Defined Benefit Pensions: Conflicts of Interest Involving High Risk or Terminated Plans Pose Enforcement Challenges
Published: 2007-06-28T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: 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. 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. 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.
subsections: section_title: Background
paragraphs: ERISA is the primary federal law governing the sponsorship and operation  of private sector employee pension plans, including DB plans. 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 and also prohibits certain transactions  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.
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. 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; 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. 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. 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. 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.
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. 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. 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. 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.
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.
section_title: Some Pension Plan Service Providers May Have Conflicts of Interest, but Determining Whether Harm Results Is Difficult
paragraphs: 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. 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.
subsections: section_title: Pension Plan Fiduciaries and Money Managers Can Have Conflicts of Interest, Although Little Information Is Available on Their Prevalence
paragraphs: 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. 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.
section_title: Consultants Identified by SEC as Having Significant Ongoing Conflicts of Interest Provide Services to Many Pension Plans
paragraphs: 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. 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. 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;     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;    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.
section_title: Our Analysis Shows an Association between Inadequate Disclosure of Conflicts and Lower Rates of Return, Although Proof of Financial Harm Requires a Detailed Audit
paragraphs: 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. 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. 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. (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.
section_title: PBGC’s Current Policy and Procedures Are Not Focused on Detecting Conflicts of Interest among Service Providers
paragraphs: 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. 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.
subsections: section_title: PBGC Policies and Procedures Are Focused on Recovering Plan Assets
paragraphs: 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. 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.
section_title: Although PBGC Has Authority to Recover Losses, Cost Benefit Considerations Shape the Agency’s Actions
paragraphs: PBGC has the authority, as trustee, to recover losses from any party,  including service providers that are not fiduciaries under ERISA.  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.
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. 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.
section_title: While Most of Its Pension Holders Would Not Likely Benefit, Additional Monetary Recoveries Could Potentially Reduce PBGC’s Deficit
paragraphs: 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. 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. 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.
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. 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.
section_title: 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
paragraphs: 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.
subsections: section_title: EBSA Has No Specific Enforcement Strategy for PBGC-Trusteed Plans or Plans that PBGC Deems Likely to Terminate
paragraphs: 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. 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.
section_title: EBSA Has a New Initiative to Focus on Conflicts of Interest among Service Providers
paragraphs: 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. 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. 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.
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.
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.
section_title: EBSA Officials Cite ERISA as Constraint in Pursuing Conflicts of Interest
paragraphs: 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. 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.
section_title: Different Authorities and Roles Have Limited Agency Collaboration
paragraphs: 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.
subsections: section_title: Agency Collaboration on Conflicts of Interest Largely Informal
paragraphs: 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. 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.
Nevertheless, there is no systematic procedure among the three agencies  that would effectively target or monitor service providers engaged in  conflicts of interest. 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.
section_title: Different Agency Responsibilities Tend to Reinforce Limited Collaboration among EBSA, SEC, and PBGC
paragraphs: 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 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.
section_title: Conclusions
paragraphs: 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.
section_title: Matters for Congressional Consideration
paragraphs: 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.
section_title: Recommendations for Executive Action
paragraphs: 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.
section_title: Agency Comments and Our Evaluation
paragraphs: 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.
section_title: Appendix I: Scope and Methodology
paragraphs: 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.
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. 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:  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.
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.
section_title: Appendix II: Econometric Analysis of the Effect of Inadequately or Undisclosed Conflicts of Interest on Pension Plan Rates of Return
paragraphs: 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.
subsections: section_title: GAO Panel Data Sample Constructed from Two Primary Data Sources
paragraphs: 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.
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.
section_title: Standard Econometric Modeling Procedures for Handling Panel Data: Random and Fixed-Effects Model
paragraphs: 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 = θ + Xitβ + Zδ + εit where  y =   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.  θ =  constant term.  i =  1, 2, . . ., 1111 and represents the individual pension plans in  the panel data.  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) εit = α + ηit where  α =  plan-specific error component which captures the  unobserved heterogeneity across plans (either as a fixed- or random- effect).
