As a result of its probe into the operations of 24 pension consultants who are also registered investment advisors (RIAs), the SEC recommended sweeping changes in the consultants’ policies and procedures to make sure the advisor is fulfilling its fiduciary obligations to its advisory clients – including the proper disclosure of potential conflicts of interest, an SEC news release said. The probe covered operations between January 2002 and November 2003 (See SEC Looks At Consultant, Pension Fund Relationship ).
“Although investment advisors owe their clients a fiduciary obligation – including to adequately disclose all material conflicts of interest – some pension consultants appear to have erroneously concluded that they are not fiduciaries to their clients,” SEC investigators wrote in the seven-page report .
After the probe – which focused on pension consultants’ products and services, how the consultants were paid for those products and services, and the extent of their client disclosure – the federal securities regulators concluded that:
- Thirteen of the pension consultants or their affiliates provided products and services to both pension plan advisory clients and to money managers and mutual funds on an ongoing basis. In some cases, money manager payments represented a significant part” of the consultants’ revenue, investigators reported. Thirteen consultants hosted pension plan advisory client conferences, including eight who allowed money mangers to attend for a fee. Some in the consultant community began redesigning their conferences in light of the SEC inquiry (See “Pay to Play” Scrutiny Has Consultants Rethinking Business Structures ). Ten consultants also sell software to money managers for fees as high as $70,000.
- Fourteen of the pension consultants have affiliated broker-dealers or relationships with unaffiliated broker-dealers which may provide a mechanism for money managers to compensate pension consultants “perhaps as a way to curry favor with the pension consultant,” the SEC said. Regulators said a consultant’s having an affiliated broker dealer allows the consultant to be paid through brokerage commission recapture arrangements – programs under which pension advisory clients direct that a portion of their brokerage commission be rebated to the plan or used to pay the consultant’s fee. “These arrangements are not well documented, and raise many issues, including the extent to which plan assets may not be receiving ‘best execution’ because their trades are directed to the broker that provides these rebates,” the SEC warned in the report.
- Many pension consultants have affiliates that also provide services to pension plan clients. “These relationships create disclosure and conflict of interest issues that have not been addressed by pension consultants,” the report said. For example, nine consultants employ advisory representatives that also represent a broker dealer.
- Many pension consultants do not adequately disclose material conflicts of interest arising from these practices to their clients. The SEC said that of the 19 consultants or affiliates providing money manager products or services, three made no disclosure of the practice and the remainder only offered “limited” disclosure.”With respect to the pension consultants that do provide disclosure, it does not clearly indicate that providing products/services to money managers may create a conflict of interest for the consultant, or it is not specific enough for a reasonable person to discern the potential harm of the conflict of interest,” regulators asserted. “That is, some pension consultants disclose generically that various services are provided to money managers and require the advisory client to infer that the consultant receives compensation from money managers. Pension consultants typically do not disclose to current and prospective pension plan clients that they receive compensation in various forms from the same money managers that the consultant may recommend to the client.”
As a result of the probe, the SEC asserted that pension consultants "should enhance their compliance policies and procedures to include those policies and procedures that will ensure that the advisor is fulfilling its fiduciary obligations to its advisory clients."
"It is clear from our examinations that many pension consultants must do more to identify conflicts of interest in their activities and to take steps to mitigate or eliminate those conflicts," said SEC Office of Compliance Inspections and Examinations Director Lori Richards, in the news release announcing the report. "We are releasing this report to alert the pension consultant community to these findings, and, based on what we found, we urge pension consultants to take a hard look at their disclosure and make improvements. And, when a consultant holds itself out as providing unbiased, objective advice, that obligation must be met."
Noting that pension consultants who are also RIAs are now subject to new fiduciary compliance obligations, the SEC said enhanced policies and procedures designed to stem possible conflict of interest abuses could include:
- features ensuring that the firm's advisory activities are insulated from its other business activities, to eliminate or mitigate conflicts of interest in its advisory services. Such policies and procedures would include those governing the process used to identify and/or monitor money managers or mutual funds for an advisory client to prevent considerations of a money manager's or mutual fund's other business relationships with the consultant or its affiliates.
- assurances that all disclosures required to fulfill fiduciary obligations are provided to prospective and existing advisory clients, particularly about material conflicts of interest arising from arrangements between the consultant and its affiliates and the money managers and mutual funds that the consultant recommends to a client during a manager search or for whom the consultant is providing ongoing monitoring services. Policies/procedures should be designed to ensure adequate disclosure concerning the consultant's compensation, including when the pension consultant receives compensation from brokerage transactions from advisory clients or money managers.
- Policies and procedures to prevent conflicts of interest or disclose material conflicts of interest with respect to the use of brokerage commissions, gifts, gratuities, entertainment, contributions, donations and other emoluments provided to clients or received from money managers.
In a statement released after the report, Ann Combs, assistant Department of Labor (DoL) secretary for the Employee Benefits Security Administration, contended that her agency and the SEC have to work together to properly ensure that plan sponsors and participants are protected. "Working together, the agencies can ensure that conflicts of interest are disclosed and appropriately addressed," said Combs in her statement.
Combs pointed out in the statement that the Employee Retirement Income Security Act (ERISA) requires that plan fiduciaries act prudently in selecting and monitoring service providers. "Disclosure of a service provider's potential conflicts of interests would be an important part of the selection and monitoring process," the Combs statement said.