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67–300 PDF 2011

S. HRG. 112–62 

SECURITIES LENDING IN RETIREMENT PLANS: WHY 

THE BANKS WIN, EVEN WHEN YOU LOSE 

HEARING 

BEFORE THE

SPECIAL COMMITTEE ON AGING 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

WASHINGTON, DC 

MARCH 16, 2011 

Serial No. 112–3 

Printed for the use of the Special Committee on Aging 

( 

Available via the World Wide Web: http://www.fdsys.gov 

(II) 

SPECIAL COMMITTEE ON AGING 

HERB KOHL, Wisconsin, Chairman 

RON WYDEN, Oregon 

BILL NELSON, Florida 

BOB CASEY, Pennsylvania 

CLAIRE MCCASKILL, Missouri 

SHELDON WHITEHOUSE, Rhode Island 

MARK UDAL, Colorado 

MICHAEL BENNET, Colorado 

KRISTEN GILLIBRAND, New York 

JOE MANCHIN III, West Virginia 

RICHARD BLUMENTHAL, Connecticut 

BOB CORKER, Tennessee 

SUSAN COLLINS, Maine 

ORRIN HATCH, Utah 

MARK KIRK III, Illnois 

JERRY MORAN, Kansas 

RONALD H. JOHNSON, Wisconsin 

KELLY AYOTTE, New Hampshire 

RICHARD SHELBY, Alabama 

LINDSEY GRAHAM, South Carolina 

SAXBY CHAMBLISS, Georgia 

DEBRA WHITMAN, Majority Staff Director 

MICHAEL BASSETT, Ranking Member Staff Director 

(III) 

CONTENTS 

Page 

Opening Statement of Senator Kohl ...................................................................... 1 

Statement of Senator Corker .................................................................................. 2 

PANEL OF WITNESSES 

Statement of Charles Jeszeck, Acting Director, Education, Workforce and 

Income Security, Government Accountability Office, Washington, DC ........... 3 

Statement of Anthony Nazzaro, Principal, A. A. Nazzaro Associates, Yardley, 

PA .......................................................................................................................... 5 

Statement of Ed Blount, Executive Director, Center for the Study of Financial 

Market Evolution, Washington, DC ................................................................... 7 

Statement of Allison Klausner, Assistant General Counsel-Benefits, Honeywell International, Inc., Morristown, NJ ........................................................... 8 

Statement of Steven Meier, Chief Investment Officer, Global Cash Management, State Street Global Advisors, Boston, MA .............................................. 10 

APPENDIX 

WITNESS STATEMENTS FOR THE RECORD: 

Charles A. Jeszeck, Acting Director, Education, Workforce and Income Security, Government Accountability Office, Washington, DC ................................ 28 

Anthony Nazzaro, Principal, A. A. Nazzaro Associates, Yardley, PA ................. 56 

Ed Blount, Executive Director, Center for the Study of Financial Market 

Evolution, Washington, DC ................................................................................. 59 

Allison Klausner, Assistant General Counsel – Benefits, Honeywell International, Inc., Morristown, NJ ............................................................................ 70 

Steven Meier, Chief Investment Officer, Global Cash Management, State 

Street Global Advisors, Boston, MA ................................................................... 74 

ADDITIONAL COMMITTEE DOCUMENTS: 

Government Accountability Report to the Chairman: 401(k) Plans, Certain 

Investment Options and Practices That May Restrict Withdrawals Not 

Widely Understood ............................................................................................... 82 

Summary of Committee Research: Securities Lending with Cash Collateral 

Reinvestment in Retirement Plans: Withdrawal Restrictions and Risk Raise 

Concerns ............................................................................................................... 155 

ADDITIONAL STATEMENT SUBMITTED FOR THE RECORD: 

ING Investment Management–US ......................................................................... 184 

(1) 

SECURITIES LENDING IN RETIREMENT 

PLANS: WHY THE BANKS WIN, EVEN WHEN 

YOU LOSE 

WEDNESDAY, MARCH 16, 2011 

U.S. SENATE, 

SPECIAL COMMITTEE ON AGING, 

Washington, DC. 

The Committee met, pursuant to notice, at 2:02 p.m. in Room 

SH–216, Dirksen Senate Office Building, Hon. Herb Kohl, Chairman of the Committee, presiding. 

Present: Senators Kohl [presiding], Manchin, Blumenthal, and 

Corker. 

OPENING STATEMENT OF SENATOR HERB KOHL, CHAIRMAN 

The CHAIRMAN. Good afternoon. I would like to welcome our witnesses and welcome everyone attending today’s hearing. 

In recent years, most workers have seen their savings take a hit, 

leaving many to wonder if they will ever be able to retire. The gap 

between what Americans will need in retirement and what they 

will actually have saved is estimated to be a staggering $6.6 trillion. 

Now more than ever we need to strengthen and protect our pension and 401(k) systems. That is why we are examining securities 

lending within retirement plans. 

In simple terms, securities lending is when a plan lends some of 

its stocks and bonds to a third party in exchange for cash as collateral that is then reinvested. Many plans participate in securities 

lending to generate a little extra revenue. For many years, it 

seemed that there were only benefits to these arrangements for all 

sides. The economic downturn showed that securities lending is not 

a free lunch. 

It was upsetting to hear reports about some 401(k) participants 

actually losing money within their 401(k) accounts due to these 

practices. Some employers were restricted from accessing their 

worker’s retirement savings in investments that lent securities. 

This is troubling because employers are required by law to be able 

to change the investment options offered in their 401(k) plans. 

Securities lending is a complex financial transaction that goes on 

every day, often without employers and employees even knowing it 

is going on within their plans. And if they are aware, many do not 

understand the added risk, and ultimately that risk lies with 

401(k) participants because banks share the cash collateral profits, 

but not the losses, so the banks always win. 

2 

Last November, this committee began an investigation of the securities lending market, which is being released today. We surveyed employers that sponsored the 30 largest 401(k) plans, and 

found that all had at least one investment option that engaged in 

securities lending at some time in the previous five years. However, 

after the downturn, five of these employers stopped participating in 

securities lending. The committee also surveyed the seven largest 

banks in the securities lending market. In 2010, these seven banks 

provided services to 570 different employer-sponsored plans with a 

total of roughly $1.3 trillion in assets. 

I hope today’s hearing and our committee report will shed some 

light on securities lending within retirement plans, and the benefits and the risk associated with it. 

We’ll start our hearing with a review of the findings of a new 

GAO report showing that securities lending is not widely understood by employers or workers. We’ll then hear experts on securities lending and the reason why employers are reconsidering their 

participation in securities lending within their 401(k) plan. Finally, 

we’ll hear from one of the major providers of securities lending 

services. 

We thank you all again for being here today. We look forward to 

your testimony and a productive dialogue. 

And at this point, we’ll turn to my colleague, the ranking member, Senator Corker. 

STATEMENT OF SENATOR CORKER 

Senator CORKER. Thank you, Mr. Chairman, and thanks for calling this meeting. And to all of you who are going to educate us 

here in just a moment, we thank you for being here, and looking 

forward to your testimony. 

We are here today to talk about securities lending and 401(k) 

plans and the events that occurred during the crisis of 2008. 

Because of liquidity constraints in the marketplace, gates were 

put in place essentially to protect people from having immediate 

access to funds being held in 401(k) plans. And unfortunately some 

people did not understand why they could not access their funds 

when they wanted to. 

Defined contribution plans are taking over as a major source of 

revenue for our retiring Americans, and so it is important to understand how they work in a properly functioning marketplace, and 

also to understand what happened during the financial crisis to understand what may or may not have gone wrong. 

As is typical in the aftermath of a financial crisis, the industry 

has improved. The leading agents and collateral managers have 

largely self-adjusted since the crisis. They have learned to adjust 

client investment objectives in collateral so that they are more liquid, less exposed to interest rate and credit risk by using more conservative investment models. 

One of the things we need to be careful about is not to overregulate, but to preserve competition and choice in retirement savings 

plans for beneficiaries. If we overregulate, there is a danger that 

the only options for beneficiaries will be lower yielding options. And 

there is always risk obviously involved when you try to seek those 

higher returns. 

3 

A better informed consumer is good, but we need to make sure 

that we are not just piling on more disclosures that consumers do 

not understand or read. We need to make sure that we are not 

needlessly regulating where the market is already corrected or 

where other laws and rules may be already addressing concerns. 