E(Xitηit) =   0 (there is no correlation between ηit and Xit).
The α 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 (ηit) 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, θ) and that the individual differences in the intercept values  of each plan are captured in the error term εit. 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). 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. serially correlated across time, invalidating OLS estimates. 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, α, were found to be unimportant (relative to the  variance of η) as the random-effect estimates approximated the pooled  OLS results. This made the choice between random and pooled OLS a  moot point (see below).
section_title: Fixed-Effect Model
paragraphs: 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, αit 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. The technique estimates the  fixed-effects estimator in three stages: the first stage runs a fixed-effect  model without the time invariant variables (Z). We then decompose the  fixed-effects estimator into a portion explained by the time invariant  variables (Z) 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. 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.
section_title: Variables Included in the Model
paragraphs: 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  (A – 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) ROR = [(A – 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) ROR = [(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. Our measure of hedge fund performance is the  Credit Suisse/Tremont hedge fund index. 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.
section_title: Results: Ordinary Least Squares (OLS) and Random-Effects Models
paragraphs: 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, α, are unimportant (relative to the variance of ηit), 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.
section_title: Results: Fixed-Effects Models
paragraphs: 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<0) and the results remain highly significant  at the 5 percent level or lower. Otherwise, the conflict variable is robust to  the inclusion of any of the additional control variables discussed above  and the two measures of returns. We generally find that an exclusive  association with one of the pension consultants identified has having  conflicts of interest is associated with a lower return by about 1.2 to 1.3  percentage points, and higher in one case.
section_title: Limitations of Our Econometric Model
paragraphs: Like many statistical analyses, the results should be interpreted with care.  Although the panel data provides many advantages and can produce more  valid and efficient estimates, drawing causal inferences is still difficult.  Even with control variables and the fixed-effects models there are a  number of threats to the validity of our results. First, although the fixed- effects estimator is robust to the omission of any relevant time-invariant  variables, if there are time-varying differences that have been omitted the  result could be biased. Although the analysis controlled for plan size,  funding level, the performance of asset markets and other key variables,  other unknown, omitted factors could still influence the results of our  analysis or account for the differences in estimated returns. There may be  additional biases resulting from the vector decomposition procedure used  to obtain the fixed-effect estimates. Second, the existence of statistical  relationship is not in and of itself, enough to assert causality. Fixed-effects,  while strengthening the validity of model’s parameters, do not completely  solve the problem of drawing causal inferences. Third, the use of the 5500  data could lead to measurement error in the dependent variable (plan  returns). We assume that any errors are random and therefore do not  impact the validity of the parameter estimates. Similarly, although we were  careful in identifying and reviewing the plans associated with the two  types of pension consultants any error, random or non-random, would  impact the parameter estimates. Moreover, we used a potentially  unrepresentative sample of pension consultants to identify the pension  plans included in our investigation that therefore limits the ability to  generalize the results. A few pension consultants that had significant  conflicts of interest that impacted their activity could very well drive the  observed negative relationship. Further, the imbalance between the large  number of plans associated exclusively with conflicted consultants and  the small number of those that were not raise additional statistical issues  and limits the ability to generalize the results. Lastly, given the short time  period analyzed, it could be possible that some plans’ return were  abnormally low due to their investment strategies, and would have higher  returns had the time period analyzed been lengthened.
section_title: Appendix III: Comments from the Pension Benefit Guaranty Corporation
section_title: Appendix IV: Comments from the Department of Labor
section_title: Appendix V: Comments from the Securities and Exchange Commission
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to the above, Charles A. Jeszeck, Kimberley M. Granger,   Joseph Applebaum, Susan Bernstein, Megan Birney, Richard Burkard,  Julie DeVault, Lawrance Evans Jr., Randall Fasnacht, Cody Goebel, Gene  Kuehneman, Michael Morris, Walter Vance, and Craig Winslow made  important contributions to this report.