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| > Investing > Fiduciary Focus |
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| Fiduciary Focus: The Pension Consultant Shell Game |
| by
W. Scott Simon
| 09-29-05 |
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The staff of the U.S. Securities and Exchange Commission issued a report on May 16 titled "Staff Report Concerning Examination of Select Pension Consultants." The U.S. Department of Labor, in coordination with the SEC, issued a fact sheet on June 1 titled "Selecting and Monitoring Pension Consultants: Tips for Plan Fiduciaries." I suggest that those of you who are investment advisors to 401(k) plans read both documents to help you better understand the shell game played by many pension consultants.
Here's how that shell game is played. Many pension consultants market their services (e.g., identify plan investment objectives, allocate plan assets, select money managers to manage plan assets, select mutual funds as plan investment options, monitor the performances of plan money managers and mutual funds, etc.) to sponsors of 401(k) plans with the hope of becoming the designated "gatekeeper" to a plan.
The gatekeeper designation is important to a pension consultant that has won it at the expense of its competition because it allows the consultant to exact a "toll" from a money manager (including mutual fund families and brokerage firms) that seeks to provide, for example, the mutual funds for a 401(k) plan's investment options.
That toll is composed of money and other forms of compensation paid by the money manager to the pension consultant--compensation in addition to the explicitly stated consulting retainer paid by the sponsor of a pension plan to the pension. In fact, the disclosed annual consulting fee paid to a pension consultant by the plan sponsor often pales in comparison to the undisclosed toll paid to the consultant by money managers. (Sometimes when the tolls are particularly high, the consulting fee is totally waived, which makes it appear that the consultant is providing its services for "free.")
So what are the services that pension consultants provide and what makes them so valuable that trustees and other fiduciaries of pension plans (ultimately, though, usually plan participants and their beneficiaries) must pay so dearly for them? Two services identified by the SEC report include 1) "selecting mutual funds that [401(k)] plan participants can choose as their funding vehicles" and 2) "monitoring performance of money managers and mutual funds and making recommendations for changes."
The first of these services provided by pension consultants involves searches to find the "best" mutual funds (or money managers) for sponsors of 401(k) plans. While many plan sponsors will admit in private that such exercises provide very little value, they nonetheless fork over large amounts of money to pension consultants to conduct them. They engage in this behavior for the simple reason that it is behavior their competition engages in. The pension consulting industry has done an excellent job at inculcating a herd mentality, to its benefit, among plan sponsors. In reality, though, many pension consultants are just expensive numbers gatherers and survey providers.
Far too many pension consultants are given an annual contract for, say, $100,000 to run their computers for a few seconds to produce a spreadsheet that gives investment performance versus a peer group and a benchmark. Four quarterly reports and some meetings on why the funds and/or managers did what they did--and voila!. That just about sums up much of the pension consulting business. Value added? It sure is difficult to think so.
There is an alternative for plan sponsors looking to save either their own money or the money of their participants. In the latter case, as fiduciaries of their plans under the Employee Retirement Income Security Act of 1974 (ERISA), sponsors have a legal obligation to avoid unreasonable expenditures of plan assets. For a paltry $125, then, they could buy a Morningstar.com subscription (in the interests of full disclosure: I swear that I am not a commissioned salesman for Morningstar) and assign some junior staffer in the finance department to spend four hours each quarter producing reports to salt the files with information. It would take about 20 minutes to teach someone how to do it. The only really hard part would be formatting all the information to make it look pretty. All in all, it could probably be done for less than $1,000 (instead of $100,000) with the same results.
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| W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing. Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals. For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. |
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