Probing Pension Advisers For Possible Conflicts of Interest

 

In "New York Is Investigating Advisers to Pension Funds" (New York Times, November 5, 2013), Mary Williams Walsh writes that "state financial regulators have subpoenaed about 20 companies that help New York's pension trustees decide how to invest the billions of dollars under their control to determine whether any outside advice is clouded by undisclosed financial incentives or other conflicts of interest." 

Conflicts of interest are not new nor are they are likely to disappear overnight. In 2010, the U.S. Securities and Exchange Commission ("SEC") adopted measures to discourage bad acts. Three elements were cited in "SEC Adopts New Measures to Curtail Pay to Play Practices by Investment Advisers" (June 30, 2010) to include the following items:

  • Prohibition of "an investment adviser from providing advisory services for compensation — either directly or through a pooled investment vehicle — for two years, if the adviser or certain of its executives or employees make a political contribution to an elected official who is in a position to influence the selection of the adviser";
  • Prohibition of "an advisory firm and certain executives and employees from soliciting or coordinating campaign contributions from others — a practice referred to as "bundling" — for an elected official who is in a position to influence the selection of the adviser"; and
  • Prohibition of "an adviser from paying a third party, such as a solicitor or placement agent, to solicit a government client on behalf of the investment adviser, unless that third party is an SEC-registered investment adviser or broker-dealer subject to similar pay to play restrictions."

In the case of the New York State Common Retirement Fund, with nearly $161 billion in assets in Q1-2013, the single person trustee and New York State Comptroller, Thomas P. DiNapoli, describes numerous attempts to enhance transparency and avoid conflicts. From the official website, one can download files that include:

  • New York State Common Retirement Fund Placement Agent Disclosure Policies and Procedures of the Office of the State Comptroller," last updated on September 11, 2013;
  • "Transactions Compliance Review: New York Common Retirement Fund," dated February 22, 2010; and
  • An amended list, published on May 6, 2009 and disclosing "placement agents used during the administration of Alan Hevesi. The list was amended June 18, 2009 to reflect new information provided by the State Attorney General’s office."

While the published files are a good start, it would be nice to have even more information, especially with respect to the detailed due diligence process that was or is being employed by various advisers for recommended asset managers. My understanding is that the New York Financial Services Superintendent, Benjamin M. Lawsky, has requested pitch books as well as information about compensation levels, the nature of existing relationships between investment advisers and consultants and asset managers and how performance numbers are to be reported, including a description about the assessment of investments that do not trade in a public market. This makes sense given the growth in allocations to hard-to-value positions.

Letting the sunshine in is a good thing for plan participants and taxpayers alike. It would be hard these days for anyone to legitimately criticize attempts to avoid costly conflicts of interest, especially if misaligned objectives lead to grossly imprudent investment decisions.

In recognition of the importance of good pension governance, the National Association of State Retirement Administrators ("NASRA") adopted a resolution to expressly address ethics and disclosure requirements. Excerpting from Resolution 2011-02, it is stated that "Public fund fiduciaries should carefully review the trust and conflict of interest laws applicable to the system to ensure that the fiduciaries’ relationships with other parties are not incompatible with the duties to the system, and service providers to the system should divulge pertinent business activities, relationships and alliances including, among other things i) all services the firm, its principals, or any affiliates provide that generate revenue, ii) if the firm is owned in whole or in part by other firms or organizations, or if the firm owns other firms or organizations, that sell services to public pension systems, and iii) if the firm, its principals, or any affiliate has any strategic alliances with firms that sell services to public pension systems."

As headlines about underfunding and bankrupt cities continue and fiscal policy becomes even more entwined with the investment activity of $3 trillion in public pension coffers, I predict that state and federal investigations will likely go up in number, magnitude and frequency.

House of Cards, Netflix and the Bottom Line

I spent hours this weekend glued to my computer screen. Curious to know if "House of Cards" would entertain as promised, I watched the first few episodes as a skeptic, only to be rewarded with solid acting, clever writing and a story line that kept on giving. This political thriller boasts a bevy of Hollywood talent, with Kevin Spacey at the helm. After losing a bid to be the next Secretary of State for a new president, this ethically challenged Congressman plots revenge and an alternative path to power. If you liked "The West Wing" and won't get discouraged by the seemingly realistic portrayal of what happens behind closed doors in Washington, you will enjoy the thirteen episodes of Season 1 and anxiously await the next baker's dozen.

Here's the rub. You need to be an existing Netflix subscriber or sign up tout-suite. In a move that has Hollywood paying close attention, this self-described "leading Internet television network" laid out $100 million to a star cast of writers and actors to recreate a Yankee version of this popular UK theatrical offering.