More disclosure is not always better, but certainly more meaningful 

disclosure could be very good. 

I am here today to learn from the witnesses testifying before us. 

I look forward to reading the majority report on securities lending. 

I think it is being released right now, as a matter of fact. 

I urge all of us to take time to consider the majority’s report, the 

GAO report, being publicly released today, as well as all of the 

laws we recently passed as part of the Dodd-Frank Wall Street Reform and Consumer Protection Law. 

Securities lending may pose risk, but it can increase yield. So let 

us be careful about how we proceed forward in order to preserve 

competition in the marketplace, allow functioning markets to flourish, and promote choice for all participants. 

And, again, thank all of you for being here. 

The CHAIRMAN. Thank you very much, Senator Corker. 

Our first witness today will be Charlie Jeszeck, who is acting director in the Government Accountability Office, Education, Workforce and Income Security team. Throughout his 26-year career at 

GAO, Mr. Jeszeck has focused on health care, unemployment insurance, private pensions, and social security. 

Next, we will be hearing from Anthony Nazzaro, who is principal 

of A.A. Nazzaro Associates, a securities lending manager and consulting firm in operation since 1987. Mr. Nazzaro has worked in 

the securities lending industry for 35 years. 

The third witness will be Ed Blount, Executive Director of the 

Center for the Study of Financial Market Evolution. The organization works with practitioners, academics, trade groups, and regulators to analyze practices in capital market sectors that have developed ahead of formal disclosure and reporting standards. 

The fourth witness today will be Allison Klausner. Ms. Klausner 

is the Assistant General Counsel–Benefits for Honeywell International. Ms. Klausner is responsible for legal matters relating to 

employee benefits at Honeywell within the United States and also 

worldwide. 

Finally, we will be hearing from Steve Meier, Chief Investment 

Officer, Global Cash Management, for State Street Global Advisors. 

Mr. Meier joined State Street in 2003. He has more than 27 years 

of experience in the global cash and fixed income markets. 

We thank you all for being here today. And we will start with 

you, Mr. Jeszeck. 

STATEMENT OF CHARLES JESZECK, ACTING DIRECTOR, EDUCATION, WORKFORCE AND INCOME SECURITY, GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, DC 

Mr. JESZECK. Mr. Chairman and members of the committee, 

thank you for inviting me here today to discuss the practice of securities lending with cash collateral reinvestment. My comments 

will focus on how these transactions occur in the context of 401(k) 

plans. While this practice appears to be an easy way for plans to 

4 

make money, these transactions are complex and pose challenges 

both to plan sponsors and participants. 

Before I continue, it is important to note that 401(k) plans are 

now the dominant retirement savings plan in the United States 

with over 49 million participants and plan assets of $2.8 trillion. 

In our view, to foster national retirement security in the 401(k) 

model, both sponsors and participants, at a minimum, need to have 

the information necessary to enable sound, prudent decision making. 

Securities lending in 401(k) plans is a transaction where assets 

held in 401(k) investment options are lent to third parties, typically 

in return for cash, which is held as collateral. The idea is that by 

reinvesting this cash, greater returns can be earned for plan participants. 

Many 401(k) investments that engage in securities lending pool 

their money into commingled or pooled accounts. These accounts 

are designed to combine assets of unrelated plans to facilitate diversification and gain the cost advantages of larger plans. While 

larger 401(k) plan sponsors may maintain separate investment accounts and can choose directly to participate in securities lending, 

it is the commingled account manager, not the plan sponsor, that 

makes that decision for commingled funds. 

The figure to my left provides a basic example of a securities 

lending transaction with a commingled account. First, a plan sponsor sends contributions to the service provider or account manager 

administering a commingled account. The account manager then 

negotiates with the securities lending agent the terms of the transaction, including the split of any gains. The securities lending 

agent then negotiates with a broker-dealer who is seeking to borrow securities for a client. The broker-dealer provides cash as collateral for the borrowed security to the securities lending agent for 

the length of the agreement. The broker-dealer earns a rebate or 

interest on the cash collateral being lent. 

The securities lending agent then works with a cash collateral 

pool manager, who may be affiliated with the lending agent, to reinvest the cash. The pool manager earns a fee for investing this 

cash. When the transaction is completed, the assets are returned 

to the original parties. 

As shown in the figure on my right, after the broker-dealer and 

the cash collateral pool manager have received their fees, the securities lending agent and the commingled fund split any gains from 

the transaction. For the participants, these gains are reflected directly in the values of the shares in the commingled account. 

It is important to note that the split is asymmetric. While the 

gains are shared between the plan participant and the securities 

lending agent—in our example, the split is 80/20 in favor of the 

participant—the investment losses are borne only by the participant; thus, a symmetry can also create an incentive for the cash 

collateral pool manager to seek riskier investments as they do not 

bear the investment loss. 

Securities lending transactions poses challenges for plan participants and sponsors alike. Participants may be unaware that their 

plan investments are utilized in securities lending transactions. We 

found that information about such transactions is often buried 

5 

deeply within investment option documents, documents which, in 

many cases, may not even be received by participants. New disclosure regulations by Labor may not be helpful because they focus 

on information about investment options, such as information on 

fees paid, and not the practices employed by those options, like securities lending. 

Plan sponsors may also be unaware or not fully understand the 

risks involved in securities lending transactions. This might be particularly the case for smaller plans with commingled funds who 

may not be as sophisticated as larger plan sponsors. This view is 

echoed by industry experts with whom we spoke. 

The SEC, FINRA, and the industry itself are already taking 

steps to address issues related to securities lending. GAO has made 

recommendations to Labor that we believe will enhance disclosure 

and transparency for both sponsors and participants, and assist in 

a negotiation of these transactions. 

That concludes my statement, Mr. Chairman. I am happy to answer any questions that you or other members may have. 

[The prepared statement of Mr. Jeszeck appears in the Appendix 

on page 28.] 

The CHAIRMAN. Thank you very much, Mr. Jeszeck. 

Now we’ll hear from Mr. Nazzaro. 

STATEMENT OF ANTHONY NAZZARO, PRINCIPAL, A. A. 

NAZZARO ASSOCIATES, YARDLEY, PA 

Mr. NAZZARO. Good afternoon. My name is Anthony Nazzaro. I 

am the principal and owner of A. A. Nazzaro Associates. We are 

a securities lending manager and consulting group in operation 

since 1987. 

I would first like to thank Chairman Kohl, Ranking Member 

Corker, and the members of the committee for the opportunity to 

appear before you today. It is a wonderful honor and a privilege for 

me to do so. 

I believe I was invited to appear and give testimony because of 

my experience and the longevity of my career in the securities 

lending industry. My participation in this industry spans some 35 

years in roles ranging from an in-house lender at Yale University, 

to a custodian agent lender for the pension funds of the Commonwealth of Pennsylvania, to a present status as an independent 

manager for university and foundation endowments. It is my hope 

that I can offer some perspective, insight, and constructive counsel 

for pension funds, which represent a large segment of the beneficial 

owners participating as lenders of securities. 

Many large pension funds that participate in securities lending 

choose to do so through an agent lender, such as their custodian 

bank. It is my sense that, when a fund enters into an agreement 

with its agent lender, the fund may not fully appreciate or understand that it has also hired an investment manager. Many times 

the fund may be focused upon the lending of securities side of the 

equation and less upon the reinvestment of cash collateral. As a result, the focus or scrutiny is more heavily weighted toward the 

counterparty risk of the borrower and overshadows or obscures the 

reinvestment risk. This may result in less scrutiny of the cash collateral investment guidelines proffered by the agent lender. In adVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
6 

dition, given the wide ranging of authority of the agent lender over 

all lendable assets and the reinvestment of cash collateral, the size 

of the assets held in the cash collateral portfolio may grow to become the largest portfolio in the funds universe, and the agent 

lender may become its largest investment manager. 

The omission or failure to perceive an agent lender as an investment manager may result in a lack of sufficient reporting and oversight of the cash collateral portfolio, and an assumption that the 

reinvestment of cash is part of the agent’s custodial function in the 

management of the securities lending program. The danger and 

risk in this perception was brought to light and exposed during the 

recent financial crisis and brings us here today. 

The reason I’m highlighting this issue is because I believe there 

are some basic steps that can be taken to protect pension funds 

and limit their risk. 

Step one, documentation. In addition to the execution of a securities lending agency agreement, which is standard documentation, 

pension funds should execute an investment manager agreement. 

