Consultants Intensify Opposition to Investigations of Their Conflicts
In the past investment consultants fought hard to keep pension clients from investigating allegations of pay-to-play arrangements between them and money managers. Denials were generally sufficient to squash concerns. Now that the Securities and Exchange Commission and Department of Labor have confirmed the existence of consultant conflicts, consultants are intensifying their efforts to thwart independent investigations. Given the magnitude of the harm related to these conflicts, it’s a desperate struggle that threatens the very survival of the largest consulting firms.
It’s official now. The Securities and Exchange Commission on May 16th released the findings of its 18- month investigation into the investment consulting industry and concluded that conflicts of interest were pervasive, potentially tainting the objectivity of the advice consultants provide to pensions; further, disclosure of these conflicts by consultants was found by the SEC to be “abysmal.” Shortly thereafter, on June 1st, the SEC and Department of Labor issued a list of questions pensions should ask of their consultants regarding conflicts and other matters.
Since 1996 we have written about investment consultant conflicts and the related harm to pensions. In the past pensions that have doubted our assertions have asked, “If consultant corruption really is a problem, why hasn’t the SEC done anything about?” Now the SEC and the DOL have confirmed the existence of pervasive consultant conflicts and we applaud these agencies for their joint effort.
Need to Improve Pension Policing
As we have commented in the past, asset management issues arising in the pension context frequently have not been properly addressed by regulators because the SEC, an agency that knows lots about money management, has historically offered little guidance specific to pensions and the DOL, the pension agency, has seldom provided meaningful direction to pensions on money management matters. The SEC’s investigation into pension consulting is, to the best of our knowledge, its first pension-directed initiative. The subsequent SEC/DOL joint release proving guidance on these conflicts signals, in our opinion, a recognition that the two agencies must begin to work together if the nation’s pension problems are to be adequately addressed. (The need to better coordinate enforcement strategies with the SEC was cited as a significant challenge to Department of Labor’s Employee Benefits Security Administration ERISA enforcement activities in a June 9, 2005 GAO-05-784T U.S. Senate testimony.)
The SEC/DOL joint action could not have come at a more opportune time, following, as it did, the transfer of the United Airlines pension to the PBGC. Today more than ever clarifying the standards applicable to handling the nation’s pensions and effective regulation of pensions are immediate concerns. If conflicts of interest, hidden financial arrangements, fraud, collusion between parties providing services to pensions, or even mismanagement are contributing to the demise of our pensions, action must be taken before more plans fail.
As we have mentioned elsewhere, the PBGC does not conduct forensic investigations of pensions for which it assumes responsibility. One of a handful of private firms, staffed by former DOL employees, may be hired (without competitive bidding) to act as the independent fiduciary to the failed pension by the PBGC and manage the fund going forward; however, no investigation is undertaken to determine whether a recovery is possible related to any firms that may have caused harm to the pension in the past. Inside counsel at PBGC has admitted to us that the agency lacks the staff and knowledge to undertake such inquiries. The independent fiduciaries the DOL and PBGC routinely hire also lack expertise in ferreting out investment management wrongdoing. The result is that investment scams that may have contributed to the demise of these pensions are not identified. The taxpayers pick up the tab and the perpetrators are free to continue scheming to undermine other still-viable funds.
SEC/DOL Resolve Fiduciary Debate
What the SEC and DOL have now said in no uncertain terms is that investment consultants are fiduciaries to their pension clients under the federal securities laws. Consultants have historically sought to insulate themselves from such liability by denying they are fiduciaries or not acknowledging fiduciary status in their contracts with clients, even as they have encouraged clients to rely heavily and exclusively upon their advice. The question of whether consultants are fiduciaries under ERISA may be a bit more complex but generally the answer is also “yes.”
Unanswered Questions
What the SEC and DOL did not say is whether the pervasive conflicts and non-disclosure they discovered have resulted in any harm to pensions. With regard to whether payments by money managers influence consultant recommendations, the SEC said it was unable to determine such a link because consultants do not maintain the records necessary to prove “pay to play” exists. However, several years ago the Hawaii State Auditor was able to show in an investigation it undertook that virtually all managers hired by the Hawaii government employees pension had established business dealings with the plan’s consultant.
