(September 4, 2004 ) Pension Consultant Shenanigans |
Pension Consultant Shenanigans
In May 2004 we warned, “Faced with mounting allegations of wrongdoing, lawsuits and regulatory scrutiny, the pension consulting industry is bracing for harder times ahead. Quietly some of the larger firms are retiring or replacing key senior managers who have overseen pay-to-play schemes, spinning off conference organizing and money manager marketing operations and erecting “Chinese Walls.” Since it is virtually certain that full disclosure of sources and amounts of their conflicting revenues will be required either as a result of growing client sophistication or SEC rule in the near future, firms today are implementing strategic changes intended to blunt criticism once the numbers come out. The goal is to reduce the appearance of impropriety.”
This week Dow Jones reported that “Bank of New York Co.'s BNY Brokerage Inc. unit signed a definitive agreement to acquire the execution and commission management assets of Wilshire Associates Inc. Financial terms of the acquisition, which is subject to New York Stock Exchange approval, weren't disclosed.”
Hmmm…Calpers, Wilshire’s massive public fund client, recently adopted a conflict of interest disclosure policy that requires consultants to disclose their divergent sources of revenues and we anticipate that the SEC is, as we wrote in May, on the verge of proposing a consultant disclosure rule. By “selling” its substantial brokerage business now, Wilshire could avoid having to disclose the millions in brokerage revenues it derived from money managers it recommended to its pension clients in the past. (Such disclosure is especially problematic for consultants who have consistently assured pensions that their affiliated brokerage operations are insignificant.)
Pensions should still insist upon disclosure of Wilshire’s past brokerage revenues, in order to determine the objectivity of Wilshire’s past recommendations that may have impacted upon past performance, as well as continue to impact future results. Further, scrutiny of the underlying selling agreements is necessary in order to determine whether the economic benefits of ownership have been substantially retained by the “seller.” You may recall, Callan Associates also entered into an apparent sale of its affiliated brokerage to BNY.
Personal Responsibility For Retirement Planning?
Americans today are at a crossroads in retirement investing. For better or for worse the nation appears to have accepted the notion that each of us should be responsible for planning for our own retirement. Personal responsibility for retirement planning is so ingrained at this point in time that some are even calling for changing Social Security to permit participants to direct the investment of these funds. (Don’t be surprised when politicians argue that allowing participants to direct their Social Security funds into equities and other investments, as Social Security benefits are decreased, will result in comparable or enhanced retirement security.)
It’s a fundamental freedom: the right to make our own investment decisions. Gone are the days when workers could look to their employers to manage their retirement funds and soon workers may not be able to even look to the government to provide a final safety net. We shall all sink or swim, depending upon our own individual investment acumen.
A coalition of financial services firms and employers lobbied hard over the years for this shifting of responsibility onto the individual. Their successes, such as the IRA and 401(k) legislation, fueled the boom in mutual fund and other collective investment vehicles aimed at the retail investor. In their marketing materials financial services firms presented images of successful retirement investors who prospered as a result of entrusting assets to these firms. Investors came to believe what they were told by Wall Street marketers and eventually seized the opportunity to participate in a seemingly ever-rising stock market. Based upon preliminary or short-term results, some believed they could do a better job of managing their retirement monies than their employers had.
Employers, on the other hand, were thrilled so many workers were convinced this shift in responsibility was beneficial to them. In the prolonged bull market any downside to personal responsibility for retirement planning received little attention.
Happiest of all was the financial services industry. Since retail fees are significantly greater than the fees pensions pay, the shift of responsibility onto the individual resulted in significantly higher revenues to financial services firms. Furthermore, the creativity of marketers at financial services firms was unleashed as products designed to appeal to the appetites of retail investors, but lacking investment merit and heavily laden with fees, were churned out. Products unfit for the institutional marketplace could be foisted onto the unsuspecting public further enriching their unscrupulous promoters. Government plus and option income funds were sold to individuals living on fixed-incomes to compete with CDs. Sector funds of all sorts were created, slicing and dicing the market in every way conceivable. Funds were created that invested solely in companies headquartered in St. Louis or solely in telephone companies in emerging countries.
