risky?
    Mr. Marco. That is possible.
    Mr. Hutcheson. If I may also just comment. One thing that 
comes to mind is naked short selling. Not only--I think that 
that shouldn't exist within qualified retirement plans, number 
one, because of the risk that it creates not only for the plan 
but also as a systemic risk. Failed naked short sales create a 
systemic problem that affects other hedge funds, other pension 
plans.
    So when you said is there something of substance that you 
would limit, I would say, if a plan is considering a hedge fund 
or some type of investment philosophy, I would personally ban 
naked short selling. I won't buy knowingly anything that has 
exposure to failed short sales or other systemic risks like 
that.
    Mr. Chambers. May I just take one moment? Congressman, I 
think that your question requires taking a step back because it 
is not just a matter of deciding what needs to be restricted, I 
think it is a question of weighing the rights of people who are 
putting together a particular type of investment and the rights 
of people who are thinking about investing in that investment. 
And as I mentioned earlier, and I think you were not here at 
the time, if you are going to be making public opportunities 
available, then I think, as a matter of public policy, yes, 
there is a lot of information that needs to be required. On the 
other hand, most, not all, but most of these private equity 
funds and certainly hedge funds are private arrangements. They 
are contracts between investors who want to find out as much as 
they can about those investments and the people who put the 
investments together, the managers or the advisers, who decide 
how much information they wish to provide and how much they do 
not. And I think that the weighing of this now is: Are you 
going to be taking what is now available only in conjunction or 
required only in conjunction with public investments, publicly 
traded investments, and are you going to be making some of that 
required for private industry? And that is an enormous step. 
And the question is, as I mentioned earlier, isn't the answer 
to this that someone is willing to give this amount of 
information, and if the person is not willing to make an 
investment based upon that information, they don't have to make 
the investment. Why is it that DB plan fiduciaries should have 
a right that perhaps is greater than investors who are 
investing for themselves or who are investing for college 
endowments. These are willing buyers and willing sellers, and I 
think that what you are asking is that we might be interested 
in making some of these disclosure requirements much further 
downstream than we have ever considered doing before.
    Mr. Wu. Well, there are some open--there are some 
transactions that folks might be openly going into that we 
banned for other reasons. We don't permit someone to sell 
themselves into slavery or to do a murder contract. Those are 
extreme examples, but in all the market or the transactions 
that you are talking about, whether in an open market or not, 
they have, by their nature, some impact on folks who are not 
parties.
    Chairman Andrews. The gentleman's time has expired.
    Dr. Price, if there is any closing.
    I will, again, thank the witnesses and members of the 
committee.
    When the discussion that Mr. Hutcheson theorized takes 
place in an office where a fiduciary for a defined benefit plan 
or the representative of fiduciaries is meeting with the 
representative of a hedge fund or private equity fund and 
discussing whether or not to make an investment, obviously the 
people who have received the pension from that fund have a 
vital stake in that discussion. But there is also a silent 
partner in any one of those discussions, and one way or another 
it is the taxpayers of the United States because of the PBGC 
and the role the taxpayers, I think, ultimately have in 
standing behind the PBGC.
    In my mind, this leads to one conclusion and then a series 
of questions. As I said at the outset of the hearing, I do not 
embrace the proposition that protecting the taxpayers requires 
precluding investment in these classes of assets. I think the 
opposite is true. I think that a fiduciary who diversifies is a 
more prudent fiduciary than one who doesn't. So I think making 
these classes of assets fully available to defined benefit 
plans ensured by the PBGC is entirely appropriate, and I would 
not favor anything that restricts that.
    The series of questions that are raised though are: Do 
these decisions take place in a context of adequate or 
desirable transparency? Do the fiduciaries have access to 
comprehensive, relevant, real-time information to help them 
make these decisions. I don't know the answer to that question. 
I think that is a question that ought to be looked at.
    To the extent that there is not; to the extent that there 
is not access to relevant, adequate, real-time information, 
what conditions might create the environment where that is the 
case?
    Clearly, a pension fund with a robust balance sheet is in a 
market position to demand such access or not make the 
investment. And I do think that is the most powerful way to 
avoid this problem, the most powerful antiseptic to any toxin 
that might exist. The question becomes what, if any, steps are 
appropriate for us to take to create that environment. These 
steps range from perhaps simply making more education more 
available to more fiduciaries on a basis of education, ranging 
all the way from there to legal changes that would require such 
disclosures.
    I find myself this morning in a position that is agnostic 
on that question. I think before one answers the question of 
whether the law should require more disclosure, we have to get 
to the issue as to whether disclosure is adequate or inadequate 
in the first place. I would hope that the committee would 
pursue that question, again not so that we might necessarily 
lead to a legislative proposal or a regulatory one, but so that 
we can assure that the best quality of transparency is 
available in every one of these transactions.
    Sort of an implicit answer to Mr. Chambers' argument, which 
I think he makes very persuasively, the reason that that 
defined benefit plan trustee may have some right that is prior 
to some of the other investors that you mentioned in your last 
comments is that the taxpayers are underwriting that decision 
in a way they are not in at least some of the others that you 
mentioned. So there is a public interest here in trying to 
prevent yet another bailout, yet another financial disaster the 
taxpayers of this country would be called upon to address.
    I think that the defined benefit system is a success, and I 
think the record will show that investments in alternative 
investments have been a success, by and large. I think that the 
last thing in the world that we want to do is micromanage 
fiduciary decisionmakers around this country. What we want to 
do is create an environment where those fiduciary 
decisionmakers have adequate access to adequate, relevant, 
real-time information so they may do their job and be held to 
the high standard to which the law holds them today.
    You, ladies and gentlemen, have given us much food for 
thought. You have given us a lot of excellent information. I am 
sure that we will be calling upon you again as we deliberate on 
this and other issues.
    Without any further ado, without objection, the Members 
will have 14 days to submit additional materials or questions 
for the hearing record.
    Without objection, the hearing is adjourned.
    [Additional submission of Mr. Kucinich follows:]