This elevates the duty and standard of care by the agent lender/ 

investment manager. The investment reports would receive a 

heightened degree of visibility and are more likely to come within 

the purview of those persons or committees with oversight at the 

pension fund. 

Step two, investment guidelines for cash collateral. Implementation of stringent guidelines for the reinvestment of cash collateral 

similar to those of a Rule 2a–7 money market fund. This would 

limit holdings in the portfolio to only securities of high credit quality, high liquidity, shortened duration, or weighted average maturity. 

Step three, reporting and valuation. Receipt of daily reports as 

to the valuation of the cash collateral corresponding to the securities lending loan balances. The value of the cash collateral portfolio 

report should be equal to or close to the 102 percent 

collateralization required for loans and received from counterparty 

borrowers. 

Step four, limits upon program participation. Implementation of 

a limit or cap upon the amount or value of securities which may 

be loaned in order to reduce exposure of a portfolio. This limit may 

be expressed as a specific dollar amount or as a percentage of the 

total assets. 

The above recommendations are four steps that pension funds 

can implement that I believe would be both constructive and prudent. It is my opinion that implementation of some or all of these 

steps could have mitigated the problems that funds experienced 

during the financial crisis. 

Thank you. 

[The prepared statement of Mr. Nazzaro appears in the Appendix 

on page 56.] 

The CHAIRMAN. Thank you very much, Mr. Nazzaro. 

Mr. Blount, we would like to hear from you. 

7 

STATEMENT OF ED BLOUNT, EXECUTIVE DIRECTOR, CENTER 

FOR THE STUDY OF FINANCIAL MARKET EVOLUTION, WASHINGTON, DC 

Mr. BLOUNT. Chairman Kohl, Ranking Member Corker, and 

members of the committee, thank you for the opportunity to share 

a few thoughts with you today. 

I approach this issue with the perspective gained from 35 years 

of varied roles in the securities lending community, and the experience gained from having built and then sold a profitable business 

that pioneered the analysis of performance measurement for securities lending programs. 

On the surface, the problems cited by the GAO report appear to 

be a lender side issue; that is, the cash collateral lock ups that 

froze the assets of 401(k) defined contribution participants and others during and for up to a year after the crisis. However, this is 

really an issue for the entire investment community. 

The effect of restrictions on the supply of lendable securities 

could quickly degrade the liquidity and efficiency of U.S. capital 

markets by raising the risks of settlement failures and increasing 

the capital charges for brokers with customer segregation deficits. 

In particular, restrictive actions of regulators affecting the 

lendable supply of securities could well impair the ability of pension plan sponsors to offer passive index funds and to hedge actively managed portfolios. The reduced availability of index funds 

and hedges in turn would increase portfolio risks and threaten the 

investment returns that pension beneficiaries need and expect. 

At a very fundamental level, securities lenders help to make the 

markets more efficient. This has been documented in a number of 

reports by international regulators. 

And the supply of lendable securities is highly sensitive to the 

actions of Federal regulators. I would cite the 1981 decision of the 

Department of Labor to amend the prohibited transactions exemption as one example of this. 

But let me pause here for a minute. If I say that securities lending is important, I do not mean to say that problems do not exist 

in the lending community, nor do I intend my comments to be 

taken as a defense of the status quo such that pensioners might 

once again be deprived of access to their own funds in the uncertain days of financial crisis. 

However, the cause of the lockups was the illiquidity of certain 

asset-backed securities, which were included in the cash collateral 

pools of those funds that lent out their securities. In that regard, 

the problems of securities lenders and their investor beneficiaries 

are the same as those of many other commingled funds in the 

United States during the recent market crisis. During that crisis, 

the suddenly illiquid individual beneficiaries of defined contribution plan accounts absorbed the effects of investment choices made 

by others; that is, their plan sponsors and cash managers. Unfortunately, DC plan sponsors, unlike defined benefit plan sponsors, 

have no financial incentive to increase investment revenue, such as 

securities lending income for their participants. 

Plan participants gained the income from securities lending 

while their administrators merely gain more work and more risk. 

As a result, it is easier for DC plan sponsors to simply reject as 

8 

investment options those mutual funds which lend rather than 

learn how to evaluate the ways in which risks and securities lending evolve as market conditions change, so as to help participants 

fine tune their exposures. 

Such a decision appears now to have been made by many plan 

sponsors, whose management mandates routinely reject the possibility of income from securities lending services. As a result, the investment performance of DB plans is exceeding that of DC plans, 

even when offered by the same corporate plan sponsor. In effect, 

we are creating a yield deviation between DC and DB plans where 

there is not a good reason for it. 

Going forward, however, it will be necessary to construct a 

framework which more closely aligns the interests and responsibilities of all those in the DC plan securities lending community without unnecessarily impairing the ability of the market system to 

contribute to the welfare of both DC and DB plan beneficiaries. 

Among the changes that I believe are necessary are an improvement and extension of the disclosure regime for securities lending 

cash managers. Furthermore, I believe that an expert council 

should be established to define the limits of prudence for collateral 

cash managers, one that is based on close monitoring of changing 

market conditions. I do not—or I do believe that educational programs should be funded by the securities lending community, not 

the government, through incentives, such as capital charge credits, 

and then provide it to DC plan sponsors and participants as a way 

of improving the awareness of their own responsibilities and those 

of their service providers. 

In conclusion, if all members of the service provider community 

fulfill their responsibilities, I do not believe that new legislation or 

regulatory actions will be necessary. The cash lockups of the financial crisis were not attributable to a failure of securities lending. 

Thank you. 

[The prepared statement of Mr. Blount appears in the Appendix 

on page 59.] 

The CHAIRMAN. Thank you very much, Mr. Blount. 

Ms. Klausner. 

STATEMENT OF ALLISON KLAUSNER, ASSISTANT GENERAL 

COUNSEL–BENEFITS, HONEYWELL INTERNATIONAL, INC., 

MORRISTOWN, NJ 

Ms. KLAUSNER. Thank you. 

My name is Allison Klausner, and I am the Assistant General 

Counsel–Benefits for Honeywell. On behalf of Honeywell, a Fortune 

50 company, I want to express Honeywell’s appreciation of Chairman Kohl’s and Senator Corker’s desire to understand the practice 

of securities lending in the context of employer-sponsored defined 

contribution plans. 

I understand that my testimony today has been requested to provide the Senate Special Committee on Aging with insight into how 

one plan sponsor’s fiduciary committee has addressed securities 

lending issues. 

Over the years, securities lending has provided tremendous value 

to participants and beneficiaries of employer-sponsored DC plans, 

including those with employee deferrals and contributions. I enVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
9 

courage the Senate Special Committee on Aging to recognize that, 

if unnecessary actions are taken to restrict fiduciaries from offering 

securities lending funds in defined contribution plans, plan participants and retirees may lose valuable opportunities, now and in the 

future, as they strive to maximize retirement security. 

Honeywell’s primary defined contribution plan is a fairly typical 

401(k) plan. Participants are permitted to direct the investment of 

their deferrals and contributions, as well as their vested matching 

contributions. They have the opportunity to select from a robust 

range of asset classes with varying potential risks and rewards. 

The Honeywell Savings Plan Investment Committee is a fiduciary committee consisting of five professionals at Honeywell. Two 

of the current committee members dedicate significantly all of their 

time addressing issues relating to ERISA plan assets, one of whom 

does exclusively for the company’s defined contribution plans. All 

the members have fiduciary education and are counseled on an ongoing basis with regard to their fiduciary duties. 

The Honeywell committee members understand that satisfaction 

of their fiduciary duties is critical to supporting a long-term retirement security of the plan’s participants and the company’s retirees. 

The company members recognize they must engage in a prudent 

process, which considers many factors when selecting and evaluating investment funds, including, but not limited to, whether it 

has a securities lending component. 

I encourage the Senate committee to consider that the matter of 

whether defined contribution plan assets are invested in securities 

lending funds is one that should be evaluated in the context of the 

fiduciary process. 

A fiduciary’s process in selecting a fund will be based on many 

considerations: fees to be charged by the investment manager, the 

type of fund, the asset class, the past performance, and the plan’s 

complete fund line-up. 

Securities lending funds in the Honeywell defined contribution 

plans fund line-up has in fact supported many participants’ retirement goals as those investment funds typically charge lower fees 

than comparable non-securities lending funds and historically had 

investment gains that contributed to the investment returns for the 

assets invested in such funds. 

