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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Risks and Opportunities for Public Pension Plans

Keynote Address by

Paul F. Roye

Director, Director, Division of Investment Management
U.S. Securities & Exchange Commission

Before the Public Funds Symposium

July 17, 2001

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed in this speech are those of the author, and do not necessarily reflect the views of the Commission or other members of the staff of the Commission.

I. Introduction

I am pleased to be here at this year's Public Funds Symposium. And I am equally pleased that the conference sponsors have characterized the SEC's latest initiatives in overseeing the money management industry as "vigilant, virtuous and valiant". For the most part, the investment management industry continues to be virtuous in helping investors prepare for their retirement. But we continue to be vigilant in identifying those instances when some members of the investment management industry act in a manner inconsistent with their fiduciary obligations. Today I want to discuss some of those instances with you, and the cautionary lessons that they provide. Specifically, given the importance of public pension funds to our securities markets and those who depend on their viability, I thought I would discuss efforts on the part of the SEC to target fraud in the pension fund area, as well as our efforts to curb fraud in the investment adviser area. In addition, I would like to discuss some of the emerging trends in the public pension plan area and some of the implications of these trends, including the growing interest by pension plans in alternative investments such as hedge funds and the movement away from defined benefit plans to defined contribution plans. Finally, I will discuss efforts on our part to encourage investment advisers to maximize value for clients and improve the regulation of investment advisers.

II. Importance of Public Pension Funds

The U.S. retirement market, comprising IRAs, defined contribution and defined benefit plans, state and local government retirement funds and fixed and variable annuities, had assets of $11.5 trillion at year-end 2000. Public pension plans today have assets of approximately $2.5 trillion, representing 20% of retirement assets, covering about 13 million state and local government workers and paying benefits to over 5 million retirees. Thus, your funds are among the largest and most active institutional investors in the United States. Indeed seven of the ten largest pension funds in the United States are sponsored by state and local governments. The management of public pension funds significantly affects publicly held companies, the securities markets and the economy as a whole. Perhaps more directly, the management of public pension plans affects taxpayers and the millions of state and municipal retirees who rely on the funds for their pensions and other benefits.

III. Pension Fund Fraud

Through several enforcement actions, the SEC has made it clear that we have zero tolerance for fraud by those entrusted to invest the retirement dollars of pension funds. Given that public pension funds comprise the hard-earned contributions of public employees, it is imperative that such funds be managed with complete honesty and integrity and for the sole benefit of the fund's beneficiaries.

On October 10, 2000, the SEC filed a civil fraud complaint against Paul J. Silvester, the former Treasurer of Connecticut and two private equity firms allegedly involved in a fraudulent kickback scheme in connection with the investment of state pension fund money. The Commission alleges that the scheme worked as follows: Silvester solicited two private equity firms to pay substantial fees to Silvester's close friends and political associates in return for investing $350 million dollars from the state pension fund with those private equity firms. The firms agreed to pay $2.5 million in consulting or finder's fees in order to secure the investments. The complaint alleges that Silvester then demanded and received kickbacks of a portion of these fees from his friends. A criminal action was also filed in this matter.

The Commission's complaint contends that the two private equity firms and certain of their firm's officers violated their fiduciary duties by failing to disclose the quid pro quo.

The complaint alleged violations of the antifraud provisions of the federal securities laws and sought to enjoin each of the defendants from continuing to violate or aid and abet violations of these laws. The Commission also sought disgorgement of monies fraudulently received by the defendants and civil monetary penalties. Silvester; Landmark Partners, Inc., one of the private equity firms; a consulting firm; and an associate of Silvester's settled the Commission's charges, without admitting or denying the allegations in the Commission's complaint. The case remains pending against six additional defendants.

The harm to investors in these types of cases is not unlike the harm suffered in municipal finance "pay-to-play" cases. While we did not allege that the pension fund lost money, we asserted that the process of selecting investments for the pension fund was corrupted.

