Now that the Securities and Exchange Commission has released a staff report of its examination of the business practices of pension consultants, every pension plan sponsor should demand its consultant address the issues raised by the report.
Key among those issues is the lack of disclosure of conflicts of interests in financial arrangements that consultants have with money managers and brokers. Sponsors need to ask other vendors about potential conflicts of interest also.
The SEC and the Department of Labor should help pension trustees by developing a checklist that would serve as a minimum standard for consultants, money managers and brokers on potential conflicts and the financial impact they might have.
The SEC findings are likely just the tip of an iceberg, since the regulators examined only 24 of 1,742 SEC-registered investment advisers that provide consulting services. However, it found that 13 of the 24 consultants examined provided products and services to both pension funds and money managers and mutual fund companies on an ongoing basis. In addition, 14 have affiliated broker-dealers or relationships with unaffiliated broker-dealers.
The SEC found that among the consultants that provided products and/or services to money managers, disclosure of such conflicts was generally not specific enough "for a reasonable person to discern the potential harm of the conflict of interest."
The SEC report said it was unable to fully analyze whether pension consultants "skewed" their recommendations to favor certain managers because most consultants did not keep information about searches in a format that allowed such analysis. However, it found indications that three consultants had skewed their recommendations — a troubling sign.
While some consultants do not regard themselves as fiduciaries to pension plans, the SEC staff report said under the Investment Advisers Act of 1940, "a person that advises as to the selection or retention of an investment manager is considered an investment adviser." Consultants therefore owe their clients "a duty of utmost good faith, and full and fair disclosure of all material facts."
The staff report strongly suggests some consultants have breached their fiduciary duty to their clients by providing inadequate disclosure of conflicts and potential conflicts at the very least.
Consultants need to be held to account by regulators and trustees for any such failure, and for allowing financial arrangements with money managers and brokers to bias what should be objective recommendations to plan sponsors.
The SEC at least should sanction the firms against which it has the strongest evidence as a warning to other consultants to take seriously the need to address conflicts of interest, and to disclose them clearly to clients.
It is possible, too, pension clients will sue consultants; sponsors must now demand what they should have been demanding all along — proper disclosure of all relationships with actual or potential conflicts.
Trustees now are on notice that their complacency is unacceptable. They could face liability for their own actions or inaction in overseeing consultants if they fail to heed the SEC's warnings. Trustees need to know where their consultant's loyalty lies. They must demand disclosure of how much revenue comes from money mangers and brokers, and seeking evidence of whether those arrangements skew recommendations. They can no longer simply accept bland assurances that they do not.
The Department of Labor long ago should have looked into these deep-rooted questionable practices by some consultants and their impact on the financial well-being of pension plans. Now it must articulate clear policies for plan sponsors to follow when hiring consultants, and for consultants seeking to advise pension funds.
It also must demand fuller disclosure by consultants of business arrangements that present actual or potential conflicts of interest. It must also demand better record keeping so that any biased recommendations tied to the provision of other services can be detected.
