Comprehensive financial services reform legislation passed by the Senate could limit the way pension plans use swaps, a tool often used by defined benefit plans to manage financial risks such as interest rate or currency hedges.
At press time, the Restoring American Financial Stability Act of 2010 (S. 3217) was in congressional conference for reconciliation with the House version of financial services reform legislation, The Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173), passed last December.
"A swap is a contract between two parties, a buyer and a seller, where the buyer pays a series of payments - generally quarterly - to the seller in exchange for a payoff if the property they're buying, generally a bond or a loan, goes into default," explains Joe Gordon, co-founder and managing partner of Gordon Asset Management in Durham, N.C.
Of greatest concern to plan sponsors is a provision in the Senate bill that would impose fiduciary duties on swap dealers offering to enter into, or entering into, a swap with a retirement plan. This fiduciary status would create a conflict of interest under ERISA and would prevent retirement plans from engaging in swap transactions.
"The use of the term 'fiduciary duty' is the thing that raised alarm bells the most," says Todd Solomon, a partner in the employee benefits practice group at McDermott Will & Emery. "Because if the swap dealer owes a fiduciary duty to the plan, and then is, of course, on its own side, it's basically on both sides of the swap transaction. And that's not a workable result."
Toni Brown, partner with Mercer Investment Consulting, likens the situation to a realtor who helps you buy a house but also represents the seller of the house you're buying. "As they sell to pension plans, swap dealers are representing the other side," she says. "So I don't know how they can represent both sides of a transaction."
DB plans often use swap trades to manage risk, and the inability to do so would likely increase volatility and potential costs as plans would need to find alternative approaches to risk management.
Defined contribution plans that offer stable-value funds in their investment lineup, meanwhile, also could be affected. The guarantees, or wrappers, issued in connection with these funds could be considered swaps under the Senate legislation. As a result, plans could be forced to eliminate or modify this fund option.
"It's difficult to go to participants and say, 'We can no longer offer this, you need to move your money,'" says Solomon. "Participants may not be pleased with that, and a lot of them may not read the mailers. There are a lot of issues with respect to having to discontinue a large fund under these plans."
But Marcia Wagner, president and founder of Wagner Law Group in Boston, Mass., sees the potential move to fiduciary responsibilities for swap dealers as a good thing for plan sponsors.
"If this is how the law reads, then these companies, these brokerage houses, should ask for and receive some type of prohibited transaction exemption from the Department of Labor," she says. "And to the extent that there are enough protections, I'm sure these exemptions will and have been granted in several circumstances."
Congress also is moving ahead with legislation to increase 401(k) fee disclosure. The American Jobs and Closing Tax Loopholes Act of 2010, passed by the House in May, is currently before the Senate. Wagner maintains those two trends - increased fee transparency and broadening the definition of fiduciary - signal a big change for the retirement plan industry.
"Two massive changes in the way the retirement plan structure is done in this country are moving forward," she says. "The trend is extremely good for plan sponsors. It might not be as good for vendors, but it's really good for sponsors. Nothing is perfect; things can get fixed, things can get ironed out in conference. Nonetheless, it is nice to see Congress taking ERISA seriously and in a practical way."
Even if amendments remove the word 'fiduciary' from the final legislation, concerns remain. "Even if it's not a fiduciary duty, but some kind of duty, how far does that duty extend to these transactions?" says Solomon.
"That's a thought, that if we remove the word 'fiduciary' perhaps there's less confusion that this isn't an ERISA issue. But it still may be an ERISA issue if they [swap dealers] owe significant duties to the plan sponsors because, even absent owing a fiduciary duty, you can't have a situation where the dealer is essentially on both sides of the transaction."
