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Cypen & Cypen
MAY 19, 2005

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


On May 16, 2005, the Office of Compliance Inspections and Examinations (OCIE), U.S. Securities and Exchange Commission, issued its “Staff Report Concerning Examinations of Select Pension Consultants.” The report (covering only January 1, 2002 - November 30, 2003) merits extensive discussion here. A “pension consultant” provides advice to pension plans and their trustees with respect to such matters as: (1) identifying investment objectives and restrictions; (2) allocating plan assets to various objectives; (3) selecting money managers to manage plan assets in ways designed to achieve objectives; (4) selecting mutual funds that plan participants can choose as their funding vehicles; (5) monitoring performance of money managers and mutual funds and making recommendations for changes; and (6) selecting other service providers, such as custodians, administrators and broker-dealers. There are over 1,700 SEC-registered investment advisers, ranging from one person operations to large organizations that employ hundreds. Investment advisers owe their advisory clients a fiduciary duty. The Investment Advisers Act of 1940 reflects a congressional recognition of the delicate fiduciary nature of an investment advisory relationship, as well as congressional intent to eliminate, or at least expose, all conflicts of interest which might incline an investment adviser - - consciously or unconsciously - - to render advice which was not disinterested. An adviser owes its clients a duty of utmost good faith, and full and fair disclosure of all material facts, as well as an affirmative obligation to employ reasonable care to avoid misleading clients. Questions have been raised regarding independence of the advice that pension consultants provide, in light of the fact that many pension consulting firms provide services both to pension plans that are their advisory clients and to money managers. Questions have also been raised regarding the extent to which pension consultants disclose these conflicts of interest to their clients, particularly when the pension consultant has other by business relationships with money management firms that may compromise its ability to provide objective recommendations with respect to money managers. OCIE conducted focused examinations of just 24 pension consultants that are registered investment advisers, representing a cross-section of the pension consultant community. About half of the pension consultants examined are among the largest pension consulting firms - - measured in terms of assets of plans they advise. OCIE sought information regarding pension consultants’ practices with respect to: (1) products and services they provide to pension plan clients and any products/services provided to money managers or mutual funds; (2) the method of payment for the pension consultants’ services; and (3) the disclosure provided to the pension consultants’ clients. (As a means to view pension consultants from a distinct vantage point of those being employed based on recommendation of a pension consultant, OCIE also examined several money managers.) The following summarizes the findings:

  • More than half of pension consultants or affiliates reviewed (13) provided products and services to both pension plan advisory clients and money managers and mutual funds on an ongoing basis. Thirteen consultants host conferences for their pension plan advisory clients, who are typically invited to attend without charge. Of these 13, eight also allow money managers to attend for a fee. Ten consultants sell software programs (costing as much as $70,000 per year) to money managers, which analyze performance of clients’ accounts.
  • A majority of the pension consultants examined (14, or 58%) have affiliated broker-dealers or relationships with unaffiliated broker-dealers. Having an affiliated broker-dealer allows the pension consultant to obtain payment for its services with brokerage “commission recapture” programs. Two pension consultants have brokerage referral arrangements with unaffiliated broker-dealers that do not appear to be disclosed. These relationships with broker-dealers also provide a mechanism for money managers to compensate pension consultants, perhaps as a way to curry favor with the pension consultant.
  • OCIE could not fully analyze whether pension consultants “skewed” their recommendations to favor certain money managers. Of the six consultants where data allowed for this analysis, OCIE found indications that three had recommended money managers that purchased products and/or services from the pension consultant more frequently than money managers that did not purchase products from the pension consultant.
  • Many pension consultants have affiliates that also provide services to pension plan clients. These relationships create disclosure and conflict of interest issues that have not been addressed by pension consultants. More than a third of the pension consultants examined (9, or 38%) employ advisory representatives that are also registered representatives of a broker-dealer. Based on the recommendation of their pension consultant, many pension plan clients choose to utilize an affiliate of the pension consultant to provide various services, including investment management, brokerage execution and transition management.
  • Of the 19 consultants or their affiliates that provided products/services to money managers, three (16%) provided no disclosure of these other services and 16 (84%) provided limited disclosure. With respect to the pension consultants that do provide disclosure, it does clearly indicate that providing products/services to money managers may create a conflict of interest for the consultant, or it is not specific enough for a reasonable person to discern the potential harm of the conflict of interest.
  • Many pension consultants do not consider themselves to be fiduciaries to their clients!
  • Many pension consultants do not maintain policies and procedures that were tailored to the nature of their business.
  • Money managers appear to have relationships with multiple consultants, appear to purchase overlapping products from more than one consultant and are recommended by those consultants to plan sponsors.

