EMPLOYEE BENEFIT FUNDS - PART I - HOW MODERN PENSIONS DEVELOPED
Companies had pension plans as early as the 1890s. But new laws in the 1920s regulated pensions and defined much of what they are today. These laws let corporations deduct pension plan contributions from their reported income, allowed pension funds to accumulate income tax-free, and deferred taxes until the pension was distributed to the employee. However, pension funding rules were loose, and pensioners had little or no recourse against employer mismanagement.
A single event highlighted this problem. Studebaker-Packard closed its car plant in South Bend, Indiana in 1963. Soon after, Studebaker terminated the retirement plan for hourly workers, and the plan defaulted on its obligations – slashing or entirely denying the pensions for 4,000 workers. The plan did not have enough money to cover its promised benefits. [i]
Auto makers knew their pensions were underfunded—they simply ignored the problem. The major failure of Studebaker, along with a high-profile conviction of Teamsters boss James Hoffa on pension fraud, drew attention to pension corruption and mismanagement. Washington began to talk about reform and regulation, eventually passing the Employee Retirement Income Security Act (ERISA).
Senator Vance Hartke of Indiana (where Studebaker was located) proposed legislation in 1965 to create the Pension Benefit Guaranty Corporation (PBGC). It would collect premiums from insured pension plans and pay the shortfall if an underfunded plan were to close.
Senator Jacob Javits was the architect of the main ERISA law, sponsoring several bills in the late 1960s that would become key components of the final law. These touched on vesting, funding, and reporting for private pension plans.
Companies and labor unions fought any new regulations on pension plans, but they finally accepted a national pension law; this was more acceptable that dealing with a multitude of state regulations. After 11 years of wrangling, Congress passed ERISA in September 1974. Employers now had to create a fund with an independent trustee, and that trustee had a fiduciary duty to put the interests of the pensioners before those of the company.
ERISA had unintended consequences. At first, investment advisory firms – banks, insurance companies, and independents feared that this law threatened them with onerous fiduciary responsibilities, and therefore massive lawsuits if something went wrong. Wags within this group referred to ERISA as “Every Ridiculous Idea Since Adam.”
The future that unfolded for these firms was far different from what they feared. U.S. companies, like RJR, began to place billions of dollars into their pension plans as they rushed to better fund their obligations to pensioners. They needed professional investment advisors as the assets under management (AUM) ballooned. The giant funds grew even bigger, and many small firms’ AUM exploded. It was not uncommon for a firm with a reasonable investment history to grow in just a few years from $50-100 million AUM to a billion dollars or more. The principals of such firms might see their annual income increase from a modest $60,000 to more than a million dollars. And to my knowledge, no reasonably responsible investment firm ever faced a major fiduciary lawsuit.[ii] [iii]
[i] Nancy Riedel, CEO of Benefits Tree in Atlanta provided significant background on this tragedy. She grew up in South Bend and many of her family worked for Studebaker.
[ii] One such case involved Citizens and Southern Bank in Atlanta, GA. The story goes that in 1978, the bank was concerned about the negative impact ERISA might have on its trust department, an asset manager. The bank had recently faced the challenges of bad real estate loans resulting from the 1973-74 real estate depression in Atlanta. The bank feared that ERISA would compound its risk. The head of the asset management group, Charles Brady, convinced C&S to spin off the group as an independent firm. Brady along with his chief associate, Wendell Starke, took control of the new business named INVESCO. At its beginning, INVESCO had $400 million AUM that grew in 10 years to $14 billion. Today the firm manages $1.4 trillion in 20 countries. It has 8,900 employees and is a public company that is in the S&P 500 index.
[iii] Judy Diamond Pension History The History of the Employee Retirement Income Savings Act (ERISA) 12/03/2018