English: DFW American Airlines Departure (Photo credit: Wikipedia)
Some of the nation’s largest operating companies have succumbed to the temptation to profit off their employees’ retirement savings plans by creating investment advisory subsidiaries that earn rich fees from managing the assets in these plans. American Airlines, Bechtel, Caterpillar, General Dynamics and General Electric are but a few of the major corporations that have, or had, affiliated investment advisory firms which none-too-coincidentally were selected by pension fiduciaries to manage the retirement assets of their employees.
Earlier this year in an article entitled, Flawed 401(k) Plan Structures to Blame for Systemic Failures, I indicated that whether that’s been good or bad for employees can be debated but there is no question that some employers have enjoyed windfalls.
When the assets of retirement plans are managed by an affiliate of the employer, I refer to these plans as “conflicted” because of the obvious conflict of interest that exists whenever an employer, or named fiduciary of a plan controlled by the employer, decides to hire itself (or an affiliate) to manage the plan.
In my experience whenever an employer-plan sponsor has an investment advisory affiliate, rest assured, that affiliate will be selected, out of all the thousands of SEC registered money managers, to manage employee retirement monies. That may not be surprising given that for-profit companies are driven to pursue, well, profits. But that’s not how the pension regulatory scheme is suppose to work.
Allen Engerman, a well-respected class action benefits attorney notes that “ERISA, the federal law enacted in 1974 to protect the interests and rights of participants of pension plans, generally prohibits self-dealing and requires that decisions regarding the management of retirement plan assets must be determined solely on the basis of what’s best for the plan participants—not what’s best for the employer. Many of these conflicted plans (where the employer or an affiliate is managing the money) do not meet the high fiduciary standards imposed by ERISA. Plan participants should always be vigilant and alert and question any actions which may be beneficial to the employer and detrimental to the employees and take action to right any improper actions that affect their benefits.”
Regulators have generally looked the other way, buying into the fiction that the employer hiring itself to manage employee retirement plan assets can somehow be considered “arm’s length.” Regulators have never bothered to investigate whether these flawed arrangements harm employees.
I believe further scrutiny of these conflicted arrangements (some of which are decades-old) is long overdue and may be especially relevant at this time given the precarious state of the nation’s defined benefit plans and the widespread disappointment with 401(k)s.
For example, take a peek at the employee retirement plans of the nation’s leading struggling airline, American.
AMR, the parent company of American Airlines, filed for bankruptcy on November 29, 2011. American sponsors four defined benefit pension plans covering nearly 130,000 workers and retirees. On February 1, 2012, American Airlines announced it would seek to terminate all four of its pension plans. According to the Pension Benefit Guaranty Corp., “America’s four defined benefit plans have assets of $8.3 billion and liabilities of $18.5 billion, and officials at the agency, which sits on the airline’s creditors committee, pressed American to avoid terminating the plans.” Under pressure from the PBGC, American relented and On March 7, 2012, AMR announced it would freeze, not terminate, the pensions of its non-pilot employees.
It seems to me that if American was looking to dump its failed pensions on the government, someone, somewhere (either in Washington, or employed by, or retired from, the airline), should be interested in whether the assets of these $10 billion plus underfunded plans have been properly managed and whether anyone may have contributed to their demise.
I recently reviewed the American Pilot Plan Document, as amended and restated effective as of January 1, 2009, and according to this document, a firm called American Beacon is the fiduciary to the plan with authority to select, appoint and monitor money managers, lending agents and brokers and allocate assets among managers. Clearly, American Beacon has broad responsibility with respect to management of the plans’ assets.
In its sales literature American Beacon touts its unique “fiduciary perspective,” boasting that it acts “as fiduciary for the pension plans of one of America’s leading corporations. We apply that same investment expertise to the methodology of the American Beacon Funds.”
Not-so-sure if I were American Beacon that I’d want to draw attention to the fact that I am an investment fiduciary to failed pensions that “one of America’s leading corporations” in bankruptcy has attempted to foist onto the PBGC. Worse still, that I “apply that same methodology to the mutual funds I manage.”
American Beacon was created in 1986 by American Airlines to provide short-term cash management services to AMR and its employee retirement plans. Today the firm contracts with other money managers, as sub-advisers, who actually manage many of its equity and other style investment funds. In other words, with respect to these funds, American Beacon is merely a middleman—a dispensable intermediary whose fees could presumably be eliminated by contracting directly with the underlying advisers.
The airline sold American Beacon Advisers in 2008 to two private equity firms for $480 million. That’s right- American sold the affiliate it created to manage employee pensions for almost half a billion and then with its pensions failing, tried to dump $10 billion in unfunded pension obligations onto the PBGC. Talk about heads we win, tails pension participants and the government lose.
American Beacon also manages many of the investment options offered within the AMR 401(k) plan.
