Defined Benefit Pensions
Conflicts of Interest Involving High Risk or Terminated Plans Pose Enforcement Challenges Gao ID: GAO-07-703 June 28, 2007To protect workers' retirement security, the requesters asked GAO to assess: 1) What is known about conflicts of interest affecting private sector defined benefit (DB) plans? 2) What procedures does the Pension Benefit Guaranty Corporation (PBGC) have to identify and recover losses attributable to conflicts? 3) What procedures does Employee Benefits Security Administration (EBSA) have to detect conflicts among service providers and fiduciaries for PBGC-trusteed plans? 4) To what extent do EBSA, PBGC, and the Securities and Exchange Commission (SEC) coordinate their activities to investigate conflicts? GAO interviewed experts, including agency officials, attorneys, financial industry representatives, and academics, and GAO reviewed PBGC documentation and EBSA enforcement materials. GAO analyzed Labor, SEC, PBGC, and private sector data, including data on pensions, pension consultants, and rates of return data, and conducted statistical and econometric analyses.
A conflict of interest typically exists when someone in a position of trust, such as a pension consultant, has competing professional or personal interests. Though data are limited on the prevalence of conflicts involving plan fiduciaries and consultants, a 2005 SEC staff report examining 24 registered pension consultants identified 13 that failed to disclose significant conflicts. GAO's analysis found that, in 2006, these 13 consultants had over $4.5 trillion in U.S. assets under advisement. GAO also analyzed a sample of ongoing DB plans associated with the 13 consultants that, as of year-end 2004, had total assets of $183.5 billion and average assets of $155.3 million. Additional sample analysis showed that the DB plans using these 13 consultants had annual returns generally 1.3 percent lower than those that did not. Because many factors can affect returns, and data as well as modeling limitations limit the ability to generalize and interpret the results, this finding should not be considered as proof of causality between consultants and lower rates of return, although it suggests the importance of detecting the presence of conflicts among pension plans. Whether specific financial harm was caused by a conflict of interest is difficult to determine without a detailed audit. As a creditor and a trustee of terminated plans, PBGC's policies and procedures are oriented toward the likely recovery of assets, rather than explicitly focusing on losses associated with conflicts of interest involving service providers. Although PBGC has broad legal authority to recover losses attributable to conflicts of interest, PBGC officials told us that the agency limits its pursuit of cases to those in which the recovery will likely exceed the cost of bringing a case to court successfully. While monetary recoveries by PBGC may improve the agency's financial position, they generally have little effect on participant benefits because most affected participants already receive their full benefits promised by their plans. According to PBGC, more than 90 percent of all beneficiaries of PBGC trusteed plans received their full promised plan benefit. While EBSA's enforcement program is concerned with conflicts of interest affecting all private pension plans, it does not have specific procedures for plans trusteed or likely to be trusteed by PBGC. EBSA has recently initiated the Consultant/Advisor Project (CAP) to focus on conflicts among service providers, though it includes no specific focus on high risk or terminated plans. Moreover, existing law limits EBSA's efforts to pursue conflicts and redress for financial harm when certain service providers are either not fiduciaries under the Employee Retirement Income Security Act (ERISA) or did not knowingly act in concert with a fiduciary. Coordination among EBSA, PBGC, and the SEC on conflicts of interest is primarily informal, in part because of agencies' different responsibilities. The agencies' investigative activities for conflicts of interest tend to operate independently. Differences in agency missions pose challenges to the three agencies' developing a coordinated focus to pursue conflicts of interest affecting individual pension plans.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-07-703, Defined Benefit Pensions: Conflicts of Interest Involving High Risk or Terminated Plans Pose Enforcement Challenges
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Report to Congressional Requesters:
United States Government Accountability Office:
GAO:
June 2007:
Defined Benefit Pensions:
Conflicts of Interest Involving High Risk or Terminated Plans Pose
Enforcement Challenges:
GAO-07-703:
GAO Highlights:
Highlights of GAO-07-703, a report to congressional requesters
Why GAO Did This Study:
To protect workers‘ retirement security, the requesters asked GAO to
assess: 1) What is known about conflicts of interest affecting private
sector defined benefit (DB) plans? 2) What procedures does PBGC have to
identify and recover losses attributable to conflicts? 3) What
procedures does Employee Benefits Security Administration (EBSA) have
to detect conflicts among service providers and fiduciaries for PBGC-
trusteed plans? 4) To what extent do EBSA, PBGC, and SEC coordinate
their activities to investigate conflicts? GAO interviewed experts,
including agency officials, attorneys, financial industry
representatives, and academics, and GAO reviewed PBGC documentation and
EBSA enforcement materials. GAO analyzed Labor, SEC, PBGC, and private
sector data, including data on pensions, pension consultants, and rates
of return data, and conducted statistical and econometric analyses.
What GAO Found:
A conflict of interest typically exists when someone in a position of
trust, such as a pension consultant, has competing professional or
personal interests. Though data are limited on the prevalence of
conflicts involving plan fiduciaries and consultants, a 2005 SEC staff
report examining 24 registered pension consultants identified 13 that
failed to disclose significant conflicts. GAO‘s analysis found that, in
2006, these 13 consultants had over $4.5 trillion in U.S. assets under
advisement. GAO also analyzed a sample of ongoing DB plans associated
with the 13 consultants that, as of year-end 2004, had total assets of
$183.5 billion and average assets of $155.3 million. Additional sample
analysis showed that the DB plans using these 13 consultants had annual
returns generally 1.3 percent lower than those that did not. Because
many factors can affect returns, and data as well as modeling
limitations limit the ability to generalize and interpret the results,
this finding should not be considered as proof of causality between
consultants and lower rates of return, although it suggests the
importance of detecting the presence of conflicts among pension plans.
Whether specific financial harm was caused by a conflict of interest is
difficult to determine without a detailed audit.
As a creditor and a trustee of terminated plans, PBGC‘s policies and
procedures are oriented toward the likely recovery of assets, rather
than explicitly focusing on losses associated with conflicts of
interest involving service providers. Although PBGC has broad legal
authority to recover losses attributable to conflicts of interest, PBGC
officials told us that the agency limits its pursuit of cases to those
in which the recovery will likely exceed the cost of bringing a case to
court successfully. While monetary recoveries by PBGC may improve the
agency‘s financial position, they generally have little effect on
participant benefits because most affected participants already receive
their full benefits promised by their plans. According to PBGC, more
than 90 percent of all beneficiaries of PBGC trusteed plans received
their full promised plan benefit.
While EBSA‘s enforcement program is concerned with conflicts of
interest affecting all private pension plans, it does not have specific
procedures for plans trusteed or likely to be trusteed by PBGC. EBSA
has recently initiated the Consultant/Advisor Project (CAP) to focus on
conflicts among service providers, though it includes no specific focus
on high risk or terminated plans. Moreover, existing law limits EBSA‘s
efforts to pursue conflicts and redress for financial harm when certain
service providers are either not fiduciaries under ERISA or did not
knowingly act in concert with a fiduciary.
Coordination among EBSA, PBGC, and the SEC on conflicts of interest is
primarily informal, in part because of agencies‘ different
responsibilities. The agencies‘ investigative activities for conflicts
of interest tend to operate independently. Differences in agency
missions pose challenges to the three agencies‘ developing a
coordinated focus to pursue conflicts of interest affecting individual
pension plans.
What GAO Recommends:
GAO recommends that PBGC assess the risks from conflicts of interest;
that EBSA expand enforcement to include a focus on PBGC-identified
plans; and that each agency share data on conflicts. Congress should
consider amending ERISA to expand Labor‘s authority to recover losses
against non-fiduciaries. Each agency generally concurred with the
report, although EBSA expressed some methodological concerns.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-703].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Barbara Bovbjerg at (202)
512-7215 or Bovbjergb@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Some Pension Plan Service Providers May Have Conflicts of Interest, but
Determining Whether Harm Results Is Difficult:
PBGC's Current Policy and Procedures Are Not Focused on Detecting
Conflicts of Interest among Service Providers:
EBSA's Enforcement Strategy Does Not Include Procedures That Focus on
Conflicts of Interest Involving PBGC Trusteed Plans or High Risk Plans
Likely to Terminate:
Different Authorities and Roles Have Limited Agency Collaboration:
Conclusions:
Matters for Congressional Consideration:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Econometric Analysis of the Effect of Inadequately or
Undisclosed Conflicts of Interest on Pension Plan Rates of Return:
Appendix III: Comments from the Pension Benefit Guaranty Corporation:
Appendix IV: Comments from the Department of Labor:
Appendix V: Comments from the Securities and Exchange Commission:
Appendix VI: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Pension Plan Sponsors Employing 13 Consultants of Concern to
the SEC Regarding Inadequately Disclosed Conflicts of Interest.
Table 2: Selected Descriptive Statistics for Plans included in the
Econometric Model:
Table 3: Econometric Estimates of the Relationship between Undisclosed
Conflicts of Interest and Plan Returns (OLS and Random Effects):
Table 4: Econometric Estimates of the Relationship between Undisclosed
Conflicts of Interest and Plan Returns (Fixed-Effects):
Figures:
Figure 1: Average Annual Rates of Return Achieved by Plans Terminated
in 2005 Sponsored by Publicly Traded Companies Compared to CalPERS, TSP
and the S&P 500 Benchmarks, 1997-2002:
Figure 2: Identifying Plans for GAO's Pension Plan Sample:
Abbreviations:
CalPERS: California Public Employees' Retirement System:
CAP: Consultant Advisor Program:
DB: defined benefit:
DC: defined contribution:
DOL: Department of Labor:
EBSA: Employment Benefits Security Administration:
ERISA: Employee Retirement Income Security Act:
GLS: generalized least squares:
MOU: memorandum of understanding:
OCIE: Office of Compliance Inspection and Examinations:
OLS: ordinary least squares:
PBGC: Pension Benefit Guaranty Corporation:
SEC: Security and Exchange Commission:
S&P: Standard and Poor's:
United States Government Accountability Office:
Washington, DC 20548:
June 28, 2007:
The Honorable George Miller:
Chairman:
Committee on Education and Labor:
House of Representatives:
The Honorable Edward J. Markey:
House of Representatives:
The bankruptcies of United Airlines, Bethlehem Steel, and other firms
since 2000 have resulted in the termination of a number of large
underfunded pension plans and their becoming the responsibility of the
Pension Benefit Guaranty Corporation (PBGC), the federal guarantor of
private sector defined benefit (DB) plans. Since then, the number of
pensioners who depend on the agency for their retirement benefits has
almost tripled, and the agency's single employer insurance program has
moved from a surplus of $9.7 billion to an accumulated financial
deficit in 2006 of more than $18 billion. Recent experiences involving
the termination of large DB plans have illustrated the weaknesses in
funding rules.[Footnote 1] Adding to concern over the health of DB
plans have been recent reports about conflicts of interest among
pension consultants - advisers who often play a major role in guiding
plan investments. In June 2005, the Aircraft Mechanics Fraternal
Association, which represents certain employee groups in terminated
United and Northwest Airlines DB plans, expressed concern that
conflicts of interest may have been present in the DB plans of
employees the union represents. The union's concerns were raised as a
result of a May 2005 study by Securities and Exchange Commission (SEC)
staff on conflicts of interest among pension consultants. The SEC study
revealed that many pension consultants have failed to adequately
disclose conflicts of interest in the process of advising pension plans
and their trustees, including DB plans.[Footnote 2] A conflict of
interest is typically a situation in which someone in a position of
trust, such as a pension plan trustee or investment adviser, has
competing professional or personal interests. Such competing interests
can make it difficult for fiduciaries and others, in general, to
fulfill their duties impartially and could cause them to breach their
duty to act solely in the interest of investors, plan participants, or
beneficiaries. Having a conflict in and of itself does not constitute a
breach of fiduciary duty. However, given the potential of financial
harm to plan sponsors and participants, concerns have been raised about
the extent and nature of these conflicts of interest.
In view of the importance of protecting the retirement security of plan
participants and bolstering the financial position of the PBGC, you
asked us to pursue the following questions:
* What is known about conflicts of interest on the part of service
providers and plan fiduciaries to single employer, private sector DB
plans?
* What policies and procedures does the PBGC have in place to identify
and recover losses attributable to conflicts of interest in plans it
trustees?
* Does the Department of Labor's (Labor) Employee Benefits Security
Administration (EBSA) have procedures in place to detect conflicts of
interest among service providers and fiduciaries for plans now trusteed
by PBGC?
* To what extent do EBSA, PBGC, and SEC coordinate their activities to
identify and investigate conflicts of interest?