In another case, we also made it clear that investment adviser pay-to-play will not be tolerated. In June 2000, the Commission charged William Stephens, the Chief Investment Strategist of a large San Francisco-based investment adviser, with participating in a kickback and bribery scheme involving the investments of certain labor union pension funds. The Commission alleged that in order to land the pension funds as advisory clients, Stephens agreed in advance to channel a portion of the funds' assets into rigged investment vehicles from which a portion of the funds' assets would then be siphoned off to trustees of the funds as kickbacks.

The Commission alleges that the fraudulent investments were designed to appear legitimate, so as to withstand scrutiny by union fund officials who were not involved in the bribery scheme. The investments included preferred stock issued by a realty trust listed on the New York Stock Exchange and an interest in a hedge fund. A hearing will be held before an administrative law judge to determine whether the allegations against Stephens are true, and if so, what remedial actions, if any, are appropriate.

IV. Pay-to-Play Rule Proposal

As many of you may be aware, the SEC has outstanding a proposed rule under the Investment Advisers Act that would prohibit investment advisers from making political contributions to obtain government contracts to manage public pension funds.

Modeled substantially on the Municipal Securities Rulemaking Board's Rule G-37, which prohibits municipal bonds dealers and brokers from engaging in pay-to-play, the proposed rule would generally prohibit investment advisers registered with the SEC from providing public pension plan advisory services for two years after the adviser, or any of its partners, executive officers or solicitors, contributes to the campaigns of certain elected officials or candidates. The rule would exempt certain de minimus contributions. The rule would also require registered advisers with government clients to keep records of their political contributions.

The rule proposal generated a lot of controversy, with some persons questioning its approach and scope. Some argued that the nature of the investment adviser industry warranted a different approach to the problem of pay-to-play rather than the G-37 approach. And indeed, the Municipal Securities Rulemaking Board is currently soliciting comment on Rule G-37 regarding areas in which the rule should be modified for the municipal finance industry, including the rule's scope, provisions on waivers and de minimus contributions. Additionally, subsequent to the issuance of our proposal, the Investment Counsel Association of America issued recommended best practice guidelines for advisers to adopt in order to prevent pay-to-play practices. Consideration of a final rule in this area awaits review by the new Chairman of the agency.

V. Investment Adviser Fraud

The Commission continues to bring a number of enforcement actions, involving investment advisers. Although the SEC has brought a number of cases involving non-controversial antifraud charges, such as, out-and-out theft of client's assets; the SEC has also targeted various fraudulent practices peculiar to the operations of investment advisers, including fraudulent marketing and advertising. Fraudulent advertising may take many forms including use of inflated and/or selective performance results, misleading use of back tested data, misleading use of model or hypothetical data, submission of false or misleading information to publications and consultants and use of false information about compliance with AIMR standards.

The Commission and staff have also devoted significant enforcement and examination efforts to individual conflicts of interest and personal trading by investment advisers. Recent enforcement actions have involved front running and other abusive trading practices by which insiders unlawfully benefit from their positions. For example, in a case involving Nicholas-Applegate Capital Management, the Commission instituted administrative and cease and desist proceedings against an adviser in which a portfolio manager engaged in a day trading strategy in which he fraudulently allocated profitable equity day trades to his personal account rather than to the pension plan he was managing. The firm's procedures gave the portfolio manager the opportunity to allocate a buy or sell of the same security within the same day to the pension plan or to one of his personal accounts without anyone's knowledge or consent. The federal district court entered a judgment of permanent injunction and other relief against the portfolio manager. Following the entry of the judgment, the SEC settled the administrative proceeding against the portfolio manager, baring him from association with any investment adviser and ordered the portfolio manager to disgorge his ill-gotten gains. The Commission found that the advisory firm failed to reasonably supervise the portfolio manager and the firm was required to pay a civil money penalty of $250,000 and maintain and implement corrective compliance procedures.

