Two years ago, senior executives at LandAmerica Financial Group Inc. hired a pension consultant to review the investment options in the company's 401(k) plan. The reason? Managers at the title insurance company wanted an independent analysis of the investment-selection process.
It was a prudent move. While LandAmerica CFO G. William Evans says the review turned up nothing irregular at the Richmond, Virginia-based company, it appears some pension consultants have been recommending money managers based on self-interest, and not on the needs of their clients. Indeed, a study of 24 pension consultants conducted by the Securities and Exchange Commission found that more than half of the advisory firms earned money from both retirement-plan clients and money-management funds. According to the SEC study, issued in May, most of these pension advisers had relationships with unaffiliated broker-dealers or operated their own broker-dealers — thus providing themselves with an easy way to receive indirect payments from money managers.
At press time, the SEC had yet to take official action against any pension consultants. (The commission's enforcement division is thought to be looking into the matter.) But the cozy relationship between pension consultants and the money managers who love them could be bad news for employers. According to Jay Harrelson, an attorney with the Nashville-based law firm Waller Lansden Dortch & Davis PLLC, an employer that relies on a single — and tainted — pension consultant could find itself on the hook. The same is true for a plan sponsor that fails to properly vet the selection of the funds in a plan. "If a fund performs poorly," says Harrelson, "the plan sponsor could be liable for restoring those losses."
Lawsuits in the Making?
So far, plan sponsors have been slow to see the danger in this situation. That's surprising, considering that the potential conflicts of interest in the pension-advisory business are similar to those exposed in the insurance-brokerage business last year. Those conflicts, brought to light by New York Attorney General Eliot Spitzer, received a great deal of press coverage — and led to sizable settlements by three of the nation's largest insurance brokers.
While no one knows if the SEC's review of pension consultants will lead to any penalties or sanctions, publicity about potential conflicts could trigger worker suits — particularly in a down stock market. Still, few employers are doing what LandAmerica did. Harrelson says he has a few corporate clients that are beginning to ask hard questions of their pension-plan consultants, but labels them "the exceptions rather than the rule." Adds David Wray, president of the Profit Sharing/401(k) Council of America: "I don't think plan sponsors are reacting at this point to a list of possible concerns."
One fiduciary who isn't waiting to act is Robert Belk, executive vice president and CFO of Shaw Group Inc. Belk says the engineering and construction firm has been using a pension consultant for its 401(k) plan for several years. For his part, Belk believes the consultancy — R.V. Kuhns & Associates Inc., of Portland, Oregon — is a truly independent adviser.
Following the release of the SEC report, however, management at the Baton Rouge, Louisiana-based Shaw Group asked the firm to respond to a set of 10 questions put out by the SEC and the Department of Labor (DoL). "[Kuhns] not only provided us with answers to the questions," reports Belk, "it also supplied us with its code of ethics."
In fact, R.V. Kuhns has posted its answers to the SEC/DoL questions on its Website. There the firm also states that 100 percent of its revenue comes from direct cash payments from clients. In addition, Kuhns claims it accepts no gifts, perks, or other gratuities from investment managers or other firms.
Meandering Money Trail
Whether such disclaimers carry any legal weight — or get plan sponsors off the hook — remains to be seen. One thing is for certain, though: the money trail between pension consultants and fund managers is often a maze.
In some cases, consultants charge fees to money managers to attend conferences that are free for other clients. Other times, pension advisers sell proprietary software — at full price — to fund managers to analyze the performance of clients' accounts. In addition, observers say many consultants operate "commission recapture" programs through affiliated broker-dealers. Under that type of arrangement, a portion of the brokerage commissions paid by plan sponsors is rebated to the plans or used to pay consultants' fees.
Admittedly, these sorts of setups are not illegal, and sometimes even benefit corporate clients. But the SEC warns that when the arrangements are not well documented, they raise troubling issues. For starters, a plan sponsor may not receive the best available terms on a transaction, because trades have been funneled to a broker that is providing rebates to a consultant. It's also possible that a corporate client can overpay for the services of a pension consultant if directed-brokerage arrangements don't terminate when the consultant's fees are paid in full. Moreover, experts say a retirement-plan administrator might agree to a trading strategy that's actually intended to generate more commissions for a consultant's affiliated broker-dealer.
