Reflections of Earth fireworks show at Epcot at Walt Disney World.

In recent years the U.S. Department of Labor, the Securities and Exchange Commission, and the General Accountability Office have all advised companies sponsoring retirement plans that conflicts of interest related to investment consultants to plans are widespread and that these conflicts have resulted in reduced returns, as well as higher fees for retirement investors.

Investment consultants advise retirement plan sponsors about allocation of assets (in the case of pensions) or investment options to be offered (with respect to defined contribution 401(k) and 457 plans) and recommend money managers to actually invest the assets of the plan, e.g. buy and sell, stocks and bonds. While every investment consultant I’ve ever met claims to provide objective, independent advice, the industry is rife with conflicts. If the gatekeepers vetting and recommending money managers to plans are corrupt, then the plan’s entire investment program may be tainted.

A very few savvy retirement plan sponsors have heeded regulatory and governmental warnings about this ethically-challenged industry. Most, unfortunately, have not.

Earlier this year, the Orange County Board of County Commissioners, Orange County, Florida, issued a Request for Proposals inviting interested parties to submit proposals for providing investment consulting services related to approximately $200 million in retirement assets.  

The RFP indicated that the County intended to utilize an outside consulting firm to conduct due diligence reviews of all proposing firms. As stated in the RFP, “Such due diligence reviews will include, but not be limited to, investigation of conflicts of interest, scrutiny of prior work product and contact with client references. Proposers consent to these due diligence reviews by responding to this RFP.”

My firm, Benchmark Financial Services, Inc. was retained by the County to conduct a due diligence review of the firms responding to the RFP.

This seemingly straight-forward project proved to be no lay-up. Increasingly I have come to accept that if an assignment seems easy, I’m probably not doing my job.  

The Minimum Firm Requirements included in the RFP included, “The firm must not be affiliated in any manner whatsoever, either directly or indirectly, with any organization that provides brokerage, insurance, investment management or any other service that, in the opinion of the County, constitutes a conflict of interest. The firm may not derive compensation from any brokerage, insurance, investment management or other provider that, in the opinion of the County, constitutes a conflict of interest. The County retains sole discretion to determine whether actual or potential conflicts of interest exist related to a proposer.”

Our methodology in undertaking the due diligence review was to initially determine whether the firms responding satisfied the conflict of interest prohibitions in the RFP. With respect to firms that clearly did not satisfy this requirement, little or no further review was undertaken. Why rub salt into the wound? With respect to firms that did satisfy the conflict of interest prohibition, or initially appeared to, client references were contacted, copies of their most recent Securities and Exchange Commission filings, along with the results related to their most recent SEC examinations, were reviewed.

The following seven investment consulting firms responded to the RFP: The Bogdahn Group; Bolton Partners; Dahab Associates, Inc.; FiduciaryFirst, LLC; Meketa Investment Group; PFM Asset Management LLC; and Segal Rogerscasey. In our final opinion, only one firm satisfied the conflict of interest concerns.

While Graystone Consulting, mentioned below, did not respond to the RFP, a limited review was undertaken of the firm in response to an inquiry received by the County from the firm.

A.     BOLTON PARTNERS INVESTMENT CONSULTING GROUP, INC.

In its March 13, 2013 cover letter, Bolton indicated that “the firm is independent and does not have any relationships with investment managers, brokers, plan administrators or custodians.” The firm indicated that it was “paid on a flat fee basis and does not accept soft dollars as payment for its services.”

In its RFP response, Bolton stated, “We do not derive compensation from any brokerage, insurance or investment management providers.” 

In April 2012, I wrote that three Louisiana public pensions which invested $100 million in a New York hedge fund managed by Fletcher Asset Management promising high returns with low risk should have thought twice about defensively referring to the hedge fund in the media as their “best investment.”

Last week, five years after the initial investment in 2008, the Louisiana Firefighters’ Retirement System, the Municipal Employees’ Retirement System and the New Orleans Firefighters’ Pension and Relief Fund filed a lawsuit related to their investment in Fletcher Asset Management, according to The Times-Picayune.