The take away is that, depending upon facts and circumstances, 

offering defined contribution plan participants the opportunity to 

invest in securities lending funds can indeed be a prudent decision. 

Notwithstanding the potential benefits, the Honeywell Savings 

Investment Committee did determine in October of 2008 to transition from securities lending funds to nonsecurities lending funds. 

The committee recognized that the then economic climate, and that 

which was anticipated in the then near future, and the gatekeeping 

measures which were being implemented, weighed against continuing to offer securities lending funds for investment of defined 

contribution plan assets. 

Although the plan’s fiduciaries understood that the gatekeeping 

measures were purportedly designed to stem the possibility that 

there would be a run on the bank within the sec lending programs, 

and that the gatekeeping measures did, in fact, achieve such goal, 

the gatekeeping measures did handcuff plan fiduciaries and reVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
10 

stricted them from making decisions, which could have impacted 

plan participants’ opportunity to maximize retirement security. 

Today’s legislative and regulatory framework permits fiduciaries 

to offer defined contribution plan participants access to investment 

funds with securities lending features. I encourage the Senate committee to recognize the importance of maintaining the flexibility 

currently available. Fiduciaries should not be required to operate 

in a rigid environment which prohibits them from providing plan 

participants and retirees with valuable opportunities to achieve retirement security. 

Securities lending employer-sponsored DC plans is a topic that is 

worthy of your attention. However, we must take care not to study 

the issue in a vacuum or elevate the matter of securities lending 

over other issues of equal or greater importance to define contribution plan participants and retirees. 

Plan administrators and fiduciaries, as well as third party providers, are in the process of implementing new legislation and regulation, all designed to protect participants. But there does not appear to be an urgent need to address the issue of employer-sponsored defined contribution plans and securities lending features. 

Perhaps this is a time to rest and allow the new rules to take hold 

before we consider any new rules or requirements. 

I want to thank you for asking me to be a witness today, and I 

would be happy to address any questions you may have. 

[The prepared statement of Ms. Klausner appears in the Appendix on page 70.] 

The CHAIRMAN. Thank you, Ms. Klausner. 

Mr. Meier, we would like to hear from you. 

STATEMENT OF STEVEN MEIER, CHIEF INVESTMENT OFFICER, GLOBAL CASH MANAGEMENT, STATE STREET GLOBAL 

ADVISORS, BOSTON, MA 

Mr. MEIER. Chairman Kohl, Ranking Member Corker, and members of the Special Committee, thank you for the opportunity to appear today. 

My name is Steven Meier, and I am the Chief Investment Officer 

of Global Cash Management at State Street Global Advisors, the 

investment management arm of State Street Corporation. I hope 

my testimony will assist you in your important work. 

At State Street, we believe that securities lending can play an 

important role in a balanced investment program for professionally 

managed retirement plans. As you know, employee retirement 

plans typically earn dividends and interest income from the plan’s 

investment portfolio. 

If participants choose to invest in a plan option that engages in 

securities lending, the investment portfolio can earn additional incremental income. While the amount of income varies by portfolio 

and depends upon a number of factors, it can be significant and 

may be used to either offset expenses or supplement the plan’s investment return. 

An investor like a 401(k) plan can earn this incremental income 

when it lends a security it owns to a borrower, who uses the security to settle another transaction, often in connection with a short 

sale. The borrower provides collateral to the lender for the borVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
11 

rowed security, typically in the form of cash. During the course of 

the loan, as the market value of the borrowed security changes, the 

lender either collects or returns collateral based on changes in the 

value of the security. If the lender has received cash collateral, it 

invests the cash to earn investment income. When the loan terminates, the lender returns the borrower’s collateral, along with an 

additional payment known as a ‘‘rebate.’’ The lender shares the remaining income with the securities lending agent as compensation 

for its services administering the program, such as matching lenders to borrowers, reassigning loans when the lender sells a security, and revaluing the securities on loan and marking to market 

the collateral daily. 

The lending agent’s share of the securities lending income also 

compensates it for indemnifying lenders against the failure of a 

borrower to return a security if the borrower defaults on its obligations. 

As this Committee is aware, the events of the recent global financial crisis were unprecedented and created challenges for the 

securities lending business. State Street acted cautiously and 

thoughtfully before and during the financial crisis to protect the interests of our securities lending clients. Due to our prudent management, none of our cash collateral pools realized credit losses. 

In addition, we maintained 401(k) plan participants’ full, unrestricted ability to make withdrawals from our lending funds. Investors in our lending funds did not incur any realized losses in connection with cash collateral reinvestment unless they chose to take 

an in-kind distribution of securities and sell them at a loss. 

State Street believes that it acted in the best interest of our securities lending clients and significantly mitigated the potential adverse impacts from the financial crisis. 

Our securities lending clients are generally long-standing clients 

for whom securities lending is just one of many services State 

Street provides. We believe our interests are appropriately aligned 

with those of our clients. We are committed to best practices in disclosure and risk management. We also welcome the opportunity to 

learn more from you today about how the industry can better serve 

its clients, and particularly retirement plans. 

Thank you for the opportunity to be here today. I will be pleased 

to answer any of the Committee’s questions. 

[The prepared statement of Mr. Meier appears in the Appendix 

on page 74.] 

The CHAIRMAN. Thank you, Mr. Meier. 

I would like to start out with a question and ask for a response 

from each of you. 

What are the risks for both the retirement plan and the individual participants of participating in a securities lending program? Do you think that both employers and their workers are 

aware of the risks? We will start with Mr. Jeszeck and then move 

to his left. 

Mr. JESZECK. In our firm, what we have found is that there is 

an asymmetry. While the gains are shared between the securities 

agent and the lending agent and the plan, the losses are completely 

borne by the participant. So in that sense, there is an asymmetry 

there, and, as I mentioned earlier, we think it also creates an inVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
12 

centive for pool managers, because they do not bear any of the loss, 

to possibly invest in more risky assets. 

As to whether participants and sponsors are aware of securities 

lending with cash collateral reinvestment, our work has found that 

in general there may be some savvy participants who know, but in 

general, participants, frankly, have no idea what securities lending 

is, much less whether they are aware of whether it is going on in 

their 401(k) plan. 

The other area, while an argument could be made that plan 

sponsors should be aware of securities lending, during our work in 

our report, we found a number of plan sponsors who were not 

aware of securities lending with cash collateral reinvestment, or securities lending at all going on in their plan. So that was a disturbing finding. 

The CHAIRMAN. Thank you. 

Does anybody substantially disagree with Mr. Jeszeck’s description? Yes, Ms. Klausner. 

Ms. KLAUSNER. Thank you, Chairman. 

In our experience at Honeywell, the fiduciaries are extremely 

well aware of which funds are able to have securities lending activity in the fund. We also are aware that we have disclosure in our 

summary plan description and in other places, perhaps like on our 

website and in other informal communications, that identify in 

their description of the funds that securities lending does in fact 

exist. So I would not necessarily characterize all plan participants 

as not being aware. I understand that disclosure doesn’t always 

bring awareness, but there are certain populations in Honeywell, 

as well perhaps in other organizations where the sophisticated professionals and other well-educated individuals do know that it exists and understand it. 

In terms of loss and risk, I also think they understand that the 

varying funds that are available all have the opportunity to go 

down in their account balance and not just up. And so, this is 

something that I think in terms of recognizing the variation between what is available to individuals is true, and perhaps the bar 

needs to be raised. But I would not characterize our plan participants as not having the information readily available. 

The CHAIRMAN. Does your company, Honeywell, take time and 

make the effort to see to it that everybody involved understands 

this transaction? 

Ms. KLAUSNER. May I ask, when you ask everybody involved, do 

you mean at the plan sponsor/plan fiduciary level? 

The CHAIRMAN. Yes, as well as those who are in the plan itself. 

Ms. KLAUSNER. At the plan sponsor/plan fiduciary level, the answer is absolutely yes. As to the plan participants at that granular 

level, I would hesitate to say yes. Just like with all aspects of the 

investment, they have high-level information about the character of 

the asset class and the different activities that might go on in 

terms of the fund. As to whether or not they understand the granular level of securities lending, I would say that is probably not likely. 

The CHAIRMAN. Okay. Yes, sir, Mr. Blount. 

