Now that the Securities and Exchange Commission has warned pension executives and trustees to safeguard against conflicts of interest by consultants, they must do more than just ensure those conflicts are disclosed and acted upon.
The executives and trustees should audit their consultants' past work to see if activities harmed the pension funds' financial interests.
And they must also look inward. They must examine whether their activities in conjunction with those of the consultants compromised the integrity of any investment or trading decisions.
It's apparent from the SEC's examination of the consulting business that trustees by and large have not scrutinized the activities of either consultants or those of their own fund. They need to do so quickly, and look not only at the present and future, but also in the past.
Reviewing past activity may well provide insights that can improve the understanding of current potential conflicts. It may also reveal that some decisions, such as which managers to hire, were flawed and need to be revisited. Pension executives and trustees should not sweep the flawed decisions under the rug.
Pension consulting firms that have not sought to collect additional revenue through conflict-laden relationships at the expense of their fiduciary loyalty to their clients should welcome such audits and cooperate with them.
More than 30 years after the adoption of the Employee Retirement Income Security Act, the issue of potential conflicts by consultants is finally getting the attention it deserves in Congress. In mid-June, Sen. Mike Enzi, R-Wyo., chairman of the Senate Health, Education, Labor and Pension Committee, sent letters to the governors of all 50 states, warning them to be on guard against fraud by investment consultants, investment advisers and other fiduciaries of state pension funds. In many of these states, the governor appoints some or all trustees to state pension funds.
Also, the Aircraft Mechanics Fraternal Association has asked the Pension Benefit Guaranty Corp. to conduct a forensic audit of the UAL Corp. pension fund, and in fact of any distressed plan, to determine if malfeasance contributed to the demise of the retirement plan.
Pension funds must examine whether contracts calling for most-favored client fees indeed result in the lowest fee. Why do some contracts not seek the lowest fees? Or among other issues, how fees paid by managers to consultants and how soft-dollar arrangements impact money manager selection, retention and trading?
Pension funds shouldn't rely on their consultant to provide this verification. Many consultants will be reluctant to acknowledge that any conflict led to biases in their decisions, fearing litigation for breaching fiduciary duty.
The examination also should include what policies and procedures the pension funds had to guard against biased advice, and what kind should they adopt now. Did trustees open accounts with money managers or brokerage firms that provide services to the pension fund, and did they receive any special treatment, such as initial public offering allocations? Pension fund policies must be made to ensure trustees disclose relationships with existing and prospective vendors, and trustees must recuse themselves or resign from the board if conflicts aren't manageable.
Because companies and legislatures often shortchanged pension funds in terms of the resources they needed to operate effectively, pension staff and trustees sometimes turned to soft dollars and other preferences from consultants and money managers.
This provided a breeding ground in which conflicts of interests could grow. Corporate management and legislatures need to look at their own budget approvals to ensure they aren't shortchanging good pension fund management.
In the end, consultants must begin to disclose potential conflicts of interest and must answer for their activities on behalf of their clients.
And trustees must end their complacency, get fiduciary training, and examine the past actions of the board.