Tainted Pension Fund Advice

Asher Hawkins with David K. Randall,
May 20, 2009
Forbes Magazine dated June 08, 2009

In the eternally sleazy pension consulting industry, some of the guys allegedly taking kickbacks are going away in handcuffs. That could crimp the business model of outfits like Consulting Services Group.

You might think that being in the business of advising pension funds where to invest and then steering them into Ponzi schemes run by Bernard Madoff and Bayou Group would damage a consultant's reputation. Or that cheating on federal ethics forms and having regulators bar a cofounder from a supervisory role would hurt business. Or that having its practices described in an independent report as "subject to myriad conflicts of interest" might tarnish its reputation.

Not at Consulting Services Group. Despite suffering all of the above, the Memphis, Tenn. firm is going strong, advising 42 public and private pension funds on how to allocate $16 billion and which money managers to hire--even while taking money from some of those same managers for steering business their way.

If getting paid from both sides strikes you as a tad conflicted, you're not alone. The Securities & Exchange Commission released a study 11 years ago warning that the pension consulting game was riddled with pay-to-play scams. It did little to clean things up, however, except release another study with similar conclusions in 2005. The Government Accountability Office estimated two years ago that biased consultants cost pension funds over one-quarter of the returns they would have earned with honest advice.

With anger toward crooked financiers at a boil, this year is proving a tough one for pension consultants like CSG, and for placement agents, whom money managers pay to lure cash from large investors. New York Attorney General Andrew Cuomo has indicted two middlemen on charges of steering state pension funds to favored money managers in exchange for illegal kickbacks. To press the issue further, Cuomo has issued more than 100 subpoenas and assembled a task force of 36 state attorneys general. CSG, which made one of the payments now under scrutiny, but has not been accused of wrongdoing, offers a peek at what further investigations might uncover.

"I'm very proud of our people. We do business the right way. But that's not the sexy part of the story," says CSG President Brian Jones.

Since its 1990 founding CSG has been an example of how the clubby world of pension consulting operates. It was set up by four Memphis employees of E.F. Hutton & Co., with early financial backing from Michael Robinson and the company he runs--century-old D. Canale & Co., whose namesake clan has interests in a beer distributor, financial services, real estate and timber.

Like many pension consultants, CSG charges pension funds $100,000 or so a year to provide soup-to-nuts investment advice to pension directors, who often have little knowledge of finance. The real money is made on the back end and not necessarily by dispensing advice that's in clients' best interests.

From the outset CSG has operated its own broker-dealer, Trading Services Group, which handles client trades. Such institutional brokerage can be a highly profitable business, but it is one whose spoils CSG told clients it would share with them via commission rebates.

"Any way we can help them lower their costs is a valuable service," says Jones.

That value hasn't always been shared, however. CSG "failed to timely provide promised commission rebates" to unnamed private pensions between 2002 and 2006 and repaid $278,000, according to the terms of a February settlement with the Department of Labor. CSG also agreed to pay a $28,000 fine. Jones attributes the entire affair to "miscoding in our billing system."

The settlement severely limits CSG cofounder Joe D. Meals from dealing with corporate pensions. The restrictions come on top of a 2007 SEC censure of Meals for instructing CSG employees to misrepresent ethics forms as having been completed prior to a filing deadline. Rather than oust Meals, CSG employs him to work with public pension plans, over which the DOL has no jurisdiction.

With alternative investments all the rage in the mid-1990s, CSG began steering clients into hedge funds--including its own and others that paid it finder's fees. One client since CSG's inception was municipally owned Memphis Light, Gas & Water. In 1997 Memphis Light began to express concern when it discovered that CSG was collecting $800,000 annually in commissions from a Florida money manager. The utility's pension replaced CSG later that year as its consultant.

The following year CSG signed as a new client the $670 million pension fund of Shelby County, which includes Memphis. CSG put Shelby County into five so-called funds of funds, which in turn invested in a total of 120 hedge funds. That subjected Shelby County to three layers of fees that together siphoned off between 2.5% and 3.25% annually, plus 20% of any profits.

Prompted by concerns about pension consultant shenanigans in Nashville and Chattanooga, the Shelby pension board in 2006 commissioned a review of CSG's practices. Benchmark Financial Services, which did the review, issued a scathing report that December. In addition to citing CSG for conflicts of interest, it said the pension consultant "has derived exponentially greater compensation from the [pension] fund as a result of this elaborate hedge fund of funds arrangement."

Exactly how much CSG makes off the setup, and what risks Shelby County faces as a result, cannot be quantified because the "identities, securities holdings, trading costs and custodians are unknown" for some or all of the 120 underlying hedge funds, the report said.

CSG responded that Benchmark's findings were filled with "misstatements, inaccuracies, and baseless suggestions." The report did not harm CSG's relationship with the Shelby County fund, which re-signed a contract the following year. At the end of 2008, 18% of its assets were in CSG's fund-of-funds program, for which it's paying out 55% of its annual management fees, says David Pontius, the Shelby fund's investment officer. Last year the pension lost 25% of the assets it had invested in CSG's hedge fund program, net of fees. It could have done at least as well with a low-cost stock-and-bond portfolio.