Shame and Scandal in the Florida Public Pension Community
Public pensions throughout Florida are being defrauded by brokers registered with Wall Street powerhouses who hold themselves out as pension experts. Over the past year we have met with trustees of many of these funds advising them of our preliminary findings, as well as reviewing investment performance reports prepared by their broker-consultants. The performance of the funds is generally dismal. We have seen reported performance in the bottom 5%; other more fortunate funds are simply in the bottom half. In addition to questionable performance figures, the consultant reports we have reviewed are seriously deficient.
We have provided letters to board members indicating that, in our opinion, these funds may have been harmed by the arrangements they have with their broker-consultants. Remarkably the trustees who are fiduciaries to these funds have generally resisted undertaking investigations, choosing instead to rely upon reassurances provided by the consultants themselves. We have seen this behavior before where trustees have maintained their confidence in corrupt consultants and money managers—even after being contacted by regulators and law enforcement. The bond between consultants and their clients is unbelievably strong. We also received a threat from one of the more successful of these broker-consultants to which we have forcefully responded, including notifying the internal counsel to his firm. (See our policy regarding threats below.)
Given the prevalence of broker-consultants in the Florida public pension community, the cost of the corrupt advice they provide is costing the State’s taxpayers plenty—hundreds of millions annually.
We will continue to urge trustees of these funds to do their fiduciary duty and investigate allegations of wrongdoing. If pension assets are at risk, there is no doubt that fiduciaries are required by law to take action. Public fund trustees who fail to protect their funds from dangers, as to which they have been specifically advised, proceed at their own risk. Given the number of funds involved, it is likely that sooner or later at least one fund will initiate an investigation and uncover the truth. When the facts related to the advice these broker-consultants provide become known, a lot of trustees are going to have to have a difficult time explaining their failures to act.
Some of the lawyers who advise public pensions in the State also have failed to provide funds with sound advice regarding this matter. They too have been willing to accept assurances from these broker-consultants that there are no improprieties, rather than recommend an inquiry. This is surprising since the SEC has indicated it is currently investigating pension consultant conflicts of interest. Even lawyers lacking pension asset management expertise should recognize these are treacherous waters and acknowledge their limitations. Apparently one Florida public pension attorney has compensation arrangements with at least one broker-consultant and certain money managers regularly recommended by the broker-consultant. Why other Florida attorneys who advise public pensions have failed to recommend an appropriate response to allegations of wrongdoing is unclear. We encourage attorneys throughout the state to join us in an effort to protect the public funds within the state.
We began warning readers about illegal mutual fund activity and conflicts of interest in pension consulting ten years ago. Elliot Spitzer, the Attorney General of the State of New York, revealed to the world the pervasiveness of mutual fund wrongdoing. Late last year the SEC and DOL contacted us for guidance on pension consultant matters since we are the only firm that has undertaken successful investigations of pension consultants. At this point one would think that pensions would heed our warnings. In Florida (which is our home) our message is still not being heard. However, as indicated below, funds in other states are responding to our call to action and Florida trustees should take notice of these developments.
SUNDAY FOCUS: City uncovers pension loss Officials file complaint alleging mismanagement by financial adviser cost fund $20 million
By Duane W. Gang Staff Writer
Chattanooga officials filed a complaint Friday against two Wall Street brokerage houses, charging a financial adviser through a "fraudulent and deceptive scheme" cost the city’s pension system more than $20 million. City Finance Officer David Eichenthal, the pension board’s chairman, said the $180 million retirement fund lost significant amounts from 2000 to 2003 while William Keith Phillips helped manage the city’s investments for UBS PaineWebber and Morgan Stanley. "We decided to go back and conduct a review of the performance of our investment consultant," Mr. Eichenthal said last week. "In the course of that review, it became clear the consultant engaged in practices that directly contributed to those losses."
He said the city filed the complaint by mail Friday, seeking at least $20 million in damages in an attempt to regain money the system lost. On Friday, Mr. Phillips said company policy did not allow him to comment on the city’s complaint. Aubrey Harwell, Mr. Phillip’s attorney, speaking for him and Morgan Stanley, said he had no knowledge of any case being filed and could not comment without seeing the complaint. Peter Casey, a spokesman for UBS Financial Services, formerly UBS PaineWebber, said the company had no information about any action the city has taken. Taxpayers and 1,600 employees contribute to the general pension fund. None of the 700 people receiving pensions will lose benefits, but if the fund performs poorly in the markets or other factors hurt it financially, the city must use general tax dollars to keep it fiscally sound, city officials said. Since fiscal year 2001, the city has used nearly $3.7 million in general tax dollars to shore up the fund, officials said.
The general pension board, made up of seven volunteer members, oversees the retirement fund for all city employees except firefighters and police officers. The board relies on professional money managers and consultants to advise it on investments. "The pension (board members) had a legitimate expectation that the advice they were getting was in the best interest of the pension plan," Mr. Eichenthal said. "It wasn’t. It was in the best interest of the firms." Private attorneys for Chattanooga in Fort Lauderdale, Fla., sent the complaint by United Parcel Service to the National Association of Securities Dealers in New York, an organization that helps regulate the securities industry and nearly all U.S. stockbrokers. City officials said the mailing of the complaint constitutes a formal filing. The city is asking that the NASD, which can levy fines against stockbrokers, appoint a three-member arbitration panel to decide the case.
