(November 1, 2001) Consultant Refuses to Disclose Manager Brokerage to Pension - Asserts Duty to Protect Confidentiality of Its Brokerage Clients! |
There is no greater threat to the financial security of millions of Americans than the corruption of pension consultants who advise the pension plans in which they participate. The conflicts of interest most consultants are subject to are so profound as to destroy the integrity of the advice they offer. As we said last month, the potential for pecuniary gain exists in connection with every decision a pension consultant advises a fund in making. Unless pension boards identify and quantify the nature and extentof consultant conflicts, they are unjustified in relyingupon the advice consultants provide. We have always believed that the dangers are real and serious harm results to funds from these conflicts.
Just how damaging the"pay-offs" consultants solicit can be, we continue to learn through the investigations we conduct on behalf of pension sponsors. Let's not mince words. When a consultant receives brokerage or conference fees from a manager it recommends a fund hire, that is a pay-off. There are no harmless pay-offs. Boards that choose to turn their backs to such dealings are enabling their consultants to use pension assets for their own financial gain, to negotiate for brokerage and other compensation with managers. That is a violation of the fundamental duty boards have to protect retirement assets. Decisions must be made with the best interests of the participants in mind and not the financial interests of the consultant.
We often say that Benchmark specializes in handling problems that do not exist. These are matters the SEC, NASD, AIMR and others maintain pose no risk to investors. According to these organizations, the NASD's public disclosure system effectively informs investors of the disciplinary histories of brokers and their firms; hedge fund and venture capital managers are superstars who need no regulation; personal trading violations of money managers are rare; financial analysts and pension consultants offer independent advice; there are no hidden dangers related to 401k plans or other pension plans. These myths are propagated by the securities and money management industries, pension officials and regulators. To which we respond: we know of the abuses and risks. We can identify, analyze and quantify the harm. Anyone who says the dangers we write about don't exist, simply are uninformed or are intentionally misleading the public. Pension boards and participants that choose to ignore these problems will eventually suffer embarrassing losses that could have been prevented. Unfortunately when pensions make costly mistakes, most try to cover them up.
In our last month alert, we wrote about a pension board member that submitted a memorandum to his board including motions to require the fund's consultant to disclose financial information regarding conflicts of interest. Most importantly, the trustee asked that the consultant disclose all compensation, including brokerage and conference fees, the consultant received from the fund's managers.
We somewhat cynically predicted his proposal would be rejected by his fellow board members. There was no room for debate regarding the merits of his proposal. Disclosure of financial information regarding conflicts of interest should never be rejected. Nevertheless, the board for personal and political reasons chose to do the wrong thing. This did not surprise us. We are not na´ve to the realities of pension fund decision-making. What did surprise us was the willingness of the board to accept an outrageous argument presented by its consultant.
We thought we had seen it all. But when the consultant responded to the trustee's request by asserting that disclosure of compensation received from managers would violate the consultant's duty of confidentiality to the managers, we were floored. The consultant was saying that when it's duty to money managers conflicted with its duty to the fund, the duty to managers, not the fund, should prevail. Of course, this is an admission of the very conflict of interest the trustee was attempting to ferret out. "If you're going to be promoting my managers' best interests, then you can't be effectively serving the fund," the trustee was saying, or "You can't serve two masters." The consultant's response points out the underlying economics of its consulting business: the consultant is earning far more money from the managers of the fund than from the fund itself, ten or more times as much. Consequently when the trustee pressed for disclosure, the consultant had no choice but to refuse. To refuse to disclose merely creates suspicion; to disclose would be to confirm the abuses.
The losers in this showdown between trustee, his board and the consultant are the participants in the fund. The board made the fatal mistake of thinking it knew the extent of any possible harm and dismissed the need for an inquiry, before even looking into the facts. They were comfortable in their ignorance. When boards reject proposals for additional disclosure of conflicts of interest, when they refuse to investigate wrongdoing that has been brought to their attention, they should be held personally liable for any loss to the fund. There is simply no excuse for this intentional refusal to investigate. We look forward to the day when pension participants become aware of these omissions and hold their board members accountable.
This case also points out a disturbing reality about the relationship between pension consultants and the funds they advise. We refer to it as "circularity of reasoning." Fund boards rely upon consultants to tell them what should be of concern to them. If the consultant says that the brokerage and conference fees it collects from the fund's managers are inconsequential and pose no real risk of harm, the board will believe what they are told. They are accustomed to the consultant playing the role of objective evaluator. Boards fail to grasp that, in this situation, they cannot rely upon the consultant to advise them against a course of action in which the consultant has a substantial financial interest. And, of course, the consultant will deny that there are any situations where he has a substantial conflicting financial interest.
In the final analysis it is up to the boards themselves to identify consultant conflicts of interest. They cannot rely upon their consultants to candidly admit when a conflict exists. Consultants will resist efforts to force them to disclose financial information when a conflict exists. Count on it. So board members must be prepared for a fight and be insistent. If there is truly nothing to be concerned about, there is nothing to hide and disclosure should be uncontested.
Every pension board should, at a minimum, require its pension consultant to provide a copy of the most recent audited financials of its affiliated brokerage, including information regarding the firm's gross revenues. In this case, the consultant also refused to provide this information. The SEC and the NASD require brokerages to provide audited financial information to clients, including a balance sheet and net capital computation. You can obtain this limited information from the SEC, if your consultant won't give it to you. But this is not enough. Only gross revenue information will reveal how much brokerage business a consultant is receiving. In our opinion, any consultant with a brokerage affiliate that won't disclose its full audited financials, should be summarily terminated.
Finally, pension boards should keep in mind that any information the consultant will not provide regarding brokerage, conference fees and other compensation it receives from the fund's managers, can be obtained from the managers themselves. Many managers are eager to share this information to plan sponsors. These managers resent consultants always hitting them up for brokerage and other fees, in order to be considered in searches. Money managers can be the board's allies in bringing an end to "pay to play."