Why would a company do this? Some assert that original content is where the money is. According to several recent studies, "Streaming videos online are becoming more popular as technology evolves and more content is created for the Internet." See "NPD study: More people watch Internet videos on TVs than computers." CBS News, September 26, 2012. If you hate the countless ads that now consume the first twenty minutes of any in-person showing, you will be glad to have an alternative to movie-watching.

For institutional investors, this push to garner new subscribers and hopefully add to the bottom line is noteworthy. According to the NASDAQ website, 86.85% of the $8+ billion capitalization for Netflix, Inc. (ticker is NFLX) is in the hands of institutional owners. Some of them may not be appeased, certainly those who have sued the company over financial statement disclosures. In April 2012, Judge Samuel Conti appointed the Arkansas Teacher Retirement System and State-Boston Retirement System as lead plaintiffs in this putative class action. Click to read the "Netflix Inc. Securities Litigation" court order.

What Every Fiduciary Needs to Know About How to Mitigate Investment Fraud Risk

Economic growth may be anemic but fraud continues to find a life of its own. According to the Financial Fraud Research Center, at least 30 million people are impacted by fraud each year with an annual cost of $100 billion for retail fraud alone.  In a 2011 speech, the head of the U.S. Securities and Exchange Commission discussed how key offices and divisions are working together in all areas of its anti-fraud efforts and how the SEC is collaborating more frequently with state regulators, criminal prosecutors or local nonprofits in an effort to weave these initiatives into an increasingly fine-meshed net that is focused on fighting fraud. While the U.S. Department of Labor is not exclusively focused on fraud, enforcement teams have been busy with a closure of nearly 3,500 civil cases and 302 criminal cases, monetary results of $1.39 billion and 129 indictments.

Surprisingly, there is little information available to institutional and individual investors alike as to how to mitigate the risk of losing money to fraudsters. The goal of this webcast is to empower investors to better protect themselves with knowledge of situations to avoid whenever possible. Attendees will hear experts talk about:

  • Common causes of investment fraud;
  • Enforcement and litigation trends relating to investment misdeeds;
  • Lessons learned from financial scandals of the last decade;
  • Role of the investment fiduciary in vetting service providers;
  • Red flags to detect poor internal controls that could lead to fraud; and
  • Regulatory action to stem financial fraud and preserve the integrity of the capital markets.

Speakers for this 75-minute event include:

  • Dr. Susan Mangiero, CFA, FRM – Managing Director, FTI Consulting
  • Jonathan Morris, Esq. – Day Pitney LLP / former General Counsel of Barclays Wealth
  • Brian Ong – Senior Managing Director, FTI Consulting
  • Karen Tyler, North Dakota Securities Commissioner and former president of the North American Securities

To attend this webcast scheduled for Wednesday, June 13, at 1 pm Eastern and sponsored by FTI Consulting, please visit the investment fraud webinar page at http://www.securitiesdocket.com/2012/05/18/june-13-webcast-what-every-fiduciary-needs-to-know-about-how-to-mitigate-investment-fraud-risk/.

BP Investments - The Role of Ethics and Risk Management

The current situation with British Petroleum ("BP") raises a bevy of thorny questions, not the least of which is how pensions and other types of institutional investors should deal with the asset allocation fallout.

Let's start with the facts about institutional ownership of BP. According to Yahoo Finance and as excerpted in the table below, over 1,000 institutions owned stock in BP as of late March 2010. A relatively high dividend payout rate and dividend yield likely held great appeal for organizations seeking stability.

Things have changed materially, leaving large owners of BP stock to determine whether they should short, double up for a long-term play or exit altogether. Those that outsource their money management function rightly ask whether third party traders did enough to vet the issues associated with energy sector exposure. Additionally, one now deals with the question as to whether BP and similar types of stocks should be analyzed in the context of socially responsible investing. One organization - Fair Pensions - wants Shell and BP board members to beef up their disclosure about oil sands project risks. Lawsuits loom large too. According to "New York Pension Fund Considering Suit Against BP" by Jillian Mincer (Wall Street Journal, June 17, 2010), the New York State Common Retirement Fund owns 17.5 million shares indirectly, via its index fund allocation.

At the same time, anything that further erodes the price of BP shares could put parent company employees, gas station owners and related vendors out of work.

The oil spill in the Gulf is an environmental tragedy of major proportions. It may soon become a further financial debacle as well.

"Up in the Air" - Stark Reality About the Employee - Employer Relationship?

