The Complete Letter

Jim Norby to Elaine Chao Secretary of Labor
Re: Corporate fiduciary breach

May 22, 2003

The Honorable Elaine L. Chao
Secretary of Labor
U.S. Department of Labor
200 Constitution Avenue, N.W.
Washington, D.C. 20210

Dear Madam Secretary:

It is imperative that your agency commence an immediate investigation into whether certain companies now pressing for relaxation of ERISA funding standards have committed violations of ERISA’s fiduciary requirements and whether those violations played a substantial role in creating the increased funding obligations they now seek to avoid.

This problem arises because of the introduction of H.R. 1776 by Representatives Rob J. Portman (R. Ohio) and Benjamin L. Cardin (D. Md.), which contains numerous technical provisions that would lower the funding obligations of employers to PBGC-insured pension plans. Among these provisions, for example, is one that would have the effect of increasing the discount rate used to measure a defined benefit plan’s growth in fund assets and thereby lower both the plan’s projected benefit liabilities and the amount of contributions that must be made by the plan’s sponsor.

In addition, this problem is exacerbated by the efforts of the airlines to seek legislation that would defer making catch-up contributions to their underfunded pension plans, as reported in the Wall Street Journal of May 6, 2003. Obviously, if the airlines succeed in obtaining this special treatment, it will embolden other industries, especially those that perform national security or defense-related functions, to make similar claims. If successful, the net result of all these efforts to water down ERISA’s funding rules will be to destabilize the remaining universe of defined benefit plans and threaten the financial integrity of PBGC.

Of particular concern is the fact that the provision in the Portman-Cardin bill that would change the discount rate (from one derived from a 30-year Treasury bond rate to one based on a composite long-term corporate bond rate) appears to have resulted from a letter sent to the Secretary of the Treasury John Snow on February 14, 2003 by the ERISA Industry Committee, the Committee on Investment of Employee Benefit Assets and the American Benefits Counsel. This letter was also signed by some of the leading U.S. corporations, including AT&T, Boeing, Budget Rent-a-Car, Chevron-Texaco, Delta Airlines, Dow Chemical, Goodyear Tire & Rubber, Hewlett-Packard, International Paper, Lucent, Motorola, Sears Roebuck, Shell Oil, United States Steel, Verizon, Wells Fargo Bank and Xerox.

This letter contended that it was urgent to replace the 30-year Treasury discount rate with a long-term corporate bond rate and that the failure to do so before the end of the second quarter of 2003 would have a “dramatic and damaging impact on plans and plan participants, companies, and the prospects for economic recovery”. The letter also contended that the continued use of the temporary discount rate of 120% of the four-year weighted average of 30-year Treasury bond rates was already “creating dangerous dislocations” and that companies “that do not have cash available for artificially inflated contributions have decided to freeze future benefit accruals or are considering such action”. In addition, the letter contended that the use of the temporary Treasury rate was “leading many companies to severely restrict near-term spending plans”, was undermining the ability of companies to proceed with corporate transaction,” and “future growth”, and “hampering the ability of U.S. companies to rebuild the economy”.

Most, if not all, of the companies that signed the February 14 letter to Secretary of the Treasury Snow were sitting on supposedly substantial surpluses in their pension plans just a few short years ago. As a result of these surpluses many, if not most of these companies, took funding holidays for close to a decade. In other words, they did not contribute a dime to the funding of their pension plans for a very long period of time, and the result of adopting their proposal to use a discount rate based on corporate rather than Treasury bonds, as now reflected in the Portman-Cardin bill, would be to extend these funding holidays, or come very close to accomplishing the same thing.

Moreover, at the same time that these companies were not contributing to their plans, they reported these pension surpluses on their financial statements. This gave the impression that many of these companies were more profitable than they really were. In fact, some of these companies were actually unprofitable during the same period of time that, by incorporating the surplus in their financial reports, they appeared to be reporting business success.

Indeed, many of the companies signing the February 14 letter provided their top executives with increased cash bonuses and stock options not only because their pension surpluses made funding their pension plans unnecessary, and therefore, improved their cash flow, but also because the impression of business success fostered by the surpluses led to the artificial inflation of the companies’ stock values.

For example, as recently reported by columnist Robert D. Novak, one of the companies signing the February 14 letter, Delta Air Lines boosted its CEO Leo Mullins’ compensation to $12.9 million at the same time the company was actually losing $1.3 billion, and it, along with other airlines, was requesting Congress to provide it with $2 to $3 billion in federal aid. This led Senator John McCain (R-AZ), among others, to insist that federal aid to the airlines be accompanied by a cap on airline executive compensation. It should be also noted that Delta Air Lines is one of the airlines now positioned to obtain even further funding relief if Congress grants the airlines a blanket exemption from having to make special catch-up contributions if their pension plans are less than 90% funded. Yet, it also should be noted that in 2000, Delta’s pension plan reported being more than fully funded by actuarial standards (112.3 percent), but, by the same standards, was only 58 percent funded in 2002.