To determine what is known about the existence of conflicts of interest
in the context of single employer private sector DB plans, we
interviewed a variety of professionals with expert knowledge of the
issue, including agency officials, forensic auditors, accountants,
attorneys, financial industry representatives, and academics. We also
analyzed Form 5500 data, Nelson's Directory of Plan Sponsor data,
Nelson's Directory of Pension Consultants data, SEC examination data,
Pensions and Investments periodicals, and data received from the PBGC
associated with terminated DB plans. In addition, we analyzed Standard
and Poors (S&P) rate of return and asset allocation data for ongoing
and terminated plans. To determine the policies and procedures PBGC has
in place on conflicts of interest, we interviewed PBGC and EBSA
officials and reviewed PBGC documentation related to this issue. To
determine the procedures EBSA has in place to detect and investigate
conflicts of interest at service providers or plan fiduciaries, we
reviewed EBSA's enforcement materials, our previously issued reports on
EBSA's enforcement program, and interviewed EBSA officials. To
determine EBSA's, PBGC's, and SEC's coordination efforts, we
interviewed officials at all three agencies and reviewed previously
issued reports that provided related information on this issue. We
conducted our work between February 2006 and May 2007 in accordance
with generally accepted government auditing standards. See appendix I
and appendix II for more information on our scope and methodology.
Results in Brief:
Although no complete information is available regarding the prevalence
of conflicts of interest, pension plan consultants assisting
significant numbers of pension plan sponsors may have conflicts of
interest, as a result of their affiliations or business arrangements
with other firms that could affect the advice they provide to these
sponsors. A May 2005 SEC staff study of pension consultants registered
as investment advisers found that 13 of the 24 consultants reviewed
that had provided services to sponsors of pension plans, including
ongoing DB and PBGC trusteed DB plans, had failed to disclose
significant ongoing conflicts of interest to their pension fund
clients. Our analysis of data found that, in 2006, these 13 consultants
had over $4.5 trillion in U.S. assets under advisement, which included
DB, DC, and other types of assets. We also analyzed a sample of ongoing
DB plans associated with the 13 consultants that, as of year-end 2004,
had assets of $183.5 billion for these plans and average assets of
$155.3 million. Additional analysis found that the DB plans using these
13 consultants had annual returns generally 1.3 percent lower than
those that did not. Because many factors can affect returns, and data
and modeling limitations limit the ability to generalize and interpret
the results, this finding, while suggestive, should not be considered
as proof of causality between consultants and lower rates of return.
Lack of data prevented a similar study of PBGC trusteed plans or high
risk plans likely to terminate. Although SEC staff have reported that
some of the consultants examined in its study have since taken some
corrective action, this finding nevertheless illustrates the importance
of detecting the presence of undisclosed conflicts of interest among
ongoing plans, and likely among terminated plans. However, independent
experts, EBSA and PBGC officials all concur that while analyzing rates
of return is a useful first step, determining whether conflicts
resulted in financial harm to individual plans and the magnitude of
that harm is often extremely difficult without a detailed forensic
audit.
As a creditor and a trustee of terminated plans, PBGC's policies and
procedures are oriented toward the likely recovery of assets, rather
than specifically focusing on losses associated with conflicts of
interest involving service providers. When assuming responsibility for
a terminated plan that is underfunded, PBGC takes steps to identify
improper activities of the plan fiduciary, such as theft or improper
loans of plan assets, but does not collect and evaluate service
providers' records to identify their conflicts of interest and any
associated losses to the plan. PBGC officials told us that, given the
agency's mission, balancing scarce resources against the likelihood of
recovering losses makes pursuing conflicts of interest cases
particularly risky for PBGC. Although PBGC has broad legal authority to
pursue and recover losses attributable to conflicts of interest, PBGC
officials told us that the agency limits its pursuit of cases to those
in which the recovery will likely exceed the cost of identifying and
gathering evidence and bringing a case through the courts successfully.
While monetary recoveries of missing assets by PBGC may improve the
agency's financial position, they generally have little effect on
participant benefits because most participants of PBGC trusteed plans
already receive their full plan benefits. According to a PBGC 2004
report, more than 90 percent of all beneficiaries of PBGC trusteed
plans received their full plan benefit.
EBSA's enforcement program is concerned with conflicts of interest
affecting private-sector pension plans generally and does not have
specific procedures for plans trusteed by PBGC. EBSA officials told us
they do not focus their enforcement efforts on PBGC-trusteed plans and
generally leave the responsibility of identifying potentially harmful
conflicts of interest to PBGC for those plans under PBGC control. EBSA
has recently expanded its enforcement activities to focus more heavily
on conflicts of interest involving service providers through a new
initiative known as the Consultant/Adviser Project (CAP). However, EBSA
officials said there are no explicit procedures in the CAP that focus
on service providers of plans that PBGC deems as likely to terminate or
those plans now under PBGC's control. EBSA officials also noted that
existing law limits their efforts to pursue conflicts involving those
service providers that are not fiduciaries under ERISA or that did not
knowingly participate in a breach by a fiduciary.
The current level of coordination among EBSA, PBGC, and the SEC
regarding conflicts of interest is limited, largely because of the
different authorities and missions of each agency. Exchanges of
information are informal and have occurred both between staff at these
agencies' headquarters and between their local offices. At the national
level, for example, SEC has shared examination reports that it
concluded would be helpful to EBSA and provided access to the non-
public exam files related to its 2005 pension consultants study.
Locally, information is generally exchanged when two or more local
agency offices have good working relations. Differing agency
responsibilities tend to reinforce limited collaboration among these
agencies. For example, SEC is primarily concerned with regulating
investment advisers to ensure compliance with securities laws, while
EBSA is tasked with protecting participant benefits. PBGC, in contrast,
provides an insurance program for plans in the event a plan is
terminated without sufficient assets to cover promised benefits.
However, more regularized coordination could improve agency efforts
regarding conflicts of interest. Because of their different missions,
these agencies have not established systematic procedures for regular
sharing and coordinating on conflicts of interest.
We are making recommendations to Labor and PBGC that are intended to
improve the detection and oversight of conflicts of interest, and
strengthen EBSA's enforcement ability over non-fiduciaries and recovery
of losses to PBGC-trusteed plans and to improve the collaboration among
EBSA, PBGC, and SEC. We are also asking that Congress consider amending
ERISA to give the Department of Labor greater authority to recover
losses from non-fiduciaries. We provided a draft of this report to
Labor, PBGC, and the SEC for their review and comment.
We obtained comments from the acting Assistant Secretary for the
Employee Benefits Security Administration, the Deputy Director of the
Pension Benefit Guaranty Corporation, and the Director of Compliance
Inspections and Examinations for the Securities and Exchange
Commission. Each of the agencies also provided technical comments,
which were incorporated into the report as appropriate. EBSA, PBGC, and
SEC generally agreed with the findings and conclusions of the report.
PBGC noted that although it has no authority to take action against
service providers with conflicts of interest involving ongoing plans,
its recent initiative to enhance its procedures for identifying and
pursuing fiduciary breach and other types of claims is fully consistent
with our recommendation. In its comments, EBSA agreed to consider our
recommendation to expand the focus of its CAP program to PBGC-
identified pension plans that may be trusteed or are high risk as it
reviews the results of its initial efforts under CAP and gains
additional experience through project investigations. EBSA also noted a
number of concerns about our statistical analysis and in particular our
econometric analysis that suggests a negative association between
consultants with undisclosed conflicts of interest and rates of return
on assets. In response to these concerns, we now discuss the
limitations of the analysis more prominently and have added more
information on our statistical analysis and data in appendix II. All
three agencies acknowledge the importance of effective cooperation to
facilitate their respective missions. EBSA's, PBGC's and SEC's comments
are reproduced in appendix III, appendix IV and appendix V.
Background:
ERISA is the primary federal law governing the sponsorship and
operation of private sector employee pension plans, including DB
plans.[Footnote 3] Title I of ERISA gives Labor the primary authority
to enforce requirements governing the conduct of fiduciaries of pension
and other employee benefit plans. EBSA is the Labor agency responsible
for administering and enforcing Title I. ERISA has requirements
relating to the standard of conduct of plan fiduciaries[Footnote 4] and
also prohibits certain transactions[Footnote 5] between fiduciaries and
parties in interest. Under Title IV of ERISA, PBGC was established to
provide insurance to covered private-sector single-employer and
multiemployer DB plans. The PBGC is not an enforcement agency and
receives no funds from general tax revenues. When a bankrupt plan
sponsor terminates an underfunded pension plan, PBGC assumes
trusteeship of the assets and liabilities of the plan, pays participant
and beneficiary benefits, and acts as a creditor of the bankrupt
sponsor in the interest of the plan's participants and beneficiaries.
As plan trustee, PBGC may file suit to recover missing assets of the
plan as well as other assets of the bankrupt sponsor or to recover
losses and debts owed to a plan, including those resulting from the
improper actions of anyone whether or not they are considered
fiduciaries under ERISA.[Footnote 6]
Among other things, ERISA provides that private sector employee pension
plans, including DB plans, must have one or more named fiduciaries who
have authority to control or manage the operation and administration of
the plan.[Footnote 7] ERISA requires fiduciaries to discharge duties
solely in the interest of the participants and beneficiaries with care,
skill, prudence, and diligence. The law states that a person acts as a
fiduciary when they 1) exercise any discretionary control or authority
over plan management or any authority or control over plan assets; 2)
render investment advice for a fee or other compensation, direct or
indirect, with respect to any moneys or property of a plan or has any
authority or responsibility to do so;[Footnote 8] or 3) have any
discretionary authority or responsibility in the administration of a
plan.
Pension plans and their fiduciaries often rely on consultants and other
service providers to assist them in plan administration and asset
management, which include selecting money managers and monitoring money
managers' performance and brokerage transactions. Not all of these
consultants and service providers are at all times fiduciaries under
ERISA. ERISA takes a functional approach to fiduciary status.
Fiduciaries that breach their plan duties are personally liable for
making up losses to the plan, restoring any profits made through the
use of plan assets, and face removal as plan fiduciaries.[Footnote 9]
To the extent that a service provider was not functioning as a
fiduciary under ERISA; however, EBSA can seek recovery against that
provider if it knowingly participated in a breach by a fiduciary. Any
such recovery is limited to plan funds the service provider received
(typically in the form of fees paid to it) and any proceeds derived
from those funds to the extent that they remain in the service
provider's possession.
SEC regulates certain money managers and pension consultants under the
Investment Advisers Act of 1940 (Advisers Act), which requires those
firms meeting certain criteria to register with the commission as
investment advisers.[Footnote 10] SEC regulates potential conflicts of
interests at registered investment advisers and requires that they
disclose information about affiliations, business interests, and
compensation arrangements to their advisory clients, primarily by
providing Part II of SEC's Form ADV or a brochure containing the same
information to clients at the beginning of a relationship and by
offering to provide it annually thereafter.[Footnote 11] According to
SEC, investment advisers have a fiduciary obligation under the Advisers
Act to provide disinterested advice and disclose any material conflicts
of interest to their clients. When an adviser fails to disclose
information regarding material conflicts of interest, clients are
unable to make informed decisions about entering into or continuing the
advisory relationship. Failure to act in accordance with requirements
under the Advisers Act may constitute a violation. According to an SEC
official, if SEC becomes aware of conflicts of interest that are
inadequately disclosed or pose harm to investors, it can require a firm
to remedy the deficiencies or take formal enforcement action against
the firm. SEC also regulates broker-dealers under the Securities
Exchange Act of 1934 (Exchange Act), which governs how they may engage
in transactions in securities for their customers and make
recommendations to their customers.[Footnote 12]
The financial services industry and the DB pension system have changed
significantly since the early 1970s. The globalization of financial
markets, as well as technological and international regulatory changes,
has facilitated the development of new financial instruments and the
complexity of investment opportunities.[Footnote 13] Meanwhile, despite
the long term decline in the number of plans and active participants,
DB pension plans remain a major holder of financial assets.
Consequently, the financial services industry has responded to the
growing need for assistance with managing, investing, transferring,
settling, valuing, and holding pension assets. In 2005, over 81 percent
of large public/government plans utilized a consultant and 42 percent
of private pension plans did so.[Footnote 14] According to an SEC
official, as of October 31, 2005, there were more than 1,800 SEC-
registered investment advisers that indicated on their SEC registration
forms that they provide pension consulting services.[Footnote 15] The
official stated that these firms vary widely from small one-person
operations to large organizations employing hundreds. Some firms only
provide pension consulting, while others may have started as pension
consultants, but then added additional business operations such as
brokerage and money management. It has been reported by a financial
newspaper that in order to remain competitive, some consulting firms
are assuming the fiduciary responsibility of making investment
decisions and have been expanding the range of services they
offer.[Footnote 16]
This trend toward diversification leads to the potential for conflicts
of interest that could harm pension plans because of competing
professional interests. While conflict of interest is a broad term that
can encompass many specific arrangements, according to an SEC official,
conflicts can occur in the case of money managers, broker-dealers, or
pension consultants when business relationships, particularly those
that involve business among each other, may make them vulnerable to
breaching their fiduciary obligation or duty. Such competing interests
can make it difficult for fiduciaries, in general, to fulfill their
duties impartially and could cause them to breach their duty to act
solely in the interest of investors, plan participants, and
beneficiaries. According to Labor officials, having a conflict in and
of itself does not constitute a breach of fiduciary duty. However,
under securities law, acting on and benefiting from the existence of a
conflict without making full and fair disclosure of all related issues
to clients potentially affected by the conflict may very well
constitute a breach. As ERISA fiduciaries, plan trustees also may face
significant conflicts of interest as they may have allegiance both to
the plan and its beneficiaries, as well as to the plan sponsor that
appoints them, and they may receive economic benefits directly or
indirectly from plan service providers.
