(November 6, 2005 ) Misappropriation of Investment Opportunities: An Explanation for Public Pension Boards’ Opposition to Consultant Investigations?|
Since 2000 we have written and spoken about the broker consultant epidemic that plagues the Florida public pension community. Over 120 Florida public pensions rely upon retail brokers posing as pension experts to advise them on critical matters such as asset allocation, manager selection, commission rates and investment advisory fee negotiations. In addition to lacking pension knowledge, these brokers are subject to conflicts of interest. The advice they provide is not objective; rather, it has been corrupted by hidden financial arrangements the brokers have with the money managers they recommend. The result is that the best money managers are not recommended and selected; rather, those managers who agree to “pay-to-play,” i.e. pay the consultant for the recommendation consistently appear as managers for the funds. Not surprising, these Florida public pensions have dismal investment performance. Florida taxpayers are paying the cost of this corruption – which amounts to hundreds of millions annually.
The Boards of these funds have been remarkably resistant to learning about how they are being duped. We have actually witnessed Boards turning to the perpetrators themselves for advice as to whether an investigation should be undertaken. Local lawyers for these funds, unskilled in investment management matters, have contributed to the problem by not acknowledging their lack of expertise and instead offering flawed solutions. In some instances, financial arrangements exist between local pension lawyers and the conflicted consultants that are not fully disclosed to Boards. A more common scenario, however, is that local pension lawyers, who often have fragile relationships with their clients, are reluctant to suggest an investigation of the charismatic broker/consultant/salesmen who wine and dine the Boards.
Another factor, which may partially explain the reluctance of public pension Boards to investigate consultant wrongdoing, is far more sinister and may rise to the level of criminal activity. We have learned that, at least with respect to certain funds, many Board members may have personal accounts with the brokers serving as investment consultants to their funds. Some Board members have apparently enjoyed tremendous investment success with respect to their personal accounts at these brokerages while the funds they serve have faltered. The issue here, termed “misappropriation of investment opportunities,” is whether investment opportunities that rightfully belong to pensions have been directed to the personal accounts of Board members.
For example, what if a Board member, with $15,000 in an account at the consultant’s brokerage, was allocated “hot issues” during the late 1990s, as a result of his status as a member of the Board of a $100 million fund? A customer of a brokerage with $15,000 in assets generally would not be allocated shares in a hot initial public offering. On the other hand, if he were considered a $100 million customer (because of the size of the pension to which he was related) then he might very well enjoy such investment opportunities repeatedly.
As indicated in the Money Management Letter article below, Florida regulators are already looking into the issue of Board member personal investments at consultant brokerages. Nationally, however, public pensions boards are awakening to the fact that they are entering a new era of heightened scrutiny of pensions. The recent massive private pension failures and growing uneasiness regarding the magnitude of public pension shortfalls no doubt have served to draw attention to pension matters.
Public pensions that resist inquiries into the integrity of any parties involved in pension decision-making appear as if they have something to hide. When the truth eventually and inevitably does come out, many funds may find that the problems they have been concealing are far worse than they imagined. All-too-often pension Boards’ private assessments of their problems are faulted due to incomplete or unprofessional reviews of the facts. “Harmless conflicts” and “harmless kick-backs” rarely appear so benign when subject to public scrutiny. It is beginning to appear that it may take the threat of incarceration to shock public pension trustees to do their duty.
Florida Regulator Examining Complaints On Broker/Dealers September 23, 2005
Florida's Office of Financial Regulation is examining potential conflicts of interest at certain municipalities and pension funds within the state, involving the broker/dealers that advise them. Bill Reilly, bureau chief of securities regulation, said these practices are not necessarily pervasive or a major problem and there is no timetable for completing the examinations. Allegations of misconduct have been brought to the office's attention by individuals, during law suits and in the press, he said, and the office is looking into them.
The office is examining whether board members of municipalities who have accounts with the broker/dealers that their pension funds use are receiving services or securities usually reserved for customers with much larger accounts, Reilly said. The office is also looking at whether the fee break points of mutual funds were disclosed to pension funds and whether they invested in the right fashion to ensure they paid lower fees, he said. One observer explained that consultants could be breaking up pension funds' orders to ensure the consultant gets the maximum finder's fee.
More than 100 public pension funds in Florida use consultants that are part of broker/dealer firms and Merrill Lynch has the largest market share. "We don't give board members preferential treatment and we don't break up orders to generate fees," said Mark Herr, spokesman. "On the contrary, we have attracted and retained clients for the best of reasons: we provide our clients with sound advice and good service."
Emma Blackwell Managing Editor Money Management Letter Foundation & Endowment Money Management
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Financial report on Delray pension fund is investigated
By Erika Slife Staff writer
December 1, 2005
Delray Beach * An investigation of the Delray Beach police and firefighters' pension fund suggests that financial giant Smith Barney could be inaccurately reporting the $100 million fund's performance, which could misrepresent the actual health of the fund.
