US - An internal Wilshire memo sent to all its senior consultants has warned them of potential legal pitfalls for clients when advising on the suitability of liability driven investment (LDI) products in the US.
It was sought by Donald Myers of ReedSmith on behalf of JPMorgan Chase Bank and asked for clarification on whether it was prudent for a fiduciary to consider LDI under the Employee Retirement Income Security Act (ERISA).
Under ERISA, investment strategies must primarily benefit the pension plan. As LDI strategies seek to reduce pension fund volatility, it could be argued they could also benefit plan sponsors by reducing volatility on their overall balance sheet.
The DOL advisory opinion subsequently approved the use of LDI as described in the request, however, the Wilshire memo raised concerns LDI marketers didn't recognise the limits of the advisory opinion.
Dimitry Mindlin, managing director at Wilshire, told Global Pensions: "It bothered me a great deal when many LDI marketers told us at conferences and presentations that this advisory opinion was the final word. I read the opinion and I found it inconclusive. Although I am not an attorney, I believe that if this ever ended up in a court of law, they would not find it very helpful."
One senior executive from an American asset manager, who asked not to be named, backed Mindlin. He noted: "The advisory opinion does not address the significant potential conflict between two goals - maximising the probability that the plan's funding objective will be met by a particular investment strategy in the long run and reducing volatility of the plan's funded status on an annual basis."
He said the first goal was clearly prudent under section 404 of ERISA, but the second goal was problematic if it conflicted with the first goal. He suggested the argument the benefit to the plan sponsor was more than incidental could be applied if, in a bid to reduce annual volatility, it adopted a strategy that reduced the probability of funding the plan in the long run.
Marc Van Allen, a partner and member of the ERISA litigation group at law firm Jenner & Block, said: "From an ERISA fiduciary point of view, [when] looking to implement LDI, pension funds have to satisfy their twin duties; duty of loyalty and duty of care. The tricky part can be separating the benefits to the plan from the benefits to the plan sponsor's balance sheet."
He said the ERISA fiduciary needed to be able to demonstrate they were principally focusing on the benefits of the plan. "If there then turned out to be some sort of incidental benefit to the plan sponsor, then that's OK," he said.
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