Some Pension Plan Service Providers May Have Conflicts of Interest, but
Determining Whether Harm Results Is Difficult:
Although no complete information is available regarding the prevalence
of conflicts of interests, pension plan consultants assisting
significant numbers of pension plans sponsors may have conflicts of
interest as a result of their affiliations or business arrangements
with other firms that could affect the advice they provide to these
plan sponsors. A May 2005 SEC staff study of pension consultants
registered as investment advisers found that more than half (13 out of
24) of the 24 consultants examined had failed to disclose significant
conflicts of interest to their pension fund clients, including ongoing
and PBGC trusteed DB plans.[Footnote 17] We determined that, in 2006,
these 13 consultants had over $4.5 trillion in U.S. assets under
advisement, including private DB and defined contribution (DC) plan
assets, as well as public pension plan and other types of assets. We
also analyzed a sample of ongoing DB plans associated with the 13
consultants that, as of year-end 2004, had assets of $183.5 billion for
these plans, while average assets were $155.3 million. Additional
analysis found that the DB plans using these 13 consultants had annual
returns that were generally 1.3 percent lower than those that did not.
Because many factors can affect returns, and data and modeling
limitations limit the ability to generalize and interpret the results,
this finding, while suggestive, should not be considered as proof of
causality between consultants and lower rates of return. Although SEC
staff have reported that some of the consultants examined in their
study have since taken corrective action, our analysis illustrates the
importance of detecting the presence of undisclosed conflicts of
interest among ongoing plans, and likely among terminated plans.
However, independent experts, EBSA and PBGC officials all concur that
while analyzing rates of return is a useful first step, determining
whether conflicts resulted in financial harm to individual plans and
the magnitude of that harm is often extremely difficult to detect
without a detailed forensic audit.
Pension Plan Fiduciaries and Money Managers Can Have Conflicts of
Interest, Although Little Information Is Available on Their Prevalence:
According to experts we interviewed, fiduciaries of pension plans often
have an inherent conflict of interest because they are frequently
employees of the plan sponsor. As fiduciaries, they are charged by law
to act solely in the interest of plan participants and beneficiaries,
but they may also have loyalty to the plan sponsor. For example, in
2004, United Airlines, a plan sponsor, appointed itself fiduciary of
its employee pension plans after all three members of its plan trustee
board resigned during bankruptcy negotiations. A conflict of interest
existed because the newly appointed fiduciaries would have reason to
make decisions that would benefit the plan sponsor instead of the plan
participants. In this instance, the fiduciaries of the United Airlines'
plans faced the obligation to ensure that minimum funding standards
explicitly set in ERISA were satisfied by the plan sponsor. United
Airlines subsequently decided to stop making contributions to the
pension plans it was attempting to terminate. Labor stated that United
Airlines' decision to stop funding its pension plans made clear the
need to appoint an independent fiduciary to represent the interest of
workers and retirees and resolve this conflict of interest.
Subsequently, Labor and United Airlines agreed that United Airlines
would appoint an independent fiduciary.
Plan fiduciaries may also be more prone to conflicts of interest such
as prohibited transactions involving improper loans or more serious
actions such as taking money from the pension plan for personal or
business use when the plan sponsor is financially unstable and may be
heading toward bankruptcy. Experts told us that plan fiduciary
conflicts of interest and other acts such as these are less likely to
occur in larger plans since they often have many professionals to
assist with a plan's administration and management of plan assets.
Despite this potential, there is little information on the extent to
which conflicts of interest occur among plan fiduciaries of DB plans.
Though no formal study has reported statistics quantifying the
prevalence of conflicts of interest among money managers, SEC through
its examination and enforcement efforts has also identified potential
conflicts of interest at money managers that could result in harm to
clients, including pension plans. Money managers may in some cases have
incentives to allocate investment opportunities in a way that could be
unfair to certain advisory clients. For example, an adviser might make
more money in fees based on how it allocates an investment opportunity-
-such as an initial public offering--among its clients and steer that
opportunity to the advisors' more lucrative clients. In deciding
whether to allocate the opportunity among its clients, the adviser may
have an incentive to unfairly allocate the investment to a client that
pays higher fees. For example, as between a hedge fund and a pension
fund, the adviser could make more money in fees paid by the hedge fund
(for which fees are generally calculated as a percentage of the fund's
overall performance, which could increase significantly from the
investment) than in fees paid by the pension plan (for which fees are
generally calculated as a percentage of plan assets). Another form of
this conflict of interest, referred to as "cherry picking," occurs when
an adviser places a trade without immediately identifying the client
the trade is associated with, and then allocates the investment after
learning of its value. If the purchase appears valuable based on market
conditions, the adviser might place it in its own portfolio or a more
profitable portfolio, but if it appears less valuable, the advisor
might instead place it in one of its client's portfolios.
Money managers, including those at pension plans, may also face
conflicts of interest because of due to soft dollar payment
arrangements. Under soft dollar arrangements, money managers use part
of the brokerage commissions their clients pay to broker-dealers for
executing trades to obtain research and other services.[Footnote 18]
These arrangements can create a number of problems. They can create
incentives for investment advisers to trade excessively to obtain more
soft dollar services, thereby increasing costs to pension plan clients
or other clients. They can also influence advisers to place trades with
a broker-dealer that provides the adviser with soft-dollar services
rather than another broker-dealer that might provide best execution.
Consultants Identified by SEC as Having Significant Ongoing Conflicts
of Interest Provide Services to Many Pension Plans:
No complete information exists about the presence of conflicts of
interest at pension plan service providers. However, a 2005 SEC
examination of the activities of 24 pension consultants from 2002
through 2003 revealed that 13 out of 24 of the firms examined failed to
disclose significant ongoing conflicts of interest.[Footnote 19] These
ongoing conflicts took a number of different forms. For example, SEC
found that 13 pension consultants or their affiliates were found to
have conflicts of interest because they provided products and services
to both pension plan advisory clients and money managers and mutual
funds on an ongoing basis without adequately disclosing these
conflicts. Specifically, the study found that 10 pension consultants
sold money managers analytical software packages, which they use to
help analyze and improve the performance of clients' holdings. This
creates a conflict of interest for the pension consultant that might be
more inclined to recommend to pension plans the money managers that buy
software because those business relationships are profitable for the
consultant. Similarly, 13 pension consultants hosted conferences
attended by pension plan advisory clients, who were typically invited
to attend without charge, and money managers, who were often invited to
attend for a fee. A consultant hosting such a conference has a conflict
of interest because it might be more inclined to recommend to pension
plans the money managers that pay fees to attend conferences as such
fees are used to offset costs incurred in hosting the conference.
SEC staff also found that the majority of pension consultants examined
had business relationships with broker-dealers that raised a number of
concerns about potential harm to pension plans. For example, in certain
directed brokerage arrangements, a pension consultant may convince a
pension plan client to direct their money manager to place plan trades
through a broker-dealer that was affiliated with the consultant as a
means for paying advisor fees a plan owed to its consultant using a
portion of the brokerage commission paid on such trades. These
arrangements raised concerns that plans might not have received the
best price for each trade--or "best execution"--because the directions
given to a plan's money manager by the plan may have restricted the
money manager's ability to select a broker-dealer that was the best
able to execute a trade. These arrangements raised the additional
concern that consultants might be overpaid because the plan did not
always know when the fee had been paid in full because brokerage
commissions were being used to pay the fee rather than checks drawn on
the plan's checking account.
Following up on its examinations of 24 pension consultants, in late
2005, SEC staff subsequently sought to determine what steps these firms
had taken to address the findings from the earlier examinations.
According to SEC staff, in general, most pension consulting firms it
had examined had taken positive steps to reevaluate, revise, and
implement changes to their policies and procedures. Specifically,
pension consultants implemented policies and procedures to insulate
their advisory activities from other activities, including for example,
creating separate reporting lines and firewalls between employees that
perform these separate functions, and considering employee compensation
and incentives. In addition, SEC staff said that most consultants they
examined had updated their policies and procedures to improve their
disclosure of material conflicts of interest to pension plan clients
and potential clients. Many pension consultants the SEC staff examined
also reviewed and improved their policies and procedures to prevent
conflicts of interest with respect to brokerage commissions, gifts,
gratuities, entertainment, contributions, and donations provided to
clients or received by money managers. However, SEC staff noted that
while the pension consultants it had examined had improved their
practices, it was not able to conduct examinations of all 1,800
investment advisers that indicated that they provide pension consulting
services.
Our analysis of industry data regarding the 13 pension consultants that
failed to disclose serious conflicts of interest found that these
consultants provided services to a number of pension plans.[Footnote
20] In particular, the 13 consultants:
* in 2006, had over $4.5 trillion in U.S. assets under advisement,
including private DB and defined contribution (DC) plan assets, as well
as public pension plan and other types of assets;[Footnote 21]
* provided advisory services to 36 percent (9 out of 25) of the largest
plan sponsors, in terms of claims, currently trusteed by PBGC since
2000;[Footnote 22]
* provided advisory services to 14 percent (12 out of 86) of the plan
sponsors that were trusteed by the PBGC in 2005; and:
* provided advisory services to 24 percent (1009 out of 4203) of the
sponsors of ongoing DB plans between the years 2000 and 2004.
Our Analysis Shows an Association between Inadequate Disclosure of
Conflicts and Lower Rates of Return, Although Proof of Financial Harm
Requires a Detailed Audit:
We conducted an analysis using ongoing DB plans that revealed a
statistical association between inadequate disclosure and lower
investment returns for ongoing plans, suggesting the possible adverse
financial effect of such nondisclosure. Specifically, we conducted an
econometric analysis using ongoing DB plans and SEC study data on
pension consultants that either adequately disclosed their conflicts of
interest and those who did not.[Footnote 23] We found lower annual
rates of return for those ongoing plans associated with consultants
that had failed to disclose significant conflicts of interest, with
lower rates generally ranging from a statistically significant 1.2 to
1.3 percentage points over the 2000 to 2004 period, depending on the
different model specifications tested.[Footnote 24] Since the average
return for the ongoing plans that used consultants who did not have
significant disclosure violations was about 4.5 percent, the model
implies that the average returns for ongoing plans that used
consultants who failed to disclosure significant conflicts was 3.2 to
3.3 percent for the period. We did not find significant differences in
returns for those plans that had associations with both types of
consultants. As of year-end 2004, our sample of ongoing plans
represented assets of $183.5 billion for these plans, and average
assets were $155.3 million. We conducted our analysis using ongoing
plans rather than terminated plans because the ongoing plans provided
the necessary sample size to conduct our analysis, compared to a much
smaller sample of terminated plans.
While, the results suggest a negative association between returns and
plans that are associated exclusively with pension consultants that did
not properly disclose significant conflicts of interest, the results
should not be viewed necessarily as evidence of a causal relationship
in light of modeling and data limitations. Although the analysis
controlled for plan size, funding level, performance of asset markets,
differences in plan fiscal years and other key variables, other
unknown, omitted factors could have influenced the results of our
analysis. While this result gives an indication of the potential harm
conflicts of interest may cause in the aggregate, these results cannot
be generalized to the population of pension consultants since the
consultants examined by the SEC were not selected randomly. In
addition, while these findings are consistent with the views of the
experts we interviewed concerning the adverse effect that complex
service provider related conflicts of interest can have on pension
plans, we cannot rule out the possibility that some other differences
between the plans could explained the differences in estimated returns.
See appendix II for a fuller discussion of the limitations and caveats.
Although statistical analysis is useful, a detailed audit would be
needed to uncover a conflict of interest in any one plan. Independent
experts and officials stated that though a typical first step to
identify harm related to a conflict of interest is to examine a plan's
investment returns, determining whether any financial harm is caused to
an individual pension plan by a conflict of interest requires a
detailed forensic audit. A rate of return for any single plan is not
necessarily a good litmus test for deciding whether to pursue an
investigation. For example, two trusteed sponsors of plans that had
some history with consultants reported as having business arrangements
that could pose conflicts of interest had very different rates of
return for their plans. The U.S. Airways plans, which were trusteed by
PBGC in 2003 and 2005, had a rate of return that exceeded the average
measured the benchmark returns earned by the Standard and Poors (S&P)
500, CalPERS (a major public plan) and the Thrift Savings Plan (the
defined contribution plan for federal employees). Yet, at some point
from 2000 through 2005, the U.S. Airways plan used the services of
consultants who had business arrangements that are of the form
described in the SEC study that raise concerns regarding conflicts of
interest. These business arrangements included directed brokerage
arrangements and hosting conferences. (See figure 1.)
