In April the U.S. Department of Labor announced a settlement with investment firm Morgan Keegan. The settlement requires the firm to pay over $600,000 to ten of the firm’s pension plan clients. The settlement follows a DOL investigation that found Morgan Keegan “violated federal law” in recommending certain hedge funds of funds as investments to the clients. According to the DOL, “these recommendations resulted in the hedge funds of funds paying Morgan Keegan revenue-sharing and other fees.”
News articles call the payments to Morgan Keegan kickbacks. A link to the DOL press release announcing the settlement appears here. The press release states that the behavior investigated occurred during a seven year period that ended November 2008.
Hopefully Morgan Keegan is chastened by the settlement with the DOL, the required payments to clients - some of which one supposes may now be former clients - and the resulting embarrassment from unflattering headlines. Those consequences should reduce chances the firm is a repeat offender when it comes to accepting monies it shouldn’t.
But what incentives exist to cause a hedge fund of funds to not offer or make payments it shouldn’t to a firm that can steer pension-assets-to-be-managed to the fund? Apparently not many. According to the person identified in the press release as a DOL contact person, the DOL is not making public the names of the hedge fund of funds that made the payments.
Hard to stamp out “pay to play” in pension investment management if one works only one end of the problem. (Granted, some payments that appear questionable may be made with innocent intent. And of course even if a payment was made with other than innocent intent proving “pay to play” often is difficult.)
And several additional unanswered questions remain. How many hedge funds of funds made payments to Morgan Keegan? Did any individuals at the funds or at Morgan Keegan incur any regulatory or legal consequences in the matter? What was the value of the pension assets invested with the funds as a result of Morgan Keegan’s recommendations? Did the funds disgorge any management fees or other revenues resulting from the Morgan Keegan recommendations? Does the $600,000+ bear a relation primarily to, or is it derived primarily from, the total untoward payments Morgan Keegan received? If a pension plan invested in several hedge fund of funds pursuant to Morgan Keegan’s recommendation then surely in connection with the DOL settlement the plan was told which fund or funds made questionable payments to Morgan Keegan, right? Are the disclosure obligations Morgan Keegan agreed to in the DOL settlement prospective only? (The DOL press release isn’t clear about that.) Was the financial crisis a factor in the November 2008 end of the matters investigated? And if so then how? How did the tainted hedge fund of funds investments perform? (Of course, good performance doesn’t make “pay to play” acceptable. But also, of course, poor investment performance compounds the foul.) According to the DOL’s contact person, the DOL isn’t releasing the names of the plans affected. Why? And have the plans’ participants been notified – or will they? And so on.
In investment management, until payors of questionable payments receive the same investigative scrutiny as payees, “pay to play” will slither along. And payees’ clients and the clients’ beneficiaries – pensioners, in this Morgan Keegan situation - will continue to bear the considerable investment costs of the distortions in investment decision-making caused by “pay to play.”