Mr. BLOUNT. Senator, I think the issue of comprehension by participants and the disclosure by their service providers is comVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
13 

plicated. The service providers, I believe, attempt to provide as 

much information as possible. Plan participants in many cases are 

no different from the board members of defined benefits plans. And 

I find when meeting with plan sponsors that there are different 

levels of comprehension even at the board level. There are members of the investment committee that might have an extremely 

good understanding. Others are more concerned with retirement 

issues and leave the investment matters to other board members 

and directors. 

I think when you start to talk about individuals who are investing in any investment program, there is a presumption of trust 

that they believe protects them. They will assume that if they are 

being offered a program—an option—that it has been thoroughly 

vetted, and there is, in effect, an imprimatur to it. Whether they 

fully understand the details, I think, is actually impossible for most 

of them. There are many—and I say this with a smile—there are 

many contemporaries of mine who have been in the business for 

three decades or more, very closely in the securities lending world, 

and still don’t understand it all. It is an extremely complex and 

opaque area, so there is a level of trust that I think goes beyond 

that. 

The CHAIRMAN. Thank you. Mr. Meier. 

Mr. MEIER. Senator, at State Street, we are completely committed to transparency in terms of all of our investment strategies, 

including our securities lending activities, as well as our cash collateral reinvestment pools. 

In terms of our outreach, we tend to spend a lot of time with 

plan sponsors and their consultants to go through our program to 

make sure that there is that level of understanding. 

I would say from an industry perspective, one of the frustrations 

may be that we do not have the ability to actually reach down and 

communicate directly with the plan participants. Again, our activities are with the plan sponsors and their consultants. 

In terms of the characterization about a potential misalignment 

of interests, I will say that our interests at State Street are completely aligned with those of our clients. We have been in the securities lending business since 1974. It is a core competency of ours 

as a custodial bank, and we have committed many resources to 

making sure that we continue to manage those programs in a prudent manner. 

We at State Street actually have a little bit of a unique business 

structure in that we have a division of responsibilities. For example, we have one division that is responsible for lending the securities, and another division, the investment managing arm that I 

work for, that actually manages the cash collateral. In terms of the 

fee structure and the revenue sharing, we actually work for a modest set fee on the investment management side, of typically anywhere between one to three basis points, to manage those portfolios. 

We are acting as a fiduciary. We are not incented to take on additional risk to increase the return so that State Street Bank, for 

example, would earn a higher level of income off of those activities. 

14 

The CHAIRMAN. Thank you. I will ask Mr. Jeszeck a question, 

and then we’ll turn to Senator Corker. And I think you have alluded to it, but I would like to ask you directly. 

Your report shows that the risk of securities lending with cash 

collateral reinvestments are all borne by the participants, while the 

rewards are spread around, as you indicated. In fact, some of those 

involved in the transaction, including securities lending agents, 

broker-dealers, and collateral pool managers always win and never 

lose. Does that make you nervous? 

Mr. JESZECK. Well, certainly from our work we have found that 

participants and sponsors are not favored compared to other actors 

in these transactions. Having said that, we continue to believe that 

securities lending with cash collateral reinvestment could benefit 

401(k) participants if it is managed responsibly. And I think that 

means getting more information to plan sponsors so that they can 

negotiate these transactions more prudently, for plan participants 

to be aware of the existence of securities lending, the implications 

of securities lending with cash collateral reinvestment for their 

portfolios so they can make an informed decision consistent with 

their general preference towards risk. Some individual participants 

like risk. They like more risk and will be comfortable with securities lending transactions. Others may not like risk as much. And 

so for these reasons and others, we made the recommendations in 

our report to the Department of Labor. 

The CHAIRMAN. Okay. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. 

Mr. Jeszeck, I am not the most sophisticated investor in the 

world, but I have been fortunate and do do some investing. I do not 

know if I have ever seen a scenario where it was different than 

what you just said. I mean, typically when investments are made, 

the investment manager participates in the gain, and they do not 

participate—I mean, that is the way hedge funds operate. It is the 

way most funds operate. I have not been aware of managers who 

participate in gains as a way of making fees, participating in 

losses. So I do not find anything unique about that. Is there something—I could ask Mr. Blount—but is that not standard that usually when people are making investments, they participate in gains 

and incentive, but do not participate in the losses? As a manager, 

is that not kind of standard/typical in the industry? 

Mr. BLOUNT. I would say it is, Senator, yes. 

Senator CORKER. I know you have to have had involvement in 

this industry other than just this report, right? 

Mr. JESZECK. Well, Senator, I—I’ve been at the Government Accounting Office for the last 26 years, so in that sense I have worked 

on pension issues. I have worked on issues involving the industry. 

I have had interactions with the industry, but I have not had any 

direct involvement myself in the industry. 

Senator CORKER. Well, let me just state that as a guy who is certainly no professional that it is a very standard typical arrangement that you are describing, and there is nothing—I mean, that 

is typical of the way it is. It is very asymmetric. Is there anybody 

that disagrees with that? I mean, so I just find you making a point 

out of that odd when, you know, just for the little bit of looking into 

15 

what is happening in the industry you would understand that that 

is the way the industry operates. 

Mr. JESZECK. Well, sir, I think the point—what we come away 

from here is that it is unclear whether plan sponsors know that 

there is an asymmetry here. In some other cases—— 

Senator CORKER. Yes. Yes. 

Mr. JESZECK [continuing]. Many other transactions there may 

be—both sides may have some skin in the game. When we looked 

at these transactions in this instance, in the case dealing with cash 

collateral reinvestment, the losses are borne by the participants. 

Now, the other issue here is, is that the participants, at least 

from the work that we have done, are not aware—they are not 

even aware of securities lending in general, much less the fact that 

they are bearing an additional risk here. And I think that is the 

issue. It may be typical in the industry, but I think in general, it 

would be—I think it would be more—I think it would be nice—I 

think it would be helpful for plan participants, who, after all, it is 

their money, and we are placing the responsibility on plan participants to invest prudently, to have information about these transactions and the implications of these transactions. And it may be 

in that case that many plan participants may choose to assume the 

risk of these transactions and go forward. We know that risk preferences for individuals vary across the board. But I think for us, 

the key thing is that plan participants should be aware of the particular relationship—the dynamics of these agreements. 

Senator CORKER. I appreciate what you are saying. I have to tell 

you that I would go back to one of the earlier witnesses. I think 

plan participants sign up more on a sort of global basis of what 

they think the fund does. I would assume that Honeywell has 

hedge funds in their fund, and I would assume that there is all 

kind of long, short, all kinds of activities taking place that a standard typical plan participant would have no idea what that means, 

nor the risk involved in that. But they would assume that the plan 

sponsor is making a prudent allocation of resources there. 

I can assure you that if I had to know all of those things myself—signing up for a defined contribution plan—again, I am not 

the most sophisticated person. I do not want to know all that, and 

I do not know that you are really doing the participant a lot of good 

in knowing that. I assume a long disclosure form would be okay, 

but, again, I do not see—I think we are barking up the tree. 

Mr. Blount, do you want to add to that? 

Mr. BLOUNT. Senator, I think we can even go beyond the mutual 

fund or the investment world. People buy stocks for airlines, and 

airlines engage in hedging strategies to protect their cost as fuel 

prices change. Some do, some do not. If you buy an airline stock, 

you do not necessarily understand what the hedging strategy is. 

Senator CORKER. You might not know that Southwest made inordinate profit for years because they had a great hedge that was 

going to disappear in a month, right? 

Yes, ma’am. 

Ms. KLAUSNER. Thank you. I just wanted to make sure I made 

sure the record was correct. I am not confident that we actually 

have hedging or hedge funds specifically in our Honeywell 401(k) 

plan funds. 

16 

Senator CORKER. But you might. 

Ms. KLAUSNER. We clearly—it is possible. What I wanted to note 

was that we certainly have many funds that are index based and 

some that are actively managed. And our participants do understand, through a lot of disclosure, not only through our summary 

plan description, which I discussed or noted before, but through 

what we call our fund fact sheets, which are very dense pieces of 

information about all aspects of each fund, including with charts so 

that those that are better to understand things through, you know, 

a description of whereas others through an illustration. There are 

varying ways to understand what is there. 

In terms of getting to the granular level of talking about securities lending and how that may or may not impact the fees of a fund 

manager, I think that goes to your earlier question, does that provide meaningful information to the individual, or is it just piling 

on additional information so that the salient points that you want 

them to know about actually get lost in the density and the volume 

of information being provided. 

