Pension Consultants Under the Microscope in Wake of Confilct-of-interest Findings
After a string of corporate scandals, working with a pension consultant has presented employers with a minefield of potential liability issues.
But today, after a string of corporate scandals such as Enron and WorldCom that resulted in employees losing millions of dollars in retirement savings, working with a pension consultant has presented employers with a minefield of potential liability issues.
In May, a Securities and Exchange Commission investigation found that the pension consultant industry was rife with undisclosed conflicts of interest. The report issued after the investigation, which was based on examinations of 24 pension consultants, discovered that the majority of pension consultants or their affiliates provided products and services to both pension plans and money managers and often did not disclose these relationships to clients. Similarly, a number of the pension consultants had affiliates that worked with the pension plan sponsors, and these relationships were not disclosed. The report concluded by advising pension plan sponsors to increase their efforts to make sure that they are receiving objective advice from their consultants.
"The implications of these conflict-of-interest findings is that the advice that plan sponsors were getting from the gatekeepers that they hired to vet, monitor and recommend money managers has been corrupted and tainted," says Edward Siedle, a former SEC attorney and president and founder of the Benchmark Financial Services, an Ocean Ridge, Florida-based company that investigates conflicts of interest for pension funds. The SEC report brought to light the potential for conflicts of interest among pension consultants, but many industry observers predict that this is just the beginning of a deeper, more thorough investigation. "State and federal regulators are turning their eyes to pensions," Siedle says. "There is a wave of scrutiny coming pension plan providers’ way, and this ‘Cover your ass with a memo in a file’ mentality is not going to save companies going forward."
Asking the right questions
To make sure that companies screen out potential conflicts of interest, the SEC, with help from the Department of Labor, included in its report a list of 11 questions that companies should ask pension consultants. For example, plan sponsors should ask consultants if they or any of their affiliates receive payments from money managers that they recommend and to disclose those payments. Another question asks consultants to describe their policies and procedures to address conflicts of interests.
The goal of the questions is to get an idea of a consultant’s relationships, what revenue it collects from those relationships and if any of these relationships pose a potential conflict of interest. But asking these questions isn’t enough to avoid problems, says Donald Trone, president and founder of Fiduciary360, a Sewickley, Pennsylvania-based fiduciary consultant.
"The questions in the report were focused on potential conflicts of interest, but the more fundamental issue is what the specific role of the consultant is," he says. As seen in a number of the pension plan scandals, consultants often deny fiduciary responsibility, so it is essential that these responsibilities are established before a plan sponsor signs a contract with a consultant, he says.
Getting references from other plan sponsors is also important, but getting feedback from plan sponsors that were not provided as references might be more valuable, says Martha Tejera, president of Tejera & Associates, a Bainbridge Island, Washington-based retirement consulting firm.
She suggests that companies find other plan sponsors that worked with the consultants and talk to them about their experiences. "Companies want to make sure that the answers that the consultant provides them about their processes are consistent with others’ experiences," she says.
Wayne Miller, president of Denali Fiduciary Management, says that companies should ask consultants whether they have ever been fired before, and if so, for what. Often, being fired can mean that the consultant has a high ethical standard, he says.
"If you have been in this business long enough, you will come across plan sponsors that want to pull the wool over people’s eyes and you have to say, ‘Even if I make $50,000 for this account, I don’t want to work with you,’ " he says. Miller says companies need advisers who will tell them what they need to know, not just what they want to hear.
When conducting their due diligence, employers should make sure to ask consultants about all types of relationships with other companies, not just financial ones, says Mark Perlow, a partner in the San Francisco office of Kirkpatrick & Lockhart Nicholson Graham. "Even if the relationship is not financial, there could be other incentives for a consultant to recommend a money manager," he says. For example, family ties or old or close relationships not based on business should be disclosed.
