The U.S. Securities and Exchange Commission is finally examining the dark side of pension consulting, which could lead to a crackdown on...
The U.S. Securities and Exchange Commission is finally examining the dark side of pension consulting, which could lead to a crackdown on hidden abuses that have hurt pension-fund returns for years.
In a recently released study that examined 24 large, unidentified pension-fund consulting firms, the SEC said some consultants didn’t clearly disclose conflicts with income received from money managers they also recommend to their clients.
Such conflicts have the “potential to cloud the objectivity of a pension consultant’s recommendations to advisory clients,” the SEC report mildly states.
Pension consultants, who are gatekeepers among pension funds, 401(k)s, brokers and money managers, are poorly policed middlemen who give advice on about $2.4 trillion in assets.
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If you want to know how much pension-fund returns have been diminished by consultant abuses, it’s not in the SEC report.
There is little question that conflicts of interest exist in the pension-consultant industry, which consists of more than 1,700 firms.
The SEC said 13 of the largest consultants in its 24-company survey “provide products and services to both pension-plan advisory clients and money managers and mutual funds on an ongoing basis.”
In other words, consultants may be double dipping by charging money managers for being introduced to pension-fund clients while also billing retirement plans for consulting services.
Fund trustees in dark
The SEC said that some of the most egregious practices by pension consultants aren’t clearly disclosed.
A majority of the consultants surveyed may have directed brokerage trades to appointed or affiliated brokers to offset consulting fees, as well as recommended money managers who also paid consultants for expensive software, performance monitoring or educational seminars.
It’s unlikely that fund trustees knew the full extent of these arrangements or how they affected their net returns because consultants “do not adequately disclose material conflicts of interest arising from these practices to their clients,” the report states.
“By paying for the consultant’s fees with the plan’s brokerage, plans may overpay for the pension consultant’s services because the directed brokerage arrangements may not be capped to terminate when fees due a pension consultant may be paid in full,” the report adds.
Another component of this conflict is that because compensation may be indirectly based on trading volume, consultants have a powerful incentive to recommend a more-expensive, poorer-returning active trading strategy.
Firms not named
Unfortunately, the SEC report doesn’t state how prevalent these practices are or identify the firms involved. It also doesn’t estimate the amount of overpayment in fees or commissions, or the negative impact on fund returns.
Under the lax current regulation, pension funds and participants often aren’t aware that they are getting conflicting advice.
The key document that outlines compensation arrangements — Form ADV, Part II — is difficult to obtain because consultants are required to send it only to their clients. It also contains sketchy details about how much money is charged to money managers and brokers.
In addition to scant disclosure, pension-fund consultants have found ways to skirt responsibility for their advice by avoiding being “named fiduciaries,” the SEC report notes. That means consultants may dodge being held legally accountable for their actions.
“As a result, it appears that many consultants believe they don’t have any fiduciary relationships with their advisory clients and ignore or are not aware of their fiduciary obligations under the [Investment] Advisers Act,” the report adds.
No action taken
While revealing that conflicts exist, the SEC hasn’t proposed any new rules or taken enforcement action to clean up the industry, even though it has been researching the problems since 2003. More regulation and enforcement is needed before retirement funds are truly protected.
The agency says it is in the process of requiring greater disclosure in its forms and already requires chief compliance officers and adherence to related rules that were enacted last fall for consultants registered as investment advisers.
Concrete enforcement of existing rules and new guidelines may be forthcoming, although the agency doesn’t give details in its recent report. Nevertheless, Edward Siedle, a former SEC lawyer and the president of Benchmark Financial Services in Ocean Ridge, Fla., who has advised hundreds of U.S. pension plans, calls the report “an important new initiative for the SEC. They’ve never done this before. They’ve given fiduciaries and plan sponsors the wake-up call they’ve needed.”
It’s tough to ferret out abuses within your pension plan or 401(k). Yet your employer still has a legal responsibility to you. Here are some questions to ask:
• How has your pension plan or 401(k) performed relative to industry benchmarks?
• If there is underperformance, have the managers (or funds) been replaced by the consultant with lower-cost, higher-performing funds/managers? If your plan’s returns are below par, request a “fiduciary audit” by a qualified independent lawyer or consultant.
• If your fund’s consultant has recommended that your pension managers use specific brokers for “commission recapture” or “directed brokerage” programs to offset consultant fees, has your fund received “best execution” rates, that is, the lowest possible commissions on trades? If not, your fund performance may be suffering.
Satisfying selfish interests
Go online to www.sec.gov and search investment advisers by the consultant’s firm. Review their Form ADV, Part I, Item 8 (sections B and C) for any “yes” questions checked. This means that the consultant is selecting brokers or investments and may receive additional compensation. Better yet, request their ADV, Part II, Schedule F, which lists more detailed information on potential conflicts.
Ultimately, one of the best ways to avoid pension conflicts is not to use consultants who employ directed-brokerage or dual-compensation practices. Consultants who work exclusively for the pension fund are less likely to run afoul of your interests.
“The conflicts will exist as long as the moneys involved are as huge as they are and as long as people in the industry place their own interests above those of their clients,” says David Kudish, the president of Advocate Asset Management, an investment advisory firm in Chicago.
Any consultant or adviser who is paid by commissions and eschews passive investing strategies should be suspect. Deal with fee-only consultants who act as fiduciaries and have a sole obligation to your pension plan.
You need to know how commissioned consultants feather their nests now so you won’t lose sleep over your retirement funds later.