Senator CORKER. Now, I know that I have used a lot of time. I 

just—we did some calculations yesterday, and for a young person 

beginning to invest in a defined contribution plan and not having 

the option of lending securities as part of that portfolio, it makes 

a huge difference at their time of retirement. We looked just on a 

sort of an ordinary, very conservative basis that if that option were 

not available to an individual starting out at age 25 and working, 

that it is likely they would actually have to work a minimum of a 

year longer, if not more, if that option is not readily available to 

them. Would any of you all like to comment on that? So, in essence, 

if we sort of regulate it out and make it so it is very difficult for 

that to occur, what we are really doing is hurting individuals from 

the standpoint of amassing a retirement that allows them to retire 

at an age they would like to retire. 

Yes, sir. 

Mr. NAZZARO. Senator, I would say that just by that fact, securities lending has merit. The issue before me as I looked at this is 

really about how much risk one is willing to accept. Done in its 

basic form, it should be as low risk as possible, and that is how securities lending has always been. I think it got away from us a little bit in the 2003 to 2008 period. All we are really talking about, 

from my perspective, is reining that in a little so that it becomes 

the modest, low-risk activity that it should be. It is only meant to 

hit singles, not home runs, and that is what I would like to see it 

get back to. 

Senator CORKER. Do you think the industry, as Mr. Blount mentioned, has the ability to take care of that themselves and learn 

from what has just occurred? 

Mr. NAZZARO. Yes, Senator, I do, and I think they are already 

moving in that direction, to their credit. 

Senator CORKER. Thank you. Somebody wants to speak. I do not 

know if I have taken too much time. 

The CHAIRMAN. No, go right ahead. 

Senator CORKER. Thank you. Mr. Meier. 

Mr. MEIER. Thank you, Senators. 

17 

I would just like to comment. I agree. I do think that securities 

lending is a very viable, long-term strategy. I think it is an excellent source of low-risk incremental income. I think you have to look 

at the risks associated with securities lending in light of the unprecedented financial crisis that we have been through and potentially are still in, hopefully at the tail end of it. 

But I think what we saw over the last three and a half to four 

years is really a perfect storm in terms of excess leverage in the 

marketplace. Credit spreads are very tight. I do not think what we 

saw happen over the last few years is going to happen again, and 

I would hate to see us eliminate securities lending as a viable investment strategy for individual plan participants as a result of 

that. And, again, I would agree with your assessment. It can make 

a significant difference in a young person’s retirement savings over 

a period of time. 

Senator CORKER. Thank you, Mr. Chairman. Thank you. 

The CHAIRMAN. Thank you, Senator Corker. 

Senator Blumenthal. 

Senator BLUMENTHAL. Thank you, Mr. Chairman. And I want to 

express my appreciation to you for holding this hearing on a very 

profoundly important topic. And I apologize for my lateness, but 

like many of us, I had several hearings and meetings at the same 

time, and I have been following your testimony. I want to thank 

everyone who is here today to educate us for the very important 

testimony that you have given. 

And it is important because obviously this issue is of profound 

and growing importance. We have made great progress in fighting 

poverty among our seniors. The rate is down from 50 percent in 

1939 to 10 percent now, largely because of Social Security, which 

is one of the reasons why I have strongly opposed any measures 

to cut Social Security. But in 2009, 49 million Americans were active 401(k) plan participants—many thousands in Connecticut as 

well—dependent on these plans for their financial well-being, and, 

in fact, for many of them, a primary way to save for retirement. 

And I understand your point, Mr. Meier, and others here, that the 

recent crisis—the near collapse of our economy—may have been a 

perfect storm, but there remains the possibility that there may be 

similar storms, perhaps not of the same severity, but equally 

impactful on the lives and livelihoods of people saving for their retirement. 

So, my first question is to you. I understand that State Street 

has effectively managed securities lending funds during even this 

very difficult time. In terms of disclosure, you mentioned that you 

went above and beyond the Federal guidelines to keep your clients 

informed. But do you believe that more clear Federal banking regulations are appropriate and necessary to assure that others—other 

service providers follow that lead? 

Mr. MEIER. Thank you for that question, Senator. As I intimated 

earlier, we are completely committed to transparency. And I do 

think transparency certainly helps level set expectations. I think as 

an investment manager, it sets for a clear discussion around investment goals and objectives. I, for one, do not want to be in a 

conversation with a client that is suddenly surprised at the outcome. So, again, we are committed to transparency. 

18 

In terms of the specific Federal regulations or changes that you 

are talking about, Senator, I am not familiar with those. I would 

be happy to look at them and perhaps come back, if that is appropriate, and give you some feedback on whether I think that would 

help the situation. But I just have not seen them at this point. 

Senator BLUMENTHAL. So, your answer would presumably be— 

and I do not mean to put words in your mouth, but what I hear 

you saying is in spirit, yes, and you would want to see the specifics 

before you either approve or disapprove of the particular regulation. 

Mr. MEIER. Yes, sir. That is correct. 

Senator BLUMENTHAL. Anyone else have a—yes, sir. 

Mr. BLOUNT. Senator, I think that if we draw a line between the 

crisis problems that we are discussing here and Federal banking 

regulations, at the moment—and I am not a lawyer, so there this 

probably needs to be vetted—if a bank were to guarantee the investments of any securities lending pool, there would be 100 percent risk capital charge to the bank, which would basically put it 

off the table. It would make it too expensive. But when the banks— 

State Street, I think, in particular—applied for a work around to 

that, the FED was pretty flexible in saying, well, it depends on 

what you invest in. If you were to invest in overnight treasury 

repos, then there is a way to reduce those capital charges. 

Now, the unfortunate part of that is that you really cannot make 

any money in the securities lending pool if that is what you are investing in. But the concept of reducing the capital charges as a result of a more conservative investment strategy is, I think, a direction that might be explored further. And I believe that it is possible 

to create incentives for the banks and brokers relative to their capital charges, especially as Basel III comes in, that would encourage 

either more conservative—not implying that the current strategy is 

too aggressive—but more conservative implementation of strategies, as well as disclosures that help cash managers themselves 

know where they are. 

One of the problems in the securities lending cash management 

world is there is virtually no contemporaneous information. You do 

not know what is happening at other pools, so if you are to protect 

your competitive position, there is an incentive to try to be a little 

bit more aggressive. So a little bit more information perhaps combined with an incentive in the capital charges might be worth exploring. 

Senator BLUMENTHAL. Well, I really welcome that comment insofar as it says that more information, in effect, more education 

might be welcome and specific incentives for the kind of steps that 

you would recommend. Do you have more specifics about the kinds 

of incentives, to use your word, that might be provided? 

Mr. BLOUNT. Well, I tend to think in terms of metrics, having 

run a data business, rather than information. So I would—which 

is a calibrated form of information—write the metrics that allow 

you to compare where you are to others. 

I think the SEC looks at these matters, among other directions, 

in terms of systemic risk. So the capital charge credits or the capital credits might be somehow tied to some reduction and overall 

19 

systemic risk through a conversation between the FED and the 

SEC, but that is beyond my pay grade. 

Senator BLUMENTHAL. Well, whether it is within your pay grade 

or outside it, I would welcome additional specific thoughts you may 

have. You may want to consult with some of your colleagues and 

anyone else now or afterward. I think normally we keep open the 

record for additional comments, so I would welcome specific responses, both Mr. Meier, to the question I asked you and others. 

We do not always have all of the answers at our fingertips, as I 

know from having been on your side of the table. So if you want 

to follow up, we would welcome it. 

Mr. BLOUNT. I would be happy to do that, Senator. 

Senator BLUMENTHAL. Thank you very much, Mr. Blount. 

Mr. Nazzaro, your suggestions to protect pension funds and limit 

their risk include increased documentation, and more stringent 

guidelines for cash collateral reinvestment, and more reporting requirements and loan limits. What do you think the effect would be 

on loan servicers? And I apologize if you may have covered this 

point in part. And would that kind of increased regulation be too 

much of a burden, in your view? 

Mr. NAZZARO. I do not know if it would be too much of a burden 

on loan servicers. What I am trying to—the message that I am trying to get across is that securities lending is a short-term, overnight, week, day activity, and there is an imbalance when corresponding cash collateral investments are five, six, and seven 

years. There is no correlation there. So what I am suggesting is the 

maturity ranges of the cash collateral portfolio should be much 

shorter than the broader guidelines that had been in place. But as 

we mentioned a few minutes ago, the industry has recognized that 

because of what has happened in 2008, and I believe there has 

been self-correcting in that regard. So I think the large providers 

of this service are shortening their maturity guidelines and tightening up their regulations and their investment portfolio, and that 

is what I think is important to protect retirees and pension plans. 