The Commission has also continued to consider the appropriateness of various trading practices by investment advisers. A number of enforcement actions have addressed the practice by which investment advisers favor one or more clients over other clients in the allocation of trades. For example, we have brought actions involving situations in which investment advisers have favored its performance fee-paying clients over its other clients in the allocation of hot IPOs and other equity trades, and in situations in which hot IPOs were disproportionately allocated to certain clients to boost performance records for marketing purposes.

The Commission has instituted a number of enforcement actions in recent years concerning the best execution and soft dollar practices of investment advisers. These cases have involved the use of soft dollars improperly to pay for certain undisclosed expenses, including personal travel, marketing and other non-research administrative expenses of the adviser, as well as undisclosed soft dollar arrangements directing client brokerage in exchange for client referrals, including the payment of excessive commission rates for these referrals.

Earlier this year, the Commission filed suit against investment adviser Gordon J. Rollert of Wellsley, Massachusetts, alleging that he defrauded one of his clients, a church in Auburn, Massachusetts, of approximately $900,000. In the complaint, the Commission alleges that Rollert used his investment advisory firm, to misappropriate hundreds of thousands of dollars in soft dollar credits generated by securities transactions made on the church's behalf. The complaint further alleges that as part of the scheme to misappropriate soft dollar credits, Rollert submitted over a hundred invoices to the broker-dealer for payments with soft dollars that had been generated by trading in the church's account. Many of the invoices that were submitted were in the name of a shell entity that Rollert controlled, and indicated that the entity had provided services to the advisory firm. It is alleged that Rollert personally picked up these payments from the broker-dealer and deposited them into bank accounts that he controlled and then withdrew the majority of the funds for his personal use. The Commission also alleges that Rollert violated his fiduciary duty of best execution for his client's securities trades by fraudulently setting the commissions paid by the church at a rate that was approximately five times higher than the average rate charged for soft dollar transactions at the time. The Complaint also alleges that Rollert churned the church's account to generate soft dollar credits, which he allegedly misappropriated.

The Commission also sued a New York pension fund manager, Alan Bond, alleging that he fraudulently received over $6.9 million in kickbacks from brokerage firms in connection with his management of pension and investment funds of such notable clients as the National Basketball Association Player's Pension Plan, the Washington Metropolitan Transit Authority Retirement Fund and the City University of New York. Bond was a frequent guest on PBS's Wall Street Week with Louis Rukeyser.

The Commission's complaint alleges that Bond received commission kickbacks from three brokerage firms through trades directed to these firms by his money management business. It is alleged that the kickbacks he received were siphoned off the investment returns of his clients in the form of mark-ups on principal trades in the over-the-counter market. According to the complaint, Bond dictated to the brokerage firms the amount of the mark-up on each trade and the firms, in turn, kicked back 57 - 80% of the mark-up to Bond. The Commission's complaint alleges that most of the money in this scheme went to finance Bond's lavish personal lifestyle. In addition to 75 cars (luxury and antique) and two real estate properties in Florida, Bond frequently went on shopping sprees running up American Express bills of $200,000 to $470,000 a month. It is also alleged that Bond used some of the illicit payments to purchase gratuities for the trustees and employees of his pension fund clients, including limousine service, overnight stays in posh hotels, expensive clothing and tickets to sporting events.

In February of this year, the heads of two now defunct broker-dealer firms were fined and sanctioned in conjunction with this alleged kickback scheme.

VI. Best Execution

Short of actual fraud, many advisers need to pay more attention to seeking the best execution for their clients' trades.

If an adviser is in a position to direct brokerage transactions, the adviser's fiduciary duty includes the requirement to seek the best execution for clients' securities transactions. The SEC has stated that:

The [Adviser] must: execute securities transactions for clients in such a manner that the client's total cost or proceeds in each transaction is the most favorable under the circumstances. [An Adviser] should consider the full range and quality of a broker's services in placing brokerage including, among other things, the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness to the money manager. The Commission wishes to remind [Advisers] that the determinative factor is not the lowest possible commission cost but whether the transaction represents the best qualitative execution for the managed account. In this connection, [Advisers] should periodically and systematically evaluate the execution performance of broker-dealers executing their transactions.

