With the SEC’s recent focus upon pension consulting, it’s incumbent upon the chief compliance officers of investment advisors to review again whether their firms are properly disclosing the conflicts of interest that may exist with their pension consulting services and then supervising, mitigating and/or eliminating such conflicts.
Since the relationships and apparent methods for compensation aren’t always obvious, this may be a challenge for those compliance officers that aren’t experts in this business line.
Our advice is to start this process by following the money. In other words, look at how your firm is being compensated. Is your firm receiving compensation directly from the pension client, or is the money manager paying indirect compensation to the pension consultant?
For purposes of those disclosures required by the SEC rules, here are a few items that most likely should be disclosed.
1) Conferences – Does your firm host a conference for its pension clients? Are money managers charged a sponsorship or exhibit fee? Does your firm provide training to money managers and trustees, but only charges money manager staff? Does your firm tend to recommend these money managers more often than other money managers?
2) Software – Does your firm sell software to money managers, which analyzes clients’ performance? Similarly, Are these money managers recommended more often than others?
3) Marketing Services – Does your firm sell marketing services to money managers?
4) Affiliated B/D – Does your firm direct its pension clients to pay pension consulting fee through directing transactions/commissions to an affiliated B/D? Is this disclosed? Is best execution taking place? If so, how is this documented?
5) Referral Fees from Unaffiliated B/D – Does your firm direct its pension clients to an unaffiliated B/D that then pays a referral fee?
6) Employees Dual Registered as Reg Reps – Are your investment advisor reps serving pension clients also registered representatives and receiving compensation for trades placed by the pension client.
7) Gifts/Entertainment/Trips – Are your investment advisor reps receiving gifts from money managers? Are you tracking such gifts, entertainment or trips?
8) Change of Money Manager – Does your firm charge a “search fee” or receive additional brokerage commissions when terminating a pension client’s money manager?
9) Additional Money Manager Accts. – Do your pension consultants seek or obtain brokerage transactions from other accounts managed by the money manager?
Once you identify these disclosure items, you need to consult with your experts to properly tailor your response. (This blog entry is certainly no substitute for consulting with your compliance expert on the specifics of your situation, and how it should be handled. Our goal is to make sure you’re aware of the issue.)
As alluded to in the SEC report, it’s likely that the disclosures need to be more than a mere reference stating that services are provided by the pension consultant to the money manager. The best practice is spelling out to the pension client that the same money managers being recommended by the pension consultant are also paying the pension consultant for other services. Depending upon the circumstances, this disclosure may need to include the dollar amounts being paid by such money managers so the client can truly grasp the extent of the conflict.
It’s also important to recognize that disclosure isn’t enough. The investment advisor serving as a pension consultant is a fiduciary, which means that these practices creating the conflicts will have to be carefully managed/supervised/mitigated or completely eliminated if the potential conflict is too great. Under the new Chief Compliance Officer Rule, the SEC will expect the CCO to formalize policies and procedures to address these conflicts.
Finally, the last wild card to throw into the mix — some of these pension consulting compensation practices creating a conflict might be considered by the Dept. of Labor (DOL) to constitute “prohibited transactions” under ERISA even with the proper disclosure in your ADV, which will have to be addressed in a seperate blog entry at a later date.
Posted by Bryan Hill