However, as responsibility for retirement matters was shifting onto the individual, the complexity of all financial matters was growing exponentially. As a result of exploding credit card issuance, products could be bought (with funds borrowed at usurious rates) that would become worthless long before they were ever paid off. Debt mushroomed as individuals were offered multiple cards, including new cards to consolidate existing card balances. Adjustable rate mortgages exploded onto the scene offering us the opportunity to prosper from correctly guessing the future movement of interest rates but requiring us to comprehend the financial gyrations of these loans. Who could verify the accuracy of the payment amounts, balances, interest charges and late fees reflected on these statements? With the introduction of debit cards, money could be withdrawn from personal accounts instantaneously, leaving the individual little recourse in the event that the product or service was unsatisfactory or a billing error had occurred. Debit cards excused the issuer from any responsibility for resolving these consumer headaches (which was wonderful for issuers but bad for consumers). Changes in the telecommunication industry resulted in so many choices that with each passing day firms pitching long distance or local phone service grew more feverish in their marketing efforts. Then came cell phones with their unique and incomprehensible pricing plans. For the first time we were required to actually pay for wrong phone calls we received! Life sped up and became more complex.
How competently are any of us handling these responsibilities?
Let’s face it—virtually no one fully understands even his telephone bill. We are incapable of reviewing these bills to determine whether they are right or wrong because they’re so damn complicated and each business or industry has come up with its own definitions, practices and rules to confuse and coerce the consumer. We all need full-time accountants to establish the veracity of the bills we pay and lawyers to handle matters we legitimately contest.
In summary, here is where we are in America today: We are solely responsible for handling our most complex financial matters, such as providing for our retirement security- for reviewing every prospectus of every fund or stock in which we invest over our lifetime (before we invest)- yet we cannot fully comprehend even the smallest financial events of our daily lives, such as our phone bill.
Today companies often don’t bother trying to address customer complaints—they simply seek to enforce the payment obligation: “Pay us or we’ll report you to a credit reporting agency,” they say. What’s unsaid is that the consumer will then have to spend hours trying to explain or clarify the matter with the credit bureau. Forget trying to please the customer; focus upon collection of the receivable that has already been booked in the company’s financial statements. Nonrefundable airline tickets, pre-payment requirements to ensure hotel reservations and similar policies are all aimed at creating an obligation to pay regardless of customer satisfaction or whether the product was actually used by the customer. Companies know we are so overwhelmed by all the unclear bills we regularly pay that we don’t have the time for a protracted fight—even over things we never actually agreed to buy or are unhappy with. (Whatever you do, don’t accept a “free trial offer.” The minute the item is sent to you, it’s booked as a sale by the company and it takes a Herculean effort to get the company to stop hounding you for payment.)
Our legal system is stuck in a time warp where we are still held responsible for having consented to matters disclosed in fine print contracts and prospectuses we could not possibly have read or understood. Today we may be forced to accept dozens of such contracts or agreements in a single day. When life was slower and business dealings less complex, it may have been reasonable to uphold such agreements; today it is an absurd legal fiction to maintain that any of us consents to these generally one-sided agreements.
The reality is that we cannot understand our phone bills yet are required to navigate through the treacherous waters of planning for our retirement security, avoiding every bogus product thrown our way by unscrupulous promoters.
Planning for our retirement over a lifetime, making decisions the consequences of which may take decades to fully unfold, has to be one of the most difficult tasks any individual can undertake. In addition to requiring tremendous language skills and comfort with numbers, a certain emotional maturity—the ability to remain calm when others are losing their heads (and your investments are plummeting in value)—is required. And even the savviest investor can make bad decisions and be the victim of fraud. It seems likely that less than 10% of the population has the ability to avoid the pitfalls of retirement planning. Yet all of us are charged with the responsibility for doing so.