Many factors go into a "best execution" analysis, for example:

  • Obtaining the best price (for large trades, this means getting the whole trade done with the least amount of market impact);

  • The speed of execution;

  • The certainty of execution; and

  • The commission rate or spread.

Commission staff have spent quite a lot of time in examinations recently looking at how advisers fulfill their duty of best execution. The staff no longer examines only commission rates and trade prices, but has expanded its review to focus on the process by which an adviser seeks to achieve best execution. While our Office of Compliance Inspections and Examinations ("OCIE") is currently working on a report of its findings, I wanted to share with you, as clients of investment advisers, some of their observations. First, not all advisers consider possible execution alternatives. Some advisers appear too comfortable with existing execution quality. Remember that advisers are required to perform a "periodic and systematic" review. One would think that this would lead to rerouting orders on occasion and not routing status quo. Second, advisers don't always identify those execution quality factors that they are relying on in routing order flow, and they don't always analyze these factors in a systematic way. In particular, advisers should consider the opportunity to obtain better executions for clients in light of the conflicts of interest in trade placement, including directing brokerage to broker-dealers that make client referrals to the adviser, and using commissions to pay for research or other services. OCIE has observed some practices that should be considered by advisers:

  • Some advisers have established a committee to review trade placement and best execution. This committee aids in identifying all factors that are important to the firm in routing trades.

  • Some have established criteria to measure these factors. As part of this process they obtain and review a variety of quantitative as well as qualitative information.

  • Others have procedures to identify, resolve and disclose conflicts of interest in trade placement.

It makes no sense for you to try and identify managers that will make superior investment decisions without also investigating whether the firm is likely to lose or give away the value of these decisions through sloppy placement of orders for execution. As clients, by demanding that all relevant information and attendant conflicts of interest regarding trade placement are periodically and systematically evaluated, you can help ensure that your adviser obtains best execution and achieves the highest returns for your fund and its beneficiaries.

To reduce transaction costs, more and more pension plans now have commission recapture programs whereby trades are directed to brokers who are willing to rebate commissions to the plans. But you should note that restricting money managers to only a few brokerage firms can potentially result in poor execution, such that the savings achieved through the rebates can be lost through the price at which the trades are effected.

VII. Alternative Investments

I think it is entirely appropriate that your conference program emphasizes that there is no "safe haven" for pension fund assets. U.S. public retirement funds with more than $1 billion lost about 10% of their assets in the nine months ending March 31, putting pressure on some state and local governments to increase spending on pensions. There is certainly no "safe" way to generate the high returns that many funds experienced in the boom market of the 90's. Undoubtedly there are lessons to be learned from the recent reversals in the market, but knowing which lessons are the right ones is more important than just stampeding away from the technology investments which were touted as a sure path to above-average returns to the next strategy holding out the same unrealistic promise.

Hedge funds are the "new" craze in the pension plan world -- a fact that is borne out both anecdotally and by hard statistics. Tass Research recently reported that the amount of money flowing into hedge funds rose dramatically at the start of this year with $6.9 billion going into them in the first quarter - almost as much as in the whole of last year.

Assets pouring into the hedge fund market have risen by 13% a year for the last five years. At the end of 2000, an estimated 6,000 hedge funds worldwide managed $400 billion of assets. An increasing portion of that growth is coming from pension funds. The California Public Employees Retirement System reportedly is prepared to put up to $5 billion into hedge funds. Experts predict that assets in hedge funds may expand many times over in coming years as a result of increasing interest by institutional investors. Institutional investor interest in hedge funds is partly growing because of the difficult market environment. When equities were moving steadily upwards, pensions funds did not need to worry too much about meeting their growth targets - just about any index fund would do that for them.

The climate now is a lot tougher. Funds that have to generate returns to meet obligations to pensioners need to find a way of boosting their returns - and many of the new, aggressive breed of hedge funds promise to do just that. Many hedge fund managers claim they can produce market-beating returns with an acceptable level of risk. But, of course, risk comes in many forms.

