investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
(November 3, 2006) Retirement Savers Respond to Call for “Ownership Society”

Money Matters

There are five articles presented below.

Retirement Savers Respond to Call for “Ownership Society”

There are sure signs that Americans are responding to President Bush’s call for an “ownership society” in which each individual is responsible for his own retirement security. However, it seems unlikely that the President envisioned the investor response to which we are referring. It’s easy to say that individuals should take more responsibility for their retirement. We as a nation agree that self-reliance is a virtue. Far more challenging is identifying and implementing changes to our existing legal and regulatory scheme that are necessary to make this vision a workable reality. After all, workers have been told that this “ownership society” model is in their best interests. Workers are suppose to benefit, even as America’s corporations emerge more globally competitive, freed of their old fashioned pension obligations to workers. The benefit America’s corporations will realize from shifting responsibility for retirement security onto workers is clear; however, unless fundamental changes are made today (the beginnings of which we believe we are witnessing already) workers will be the losers.

At the outset let’s clarify two fundamental misconceptions. First, we are not talking about individuals actually taking responsibility for managing their retirement assets themselves. In our “ownership society” individuals are generally required to hire financial services firms, largely mutual fund money managers and stockbrokers, to make investment decisions for them. For example, an individual is not free to take the assets from his IRA or 401k to start a restaurant or purchase a herd of dairy cattle for milk production, to provide retirement income decades from today. The legal and regulatory scheme essentially mandates investing in securities, doing business with money managers and stockbrokers. Opening a retirement account with such firms almost certainly involves entering a world of industry “self-regulation,” leaving behind important legal and regulatory protections.

There is an insurmountable conflict of interest inherent in self-regulation. That’s why the rest of us, who are presumably at least as trustworthy as stockbrokers, are not allowed to self-regulate. Today the brokerage industry is allowed not only to self- regulate but also self-adjudicate (through mandatory arbitration provisions in contracts with investors); self-insure (through the Securities Investor Protection Corporation) and even control public access to disciplinary records regarding its membership, such as regulatory, civil and criminal information.

Brokerage industry self-regulation as we know it today originated at a time (the 1930s) when less than one percent of Americans had brokerage accounts. There was no public outcry for true regulation of the brokerages because at that time the lives of most Americans were unaffected by the industry. While self-regulation may have made sense back then, in today’s “ownership society,” all Americans with retirement savings are expected to have at least one brokerage account and indeed the majority of American households already do.

Self-regulation makes no sense today. If we are going to hold individuals responsible for their retirement decisions, then it only makes sense that we hold the firms Americans entrust with their retirement assets fully accountable for their actions. All of the legal and regulatory protections must be in place for investors to rely upon in holding Wall Street responsible for wrongdoing. In our “ownership society,” owners must have rights. Owners must vigorously protect their pecuniary interests. They do not rely upon others to protect them, especially not conflicted self-regulators. We do not want disempowered owners, unable to defend their accumulated wealth.

The second fundamental misconception is that in our “ownership society” individuals are free to choose which Wall Street firms they invest with. In company-sponsored retirement plans, the sponsor of the plan is required under the existing legal and regulatory scheme to initially prudently select a menu of investment options from which the individual may choose. In short, the sponsor still has certain responsibilities with respect to the retirement plan and the plan participants lack complete discretion regarding investments. If the sponsor fails to fulfill his duties, theoretically the Department of Labor may take action against him. We say “theoretically” because unfortunately, the Department of Labor does little to enforce sponsors’ fiduciary obligations.

For the “ownership society” to work, i.e. for workers to be successful in taking responsibility for providing for their own retirement security, the duties of money managers, stockbrokers and others responsible for managing retirement assets must be re-evaluated, further defined and strengthened. In a world where all Americans are forced to trust such firms with the majority of their wealth, we cannot afford uncertain fiduciary standards and lax regulation. In our “ownership society” the duties of the companies that sponsor retirement plans must likewise be re-evaluated, further defined and strengthened. We cannot allow workers to be doomed to join the ranks of the elderly poor, as a result of negligent investment decision-making on the part of their employers.

