Aspen Publishers
Vol. 12, No. 8 • August 2005
SEC and DOL Provide Guidance on
Selecting and Monitoring Pension
Consultants
T
by Douglas J. Ellis
he complexity and associated liability of managing pension and other retirement
plan assets and complying with relevant tax, fiduciary, and securities require-
ments have caused a growing number of plan administrators and trustees to
retain the services of pension consultants. Pension consultants provide assistance
in a number of areas, including (1) establishing investment objectives, restrictions and funding
vehicles, (2) determining proper asset allocation, (3) tracking and benchmarking investment performance, and (4) selecting money managers, broker-dealers and other service providers. Many
pension consultants, especially the larger ones, offer “bundled” services, often through affiliates,
that include brokerage, money management and other services.
There are over 1,700 investment advisers registered with the Securities and Exchange Commission
(SEC) who indicate that they provide pension consulting services. Under the Investment Advisers Act
of 1940, as amended (the Advisers Act), investment
advisers owe their clients a fiduciary duty of good
faith and full and fair disclosure of all material facts,
Douglas J. Ellis is an associate at Kirkpatrick & Lockhart
Nicholson Graham LLP in Pittsburgh, PA. Mr. Ellis provides a variety of services to employers with respect to their
employees benefits.
which includes any material conflicts of interest.1
In many instances, a pension consultant also may
be considered a fiduciary of a pension or retirement plan under the Employee Retirement Income
Security Act of 1974, as amended (ERISA), in which
case the consultants are required to provide advice
that is solely in the interests of the plans’ participants
and beneficiaries.
A recent study2 by the SEC’s Office of Compliance
Inspections and Examinations of 24 registered pension consulting firms found that, while many pension
consultants have significant conflicts of interest, they
are either entirely unaware of their fiduciary duty
to disclose, or otherwise fail to adequately disclose,
those conflicts to their advisory clients. For example,
the study found that more than half of the pension
consultants in the study provided services to both
pension plan administrators and money managers
or mutual funds. Although not illegal or unethical
in itself, the fact that the consultant may receive
substantial fees from money managers or mutual
funds that the consultant may be recommending to
its plan clients creates an important potential conflict of interest of which the plan clients should be
aware. Also, a majority of the firms surveyed had
undisclosed or inadequately disclosed relationships
with broker-dealers, including special fee-sharing or
“commission recapture” arrangements and referral
arrangements. In addition to other possible conflicts
that may arise from these arrangements, the payment
of a pension consultant’s fees from a plan’s brokerage transactions may encourage the consultant to
recommend an active or even aggressive trading style
for the plan, whether or not such trading is really in
the plan’s interests. Generating fees from trades also
may raise questions about whether a plan is receiving
“best execution”3 for its broker transactions.
Of course, whether an actual conflict of interest
is occurring or may arise under a certain arrangement depends on the relevant facts and circumstances. However, these findings raise questions
about the independence and objectivity of the
advice being given by pension consultants to benefit plan clients. Independent and objective advice
is important for plan administrators and trustees
who rely on that advice to effectively manage
their plans’ assets. Moreover, plan administrators
and trustees, as ERISA fiduciaries, also have a
personal stake in properly selecting and monitoring pension consultants in a way that avoids or at
least minimizes potential conflicts of interest that
may cause the administrator or trustee to violate
its own fiduciary duty to plan participants and
beneficiaries. For the pension consultant, the failure to disclose material facts concerning a conflict
of interest may be considered fraudulent conduct
that violates Section 206 of the Advisers Act.4
Consequently, it is vital that plan clients ask the
right questions when selecting a pension consultant and that consultants be prepared to answer, or
even anticipate, such questions.
In coordination with the release of the pension consultant study, the SEC and the Department of Labor
(DOL) jointly issued “best practices” guidance to
plan administrators and trustees that provide tips for
selecting and monitoring pension consultants.5 The
guidance sets out 10 questions that administrators and
trustees can use to encourage greater disclosure of
potential conflicts of interest and to assist in determining the independence and objectivity of the pension
consultant. The questions explore issues such as:
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Whether the consultant is registered with the
SEC or another regulatory agency and whether
the disclosures required for registered advisers
have been provided to the plan;6
Whether the consultant has relationships or
receives payments from money managers, broker-dealers or other service providers that the
consultant may recommend or mention to the
plan;
Whether the consultant allows plans to pay consulting fees using the plan’s brokerage commissions and, if so, how those fees are monitored
to prevent overpayment and how the consultant
ensures that the plan receives “best execution” of
its trades;
Whether the consultant acknowledges its fiduciary duty under the Advisers Act and whether it
considers itself to be a fiduciary under ERISA;
and
Disclosure of the percentage of a consultant’s
plan clients that use money managers, investment funds, brokerage services or other service
providers from whom the consultant receives
fees or with whom the consultant has any other
material relationship.
