Based upon an unprecedented number of inquiries we received earlier this year and related ongoing investigations, we have identified several discrete areas worthy of focused efforts. We believe that in these specific areas pensions are more likely than not to have problems that have not been identified or adequately addressed. Furthermore, based upon information we possess we believe that regulatory, criminal and/or civil action will ensue in these areas in the near future. We encourage concerned pensions to contract us on a confidential basis for additional information on the matters described below.
Project 457/403(b)
Section 457 deferred compensation plans offered to governmental employees are an investment backwater. Expensive, poor performing variable annuity insurance products dominate this niche that many mutual fund companies seemly ignore. Many of these plans have no investment consultant to provide advice upon prudent procedures or evaluate the performance of funds. That is, there are no gatekeepers. On the other hand, a number of insurance companies have paid handsomely to have their annuity products endorsed by unions and associations with substantial 457 participant members that are hungry for additional income. These organizations, the defacto gatekeepers, appear unaware of the grievous harm they are inflicting upon their membership by endorsing products doomed to underperform. In our opinion this may be the year that regulators and others begin to take action against companies that prey upon these plans and plan sponsors awaken to the need for reform.
Most 403(b) plans are also saddled with excessive costs and underperforming investment products that have been endorsed by educational associations. We are aware that certain investment advisory firms that focus upon 403(b) plans intentionally do not seek business in competitive environments; instead these firms prey upon groups in smaller, less sophisticated environments. While we are not aware of specific action contemplated with respect to 403(b) plans, we believe developments regarding the business practices of providers of investment services to 457 plans will impact the 403(b) marketplace as well.
Project Custodial Services
Most pensions that utilize banks to custody their assets have failed to examine the compensation these banks derive from handling their assets and the related conflicts. Custodians, who often deny they are fiduciaries in their contracts with pensions, secretly profit in numerous ways that may be harmful to pension clients. Similar to the investment consulting industry, stated or disclosed custody fees are artificially low; exponentially greater fees related to other services ancillary to the custody relationship are undisclosed. The conflicts are not clearly explained; neither is the related potential harm. Pensions seeking means to reduce costs and enhance returns are well-advised to consider an audit of their custodians. Why is it that many pensions pay substantially higher fees for their money market cash sweep than they pay their best performing bond and equity managers? Answer: no one’s paying attention to the money market fees.
Pensions that permit their custodians to lend portfolio securities need to revisit these lending arrangements in light of emerging concerns. Securities lending is rapidly becoming a highly controversial issue after years of neglect.
In our experience, few pensions fully understand the various activities in which their custodians engage or have taken the time to carefully scrutinize their arrangements with custodians, despite the fact that custodians (charged with safekeeping pension assets) are uniquely capable of misusing those assets.
Project Emerging/Minority Managers
As pensions continue to seek to enhance minority participation in asset management through ill-conceived schemes that result in uncompetitive returns and condone unprofessional or illegal behavior, the likelihood of a confrontation with regulators or law enforcement grows. While the social objective of these minority or emerging manager programs is commendable, in today’s environment of diminished investment returns and growing funding shortfalls, pensions cannot afford politically correct initiatives utterly lacking investment merit. It is time for an intelligent response to the question of how to enhance minority participation. And it’s also time for elected officials (who are not pension fiduciaries) to stop pressuring severely underfunded pensions to invest with specific minority managers that are significant campaign donors.
In our opinion, if the losses related to many existing minority/emerging manager programs were fully disclosed it is unimaginable that even the minority participants in these pensions would support them. In many cases we have encountered, pensions would be better served by simply making a gift (perhaps in the amount of an asset based fee) to the minority managers they wish to support, as opposed to actually letting such managers handle pension assets and underperform.
Due to the intense politics involved, few have dared to demand a true accounting of these programs in the past. However, today as corporate defined benefit pensions vanish, national attention is shifting to public pensions and related excesses and abuses. Minority/emerging programs will be a source of embarrassment for many public funds and will figure prominently in the debate as to whether taxpayers should continue to bear the costs of these funds.
Our December 2005 article entitled “Why the PBGC Can’t Afford Free Forensic Audits,” included a copy of an October 17, 2005 letter we sent to Bradley Belt of the PBGC offering to conduct a forensic investigation of the investment consultant to the PBGC, Wilshire Associates. As you may recall, in response to our offer the PBGC indicated that there was no basis for such an inquiry, i.e., no “red flags” were present. Apparently the fact that the SEC had investigated the pension consulting industry and found conflicts pervasive and disclosure practices wanting was not sufficient. The fact that the SEC, in connection with that industry review, had requested Wilshire change its disclosure practices regarding conflicts of interest also was not sufficient cause for concern by the PBGC.
In April 2006 Wilshire Associates revealed that it received a subpoena from the Department of Labor (DOL) in connection with DOL's investigation of conflicts of interest among investment consulting firms. Thus, one governmental pension agency, the PBGC, continues to rely upon advice provided an investment consultant currently under investigation by another governmental pension agency, the DOL. This makes no sense to us. Surely there are sufficient “red flags” at this point to spur even the PBGC into action.
Representatives Markey and Miller apparently agree with our analysis. On April 21, 2006 they issued a public statement about this unsettling state of affairs. (See Press Release Below.)