Seeking a fun film over the holidays, I persuaded my husband to join me at a viewing of "Up In the Air" with George Clooney.This modern Cary Grant did not disappoint, doing a great job of conveying his own search for the meaning of life as he travels the United States, laying off workers at various companies. In an interesting twist, many of the actors are "real people" who had at one time apparently sat across the desk from a non-Hollywood version of a jobs terminator. 

I recommend the movie but don't expect a romantic comedy. In fact, don't expect to laugh more than once or twice. It is a serious montage of human angst at a time of when unemployment is high and only the adventurous are popping champagne corks to celebrate the end of the recession.

I would however like to offer a counter to this Tinseltown intimation that management is always bad and labor is nothing but pure at heart. In today's mobile, global and less than long-term workplace, it is imperative for everyone to continuously evaluate their skill set, make sure they are adding value and can quickly adapt to change. Be part of the solution, not the problem. This is not to say that layoffs of hard-working individuals, due to incompetent leadership, are less than tragic. It's only to suggest that there are countless opportunities to retool and taking responsibility for one's ability to earn a living is paramount.

A former manager urged me to think of myself as a box of cereal and periodically ask whether I'm "new and improved" enough to compete with the other brands. 

  • Are you doing enough to encourage your team to grow and learn?
  • Are you focused on being the best you can be in terms of wealth creation on behalf of shareholders and, by extension, yourself?

Investment Ethics, Balloon Boy and Sizzle

A colleague called me the other day, after attending a recent Connecticut event that addressed "too big to fail" concerns on the part of state regulators. In response to her comment about the large crowd size, I queried her about whether a forum on investment ethics would likely be a similar draw. Somewhat surprising to me she said "no" with nary a hesitation in her voice. Teasing her for more information, she simply declared that the topic of ethics is boring. Is she right?

Is ethics too dry to appeal, even to those tasked with compliance and investment best practices? Should we even compare ethics hounds to those of us who watched the silver spaceship-like balloon, floating above the Colorado countryside a few weeks ago, wondering if Balloon Boy was safely tucked inside? (Go on, admit it. You took at least one peek to hear whether a 6-year old really can fly, unsupervised, 8,000 feet above ground.)

Let's assume for a moment that celebrity and quirky news stories trump discussions about ethics and governance. Should we care? 

I've long maintained that carrying out one's professional duties with integrity does indeed impose a need to pay attention to what is right. Yet recognizing that one should be "ethical" is a necessary but insufficient condition. One can acknowledge the need to act properly yet do nothing about it, exposing ultimate beneficiaries to potential ruin. Then there are those who embrace the mantra but are blind to the gap between "investment best practices" and compliance. One can adhere to the letter of the law and yet fail miserably in terms of improving internal controls (and much more) so that investment risk is mitigated.

Since compensation levels are in the headlines of late, I'd like to repost an article that my colleague Wayne Miller and I wrote several years ago. Though written for retirement plan executives, the issues we discuss in "Do Fiduciaries Need Better Incentives to Make the Retirement System Work?" ring true today and will apply tomorrow. The primary assertion is that individuals behave according to incentives in place. The rewards must be clearly positive and attainable for anyone who rightly walks the extra mile on behalf of beneficiaries (mutual fund investors, retirement plan participants, etc).

What will entice my friend to race to a meeting to learn more ethical behavior, along with hundreds of others? Free wine and cheese or a true belief that comprehensive risk management is simply the only course of action for high-integrity stewards of other people's monies? Alas, she may not soon have a choice. Regulators and politicians will not be handed the next Madoff scandal on their watch.

According to her October 27, 2009 speech to attendees of the SIFMA Annual Conference, the SEC Chairman Mary Schapiro has created a new Division of Risk, Strategy and Financial Innovation and has its sights set on "new products - particularly those related to retirement investing." She emphasizes the need for "simple, clear disclosure" in lieu of "complex fee arrangements or product descriptions...Already on the radar screen are target date funds and securitized life settlements."  Click to read "The Road to Investor Confidence."

Is the SEC focus a faux reward? Comply and stay out of trouble (a carrot of sorts) but not necessarily map actions to best practices (hence one runs into a proverbial brick wall with attendant pain). How will good players be differentiated from bad but lucky investment professionals? Alas, this is a topic for another day.

 

Hamsters and Investment Governance

The plight of the hamster is simple. He is cute, furry and going nowhere fast. Sure he gets exercise but, measured in inches and miles, he's stuck in the same place, treading the same pattern over and over again.

Lest this sound like a zany rant from a busy blogger, might I suggest that the current spate of "pay to play" scandals reflects what some in the industry have been saying for years? Be scared, be very scared about the dsyfunction that is roiling financial markets. 

