In 1996, I designed and chaired a convention entitled, "Hiring and Managing Investment Consultants." It was marketed as an "intensive course to prepare pension plan sponsors for the decision-making process of hiring and evaluating investment consultants." Topics addressed at the convention included, identifying the role of the consultant; defining the standard of care the consultant will be held to; the hiring process; compensating the consultant; and selecting consultants for brokerage services, including soft dollars and commission recapture. To the best of my knowledge, this was the only convention ever held addressing the all-important question: Who manages the consultant?
As I stated in my opening speech to the convention, (the full text of which can be found in our Library of Articles):
"One of the most important and controversial issues facing pension funds and investment managers today is the role of investment consultants. Tremendous energy has been focused on the question of the appropriate expectations, goals and methodology for selecting investment managers for pension funds. However, remarkably little attention has been paid to the hiring and managing of investment consultants. Consultants are the advisors, gatekeepers, interpreters, data collectors and information processors to the pension fund community. This is a tremendous responsibility. Pension funds involve trillions of dollars and effect the economic security of millions of beneficiaries and their families. More than half of corporate plans currently use consultants. The percentages are considerably higher in the case of public funds (75%) and endowments and foundations (63%).
Yet, the business of investment management consulting has always been plagued with issues of perception versus reality. Investment consultants for the most part operate outside the regulatory scheme. Fundamental issues, such as the role of consultants, capabilities of consultants, regulation of consultants, disclosure obligations of consultants and conflicts of interest in the consulting business have never been openly and clearly addressed.
At this point, under current law, it is generally up to the parties involved to identify and address all of these issues. There is virtually no federal and state law to guide you and very little information of any sort is available for plans sponsors."
In 1997, with the backing of a large venture capital firm, I undertook an analysis of the consulting business that included a review of the financial operations of a diverse group of consultants, including both smaller and larger firms. While I was, in some cases, astounded by how much money some of the least credible consultants earned from the divergent lines of business their firms exploited, more often I was disappointed by the compensation levels of the more ethical, disciplined consultants. Overall, my respect for consulting grew as a result of this study; however, some of the most notoriously unscrupulous firms refused to meet with me.
I had written articles in the past such as, Consultants With Affiliated Broker-Dealers: How Independent Is Their Advice?" which harshly criticized consultants who earned income from multiple sources that posed conflicts of interest, without adequately disclosing the conflicts to clients. My initial position was that consultants with divergent lines of business were suspect and should be avoided by plan sponsors, given the lack of candid disclosure. However, a review of the economics of consulting in 1997, led me to reconsider my position. Ethical consultants who limited themselves to offering services to plan sponsors only, were being unduly penalized. Furthermore, it seemed unlikely plan sponsors would ever agree to pay higher consulting fees for "pure" consultants.
Money managers, investment banks, brokerages, and insurance companies, all offer different products and services. Money managers do business with their affiliated brokerages. Mutual funds buy stock from their affiliated underwriters. Those of us in financial services are in the business of managing conflicts of interest. One important difference between us is how we manage these conflicts. Should consultants be frowned upon for maximizing their business opportunities, if they can do so ethically? After all, I quit the practice of law in part because getting paid on an hourly or retainer basis could never be as interesting (or profitable) as creatively managing an investment banking, brokerage and investigative services firm.
While I do now accept that consultants can ethically offer different products and services to both money managers and plan sponsors, my initial concerns remain. Not only do certain consulting firms fail to disclose to clients important information about conflicts of interest, some firms outright lie about their lines of business when asked. A recent article in Forbes entitled, Pay For Play, for the first time has drawn national attention the existence of conflicts in the consulting business. A letter sent to us by Jack Silver, a trustee with the Chicago Public School Teachers Retirement Fund, provides further examples of conflict-of-interest situations that should be disclosed. The letter can be found below.
In light of these ongoing concerns and the risks to pensions that conflict situations pose, I would propose the following simple list of questions to be asked of pension consultants prior to hiring.
1.What services does your firm or its affiliates offer in addition to pension consulting services?
2. Detail any financial arrangements that exist with affiliated or other financial organizations.
3. Describe your policies and procedures to prevent possible conflicts of interest.
4. Does your firm accept soft dollars as a method of payment for services provided?
5. Describe all fees or other consideration you receive from managers.
The following standard operating procedures for pension funds to require of their consultants is also advisable.
1.Please advise us promptly and in advance when possible, of personnel or organizational changes at your firm.
2. Please advise us immediately of any legal or regulatory proceedings involving your firm.
3. Please provide specific written notification whenever a former employee of your firm is employed by a manager you recommend to us.
4. Please return all phone calls to board members within 24 hours; staff phone calls should be returned with 48 hours.
5. Please provide board members with an agenda and materials for board meetings at least ten days in advance of a meeting.
Plan sponsors should bear in mind that consultants are not subject to a regulatory body. Terms such as "affiliated persons," which are defined under the federal securities laws and have a specific meaning when used by entities registered under the securities laws, may not be used by consultants with the same meaning. As a result, a consultant may maintain it has no affiliates in the money management business when the manager would be required under the federal securities laws to name the consultant as an affiliated company.
It is up to plan sponsors to do their own due diligence of consulting firms prior to selecting a firm and to craft a contract for services, as well as standard operating procedures that reflect the unique concerns of the fund. We would be interested in hearing from you as to whether the above proposal is useful.
___________________________________________________ To: Benchmarkalert.com
From: Jack Silver Trustee, Chicago Public School Teachers Retirement Fund
Date: August 28,2000
Dear Sirs:
It is not at all unusual for a pension fund trustee to receive a recommendation from his fund's investment consultant to terminate a money manager due to "personnel turnover" or "organizational changes." The investment consultant's duties typically include not only guidance on selection of managers or "manager searches" but also ongoing review of managers' and their performance. Certainly loss of key personnel at a money management firm and other "organizational" developments, such as questionable manager conduct, are matters as to which fiduciaries charged with the responsibility of overseeing pension assets should be advised.
We often refer to investment consultants as "gatekeepers" who provide a "due diligence" service to trustees of pension funds. The consultant's job is to inform trustees as to all facts material to the investment decision. However, increasingly it has become clear to me that while consultants may be thorough in their review of money managers and provide their fund clients with full disclosure as to manager developments, consultants regularly neglect to disclose important information about themselves to pension funds.
In case you hadn't heard, the pension consulting business is in turmoil at this time. Consultants generally do not pay their employees salaries comparable to the money management industry. As a result, many consulting firms are losing key employees to managers and shutting offices. Do consultants advise their clients when they have lost key employees? In my experience, they generally do not. Often pension fund trustees are the last to learn of consultant personnel losses. Money managers to whom the consultant's employees have been applying for jobs and others in the "manager grapevine" know well in advance. I can't tell you how annoying it is to hear "on the street" something my consultant hasn't told me! What about when former employees of the consultant are hired by a manager who the consultant subsequently recommends in a search? Does the consultant disclose that a former employee now works for the manager? After all, a conflict of interest does exist in this situation. The consultant may favor the manager purely because of the prior employment relationship. Again, in my experience, consultants do not routinely disclose such prior employment information.
Finally, consultants are increasingly turning to alternative sources of revenue to increase their bottom-lines. Apparently there isn't enough money in the "pure" consulting business to keep many firms interested. Consultants are selling services to money managers and hosting conferences where their manager clients can, for a hefty fee, meet their pension fund clients. I'm not saying its wrong for a consultant to make money from having me as a client. What I am saying is that I want to know about it. And I want to hear about it from my consultant-not "the street."
Very Truly Yours, Jack Silver
Setting Standards For The Investment Management Industry
