WASHINGTON -- A Labor Department task force is expected to recommend pension executives hire only consulting firms with no financial arrangements with brokerage firms.
The recommendation by the ERISA Advisory Council is aimed at avoiding soft-dollar conflicts of interest. It could hit most major consulting firms hard. Many have brokerage subsidiaries for processing payment of fees in soft dollars, and others have arrangements with brokerage firms to accommodate soft-dollar fee payments. It also would hurt the consulting arms of brokerage firms.
The big question, however, is whether pension funds will heed the recommendation.
The group has no legal standing, and the Labor Department might or might not use the panel's findings to shape its pension legislative and regulatory agenda.
Still, some see the recommendation as a wake-up call to pension executives. The increased emphasis on soft dollars -- not just by the ERISA Advisory Council but also by the Association of Investment Management Research and the Securities Industry Association -- might prompt pension officials to ask their consultants some hard questions about soft-dollar arrangements, they say.
But Ronald D. Peyton, president and chief executive of Callan Associates, San Francisco, does not expect the group's recommendation will have any impact on his firm's business.
"I can't imagine that we could be one of the top consulting firms in the industry if this was really a problem," he said. Callan has a brokerage unit, Alpha Management Inc.
The recommendation is one of several by the ERISA Advisory Council's working group on soft dollars. The group approved the recommendations this month, but is not expected to release its report until early December.
Sources said the report won't condemn soft-dollar practices, nor will it ask for a repeal of the law that permits money managers to pay higher than the prevailing commissions for a securities trade, in exchange for research services and products that can help them make better investment decisions.
In typical soft-dollar arrangements, money managers receive investment research or other products and services from brokerage firms in exchange for trading securities through them.
Possibility of coercion
But several witnesses testified before the ERISA Advisory Council's soft-dollar working group that consultants with ties to brokerage firms could coerce money managers into trading securities through them in order to be included in manager searches.
Others said consultants with links to brokerage firms that conduct commission recapture programs for pension plans might be violating their fiduciary duty under the Employee Retirement Income Security Act -- that such programs could be construed as self dealing.
As expected, some consultants that don't have brokerage affiliates commended the ERISA Advisory Council for its recommendation; those with brokerage affiliates openly condemned it.
"From the inception we were aware of the potential conflicts of interests," said Martin Levenson, senior vice president at Segal Advisors, a New York-based consulting firm with no brokerage affiliate. "We did not want to be compensated by a client's trading activity."
The council's recommendation could lead to pension executives using the request-for-proposal process to ask hard questions of consultants and money managers, observed Samuel W. "Skip" Halpern, general counsel at Independent Fiduciary Services Inc., a Washington-based investment consulting firm that does not accept soft dollars
"The potential for conflicts of interests is so great that I think there has to be a very clear separation between consulting and brokerage," he said.
Potential conflict, not real one
Others, of course, disagree.
Said Kenneth L. Kahn, president of San Francisco's Alpha Management, Callan's brokerage affiliate: "It all comes down to how you manage your conflicts of interests. Anyone who looks at Callan and looks at its records, will realize there is a potential conflict of interest, but not a real one."
Added Stephen L. Nesbitt, senior vice president at Wilshire Associates, Santa Monica, Calif.: "Plan sponsors should choose to hire whoever they want to hire, whether they want to use soft dollars, and what vendor they want to use to capture soft dollars."
"The fact that the largest consulting firms for ERISA funds are also broker-dealers reflects the fact that some of the clients like to have that facility available, either for commission recapture or for some other reason," he observed. Wilshire accepts soft dollars.
An attempt to water down the recommendation -- by suggesting pension executives merely be alert to the potential for conflicts -- failed by a 5-2 vote. The change had been pushed by Thomas J. Healey, a Goldman, Sachs & Co. managing director and member of the ERISA Advisory Council.
The group did agree, however, to Mr. Healey's suggestion not to include investment managers with brokerage affiliates because such a dictate effectively would bar many of the largest money managers from managing pension assets, including Fidelity Investments, J.P. Morgan & Co. and Merrill Lynch & Co.
Other recommendations
The report also is expected to recommend:
Pension executives should obtain written confirmations of oral reports made by consultants and investment managers regarding brokerage arrangements.
Investment managers should give plan sponsors details of all securities trades, as well as a description of their policies on soft dollars.
Plan sponsors should develop guidelines for their use of soft dollars and directed brokerage, and discuss with their investment managers how much of the commissions on their securities trades should be directed to specific brokerage firms.
The ERISA Advisory Council is not the only organization to jump on the soft-dollar bandwagon -- both the AIMR and SIA are attempting to self-regulate the issue. "Some might view the efforts of AIMR and the SIA as a way to pre-empt the SEC," said Douglas J. Scheidt, chief counsel of the Securities and Exchange Commission's investment management division, which oversees investment advisers and the mutual fund industry.
"If the industry can police itself, then there won't be so much need for regulation," he noted.
Non-commission trades eyed
Perhaps one of the most controversial recommendations the AIMR committee is expected to make is that managers should disclose to their pension clients if they receive research from trades where no commissions are paid, such as principal and fixed-income trades.
This recommendation, which recognizes that research is paid for by brokerage expenses other than commissions, did not go down well with SEC officials asked to review the draft report, a source said.
Catherine McGuire, chief counsel in the SEC's division of market regulation, was at the meeting, but declined to comment on the AIMR draft report.
Other AIMR recommendations would:
Limit the definition of "research" expenses money managers can claim against brokerage trades to custom-made products and services used by investment managers in making investment decisions.
Standard office equipment such as personal computers, television sets and wire services would not considered research.
Require Wall Street firms to break out the cost of providing routine research reports.
Require money managers to give their clients an annual listing of total brokerage commissions as well as a breakdown "of what was paid for through the individual account," a source said.
Provide guidance on "mixed use" of commission dollars, where they might be used not only to purchase research products and services, but also products and services necessary for a firm's day-to-day operations.
Require managers to provide guidance to plan sponsors on directed brokerage arrangements. This could include discussions on what brokers the managers would be comfortable dealing with, and the level of directed brokerage appropriate for the plan.
Require money managers to disclose to clients their soft-dollar policies and procedures and the methods they use to review research firms and allocate brokerage accordingly, said Howard J. Schwartz, chairman and chief executive of Lynch, Jones & Ryan Inc., a New York-based discount brokerage firm, and a member of the AIMR soft-dollar committee, who also headed SIA's soft dollar group.