On the other hand, at some point during that time period United
Airlines used a pension consultant who had been noted for engaging in
business arrangements such as directed brokerage and commission
recapture programs that are similar in form to the type that SEC
concluded in their 2005 study posed a conflict of interest. During our
analysis period, United Airlines showed a rate of return somewhat lower
than three of the four benchmarks.[Footnote 25] (See figure 1). For
both cases, and very likely most cases, a detailed, forensic audit
would be necessary to identify any accrued harm from a conflict of
interest. Even then, the magnitude of the harm could be difficult to
determine. Experts told us that determining harm often involves a
resource-intensive audit of a plan's service provider's records and the
investment performance of the plan's assets. To perform such an audit
effectively, experts told us that they would need, at a minimum, 5
years worth of service provider specific documents, including contracts
with the plan sponsor, fees charged, payments and other financial
transactions between service providers and those involving plan
fiduciaries. In addition, experts told us that it would be important to
review the investigative files and complaint records of agencies like
the SEC to determine if there is a history of problems at plans and
service providers.
Figure 1: Average Annual Rates of Return Achieved by Plans Terminated
in 2005 Sponsored by Publicly Traded Companies Compared to CalPERS, TSP
and the S&P 500 Benchmarks, 1997-2002:
[See PDF for image]
Source: GAO analysis based on, TSP, PBGC, CalPERS, and S&P 500 data.
Note: Analysis based on calculated average rate of returns for the
publicly traded firms taken over by the PBGC in 2005. We selected a
range of benchmarks beginning with a very conservative benchmark to an
all stock investment portfolio, the S&P 500. The average return for the
TSP is based on a conservative portfolio whose allocation mimics the
conservative Lifecycle Fund 2010, as of April 6, 2007. The TSP 2020
fund, whose allocation mimics the less conservative Lifecycle Fund
2020, earned less than the 2010 fund during the period of analysis. As
a result, we chose the 2010 fund as one of our benchmarks. S&P 500
returns are based on the actual S&P total return index and therefore do
not consider the cost involved with maintaining a portfolio indexed to
the S&P 500. The CalPERS benchmark was selected to provide a more
realistic comparison given its asset mix of bonds and stock for a
pension fund than the S&P 500 could.
[End of figure]
PBGC's Current Policy and Procedures Are Not Focused on Detecting
Conflicts of Interest among Service Providers:
As a creditor and a trustee of a sponsor's terminated plan, PBGC's
policies and procedures are designed to review a plan's assets and
liabilities and recover any shortfall. Agency officials told us that
such audits include identifying missing money and conflicts of interest
involving improper activities by a fiduciary such as improper loans and
other prohibited transactions or those that rise to the level of fraud
and theft of fund assets.[Footnote 26] However, there is no explicit
focus on potential losses associated with conflicts of interest by
service providers since these losses are likely to be found in service
provider records and not in the plan's financial records. Agency
officials told us that they currently do not collect the service
provider's records to the extent needed to uncover conflicts. Although
PBGC has authority to recover losses from a broad group of service
providers and not merely ERISA fiduciaries, agency officials said it
may not be cost effective to do so. Our own analysis also indicates
that while recoveries could have a positive, but likely small effect on
the agency's financial position, they would have little effect on
benefits for the large majority of participants.
PBGC Policies and Procedures Are Focused on Recovering Plan Assets:
As the insurer of private sector DB plans, PBGC has a primary
responsibility to provide timely and uninterrupted payment of
guaranteed pension benefits. Given that plans trusteed by the PBGC have
insufficient assets to pay all accrued benefits, the agency seeks to
bridge that gap by reviewing the plan, in part, to help recover assets.
Such recoveries include the difference between the plan's assets and
liabilities and quarterly contributions that employers have failed to
make. PBGC uses plan financial documents and a variety of procedures
and processes to identify and value plan assets and liabilities. The
financial documents used also assist the PBGC in uncovering fiduciary
breaches, including conflicts of interest such as prohibited
transactions, improper loans and acts of theft and fraud. However,
these financial documents do not provide financial information that
would assist the PBGC in uncovering conflicts of interest associated
with service providers. Agency officials told us that they currently do
not collect such documents.[Footnote 27] Experts told us that the
agency would, in fact, need to collect and analyze 5 to 10 years worth
of contracts between service providers and plan sponsors and documents
that reveal fees charged, payments, and other financial transactions in
order to conduct a forensic audit. The agency would also need to
collect an historical list of investment advisers, pension consultants
and broker dealers, the plan's investment strategy, the money managers'
selection process, and the money managers' investment performance gross
and net of fees.
According to PBGC officials, the only circumstances in which their
agency would have examined records to detect potentially harmful
conflicts by a service provider would be in the case of a complaint
providing specific allegations of wrongdoing with a plan's assets.
Agency officials told us that they had never received a complaint
regarding conflicts of interest by a service provider. In 2005, they
received a letter involving the underfunded United Airlines plans that
had been trusteed by PBGC. The letter was filed by union
representatives of affected participants out of concern emerging from
the findings of the SEC staff report on conflicts of interest among
pension consultants. PBGC officials told us that one reason they did
not conduct a forensic audit of the United Airlines plans under their
control was that the letter did not direct them to specific violations
that they should audit. Agency officials also told us that they did not
find it necessary to conduct a detailed audit of any of the plans
following the SEC study because: 1) the plan's investment performance
did not appear out of line; and 2) after reviewing the fees charged,
assets managed, and the type of disclosures implicated, PBGC concluded
that it was unlikely that the conflicts could have had a material
adverse affect on United's pension plans.[Footnote 28]
Although PBGC Has Authority to Recover Losses, Cost Benefit
Considerations Shape the Agency's Actions:
PBGC has the authority, as trustee, to recover losses from any party,
including service providers that are not fiduciaries under
ERISA.[Footnote 29] Specifically, ERISA authorizes PBGC to recover from
any entity that has caused a loss or liability to the plan utilizing
any available federal or state cause of action. However, agency
officials and experts explained that since PBGC is not an enforcement
agency, their responsibility is to bring cases to recover losses to a
plan, not to bring cases for ERISA violations. For example, a kickback
arrangement--where an investor receives a financial benefit for
choosing a particular investment--or other types of self-dealing
constitute conflicts of interest that may violate ERISA's prohibited
transaction rules. Although it is often difficult to determine whether
a kickback causes a loss to a plan, under the prohibited transaction
provision, the existence of a violation does not depend on whether any
harm results from the transaction. Hence, identifying and bringing
these types of cases would not necessarily be something that PBGC would
pursue unless the violation caused a loss to the plan.[Footnote 30]
PBGC has pursued cases against plan fiduciaries in an effort to seek
such recoveries. However, in many instances, according to PBGC
officials, seeking recoveries from the plan fiduciary of a small plan
to recover missing money or improper loans may prove fruitless since
the plan fiduciary may have few assets to place a claim against. In
fact, in some cases, a plan fiduciary's only asset from which to
recover may be an accrued pension benefit.[Footnote 31] PBGC officials
told us that the majority of their cases of fiduciary breach involve
action by a fiduciary that adversely affected plan assets. The
officials and outside experts told us that the majority of cases
against fiduciaries to recover missing money or involving improper
loans or prohibited transactions occur with small plans rather than
large plans since large plans typically have many professionals
involved in the management and administration of the pension plan.
While identifying and pursuing cases against a small plan's fiduciary
is typically not resource intensive, agency officials and experts have
told us that identifying and pursuing harm related to conflicts of
interest by service providers is a resource intensive effort that does
not always result in the ability to quantify associated harm and make a
recovery. Agency officials told us that, given their mission, measuring
the investment of scarce resources against the likelihood of recovering
losses makes pursuing conflicts of interest cases particularly risky
for the PBGC. Further, officials explained that the agency must pursue
cases where the recovery will likely exceed the cost of investing the
agency's resources for identifying and gathering evidence and bringing
a case through the courts successfully. If the agency does not believe
that a recovery will exceed its costs, it would be imprudent for the
agency to pursue that case. Nevertheless, as part of the agency's
efforts to evaluate their exposure to certain risk factors, PBGC has
undertaken two relevant studies, one of which includes an assessment of
the risks that relate to the potential for unidentified claims against
outside parties, which includes conflicts of interest[Footnote 32]
While Most of Its Pension Holders Would Not Likely Benefit, Additional
Monetary Recoveries Could Potentially Reduce PBGC's Deficit:
PBGC recoveries generally have little impact on participants in PBGC
trusteed plans because, as an insurer, the agency may pay benefits up
to a guaranteed limit that is higher than the benefits promised to most
participants of trusteed plans.[Footnote 33] According to a PBGC 2004
annual report, more than 90 percent of the participants and
beneficiaries of single employer plans that were trusteed by the agency
received their full promised plan benefits.[Footnote 34] Officials
explained that many plans offer benefits that often fall under the
guaranteed limits. The small percentage of participants and
beneficiaries who currently could be helped by such monetary recoveries
represents those that have lost promised plan benefits that were not
guaranteed by PBGC and were not funded by the plan's assets.[Footnote
35]
PBGC is required by law to use a portion of its employer liability
recoveries and remaining plan assets to cover the non-guaranteed
benefits of pension holders after guaranteed benefits are funded and
allocated.[Footnote 36] An expert we interviewed explained that a
portion of the recovered money goes toward assisting the agency in
covering the guaranteed benefits it pays out. Agency officials told us
that recoveries on claims for employer liability are distributed as
prescribed by law and typically increases a participant's benefit
payment less than $20 per month. It is not clear whether recoveries
related to conflicts of interest would provide significant additional
benefits for participants since, according to experts we interviewed,
recoveries for conflicts are likely to be small compared to represent a
small fraction of a terminated plan's total underfunding.
Benefit recoveries may still help to reduce PBGC's accumulated deficit
and support the agency's mission. PBGC's financial position declined
dramatically for single-employer pension plans from fiscal year 2000 to
2005, with a four-fold increase in underfunding claims of $25 billion.
As of September 2006, the accumulated deficit for PBGC's single
employer program was $18.1 billion. Though recoveries from conflicts of
interest are likely to be small compared with the agency's accumulated
deficit, agency officials say that pursuing conflicts of interest would
be beneficial as long as the costs do not outweigh the benefits
obtained from the recovery.[Footnote 37]
EBSA's Enforcement Strategy Does Not Include Procedures That Focus on
Conflicts of Interest Involving PBGC Trusteed Plans or High Risk Plans
Likely to Terminate:
Though EBSA's enforcement program is concerned with conflicts of
interest affecting all private sector pension plans, the agency does
not have a specific focus on plans that are trusteed by PBGC or ongoing
high risk plans that PBGC identifies as most likely to terminate. Among
EBSA's reasons for not having such a focus is the agency's view that
the PBGC is in the best position to detect conflicts of interest at
terminated plans and to refer cases to EBSA. Meanwhile, EBSA has
recently expanded its ERISA enforcement effort by implementing its new
Consultant/Adviser Project (CAP) to focus more heavily on conflicts of
interest at all pension plans. EBSA officials also emphasized, however,
that existing law presents a limitation to their pursuing conflicts on
the part of several types of service providers.
EBSA Has No Specific Enforcement Strategy for PBGC-Trusteed Plans or
Plans that PBGC Deems Likely to Terminate:
While EBSA's enforcement program does include a focus on conflicts of
interest affecting all private sector pension plans, agency officials
told us they have no specific procedures for detecting conflicts that
may have involved plans that have been trusteed by PBGC or may be
trusteed in the future.[Footnote 38] There are several reasons for
this, according to EBSA officials. First, they emphasized the view that
it is primarily the failure of plan sponsors to adequately fund pension
plans causing plan underfunding problems rather than poor investment
advice from self-interested service providers. Second, officials told
us that while they do have the responsibility to enforce fiduciary
violations regardless of whether a plan has terminated, they do not
focus their enforcement efforts on PBGC trusteed plans and generally
leave the responsibility of identifying potentially harmful conflicts
of interest to PBGC for the plans under their control. EBSA officials
also said, that while their agency has subpoena power, PBGC has the
necessary authority and access to the many documents needed to pursue
conflicts in the plans it trustees. However, PBGC officials noted that
while this may be true for terminated plans, it does not have
jurisdiction to collect such documents for plans that have not yet
terminated.