Industry conferences are another area where money changes hands between consultants and money managers. Often money managers will pay to host a session of a pension consultant’s conference. The pension plan sponsors are invited as attendees for free. "If you go to a conference at the Four Seasons and you aren’t paying for it, that should raise some questions," says Gary Findlay, executive director of the Missouri State Employee Retirement System. "You are there as bait."
David Wolfe, a partner in the Chicago office of Gardner Carton & Douglas, says having conferences in such a way is not inherently bad as long as it is disclosed. "Companies need to ask questions about who is going to the consultants’ conferences and who is paying for what," he says.
Figuring out fees
Conflicts of interest can also be discovered when companies examine the revenue streams of the money managers they use. Last year the $34 billion Illinois Teachers Retirement System began requiring its money manager partners to disclose all payments they made to third parties on an annual basis.
"I was surprised by the overall levels of payments that were going on between consultants and money managers," executive director Jon Bauman says. He says it can be difficult to extract revenue information from money managers because they often cite confidentiality agreements. Often pension consultants will claim the same issue, saying that those arrangements are not directly related to the company’s pension consulting business and thus are not relevant, he says. Bauman’s solution to the problem: "Don’t hire them if they don’t provide that information."
Tracking the sources of revenue for consultants and money managers is just as difficult for companies with 401(k) plans. This is largely due to the prevalent practice of revenue-sharing, whereby mutual fund companies pay fees to broker/dealers and 401(k) plan administrators for marketing and servicing fund shares. Late last year, the SEC announced it was examining how companies that service 401(k) plans were being compensated, but the results of the examination have not been released.
"It is surprisingly difficult to find out and confirm what the investment consultant’s sources of revenue are," Tejera says. Since these revenue-sharing expenses are not disclosed anywhere, it is up to the plan sponsor to dig deep and figure out what they are. And that can take a lot of digging, she says.
Many plan sponsors don’t even know these agreements exist, she says. To remedy the situation, Tejera says that regulators need to force mutual fund companies to break out all of their sources of revenue and fees.
Siedle suggests that companies follow up and check the answers that consultants give them. "Just asking the consultant questions and calling it a day is like asking the baby sitter if they have ever been convicted of a felony and taking their word for it," Siedle says. "Their job is to safeguard people’s assets and they have to do more than just ask questions."
The Missouri Public Employee Retirement Plan conducts annual internal audits of its investment management consultant to make sure that everything is in order, Findlay says. Companies also need to audit their internal processes, such as how their investment committees operate, on a periodic basis, Trone says. "They need to be taking a close look at who they are putting on the investment committees," he says.
Miller suggests that companies go one step further and provide training to the members of the investment committee to make sure they understand their fiduciary responsibilities. "A lot of people think they can sit on a committee because they know something about mutual funds," he says. But these executives should also be well-versed on their responsibilities as fiduciaries.
Potential vs. problem
After the Illinois Teachers Retirement System completed its review of the fees that its money managers were receiving, Bauman saw that he had a decision to make. The review found that a couple of the managers licensed indexes from Wilshire Associates and Russell Investment Groups, two companies that act as pension consultants as well as investment managers.
Money managers often license indexes provided by the likes of Wilshire and Russell to benchmark the performance of their portfolios. But Bauman had to decide whether the ties between the money managers and these pension consultants, which have multiple lines of business, posed a potential conflict of interest that threatened the quality of the services the pension plan was receiving.
In this instance, Bauman did not see it as an issue, especially since the plan uses a separate pension consultant, Callan Associates. But another pension plan might have taken a more extreme view and decided that any link to a pension consultant with multiple lines of business was too much.
"There are certainly divergent points of view about this, but if the conflict of interest has been disclosed upfront and the decision-makers are assured that they are getting clear, unbiased advice, then they should continue to use those companies," he says. "Just because there is a potential for conflict does not mean there is an actual conflict."
Workforce Management, October 10, 2005, pp. 58-60 -- Subscribe Now!