WASHINGTON — The Securities and Exchange Commission is planning to take legal action against many investment consultants for violating securities laws, and is expected to ask several others to beef up their compliance procedures and policies and their ethics codes to prevent or disclose conflicts of interest to their clients.
The results of the SEC's first "sweep" examinations of 24 consultants ere expected to be released on May 16, but without any consulting firms named.
Lori A. Richards, director of the SEC's Office of Compliance Inspections and Examinations, confirmed that many pension consultants examined face legal action and fines, as well as "deficiency letters," as a result of the inspections.
Gene A. Gohlke, associate director of the division in charge of investment adviser examinations and oversight, told a group of pension lawyers at a conference in New York earlier this month that disclosures of conflicting arrangements by pension consultants were "abysmal."
Ms. Richards and Mr. Gohlke declined to name any of the consultants.
More than a year ago, however, officials at Mercer Investment Consulting Inc., Chicago; Watson Wyatt Investment Consulting, Chicago; Wilshire Associates Inc., Santa Monica, Calif.; Frank Russell Co., Tacoma, Wash.; Strategic Investment Solutions Inc., San Francisco; Summit Strategies Group, St. Louis; and Segal Advisors Inc., New York, had confirmed they were examined by the SEC.
And, New England Pension Consultants, Cambridge, Mass., announced in March the firm had received a clean bill from the SEC as part of the extensive investigation into pay-to-play, soft-dollar and other compensation arrangements.
As for what the offending consulting firms can expect, the SEC's enforcement actions typically involve hearings before administrative law judges and can result in fines or civil lawsuits.
Ms. Richards' office found the way some consultants operate could cloud the objectivity of their advice. The SEC long has been concerned about ties between consultants and brokerage affiliates. The agency also examined the practice of consultants being compensated by both pension funds and money managers. The SEC will require consultants to have written policies and procedures to ensure that brokerage commissions, gifts, donations and entertainment provided to clients — or received from money managers — do not influence their professional judgment.
The sweep also discovered pension plans might be paying too much in consulting fees, in part because the fees are being paid through commission recapture arrangements with the consultant's affiliated broker that allow them to be paid in kind, such as through soft dollars instead of cash. Also, consultants recommend active trading strategies that permit their brokerage affiliates to collect more commissions. Plus, pension funds might not get the best price on trades if they're conducted through affiliated brokerages that might not be able to obtain best execution.
The examinations found many investment consultants do not believe they have any fiduciary responsibilities to their pension clients, or were ignorant of their obligations under federal securities laws. Nor did many maintain compliance policies or procedures, as required by the law, or wall off conflicting business operations.
The SEC intends to follow up on the 24 consultants in subsequent examinations to assess if their compliance policies and procedures and their disclosures of conflicts have improved, Ms. Richards said in an interview.
She said SEC officials are publicly discussing the findings of the examinations — not their usual practice — to alert all 1,742 pension consultants registered with the SEC that "there are problems here, and take a hard look at their activities, identify the conflicts in their operations and really take steps to improve their disclosure."
The SEC also is releasing its findings to offer guidance to consultants about their fiduciary responsibilities to offer unbiased advice, disclose conflicting arrangements that might prevent them from doing so and, ideally, eliminate those conflicts, she said.
Since the inspections were conducted, one consultant has already begun telling clients about fees the firm or its affiliates receive from money managers it recommendsthe report says.
Specifically, the SEC's sweeps found:
• More than half of the consultants or their affiliates examined regularly provided services and products to both pension funds and money managers/ mutual funds, and many earned a "significant part of their annual revenue" from dealings with the latter.
• More than half host investment conferences where money managers and their clients are both present. The money managers typically pay thousands of dollars for such conferences, while plan sponsors attend for free.
• Ten of the consultants sell performance analysis software to money managers for fees as high as $70,000 annually.
• A majority of the firms have affiliations with brokerage houses or relationships with outside broker-dealers that have raised concerns about whether clients are getting best execution on trades, whether pension plans are paying too much in fees, and whether the pension plans' assets are being traded more frequently than they should.
• Two also had relationships with unaffiliated brokerage firms that they did not disclose to their clients. These relationships might provide a way for money managers to indirectly reward consultants for recommending their services.
• Some consultants had recommended money managers that purchased products and services from them more frequently than they recommended those that did not.
• Many also have affiliates that provide services, such as investment management, performance analysis or transition management, to pension plans. Fund executives aren't always told about these relationships or about the fees consultants earn as a result.
• Many consultants failed to maintain policies and procedures that enable them to prevent or manage conflicts of interest.
Mr. Gohlke said the SEC's findings have been shared with the Labor Department's pension office, which is considering offering guidance to plan sponsors and trustees on their fiduciary responsibility to ask consultants hard-hitting questions about real or potential conflicts.