                [From the New York Times, July 17, 2010]

                A.I.G. to Pay $725 Million in Ohio Case

               By Michael Powell and Mary Williams Walsh

    The American International Group, once the nation's largest 
insurance group before it nearly collapsed in 2008, has agreed to pay 
$725 million to three Ohio pension funds to settle six-year-old claims 
of accounting fraud, stock manipulation and bid-rigging.
    Taken together with earlier settlements, A.I.G. will ladle out more 
than $1 billion to Ohio investors, money that will go to firefighters, 
teachers, librarians and other pensioners. The state's attorney 
general, Richard Cordray, said Friday, that it was the 10th largest 
securities class-action settlement in United States history.
    ``No privileged few are entitled to play by different rules than 
the rest of us,'' Mr. Cordray said during a news conference. ``Ohio is 
determined to send a strong message to the marketplace that companies 
who don't play by the rules will pay a steep price.''
    A.I.G. disclosed the terms of the settlement in a filing with the 
Securities and Exchange Commission.
    How A.I.G. will pay for this settlement is an open question. It has 
agreed to a two-step payment, in no small part to give it time to 
figure out how to raise the money.
    Executives are well aware that taxpayers and legislators would cry 
foul if it paid the lawsuit with any portion of the $22 billion in 
federal rescue money still available from the United States Treasury.
    Instead, the company intends to pay $175 million within 10 days of 
court approval of its settlement. It plans to raise $550 million 
through a stock offering in the spring of 2011. That prospect struck 
some market analysts as a long shot.
    ``There's still a lot of question marks hanging over A.I.G.,'' said 
Chris Whalen, a co-founder of Institutional Risk Analytics, a research 
firm. ``How would you write a prospectus for it?
    ``The document,'' he said, ``would be quite appalling when it 
described the risks.''
    A.I.G.'s former chief executive, Maurice R. Greenberg, and other 
executives agreed to pay $115 million in an earlier settlement with 
Ohio, which filed its lawsuit in 2004.
    State attorneys general often have proved more aggressive than 
federal regulators in going after financial houses in the wake of the 
2008 crisis. And A.I.G. could face new legal headaches. For instance 
New York's attorney general, Andrew M. Cuomo, has stepped up his 
investigation of the company in the last few weeks, according to a 
person with direct knowledge of the case.
    The Ohio settlement allows ``A.I.G. to continue to focus its 
efforts on paying back taxpayers and restoring the value of our 
franchise,'' Mark Herr, a company spokesman, said in a news release.
    The Ohio case was filed on behalf of pension funds in the state 
that had suffered significant losses in their holdings of A.I.G. when 
its share price plummeted after it restated results for years before 
2004. Those restatements followed an investigation by Eliot L. Spitzer, 
Mr. Cuomo's predecessor, into accounting irregularities at the company 
and the subsequent resignation of Mr. Greenberg.
    But the company faces a long and uncertain road, say Wall Street 
analysts.
    Its stock, after adjusting for a reverse split, once traded at 
$1,446.80 a share; it stands now at $35.64.
    A.I.G. has become the definition of turmoil. Its chairman resigned 
this week after a fierce feud with the chief executive, who has 
referred dismissively to ``all those crazies down in Washington.''
    Those crazies presumably include the federal government, which over 
the last two years gave A.I.G. the largest bailout in United States 
history, making $182 billion available to the company.
    And the company's proposed stock offering next year is rife with 
uncertainties. Such an offering would by definition dilute the value of 
the government's holdings.
