Pension fund officials are paying closer attention to ancillary businesses of consultants, such as soft-dollar brokerage and manager performance measurement.
At issue are potential conflicts of interests. And while questions about revenue sources long have been common when executives of pension funds are searching for a new investment management consultant, pension executives and trustees now are demanding more in-depth explanations from candidates.
For example, a recent request for proposals issued by the New York City Retirement Systems for the $9.6 billion city police fund asked the consultant to disclose any ancillary services it offers and what percentage of the firm's total income those services generate. The New York RFP also asked for information on financial relationships the consultants had with institutions such as brokerages and banks, what fees it receives from them and what steps it takes to prevent conflicts of interests.
The RFP stated the consultant will be held to the same standard of conduct and diligence as a plan fiduciary or trustee.
Consultants seem used to complying with such requests. 'I think lately, they've (sponsors) been perusing those answers and following up more closely," said Thomas H. Dodd, senior consultant at Stratford Advisory Group Inc., Chicago.
Diane Brown, manager of fiduciary services of Frank Russell Custom Management, a unit of the Frank Russell Co., Tacoma, Wash., said Russell will break out its lines of business and the percentage of revenue from each line when responding to RFPs.
Russell has a brokerage subsidiary, Frank Russell Securities, and units selling investment management research and performance tools.
Still, every year the requirements become slightly tougher, said Roger Bransford, a principal of LCG Associates, Atlanta. The change is evolutionary, he said, as officials of pension funds better understand the relationships and connections involved.
In a recent search, for example, Mr. Bransford said he was surprised when a sponsor reviewing LCG called all five references the firm had given.
The burden of uncovering these potential conflicts of interests rests with the plan sponsor. No regulatory body oversees consultants the way the Securities and Exchange Commission does for money managers, noted Edward A.H. Siedle, a former SEC attorney who is president of Anvil Institutional Services, New York, an institutional broker-dealer that handles soft-dollar business.
Mr. Siedle said it would be only prudent for other plan sponsors to require the extensive disclosure that the New York City Retirment Systems and other funds are writing into their RFPs.
Such questioning "has made a difference over the years in the consultants we've hired," said Thomas Lopez, chief investment officer of the $6.4 billion Los Angeles Fire & Police Pension Systems.
The fund uses Wyatt Investment Consulting Inc., Washington, for its management searches because Wyatt Investment doesn't sell services to investment managers, Mr. Lopez said. The fund recently hired Wilshire Associates Inc., Santa Monica, Calif., for an asset allocation study; Mr. Lopez noted Wilshire will terminate its consulting relationship with a client that hires Wilshire for another function.
Gary Findlay, executive director of the $2.8 billion Missouri State Employees' Retirement System, Jefferson City, said a sponsor should ask a consultant or any other service provider what revenue the firm expects to realize from the fund's business - not only from its retainer, but also from any other fees such as directed brokerage.
The $4.6 billion Los Angeles City Employees' Retirement System asked similar questions regarding ancillary revenue when it issued a request for proposals for a fund consultant about two years ago, said Oscar Peters, general manager.
"I'm not sure that (question) is going to make or break" the selection, said Mr. Peters. But, "if they're head and shoulders above the others and there is some possibility of conflict of interest, we would want to be aware of the possibilities."
Pension executives and trustees want to hire consultants whose firms consider consulting to pension funds to be a primary line of business, noted Janie Kass, director of investment counseling services at Kwasha Lipton, Fort Lee, N.J.
"What they're trying to find out is 'How important is it to the organization,'" said Ms. Kass. She noted one question not normally asked by sponsors would give them a better idea: a breakdown over time of what percentage of the firm's total revenue is derived from consulting.
If the percentage is steadily declining over time, it's a sign that consulting is being eclipsed within the organization, Ms. Kass said.