Finally, EBSA officials told us they had not had occasion to
investigate any PBGC-trusteed plans for conflicts of interest insofar
as PBGC had not made any investigative referral to EBSA concerning
conflicts of interest. Further, EBSA officials said they had not
received any complaints regarding service providers' conflicts of
interests involving a terminated plan prior to a letter it, along with
PBGC, received in 2005 from representatives of certain United Airlines
employees. Agency officials told us that they responded to concerns
raised in that letter by reviewing the plan performances and the
portfolio distributions of United Airlines' plans and determined that
they were in line with those demonstrated in the industry. In fact, in
some discrete years, the performance for the United Airlines plans
exceeded some industry benchmarks. Finally, EBSA used United's Form
5500 information to review the fees paid to service providers and found
them to be comparable to other plans and reasonable. Thus, the agency
did not believe that a forensic audit for service provider conflicts at
United Airlines' plans was warranted.
EBSA Has a New Initiative to Focus on Conflicts of Interest among
Service Providers:
Despite the current lack of information about the extent of any harm
that may have occurred as a result of conflicts of interest, EBSA
officials acknowledged that such conflicts are a growing concern for
their agency. In order to address these concerns, the agency has,
therefore, undertaken a new national enforcement project, known as the
Consultant/Adviser Project (CAP), which largely focuses on issues
identified in the SEC's 2005 study of pension consultants.[Footnote 39]
In addition, with this project, EBSA hopes to identify other service
providers that may be using or managing plan assets for personal
benefit. Specifically the agency will look for improper, undisclosed
compensation such as kickbacks, pay-to-play arrangements, and soft
dollar arrangements. Further, to acquire more information about the
fees charged by service providers, EBSA has proposed several revisions
to the Form 5500, which plan sponsors are required to file annually.
Among the many changes, the revised form would require increased
disclosure regarding the types and amounts of payments made to service
providers, including amounts paid via third-party arrangements, both
direct and indirect.
Despite these changes, EBSA officials said the CAP will not have
specific procedures focused on examining service providers of high risk
and underfunded plans once they are trusteed by PBGC. In addition, as
we previously reported, challenges remain for pursuing more complicated
conflicts of interest cases impacting plans in the context of EBSA's
overall enforcement program.[Footnote 40] For example, EBSA uses
participant complaints and other agency referrals as sources of
investigative leads and to detect violations. EBSA also identifies
leads through informal targeting efforts by investigators primarily
using data reported by plan sponsors on their Form 5500 annual returns.
While these sources are important, such methods are generally reactive
and may reveal only those violations that are sufficiently obvious for
a plan participant to detect or those that are disclosed and not those
violations that are more complex. Moreover, complaints have primarily
originated from participants in defined contribution (DC) plans since
certain problems (e.g., failure to credit participants' accounts with
deposits) involving DC plans are often more apparent to participants.
Requiring more information on the Form 5500 could, according to
experts, uncover or discourage many abuses concerning conflicts of
interest. However, the Form does not necessarily offer the agency
timely or accurate information, because of the 285 days allowed for its
completion and the possibility that errors may be present on the Form
5500 using the current paper-based filing system.[Footnote 41]
It is also unclear how much time EBSA investigators, given their other
duties, will be able to devote to the complex conflicts of interest
cases similar to those targeted by the CAP. EBSA officials told us that
they are addressing their resource constraints in the CAP by
concentrating on a relatively small number of carefully targeted cases.
They said they are undecided as to whether the agency will expand CAP
beyond the cases identified as a result of the SEC study once these
investigations are completed. We had previously reported that Labor's
revised performance goals for EBSA enforcement may encourage a focus on
cases that are more obvious and easily corrected, such as those
involving delinquent employee contributions to DC plans, rather than on
investigations of complex and emerging violations where the outcome is
less certain and may take longer to attain. We had suggested changes to
EBSA's approach to assessing performance to better promote industry
compliance and address emerging violations although the agency has yet
to make substantial changes to its performance measures.[Footnote 42]
Further, though fiduciaries are considered the first line of defense in
avoiding conflicts of interest, EBSA does not conduct routine
compliance examinations or routinely evaluate plan fiduciaries that are
not part of an ongoing investigation to determine how well they select
and monitor service providers. Agency officials and experts have stated
that having a formal set of procedures and guidelines in place to guide
the selection of service providers as well as a formal investment
strategy to guide how assets are to be invested helps to mitigate
conflicts of interest. EBSA officials said the agency lacks sufficient
resources to conduct such general oversight and, instead, uses outreach
programs to educate fiduciaries on the importance of avoiding conflicts
of interest. Other expert observers, however, commented that EBSA's
education program only addresses abuses that occur as a result of
ignorance or unintentional negligence, not those conflicts that are
intentional. The experts emphasized that it is difficult to detect
harmful conflicts of interest without some form of regularized or
routine examinations. Although EBSA, in concert with the SEC, has
issued a "tip list" of questions to help plan fiduciaries avoid
conflicts among service providers, EBSA has no compliance procedures to
determine whether fiduciaries are generally using this
information.[Footnote 43]
EBSA Officials Cite ERISA as Constraint in Pursuing Conflicts of
Interest:
EBSA's ability to recover plan losses related to conflicts of interest
by a service provider is largely limited by the extent to which the
service provider was functioning as a fiduciary under ERISA.
Additionally, for EBSA to take action against an individual or entity,
there generally must be a breach of fiduciary duty. Many service
providers carefully structure their contracts with plans in an attempt
to avoid meeting the ERISA definition of a fiduciary, but whether or
not they do depends on the facts and circumstances in each case. EBSA
officials said that many service providers, such as accountants,
auditors, and actuaries are seldom fiduciaries under ERISA even though
they provide important consulting services to DB plans by evaluating
plan assets, calculating required funding levels, and evaluating
financial statements.[Footnote 44] Experts told us that broker-dealers
are a growing concern, for example, because they have been expanding
their services to include both consulting and investment services--
triggering conflicts of interest questions because offering both
services raises concerns regarding the best execution of trades and
introduces incentives that may not promote practices in the best
interest of plans and participants. Nevertheless, to the extent that a
broker-dealer is not a fiduciary under ERISA, EBSA typically has no
authority to take action against them for not acting solely in the
interest of plans and participants.
To the extent that a service provider was functioning as a fiduciary
under ERISA, in addition to recovering any funds taken from the plan
and profits derived from them, EBSA can recover losses to the plan to
the same extent that it can recover them from other fiduciaries. To the
extent that a service provider was not functioning as a fiduciary under
ERISA, however, EBSA cannot recover from them at all unless the service
provider knowingly participated with a fiduciary under ERISA in a
fiduciary breach. EBSA officials said that proving such knowing
involvement is often quite difficult. Even in cases where EBSA can
prove that a non-fiduciary knowingly participated in a fiduciary
breach, however, EBSA is limited in its ability to obtain meaningful
recoveries. Specifically, EBSA cannot recover plan losses but usually
only amounts the plan paid to the non-fiduciary and any profits derived
from those payments. Furthermore, courts have required proof that these
amounts remain in the possession of the non-fiduciary plan in order for
them to be recovered.
In addition to such monetary recoveries, EBSA can also obtain
injunctions against fiduciaries initiating or continuing, and non-
fiduciaries knowingly participating with fiduciaries in, activities
constituting fiduciary breaches. Officials explained that, in theory,
EBSA does not have to prove that an activity will cause financial harm
to a plan before obtaining an injunction but as a practical matter it
is very difficult to persuade a judge to grant one without being able
to show such harm.
Different Authorities and Roles Have Limited Agency Collaboration:
Currently, collaboration on the part of EBSA, PBGC, and SEC regarding
service providers with conflicts of interest is largely informal. At
the national level, SEC and EBSA have communicated about staff
examinations related to the pension consultant study. At the local
level, information about conflicts of interest involving pension plans
has been exchanged between agencies where staffs have developed working
relationships. For example, EBSA officials noted that two of its
regional offices have been collaborating with regional SEC staff on
some conflict of interest related cases. However, exchanges of
information generally occur when local employees of different agency
field offices have good working relations and decide that such contact
is helpful. Differences in agency missions and responsibilities tend to
reinforce such informal coordination.
Agency Collaboration on Conflicts of Interest Largely Informal:
Collaboration on the part of EBSA, PBGC, and SEC that might facilitate
identifying conflicts of interest is largely informal, particularly
with regard to PBGC trusteed plans. With respect to EBSA and PBGC,
there is a memorandum of understanding (MOU) for sharing quarterly
information on the financial status of plans, but it does not provide
for collaborating over potential conflicts of interest. Moreover, EBSA
and PBGC officials told us that the data currently shared would not
likely reveal conflicts of interest. EBSA officials told us that their
weekly discussions with PBGC representatives are related to financial
matters of plans that may be experiencing financial trouble. With
regard to the SEC, there is no formal agreement with the other two
agencies to share information relevant to conflicts of interest.
However, EBSA officials stated that there is some collaboration between
EBSA and SEC both nationally and locally, generally occurring on an
informal basis.
At the national level, SEC has shared examination reports that it
concluded would be helpful to EBSA, including the non-public exam files
related to the pension consultants study. At the local level,
information about conflicts of interest involving pension plans has
been exchanged between agencies where employees developed working
relationships. For example, EBSA officials noted that two of its
regional offices had been collaborating with regional SEC staff on some
conflict-of-interest related cases.[Footnote 45] However, under
securities laws, SEC is subject to confidentiality restrictions with
respect to information it can disclose to EBSA pertaining to an ongoing
investigation, even if the information pertains to possible violations
of ERISA. Likewise, EBSA investigators can alert SEC to information
that is discovered during an ERISA investigation that might be of
interest to SEC. However, unlike EBSA, SEC may not share documentation
associated with its findings unless EBSA submits a written request for
information which, if approved, allows access to any evidence that SEC
has obtained during the course of its investigation.[Footnote 46]
Nevertheless, there is no systematic procedure among the three agencies
that would effectively target or monitor service providers engaged in
conflicts of interest.[Footnote 47] However, more regularized
coordination could improve agency efforts regarding conflicts of
interest. For example, during investigations and examinations, SEC and
EBSA tend to collect documentation that is specific to their individual
enforcement objectives. Experts told us that creating efficiencies
through collaborative and supportive enforcement practices where both
agencies collect and share information that both agencies would find
useful would be a major improvement in collaboration.
Different Agency Responsibilities Tend to Reinforce Limited
Collaboration among EBSA, SEC, and PBGC:
To some extent, differences in each agency's roles and responsibilities
affect the level of collaboration regarding conflicts of interest among
the three agencies. First, EBSA is tasked with enforcing the fiduciary
standards required under Title I of ERISA, which seeks to ensure that
fiduciaries operate their plans in the best interest of plan
participants. Second, SEC enforces securities law and is primarily
concerned with regulating professional entities, such as pension
consultants or investment advisers. Finally, PBGC insures benefits for
the beneficiaries of private-sector DB pension plans.
Federal law and regulation across the agencies are not consistent on
the treatment of conflicts of interest. For example, under securities
law, a conflict of interest that is disclosed may not be a violation,
and would not necessarily prompt investigation by the SEC, although it
may prompt investigation by EBSA. However, Title I of ERISA applies
only to those who have carried out or been associated with fiduciary
responsibilities, which does not always include all types of service
providers. In addition, differences in definitions and terminology
create challenges for the agencies to gather useful information for
collaborating on investigations. For example, all money managers and
others that actively manage or invest pension assets have a fiduciary
obligation under the Advisers Act. Money managers are generally
considered fiduciaries under ERISA, though broker-dealers are
considered to be fiduciaries under ERISA only under certain
circumstances. Pension consultants typically have a fiduciary
obligation under the Advisers Act[Footnote 48] but may not be
fiduciaries under ERISA.
While PBGC has broad authority to recover losses, it is not an
enforcement agency and therefore is not in the business of
investigating conflicts of interest or other fiduciary violations
without the intention of recovering meaningful losses. To the extent
that there would be meaningful losses to recover, as trustee, PBGC has
the ability to collect a range of service provider documents that might
suggest a history of conflicts involving the pension plans it trustees.
EBSA, which does have authority to investigate and bring conflict cases
involving plan fiduciaries to court, does not have ready access to
these documents without a subpoena. Although EBSA does have broad
subpoena powers, the use of these subpoena powers and enforcing
subpoenas can involve significant delays in enforcement and case
resolution.
The lack of formal collaboration between the three agencies also
reflects their differing missions. While the SEC and EBSA both have an
enforcement role, their missions have different orientations. SEC
enforces securities law and is primarily concerned with regulating
professional entities, such as pension consultants or investment
advisers, to the extent that all conflicts of interest are adequately
disclosed and plan sponsors can make informed decisions about whom to
hire. In most cases, the SEC is able to act administratively, in that
it can levy fines and suspend registered advisers without having to use
federal courts. Further, since advisers have a statutorily imposed
fiduciary responsibility, investigators do not have the burden of
proving a fiduciary status before taking action.