    A.I.G. has struggled of late to sell off subsidiaries to repay the 
Federal Reserve Bank of New York. This year the company failed in its 
attempts to turn its Asian life insurance subsidiary over to Prudential 
of Britain. This week the company's directors voted to proceed with an 
initial public offering of the same subsidiary, with the proceeds 
intended for the Federal Reserve.
    Should the company fail to raise the $550 million, Ohio has the 
right to resume its litigation.
    The fall of the world's largest insurance company began in the 
autumn of 2008, when a sudden downgrade in its credit worthiness set 
off something like a bank run. It turned out that the company had sold 
questionable derivatives that were used to prop up the portfolios of 
other financial institutions.
    Federal officials moved quickly to bail out the company, fearing 
that if A.I.G. toppled, dozens of financial institutions would quickly 
fall as well. Havoc seemed in the offing.
    Federal investigators have since examined many aspects of the 
company's behavior, even convening a grand jury in New York. But they 
have never brought charges against the company or its top officials.
    ``The states are too often the only ones to watch out for this 
misconduct,'' Mr. Cordray said Friday. ``For years, people have been 
asleep at the switch.''
                                 ______
                                 
    [Additional submission of Dr. Price follows:]

         Prepared Statement of Richard H. Baker, President and
           Chief Executive Officer, Managed Funds Association

    Managed Funds Association (``MFA'') is pleased to provide this 
statement in connection with the House Subcommittee on Health, 
Employment, Labor, and Pensions hearing, ``Creating Greater Accounting 
Transparency for Pensioners'' held on July 20, 2010. MFA is the voice 
of the global alternative investment industry. Its members are 
professionals in hedge funds, funds of funds and managed futures funds, 
as well as industry service providers. Established in 1991, MFA is the 
primary source of information for policy makers and the media and the 
leading advocate for sound business practices and industry growth. MFA 
members include the vast majority of the largest hedge fund groups in 
the world who manage a substantial portion of the approximately $1.5 
trillion invested in absolute return strategies.
    MFA appreciates the opportunity to express its views on the 
benefits that hedge funds provide with respect to pension plans and the 
beneficiaries of those plans and the legal requirements that must be 
met before a pension plan can invest in hedge funds.
    Before doing so, I believe it is important to underscore the 
comprehensive and robust nature of the regulatory framework that 
applies to hedge funds and their advisers now that the Dodd-Frank Wall 
Street Reform and Consumer Protection Act has been enacted. All hedge 
fund advisers of meaningful size must register with the SEC under the 
Investment Advisers Act of 1940 (the ``Advisers Act''). The 
responsibilities imposed on hedge fund advisers by the Advisers Act 
entail significant disclosure and compliance requirements, including: 
publicly available disclosure to the SEC regarding the adviser's 
business; extensive systemic risk reporting to the SEC; detailed 
disclosure to clients; policies and procedures to prevent insider 
trading; maintaining extensive books and records; and periodic 
inspections and examinations by SEC staff.
Benefits of investing in hedge funds
    First and foremost, our industry consists of successful investment 
managers. As noted in the chart on the following page, and the charts 
included in Appendix A, the hedge fund industry has grown significantly 
over the last two decades. This growth is due to the value we provide 
our clients, which are predominantly institutional investors such as 
corporate and public pension plans, insurers, and educational 
endowments.