The suit lodges 13 counts against the defendants, which include Fletcher Asset Management and several top executives, administrator Citco Group and its subsidiaries, accounting firm Grant Thornton and investment consulting firm Consulting Services Group, which advised the three pensions on the investment. All three plans have since terminated CSG and hired new investment consultants or are in the process of conducting a search, according to The Times-Picayune.

The losses resulting from this improbable investment scheme were clearly avoidable, in my opinion.

The three pensions invested a combined $100 million in Fletcher, which promised a guaranteed 12 percent return. Sound fishy? If the fund returned less than 12%, an unnamed financial backer would make up the difference. How could three public funds have fallen for a preposterous investment scheme involving a 12% guaranteed return backed by a mystery investor?

The answer: The investment consultant used by the three pensions, Consulting Services Group recommended it.

The Louisiana funds had plenty of warning that CSG’s advice might be conflicted.

In 2004, the Legislature of Louisiana had voted to enact a new law aimed at providing greater protections to public pension systems within the state. R.S. 11:269 required pension consultants and money managers to provide public pensions with full disclosure of any conflicts of interest, including payments these advisers received from money managers they recommended to pensions.

Louisiana was the first state to adopt such legislation aimed at thwarting “pay-to-play” schemes involving public pensions– approximately a year before the SEC and DOL released their findings and recommendations.

Then-State Representative M. P. Schneider, III, Chairman of the House Retirement Committee and an ex-officio trustee of the 13 state systems, invited me to testify at a March 21, 2004 hearing about unsavory practices involving investment advisers to public pension funds. Schneider had championed this legislation and was concerned conflicts of interest could be undermining the performance of the state’s already severely underfunded pensions.

I testified that I believed, based upon actual knowledge, some disturbing financial relationships between consultants and investment managers retained by Louisiana public pensions would be revealed through the legally-mandated disclosure process. Schneider and I subsequently discovered that while the funds, their managers and investment consultants would comply with the requirements of the new law, none of the pensions within the state were interested in proactively investigating the types of abuses upon which the new legislation was focused—even when we warned the pension officials that we had reason to believe the funds they oversaw were at risk. But there’s more.

In 2006, a publicly-available fiduciary review conducted by my firm on behalf of the $1 billion plus Shelby County, Tennessee retirement system investigated conflicts of interest and undisclosed financial arrangements involving the investment consulting firm which served advised that pension, CSG.

As we opined in 2006, “the pension has been relying upon an investment consultant who was subject to myriad conflicts of interest for objective advice regarding management of its assets. These conflicts, as well as the compensation derived by the investment consultant, have not been adequately disclosed. The review uncovered that the consultant has undisclosed arrangements with many of the Fund’s managers and earns $4 million to $5 million a year in brokerage commissions.”

As a result of the recommendation of the investment consultant, Shelby County had, at that time, $135 million or approximately 15% of its assets invested with over 120 largely unregulated high-risk money managers scattered throughout the world whose identities, securities holdings, trading costs and custodians were unknown. The findings in our report were generally dismissed and the County has stayed with CSG, which is headquartered in Memphis, over the years.

While having a national expert in pension forensics review your work may be unnerving, I would expect the chief fiduciary of this multi-billion pension to recognize that the participants paying into the fund have the right to a second (expert) opinion. After all, it is their retirement security that has been jeopardized by the Wall Street feeding frenzy she created at the fund. She’s the architect of “3% COLA Cut/4% Wall Street Bump” so-called pension reform.

Whether she likes it or not, Raimondo has a fiduciary obligation to these government workers, not Wall Street.

The fact that I will publish my findings and report any potential breaches of fiduciary duty or violations of law I uncover to the appropriate regulator or law enforcement (which is my standard practice), should, if she has done her job properly, be of little concern. (By the way, I’ll be speaking about the Rhode Island investigation at the FBI National Academy Associates Annual Training Conference in Orlando next month.)

Instead the Treasurer has come out swinging, using the familiar tactic of arguing that the investigator should be investigated. Kill the messenger before he delivers his message.