Hedge funds were first thought up by Alfred Winslow Jones in the United States more than 50 years ago as a way of limiting market risk and concentrating on the skills of the manager. Jones' idea was that since no one can predict how markets move, he would buy undervalued stocks and sell overvalued stocks that he had borrowed in order to reduce his overall exposure to the market and hedge against market falls.

But today, there are a multitude of different hedge fund strategies. Some managers seek to profit from extraordinary events in a company's life - for example, takeovers, or changes in regulation. Others specialize in arbitraging pricing anomalies. They seek, for example, to make money out of the difference in prices for the same asset in two markets, or to buy convertibles that are cheap compared to the underlying stock.

Indeed, it seems that the only common denominators in the hedge fund universe are that:

    (1) the managers are paid high performance fees;

    (2) the managers can sell borrowed stock in expectation that the price will fall; and

    (3) the funds are relatively unregulated, which allows the managers to use derivatives or debt to gear up returns and to be more secretive.

High debt and secrecy have become parts of the hedge fund culture. Many hedge fund managers make money because they are privy to information others do not have. Demands for regular disclosure and transparency from investors can hinder this process - if your competitor knows what you are up to, he might get a leg up on you.

As a result, it is harder for hedge fund investors to know how their funds are being managed, much less exert control over the manager. Managers can change investment strategies and their investors would never know. Moreover, it is more difficult for hedge fund investors to vote with their feet. Many hedge funds only allow investors to cash in their holdings on a few days a year.

All of this can make it easier for a hedge fund manager to engage in fraud. If one needs a reason to appreciate the regulatory framework governing the mutual fund industry, you need only look to the recent miniboom we have experienced in hedge fund fraud. The SEC has brought a number of cases in recent months exposing schemes that siphoned hundreds of millions of dollars from investors in these largely unregulated funds. Some have mistakenly concluded that hedge funds are beyond our reach, because they are not subject to registration or reporting requirements. Nonetheless, hedge funds are subject to the antifraud provisions of the federal securities laws. Just last month, the Commission filed securities fraud charges against Burton Friedlander, a hedge fund manager, two investment management entities he controls, and three hedge funds that he manages. The defendants are charged with market manipulation and with fraudulently inflating and misrepresenting the value of one of the funds. Among other things, the Commission charges that Friedlander manipulated the common stock of a company in which the hedge fund held an interest at the end of each month during the last five months of 2000. This conduct is commonly known as "portfolio pumping." The Commission alleges that Friedlander caused approximately $2.4 million in fund redemptions to be made at the inflated fund net asset values for his and his entities' benefit, to the detriment of the fund's other investors. The Commission also alleges that Friedlander assigned arbitrary values to warrants in the fund's portfolio that were higher even than the price of the underlying common stock and caused additional investors to subscribe to the fund at inflated net asset values.

Clearly, the flow of billions of dollars into hedge funds creates opportunities for legitimate fund managers, but also for ponzi scheme operators and swindlers.

There are other reasons to be cautious about the hedge fund craze. The growth in hedge fund assets has caused some market strategists to compare it to the recent technology bubble. These strategists note that hedge funds' strategies usually decrease in effectiveness as their assets grow and that many of the best managers have closed their funds. As a result, over the last year new hedge funds have sprouted in the United States and Europe run by managers with little experience or track record in hedge fund strategies, raising questions about capacity to handle the billions of dollars flowing into these funds.

I do not doubt that hedge funds have some proper role to play in helping pension funds secure the retirement fortunes of their beneficiaries.

However, the nature of hedge fund investments and the relative lack of regulation mandates that you conduct adequate due diligence when considering these types of investments.

Another problem is potential conflicts of interest. Consultants hired to identify hedge fund investments are sometimes involved on some level in servicing the hedge funds they promote. Some firms offer and sell interests in hedge funds that are substantial brokerage customers of their firms.

