Compliance May 23, 2022

Pensions Will Recoup Losses From Allianz Structured Alpha Investments

Following an SEC settlement, most of the U.S. business of Allianz Global Investors will transfer to Voya Investment Management.

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Allianz Global Investors U.S., the U.S.-based asset management arm of German insurer Allianz SE, has agreed to pay billions of dollars as part of an integrated global resolution, including more than $1 billion to settle Securities and Exchange Commission charges and, together with its parent, Allianz SE, over $5 billion in restitution to victims

The SEC charged that the firm and three former senior portfolio managers conducted what the agency called “a massive fraudulent scheme” that cost investors more than $5 billion in losses.

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The scheme involved a trading strategy called “Structured Alpha,” which used complex options trading to earn returns for investors. However, the perpetrators of the scam did not reveal the potential immense downside risks of this trading strategy to investors. In March 2020, when the COVID-19 pandemic caused markets to crash, the losses were dramatic. Approximately 114 institutional investors bought the investment product and paid more than $550 million in fees, according to the SEC press release.

Institutional investors that sued or filed complaints against Allianz included the Arkansas Teacher Retirement System, the Employees’ Retirement System of Milwaukee, San Diego City Employees’ Retirement, Chicago Laborers Pension and Welfare Funds, Raytheon, Blue Cross Blue Shield, the Metropolitan Transit Authority Pension Funds and the J. Paul Getty Trust.

“This case once again demonstrates that even the most sophisticated institutional investors, like pension funds, can become victims of wrongdoing,” said SEC Chairman Gary Gensler in the commission’s release. “Unfortunately, we’ve seen a recent string of cases in which derivatives and complex products have harmed investors across market sectors.”

As a consequence of pleading guilty, AGI U.S. is automatically and immediately disqualified from providing advisory services to U.S.-registered investment funds for the next ten years and will exit the business. Allianz SE plans to sell most of the U.S. piece of Allianz Global Investors to Voya Investment Management.

Voya Investment Management will add about $120 billion of assets under management as well as some investment teams, the company said in a statement. Allianz will take a 24% stake in Voya IM. 

The funds will transition over a period of up to ten weeks for the U.S. mutual funds that AGI U.S. sub-advises and four months for the U.S. closed-end funds that AGI U.S. advises, according to the SEC.

The Case

The SEC’s complaint, filed in the U.S. District Court in Manhattan, alleges that Structured Alpha’s lead portfolio manager, Gregoire P. Tournant, orchestrated the multi-year scheme to mislead investors who invested approximately $11 billion in Structured Alpha. The SEC’s complaint further alleges that, with assistance from Co-Lead Portfolio Manager Trevor L. Taylor and Portfolio Manager Stephen G. Bond-Nelson, Tournant manipulated numerous financial reports and other information provided to investors to conceal the magnitude of Structured Alpha’s true risk and the funds’ actual performance.

AGI U.S. admitted that its conduct violated the federal securities laws and agreed to a cease-and-desist order, a censure and payment of $315.2 million in disgorgement, $34 million in prejudgment interest and a $675 million civil penalty, a portion of which will be distributed to certain investors, with the amount of disgorgement and prejudgment interest deemed satisfied by amounts it paid to the U.S. Department of Justice as part of an integrated global resolution. In a parallel criminal proceeding, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges for similar conduct against AGI U.S., Tournant, Taylor and Bond-Nelson. As part of the parallel criminal proceeding, AGI U.S., Taylor and Bond-Nelson have agreed to guilty pleas. 

AGI U.S. deliberately increased risk levels in its portfolio in late February and early March in order to “recoup” losses that had already occurred earlier in the year, according to information available on the website of Litowitz Berger & Grossman, a law firm leading the litigation on behalf of multiple institutional investors.

In their filing against AGI U.S., San Diego City Employees’ Retirement System claimed the portfolio’s positions left the fund dangerously exposed to even the slightest increase in market volatility or decline in equity prices—the very conditions that Allianz economists, and many others, warned were on the immediate horizon.”

Allianz had marketed Strategic Alpha Funds as safe investments that would be protected from risk in multiple different scenarios.

“The Alpha Funds’ purportedly unique ‘alpha’ component—the actively managed options strategy overlay—was supposed to provide investors with downside protection and possible upside in both bull and bear equity markets, and in times of both high and low volatility,” according to the documents the San Diego retirement system filed in December 2020 to the Supreme Court of the State of New York.

Staff at AGI U.S. manipulated performance and risk data by deliberately changing the numbers in their reports to investors, according to SEC complaints. Once the pandemic hit and losses became more severe, AGI U.S. once again allegedly engaged in data manipulation. Losses reported to investors were reduced.

The SEC’s press release also states that the three senior portfolio managers continued to lie to SEC staff after they began investigating the matter.

“Following the crash of the Structured Alpha Funds, the defendants continued their pattern of deceit by lying to SEC staff, and their fraud would have gone undetected if it weren’t for the persistence of SEC lawyers who pieced together the full scope of the massive fraud,” stated Gurbir S. Grewal, director of the SEC’s Division of Enforcement.

Seth Levine and Daniel Alonso, who together serve as counsel for Greg Tournant, both state that they believe Tournant should not face criminal charges. “We have faith that the justice system will reject this meritless and ill-considered attempt by the government to criminalize the impact of the unprecedented, COVID-induced market dislocation of March 2020,” they stated. “Greg Tournant has been unfairly targeted despite the fact that he was on extended medical leave during these market events, and the funds had thrived under his leadership for the previous 14 years. The losses resulting from these market events were suffered by sophisticated institutional investors—including Greg himself who had a considerable investment in the fund. While the losses are regrettable, they are not the result of any crime.”