As an expert witness testifying in high-stakes adversarial proceedings, I am accustomed to such maneuvers. However, the Treasurer apparently fails to appreciate that we are not adversaries. As a fiduciary to the pension, she has a duty to the very participants who hired me (and who are paying out of their own pockets for this forensic review). We are largely on the same side—both legally bound by a duty to these workers.

In the past few months I have often been surprised by Gina Raimondo’s actions. She behaves like no other fiduciary to a pension I’ve encountered in my 30 years of experience. If the state pension were governed by ERISA, the federal law that protects private pensions, in my opinion she’d be mired in litigation.

For example, she initially publicly stated that she didn’t know the investment advisory fees the pension pays. ERISA requires plan fiduciaries to specifically review the reasonableness of fees. If you don’t know the fees, you obviously can’t establish their reasonableness consistent with your fiduciary duties.

Later she stated that the fees don’t matter—only performance. The Department of Labor has consistently stated that fees are one of the few variables impacting net pension performance that a sponsor can predict/control and are a paramount concern. Past performance does not guarantee future results and future performance is unknowable.

More recently Raimondo has disclosed a small portion of the investment advisory fees, but not all the fees that are applicable. In other words, she has understated to participants the investment advisory fees they pay.

On the other hand, she dramatically overstated the performance of Point Judith II, the venture capital fund she formerly managed and in which the state pension invested. Initially she told the public the  performance of the fund was 22% to date but later corrected herself to say 12% was the correct unenviable return.

Prudent practice requires fiduciaries to be especially careful to accurately disclose information related to self-dealing or conflict of interest scenarios.  Don’t defensively shoot from the hip, Gina.

Tom Theado, a pension-benefits litigator I often consult on ERISA matters, tells me that “an ERISA-regulated fiduciary’s ignorance of the advisory fees her plan pays, or the performance a fund in her plan returns, can be actionable,” which is Tom’s legal-ese for saying that ignorance isn’t always bliss.

Rhode Islanders deserve better fiduciary behavior, in my opinion. It is my hope that her staff and I will be able to work together on this forensic review of the state pension. Regardless, the investigation is unstoppable.

American Federation of State, County and Municipal Employees

The Treasurer of Rhode Island reacted angrily to news this week that Rhode Island Council 94 of the American Federation of State County and Municipal Employees had hired me and my firm to conduct a forensic investigation of the state pension she oversees.

While having a national expert in pension forensics review your work may be unnerving, I would expect the chief fiduciary of this multi-billion pension to recognize that the participants paying into the fund have the right to a second (expert) opinion. After all, it is their retirement security that has been jeopardized by the Wall Street feeding frenzy she created at the fund. She’s the architect of “3% COLA Cut/4% Wall Street Bump” so-called pension reform.

Whether she likes it or not, Raimondo has a fiduciary obligation to these government workers, not Wall Street.

The fact that I will publish my findings and report any potential breaches of fiduciary duty or violations of law I uncover to the appropriate regulator or law enforcement (which is my standard practice), should, if she has done her job properly, be of little concern. (By the way, I’ll be speaking about the Rhode Island investigation at the FBI National Academy Associates Annual Training Conference in Orlando next month.)

Instead the Treasurer has come out swinging, using the familiar tactic of arguing that the investigator should be investigated. Kill the messenger before he delivers his message.

As an expert witness testifying in high-stakes adversarial proceedings, I am accustomed to such maneuvers. However, the Treasurer apparently fails to appreciate that we are not adversaries. As a fiduciary to the pension, she has a duty to the very participants who hired me (and who are paying out of their own pockets for this forensic review). We are largely on the same side—both legally bound by a duty to these workers.

In the past few months I have often been surprised by Gina Raimondo’s actions. She behaves like no other fiduciary to a pension I’ve encountered in my 30 years of experience. If the state pension were governed by ERISA, the federal law that protects private pensions, in my opinion she’d be mired in litigation.