Recognizing their lack of investment prowess, the vast majority of Americans, in exercising their freedom to make their own investment decisions, turn to “trusted” financial advisors. In other words, they are not really taking responsibility for their own investment decisions. They are merely deciding which financial advisor to rely upon to make those decisions for them.
Americans think they are contracting for objective advice when they hire a financial professional. They believe their financial advisor will recommend products that are best for them, not that are most lucrative to the adviser. “Trust us—we’re working for you,” they are told. Unfortunately they’re not getting objective advice. Rather, they’re almost always getting advice that’s tainted. Few financial advisors are paid a separate fee by investors for providing objective advice. The vast majority of advisers are compensated by manufacturers of investment products for selling product. The higher the compensation related to a product, the greater the likelihood the adviser will recommend the product.
Your trusted financial advisor cannot be trusted or, if you like to think of yourself as a trusting person, trust that he will do what’s best for him, not you. This is not the message you’ll hear on CNBC or in the financial press. The financial media, supported by investment product advertising, does not want to discourage investors from taking on the risks related to the cornucopia of products advertised—even those products that are always a bad deal, such as variable annuities.
In summary, the shift of responsibility onto the individual investor has resulted in investors turning to and relying upon corrupt advisers.
That in a nutshell is where we are today. However, investors recently have begun waking up to the fact that virtually every financial professional retained to provide objective advice has been corrupted. No one can be relied upon to provide advice free of self-interest. Research analysts, insurance brokers, stockbrokers, mutual fund directors, 401(k) intermediaries, pension consultants are all suspect.
In this era of personal responsibility it is fair to ask: how are investors to blame? Investors are almost universally not prepared to pay the full price for objective advice and are generally resistant to paying any separately stated fee for it, however small. “Why pay $2,000 a year for objective advice when I get it for free from my stockbroker,” they say. The answer is, of course, that they are not getting objective advice. They are getting bad advice and bad advice for free is never a good deal. Unless investors are willing to pay for objective advice, they may be doomed to receive bad advice. Ironically, the cost of corrupted advice is rarely known and generally only becomes apparent when damages are calculated in the context of a lawsuit. When investors compare the disclosed cost of objective advice against free or less pricey bad advice where the true cost is undisclosed, they generally choose the lower disclosed cost alternative—bad advice.
Institutional investors also make the mistake of relying upon tainted or conflict of interest ridden advice and pension returns generally suffer as a result. Pensions are in a better position to know of the conflicts of interest related to an advisor but all-too-often accept assurances from management of these firms that Chinese Walls and other internal operating procedures are adequate to protect against harm. Many of the leading advisors to the nation’s pensions, including alternative investment managers such as venture capitalists, are subject to insurmountable conflicts as to which pension clients do not object. There really is no excuse for this insensitivity to conflicts on the part of institutional investors other than the prolonged bull market has hidden the related harm. As investment returns diminish in the future, identifying and eliminating harmful conflicts, as well as recovering from past corruption, will be of greater importance than ever. Most pensions have the resources to better scrutinize those they rely upon for advice. For defined contribution plans (where participants choose among investments), plan sponsors should more carefully scrutinize the intermediaries and managers they entrust with assets, especially now that so many hidden financial arrangements between these parties have surfaced. Unfortunately most sponsors of defined contribution plans seem uninformed or unwilling to roll up their sleeves and investigate the implications of the recent mutual fund scandals upon their plans.
In conclusion, the individual investor is left with the daunting task of planning for his retirement knowing that he does not have the skills to handle the task on his own and that few of those who hold themselves out as investment professionals can be trusted. What the nation sorely needs is a financial services company that can live up to the public’s trust, offering sound investment products that are low cost without absurd conflicts of interest. Is it really so difficult to imagine such a company? We think not. The nation’s retirement savers have paid an enormous cost for the bad advice they have relied upon to date. We estimate the cost to be approximately a trillion dollars over the past twenty-five years. That’s a trillion dollars that has been snatched from the savings accounts of the nation’s investors and paid to financial services firms who betrayed their trust. Hopefully lessons have been learned and in the future investors will demand products and services that are conceived with their best interests in mind.