Mr. Phillips worked for the pension system as a head of the Phillips Group. The city’s complaint alleges that Mr. Phillips, operating under the umbrella of UBS PaineWebber from 1996 to 2000 and Morgan Stanley since 2000, used "improper methods and tactics" to gain financially from the city. The city’s complaint alleges the Phillips Group used the same type of activity when handling investments for the Metro Nashville Pension Plan. Nashville officials in 2002 settled with UBS PaineWebber for $10.3 million after that city’s pension board raised allegations of conflicts of interest and excessive commission fees, records show.
FEE STRUCTURE At the heart of Chattanooga’s complaint is the fee structure the pension board used to pay Mr. Phillips. That arrangement gave him authority to advise the board on asset allocation, investment manager selection and overall performance of the pension fund. According to the city’s complaint, Mr. Phillips persuaded the board to hire money managers who would do the bulk of their trading with his firms — UBS PaineWebber and Morgan Stanley. Mr. Phillips, who made more than $2 million in seven years managing the city’s fund, received commissions on trades in addition to his adviser fees. "The Phillips Group was not motivated to aggressively negotiate on behalf of the Chattanooga Pension Plan and thereby risk the loss of commission business from a manager," according to the city’s complaint. "Rather, the Phillips Group recommended unqualified managers based upon their willingness to pay, as opposed to their abilities or qualifications." The city also alleges Mr. Phillips circumvented the pension board’s own guidelines in investing millions of dollars. The pension board had rules that set its maximum asset allocation at 70 percent in equities and 30 percent in fixed-income funds. But the city claims the equity allocation grew without the board’s approval to 78 percent while Mr. Phillips consulted for the city.
According to the city’s complaint, Mr. Phillips also acted contrary to the pension board’s rules and invested to "reap substantial commissions." For instance, the city’s complaint states Mr. Phillips invested in a venture capital fund called FCA II, a health care related fund, in 1998. At the time, the board’s rules did not allow venture capital investing. The board’s rules were not changed until February 2001. In addition, according to the city’s complaint, the Phillips Group: Failed to disclose fully and explain inherent conflicts of interest. Misrepresented true nature of the "soft dollar" pay arrangement. Charged excessive fees for investment services.
CITY ACTION The city hired Mr. Phillips in 1996 and renewed its contract with his firm in 1999. At the time, Mr. Phillips was affiliated with UBS PaineWebber and was managing investments for Metro Nashville. But in 2000, a KPMG audit of Nashville’s $1.6 billion pension fund questioned the contract with Mr. Phillips and UBS PaineWebber and the transactions he recommended that led to excessive commission fees, according to published reports. Nashville did not renew its contract with Mr. Phillips, who in March 2000 switched to Morgan Stanley. In 2002, Nashville settled with UBS PaineWebber. Mr. Phillips also managed a pension plan for the Nashville and Davidson County Electric Power Board, which settled its case for $440,000, according to reports. During this time, Mr. Phillips continued to advise Chattanooga’s pension board.
Mr. Phillips appeared before the board in March 2002 and defended his actions with Nashville’s pension fund after a critical editorial ran in Pension & Investment magazine, a trade publication. Mr. Phillips told board members his goal in the relationship with Chattanooga was to have "no surprises," according to board minutes. He told members he expected bad publicity after the editorial ran. But during his time working for Nashville, the pension fund there performed in the top 5 percent of all public funds, according to board minutes. Even though a board attorney disputed some aspects of a critical audit of Nashville’s pension fund in 2002, the board decided to hire a new consultant. But the Phillips Group remained the city’s adviser until May 2003. According to minutes for a July board meeting, the Phillips Group was removed because of a "perceived notion that they engaged in a practice of questionable commissions."
Based on the size of Nashville’s pension fund, Chattanooga pension board minutes show Chattanooga originally expected its claim to be worth about $400,000. Chattanooga officials, however, continued investigating and in December 2003 hired former U.S. Securities and Exchange Commission lawyer Edward Siedle to look into the matter, according to board minutes. Separately, the SEC is investigating potential conflicts of interest at UBS PaineWebber and Morgan Stanley, according to published reports. A report prepared in April by Mr. Siedle led the city to file a complaint against Mr. Phillips, UBS PaineWebber and Morgan Stanley. In June, the city reported potential sales practice violations to the National Association of Securities Dealers about Mr. Phillips but until now had not filed a formal complaint. According to the association’s records on the case, Mr. Phillips "denies there was any impropriety or wrongdoing and intends to vigorously contest the allegations, if any are formally asserted." Mr. Siedle’s firm, Florida based Adorno & Yoss, remains counsel for the city on the complaint. Mr. Siedle negotiated the settlement between Nashville and UBS PaineWebber. Looking forward, city officials said they have begun measures to avoid a similar arrangement in the future. The board has hired a Memphis firm, CSG, to act as its investment consultant. The city pays the firm $75,000 a year. In addition, the board now meets at City Hall and not in a private bank, giving the public more access. Board agendas are printed, and annual elections are held for officers. "We have put in place all of these reforms to improve and enhance how our board acts going forward," Mr. Eichenthal said.
Staff writer Michael A. Weber contributed to this story. E-mail Duane W. Gang at dgang@timesfreepress.com
This story was published Sunday, October 10, 2004
Benchmark Financial Services Policy on Threats Investigations of wrongdoing involving pensions, money managers, brokers and investment consultants evoke strong responses from firms and individuals involved. (Even parties not targeted by our investigations may react angrily.) Our policy is to refer threats, where appropriate, to law enforcement and regulators, as well as to publicly expose the threat. In so doing, we believe we minimize the likelihood that the threat will be acted upon.
Setting Standards For The Investment Management Industry
