Who pays when the people who oversee retirement plans bet on risky investments and end up losing big time?

Thursday’s settlement deal in a case brought by a onetime Philadelphia area saxophonist against a $2 billion musicians’ pension fund shows that the trustees who ratify advisers’ and outside managers’ investment picks can be held responsible for their mistakes.

Management and labor trustees who oversaw the American Federation of Musicians and Employers’ Pension Plan for 50,000 working and retired entertainers will have to pay the fund $26.85 million -- minus up to $10 million in legal costs-- to settle a civil complaint that they gambled tens of millions away on poorly performing private equity and foreign investments. They did all that while avoiding U.S. stocks even as their value soared in the early and middle 2010s.

That’s according to the agreement between lawyers for trustees for the joint plan, co-managed by the American Federation of Musicians labor union, a group of employers including Time-Warner, Disney and Broadway theater owners, and the musicians who brought the suit, including Andy Snitzer, a Cheltenham High graduate known for his work with Paul Simon, Sting, and the Rolling Stones.

Pending approval from a federal judge in New York, the money will be paid by trustees’ board insurance -- which, though adequate in this case, is rarely called on to cover claims this expensive, said the musicians’ lawyers Steven A. Schwartz and Robert J. Kriner Jr. of Haverford-based Chimicles Schwartz Kriner & Donaldson-Smith.

Lawyers for the industry trustees, at the big New York corporate law defense firm Proskauer Rose, confirmed the settlement, which avoids “a needless and disruptive court battle” but does not result in trustees acknowledging they did anything wrong, according to a statement by James Chase, for the trustees.

“We have always taken our fiduciary responsibility seriously and acted prudently in the best interests of all Plan participants,” he added, speaking for the trustees. He noted that the trustees took other steps to cope with the funding deficit, including sharp cuts to benefits and early retirements, and boosted employer contributions, which rose from $54 million in 2009 to $76 million last year.

Besides paying cash, Chase noted the plan has agreed to reforms. Those include the appointment of veteran pension lawyer Andrew Irving as Neutral Independent Fiduciary Trustee for the musicians’ plan, which Schwartz said would make it less likely that the trustees will make high-risk investments.

The pension could certainly use additional cash. It had $1.8 billion in assets and $3 billion in liabilities as of early 2019, making it about 60 percent funded. It has only 21,000 working members paying in, compared with 15,000 retirees or survivors who are collecting and 14,000 others who no longer work but are eligible to collect.

What went wrong? The plan “got clobbered” in the stock market collapse of 2008. The trustees realized that, with a high proportion of retirees to paying members and fewer musicians making a living in the digital era, "the pension plan would run out of money” in 30 to 40 years, said Schwartz, the musicians’ lawyer.

What to do? By 2010, the U.S. stock market had fallen by nearly half from its pre-mortgage-crisis high. Plan leaders -- including union heads elected by members, as well as employer representatives (the Philadelphia Orchestra was part of the plan before its 2011 bankruptcy) -- should have broadcast the fund’s dim future and pushed for more pension contributions or reduced benefits.

But instead of braving those unpopular steps, trustees “made a decision: ‘Let’s gamble our way out of this,’” said Schwartz.

Among other steps, they doubled investments in two categories -- “emerging” stock markets in developing economies , and private equity, typically buyouts of troubled U.S. companies. Those bets came to comprise 9 percent of the fund, and reduced investment in U.S. stocks, which were beginning their longest sustained price increase since World War II.

Over the next year, “emerging markets,” instead of rising, fell so sharply that market wags called them “submerging markets.” Many private investments also floundered.

That didn’t scare the board. “They doubled down,” said Schwartz, boosting emerging markets to 11 percent and private equity to 15 percent -- totaling more than a quarter of the fund, from less than 5 percent two years earlier. At the same time, they continued to reduce U.S. stocks to around 20 percent at a time when the Philadelphia city pension system and many other large plans were closer to 40 percent.

U.S. stocks continued to beat the private and foreign investments that the trustees favored. No matter: In 2015 the board approved boosting emerging markets yet again, to 15% of the fund, and private equity to 18 percent -- totaling one-third of plan assets.

Many of those investments proved a drag on plan returns. They reduced profits when other long term investors, including the Montgomery County pension fund, were switching to Vanguard Group-style index funds, which, they noted, tended to do as well as or better than professional stock-pickers, at lower fees.

According to the complaint, the fund didn’t make clear enough to the members that it was in trouble, as required under the federal ERISA law. “It’s easy to play ‘hide the ball’ in reports to pension plan participants," said lawyer Kriner. The trustees’ lawyers said their clients complied with the law.

Growing worries about the pension plan and the prospect that benefits might have to be cut led to the formation of a dissident union group, Musicians for Pension Security. In 2018, Tino Gagliardi, a pension trustee, and career trumpeter, was defeated in his bid for re-election as president of musicians’ Local 802 in New York. (He remains on the pension board.)

Will the fat legal settlement clear the way for other pension complaints against trustees? “I bet, when you see some of these pension plans tanking and losing value in the future, if you look at their prior disclosures, you’ll see similar problems,” said Kriner.

Still, the musicians’ case has unusual features, said Schwartz. “No other plan took quite this kind of allocation plan,” he said. The trustees had effectively “pulled the goalie,” he said, referring to the hockey move where the losing team replaces its goalie for an attacker in hopes of coming from behind -- but risks losing more decisively.

From January 2010 - November 2017 the Plan had average annual returns of about 7.56%, according to the plaintiffs; Vanguard’s Index Balanced Fund returned 9.79% in that period, a significant difference underlining the shortfall from the trustees’ unusual, aggressive approach, said Schwartz.

With nearly $2 billion in assets, the plan lost out on more than $40 million a year in investment returns by pursuing its unusual strategy -- times seven years. The settlement covers a fraction of the potential loss

“The message here is, if you are going to take out-of-the-box risks as a pension plan trustee, you better disclose that you are doing that, and make very sure about understanding, not just the potential upside of the risk, but also the downside."