We now see signs that suggest the changes necessary for a successful transition to an “ownership society” are beginning to take place.

First, financial services firms of all sorts are increasingly being held accountable for breaching their fiduciary duties to retirement investors. Conflicts of interest, hidden financial arrangements and unscrupulous business practices that have existed for decades are being exposed daily. Mutual fund practices such as excessive investment advisory fees, directed brokerage, soft dollars and undisclosed revenue-sharing are notable examples. Additional practices unique to the variable annuity business, such as endorsements paid to non- profit associations for marketing assistance, are surfacing, compounding the improprieties related to the mutual funds within the annuity product. Firms that do not live up to their fiduciary duty to place the interests of their clients before their own, as well as disclose any conflicts will be punished. For example, the recent class action lawsuit brought by the Orange County (Florida) Sheriff’s Office against Nationwide for undisclosed revenue-sharing within group annuities offered to 7,600 Section 457 deferred compensation plans nationally may result in 457 plans finally becoming worthwhile investments. Today most of these plans are so costly and poor performing that the participants will be lucky to see their principal intact upon retirement.

For plan sponsors, the recent explosion of litigation involving many of the largest, lowest cost 401k plans sends a message that decades of ineffectual regulation by the Department of Labor could not. Corporations that do not take seriously their fiduciary obligations will be penalized. Reliance upon industry experts for “comfort opinions” to the effect that all’s well as long as the sponsor’s actions are consistent with questionable industry practices, will not suffice in the future. Longstanding industry practices are being challenged daily.

In our new “ownership society” where workers are forced to assume greater responsibility for their retirement security, we had better be prepared to see them begin to behave more like owners, fiercely protective of their hard-earned savings. Elected representatives who fail to take note of this change in national mood and continue to do the bidding of the financial services industry, may find themselves swept into premature retirement.


Merrill Under Fire from Florida Pensions

Article published on Nov 2, 2006

By Raquel Pichardo

The Florida unit of Merrill Lynch's consulting arm has come under fire from two local pension plans for not clearly disclosing revenue the firm was earning from investments it recommended.

The two funds claim Merrill was less-than- forthcoming on issues regarding fees and used costly share classes of mutual funds when cheaper ones were available. Both pensions have replaced or are in the process of replacing the firm as consultant. A Merrill spokesman says the firm was fully transparent on the nature of its investments.

Consultants with brokerage arms have come under scrutiny in Florida in the past year as federal regulators, state and independent investigators question potential conflicts of interests that can arise by offering both services. Last December, Merrill informed its clients it received a subpoena from the Securities and Exchange Commission concerning its Florida consulting operation. The SEC is also investigating Smith Barney, another consultant that operates heavily in the state, and has contacted pension clients for information.

The $15 million City of South Miami Pension Fund claims Merrill did not immediately disclose to the fund that it received about $47,000 from three of the six mutual funds it recommended to the board. "It is my understanding that [Merrill] disclosed that they were going to take the fees.but no one asked how much," says Bradley Cassel, a relatively new board member in South Miami who began digging into the issue in May, when he joined.

Merrill had been a consultant for South Miami since early 2002 but resigned in October amid what it considered unfair actions by the board. "Of particular concern, the board effectively denied us the opportunity to be heard at the time accusations were made against us. We cannot continue in a relationship where our good faith is not reciprocated, and where we are deprived of basic fairness and courteousness," writes Alan Kirchner, financial advisor at Merrill, in an October 19 resignation letter to the fund. Around December 2005, Merrill recommended the system terminate Trusco Capital Management, which had been managing all of the plan's assets, for under- performance. Merrill then recommended that the plan invest in six mutual funds, says Cassel. The funds were Growth Fund of America, Washington Mutual, EuroPacific, Baron Asset Fund, Royce Penn Mutual and PIMCO Total Return.

