10/16/09 - What's the value of conflict free advice?

By: Frank Armstrong, III, CFP, AIFA

Whenever conflicts of interest exist you can be sure that some people will take advantage of them.

The pension consulting business has a laundry list of possible conflicts: Pay to play, proprietary products, revenue sharing, and commissions to name just a few. Disclosure is almost nonexistent, and fiduciaries are generally inept. In theory, pensions are subject to extensive oversight, but legislation and regulatory enforcement badly lag the situation on the ground. With both regulators and plan sponsors asleep at the switch, it’s hard to imagine a more target rich environment for a sales organization. 

For plan sponsors, the Gordian knot is a simple exercise compared to untangling the conflicts embedded in a bundled product pension solution. And half of pension consultants receive compensation from the managers that they recommend. So, it shouldn’t be a big surprise that those conflicts impact both price and performance in a meaningful way.

But, is there an expected return on conflict free advice? The United States Government Accountability Office (GAO) thinks so. A report, “PRIVATE PENSIONS: Conflicts of Interest Can Affect Defined Benefit and Defined Contribution Plans” was issued in conjunction with Congressional testimony. The report finds that on average, pensions receiving conflicted advice suffered rates of return 1.2% to 1.3% per year lower than pensions receiving conflict free advice.

An annual loss of 1.2% may not sound like much, but over the life of a defined benefit plan (DB), or over the career of a participant in a 401(k) plan, those compounded losses are substantial. For the DB plan the shortfalls translate into huge additional funding costs, while for the 401(k) participant the accumulated loss can easily amount to a 30-45% difference in lifetime income after retirement.

A core principle of fiduciary standards is that it’s never prudent to waste beneficiaries’ money. Tolerating undisclosed conflicts of interest, excessive costs and/or sustained underperformance are breaches of fiduciary duty that subject the plan sponsor to personal liability. The GAO report shows that conflicted advice leads to predictable, measurable, non-trivial performance shortfalls which no prudent fiduciary should tolerate.

Of course, there is an alternative to business as usual on Wall Street. A plan sponsor might opt for unbundled solutions, hire an independent fiduciary consultant and demand full disclosures of any remaining conflicts.

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