Rep. Markey said, "The subpoena of Wilshire Associates, which also provides consulting services to the Pension Benefit Guaranty Corporation (PBGC), raises questions about whether pension funds under the control of the Federal Government are being properly managed. Rep. Miller and I intend to seek further information about Wilshire's work for the PBGC. Last year, Rep. Miller and I asked the Government Accountability Office (GAO) to investigate problems with government regulation and enforcement of pension statutes, including whether the PBGC currently, or in the past, employs any consultants the Securities and Exchange Commission (SEC) has identified as having potential conflicts of interest. The GAO investigation is ongoing, and I look forward to the results."
Rep. Miller said, "Hopefully the DOL's subpoena signals their serious commitment to uncovering more information about how troubling and significant conflict-of-interest issues within the pension plan consultant industry can affect the financial health of pension plans. With massively under-funded plans, like those at United Airlines, being terminated and dumped onto the PBGC, the PBGC cannot afford to turn a blind eye to the practices of its pension consultants. Rep Markey and I urge the PBGC to disclose all relevant information about the services it was provided by Wilshire, and examine whether there were conflicts of interest or unlawful management of terminated plans for which Wilshire may have consulted. As the GAO investigation continues, the DOL and SEC must also continue to look into these practices at Wilshire and other pension consulting firms, so we can guard against this kind of foul play and make pension plans whole - both before and after termination."
We do not know whether all potential conflicts of interest related to Wilshire’s business practices were adequately disclosed to the PBGC. We do not know whether any conflicts of interest related to the services Wilshire provides may have resulted in harm to the PBGC. We do know, however, that seven months ago we offered to conduct an independent investigation into these matters at no cost to the PBGC. That offer was summarily rejected by government officials lacking even a rudimentary understanding of pension wrongdoing.
Why these officials stubbornly refuse to listen to information regarding pension investment-related malfeasance and choose instead to smugly rely upon assurances provided by the money management/investment consulting industry itself is unclear. It appears that the Administration’s policy of facilitating the wholesale dumping of corporate defined benefit pension obligations is to blame. Anything that slows that process must be rejected, regardless of whether investment firms that have contributed to the demise of pensions are not held accountable.
FOR IMMEDIATE RELEASE CONTACT: Mark Bayer (Markey) (202)225-2836 Rachel Racusen (Miller) (202)225-3725
REPS. MARKEY AND MILLER URGE LABOR DEPARTMENT, SEC ACTION AGAINST CONFLICTS OF INTEREST IN PENSION CONSULTING INDUSTRY Subpoena of Wilshire Associates Raises Concerns About Management of Government Pension Funds
Washington, DC: Representative Edward Markey (D-MA), a senior Democratic Member of the House Energy and Commerce Committee, and Rep. George Miller, the Ranking Democratic Member of the House Education and the Workforce Committee, today issued the following statements in response to confirmation that Wilshire Associates received a subpoena from the Department of Labor (DOL) in connection with DOL’s investigation of conflicts of interest among investment consulting firms.
Rep. Markey said, “The subpoena of Wilshire Associates, which also provides consulting services to the Pension Benefit Guaranty Corporation (PBGC), raises questions about whether pension funds under the control of the Federal Government are being properly managed. Rep. Miller and I intend to seek further information about Wilshire’s work for the PBGC. Last year, Rep. Miller and I asked the Government Accountability Office (GAO) to investigate problems with government regulation and enforcement of pension statutes, including whether the PBGC currently, or in the past, employs any consultants the Securities and Exchange Commission (SEC) has identified as having potential conflicts of interest. The GAO investigation is ongoing, and I look forward to the results.”
Rep. Miller said, “Hopefully the DOL’s subpoena signals their serious commitment to uncovering more information about how troubling and significant conflict-of-interest issues within the pension plan consultant industry can affect the financial health of pension plans. With massively under-funded plans, like those at United Airlines, being terminated and dumped onto the PBGC, the PBGC cannot afford to turn a blind eye to the practices of its pension consultants. Rep Markey and I urge the PBGC to disclose all relevant information about the services it was provided by Wilshire, and examine whether there were conflicts of interest or unlawful management of terminated plans for which Wilshire may have consulted. As the GAO investigation continues, the DOL and SEC must also continue to look into these practices at Wilshire and other pension consulting firms, so we can guard against this kind of foul play and make pension plans whole – both before and after termination.”
After the Securities and Exchange Commission (SEC) released its May 2005 report that found significant conflicts of interest within the pension consulting industry, Reps. Markey and Miller wrote to SEC Chairman Cox and DOL Secretary Chao to request specific information about the report, including what, if any, action the SEC and DOL have taken to notify the clients of the firms determined to have conflicts uncovered by the report. The Congressmen also urged the Department of Labor to initiate a full-scale audit of the financial circumstances surrounding the failure of United Airlines to meet its pension obligations to its employees and retirees. In response to the Miller-Markey inquiry, the Labor Department reported that “EBSA enforcement officials are currently reviewing the documents to determine what DOL investigative action may be necessary. Based on this review, several matters have been referred to EBSA regional offices for investigation.”
Rep. Markey concluded, “The SEC report released in May 2005 exposed a disturbing pattern of conflicts of interest in the pension consulting industry. For many workers and retirees across the country, the promised pension benefits they earned over the course of their careers have been substantially reduced or eliminated. I am hopeful that the Labor Department’s subpoena of Wilshire Associates will signal the start of a sweeping, systematic movement by the Department and SEC to bring enforcement actions across the pension consulting industry whenever it is determined that advice provided by consultants is colored by conflicts of interest, rather than provided objectively in fulfillment of fiduciary duties. “
For a copy of Rep. Markey’s and Rep. Miller’s correspondence with SEC, DOL and GAO on this issue, email mark.bayer@mail.house.gov
Setting Standards For The Investment Management Industry