For example, she initially publicly stated that she didn’t know the investment advisory fees the pension pays. ERISA requires plan fiduciaries to specifically review the reasonableness of fees. If you don’t know the fees, you obviously can’t establish their reasonableness consistent with your fiduciary duties.

Later she stated that the fees don’t matter—only performance. The Department of Labor has consistently stated that fees are one of the few variables impacting net pension performance that a sponsor can predict/control and are a paramount concern. Past performance does not guarantee future results and future performance is unknowable.

More recently Raimondo has disclosed a small portion of the investment advisory fees, but not all the fees that are applicable. In other words, she has understated to participants the investment advisory fees they pay.

On the other hand, she dramatically overstated the performance of Point Judith II, the venture capital fund she formerly managed and in which the state pension invested. Initially she told the public the  performance of the fund was 22% to date but later corrected herself to say 12% was the correct unenviable return.

Prudent practice requires fiduciaries to be especially careful to accurately disclose information related to self-dealing or conflict of interest scenarios.  Don’t defensively shoot from the hip, Gina.

Rhode Islanders deserve better fiduciary behavior, in my opinion. It is my hope that her staff and I will be able to work together on this forensic review of the state pension. Regardless, the investigation is unstoppable.

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

Welcome back, would-be scammers. Apparently many readers have accepted my postulate in Part I of this series that a life of crime can pay off handsomely. History is replete with examples of people who have done very well for themselves by stealing from others, I said.

You’re also willing to heed my advice that intelligent thieves aim to get their hands on buckets of other people’s money without the use of force and prey upon victims that will almost certainly not report the criminal taking (or, better still, even understand they’ve been snookered). Still, I understand you hunger for more “fleecing facts” and I admire your dedication.

One reader asked, “You say, if you can come up with a far-fetched idea that transfers the investor’s wealth to you dollar-for-dollar, legally, you’ll never go hungry.” Give us an example, says the reader, “purely for entertainment purposes.”

Folks, Forbes is not about entertainment. We’re all about education—usually educating investors, as opposed to fraudsters. While I’m not-so-sure the request for additional detail about constructing the perfect hustle is entirely innocent, and since this is, after all, a series about stealing, I’ll honor it.    

Here’s an example based upon a typical investment offered by the major private banks that cater to the wealthy, offering supposedly red-carpet treatment. Through decades of forensic investigations I’ve learned that there are few rip-off artists more skilled than banks. Don’t waste your time hating banks—learn from them and you’ll be vacationing in the Caymans next winter sporting a new diamond-studded Rolex Rolex.   

It’s called a “structured product” and it invests in a fund of, you guessed it, hedge funds—the priciest of investments. I call hedge funds “money management on steroids” because these funds charge fees hundreds of times greater than traditional investments.

Pay attention as I explain this sleight of hand involving $1 million.

Assume an investor puts $1 million in a structured hedge fund product and pays a 5% sales load; a 2% fund-of-funds investment advisory fee; 2% underlying hedge fund investment advisory fees; and a 20% performance fee. Assume further that the underlying hedge funds leverage their assets (which is common) 200% and pay a 5% borrowing rate. This may sound like a lot of fees and it is. But I have actually investigated private bank products that impose all of the above fees and even greater expenses, such as trading commissions.

Assume further the investment returns 5% annually after all fees and expenses. Within 7 years, an amount equal to the pigeon’s original investment, or $1 million, will have been pilfered.

That’s what I call a dollar-for-dollar wealth transfer and it’s perfectly legal. My friends, if you’re going to steal $1 million, this is the way to do it.   

“Do the math and you’ll see that over that 7 year period, virtually 100% of the investment return has gone to the promoter,” says noted securities expert Steve Pomerantz. With a little advanced training, as well as savvy legal assistance, that “promoter” could be you.

This type of ruse must be complex and opaque, involving multiple layers of seemingly insignificant disclosed and undisclosed fees that add up, unbeknownst to the investor, to a lot.

The “Power of Compounding” Versus the “Beauty of Bleeding”

Warren Buffett often cites the “power of compounding” in his investment sermons. Scammers need to embrace what I term the “beauty of bleeding.”