Thursday, June 18, 2009

Recovering the Losses?

Speaking to a parliamentary committee Thursday morning, Nortel Networks Corp. chief executive Mike Zafirovski defended the decision to pay court-approved bonuses to "key" executives and employees while it denied severance payments to workers the insolvent company let go.

You can read Mr. Zafirovski's official transcript by clicking here. I quote the following on the incentive plan, the decision not to give out severance to laid-off employees and on pension related matters:
KEIP (Key Executive Incentive Plan) and KERP (Key Employee Retention Plan)

· Let me turn now to our Key Executive Incentive Program and Key Employee Retention Program.

· In this company’s situation and in a highly competitive industry, retaining key employees and preventing unwanted levels of attrition is critical to preserve value and to maximize assets for the company’s stakeholders.

· Nortel’s development of its key executive incentive plan (KEIP) and key employee retention plan (KERP) involved significant monitor input and negotiation with the Creditor Committees.

· The KERP is for almost 900 non- executive employees. This is a pretty significant number reflecting the challenges facing us.

· 92 of the most senior executives were approved to participate in KEIP. These payments are contingent upon achieving specified milestones.

· Executives that were participants in the company’s Change in Control Plan (CIC) were required to waive benefits under this plan in order to be eligible for KEIP. The CIC Plan has been cancelled.

· I am not a participant in the KEIP or the KERP programs, and I have also waived the benefits of the CIC plan.


· Let me now turn to the issue of severance for Canadian employees. This is a decision that has weighed upon me greatly. Most importantly, the decision to not pay severance was not made lightly.

· Nortel is full of hard working, highly skilled and talented people and Nortel recognizes the contributions and value added by its former employees.

· Nortel, the Board and I personally, looked at this issue extensively and considered numerous alternatives to consider scenarios that involved the payment of severance.

· However, in light of the economic reality of the company’s constrained cash resources in Canada and the competing claims of the company’s other creditors, it simply wasn’t feasible to pay severance. This was an extremely difficult decision that was not taken lightly by management or the board of directors and was made after extensive consultation with outside financial advisors and the Monitor.

· This applies to all employees and includes the management team.


· On matters related to pensions. All monies in the Canadian registered pension plans belong to the plans themselves and are not available for creditors. We are currently maintaining status quo on employer contributions to pension plans.

· There has been a lot of speculation made about the decision to reduce the commuted value paid to employees getting out of the plans.

· Prior to filing, Nortel had still paid commuted values out at 100% based on an exception in the legislation, but starting in January 2009, reduced the commuted value to approximately 86% which was based on the estimated deficits shown in the last filed valuations as at December 31, 2006.

· Unfortunately, since the last filed valuations, the deficits have grown as a result of well-reported declines in equity markets. Nortel has consulted with its actuarial advisors and believes that the deficit is currently closer to 69% as of December 31, 2008.

· Nortel therefore sought the Court authorization to reduce the commuted value payout to a percentage that more accurately reflected the current funding levels.

· The reduction was not designed to prejudice anyone but rather meant to ensure equal treatment of members and former members.
Another article by the Globe and mail captured the mood at the hearings as Mr. Zafirovski, in the hot seat, faced pensioners:

Wiping trickles of sweat from his forehead and complaining of the heat in a stuffy House of Commons committee room, the CEO of Nortel Networks Corp. told the story of how his company went from among the most prominent corporations in Canada earlier this decade to a firm begging Ottawa for help to make ends meet.

The decision to file for creditor protection on Jan. 14, and the consequent decision to pay $45-million in bonuses to executives and remaining employees, “was the most painful and agonizing in my 43 years of business,” Mr. Zafirovski said.

“We really did not believe there was any other option.”

The chief executive initially turned down an invitation from the House of Commons finance committee to appear before MPs to explain why Nortel could afford to pay bonuses but not severance and pensions. But he relented earlier this week, and spent an hour on the hot seat yesterday.

He said that last year, he had so much faith in the company's future that he had invested his sons' college tuition fund in Nortel shares. But when the credit crunch intensified last fall, “then, we frankly hit a wall,” he said.

He went to Ottawa for help, talking frequently with Finance Minister Jim Flaherty and Industry Minister Tony Clement, among others, he said. But no support was granted in time to stave off the filing for protection from creditors.

Mr. Zafirovski would not disclose exactly what he asked the ministers for. As for his own compensation, he said he took home $1.2-million (U.S.), which was 12 per cent of the $9.7-million he said he was entitled to.

Still, within weeks of filing for creditor protection and cancelling the severance pay of about 1,100 employees, he asked the court for permission to give $45-million in retention and performance bonuses to 92 executives and 900 remaining employees.

That money, he said, was necessary to make sure top-notch staff stick with the company and allow it to maintain its customer base, and eventually flourish after it emerges from creditor protection.