With respect to writer George Santayana, "Those who cannot learn from history are doomed to repeat it." With Enron, Worldcom and Bear Stearns far from a distant memory, why on earth are we still reading about bad players who end up costing taxpayers, shareholders and innocent bystanders gazillions of dollars? Worse yet, those individuals who wear the fiduciary hat proudly are being unfairly tainted by those who should know better and/or simply do not care about the lives they ruin with their bad acts.

Recent articles about California and New York pension problems only add fuel to the fire and leave most folks scratching their heads, asking legitimate questions, some of which are listed below:

  • Given existing regulations, why are there so many scandals?
  • Where is the board oversight that is supposed to prevent conflicts of interest or at least nip things in the bud before losses mount?
  • How much are Sally and Joe "everyperson" supposed to tolerate in terms of broken trust on the part of those tasked with leadership?
  • Why aren't major lessons being learned sooner than later?

As an ardent advocate of capitalism (and no, we do not have a pure capitalistic system in place anywhere, contrary to Michael Moore's movie lament), I find the current state of affairs impossible to defend.

Bad practices have got to stop. We need to be moving forward, not running around and around, making no progress and chasing our tails. Let me also add that I am not objective here. Our company (newly named Investment Governance, Inc.) has been busy at work for nearly a year, building investment "best practice" tools (to debut in short order). What has kept our team going lo these many months of 15 hour days are the repeated and strident cheers from all the good guys and gals who take their institutional fiduciary work seriously and want things to improve in a big way.

Bravo to those for whom trust is a sacred word! We seek to help you gain the recognition and support you so richly deserve. 

Dr. Susan Mangiero to Speak at Dow Jones Private Equity Analyst Conference 2009

 I am delighted to have an opportunity to speak at the upcoming Private Equity Analyst Conference 2009, to be held at the Waldorf Astoria from September 16-17, 2009. With so much focus now on ethics, conflicts of interest and transparency, the panel topic I've been asked to address is near and dear to my heart.

I've reprinted the session description below. Click here to learn more information about the conference in its entirety.

Title: "Avoiding Major Trouble: Why Private Equity Firms Must Spend More Time On Ethics"

Description: Ethics has become one of the key words over the past year, especially given the fallout on Wall Street. And regulations, both in the U.S. and overseas, now place strict curbs on many established business practices in an effort to stem corruption. The consequences for companies, both in fines and damage to reputation, can be significant, which means investors need to pay attention. But as the disclosures earlier this year in New York make clear firms are not doing as good a job as they can adhering to such policies. So what should firms be doing to ensure that they themselves as well as their portfolio companies stay compliant with not only various regulatory codes, but also just doing good business? What is the message that firms can drive home to their partners and their portfolio companies? Our panel provides their thoughts.

Panelists:

  • Barry Gonder, General Partner, Grove Street Advisors
  • Pascal Levensohn, Founder & Managing Partner, Levensohn Venture Partners
  • Susan M. Mangiero, Founder & President, Pension Governance
  • Raymond Svider, Co-Chairman & Managing Partner, BC Partners.

Business Ethics, Hollywood Style

Excited to watch handsome Clive Owen and Tom Wilkinson (a favorite actor), I paid my $10+ for a ticket to see just released "Duplicity." From an entertainment perspective, I was not disappointed. Footage of fashionable Julia Roberts and lovely backdrops from London, Zurich, Rome and New York is fun eye candy for viewers everywhere. The film's writer and director is the same Tony Gilroy who directed "Michael Clayton" (a great thriller if you haven't seen it). I don't want to give away too much about the film. Part of its appeal is a surprise ending.

What does bother me however is the almost swarmy glamorization of corporate ethics gone awry. No matter how much lipstick you put on a pig, it still oinks. Theft of intellectual property is made to seem "cool" and "hip." For those inventors and entrepreneurs who toil long hours  for little pay, and those investors (like pensions, foundations and endowments) who support them with allocations to venture capital and private equity, I found the movie disturbing to say the least. Adding insult to injury, the oft-repeated "deny everything," "make counteraccusations" and "admit nothing" seems like a page ripped from the headlines.

For a light respite after a long work week, Duplicity is worth the price of a ticket. If you are expecting to see honorable business actions being imortalized on celluloid, look elsewhere.