Senator BLUMENTHAL. Do you think the self-correcting has been 

sufficient? 

Mr. NAZZARO. That I don’t know because it is not possible for me 

to monitor industrywide the banks. But some of the larger providers, I believe, have moved in that direction, but I cannot speak 

for all of them. 

Senator BLUMENTHAL. Where would be the best place to get that 

information? 

Mr. NAZZARO. I don’t have the answer to that. I do not know. You 

would have to be privy to the programs within each individual provider. I am not privy to that. 

Senator BLUMENTHAL. So if we asked each individual provider, 

that would be the best way. 

Mr. NAZZARO. I suppose so. Yes, Senator. 

Senator BLUMENTHAL. Thank you. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator Blumenthal. 

To Mr. Nazzaro and Mr. Blount, both of you have been in the securities lending business for over 30 years. Could you explain some 

of the problems that pension funds experienced during the financial 

20 

crisis with respect to their securities lending programs? And based 

on that experience, what might you recommend that we do to prevent these things from happening again? 

Mr. NAZZARO. I would be happy to start. 

The CHAIRMAN. Mr. Nazzaro. 

Mr. NAZZARO. As I stated in my prepared remarks, Chairman, 

the guidelines are the first place I would start. I think that the 

large providers of securities lending services to the plan sponsors 

and pension funds, because it is a worthwhile activity, as we have 

agreed upon, but I think because of the profit that has been in 

there from 2003 to 2008, I think it was easy to extend maturity 

guidelines and to just go a little bit far out on the risk curve and 

the yield curve, and I think that needs to be reined in a bit. So, 

the shorter the maturity of these investments would reduce the 

risk and exposure. I think that is probably the single most important point. 

Also I would—many times it is easier to think about this as an 

equation. You have the securities lending side of the equation, then 

you have the cash collateral reinvestment side of the equation. 

Banks, custodian lenders, very large entities have done a wonderful 

job on the securities lending side of the equation. They have protected their clients’ assets. They have demanded 102 percent from 

the counterparty borrowers and marked that to the market every 

single day. That side of the equation I think has done extremely 

well. What I am talking about is now that you have the 102 percent from counterparty borrowers, it is the preservation of that 102 

percent at all times. And I think you can do that well as long as 

your maturity range is short. If you are going to then take that 

cash collateral and go out three years, four years, five years, six 

years, I think you are adding risk as you go further out with those 

investments. That was the lesson, I believe, we learned a couple of 

years ago, and that is why it is part of my recommendation. 

The CHAIRMAN. Thank you. Mr. Blount. 

Mr. BLOUNT. Senator, I would affirm what Mr. Nazzaro says in 

general. But I think there are a couple of lessons that can be taken 

from the crisis. I think historically it has been very easy for pension funds and their consultants to look at income projections expected from securities lending programs and the revenue split as 

the primary metrics when you evaluate different service providers. 

Those are easy, either 70/30 split or 80/20. You take the 80/20. 

Sounds great. Income of an expected $10 million a year versus $5 

million a year, take the 10. But there has to be a greater focus on 

what I call a holistic review of the risk within a lending program. 

Historically the industry has corrected very well. In 1982, there 

was a default by a firm called Drysdale, which caused Chase Manhattan to step up and write a $200 million check to cover its customers. After that, the industry decided that they had to market 

all the loans, so that was a self-correction. There were several others, and I will not go through all the details. But the industry corrects constantly. 

Holistically, the big risks in a lending program, if you assume 

that the collateral margin of 102 percent is enough to cover defaults, the big risks come from the difference between the assets 

and the liabilities, just like a bank. So on the liabilities side, it is 

21 

what the lending program owes to the borrowers because the borrowers, being brokers, will return the securities that they have borrowed and say, give me back my cash collateral. That is a huge 

risk. That is like the risk of depositors coming to a bank and saying, give me back all the money that I have deposited. 

Just like a bank, securities lending programs have invested with 

a gap—a maturity gap that generates a profit, so pensions have to 

look at what those redemption patterns are, the possibility that depositors may come back. The consultants have to take this look, 

too. They have to look at the assets, so not just focusing on the assets and the quality of the assets, but the potential for a run on 

the bank, the risk of the liabilities coming in and making it illiquid. And I think that has been missing by most of the pension 

funds and their consultants up till now. 

I think the service providers have been saying it, but most of the 

focus from the consultants to the pension community has been on 

give me a better split and come up with a better income projection, 

and really now has to be given more balance holistically. 

The CHAIRMAN. Yes, Mr. Nazzaro. 

Mr. NAZZARO. I think we are saying the same thing on that 

side—securities lending side of the equation. If all of the 

counterparty borrowers were to return the securities at the same 

time, i.e., a run on the bank, you would have to have the liquidity 

in that cash collateral portfolio to repay all the counterparty borrowers. If you did not, you would be in default and it would be a 

huge default. So if your collateral portfolio had to be liquidated 

quickly, unless it were in short-term securities or longer-dated securities, such as we found in 2008, large losses would have been 

realized. 

And, Chairman, we only look to the example of AIG. That was, 

in fact, what happened. All of the counterparty borrowers wanted 

their money back at the same time. AIG did not have the liquidity 

to give them their money back; hence, the bailout and the $20 some 

odd billion infusion that went to cover counterparty collateral. So 

we know what that looks like, and that is a very—that is a doomsday scenario. And Mr. Blount is right; we want to learn from that. 

The CHAIRMAN. Mr. Meier. 

Mr. MEIER. Senator, if I can comment. I work at a very conservative firm. We manage our assets prudently. We managed through 

this crisis. If I can give you a couple of data points. From June of 

2008 to December of 2008, we saw a 50 percent reduction in our 

securities lending balances. We were not a forced seller of any securities and in the liquid market throughout the crisis. And I think 

it is important to remember that prudent management doesn’t 

mean taking unnecessary risks. 

If you look at our portfolios, irrespective of whether they can invest a little further out on the curve, certainly not five or six years, 

at the heart, all of our portfolios—our cash collateral portfolios or 

money market portfolios—was what I refer to as a spread product 

overlay where we might buy unsecured debt in a 1- to 3-year space 

or asset-backed securities in the 1- to 3-year space. And those investments typically provide diversification benefits away from unsecured credits, away from M&A risk, and risks of downgrades associated with rating actions. 

22 

So I do think when you look at risks, you look at the management of these portfolios, they need to be managed prudently. They 

do need to be managed to a very high standard of liquidity. 

There is also the concept in these portfolios of latent liquidity, 

where a lender has the ability to simply put out more loans as opposed to sell assets in a declining market. And, again, we use those 

tools in terms of managing that very important asset liability mismatch. 

Mr. BLOUNT. And I think there is one more point, to extend Mr. 

Meier’s point, that it has been overlooked that during the fourth 

quarter of 2008, which was the worst of the crisis, that the securities lenders recognized the risk that they were dealing with, and 

they increased the rebates to the borrowers in order to hold those 

balances in place. And it got to a point where they were paying out 

what amounted to negative rebates. They were encouraging the 

broker-dealers to keep the funds in place, and it was pretty effective. It kept the balances until the worst of the crisis was over. So 

it was a holistic approach. 

The CHAIRMAN. Yes, Ms. Klausner. 

Ms. KLAUSNER. I would just like to add a comment to try and 

maybe put this all in a bit of perspective. Clearly I am not an investment specialist, and my knowledge is based upon my personal 

experience in being counsel to the Savings Investment Committee 

and learning a great deal from them. 

However, we are talking about liquidity, and we are talking 

about whether or not there should be potentially new rules or new 

guidance in terms of how the securities lending funds should be 

managed in terms of their liquidity, and whether or not, you know, 

there is undue risk in the event of certain doomsday events occurring and there being a potential run on the bank. 

But those concepts exist at varying levels in a defined contribution plan. So, again, just to put this in perspective, here’s my example. We have a Honeywell common stock fund. Now, we are very 

clear that it is not 100 percent stock. There is a cash buffer there. 

I believe our cash buffer is targeted to be about 3 percent. It allows 

that there would be daily trades and to be liquidity. 