    *Second quarter 2009. Estimates vary over the amount of assets and 
the number of funds. Research companies use different definitions and 
models to value hedge fund assets. Source: Hedge Fund Research, Inc. 
Available by subscription at: www.hedgefundresearch.com.

    Hedge funds and other alternative investment vehicles are a 
valuable component of the investment portfolio for many pension plans. 
The properly managed addition of hedge funds to a portfolio provides 
diversification, risk management and returns that are not correlated to 
traditional equity and fixed income markets. These are critical 
benefits that help pension plan managers generate sufficient returns to 
enable plans to meet their obligations to plan participants. These 
benefits can be seen in the chart on the following page, which compares 
the value of one dollar invested in the Hedge Fund Research, Inc. 
Monthly Index (the ``HFRI''), compared to the S&P 500 (with dividends 
reinvested).\1\ The strong performance of the hedge fund industry can 
further be seen in the charts in Appendix B, which compare the 
performance returns of the HFRI versus the S&P 500 over the past 20 
years.
---------------------------------------------------------------------------
    \1\ The HFRI is one of a series of benchmarks of hedge fund 
industry performance created by Hedge Fund Research, Inc., which are 
designed to achieve representative performance of a larger universe of 
hedge fund strategies. More information about the HFRI, and the 
methodology used to create the index is available at: https://
www.hedgefundresearch.com/index.php?fuse=indicesfaq&1280757789.



    **1989-1990 HFRI approximated with samples of roughly 90 funds from 
---------------------------------------------------------------------------
David Hsieh and William Goetzmann

    The critical importance of hedge funds and other alternative 
investments as part of a pension plan's diversified portfolio was noted 
by Joseph A. Dear, Chief Investment Officer of the California Public 
Employees' Retirement System, in his written testimony before the 
Senate Banking Subcommittee on Securities, Insurance and Investment on 
July 15, 2009.\2\ In that testimony, Mr. Dear stated that the 
performance of alternative investments:

    \2\ Available at http://banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore--id=e83f7ca16f94-4854-8aa9-
ef0ac11b4bb0.

        translates into substantial value added to the pension fund 
        over a sustained time period. It makes realization of our 
        target rate of return feasible. The consequences to our 
        beneficiaries, their government employers and taxpayers of our 
        not meeting this objective are substantial and real: lower 
        wages, higher contribution rates and higher taxes. Can these 
        performance benefits be delivered through other investment 
---------------------------------------------------------------------------
        products? No.

