Business Ethics

Pay to Play Investment Consulting: Good Business or Bad Ethics

Many companies, individuals, retirement plans, endowments, and other investors turn to investment consulting firms to assist them in their long-term investment plans. This is as common as an individual hiring an electrician to work on the wiring in their house rather than struggling to do it on their own. By relying on these experts, investors can typically attain better diversified portfolios without having to spend any significant time researching different companies and investment opportunities.1 Consultants work with their clients to draw up an investment strategy that fits their unique needs and often suggest certain funds that fit these established needs.

After creating an investment strategy with their client, investment consultants will hire a money manager to make the investment decisions for each asset class in the client’s portfolio (equities, bonds, real estate, etc.). Money managers often try to sell themselves to investment consultants in an attempt to increase the business that comes their way. Typically, this sales pitch would be given in a formal meeting, over the phone, over lunch, or even at a sporting event or weekend getaway where the costs would be covered by the money manager. This ‘gift giving’ has come to be known as “pay to play” within the industry. Pay to play has been considered the status quo of doing business since the start of the investment consulting industry.2

The practice of gift giving can create a conflict of interest for the investment consultant depending on their role as a fiduciary or non-fiduciary. A fiduciary responsibility means that an advisor is legally responsible for constructing an investment portfolio best suited for each individual client, and then continually monitoring this portfolio. A fiduciary advisor must always put their clients’ needs first. This fiduciary responsibility is enforced by ERISA section 3(21)(A).3...