The explanation was met with guffaws from the dozens of pensioners and laid-off Nortel employees who crowded into every seat in the committee room to hear their former boss.

“I feel like I was just dumped aside,” said former employee Ken Lyons.

Retention bonuses aside, many of the remaining employees are wary of the company because of the way it has treated its former staff, said Paula Klein, speaking on behalf of recently severed Nortel workers.

“One of their biggest concerns is that if they do lose their jobs, they will receive nothing from Nortel for severance or pay in lieu of reasonable notice,” she said in a submission to the Commons committee. “This is causing low morale at Nortel.”

She estimates the company owes the severed workers about $125-million in payments – money they can well afford.

The severed workers, as well as committees representing tens of thousands of Nortel pensioners, want Parliament to amend creditor-protection and bankruptcy laws so that former employees take precedence over other creditors.

They also want Ottawa to force Nortel to use the proceeds of the sales of foreign assets to pay their Canadian severance and pension benefits. Failing that, they want Ottawa to top up the pension fund and pay the severance.

Still, pensions are mainly a provincial responsibility.

The MPs' questions frequently focused on how to make sure other companies don't use creditor protection status to avoid paying severance or full pension to former employees – but there was no clear answer to those questions.

The former employees sat quietly in the hearing room but broke committee decorum and applauded when NDP MP Thomas Mulcair defended their causes.

“You didn't even try to get the money for the severance payments,” Mr. Mulcair charged.

Of course he didn't try to get the money for severance because he was more concerned about retaining the "top talent" at Nortel. Where have we heard that line of argument before?

To be fair to Mr. Zafirovski, he isn't solely to blame for that company's turmoil. Where is John Roth? He made off like a bandit selling the bulk of his shares at the top of the tech bubble, collecting multi-millions, leaving the ship right before it started sinking.

All I have to say is that Nortel's decision not to pay severance was wrong and immoral. Moreover, pensioners should get in front of creditors and get what they deserve. Like most other corporate plans, Nortel's pension plan was mismanaged and too heavily weighted towards equities. A disaster waiting to happen.

In the U.S., trucking company YRC Worldwide Inc. on Thursday said it will pledge as collateral some real estate to a multi-employer pension plan in lieu of a planned $83 million second-quarter payment, as part of an ongoing effort to preserve cash:

The Overland Park, Kan.-based company finalized the deal with Central States, Southeast and Southwest Areas Pension Fund amid growing chatter on Wall Street that the company might file for bankruptcy.

YRC has laid off thousands of workers, asked existing workers to take pay cuts and made deals with creditors to stave off debt payments it couldn't make. YRC has struggled to remain competitive as the trucking industry suffers from the worst demand in decades.

The agreement calls for the company to make the deferred payments to the pensions over three years beginning in January 2010.

Central States is the largest of the company's multi-employer defined benefit pension, making up 58 percent of its monthly pension obligations. YRC said it's also looking for other pension funds to make similar deals. It has deferred about $50 million in payments from these other funds so far.

YRC also said Thursday it has inked a deal to amend its credit agreement with lenders, which allows the company to direct $73 million in funds from previous real estate deals to repay some of the debt under its revolving credit facility.

The company has closed about $94 million in real estate sale and leaseback deals since the quarter began, and it forecasts it will close another $77 million in these deals currently under contract. A sale and leaseback transaction is an agreement where one company sells a property to a buyer and the buyer then leases the property back to the seller. In this case, it lets YRC get cash quickly to pay its debts while still using the properties.

"These transactions are especially critical as we continue to face substantial headwinds from the global economic recession," Chairman, President and CEO Bill Zollars said in a statement. "Today's announcement marks important milestones, which are part of our overall strategy to provide us with greater financial flexibility during the economic recession, giving us additional liquidity and the ability to use our cash to support the business."

The company's pension obligations are estimated at about $2 billion. Zollars has claimed the pension obligations are unfair because YRC must now pay for employees who never worked for the company.

Finally, someone from the Securities and Exchange Committee was kind enough to send me a Bloomberg article discussing how target-date fund rules may hinder recovery of losses:

Rules for “target-date” mutual funds may hinder investors’ ability to recover from 2008 losses if they force money managers to shift out of stocks too quickly, an investment company executive said.

Target-date funds move money from riskier investments such as stocks to more conservative alternatives such as bonds closer to an investor’s retirement. Regulators are considering rule changes to the funds because of investors and lawmakers’ concern that many target-date funds were too heavily invested in equities, according to a May 22 Federal Register notice.

Equity limits may mean missing out on the market’s rebound, said Jeffrey Coons, co-director of research at Manning & Napier, an investment firm in Fairport, New York that has managed target-date funds since the 1970s.

“If we have legislation that pushes people out of stocks after the worst 10 years we’ve had in the markets, that will be locking in those losses,” Coons said. The Standard & Poor’s 500 Index declined 38 percent last year.