In a July 17 e-mail, Cassel asked Kirchner for the total amount the firm received from particular funds. Kirchner replied the next day that it received $47, 515.12. "As I discussed with the trustees during the consideration of these options, and with you in our conversations, Merrill Lynch does have sales agreements with many mutual fund companies including the American Funds Family which include Growth Fund of America, Washington Mutual and EuroPacific," wrote Kirchner.

Cassel also questioned the use of the more expensive class A shares for those three funds instead of the less expensive R5 shares. Using Class A shares makes it easier to perform administrative duties, wrote Kirchner. "Additionally, the change from Trusco to the new fund structure has actually reduced the overall investment management fees being paid by the pension plan," he wrote in a June 23 e-mail to Cassel. That is a "bogus excuse" since the fund already has a custodian, says Cassel.

Generally speaking, consultants with a brokerage arm are not necessarily more likely to misguide their clients than an independent consultant, says Donald Trone, founder and CEO of Fiduciary360, a firm that offers advisory services on fiduciary matters. The question is not whether a consultant earned fees from using certain mutual funds, but whether they recommended the most cost-effective way to get the same return, he says. But South Miami was not the only fund to raise an eyebrow at Merrill's transparency. The City of Cape Coral Municipal General Employees' Pension Trust Fund recently replaced Merrill with Segal Advisors, an independent investment consultant, according to its Web site.

At a June board meeting, the trustees "expressed their dissatisfaction with multiple instances of non- responsiveness of the firm for specific requests, retention of underperforming managers, alleged use of high expense share classes of mutual funds when lesser expense ratio share classes were available and issues of transparency," according to public board meeting minutes. Cape Coral was also Kirchner's client. Merrill's spokesman could not immediately comment on Cape Coral before deadline. Trustee Sam Mazzotti declined to comment and directed calls to the fund's attorney, Lee Dehner, who was traveling and could not be reached.

Meanwhile, South Miami is considering hiring investigative firm Benchmark Financial Services to review Merrill. Founder Edward Siedle has investigated potential conflicts of interests at other Florida plans. Merrill spoke out against Siedle in their resignation letter. "Very simply, we do not believe Mr. Siedle is impartial and we believe he has pre-judged the outcome..We have no qualms about a fair and independent review of our work, but we do take issue with a review conducted by someone who has already pre-judged the outcome."

Siedle was also involved in investigating Smith Barney's work for Delray Beach Police and Firefighter Pension System where he found the firm may owe the system upwards of $2 million in fees. The Delray plan received a notice from the SEC last week asking for information regarding its consulting relationship with Smith Barney.


SEC Scrutinizes Smith Barney in Florida

Article published on Oct 31, 2006 By Raquel Pichardo

The Securities and Exchange Commission is digging for information about Smith Barney’s consulting relationship with two Florida pension plans. Those two plans and one other Florida pension fund have ended their relationship with Smith Barney.

The Delray Beach Police and Firefighters’ Retirement System and the West Palm Beach Police Pension Fund both received notices from the SEC asking for copies of all documents relating to Smith Barney. Ernie Mahler, financial advisor at Smith Barney, is consultant for both. The Commission asked West Palm Beach for all documents associated with the consulting services Smith Barney provided the fund, according to a letter from the SEC obtained by FUNDfire. The regulator asks for such detailed information as board meeting minutes, documents relating to any audits performed by the pension fund and details about brokerage services including but not limited to Smith Barney.

The SEC is requesting information dating back to January 1, 2001. It also asks for documents related to directed brokerage agreements, recapture, or soft dollar arrangements. Smith Barney and other consultants with brokerage arms have come under fire in Florida in the past year as federal regulators, state and independent investigators question potential conflicts of interests that can arise by offering both services.

The firm came under scrutiny late last year for improperly reporting returns by not clearly specifying returns net and gross of fees to the Delray fund. An investigation performed by Benchmark Financial Services found that Delray may be owed over $2 million. Delray’s counsel, Saxena White, is also investigating the services and will report its results to the fund in November, says Charles Jeroloman, president of the Delray Beach board.