A provocative report by Ocean Ridge-based Benchmark Financial Services Inc. states that Smith Barney could be issuing quarterly reviews with figures that don't include financial fees -- possibly making it appear as if the retirement accounts are performing better than they are.
The report's author, Edward Siedle, and Smith Barney representatives are scheduled to appear before the pension board Dec. 7.
"I'm anxious to see what the response is from the investment adviser," said Mayor Jeff Perlman, who sits on the board. "Those questions that were raised, we need answers."
Taxpayers are ultimately responsible for the fund, from which police and firefighters' retirement payments are drawn, and could end up paying more if there is a shortfall. So far, no shortfalls have been found.
Experts say that reporting figures without including fee withdrawals could misrepresent the overall performance of the fund, which could affect decisions made by the pension board.
"Gross, rather than net fees, can distort the performance of your investments, usually which are being managed by external asset managers," said Keith Brainard, research director for the National Association of State Retirement Administrators. "Performance would be overstated, which could lead to faulty decision making about keeping or not keeping managers, or overall asset allocation. Also, it could affect your assumptions regarding future investment returns. That particularly could have a significant affect on the fund's finances."
The report also questions Smith Barney's dual role as consultant and broker for the fund, a subject that has stirred debate in the pension world. Many pension consultants simultaneously provide services to pension boards and money managers and mutual funds, which constitutes a conflict of interest, according to a U.S. Securities and Exchange staff report released in May.
"Clients should have information about the pension consultant's conflicts of interest in order to assess the objectivity of the advice that is or may be provided by the pension consultant," the SEC report said.
"If you go to a doctor and they prescribe medicine, you assume that the doctor is not getting paid by the drug company," said Steve Lansing, president of Orlando-based Sentinel Fiduciary Services, an independent consultant. "The consultant is in a unique position of trust and should be doing his or her work solely, exclusively for the benefit of the plan and the employees who are depending on that plan for income in retirement."
The report, the initial step of the investigation, was released Feb. 4 on a contingency-fee basis and provided a "limited review of the investment performance" and "the actions of its investment consultant, Smith Barney." The nine-member pension board will hear next week what steps have been taken in the second part of the investigation.
Siedle, a former SEC attorney, is the president and founder of Benchmark, a company that focuses on investigating pension funds. The board authorized the investigation after Siedle offered the board his company's services.
"I think we did the right thing," said William Adams, pension board chairman. "We felt it was important."
Siedle would not estimate how much inaccurate reporting could cost taxpayers, but hinted that it could be enough to be detrimental. If a fund's numbers are being reported erroneously, he said, it "could amount into millions of dollars over time."
"That's why it's so important we know," he said.
Smith Barney spokesman Alexander Samuelson said company officials were aware of the report but declined to comment on its allegations.
"Smith Barney has a long-standing relationship with the client and has maintained excellent relations with the fund board," Samuelson said. He said officials would wait until after the board meeting to comment further.
The report also charges that Wachovia Bank, the pension plan's former bank, was deriving an undisclosed amount of money from the fund by investing its cash in a money market account the bank owned. Wachovia resigned unexpectedly July 1 in a short letter to the board, and the pension board moved the money to another bank. A Wachovia spokesman declined to comment.
Perlman cautioned that the report's findings are only preliminary.
"I think it's very important we hear what those answers are before we draw any conclusions," he said.
The report also raised questions about a pension fund administrator who worked part time at Smith Barney.
Adams said the arrangement was no secret to the board and had been approved by the attorney because she was not a voting member. It's no longer an issue because the longtime fund administrator no longer works for Smith Barney, he said.
Erika Slife can be reached at email@example.com or 561-243-6690.
Copyright (c) 2005, South Florida Sun-Sentinel
Merrill Unit Subpoenaed on Pensions
By GRETCHEN MORGENSON The New York Times Published: December 2, 2005
Merrill Lynch acknowledged yesterday that its pension consulting unit in Florida, which advises nearly 100 funds in the state, had received a subpoena from the Securities and Exchange Commission as part of an investigation into conflicts of interest among advisers to pension funds.
The S.E.C.'s interest in the Merrill Lynch operation, in Jacksonville, Fla., appears to have grown out of its study of the pension consulting industry, in which it found conflicts at more than half the consultants it examined.
In May, when the S.E.C. disclosed the results of its industry review, it declined to identify the firms whose operations it considered problematic. It said, though, that it had referred about a dozen of the consultants it examined to its enforcement division for possible action.
One conflict cited by the S.E.C. is that pension consultants often receive compensation from the money managers they recommend to their fund clients even though those clients are told that the choice of a manager is objective. Such compensation arrangements, and the money they generate, are not always disclosed to those overseeing the pension funds.
Merrill Lynch's consulting operation in Florida is by far the largest pension adviser in the state and counts large and small pension funds among its clients. They include the Jacksonville Police and Fire Fund, a $2 billion pension plan; the Lake Worth Police Officers Pension Fund, a $20 million fund; and the St. Augustine Firefighters Pension Fund, with $7 million.