We also have observed that more and more mutual fund managers and investment advisers are sponsoring and advising hedge funds and other alternative investments. Firms are doing this for a variety of reasons including the higher fees charged by hedge funds, to meet the demands of wealthy and institutional investors, and to retain star portfolio managers. These new opportunities raise conflict of interest issues and the potential for abuse, which we are monitoring carefully in our inspection process. Management arrangements for hedge funds can be structured to enable portfolio managers to participate directly in the profits generated by the funds that they manage. The conflicts in these arrangements result from the differing fee structures of hedge funds and mutual funds and traditional private accounts, and the fact that greater profits can be earned by the adviser from the performance based compensation of a hedge fund. The differing fee structures create a real risk of favoring a hedge fund over a mutual fund or other accounts when making investment decisions. Conflicts can also arise when hedge funds effect short sales of securities, if such securities are held long by mutual funds or private accounts managed by the same advisory firm. Such trades could adversely affect long positions held by the other accounts. Or mutual fund or private account trades could be used to benefit a hedge fund, when the long positions of these accounts are sold after the hedge fund sells the same security short. We expect firms to have compliance procedures in place to address these concerns and we will seek to examine these procedures in the inspection process.

VIII. The Rise of Defined Contribution Plans

Clearly, the growth of pension plans is a principal reason we have more Americans than ever participating in the stock market. Americans also are more directly involved in the stock market because of the growth of defined contribution plans. According to the Department of Labor, the percentage of pension plan participants who were enrolled exclusively in a defined contribution plan grew from 13% in 1975 to 50% in 1996.

More states are adding defined contribution plans, typically 401(a) plans, as an alternative to their established defined benefit plans. Ten states now offer their workers some form of a defined contribution plan, and that number is likely to grow. In most cases, the states enacted optional programs, which gave employees a choice between the defined benefit and the defined contribution plans. But at least one state, Michigan, closed its defined benefit plan to new hires.

Much of the political drive to add defined contribution plans for state employees comes as a growing number of defined benefit plans have become fully funded, thanks in part to the bull market of the 1990s or to reduce the government's liability for future retirement benefits. A frequently cited example is Florida's 401(a) plan, which is scheduled to be unveiled in 2002. Florida's plan is expected to be the largest state defined contribution plan in the nation.

Proponents of defined contribution plans argue that they offer quicker vesting of benefits and allow workers the ability to take investments with them if they change jobs. However, the new plans concern some who fear that state workers do not have the financial sophistication to manage their own money. Approximately 25% of public employees don't pay into Social Security, so they have no safety net if their investments perform poorly.

Thus, an employee who must decide how to invest his or her assets in a defined contribution plan must understand the basics of investing. However, it is not enough that employees participating in defined contribution plans understand the basics of investing, they must also receive adequate information about their investment options from the sponsors of the plans in order to make intelligent choices.

Under the Securities Act of 1933, mutual funds must deliver a statutory prospectus to investors in fund shares outside of pension plans prior to or with confirmation of a sale. The disclosure rules under the Employee Retirement Income Security Act of 1974 (ERISA) only require disclosure about the plan itself.

In 1992, the Division of Investment Management's "Protecting Investors" Study recommended legislation amending the federal securities laws to require the delivery of prospectuses to private sector plan participants who direct their investments. As a partial solution to the lack of investment information for some plan participants, the DOL adopted regulations under Section 404(c) of ERISA.

The 404(c) regulations reduce the exposure of a plan's sponsor and trustees to liability for losses in participant accounts and, at the same time provide employees more information about, and more control over, their investment choices. While the new rules are voluntary, a plan that does not conform to the rules cannot claim immunity from lawsuits by employees who are disappointed with their investment return. Among other things, the 404(c) regulations require that a plan offer a range of diversified investment vehicles. The regulations also require the sponsor to assure that plan participants are given, or can obtain, the information necessary to make an informed investment decision. At a minimum, sponsors must give employees information about each investment option, as well as information about transfer procedures, the expenses and performance of each investment option, and last, but not least, a prospectus for any vehicle, including a mutual fund, which is registered under the Securities Act.