In contrast, EBSA is tasked with enforcing the fiduciary standards
required under Title I of ERISA, which seeks to ensure that fiduciaries
operate their plans in the best interest of plan participants. In most
cases, EBSA must prove that each violation it pursues was caused by a
plan fiduciary or a party carrying out a fiduciary function. EBSA
officials told us that a consultant or other adviser is a fiduciary
investment adviser only to the extent that advice was provided (1) on
the purchase or sale of securities or other property of the plan, (2)
on a regular basis, (3) pursuant to a mutual agreement, arrangement, or
understanding, (4) as a primary basis for investment decisions, and (5)
based on the particular needs of the plan. While the courts have ruled
in some cases that EBSA can pursue non-fiduciaries that contribute to a
fiduciary breach, EBSA officials stated that the remedies they have
available to them under ERISA are limited when pursuing these entities.
Moreover, EBSA officials told us that there can be situations where a
pension consultant may not meet the conditions necessary to be
considered a fiduciary under ERISA; in which case EBSA generally would
not be able to take action against the consultant.
The role of PBGC, in turn, is not to regulate pension plan trustees and
service providers, but to insure benefits for the beneficiaries of
terminated pension plans. Therefore, PBGC's primary goal is to preserve
plan assets to the degree possible in order to pay promised benefits
and keep expenses to a minimum. Accordingly, PBGC generally does not
undertake the cost of litigation without a clear opportunity to recover
assets. PBGC officials stated that the recoveries are typically far
smaller than their claims on assets, as the agency generally recovers
at most 10 cents on the dollar. For plans terminating in fiscal 2005,
for example, PBGC reported $10.8 billion in claims but only $170.7
million in recoveries.[Footnote 49]
Conclusions:
The challenge to sound pension sponsorship posed by financial conflicts
of interest is largely a consequence of the changes experienced by
financial markets over the last 30 years. In fact, the pre-ERISA world
of 1974 never anticipated the multiplicity and complexity of financial
instruments that have expanded both investment opportunities and risks
for plan fiduciaries. Index and hedge funds, the growth of complicated
financial derivatives, and access to international financial markets
represent only some of the extraordinary number of choices confronting
today's pension plan fiduciaries.
Of necessity, DB pension plan fiduciaries must utilize the variety of
service providers that have become available to help them assess
choices. While conflicts of interest are not necessarily inherent in
the provision of such financial services, the prevalence and the
proliferation of consulting work and the complexity of business
arrangements among investment advisers, plan consultants, and others
have increased the likelihood. Our analysis of ongoing plans suggests
that, in the aggregate, there may be some cause for concern. While many
consultants have taken remedial action, there are pension plan
consultants that advise on a sizeable portion of U.S. pension assets
that did not fully disclose conflicts of interest in the past. Although
not generalizeable to all consultants and plans, our analysis
cautiously suggests an association with such undisclosed conflicts and
plan performance. However, assessing the extent and magnitude of the
problem of conflicts of interest at an individual plan level, at the
outset, may require a coordinated effort among the regulatory agencies
because of the complexities involved and the significant resources
associated with investigative audits. Regardless of the difficulty of
finding a financial trail of damage, to the extent that financially
harmful conflicts of interest exist, they pose a potential threat to
the investment confidence of sponsors and participants. For this
reason, alone, credible and visible enforcement is essential to prevent
such erosion.
Yet our findings reveal that there is limited regulatory framework for
deterrence in this area, particularly for terminated DB plans and those
likely to terminate. EBSA's recent CAP initiative to target conflicts
of interest among service providers may help, but it does not include
any specific emphasis on service providers of plans either under PBGC's
trusteeship or those considered likely to terminate. In addition, as
EBSA officials have noted, ERISA's definition of fiduciary and
associated remedies and penalties to correct potential breaches of
fiduciary responsibility, conceived to address the pension issues of
the 1970s, are less effective in combating conflicts of interest in the
far more complex world of today. Further, the SEC concluded in its
study that many pension consultants do not consider themselves to be
fiduciaries to their clients. In fact, many pension consultants believe
they have taken appropriate actions to insulate themselves from being
considered a fiduciary under ERISA. As a result, it appears that many
consultants believe they do not have any fiduciary relationships with
their advisory clients and ignore or are not aware of their fiduciary
obligations under the Advisers Act.
Meanwhile, PBGC's recent decision to conduct an overall risk assessment
and implement new screening procedures acknowledges the need for
improvement in PBGC's reviews for conflicts of interest and other risk
factors. Without procedures to evaluate the effect of conflicts of
interest on high risk and terminated plans, however, potential ERISA
violations related to such conflicts of interest could possibly go
undetected. Moreover, the current levels of collaboration among the
three agencies most involved with DB pension plans --EBSA, PBGC, and
the SEC --or their service providers, present opportunities that could
enhance enforcement. Because SEC conducts examinations of some
registered advisers it oversees, consistent inquiry by EBSA and PBGC
into SEC's inspection results would be a good first step toward
bridging the information gap. In addition, in the spirit of creating
efficiencies with overseeing service providers doing business with
pension plans, EBSA and PBGC may greatly benefit from SEC's regular
exams by giving some thought to what SEC could collect during its
efforts that would be useful to the other two agencies.
Nevertheless, it would be prudent and responsible to carefully weigh
the benefits of any new regulatory approaches against their potential
effect on continued sponsorship of DB plans. Although the percentage of
the private sector labor force covered by a pension plans has remained
roughly constant over the last decade, the number of active DB plan
participants has declined sharply. Nonetheless, given the important
role that DB plans still play in the retirement security of millions of
American workers and their families, it would be prudent to weigh any
proposed regulatory options against the additional administrative costs
they may generate on DB plans.
Matters for Congressional Consideration:
Congress may wish to consider amending ERISA to allow EBSA to recover
plan losses against certain types of service providers even if they are
not currently considered fiduciaries under ERISA.
Recommendations for Executive Action:
To enhance existing protections of plans and participants, and maintain
participant and sponsor confidence in the private DB pension system, as
part of its current risk assessment efforts, the Director of the PBGC
should:
* Develop a pilot project to collect the necessary documents on a
select group of trusteed plans to determine the extent to which
conflicts of interest may have affected these plans. This pilot project
should be undertaken with the assistance of EBSA and in consultation
with the SEC. PBGC and EBSA should provide SEC with ideas that would be
useful to them on the information SEC could gather during its adviser
and broker-dealer examinations.
The Secretary of Labor should direct the Assistant Secretary for EBSA:
* to enhance current enforcement by expanding the scope of the new CAP
program to include some emphasis on service providers of those high
risk plans PBGC deems likely to terminate in the future and plans PBGC-
trusteed.
Building on the existing memorandum of understanding (MOU) between EBSA
and PBGC and a recommendation made in our earlier work, the Assistant
Secretary of EBSA, the Director of the PBGC, and the Chairman of the
SEC should:
* Enter into an MOU to facilitate information sharing on conflicts of
interest among service providers that either consult or that provide
money management services to PBGC-trusteed plans and those likely to
terminate in the future.
Agency Comments and Our Evaluation:
We obtained comments from the acting Assistant Secretary for the
Employee Benefits Security Administration, the Deputy Director of the
Pension Benefit Guaranty Corporation, and the Director of Compliance
Inspections and Examinations for the Securities and Exchange
Commission. PBGC's, EBSA's, and SEC's comments are reproduced in
appendix III, appendix IV, and appendix V. Each of the agencies also
provided technical comments, which were incorporated into the report as
appropriate.
EBSA, PBGC and SEC generally agreed with the findings and conclusions
of the report. PBGC noted that although it has no authority to take
action against service providers with conflicts of interest involving
ongoing plans, its recent initiative to enhance its procedures for
identifying and pursuing fiduciary breach and other types of claims is
fully consistent with our recommendations. In comments, EBSA agreed to
consider our recommendation to expand the focus of its CAP program to
PBGC-identified pension plans that may be trusteed or are high risk as
it reviews the results of its initial efforts under CAP and gain
additional experience through project investigations.
All three agencies acknowledge the importance of effective cooperation
to facilitate their respective missions. SEC notes that it looks
forward to further developing its currently cooperative relationship
with EBSA and PBGC through discussion on our recommendations. PBGC
pointed to the existing information sharing arrangement that it has
with EBSA and the Internal Revenue Service that it believes could serve
as a useful model to coordinate with EBSA and SEC, and pledges to work
with EBSA and SEC to more closely coordinate agency action on PBGC-
trusteed plans and plans likely to terminate in the near future. EBSA
also notes both the importance of establishing and maintaining
effective working relations with other agencies to maximize enforcement
effectiveness, and has stated that it is prepared to work with PBGC and
SEC to facilitate information sharing.
EBSA noted a number of concerns about our statistical analysis and in
particular our econometric analysis that suggests a negative
association between consultants with undisclosed conflicts of interest
and rates of return on assets. EBSA expressed important cautions that
should be considered when interpreting our results, including some data
limitations and our use of an estimate for our investment returns
variable. We agree that our econometric study, while suggestive, should
not be considered definitive, or a proof of causality, especially in
light of the data and modeling limitations constraining the analysis.
The goal of this analysis was to shed some light on a critical public
policy issue--understanding the relationship between rates of return
and consultants that have been found to have undisclosed conflicts of
interest--given the current state of econometric techniques and limited
real world data. We view our findings as an indicator of the potential
effects that conflicts of interest can have on returns and as a
catalyst for further analysis rather than evidence of a causal
relationship. In response to EBSA's concerns, we now discuss the
limitations of the analysis more prominently and have added more
information on our statistical analysis and our data in appendix II.
We are sending copies of this report to the Director of the PBGC, the
Secretary of Labor, the Chairman of the SEC, and other interested
parties. We will also make copies available to others on request. In
addition, the report will be available at no charge on the GAO Web site
at http://www.gao.gov.
If you or your staff has any questions concerning this report, please
call me at (202) 512-7215. Key contributors are listed in appendix VI.
Signed by:
Barbara D. Bovbjerg:
Director, Education, Workforce, and Income Security Issues:
[End of section]
Appendix I: Scope and Methodology:
To conduct our review of the procedures the PBGC, SEC and EBSA have in
place to detect and coordinate on conflicts of interest that may impact
the entities they oversee, we interviewed officials from key agencies
as well as independent outside experts, lawyers and forensic auditors
knowledgeable about conflict of interest issues. We conducted
interviews with officials from SEC's Office of Compliance Inspections
and Examinations (OCIE) and SEC's Division of Enforcement regarding
their 2005 staff report concerning examinations of selected pension
consultants and the agency's general enforcement practices. We
interviewed various PBGC officials, including staff attorneys and
accountants, on their departmental procedures policies regarding the
pursuit of financial recoveries regarding underfunded terminated plans,
as well as other related issues. We interviewed various EBSA officials,
including those from EBSA's Office of Enforcement and the Solicitors
office. We interviewed a number of experts on conflict of interest
issues, including lawyers and auditing professionals knowledgeable
about conducting audits related to conflicts of interest, and those
with expert knowledge on EBSA and PBGC's policies and procedures. We
also interviewed legal experts on ERISA and securities laws.
To obtain information about agency procedures, we collected and
reviewed PBGC's operations and policy manual, and reviewed PBGC court
cases. We collected data provided by EBSA's Office of Enforcement
pertaining to the investigation of cases related to conflicts of
interest and prohibited transaction violations and reviewed EBSA's
enforcement manual. We reviewed the relevant section of ERISA and
securities laws in consultation with GAO's legal staff. Finally, we
reviewed past GAO work on SEC, PBGC and EBSA enforcement efforts with
respect to conflicts of interest, as well as agencies' general
enforcement efforts and we consulted the teams within GAO that
regularly review SEC, PBGC and EBSA operations.
To conduct our statistical analysis on the 24 pension consultants
included in the SEC study, we obtained details regarding the type of
conflicts found and the disclosure issues involving the 24 pension
consultants from SEC officials. We obtained specific information
regarding certain finding statements made in the SEC's 2005 staff
report and reviewed this information at SEC headquarters under their
oversight. To protect the confidentiality of SEC's exam practice, our
data analysis was mostly conducted at SEC headquarters. Any additional
analysis conducted by us at GAO headquarters which could reveal
information that could identify the consultants reviewed in the SEC's
2005 staff report has been destroyed.
Working with the SEC study data, we compiled a list of clients
associated with the 13 consultants identified by the SEC staff report
as having undisclosed conflicts of interest using the Form 5500 and
Thomson Nelson's database of pension consultants and plan sponsors.
ERISA and the IRC require administrators of pension plans to file
annual Form 5500 reports concerning, among other things, the financial
condition and operation of plans. Form 5500 Reports are shared among
Labor's Employee Benefits Security Administration, IRS, PBGC, and the
Social Security Administration, and each agency uses the Form 5500 to
meet its statutory obligations. Plan year 2004 was the most recent year
for which plan-specific Form 5500 data were available for our review.
