The findings of an 18-month Securities and Exchange Commission investigation into possible conflicts of interest in the investment consulting industry may have finally confirmed the suspicions of industry watchers; the pension investment consultant industry may indeed be "corrupt."

The original probe, launched at the end of 2003, shined the spotlight on several consultants including Mercer Investment Consulting, Frank Russell & Co., Strategic Investment Solutions, Bond Segal Advisors and Wilshire Associates.

Now it appears that the investigation may only have just begun, as the SEC could launch an investigation into firms that are in direct infringement on conflicts-of-interest issues.

No Names

The firms in violation of the SEC discoveries are yet to be identified, however.

"The purpose [of the probe] was to put the pension fund consulting community on notice about disclosure responsibility with the expectation that firms not in compliance would take the steps to get in compliance," said SEC spokesman John Nester.

"They looked at 24 firms, very small and very big, and basically completed that sweep and announced their findings."

Nester said that the SEC's Office of Compliance, Inspections and Examinations has yet to reveal an annunciated plan to have a continued focus on the consulting industry at this point.

"This doesn't mean that the OCIE can't make this something to focus on," he explained. "They have a risk-based approach to examinations and these findings can always be added to the list of things they look for.

While it would seem obvious that consultant firms should be aware of their contractual and moral obligations to their pension fund clients, some of the findings of the SEC investigations have proved otherwise.

Hands Off

One key discovery of the investigation was that many consulting firms did not consider themselves to be fiduciaries to their clients.

According to the SEC, the Investment Advisers Act of 1940 states that advisers owe their clients a fiduciary duty.

Edward Siedle, former SEC lawyer, Putnam Investments general counsel and founder of Ocean Ridge, Fla.-based The Benchmark Cos., deems the issue as one of the more noteworthy revelations unearthed by the investigation.

"I think it's terrific what [the SEC] has done," he said.

"They've put consultants on notice that they are fiduciaries and that many of these pay-to-play schemes have to be disclosed and it's questionable whether disclosure can even be effective.

"I think that they've also suggested that money managers may have engaged in these pay-to play schemes," Siedle continued. "This is very meaningful in that the SEC has given guidance to pension funds for the first time. The SEC has not, in the past, offered specific guidance to pensions."

Siedle, through his self-styled "watchdog" firm, has been investigating the issue since 1996 and also played a key role in the SEC's current probe of the industry.

"We provided them with copies of investigations that we've undertaken on behalf of clients. We offered suggestions on how they might go about investigating the industry," he said. "We suggested questioning all the major consultant firms about how they raise their money. I said to look at how they make money and they'll see that they're corrupt."

Mike Rosen, a principal at Angeles Investment Advisors, said his firm was not part of the SEC investigation, but agrees that consulting firms must take an affirmative stance on their role as fiduciaries.

"The SEC was absolutely spot-on in their findings," he said. "Potentially, the most important thing they found was that consultants to pension funds are in fact fiduciaries."

But not every consultant believes that fact, Rosen continued: "I know of some firms that have gone as far as saying precisely the opposite. To my knowledge, we are the only consulting firm that puts in its contracts that we are fiduciaries.

"I applaud that finding. Frankly, I'm amazed that every plan sponsor would not require that consultants affirm that they are fiduciaries," Rosen said.

Both he and Siedle agree that one of the first steps to rectify the problem is helping pension fund officials realize what services they are entitled to from industry consultants.

"The SEC will be providing trustees with a checklist to minimize these conflicts-of-interest," Siedle said, adding that all vendors, not just consultants, should be evaluated by the checklist.

Among other findings indicating conflicts-of-interest, the regulatory agency uncovered that 13 of the 24 firms reviewed provided products and services to both pension plans and money managers in the form of free conferences for its plan sponsor clients.

Last November, Mercer announced that it was dismantling its Global Investment Forum (GIF)-an organization which boasted approximately 115 money manager clients in membership and sponsored conferences (see IMW, 11/8/04), much like the ones frowned upon by the SEC.

When the program was in operation, Mercer waived the fee for its pension fund clients, while investment manager participants had to shell out $55,000 to mingle with plan sponsors.

Repeated calls to Mercer spokeswoman Stephanie Poe were not returned.

Meanwhile, the investigation also revealed that many pension consultants have affiliates that also provide services to pension fund clients, a relationship that creates disclosure and conflict of interest issues that the firms have not addressed. Also, of the 19 consultants or affiliates that provided products and services to money managers, three provided no disclosure of these other services; with the remaining 16 only providing limited disclosure.

Meanwhile, some of the investment firms originally identified in the investigation have begun to make adjustments, if warranted.

Kim Shepherd, spokeswoman for Wilshire, said the firm received a letter in late March suggesting that some changes needed to be made regarding its disclosure practices.

"Previously, when a manager search was being conducted, to ensure consulting clients were fully aware of any relationships Wilshire Analytics may have had with a manager, the Wilshire Associates accounting department would directly provide to those clients who requested it, a complete list of the managers who purchased our technology products," she explained. "We are now providing that list proactively."

Wilshire Analytics is a separate business unit within the firm that sells asset allocation, risk management and accounting software products to money managers.

An official at Strategic Investment Solutions also acknowledged that the SEC has recently contacted its firm and received the all clear.

"We've received a letter from the SEC that states that no further investigations are required and no violations were found," said Managing Director Barry Dennis.

In a written statement to IMW, John DeMairo, chief operating officer at Segal Advisors said: "Unlike many of the other pension consulting firms that the SEC examined, Segal provides no services to money managers or mutual funds and receives no compensation from them. In addition, we have no broker/dealer affiliations."

Officials at Frank Russell did not return calls for comment.

Meanwhile, Siedle suggests that plan sponsors establish guidelines with their advisers sooner, rather than later.

"Pension boards better start taking [this issue] seriously," Siedle said. "The retirement safety net is faulted and there will be more failures coming. It's like if a plane crashes, people will start assigning blame. We're in a situation where a few planes are crashing and a lot are running out of gas.

"What we're getting here is that broadly there is a fiduciary duty, it means that you've got to put procedures in place to monitor, protect and detect."

(c) 2005 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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