There are some individuals who actually will be disappointed 

that there is cash in the fund in order to allow for liquidity and 

daily trades because they caught a drag on the market when the 

Honeywell common stock is going up. On the other hand, there are 

people who are disappointed that there is not enough cash when 

stock is going down. 

The point here is that at all levels, not just with regard to the 

small portion of the fund that has securities lending, is liquidity 

issue. It is an issue that we look at as a fiduciary at a larger level 

as well. So, in terms of take-aways, the question might be, do we 

have to or should we create a situation where we are creating rules 

about liquidity specifically only for securities lending feature, or 

are there basically prudent rules that are already out there today 

with regard to the investment funds as a whole, including the securities lending feature. 

And so, I caution, again, not to look necessarily in a vacuum—— 

The CHAIRMAN. Sure. 

23 

Ms. KLAUSNER [continuing]. But to look at the larger picture as 

well. 

The CHAIRMAN. Well, that brings me to a question for you, Ms. 

Klausner. When your company, Honeywell, reviewed the securities 

lending practices within your own 401(k) plan, Honeywell decided 

to transition out of securities lending within your plan. What happened? 

Ms. KLAUSNER. A couple of things. One is we had our doomsday. 

We had our crisis, so there were a lot more issues to be reviewed 

at a very high level. When we were looking at what was going on 

with Lehman Brothers and all of the other players that were showing signs of collapse, one of the things that we looked at was 

whether or not the securities lending funds and the collateral there 

were at risk. Not my personal review, but the review of the investment managers who brought the information back to us, said the 

answer was no. As long as we allowed the collateral to stay put and 

we did not try and cash in on it and then ultimately realize a loss, 

we would not be at risk. 

So why did we move out? We recognized that because securities 

lending relationships were going to change, we would no longer in 

the future have an opportunity to get the benefit in the same manner as we did before. Securities lending would no longer be as—I 

do not want to use the word aggressive—but maybe not as conservative. We knew that the fees that were going to be charged and the 

differentials between non-securities lending funds and securities 

lending funds would be a smaller differential. 

And so at some point, the potential benefits of having those 

funds would not really necessarily outweigh the risks, coupled with 

the idea that we were in a gatekeeping situation, as Mr. Meier 

pointed out, not at a participant-directed level. Participants at each 

level were able to make their daily trades if they so chose or if they 

wanted to rebalance on a quarterly basis. They were welcome to do 

that, and there was no impact to them. 

But should we want to, from a fiduciary perspective, add perhaps 

a different investment manager in the same asset class, or if we 

wanted to put a competing one, which was a nonsec lending fund, 

we would have had adverse impact because of the gatekeeping 

measures. 

So given that then economic environment and the one that we 

expected in the then near future, we really believed it was not 

going to be in the best interests of our plan participants. We do, 

however, want to have the door open because, as with everything, 

there is a lot of learning that goes on. There is change in our economic environment, our financial environment, as well as our regulatory and legislative. And we want to leave open the door that 

should it be prudent to allow people to get the benefit as the landscape continues to change, to go back in and provide that opportunity to our participants and our retirees so they can maximize 

retirement security. 

The CHAIRMAN. Okay. Senator Blumenthal, any other thoughts? 

Senator BLUMENTHAL. No thank you, Mr. Chairman. 

The CHAIRMAN. I would like to thank all of our witnesses for 

your presence here today and for your very informative testimony. 

I think we have had a very productive conversation. In light of toVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
24 

day’s hearing and the findings of our committee investigation on 

securities lending, I would like to make some common sense recommendations. 

First, employers, I believe, should increase their knowledge on 

securities lending within their defined contribution plans. The committee report outlines a few simple questions that all employers 

should know the answer to. For example, employers should ask 

their fund manager, ‘‘Do the investment options within my plan 

participate in securities lending?’’ They should. I’m not saying we 

should have a law. They should know. 

Number two, the Labor Department should help employers better understand this practice by developing basic information and 

tools for them on securities lending within their retirement plans. 

Three, participants should be given easy to understand information about securities lending to help them make informed decisions 

when selecting investments within their plans. 

And, four, there is currently no comprehensive public data available about securities lending, including securities lending in retirement plans. 

Therefore, we recommend that companies in the business of securities lending report information about their business practices to 

the Federal Government. 

I notice you were all writing it down as I was talking. Before we 

conclude the hearing, would anybody have any disagreement on 

those recommendations? 

Yes, Mr. Blount. 

Mr. BLOUNT. Senator, just to reiterate a point I made earlier, I 

think the—if I was an editor, I would offer changing the word information into metrics. 

The CHAIRMAN. Okay. 

Mr. BLOUNT. Something that is a little bit more precise, relative 

rather than piling on information. 

The CHAIRMAN. Good suggestion. 

Mr. BLOUNT. Thank you. 

The CHAIRMAN. Yes, Ms. Klausner. 

Ms. KLAUSNER. The only additional comment I would make is 

when you talk about giving participants easy to understand information, and I completely concur that any information they are provided must be easily understood. 

I have suggested in other hearings and platforms, I think that 

there is an opportunity here, even as an aging committee, to recognize that there should be some coordination so that employers, employer plans, employer sponsors, third party administrators, you 

know, do not bear the full brunt on educating our community—our 

society—on what it means to invest, whether it’s invest through a 

plan, invest a plan with assets that are or are not with a securities 

lending feature. 

And if there is an opportunity here to recognize, as you said before, that our youngest workers need to understand from the first 

day they start working and the first day they start earning pay, an 

opportunity to make investments. You know what is out there in 

terms of the current landscape. And that that opportunity is not 

something that should be a burden on employers, plan sponsors, 

third party providers, that we should be players in that opporVerDate Nov 24 2008 13:46 Aug 17, 2011 Jkt 067300 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\67300.TXT SHAUN PsN: DPROCT
25 

tunity. But perhaps, you know, other departments and other regulatory agencies could participate in getting individuals in society 

prepared so that, when we give them information or disclose to 

them information as workers, they are ready to receive it. 

The CHAIRMAN. Well said. 

Mr. JESZECK. Senator, I would say—— 

The CHAIRMAN. Yes, Mr. Jeszeck. 

Mr. JESZECK [continuing]. This would be consistent with the findings of our report. We would support all of those suggestions. I 

think in particular, something we did not talk a lot about in the 

report, but the issue of data. One of the handicaps we had in doing 

our work here was the lack of data, really getting our arms around 

the world of securities lending. How much is going on? Who does 

it involve? How much does it involve defined contribution plans? 

And I think that would be—data in this would certainly, I think, 

make our understanding of the issue and coming out with some solutions to the extent that there are problems there much more 

easy. 

The CHAIRMAN. Yes, you are right. As I am sure you know, we 

refer and cover that in our final recommendation, the accumulation 

of data, so we understand what the dimensions of this whole issue 

are. 

Yes, Mr. Meier. 

Mr. MEIER. Senator, my only comment or suggestion would be, 

to focus on informed disclosure or data information with context, 

because I do think it is dangerous, for example, to simply publish 

a list of holdings without context in terms of the benefits of the 

portfolio, or the structures that underlie those specific securities. 

I can give you an example, the Rule 2a-7 disclosure requirement. 

We are required to post our holdings in a money market fund on 

a weekly basis. We do it on a daily basis. But the issue is, if a client looks at a holdings report and sees an asset-backed commercial 

paper conduit, they do not necessarily know who the liquidity support provider is, or the due diligence that we have done in the assets. They do not understand whether it is an appropriate and reasonable investment. And, frankly, that was what, I believe, started 

or was a considerable contributing factor, to the liquidity crisis in 

August of 2007. It was investors in money funds pulling out of 

money funds because of asset-backed commercial paper holdings 

without context—they had knowledge that they had those holdings, 

but they didn’t have context around the risks associated with those 

conduits. 

The CHAIRMAN. Thank you. Good comment. 

Mr. MEIER. Thank you. 

The CHAIRMAN. Yes, Senator Blumenthal. 

Senator BLUMENTHAL. Yes. Thank you, Mr. Chairman. I think 

those suggestions or recommendations are excellent as a starting 

point, and certainly we may want to consider going beyond them 

based on what we’ve heard and what we may find out. But I think 

the Staff Report, combined with the GAO Report, provide a really 

important source of information and a beginning point. And I 

would support those recommendations as well. 

Thank you. 

26 

The CHAIRMAN. Thank you very much, guys. You have been 

great. 

[Whereupon, at 3:20 p.m., the hearing was adjourned.] 

(27) 

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