Retirement Plan Pundits Address Conflicts of Interest

On March 24, 2009, various experts gave testimony before the U.S. House of Representatives Committee on Education & Labor, Health, Employment, Labor and Pension Subcommittee about potential conflicts of interest in the event that firms are allowed to give "conflicted financial advise" to 401(k) plan participants. Click here to access the testimonial statements of experts that include:

  • Ken Baker, Corporate Director of Human Resources Applied Extrusion Technologies Terra Haute, IN
  • Mercer Bullard, Founder and President Fund Democracy, Nonprofit Advocate for Mutual Fund Shareholders Oxford, MS
  • Sherrie Grabot, CEO GuidedChoice Los Gatos, CA
  • Charles Jeszeck, Assistant Director, Education, Workforce and Income Security Issues U.S. Government Accountability Office Washington, DC
  • Melanie Nussdorf, Partner Steptoe & Johnson LLP, on behalf of SIFMA Washington, DC
  • Andrew L. Oringer, Partner White and Case, LLP. New York, NY

New GAO Study About Conflicts of Interest and Impact on Retirement Plans

In his Congressional testimony, U.S. Government Accountability Office ("GAO") executive, Charles A. Jeszeck, describes a "statistical association between inadequate disclosure and lower investment returns." The stated premise is that pension consultants who fail to disclose  their conflicts of interest could cost defined benefit plans in excess of 100 basis points if or until the situation is corrected. Conflicts can take many forms, including, but not limited to, business relationships between pension consultants and broker-dealers that question whether pensions are getting the best execution possible.

Though the research focused on traditional plans, the GAO suggests that "participants could be more vulnerable to potential adverse effects of conflicts of interest in DC plans such as 401(k) plans." The report cites one study that showed that "36 percent of responding sponsors either did not know the fees being charged to participants or mistakenly thought no fees were charged at all." Revenue sharing arrangements remain a mystery for some while others are unaware of "hidden" fees.

As the world awaits final proposals from the U.S. Department of Labor about conflicts of interest and disclosures, one ponders - How much disclosure will truly help save the day in terms of minimizing conflicts of interest that otherwise weaken the bond of trust between a plan sponsor and its service providers as well as the relationship between plan participants and sponsor?

Editor's Note:  See "Testimony Before the Subcommittee on Health, Employment, Labor and Pensions, Education and Labor Committee, House of Representatives: Private Pensions - Conflicts of Interest Can Affect Defined Benefit and Defined Contribution Plans" by Charles A. Jeszeck, Acting Director, Education, Workforce and Income Security, March 24, 2009.

You Can't Regulate Honor

As famed playwright George Bernard Shaw once said, "The most tragic thing in the world is a man of genius who is not a man of honor." I've been thinking about the "H" word a lot lately, especially given what seems like to be a never-ending onslaught of news items about fraud or outright bad practices. The current brouhaha in the Empire State is one example. 

In "Criminal Case Ensnares Aides to Ex-New York Comptroller" (March 19, 2009), Wall Street Journal reporters Craig Karmin and Peter Lattman describe a "pay to play" scheme that has the makings of a Hollywood thriller. Attempting to outgreed Gordon Gekko, several aides to a former New York State comptroller have been charged by the U.S. Securities and Exchange Commission with over 100 counts, including money laundering and bribery. According to the regulator's website (Litigation Release No. 20963), private equity and hedge fund managers were encouraged to pay many millions of dollars "in the form of sham 'finder' or 'placement agent' fees," expecting to secure asset allocation commitments from the New York State Common Retirement Fund.

Were this an isolated event (and to be fair to the defendants, these are only allegations at this point), people may be willing to look askance. Alas, we have Madoff, Sir Stanford, AIG bonus lunacy and so much more.

Not being a psychologist, I'm unclear as to why people conduct themselves in a questionable fashion. Some say that bad players rationalize their acts as short-term (not to be repeated) or legitimate entitlements ("I'm owed'). Even if one accepts fraud or sub-par practices as okay (and hopefully few do), it is not smart business. Ultimately, people get caught, even if it means mental anguish in the form of time spent, worrying about being found out, remorse or both. How sad too that innocent spouses, family members and children get a place in the "hall of shame," next to the responsible party.

I've made no secret that I'm an advocate of free markets. In response to several colleagues who demand even more mandates, my question to them is whether they think honor can be regulated. Pour moi, I think not. Force does not equate to walking a straight line.

If there is a silver lining to financial mishaps of late, perhaps it is this. More and more individuals (business persons or otherwise) are having lively debates about ethics, best practices and fiduciary standards. It's a great start, don't you think? 

One attempt at getting the message out is the recently published "Principles of Financial Regulation Reform: A Model for Change." Developed by CalPERS and other large public pension plans, the March 2009 document urges greater transparency and freedom to invest, "consistent with fiduciary responsibilities," without limitation "on the universe of available investments." Somewhat ironically, the New York State Common Retirement Fund is a signatory to this call for reform. (Could some of the newly minted principles have possibly forestalled or prevented the alleged fraud now being investigated by regulators?)