The Form 5500 data presents a number of data limitations. These
limitations have been well documented in other reports issued by
us.[Footnote 50]
We then supplemented our Form 5500 data with information we purchased
from Thomson Nelson (Nelson). We used the Nelson databases and the
Thomson Nelson Annual Report of Pension Fund Consultants 2006 The
Nelson database contains detailed information on various aspects of
20,000 single employer DB and DC pension plans and on 350 pension
consultants and other service providers who service those plans. With
the Form 5500 and Nelson data, we developed a client list for the 13
pension consultants examined in the SEC study. We regard our client
list to be a partial list since the sources contained incomplete
information and no complete source of information was available to us.
Since creating a complete client list for the 13 consultants identified
by the SEC staff report as having undisclosed conflicts of interest was
not possible, we consider our counts of the clients of these
consultants to be conservative.
To determine the relationship between the consultants identified by the
SEC with PBGC trusteed plans and ongoing plans we conducted three
matches:
* 24 SEC identified consultants with PBGC's list of the trusteed plans
of the 25 largest companies in terms of claims since the beginning of
fiscal year 2000.[Footnote 51] We constructed each match so that we
looked at plan sponsors rather than plans. PBGC's 25 largest trusteed
companies since the year 2000 had a total of 67 plans.
* 24 SEC-identified consultants and our client list with PBGC's list of
plans that underwent PBGC trusteeship in 2005. The total number of
plans was 118.
* 24 SEC-identified consultants and our client list with plans that
were non-terminated and ongoing between 2000 and 2004. The total number
of plans was 4832.
The compilation and matching of our data sources provide the following
information is illustrated in the table 1:
Table 1: Pension Plan Sponsors Employing 13 Consultants of Concern to
the SEC Regarding Inadequately Disclosed Conflicts of Interest.
Sponsors employing 1 or more consultants with undisclosed conflicts;
25 largest PBGC trusteeships since 2000: 9;
Sponsors of plans trusteed by PBGC in 2005: 12;
Sponsors of ongoing defined benefit plans 2000-2004: 1,009.
Total number of sponsors;
25 largest PBGC trusteeships since 2000: 25;
Sponsors of plans trusteed by PBGC in 2005: 86;
Sponsors of ongoing defined benefit plans 2000-2004: 4,203.
Percentage;
25 largest PBGC trusteeships since 2000: 36%;
Sponsors of plans trusteed by PBGC in 2005: 14%;
Sponsors of ongoing defined benefit plans 2000-2004: 24%.
Source: GAO Analysis of data from PBGC, SEC, Nelson Information, and
Form 5500 filings.
[End of table]
Of the remaining 11 consultants that were of less concern to the SEC:
* Six were ranked as some of the largest pension consultant firms in
the U.S. with pension assets under advisement totaling over 1.5
trillion dollars.[Footnote 52]
* One of the 11 had an advisory relationship with one of the 25 largest
PBGC trusteeships at some point during the years they were ongoing,
although at least one or more of the 13 consultants of concern also
provided services to this plan sponsor during that same period.
* One of the 11 had an advisory relationship at some point during the 5
year period between 2000 through 2004with one of the sponsors with
plans that terminated in 2005 and was trusteed by PBGC, although at
least one of the 13 consultants of concern also provided services to
this plan sponsor during that same period.
* One or more of the 11 had an advisory relationship with 167 of the
ongoing defined benefit plan sponsors from 2000-2004, although at least
one or more of the 13 consultants of concern also provided services to
99 of these plan sponsors during that same period.
To match the 13 consultants identified by the SEC with non-terminated/
ongoing DB plans, we analyzed Form 5500 information from filing years
2000 to 2004 to identify the sponsors of DB plans we categorized as
ongoing. We selected only single employer or multiple employer DB plans
that filed Form 5500 in 2004 and were not on the PBGC list of plans
that terminated in 2005. From these we selected plans whose filings
were not partial year and were not final plan filings. Additionally, we
selected those plans with at least one other full year filing for the
period 2000 to 2003. Additionally, we chose only plans with information
on both beginning and end of year assets reported on Schedule H. This
resulted in a list of 4,203 sponsors of 4,832 plans.
To determine the consultants that worked directly for a plan or
indirectly for a plan through a plans holdings in master trusts
accounts and other such arrangements, we compiled information on
service providers reported on the plans Form 5500 schedule C and also
on service providers reported on the filings of master trust accounts
and other such plan holdings. We compiled a working list of consultants
whose service was reported with the codes 17 (Consulting), 20
(Investment advisory), and 21 (Investment management). We matched this
list to the list of consultants investigated by the SEC to determine
which plans used the services of one or more of the consultants that
were investigated. We augmented this list using consultant and client
list information available from Nelson.
Finally, we conducted an econometric analysis to determine whether
there was a correlation between undisclosed conflicts of interest and
rates of return for the ongoing DB plans identified as employing the
services of one or more of the consultants listed in the SEC study. We
included only the plans that we could link to the 24 consultants either
directly on the basis of plan form 5500 filings or indirectly based on
a plans holdings in master trusts accounts and other such arrangements.
For details of this analysis please see appendix II.
[End of section]
Appendix II: Econometric Analysis of the Effect of Inadequately or
Undisclosed Conflicts of Interest on Pension Plan Rates of Return:
The SEC has stated that disclosure helps to mitigate the effects of
conflicts of interest. There is concern that plans that use pension
consultants who have not properly disclosed conflicts of interest may
achieve lower net returns on plan assets either because of higher
administrative costs or due to poor money manager selection, among
other reasons. To investigate the relationship between returns and
improperly disclosed conflicts of interest, GAO compiled a database
using SEC data on pension consultants and the Department of Labor's
5500 data (as well as some auxiliary data sources to create additional
control variables). The data contains observations on 1111 pension
plans over a 5-year period, 2000 to 2004. To analyze the relationship,
GAO employed various multivariate econometric models using the panel
data. While, the results suggest a negative correlation between returns
and plans that are associated exclusively with pension consultants that
have not properly disclosed conflicts of interest, the results should
not be viewed necessarily as evidence of a causal relationship in light
of the modeling and data limitations. This appendix provides additional
information on the construction of GAO's database, the econometric
model, additional descriptive statistics, and the limitations of the
analysis.
GAO Panel Data Sample Constructed from Two Primary Data Sources:
To explore the risk areas relating to pension consulting, SEC's Office
of Compliance Inspections and Examinations (OCIE) conducted focused
examinations of 24 pension consultants who were registered investment
advisers, some of whom were considered at high risk for undisclosed
conflicts. These consultants examined ranged in size and by the types
of products and services offered. SEC chose its sample in part based on
geographical dispersion and judgmentally selected the consultants. SEC
found that 13 of these 24 pension consultants failed to disclose
significant conflicts of interest while the remaining 11 were found to
have less significant disclosure issues. Using the Labor's 5500 data,
GAO used the SEC information to identify 983 pension plans associated
with these 13 pension consultants and 39 pension plans associated with
the 11 pension consultants found to have less significant disclosure
issues. We were also able to identify 89 plans in the 5500 database
that were associated with both types of pension consultants (see figure
2). Given the nature of the SEC selection process (it was not selected
randomly) and the small number of pension consultants, the plans
included in the analysis should not be considered as representative of
the population of defined benefit pension plans and the results may not
be generalizeable.
Figure 2: Identifying Plans for GAO's Pension Plan Sample:
[See PDF for image]
Source: GAO analysis.
[End of figure]
To construct the database used to estimate the econometric model, we
compiled financial information from the 5500 database on these 1111
plans over 5 years and added additional data on the performance of the
S&P 500 over various fiscal year end dates taken from Robert Shiller's
Web site and market performance indicators from Credit Suisse and the
Federal Reserve Board. As a panel data set, data pooled across all
plans matched to the 24 consultants reviewed by SEC over the 2000 to
2004 period, we were able to account for variances in returns across
plans and over a short period of time and utilizes techniques that
enhance the validity of the parameter estimates. Because some of the
plans did not have the requisite data for each year, the panel is
unbalanced. While this requires minor modifications in the computation
of the related statistics, it does not preclude the estimation of the
model. Nevertheless, this panel of 1111 plans was used to empirically
evaluate the relationship between returns and undisclosed conflicts of
interest. Table 2 reports some descriptive statistics on the plans
included in the analysis.
Table 2: Selected Descriptive Statistics for Plans included in the
Econometric Model:
Plans associated with Group A;
Return (average, 2000-2004): 3.2%;
Return (standard deviation, 2000-2004): 11.5%;
Assets per plan (average, 2004): 186,708,455;
Sum of assets in 2004: 183,534,411,177;
Assets per plan (average, 2000-2004): 155,371,479.
Plans associated with Group B;
Return (average, 2000-2004): 4.5%;
Return (standard deviation, 2000-2004): 12.7%;
Assets per plan (average, 2004): 253,121,820;
Sum of assets in 2004: 9,871,750,992;
Assets per plan (average, 2000- 2004): 214,063,302.
Plans associated with Group A and B;
Return (average, 2000-2004): 4.2%;
Return (standard deviation, 2000-2004): 12.4%;
Assets per plan (average, 2004): 363,821,650;
Sum of assets in 2004: 32,380,126,875;
Assets per plan (average, 2000-2004): 317,061,230.
All plans;
Return (average, 2000-2004): 3.4%;
Return (standard deviation, 2000-2004): 11.6%;
Assets per plan (average, 2004): 203,227,983;
Sum of assets in 2004: 225,786,289,044;
Assets per plan (average, 2000-2004): 170,426,326.
Source: GAO Analysis.
Note: The groups reflected in the table are as follows: Group A
consists of those consultants that had failed to disclose significant
conflicts of interest, Group B consists of those consultants that
failed to disclose less significant conflicts of interest or that had
no conflicts of interest, and Group A and B consists of members of
group A and B.
[End of table]
Standard Econometric Modeling Procedures for Handling Panel Data:
Random and Fixed-Effects Model:
Panel data provides potential advantages over pure cross sectional and
pure time series designs as it allows us to factor out the time-and
space-invariant components of the data. As a result, panel data are
able to identify and measure effects that are not detectable in other
designs. There are two commonly accepted approaches to estimating panel
data, the "random-effects" model and the "fixed-effects" model. In a
"fixed-effects" model individual effects are estimated in this case for
each plan to reflect the assumption that special features specific to
each plan such as investment style or skill can be captured best with a
different, time-invariant intercept for each plan. In a "random-
effects" model, in this context, these individual effects are captured
through treating the intercept as a random variable with an unique
error term for each plan. While each model has its advantages and
disadvantages, the random effects model is appropriate when we can
plausibly assume that the individual effects (which are unobserved and
unmeasured in the model) are uncorrelated with the explanatory
variables that are measured and included in the model. If this
assumption holds, the random-effects model is especially attractive if
the cross-sectional units (pension plans) are drawn randomly from a
common population or alternatively when the number of cross-sectional
units is large and the time period is small. Otherwise, the fixed-
effects model is preferred, especially as a control for omitted
variables bias.
Using panel data as stated above, basic model takes the form:
(1) yit = q + Xitb + Zid + eit:
wherey = the dependent variable (plan returns).
X =a matrix of explanatory variables that varies across time and
individual plans. These variables are control variables that help
explain the variation in returns across plans such as the performance
of various markets over a plan's fiscal year, the size of a plan and
its funding status.
Z =a matrix of variables that vary across individuals plans but for
each individual plan are constant across the 5 years. The variables are
essentially the dummy variables that indicate whether a plan is
associated with the various types of pension consultants outlined
above.
q =constant term.
i =1, 2, . . ., 1111 and represents the individual pension plans in the
panel data.
t =1, 2, . . ., 5 and represents the number of years (2000 to 2004).
As is the typical case with panel data, we have a large number of cross-
sections (pension plans) and a relatively small number of time periods.
Therefore we specify the composite error structure for the disturbance
term as follows:
(2) eit = i + hit:
wherei =plan-specific error component which captures the unobserved
heterogeneity across plans (either as a fixed-or random-effect).
E(Xithit) = 0 (there is no correlation between hit and Xit).
The i is the individual effect which can be treated as either fixed or
random. The fixed-and random-effect models which take account of the
repetition inherent in the data and allow us to use the individual
differences effectively. Correspondingly, if we treat the individual
effect as zero we can estimate the model using the simple ordinary
least squares (OLS) procedure. Essentially, this is a pooled regression
model where we assume the intercept and slope coefficients are constant
across time and space and the normal error term (hit) captures
differences over time and individual plans. However, when the true
model is a random-effects model, pooling the observations in this
manner using OLS produces biased estimates that are also not efficient
when compared to the more complex GLS procedure (outlined hereafter).
The pooled OLS model is also susceptible to omitted-variables bias.