Coons is among three dozen finance executives, consumer advocates and advisers testifying at a joint hearing of the Department of Labor and the Securities and Exchange Commission in Washington today.

The average loss for 31 funds with a 2010 retirement date was almost 25 percent, with some funds losing as much as 41 percent, SEC Chairman Mary Schapiro said at the hearing. The hearing will help determine whether regulations, industry reforms or “other revisions” are needed, she said.

Surprising ‘Reality’

“The ‘set it and forget it’ approach of target-date funds can be very appealing to investors,” Schapiro said at the hearing. “Target-date funds were expected to make investing easier for the typical American and avoid the need for investors to constantly monitor market movements. The reality of target- date funds was quite surprising to many investors last year.”

The traditional strategy of diversification only provided minimal protection against losses last year, since many kinds of bonds fell at the same time as equities, said Jeffrey Knight, chief investment officer for global asset allocation at Putnam Investments LLC in Boston.

Regulators should focus more on the possibility of customized insurance against outliving savings than mandating specific asset allocations, Knight said.

“It would be difficult to have predicted declines of all assets classes last year,” Knight said. “It was a surprise to professional investors how weak diversification proved to be.”

Clearer Disclosure

The Investment Company Institute, the Washington-based trade group for the mutual-fund industry, endorsed five principles for target-date fund disclosure, including making clear that “target date” means the approximate year when an investor will stop making new contributions to the fund, according to a statement today.

Funds should also make clear whether they’re designed for investors who will withdraw the entire balance at retirement or make periodic withdrawals, the ICI statement said.

Focus on Strategy

Regulators should focus on making sure investors know the essential strategy, composition and assumptions behind target- date funds, not the abysmal performance of certain funds in 2008, said fund analyst Josh Charlson, in a June 16 article on the Morningstar Inc. Web site.

“Most fund companies have done a poor job of communicating to investors just how their target-date funds are put together, what sort of risks those funds take on, the philosophy behind the construction of the funds, what the target date in their name actually means,” Charlson wrote.

Disclosure may not be enough to address the problems posed by target-date funds that have too much risk close to retirement age, said David Certner, legislative policy director for AARP, the largest U.S. consumer group, based in Washington.

“That’s a heavy lift, given that’s what the funds were designed to avoid,” Certner said in an interview. “It’s a bit of a conundrum.”

Target-date funds were created to ensure consumers who were passive about their investments got the benefit of professional money management, Certner said. There may need to be some standardization to the plans in addition to disclosure, he said.

Continued Risk

Consumers must bear some risk even when they turn 65, T. Rowe Price Managing Director Richard Whitney said. They need to keep equities in their portfolios to ensure they don’t outlive their investments.

Making fund allocations more conservative won’t yield enough returns to offset inflation and cover typical retirees’ spending, and they don’t take into account longer life spans, said Whitney of the Baltimore-based investment company.

“The recent experience with market volatility tempts us to underestimate the risks people face,” Whitney said.

At a February hearing, the Senate Special Committee on Aging Chairman Herb Kohl, a Wisconsin Democrat, called for more study and regulations on how the funds are composed and advertised. Excessive risk can be devastating for investors nearing retirement, Kohl said.

2008 Losses

The Senate Aging Committee investigation found that equity holdings of 2010 target-date funds varied significantly. In a survey of selected funds, the panel found the portion in equities ranged from 24 percent to 68 percent.

The date included in the name of the fund “did not appear to be significant to the design of the fund,” the committee’s report said. Mutual-fund companies should be required to rename the funds for increased transparency, the report said.

In a statement today, Kohl said he hopes the Labor Department and the SEC will work together on rules that standardize the composition of target-date funds.

“As more and more Americans are defaulted into these 401(k) plans, the question still remains: are target-date funds doing what they’re defined to do?” Kohl said. “Do we even have a firm definition?”

A 2006 law allowed employers to offer more target-date funds as default options for workers who enroll in 401(k) plans. Target-date funds were about 3 percent of defined contribution savings in 2006, but are expected to increase to 20 percent in 2010, according to Kohl.

About $187 billion was invested in target-date funds as of September 2008, according to ICI. Two-thirds of that money was in employer-sponsored 401(k) plans, according to the institute.

My advice to investors is to stay away from these target-date funds. They will lock you into losses and give you no chance of recovering when markets turn around.

Just like those "smart" professionally managed pension funds that sold at the bottom of the market and are now stuck chasing equities at much higher prices as they feel the heat of performance anxiety.

But it's the anxiety of millions of workers and retirees around the world that concerns me, not that of some grossly overpaid pension fund manager or CEO of a now disgraced tech company.

When it unveiled the financial and regulatory reforms this week, the Obama administration missed an opportunity to spearhead an international conference on the global pension crisis.

Oh well, when it comes to pensions, I guess people can always work till they drop and bank on death.

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