As discussed in the New York Times article below, a cease-and-desist order was issued this week against a large pension consulting firm, Callan Associates, for failing to disclose to clients that it had an brokerage arrangement that could affect the objectivity of the investment advice it gave. Earlier in the month, the Commission fined Yanni Partners, another pension consulting firm, $175,000 and ordered it to stop violating the federal disclosure law rules. The SEC also imposed a $40,000 fine on Yanni's compliance officer. Callan Associates was not fined yet Yanni was. What can we learn from these actions? Here are our thoughts and we welcome any comments you may have.
1. Money managers and pension advisers, whether registered with the SEC or not, frequently misrepresent to pensions material information about their business practices. The reason they do is because they can. They have learned that they won't get caught. Until now, material misrepresentations by pension consultants, which were broadly disseminated orally, in writings and in their regulatory filings with the SEC have escaped notice by the agency. For over a decade the SEC apparently didn't have a clue about these misrepresentations that troubled industry insiders (and were even discussed openly on our website).
2. The SEC cannot be relied upon to provide timely protection to pensions. Why? Two major reasons.
First, the SEC lacks staff with experience in the industries it regulates and only learns about these industries through communications with self- regulatory and lobby groups and through regulatory/legal channels. As a result, the SEC often fails to act where pervasive industry practices are involved because industry lobbyists have effectively convinced the agency that pervasive business practices are not harmful. For example, investment research provided by Wall Street investment banks was always conflicted but the SEC accepted assurances that "Chinese Walls" in effect at these institutions could be relied upon to prevent abuses. It's a nice legal fiction but the only Chinese Walls are in China and even those walls are penetrable. Other examples: investment banks dumping stock they underwrite into their affiliated mutual funds; or mutual funds engaging in securities lending with affiliated lending agents; or money managers using client commission dollars to purchase research they would otherwise have to pay out of their own pockets. Despite the obvious breaches of fiduciary duty involved in all these examples, the SEC has accepted industry assurances that no harm to investors results. There are countless other examples.
Second, the SEC's regulatory mandate, i.e., protection of investors, has been compromised. The SEC today sadly lacks resolve and a commitment to the protection of investors. It is referred to frequently by commentators as a "captive regulator." Ironically, the agency today often refuses to provide investors with the very information it has collected from the regulated in the name of investor protection.
For example, the agency's efforts toward making information about money managers available online (Web IARD) has been a dismal failure. Investors are afforded less protection today, in the Information Age, than in the good ole days when registered investment advisers had to paper file completed Forms ADV with the SEC. Part II of Form ADV, which includes additional meaningful information not found in Part I (which is available online through the SEC's Web IARD), no longer has to be filed with the SEC and is completely unobtainable by investors through the agency. Prior to Web IARD, you could always get copies of Part II from the SEC's Public Reference Room. Not any more. We in the private sector, could remedy this problem overnight; the SEC (if it even acknowledges the current state of affairs as being problematic) has been unable to come up with a solution in the past five years or more.
So if you were harmed by either of these pension consulting firms and were waiting for the SEC to take action, you may very well have waited too long to recover all your damages.
3. A meaningful due diligence conducted by unconflicted firms with experience in money management wrongdoing will uncover most of the material misrepresentations that money managers and pension consultants make long before regulators are aware. There are three obstacles here. First, it is not standard operating procedure for pensions to conduct meaningful due diligences before they invest. The reviews conducted today are superficial. Generally the information relied upon is provided by the firm to be hired. Second, most pensions don't want to know the truth. By the time they have decided who they want to hire, whether based upon merit or political considerations, they do not want to be told the firm they have chosen is lying to them. The problem is even worse once the firm has been hired. Pensions feel they have nothing to gain by investigating incumbents. Lastly (and this is really only a minor concern for pensions) the cost of such reviews is not cheap. The good news is that today, in the Information Age, pensions can ferret out wrongdoing that even the SEC is unaware of for very limited money. The bad news is that smaller funds and individual investors cannot afford to hire what amounts to a private-duty SEC or a private firm that does what the SEC should be doing.
So what will happen next, now that the SEC has verified that these firms have engaged in abusive practices? Will clients investigate whether any lack of disclosure has resulted in underperformance? Will they seek to disgorge any ill-gotten gains? Why was Callan not fined by the SEC but Yanni was? While we have our beliefs as to the answers to these questions, we'd like to hear from you. Drop us an email.
Adviser Firm on Pensions Is Rebuked
The New York Times
By MARY WILLIAMS WALSH Published: September 21, 2007
Federal securities regulators have issued a cease- and-desist order against a large pension consulting firm, Callan Associates, for failing to tell its clients that it had an outside business relationship that could affect the investment advice it gave.
Callan neither admitted or denied the finding, but said it had amended its disclosure forms. The firm, based in San Francisco, advises about 300 pension funds and other institutional investors with combined assets of about $1 trillion.
Because of a drawn-out transition to an online records system, it is not yet possible for the public to inspect Callan's amended disclosure, however, or the disclosures of other pension consultants.
It was the Securities and Exchange Commission's second move in a month against a pension consulting firm, suggesting that a long-running investigation of industry practices was yielding results.
On Sept. 5, the S.E.C. fined Yanni Partners, a pension consulting firm in Pittsburgh, $175,000 and ordered it to stop violating the federal disclosure law rules. The S.E.C. also imposed a $40,000 fine on Yanni's compliance officer, Theresa A. Scotti.
Callan Associates was not fined.
Pension trustees often hire outside investment managers to handle the money in their care, and use consultants to help with the selection. The consultants typically keep databases that track the money managers' performance. When a pension fund wants to hire a new money manager, the consultant can screen candidates and make a short list for a board to choose from.
Money managers compete intensely for blocks of pension money, and there have been significant concerns about the lengths they might go to in order to secure a berth in a consultant's database.
The S.E.C. began an examination of the industry in 2003, and announced in 2005 that it had found widespread potential problems. It said it was proceeding with formal investigations of certain firms, but did not identify any of them until now.
This month, the S.E.C. issued a finding that Yanni had sold money managers periodic reports based on information in its database and offered to meet with those who subscribed and help them gain access to pension officials. Yanni also misled clients about "the potential conflicts of interest inherent in such sales," the S.E.C. said. It called the conduct a breach of fiduciary duty.
Yanni has discontinued the sale of these subscriptions. It did not respond to a call yesterday seeking comment.
On Wednesday, the S.E.C. issued a cease-and- desist order regarding a brokerage firm that Callan sold to the Bank of New York in 1998. The sales agreement called for the Bank of New York to pay Callan over eight years, paying more each year if Callan sent enough of its clients' brokerage business to the bank to meet certain benchmarks.
Pension officials occasionally asked Callan whether it was being rewarded for sending their business to the Bank of New York, but Callan told them it was not, the S.E.C. said. The commission called these responses "inaccurate and misleading."
In 2005, Callan changed its disclosure form to provide the required information about the payments. By that time, however, the S.E.C. had replaced its paper record-keeping system with an online system to give the public access to the disclosures of registered investment advisers.
The part of the disclosure form dealing with conflicts of interest has not yet been put into the online system, but the paper records are no longer accessible.
Edward Siedle, a lawyer in Florida who investigates pension consultants, called it "ironic that the online system has resulted in less meaningful disclosure than the old system."
A Callan spokeswoman, Nancy Malinowski, said yesterday that the firm's eight-year agreement with the Bank of New York had expired on Jan. 1 and that the payments at the heart of the matter had ended.