Key Takeaways
- • Fairfield, Conn.'s pension trustee Kenneth A. Flatto says investment consultant NEPC failed to warn the town about Bernard Madoff, while NEPC says it urged Fairfield to reduce its Madoff-linked feeder fund exposure before the scheme surfaced.
- • Fairfield and NEPC are litigating over responsibility for $19 million in losses; Fairfield paid NEPC $100,000 a year and manages a $300 million portfolio.
- • Consultants that steered big investors into hedge funds are facing scrutiny for conflicts of interest, fee-based steering, and inadequate due diligence, according to the New York Times.
- • The U.S. Labor Department began examining the consulting industry in 2007, settling with Consulting Services Group and suing Zenith Capital Partners over alleged payments from a hedge fund.
- • Iowa's state pension fund lost $339 million in the Westridge Capital fraud after Wilshire Associates recommended it, and has recovered $35 million so far.
Summary
The Madoff fraud has focused attention on pension and investment consultants, the gatekeepers who connect trillions of dollars in public and corporate pension assets with investment managers. According to the New York Times, Fairfield, Conn., relied on NEPC, one of the largest investment consultants, to advise on its pension portfolio. First Selectman Kenneth A. Flatto, who serves as trustee of the town's $300 million portfolio, says the experts never warned the town about Madoff. NEPC states that it urged Fairfield to reduce its holdings in a Madoff-linked fund before the scheme came to light, and that Fairfield's investment predated NEPC's hiring. Fairfield concedes NEPC disclosed that Madoff advised the Maxam Absolute Return Fund, but contends the firm did not disclose that Maxam was a Madoff feeder fund and failed to flag red flags such as Madoff's use of an obscure auditor. The two sides are in court over $19 million in losses.
The Times reports that consultants face criticism on several fronts: conflicts when they earn fees both as advisers and from recommended funds, payments from hedge funds for referring investors, and simple failures to perform diligence. Investment consulting expanded in the mid-1990s as pension funds and endowments sought alternative investments such as hedge funds and private equity. On consultants' advice, large investors moved hundreds of billions of dollars into these vehicles, and the hedge fund industry is now undergoing a sharp shakeout, with investors losing many billions and hundreds of funds closing.
Regulators have begun acting. The Labor Department started examining the industry in 2007, settled with Consulting Services Group of Memphis over conflicts of interest, and in December sued Zenith Capital Partners of Santa Rosa, Calif., alleging it accepted hedge fund payments for steering pension clients. Virginia C. Smith, the department's enforcement director, described consultants who use fiduciary positions for their own benefit. Edward A. H. Siedle of Benchmark Financial Services said consultants pushed hedge funds onto pension funds because fees were far greater than standard advisory retainers.
The Westridge Capital case illustrates the problem. On Wilshire Associates' advice, the Iowa state pension fund, the University of Pittsburgh and Carnegie Mellon University invested millions in Westridge, which authorities contend was a fraud. Iowa lost $339 million and has recovered $35 million, and has hired a law firm to pursue further recovery. Iowa declined to say whether it would sue Wilshire, and Wilshire declined to comment on client matters. Securities lawyer Ross B. Intelisano of institutional investors said the proliferation of consultants and their failure to conduct proper due diligence was troubling.
The Times reports that consultants face criticism on several fronts: conflicts when they earn fees both as advisers and from recommended funds, payments from hedge funds for referring investors, and simple failures to perform diligence. Investment consulting expanded in the mid-1990s as pension funds and endowments sought alternative investments such as hedge funds and private equity. On consultants' advice, large investors moved hundreds of billions of dollars into these vehicles, and the hedge fund industry is now undergoing a sharp shakeout, with investors losing many billions and hundreds of funds closing.
Regulators have begun acting. The Labor Department started examining the industry in 2007, settled with Consulting Services Group of Memphis over conflicts of interest, and in December sued Zenith Capital Partners of Santa Rosa, Calif., alleging it accepted hedge fund payments for steering pension clients. Virginia C. Smith, the department's enforcement director, described consultants who use fiduciary positions for their own benefit. Edward A. H. Siedle of Benchmark Financial Services said consultants pushed hedge funds onto pension funds because fees were far greater than standard advisory retainers.
The Westridge Capital case illustrates the problem. On Wilshire Associates' advice, the Iowa state pension fund, the University of Pittsburgh and Carnegie Mellon University invested millions in Westridge, which authorities contend was a fraud. Iowa lost $339 million and has recovered $35 million, and has hired a law firm to pursue further recovery. Iowa declined to say whether it would sue Wilshire, and Wilshire declined to comment on client matters. Securities lawyer Ross B. Intelisano of institutional investors said the proliferation of consultants and their failure to conduct proper due diligence was troubling.
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