J. Fielding Miller, CEO of independent advisory firm CapTrust Financial Advisors, says the Raleigh, North Carolina, firm does operate a commission-recapture program through an affiliated broker-dealer. But CapTrust limits the arrangement, Miller notes, to so-called 12b-1 fees — that is, commissions that mutual funds pay brokers and other investment advisers to market their funds. When a mutual fund in a corporate client's 401(k) plan pays such commissions, he adds, any revenue CapTrust receives above that fee is rebated back to the client.
That's not always the case. Indeed, plan sponsors often have no idea that a pension consultant has a business relationship with a money manager. On paper, there often is no relationship. A consultant will merely recommend a money manager to a client. That money manager, in turn, routes trades through the consultant's broker-dealer — even if the trades are not for that pension plan's account. "It's kind of a wink deal," Miller says. "The money managers are saying, 'I'll get you trades another day another way, but it can't be traced back to that particular client.'"
Ask Hard Questions
Surprisingly, midsize businesses are more likely to receive tainted advice than small or large companies. Judy Schub, managing director of the Association for Financial Professionals's Committee on Investment of Employee Benefit Assets, in Bethesda, Maryland, says that smaller businesses may not use pension consultants, because they can't afford them. Those businesses are far more likely to choose their plan's investment options internally, aided only by third-party administrators (mutual-fund operators, insurance companies, and the like).
Meanwhile, Fortune 500 companies employ in-house pension professionals to make sure they're getting unbiased advice. That can take some doing, however. Managers at health-care-products distributor Henry Schein Inc., for example, hired a pension consultant to help them choose the investment options for the company's $230 million (in assets) 401(k) plan about a year ago. But Schein executive vice president and CFO Steve Paladino says executives at the $4.1 billion (in revenues) company did not sign on with the consultant until they verified the independence of the firm.
How? Managers at Melville, New York–based Schein asked representatives of the consultancy to confirm that it had no relationship with any broker-dealers or mutual funds. And they wanted to know if the firm received any compensation as advisers, or in any other capacity. "We also wanted to make sure they understood that they have a fiduciary relationship with our plan," notes Paladino. "We confirmed all of those items."
Plan sponsors that have yet to get similar assurances from their pension consultants may be courting trouble. "You should always be asking these kinds of questions," says an attorney who focuses on cases involving the Employee Retirement Income Security Act, which governs the operation of 401(k) plans. Now that the SEC and the DoL have highlighted the issue, the attorney says corporate executives should be proactive in grilling pension consultants about potential conflicts of interest. "You need to get comfortable that they have procedures in place to deal with [possible conflicts]," the lawyer says. "And you need to be assuring yourself that none of this affects the integrity of the selection process."
Randy Myers is a contributing editor of CFO.
Now that the Securities and Exchange Commission is on the case, CFOs with oversight responsibility for their companies' 401(k) plans can sit back and wait, comforted by the idea that any wrongdoing will be righted — right? Wrong, says former SEC chairman Harvey Pitt, now CEO of global consulting firm Kalorama Partners LLC, in Washington, D.C. "If your interest is in protecting the employees who are going to use whatever monies are accumulated in these accounts for their retirement, then it seems to me that CFOs should basically say, 'We don't need to wait for the government inquiry. We ought to make sure the people who are servicing our employees understand that neither the employees nor we as a company have any tolerance for conflicts of interest, and we should make certain any practices that are followed are practices consistent with the interests of the plan beneficiaries.'"
Pitt calls the allegations that pension consultants could be offering advice to retirement plans based on anything other than what's best for the plan and its participants "extraordinarily serious." As noted in the accompanying article, the findings of the SEC staff have been forwarded to the SEC's enforcement division. While there is no guarantee the enforcement division will do anything with those findings — and the SEC isn't commenting — Pitt says he thinks it is "very likely" that the referrals will lead to some form of enforcement action by the SEC. — R.M.