Here’s what the company had to say about the relationship between the asset management subsidiary and the company’s retirement plans at the time it sold American Beacon:
“American Beacon currently provides a number of services for AMR and its affiliates, including cash management for AMR and investment advisory services and investment management services for American’s pension, 401(k) and other health and welfare plans. AMR anticipates that it will continue its relationships with American Beacon after the closing. However, to ensure that continuing relationships between American Beacon and American’s pension, 401(k) and other health and welfare plans after closing satisfy the fiduciary duties and other rules that apply to these plans, an independent third party has been engaged to review and approve any such continuing relationships.”
I presume that the “independent third party” mentioned in the press release has concluded that continuing the relationship with American Beacon has been in the best interests of the retirement plans over the four years since the sale. Participants in American’s retirement plans might want to take a hard look at any such enabling opinions—given that the independent third party was supposedly hired to protect their interests in connection with a transaction that involves potential self-dealing.
To whom did American sell American Beacon? Pharos Capital Group, LLC and TPG Capital, L.P., two “leading private equity firms,” according to a press release announcing the sale. Here’s what trade publication Pensions & Investments had to say about the deal:
“The purchase by TPG and Pharos of American Beacon Advisers, Inc. from American Airlines' parent AMR Corp. is an even more dramatic example of unfortunate timing.
The Fort Worth, Texas, money manager, had $57 billion in assets under management when the deal closed on Sept. 15, 2008, the day Lehman Brothers Holdings' bankruptcy sparked a global meltdown. As of June 30, 2010 the firm managed $42.7 billion in assets.”
Today the firm manages around $47 billion in assets—the overwhelming majority of which appear to be related to American Airlines. It seems that plans to grow American Beacon’s non-American business have faltered. In my opinion, without American’s assets, American Beacon would lack the critical mass needed to compete in today’s cut-throat mutual fund marketplace—especially given the fact that American Beacon doesn’t actually manage many of the mutual funds it has created. Sub-advisers, such as MFS, who investors can go to directly manage many of the funds.
What sort of due diligence did American undertake in connection with the sale of the money management subsidiary that was handling its employees’ hard-earned retirement savings? Were the participants in the retirement plans provided with background information regarding the potential buyers of the firm that would continue to manage their retirement assets after the sale?
Two of the three founders of Pharos are Bob Crants and Micheal Devlin. In a 2004 Forbes article, Hedge Hell, Bernard Condon discussed two lawsuits involving Crants and Devlin, as well as other matters.
“The two suits, filed in May in Superior Court in Delaware, list a total of 70 plaintiffs; from their peak to their trough in early 2003, the two funds declined $500 million. By some reckoning, they are down 50% even after the tech recovery. The suits target Alex. Brown; its parent, Deutsche Bank; the funds' board; and the funds' managers: D. Robert Crants and Michael Devlin, 28 and 37 respectively, at the time of the funds' launch, both of them alumni of Goldman Sachs. Among their alleged misdeeds: that the two men put $7.5 million into a money losing real estate firm they controlled and that they invested $5 million in a venture capital fund run by a fund board member.
Crants and Devlin have been hit with still other allegations. They ran a side business buying prisons that was named in now-settled securities class actions. They also managed two private equity funds that received $15 million from Nashville's pension fund; an auditor's report said the deal involved conflicts of interest and almost no due diligence. Crants and Devlin were not named in any suit, but the city sued UBS PaineWebber, whose brokers had advised it on funds. In 2002 it paid $10 million to settle.” (Full disclosure: I undertook a review of the Nashville pension fund mentioned in the article.)
Condon concluded his article saying, “Undeterred, Crants and Devlin have started a new fund for their private equity group Pharos Capital. On their Web site they quote one client who calls them the "definition of smart money."”
Who would have ever thought that a mere four years later, the acquisition by Pharos, as a “minority-owned” private equity firm with some of the nation’s largest state pensions as investors, would result in American Beacon becoming “one of the largest minority-controlled investment management firms in the country—certified in 2010 as a Minority Business Enterprise by the Dallas/Fort Worth Minority Supplier Development Council?” Never underestimate the creativity and resourcefulness of ex-Goldman guys.
Maybe American Airlines didn’t see the Forbes article, or didn’t feel the allegations of investment-related transgressions mentioned therein were important when screening prospective buyers of the firm entrusted with handling its employees’ retirement savings. Clearly, selling an investment manager whose business is so dependent upon a single client (American) would have been challenging. However, in my opinion, the track record of the two Pharos founders would have been unsettling.
In conclusion, no one can deny that conflicts of interest abound in retirement plans. The unanswered question is whether these conflicts are harmful to plans and their participants. In my opinion, they generally are. If not beforehand, certainly by the time a pension is on the verge of failing, someone should take a close look.