The question of whether consultant conflicts result in diminished performance also was not addressed in the recent SEC report. The SEC has indicated that numerous enforcement proceedings involving pension consultants are being undertaken as a result of the staff investigation of the industry. Perhaps the harm related to conflicts will be spelled out more clearly in these cases. In our investigations, we have been able to clearly establish kick-back schemes and quantify the related harm. A loss of 10-15% over time is not unusual.
For now pensions are on notice that consultants are often conflicted and should be questioned about these conflicts. Then what? Should pensions simply rely upon statements from their consultants that they have no conflicts or that conflicts are being managed to ensure clients are not harmed? Is there a duty to investigate the completeness of current disclosure or to determine whether previously undisclosed conflicts may have harmed the fund?
Consultants Fight Back
Some pension consultants are now advising their clients as to whether an independent investigation of their conflicted actions should be undertaken. Nothing could be more absurd than relying upon the party to be investigated for guidance regarding whether to undertake an independent investigation; the party that should conduct the investigation; or the scope of the investigation. The consultant should have no voice in these decisions.
Consultants just don’t get it. When you give advice and you have a financial stake in the outcome, a conflict of interest exists. Likewise, pensions just don’t get it. Do not depend upon a conflicted party for objective advice.
We believe an independent investigation must be undertaken by every pension that has a conflicted consultant, regardless of any disclosure recently provided. The consulting industry has a long history of being less than truthful about conflicts. Further, investigations of all vendors to pensions should be routinely undertaken and should not be considered tantamount to accusations of wrongdoing. If the consultant has done nothing wrong, he should welcome the review.
Care should be taken in choosing the party to conduct the investigation—another conflicted consulting firm chosen by the consultant is inappropriate. Under no circumstances should the consultant have a voice in selecting the investigator. Finally, the scope of the investigation should include looking far into the past, given that the industry has been cleaning up its act in anticipation of SEC action.
The consulting industry continues to follow the strategy that has worked so well for it in the past: deny and delay the day of reckoning. It remains to be seen how much longer this defense will succeed.
Merrill Blocking Investigations Into Conflicts Of Interest June 8, 2005
Merrill Lynch has taken steps to ensure that Florida pension plans do not conduct independent investigations into its pension consulting unit, Merrill Lynch Consulting Services Group. Edward Siedle, president of Benchmark Financial Services, met with the $123 million Boynton Beach General Employees Fund and the $116 million Lake Worth Municipal Employees Retirement System and has offered to perform free preliminary independent investigations into potential conflicts of interest involving Merrill for all Florida-based pension plans. On both occasions, Merrill flew in a lawyer from Sutherland Asbill & Brennan who convinced the plans to allow it to perform its own investigation instead or to do no investigation at all.
Siedle met with Lake Worth before and Boynton Beach after the Securities & Exchange Commission issued a report in May that heavily criticized inadequate disclosure by consultants of potential conflicts of interest. The report followed investigations of 24 consulting firms conducted by SEC's Office of Compliance Inspections and Examinations.
Barbara LaDue, administrator of the Boynton Beach plan, said there was a meeting last Friday and both Siedle and a lawyer from Sutherland were in attendance. Minutes were not immediately available. Anne Costello, director of finance for the Lake Worth plan, and officials at Sutherland did not return calls.
"Mr. Siedle has been attempting to convince clients of ours that we have done something wrong. We have not," said Merrill Lynch spokesman Mark Herr. "He has made unsubstantiated allegations about us and in response to inquiries from our clients we appeared before them and provided answers to their questions." Siedle refuted Herr's accusations. "I am not saying Merrill Lynch is doing anything wrong," he said. "I am saying let's do an investigation of potential conflicts. It doesn't matter to me who the consultant is."
"Because of the heavy reliance that these consultants have been able to foster from their pension clients, many of the consulting firms are attempting to advise and steer their clients as to how they themselves are investigated," Siedel said. Richard Lynch, executive director of the Foundation for Fiduciary Studies, said if pension funds are confident their consultant is doing the best job it can, they should welcome a free independent investigation.
The SEC report said that 14 of the 24 consultants investigated have affiliated broker-dealers or relationships with unaffiliated broker-dealers.
Matthew McCue Reporter Money Management Letter
212-224-3271 mmccue@iinews.com
Setting Standards For The Investment Management Industry