Delray is working on providing the SEC details, says Jeroloman. The fund says it recently fired Smith Barney and is now using Bogdahn Consulting, an independent consultant. Spokesmen at Smith Barney and the SEC declined to comment. The inquiry, “should not be construed as an indication by the Commission or its staff that any violation of law has occurred, nor as a reflection upon any person, entity, or security,” the letter states.

Bonni Jensen, attorney for the West Palm fund, confirmed that the system received the request and that it recently approved a search for a new consultant, but declined to comment further.

Boynton Beach Firefighters’ Pension Fund is also looking for a new consultant since Smith Barney was lax in reporting its fees, says Robert Klausner, partner at Plantation, Fla.-based Klausner & Kaufman, who is Boynton’s attorney. “We were concerned about the lack of responsiveness in the question of fees,” says Klausner. He says the fund worked with the Smith Barney group run by Mahler.

Earlier this year, the SEC indicated it was winding down its more than two-year investigation into possible conflicts of interests of consultants across the country. But the probe seems to continue in Florida. Attorneys with Florida plans, who requested anonymity, have indicated the SEC contacted them about consulting services. None could elaborate further.

The SEC has scrutinized one other firm which operates widely in Florida. In December, the New York Times reported Merrill Lynch’s consulting arm received a subpoena from the SEC as part of its probe into the pension consulting industry.


A Billion-Dollar Retirement Rip-Off

Neil Weinberg, 7.27.06,

In a move that could have far-reaching consequences for a $140 billion industry, the Orange County, Fla., Sheriff's Office has filed a class action charging units of Nationwide Financial Services with receiving illegal kickbacks from fund companies whose products it included in public employee retirement plans.

The suit, filed in United States District Court for the Southern District of Ohio, near Nationwide's headquarters, seeks as much as several hundred million dollars and aims to include as plaintiffs some 7,600 other public employee retirement plans that are Nationwide customers.

The suit involves so-called 457 retirement savings plans, which are a public-sector equivalent of the 401 (k). The 457 market, with $143 billion in assets, is dominated by variable annuities, which are bundles of mutual funds or separately managed accounts bundled into life insurance policies by Nationwide and other vendors. Variable annuities have been widely criticized as poorly disclosing what are sometimes excessive fees.

The Orange County suit claims that over the past decade and a half, Nationwide received kickbacks from the firms whose funds it included as investment options based on a percentage of plan assets gathered. Insurers refer to the payments as revenue sharing. To critics, they smack of pay-for-play. In the Orange County Sheriff's case, Nationwide's fees were frequently equal to 2% to 3% of assets annually. The plan recently switched to a Vanguard- based plan that cut fees by roughly two- thirds.

Unless these payments Nationwide received were specifically agreed to in the variable annuity contract, which they weren't, they're not allowed, says Roger Mandel, an attorney with Stanley, Mandel & Iola who is representing the plaintiffs. Fiduciaries aren't supposed to be doing side deals.

Nationwide is currently reviewing the complaint, according to spokeswoman Carah Brody. These service fee payments are legal business agreements where mutual fund companies provide payment for administrative services they would otherwise provide themselves, the company said in a written statement. This practice allows Nationwide to provide deferred compensation plans that offer significant choice and value and lowers overall costs to plan participants."

Mandel believes Nationwide's revenue sharing has also included payments from it to the National Association of Counties, the national representative of county governments, in exchange for an endorsement of the firm's 457 variable annuities. NACo, in turn, has encouraged local affiliates, like the Orange County Sheriff's Office, to invest in Nationwide's product, Mandel believes.

Brody said she did not know whether the firm has made such payments to NACo.

NACo Executive Director Larry Naake confirmed that his organization has received payments from Nationwide and endorsed its 457 variable annuities since the early 1980s. NACo shares the payments with 42 state affiliates. It does not, however, disclose the payments to the county employees sold the product. Naake declined Forbes' request to do so, claiming the payments are part of a confidential "business arrangement."