Investing May 20, 2022

Plan Progress Webinar: Managing the DC Plan Investment Menu

Providing retirement plan participants with access to a self-directed brokerage window demands the examination of plan demographics to determine if one is appropriate.

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For plan sponsors, offering retirement plan participants a brokerage window may be more trouble than it’s worth.

In overseeing investment menus, plan fiduciaries must select the funds best suited for the plan and consider what participants need and what is in their best interest, rather than attempting to satisfy plan participants’ preferences, fiduciary experts explained during “Managing the DC Plan Investment Menu,” a PLANSPONSOR webinar.

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Determining what is best requires understanding the plan’s demographics, explained Mat Powers, director for retirement consulting services at Commonwealth Financial Network, a broker/dealer registered investment adviser.

“The fiduciaries responsible for the plan’s oversight have to continue to monitor and assess and evaluate. It’s ongoing,” he said. “In making investment oversight decisions for the plan, it is something that you do need to be informed [about] and understand—the demographics of the participants who are being served by that plan. Have a prudent process for how you arrive at your decision-making and have it considered as part of that process.”

Plan fiduciaries are also grappling with including retirement income products in their investment menus, including annuities, which were permitted by the fiduciary safe harbor in the Setting Every Community Up For Retirement Act.

Kyle Smith, CIO at LeafHouse Financial, explained that plan sponsors should examine adding retirement income products but that these may not be right for every plan. Chief concerns for plan fiduciaries are fee transparency and liquidity, he said.

“As long as there’s sufficient education, transparency around fees and liquidity, we’re comfortable with looking at these types of products and including them in plans where it’s appropriate,” he said. “But it’s not appropriate for every plan by any means and there’s a lot of products that aren’t necessarily the best products out there that are very expensive. It’s still very much early days in terms of including these types of products.”

Powers agreed that plan fiduciaries can’t ignore retirement income products.

Plan sponsors can take the approach of being “thoughtful about what are the income-producing opportunities of the plan and for participants” he said. “You can’t be completely absent of giving that some consideration.” 

Plan fiduciaries are responsible for managing the retirement plan in participants’ best interest, under the Employee Retirement Income Security Act and Department of Labor and IRS regulations.

Fiduciaries must focus on participants’ best interest rather than the hot investing topic, he added.  

“[A] crypto fund is an easy example to throw out there because it has grabbed some people’s attention and people are jazzed by the opportunity to become instant millionaires,” he said. “But at the end of the day, you need to think about: is it in their best interest?”

Plan sponsors must be deliberate in examining whether the brokerage window would be appropriate for the plan, Powers added, noting that plan sponsors face several considerations.

“Expectations [for plan fiduciaries] aren’t necessarily to do due diligence on all of the investments that are offered through that brokerage window—the due diligence is more around the brokerage window itself,” he said. “Does it have reasonable fees associated with it? Are the operational administrative workflows and aspects of that brokerage window reasonable and of enough quality for them to feel it’s a viable option for participants?”

Benjamin Grosz, partner at law firm Ivins Phillips & Barker, explained that the SPARK Institute—a recordkeeper and retirement organization—surveyed the 30 or 40 largest recordkeepers on the prevalence of self-directed brokerage windows, determining that among the retirement plans that are record-kept by large recordkeepers, 13% offered a brokerage window to participants.

He added that the figure is likely lower in the small plan market, and that it varies by industry and plan size.

Grosz said that brokerage windows are often asked for and used by the more sophisticated investors—human resources personnel or senior executives who want to add more esoteric funds—but seldom used by most workers. “With brokerage windows, the rank and file are generally not asking for it and they’re generally not designed for the rank and file,” he said.

A December DOL ERISA Advisory Council on Employee Welfare and Pension Benefit Plans report to Secretary of Labor Marty Walsh found that slightly over 2% of participants with access to a brokerage window use it. Overall, 0.3% of defined contribution plan participants have investments in a brokerage window, the report found.  

The report also found that the average size of retirement accounts that use a brokerage window is $334,263, almost three times greater than the overall 401(k) plan average.

Managing the DC plan investment menu also involves ensuring that the investments available are permitted and that the plan remains viable. 

“There are certain assets which are just by statute not permitted in a retirement plan,” Grosz explained. “It’s not okay to put them in through your brokerage, so you need to make sure of that.”

One such asset could be cryptocurrency, Grosz said.

“I don’t think you get around the issues of crypto by offering it in the brokerage window. I think it’s going to be just as problematic. The DOL’s views are very clear, and I’m not sure how I would—applying your normal prudence [and] loyalty, [fiduciary] standard process—get comfortable with that,” he said.

Grosz advised that, contrary to the perceptions of some in the retirement industry, offering crypto exposure in a self-directed brokerage window is no “panacea” for plan sponsors.

“I’ve heard from time to time in the past some litigators say, ‘maybe the brokerage window is your get-out-of-jail-free card.’ It’s not, and I think the law is clear on that,” he said.

Grosz explained that the DOL has in the last decade “come down hard” on plan sponsor committees that were under the impression that  they “can just offer a brokerage window and not worry about anything else.”

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