Ironically, many of the same companies complaining about “artificially” higher funding obligations supposedly imposed by the current Treasury bond discount rate showed no such impatience with the “artificially” high pension surpluses produced by the use of overly-aggressive actuarial earnings assumptions. In December 2001, Warren Buffett stated in Fortune magazine “that anyone choosing not to lower assumptions – CEOs, auditors and actuaries all – is risking litigation for misleading investors. And directors who don’t question the optimism thus displayed simply won’t be doing their job”. Mr. Buffett’s company, Berkshire Hathaway, assumed a pension fund investment rate of return of 6.5% while most others, including all of those who produced the large pension surpluses that have since vanished, assumed returns of 9% to 10%.

If, because of unrealistic earnings assumptions, the size of these pension surpluses was a mirage, then the funding holidays taken by the companies signing the February 14 letter were undeserved. If realistic earnings assumptions had been used instead, these same companies would have been compelled to fund their plans more adequately and would have found it much harder to award outsized compensation packages to their key executives. Likewise, they would not be complaining now about
any difficulty in meeting their funding obligations since the lion’s share of these obligations already would have been discharged, or would be in the process of being discharged, in accordance with sound actuarial procedure.

Accordingly, the matter which requires investigation by your agency is whether any of the companies signing the February 14 letter violated ERISA’s fiduciary requirements by: (1) imprudently adopting unrealistic actuarial earnings assumptions and failing to evaluate carefully, critically or independently, the actuarial advice that led to the adoption of such assumptions; (2) failing to act in the exclusive interest of the plan’s participants and beneficiaries by adopting earnings assumptions that would generate unprecedented pension surpluses that ultimately could justify the award of increased compensation to the executives of the company approving the use of such assumptions; (3) permitting the assets of the plan to inure to the benefit of the employer and its top executives by adopting unrealistic actuarial earnings assumptions that would allow the company to avoid making funding contributions and lay the groundwork for awarding increased executive compensation; and (4) dealing with the assets of the plan in violation of ERISA’s specific prohibited transaction rules.

In addition, such an investigation should also determine whether the actuarial firms involved in advising that unrealistic actuarial earnings assumptions be adopted did so in the furtherance of aiding and abetting a scheme to permit the companies to take funding holidays and generate artificial actuarial surpluses that ultimately could be used to justify the awards of increased executive compensation. Finally, the manner in which the so-called pension surpluses were invested should also be investigated to determine whether their rapid disappearance was caused in whole or in part by imprudent investment conduct.

Needless to say, coming on the heels of Enron and related scandals, the granting of funding relief to companies that betrayed their fiduciary responsibilities would lead to a total collapse of public confidence in the integrity of private pensions and ERISA. I urge you, therefore, to act without delay in starting the necessary inquiry.


A.J. Norby
National Retiree Legislative Network

Cc: Hon. Ann Combs, Assistant Secretary
Employee Benefits Security Administration
U.S. Department of Labor

Mr. Steven Kandarian, Executive Director
Pension Benefit Guaranty Corporation

Hon. Peter Fisher
Undersecretary for Domestic Finance
U.S. Department of the Treasury

Mr. Mark Warshawsky
Deputy Assistant Secretary for Economic Policy
U.S. Department of the Treasury

Mr. William Sweetnam
Benefits Tax Counsel
U.S. Department of the Treasury

Mr. Carlos Bonilla
Special Assistant to the President for Economic Policy
The White House

Hon. Kathleen Cooper
Undersecretary for Economic Affairs
U.S. Department of Commerce

Hon. Judd Gregg (R. NH), Chair
U.S. Senate Health, Education, Labor and Pension Committee

Hon. Edward M. Kennedy (D. MA), Rnk. Mem.
U.S. Senate Health, Education, Labor and Pensions Committee

Hon. Charles E. Grassley (R. IA), Chair
U.S. Senate Finance Committee

Hon. Max Baucus (D. MT), Rnk. Mem.
U.S. Senate Finance Committee

Hon. John A. Boehner (R. OH), Chair
U.S. House Education and the Workforce Committee

Hon. George Miller (D. CA), Rnk. Mem.
U.S. House Education and the Workforce Committee

Hon. William M. Thomas (R. CA), Chair
U.S. House Ways and Means Committee

Hon. Charles B. Rangel (D. NY), Rnk. Mem.
U.S. House Ways and Means Committee