Insurer payments in exchange for variable annuity endorsements were the subject of a Forbes story (see: Costly Lesson) that prompted an investigation by New York Attorney General Spitzer. It concluded that ING had paid the New York State United Teachers union $3 million annually to promote its variable annuities in a deal that deliberately misled teachers.

ING agreed to pay $30 million and the union $100,000 to settle the charges of wrongdoing.

On My Mind

Forbes Magazine 11/27/06

The Irrelevant SEC

The senate finance committee and the Government Accountability Office are both taking a harsh look at the Securities & Exchange Commission. It's about time. One thing on the agenda is the SEC's questionable handling of an insider trading case involving a $7 billion hedge fund. But the bigger issue is that the federal agency charged with safeguarding investors is on the verge of becoming irrelevant. If you want protection from investment pitfalls, you're going to get it from the private sector.

Here's what's wrong with the SEC.

Political pressures Look who gets chosen for the important job of SEC commissioner. Not those with established records for fighting on behalf of investors. Rather, the post routinely goes to insiders, especially those who have devoted their careers to representing financial services firms. Former SEC chairman William Donaldson, cofounder of investment bank Donaldson, Lufkin & Jenrette, is one prominent example. Below the commissioner level, directors of divisions within the agency, such as market regulation and investment management, are also chosen according to how chummy they are with Wall Street's big guys.

The speed with which SEC managers find comfortable quarters within the industry after their period of government service is powerful evidence of how seldom these professionals seriously oppose the institutions they are supposed to regulate. Paul Roye, for example, worked as a lawyer representing the fund business before becoming its chief overseer at the SEC. Meanwhile, one of his former law firm superiors, Paul Haaga, became the industry's chief lobbyist. After the fund business stumbled into the biggest scandal in its history under this duo a few years ago, Roye rejoined Haaga at mutual fund giant Capital Research.

Reliance on self-regulation The commission is ever more willing to allow the brokerage industry to self-insure, self-adjudicate (through mandatory arbitration) and even control public access to the brokerage industry's criminal and disciplinary histories. Self-regulation involves an insurmountable conflict of interest and results in thousands of instances of avoidable fraud each year.

One almost laughable example of lame self-regulation: the BrokerCheck Program, run by the National Association of Securities Dealers, the brokerage industry's self-regulator. The NASD says it "should be your first resource to learn about the professional background, registration/license statuses and conduct of NASD-registered firms and their registered brokers." Would you believe that the program does not permit a broker or firm to respond "yes" to the question of whether the broker or firm has any disciplinary matters in his or its past? Only two answers are permitted: "no" and, get this, "maybe." That's what we call industry-friendly. For all of $5,000, I put together a disciplinary database a few years ago that showed the NASD underreports brokerage industry misbehavior by about 85%. Since the NASD blocked me in court from publishing it, investors remain perilously uninformed.

Transparency The SEC has allowed the financial industry to control the content and timeliness of disclosures to the public. For example, most of the SEC's money manager investigations uncover "deficiencies," some of them involving serious misbehavior. But the commission refuses to make its findings available.

Follow-through In May 2005 the SEC staff issued a report on conflicts of interest in the pension consulting industry. The staff concluded that the industry was subject to rampant conflicts and disclosure was abysmal. Were pension sponsors who may have suffered harm ever privy to the financial information the pension consulting industry provided to the SEC? Nope. Instead the SEC issued a vague warning to pension sponsors to more carefully scrutinize the investment consultants they hire.

This agency spends $888 million a year. If it were subject to disclosure laws the SEC would have to admit it could get a lot more bang for taxpayers' buck were it not so compromised by conflict of interest.

Edward Siedle, a former SEC Attorney and the President of Benchmark Financial Services.

Most read story about Money Matters:
(November 2009) A ''Tipping Point'' for Public Pensions?

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