Sunday, February 20, 2005

Pension Consultants

The Sunday NY Times carried an article by Gretchen Morgenson on the Unmasking of Pension Consultants. The article points out the potential conflict of interest issues that a number of large pension consultants may have. 1 large public pension plan, the Public School Teachers Pension and Retirement Fund of Chicago is considering conducting a conflict of interest audit of its investment consultant, Mercer. Considering Mercer's lineage, Marsh & McClennan and Putnam that sounds like a prudent idea!

While there are some very fine investment consulting firms in the business, there are some that find many different ways to contribute to their shareholders bottom lines, some of which might be at the expense of client plans. From a pure economic perspective, pension consulting is not a tremendously leveragable or profitable business model. Fees are not extraordinarily large in relation to the human resource and firm capital required to service clients. In fact many of the top named regional firms operating today were spawned from a prior industry purge where brokers terminated their consulting businesses because of economics and/or conflicts. Many of these firms remain privately held and the better ones have chosen a unitary consulting business model to avoid potential conflicts.

Sponsors should be curious about why large public financial firms, given their portfolios of higher ROE, ROI businesses would be involved in a lower margin consulting business. The answer most certainly lies in the "leveragable" power of being a client gatekeeper. At its best, the gatekeeper can influence clients to consume additional firm services. Often times gatekeepers will introduce non-related service providers who engage in a kind of informal "quid pro quo" client referral relationship with the consultant. At its worst and probably most common, gatekeepers can secure agreements with money managers to direct trading business through affiliated brokers. Other indirect financial relationships can also be established. These trading arrangements and other relationships are often times disclosed in some very innocuous disclosures that are provided to prospects. The only appetite larger than a public companies desire to make money is its desire to protect itself via lengthy disclosures and indemnifications.

It would be extremely challenging for a plan sponsor to really determine if potential conflicts of interest are "actual" conflicts. Therefore, Plan sponsors would be well advised to work with consultants who do not generate revenue from any source other than client fees. Investment consultants are required to describe their business activities in their SEC filings. Be sure to review the ADV form I and II when reviewing a particular consultant. Also review or have your ERISA attorney review all client disclosure material very carefully, As a fiduciary, you will be held accountable for understanding this information.


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