Many pension consultants attempt to limit their
exposure as a fiduciary under ERISA by making
representations that they are only providing general
advice and have no discretion or control over plan
assets or fiduciary decisions. The SEC-DOL guidance does not give an opinion on whether such representations are sufficient to limit a consultant’s fiduciary status under ERISA. However, ERISA defines
a “fiduciary” as, among other things, a party that
renders “investment advice” to a benefit plan for a
fee or other compensation.7 The ERISA Regulations
include under the concept of “investment advice” any
advice as to the value of securities or other property
or recommendations regarding investing in, purchasing or selling securities or other property, where such
advice will serve as the primary basis for investment
decisions by the plan, as well as individualized advice
regarding investment policies or strategies, portfolio
composition or diversification of plan investments.8
Consequently, it is likely that in many situations the
advice given by a pension consultant will cause the
consultant to be deemed a fiduciary for purposes
of ERISA with respect to that advice, regardless of
the representations or limitations that the consultant
attempts to impose on the advice.
If the pension consultant is a fiduciary under
ERISA, the receipt of fees in excess of the value of
the consulting services would constitute a prohibited transaction under ERISA, causing the parties to
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addition to, insurance products, real estate not involving securities, or other funding media, would be ‘advising’ others within
the meaning of [the Advisers Act].” Further, the 1987 Release
observes that advice regarding the selection or retention of an
investment manager also typically falls within the concept of
“advising” under the Advisers Act.
incur excise taxes and other possible penalties and
expenses. For example, this could occur if a pension
consultant agrees to receive its fees out of the plan’s
brokerage commissions or if the plan pays fees to
the consultant and other related parties as part of a
“bundled” service arrangement, but there is no cap
or other tracking of the total fees paid specifically
for the consulting services. Regardless of whether
the consultant has a fiduciary duty to the plan under
ERISA, the guidance is clear that a registered investment adviser providing pension consulting services
will have a fiduciary duty of disclosure to its benefit
plan clients under the Advisers Act.
Plan administrators and trustees should establish
a practice of asking all pension consultants the questions set forth in the SEC-DOL guidance at regular
intervals and documenting the responses. In addition,
pension consultants should be required to acknowledge compliance with a code of ethics or policies
adopted by plan administrators and trustees that target investment and asset management practices and
restrictions, including disclosure and monitoring of
related fees.
2. Staff Report Concerning Examinations of Select Pension
Consultants, http://www.sec.gov/news/studies/pensionexamstudy.pdf.
3. The “best execution” requirement obligates market makers,
broker-dealers, and others to execute a client’s trades at the best
price currently available.
4. Section IV of the 1987 Release notes that “the adviser’s duty to
disclose material facts is particularly pertinent whenever the adviser
is in a situation involving a conflict, or potential conflict, of interest
with a client.”
5. Selecting and Monitoring Pension Consultants: Tips for Plan
Fiduciaries, http://www.sec.gov/investor/pubs/sponsortips.htm.
6. The SEC study observes that investment advisers registered
with the SEC provide disclosures to advisory clients on Form
ADVs, including matters such as the adviser’s affiliations, participation or interest in client transactions, brokerage transactions, and
compensation for client referrals. Part II of Form ADV is typically
offered to all advisory clients at the beginning of the advisory relationship and once each year thereafter. In addition to the disclosure
required by Form ADV, a pension consultant has a fiduciary duty
to inform its clients of any material conflicts of interest that may be
specific to the particular client, so that the client is able to assess the
objectivity of the advice that is or may be provided by the pension
consultant.
Notes
1. While it is possible, depending on the facts and circumstances,
it is unlikely that a person providing pension consulting services
would not be deemed an “investment adviser” under the Advisers
Act. SEC Release No. 1A-1092 (Oct. 8, 1987) (1987 Release)
examines the applicability of the Advisers Act to financial planners, pension consultants, and others who typically provide some
form of investment advice as a component of a financial services
business. Section II(A)(1) of the 1987 Release notes that “a person
who advises employee benefit plans on funding plan benefits by
investing in, purchasing or selling securities, as opposed to, or in
7. ERISA § 3(21)(A).
8. DOL Regulation § 2510.3-21(c). This definition is similar in
many respects to Section 202(a)(11) of the Advisers Act, which
defines the term “investment adviser” as “any person who, for compensation, engages in the business of advising others, either directly
or through publications or writings, as to the value of securities or
as to the advisability of investing in, purchasing or selling securities,
or who, for compensation and as part of a regular business, issues or
promulgates analyses or reports concerning securities. . . .”
Reprinted from Investment Lawyer,Volume 12, Number 8, August 2005, pages 18–20, with permission from
Aspen Publishers, A WoltersKluwer Company , New York, NY 1-800-638-8437, www.aspenpublishers.com
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Vol. 12, No. 8 • August 2005