A spokesman for Merrill Lynch, Mark Herr, said in a statement: "It is common knowledge that the S.E.C. has been conducting an industrywide examination of possible conflicts of interest in the pension consulting business. As Merrill Lynch always does in regulatory matters, it has cooperated with the S.E.C. as this has unfolded. The firm has no reason to believe its circumstances or those of any of its employees are unique."
The S.E.C., through a spokesman, declined to comment on its investigation, as is its custom. Conflicts among pension fund advisers have drawn increased attention in recent years as a number of large pension funds have failed and the Pension Benefit Guaranty Corporation, the government agency that insures these funds, had to take over the obligations of the failed ones.
But conflicts among pension fund advisers are often difficult to uncover because compensation earned by a consultant may not be evident to those overseeing a fund. For example, a consultant whose operations include a brokerage unit, like Merrill Lynch's, might receive pay in the form of lucrative stock or bond trades steered to it by the money managers it recommends to pension funds. Such trades may be executed at prices that are not the most competitive, driving up trading costs for the pension fund.
Consultants with brokerage firm affiliations also have an incentive to choose money managers who trade frequently, generating greater commissions to the consultant. Or, the consultant may not be as tough in negotiating lower investment advisory fees with managers on behalf of the fund if the consultant's affiliated broker receives trades and commissions from the money managers.
"The broker-consultants have formidable conflicts of interest because the way these firms compensate their employees is primarily transaction-oriented," said Edward A. H. Siedle, president of Benchmark Financial Services in Ocean Ridge, Fla., a company that investigates money managers on behalf of pension plans. "When we look at the plans," he said, "the performance of pensions advised by broker-consultants generally is dismal and the reason is they are pursuing compensation from the money managers that they select."
An estimated $5 trillion is invested in thousands of pension funds nationwide, run for the benefit of private company, state or municipal workers after they retire. Some funds are huge, with billions of dollars under management, and are overseen by a board of financial professionals. But many are small, with a few million dollars in assets and are run by volunteers who are less wise to the ways of Wall Street.
Pension fund boards typically hire a consultant to advise them on investment strategies and on which money managers to hire. Problems can arise when these consulting firms, which have a fiduciary duty to the funds they advise, put their own interests first.
Some of the larger companies providing pension consulting services include Mercer Inc., a unit of Marsh & McLennan, and Callan Associates of San Francisco. Wall Street firms have increased their presence in pension consulting recently: Merrill Lynch, Smith Barney and Morgan Stanley are all significant players.
Pension consultant conflicts are also a subject of growing concern in Washington. On Wednesday, two members of the House asked the Government Accountability Office, the research arm of Congress, to investigate whether the federal agencies that enforce pension law have failed to police consultants and the money managers they steer pension funds to.
The lawmakers making the request were Representatives Edward J. Markey, Democrat of Massachusetts, and George Miller, Democrat of California.
"The S.E.C. has uncovered evidence that pension plans have not always received objective advice," Mr. Markey said in a statement yesterday. "Clearly, a thorough, comprehensive examination is needed to determine whether the federal government is taking the actions necessary to protect workers and their pensions from advisers more interested in padding their own profit margins than providing impartial advice to keep pension plans on strong financial footing."
Feds Subpoena Merrill in Pension Advisor Probe
December 2, 2005 (PLANSPONSOR.com) – Federal regulators have served Merrill Lynch & Co. with a subpoena about a Florida-based unit that advises public pension funds on picking money managers, according to an unnamed Dow Jones source.
The move by the US Securities and Exchange Commission (SEC) is part of a broad-ranging probe by the regulator of possible conflicts-of-interest involving public pension funds.
"It is common knowledge that the SEC has been conducting an industrywide examination of possible conflicts of interest in the pension-consulting business," said Merrill spokesman Mark Herr, who neither confirmed nor denied the subpoena to Dow Jones. "As Merrill Lynch always does in regulatory matters, it has cooperated with the SEC as this has unfolded. The firm has no reason to believe its circumstances or those of any of its employees are unique."
In May, the SEC released a study on potential conflicts in the pension-fund consulting industry, and said it was referring several cases to its enforcement division. It didn't name firms or individuals (See SEC Calls for Pension Consultant Disclosure Reforms).
At issue are consultants who may have recommended that public pension-fund clients use money managers that made kickbacks to the consultants. Some of the payments may have been made through stock- and bond-trading commissions and fees paid to affiliates of the consultants. People familiar with the Merrill probe said Michael Callaway, a Merrill consultant whose clients include the $2 billion Jacksonville Police and Fire Fund in Florida, has also received a subpoena along with some ex-Merrill employees.
The SEC study found that a majority of pension-fund consultants it examined have affiliated broker-dealers or relationships with unaffiliated broker-dealers. Fred Schneyer firstname.lastname@example.org