The random-effects technique proceeds under the premise that the
ignorance about the unobserved differences in returns across plans is
better captured through the disturbance term rather than the intercept.
The random-effects model basically maintains that the 1,111 pension
plans in the sample are a drawing from a much larger universe of such
plans and that they have a common mean value for plan returns
(represented by the constant term, q) and that the individual
differences in the intercept values of each plan are captured in the
error term eit.[Footnote 53] Given the composite nature of the new
disturbance term that incorporates the individual random effect of each
plan, the appropriate method for producing estimates is generalized
least squares (GLS).[Footnote 54] Feasible GLS derives an estimate of
the covariance matrix of the error term and uses the information
(heteroscedasticity from repeated observations of the same cross-
section unit) to estimate the coefficients in the model.
Note that the random-effects model uses the heterogeneity across units
to produce more efficient estimates.[Footnote 55] However, the drawback
to this approach is that it forces one to make the strong assumption
that the unobserved random-effects are uncorrelated with the
explanatory variables in the model (E(Xiti) = 0 in addition to the
standard assumption E(Xithit) = 0). As a result the random effect
treatment of the panel data may also produce estimates that suffer from
the inconsistency because of omitted variables. Therefore, the validity
of the results in the case would depend more heavily on the control
variables included in the model to capture differences across plans,
unless the omitted variables (unobserved heterogeneity across plan) are
uncorrelated with the conflict dummy variable. If this is the case, the
random-effect model may produce more appropriate estimates than the
fixed-effects model. In our case, the unobserved effects, i, were found
to be unimportant (relative to the variance of hi) as the random-effect
estimates approximated the pooled OLS results. This made the choice
between random and pooled OLS a moot point (see below).
Fixed-Effect Model:
When there is heterogeneity that cannot readily be explained, another
analytical approach is to incorporate it into a fixed-effects model. In
the case of the fixed-effects model, it is estimated uniquely for each
plan as a fixed coefficient to be added to the intercept term. In this
way, we take into the account the individuality of each plan (each
cross-sectional unit) by letting the intercept vary by a fixed amount
for each plan. The benefit of the fixed-effects estimator is that it is
consistent in the presence of omitted variables. Because many variables
that impact returns across plans are difficult to measure or could not
be obtained this omission could bias the parameter estimates. With
panel data and a fixed-effect specification it is possible to obtain
consistent estimates of the impact of undisclosed conflicts of interest
even when there are correlated omitted effects. The differences that
exist across plan are essentially pulled out and accounted for
explicitly, allowing for a more valid estimation of the impact of
conflicts of interest on plan returns. Moreover, in many cases the
fixed-effects estimates will still produce consistent estimates even
when the random effects model is valid.
While the easiest way to implement the fixed-effects estimator is to
include a dummy variable for each plan, we could not run a fixed-effect
model directly due to the nature of our primary regressor of interest.
Since the fixed-effects are time-invariant and the conflict variable in
our model is a qualitative variable (dummy) that does not change over
the 2000 to 2004 period either, the fixed effects model is not able to
identify the impact of the variable. Essentially the variable is
collinear with the fixed effect intercepts. Therefore we used an
alternative procedure to achieve the same effect. To produce the fixed-
effects estimator we used the fixed-effects vector decomposition
approach.[Footnote 56] The technique estimates the fixed-effects
estimator in three stages: the first stage runs a fixed-effect model
without the time invariant variables (Zi). We then decompose the fixed-
effects estimator into a portion explained by the time invariant
variables (Zi) and an error term. The final stage re-estimates the
first stage with the time invariant and time variant variables and the
error term from the stage two. In the third stage, estimated by pooled
regression, we used robust standard errors adjusted for the degrees of
freedom. In this manner we were able to approximate the unbiased,
consistent estimator in the presence of time-invariant omitted
variables.[Footnote 57] While some researchers have found that this
procedure has better finite sample properties than the alternative
approaches for estimating the effect of time-invariant variables using
panel data, it should be noted that this is a recently applied
econometric technique.
Variables Included in the Model:
The dependent variable in all of our econometric models is plan
returns. Returns were calculated two ways using the Form 5550 data. The
first return measure calculates plan returns relating the change in
plan assets (At - At - 1) over the year, netting out the impact of
benefits payments from the plan (B) and contributions to the plan (C)
and also accounts for net transfers (T) into the plan. The formula can
be written:
(3) ROR1 = [(At - At - 1) + B - C - T] / [(At - 1) + ½(C - B + T)].
As an alternative we slightly amend this calculation to account for
administrative expenses (E) paid by the plan in a different manner.
This alternative formula can be written:
(4) ROR2 = [(A - At - 1) + B + E - C - T] / [(At - 1) + ½(C - B - E +
T)].
The results we report below use this measure of returns but we obtained
similar results using the first estimate of returns.
The primary variables of interest are the time invariant variables (Z),
namely a dummy variable (conflict) that equal 1 if the plan is
associated exclusively with pension consultants found to have
undisclosed conflicts of interest and 0 otherwise. In many
specifications we also include a dummy variable (mixed) that equals 1
if the plan is associated with both types of consultants --pension
consultants found to have undisclosed conflicts of interest and pension
consultants that have no conflicts or disclosed conflicts properly and
0 otherwise.
Although, the fixed effect model guards against time invariant omitted
variables bias, it is always advisable to explore possible causes of
heterogeneity. We included a number of control variables in attempt to
capture the variation in plan return across plans although time
constraints restricted the variables we could include. Because
different plans may allocate assets differently because of investment
style or age composition of plan participants, some plans may track
more conservative or aggressive benchmarks rather than the overall
market. As a result in addition to a general market indicator, the S&P
500, we also include a measure of hedge fund performance as well as a
fixed income measure. The broad market measure the performance of the
S&P 500 over plan i's fiscal year for year t.[Footnote 58] Our measure
of hedge fund performance is the Credit Suisse/Tremont hedge fund
index.[Footnote 59] The fixed-income measure is the Moody's yield on
corporate seasoned Aaa bonds taken from the Federal Reserve Board.
These variables were constructed in a manner that also accounts for the
varied fiscal year end dates across plans. Moreover, since the size and
the funding level of the plan may influence asset allocation and
investment strategy, we included assets at the beginning of the fiscal
year and the degree of under-funding as explanatory variables as well.
Including funding status creates potential simultaneous equations bias
since the funding ratio is most likely dependent on plan returns. Since
lagging the variable resulted in a loss of both a year's data and large
number of observations as well as severe autocorrelation, we included
the contemporaneous funding ratio but did not include the variable all
specifications. The asset variable was substantively and/or
statistically insignificant across multiple specifications and
therefore it was not included in some instances.
We also included time period effects whenever possible. This amounts to
creating a dummy variable for 4 of the 5 time periods covered in the
database. While, this is straightforward in the OLS and fixed-effects
models, two way random effects or random effects with a time period
fixed effect is only possible for balanced panel in the econometric
software used for the modeling procedure. When we included time period
fixed effects in the fixed-effects model some of the explanatory
variables became redundant and added no explanatory power to the
models. In our case, we did not reproduce the random-effects model on
the balanced panel in this appendix, since the only variation across
units were the fixed effects, and the random effects model was
equivalent to the pooled OLS results.
Results: Ordinary Least Squares (OLS) and Random-Effects Models:
The simple econometric model (OLS), suggests that plans associated with
undisclosed conflicts of interest achieve returns roughly 1.2 to 1.7
percentage points lower. The results are all significant at the 5
percent level (table 3). However, this model disregards the space and
time dimensions of the pooled data and is plagued with a number of
issues including omitted variables bias, which can impact the parameter
estimates, as potentially evidenced by the somewhat low Durbin-Watson
statistic. The random-effect model, which assumes that there are
differences between the plans and that these differences are random,
did not produce results distinct from the OLS model. When the
unobserved effects, i, are unimportant (relative to the variance of
hit), the random-effects estimates will be closer to a pooled OLS
model. Our estimation found that the random-effects were unimportant
and there were no efficiencies to estimating the model via GLS.
Nevertheless, the relationship between undisclosed conflicts and
returns estimated by the OLS and random-effects models remained robust
even when additional control variables were included and, in the case
of OLS, when time fixed-effects were added to the model.[Footnote 60]
Table 3: Econometric Estimates of the Relationship between Undisclosed
Conflicts of Interest and Plan Returns (OLS and Random Effects):
Independent variable.
Conflict;
OLS/Random Effects I: -0.012[A];
OLS/ Random Effects II: -0.014[A];
OLS III: -0.014[A];
OLS IV: -0.013[A];
OLS V: -0.014[A];
OLS VI: -0.017[B].
Mixed;
OLS/Random Effects I: [Empty];
OLS/Random Effects II: [Empty];
OLS III: [Empty];
OLS IV: [Empty];
OLS V: [Empty];
OLS VI: -0.006.
SP500;
OLS/Random Effects I: 0.600[A];
OLS/Random Effects II: 0.676[A];
OLS III: -0.090[A];
OLS IV: 0.050;
OLS V: 0.053;
OLS VI: 0.050.
Hedge;
OLS/Random Effects I: [Empty];
OLS/Random Effects II: -0.575[A];
OLS III: [Empty];
OLS IV: -0.252[A];
OLS V: -0.263[A];
OLS VI: -0.253[A].
Bond yield;
OLS/Random Effects I: [Empty];
OLS/ Random Effects II: -0.023[A];
OLS III: [Empty];
OLS IV: 0.062[A];
OLS V: 0.062[A];
OLS VI: 0.0612[A].
Assets;
OLS/Random Effects I: [Empty];
OLS/Random Effects II: -0.000;
OLS III: [Empty];
OLS IV: 0.000;
OLS V: [Empty];
OLS VI: [Empty].
Funding ratio;
OLS/Random Effects I: [Empty];
OLS/Random Effects II: [Empty];
OLS III: [Empty];
OLS IV: [Empty];
OLS V: -0.000;
OLS VI: [Empty].
Constant;
OLS/Random Effects I: 0.062[A];
OLS/ Random Effects II: 0.252[A];
OLS III: 0.043[A];
OLS IV: -0.341[A];
OLS V: -0.336[A];
OLS VI: -0.330[A].
Time period fixed-effects;
OLS/Random Effects I: No;
OLS/Random Effects II: No;
OLS III: Yes;
OLS IV: Yes;
OLS V: Yes;
OLS VI: Yes.
R-square;
OLS/Random Effects I: 0.5276;
OLS/ Random Effects II: 0.5584;
OLS III: 0.6388;
OLS IV: 0.6430;
OLS V: 0.6411;
OLS VI: 0.6423.
Durbin-Watson;
OLS/Random Effects I: 1.86;
OLS/ Random Effects II: 1.95;
OLS III: 1.61;
OLS IV: 1.61;
OLS V: 1.61;
OLS VI: 1.61.
Sample size;
OLS/Random Effects I: 4,170;
OLS/ Random Effects II: 4,170;
OLS III: 4,170;
OLS IV: 4,170;
OLS V: 4,170;
OLS VI: 4,170.
Source: GAO analysis.
[A] denotes significance at the .01 level.
[B] denotes significance at the .05 level.
Notes: Conflict indicates a plan that is associated with one of the
pension consultants identified has having undisclosed conflicts of
interest. Mixed indicates a plan that is associated with a pension
consultant with undisclosed conflicts but also a pension consult found
to be free of conflict or having disclosed them properly.
Bond Yield, SP500, and Hedge are: Moody's average yield on corporate
Aaa bonds, the change in the S&P 500, and the change in the Credit
Suisse/Tremont hedge fund index return over a plan's fiscal year,
respectively. Assets denote plan assets at the beginning of the year
(squared). The funding ratio is the ratio of assets to liabilities.
[End of table]
Results: Fixed-Effects Models:
The fixed-effect model, which helps guard against omitted variable
bias, supports the results from the pooled OLS model. The R-square from
the fixed-effect regression suggest that the models explain roughly 75
percent of the variation in plan returns. Again, the results are highly
significant as the probability of an erroneous statistical conclusion
in most models is substantially lower than what is commonly accepted as
significant in hypothesis testing (5 percent or a p-value of .05).
There is one exception to be noted, when the dummy variable is included
for those plans associated with both conflicted and non-conflicted
pension consultants, the significance of the conflict variable falls to
the 10 percent level (p-value is roughly 6 percent). This implies the
probability of concluding a negative relationship when none is present
has increased to about 6 percent. Moreover, when we drop those
observations associated with both types of pension consultants, the
conflicted variable was again significant only at the 10 percent level
(p-value on roughly 6.7 percent). However, when we used the return
calculation expressed in equation (3) the conflict dummy remains
significant at the 5 percent level (p-value of roughly 3%) even when an
independent dummy variable is included for the plans associated with
both conflicted and non-conflicted pension consultants. It should be
noted that, against the one-sided alternative, returns are lower for
conflicted plans (H1: Conflict