Given the examination findings, OCIE concluded that consultants should enhance their compliance policies and procedures to include those policies and procedures that will insure that the adviser is fulfilling its fiduciary obligations to its advisory clients. Such policies and procedures might include, for example:

  • Policies and procedures to ensure that the firm’s advisory activities are insulated from its other business activities, to eliminate or mitigate conflicts of interest in its advisory activities. Such policies and procedures would include those governing the process used to identify and/or monitor money managers or mutual funds for an advisory client, to prevent considerations of a money manager’s or mutual fund’s other business relationships with the consultant or its affiliates.
  • Policies and procedures to ensure that all disclosures required to fulfill fiduciary obligations are provided to prospective and existing advisory clients, particularly regarding material conflicts of interest arising from arrangements between the consultant and its affiliates and the money managers and mutual funds that the consultant recommends to a client during a manager’s search or for whom the consultant is providing ongoing monitoring services. Policies and procedures should be designed to ensure adequate disclosure concerning the consultant’s compensation, including when the pension consultant receives compensation from brokerage transactions from advisory clients and money managers
  • Policies and procedures to prevent conflicts of interest or disclose material conflicts of interest with respect to the use of brokerage commissions, gifts, gratuities, entertainment, contributions, donations and other emoluments provided to clients or received from money managers.

Separately, Pensions & Investments reported that the SEC is planning to take legal action against many investment consultants for violating securities laws, and is expected to ask several others to beef up their compliance procedures and policies and their ethics codes to prevent or disclose conflicts of interest to their clients.


Actuaries may not have the greatest personalities, but they sure can put a positive spin on an otherwise-bleak situation. In a release dated May 12, 2005, the American Academy of Actuaries explains how termination of United Airlines’ pension plans as part of its bankruptcy proceedings will impact the Pension Benefit Guaranty Corporation, the federal agency that insures defined benefit pension plans. Contrary to some reports in the media, termination of UAL’s pension plans will likely not increase PBGC’s projected deficit, and may even help to reduce it. PBGC already included United Airlines’ pension plans as a “probable termination” in its 2004 annual report, meaning that termination of the plans will have no appreciable impact on PBGC’s deficit. In fact, the $1.5 Billion in securities PBGC may receive as part of the termination agreement could help to reduce PBGC’s deficit. According to its 2004 annual report, PBGC had a $23.3 Billion deficit, which included $16.9 Billion for probable terminations. PBGC had the foresight to include liabilities it has assumed from United Airlines’ pension plans in its deficit projections. For your information, PBGC will not take on the total amount of unfunded accrued benefits, which in UAL’s case is $9.8 Billion: it will not pay the $3.2 Billion in nonguaranteed benefits, consisting of certain benefits above the maximum guaranteed and recent benefit improvements not fully phased-in. Of course, PBGC’s maximum payment for plans terminated in 2005 is $3,801 per month ($45,613 per year) for a worker retiring at age 65. For individuals who retire early or for those receiving survivor benefits, the payments are lower.


Harry M. Markowitz, the father of “modern portfolio theory,” won the Nobel Prize in economics. However, when it came to his own retirement investments, Markowitz practiced only a rudimentary version of what he preached. But Markowitz invested more wisely than some of his fellow Nobelists. Several of them concede that they have significant portions of their nest eggs in money market accounts, some of the lowest-returning investment vehicles available. As he crisscrosses the country promoting his plan to overhaul Social Security, President Bush argues that Americans are ready to trade in a portion of their traditional benefits for ownership and control over their own investment accounts. People have grown so comfortable with stocks and bonds, he asserts, that they can invest their way to more prosperous retirements by watching their quarterly statements, adjusting their portfolios and looking out for themselves. According to the Los Angeles Times, a growing body of research shows that millions of Americans fail to get even the most elementary investment decisions right. More than one-quarter of those eligible for employer-provided 401(k)s fail to sign up for them. And more than half of those who do sign up funnel their money either into overly conservative or overly aggressive investments. Even more disconcerting, new research suggests that most people do not behave anything like the economically savvy men and women that free-market advocates and economic theorists claim they are. They often shut down in face of choices, sometimes even failing to go after free money. In committing such investment errors, ordinary Americans turn out to be in good company. Even some winners of the Nobel Prize in economics admit to making similar mistakes, either by failing to pay attention to their own retirement arrangements or by making faulty decisions when they do. Some examples are 2004 Nobel Prize winner Edward C. Prescott, 2003 winner Clive W. J. Granger, 2002 winner Daniel Kahneman, 2001 co-winner George A. Akerlof, 2001 co-winner Joseph E. Stiglitz and 1993 winner Douglass C. North. The financial shortcomings of the Nobelists and the more fundamental problem of retirement plan members failing to make appropriate investment decisions increasingly trouble officials at places like Teachers Insurance and Annuity Assn.-College Retirement Equities Fund. These officials wonder whether those for whom they are responsible - - and, more generally, Americans - - can properly handle the retirement investment responsibilities they already have, much less new ones. There are a lot of people with 401(k)s who have never managed an investment in their lives and are just trying to keep themselves from drowning, according to William F. Sharpe, who shared the 1990 Nobel with Markowitz. To quote Sharpe, “I suspect if you ask them, they’d say: ‘I’ve got enough trouble; I don’t want to screw up my Social Security.’”

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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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