    The value that hedge funds add to pension portfolios is also 
demonstrated through the significant investments made by pensions and 
endowments in hedge funds. Pensions and endowments in every state 
invest in hedge funds because of the benefits to their investment 
portfolios.
    Finally, hedge funds are one of the best examples in the financial 
community of alignment of interests. Because the typical fee structure 
for a fund includes a performance fee whereby the manager receives a 
percent of the total returns the fund generates, hedge funds are 
motivated to perform for their clients. In addition, if hedge funds 
experience losses, those same performance fees do not start again until 
the fund earns enough in investment returns to get back to its earlier 
levels. These ``high water marks'' as well as the performance fees, and 
the lack of any government safety net, explain in large part the 
excellent risk management practiced by the hedge fund industry. 
Contrary to popular media portrayals, the ``hedge'' in hedge funds is 
real.
Legal qualifications for pension plans to invest in hedge funds
    In order for a pension plan to invest in a hedge fund, two legal 
requirements must be met. First, the plan must qualify under the 
Federal securities laws as a sophisticated investor, typically as a 
``qualified purchaser'' under the Investment Company Act of 1940 or as 
an ``accredited investor'' under Regulation D under the Securities Act 
of 1933. Second, the person who makes the investment decision on behalf 
of the pension plan must make such decisions consistent with his or her 
obligations as a fiduciary to the plan under the Employee Retirement 
Income Security Act of 1974 (``ERISA'').\3\
---------------------------------------------------------------------------
    \3\ Section 3(21)(A) of ERISA provides that a person is a fiduciary 
with respect to a plan to the extent he (i) exercises any discretionary 
authority or discretionary control respecting management of such plan 
or exercises any authority or control respecting 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 such plan, or has any authority or responsibility to 
do so, or (iii) he has any discretionary authority or discretionary 
responsibility in the administration of such plan.
---------------------------------------------------------------------------
    Hedge funds provide significant benefits when appropriately 
incorporated into a pension fund's portfolio, however, as noted by the 
President's Working Group on Financial Markets' Investors' Committee 
noted in its 2009 report titled, Principles and Best Practices for 
Hedge Fund Investors (the ``Investors' Committee Report''):

          Thousands of institutional and individual investors meet the 
        legal requirements to invest in hedge funds, but it is not 
        always appropriate for them to do so. Prudent evaluation and 
        management of hedge fund investments may require specific 
        knowledge of a range of investment strategies, relevant risks, 
        legal and regulatory constraints, taxation, accounting, 
        valuation, liquidity, and reporting considerations. Fiduciaries 
        must take appropriate steps to determine whether an allocation 
        of assets to hedge funds contributes to an institution's 
        investment objectives, and whether internal staff or agents of 
        the institution have sufficient resources and expertise to 
        effectively manage a hedge fund component of an investment 
        portfolio.\4\
---------------------------------------------------------------------------
    \4\ Available at: http://www.amaicmte.org/Public/
Investors%20Report%20-%20Final.pdf.

    We fully agree with the Investors' Committee Report that pension 
plan managers should consider not only whether the plans they manage 
are eligible to invest in hedge funds under the securities laws, but 
also whether an investment in hedge funds is consistent with the plan 
manager's fiduciary duties to the plan. Included in those fiduciary 
duties is the obligation on the plan manager, or the manager's 
representative, to conduct appropriate due diligence on the hedge fund 
and hedge fund's manager prior to making an investment, as well as 
appropriate ongoing due diligence once an investment has been made.\5\ 
We believe that the combination of securities laws' thresholds and 
ERISA fiduciary obligations together work well to ensure that only 
pension plans with the appropriate sophistication and resources invest 
in hedge funds.
---------------------------------------------------------------------------
    \5\ Since 2000, MFA has been the leader in developing, enhancing 
and promoting standards of excellence for hedge fund managers through 
its document, Sound Practices for Hedge Fund Managers, which includes a 
model due diligence questionnaire for use by investors when considering 
an investment in a hedge fund. MFA's Sound Practices is available at: 
http://www.managedfunds.org/mfas-sound-practices-for-hedge-fund-
managers.asp.
---------------------------------------------------------------------------
Conclusion
    MFA appreciates the opportunity to express its views on the 
benefits that hedge funds provide with respect to pension plans and the 
beneficiaries of those plans and the legal requirements that must be 
met before a pension plan can invest in hedge funds. We would welcome 
the opportunity to elaborate on these points, or answer any questions 
that Subcommittee members or staff may have regarding our views.



      
---------------------------------------------------------------------------
    \6\ Source: Hedge Fund Research Inc.--copyright 2010 HFR Inc. 
www.hedgefundresearch.com.



                                 ______
                                 
    [Whereupon, at 11:25 a.m., the subcommittee was adjourned.]

                                 