But of course these voluntary ERISA rules do not apply to state and local government plans. This makes it imperative that sponsors and trustees of these plans adopt an aggressive approach to investor education. You need to design an effective educational program for your participants so they can make sound investment decisions. If you are considering moving to a participant directed plan, there is a lot of assistance available to you. Many of the mutual fund firms that are used as investment options provide plan participants with the tools to facilitate retirement plan investing. Comprehensive investment information and counseling are typically made available to participants initially and on an ongoing basis. Just last week Florida announced that it had hired a firm to provide advice to its defined contribution participants.

IX. IARD System

Finally, I thought you might be interested in the fact that we are engaged in a comprehensive effort to modernize our investment adviser regulatory regime. One of our more important priorities and a major step in modernizing the advisory regulatory regime is completion of our Investment Adviser Registration Depository (IARD) and revisions to Form ADV, the investment adviser registration form. A primary goal of ours in developing the new system was to allow advisory clients easier access to important information about their advisers. The IARD Public Disclosure website is scheduled to begin operating in the third quarter of 2001. At that time, members of the public will be able to view an adviser's most recent Form ADV on line for no charge. IARD has completed six months of operations and, by all accounts, has been successful, with most advisers having completed the transition to the new system. A total of 6,900 SEC advisers filed an initial electronic Form ADV through IARD by the end of April. We have had an extremely positive reaction to the relative ease with which the Form can be completed on-line. The system, which is designed as a one stop filing system for investment advisers, will eventually accommodate electronic filing of Part 2 of Form ADV, the investment adviser's brochure, and Form U-4s for investment adviser representatives. We are still analyzing the comments on Part 2 of Form ADV, and are working toward a recommendation to the Commission to finalize the Form. In the proposal to modify Part 2 of Form ADV, we suggested a requirement to update the brochure whenever information in the document became "materially inaccurate." We suggested this because we viewed the annual offer to deliver the brochure as ineffective in communicating important changes in an adviser's operations to its clients.

We also proposed that there be a brochure supplement for supervised persons who regularly communicate investment advice, formulate investment advice for, or make discretionary investment decisions on behalf of, clients. This supplement would describe the person's educational, business and disciplinary background. We think it is important that advisory clients receive background information on the persons for whom they rely on for investment advice. We are anxious to move forward with Part 2 of Form ADV, as we believe the plain English narrative brochure format will greatly benefit investment advisory clients in evaluating investment advisers.

X. Conclusion

I hope my discussion of some of the issues that we are focusing on at the SEC has been informative and useful for you. As trustees, administrators and personnel responsible for public pension plans, you have millions of retirees and taxpayers depending on the success of your efforts. This is a responsibility I know you take very seriously. I hope through our efforts at the SEC we make it easier for you to do your jobs, as we seek the appropriate focus and balance in regulating the investment management industry.

Many of you are trying to determine whether your members are ready for participant directed plans. It is clear that many of you will move toward participant directed plans because your members want to control their financial destiny. In many respects, an era of institutional reliance is ending, as an era of self-reliance has begun. Today, we stand at what may be a defining moment in American economic history, as more and more of us are taking responsibility for our own retirement needs. But, if your participants are not informed and not financially educated, opportunity will lose out to ignorance. We must work together to extend the promise of opportunity and financial security to more Americans. Even in participant directed plans, you will continue to have important fiduciary responsibilities. You will be responsible for evaluating and selecting investment managers and investment options and monitoring services, expenses and performance. There may be instances when you have to terminate an investment manager and substitute another when the manager is not meeting the needs of the participants. At the Commission, we are committed to making your job easier in this regard, be it through better mutual fund prospectuses drafted in plain English, with a focus on essential information including investment risks and fund expenses, or better information regarding advisers through the proposed new Investment Adviser Registration Depository system. Working together we can help more Americans achieve financial security for their retirement years.

I thank you for your attention.


Modified: 07/17/2001