SEC votes to ban placement agents

In the latest blow for the beleaguered fund placement business, the Securities and Exchange Commission has voted to propose its own ban on the use of third-party agents with regard to public pension funds.

The move follows the pay-to-play scandal involving the New York State Common Retirement Fund, which broke in mid-March, and the introduction of a code of conduct for investing with public pension funds by New York State Attorney General Andrew Cuomo in May that also seeks to prevent investment firms from hiring placement agents to help in their efforts to secure pledges.

“In taking these steps today, I think we can help to level the playing field for all advisers, both large and small, so that they can compete for government contracts based on investment skill and quality of service, not based on political contributions and inappropriate under-the-table payments,” said Mary Schapiro, chairman of the SEC, in a statement issued on July 22.

The SEC issued a press release detailing the nuts and bolts of its proposal although the actual wording of the measures has yet to be released. Once the rules are officially released, there will be a 60-day period for open comments from the public.

Similar to Cuomo’s code of conduct, the SEC so far isn’t leaving much room for interpretation. There’s no mention of setting up a system to vet and register placement agents, especially shops on the smaller end of spectrum that often lack internal resources to market their funds.

Instead, the proposal eliminates the use of any and all third parties and outlines a number of restrictions for political contributions.

While an outright ban would be difficult to justify, the proposed restrictions on political contributions, as sketched out, have a basis in common sense. The proposal would prohibit investment advisers from making contributions to elected officials who can influence what firms get business from the pension fund. Anyone found to have made such a contribution would be barred for two years from providing advisory services for compensation, either directly or through a fund.

The SEC proposal allows for an executive or employee of the investment firm to make contributions of up to $250 per election per candidate as long as the contributor is entitled to vote for the candidate. The rules also address various ways around the spirit of barring the political contributions, such as prohibiting the use of spouses, lawyers or companies affiliated with the investment adviser to indirectly make contributions and blocking contributions to a political party in the state or locality where the adviser is soliciting business.

The proposal, if adopted in its current form, would at least philosophically support the Cuomo code of conduct, which to this point has only been adopted by private equity players under investigation in New York. Cuomo applauded the SEC’s move.

“These rules will institutionalize on a national scale the principles we established in our Code of Conduct,” Cuomo said in a statement, adding later: “These reforms are essential to eliminating the corruption in the current system.”

In June, Riverstone Holdings agreed to pay $30 million to end a probe of its role in the pay-to-play scandal involving the New York Common Fund. The Carlyle Group, its sometime investment partner, paid $20 million in May to resolve its role in the investigation.

Cuomo said in May he was working closely with state and federal officials to combat the use of unregistered middlemen in pension fund investments, but the results of those efforts are pending.

Implementation of a specific registration system for placement agents has been suggested before, but there hasn’t been a groundswell of industry support for the idea. After all, legitimate agents most likely don’t see the necessity. They are likely to already be registered as broker-dealers with either the Financial Industry Regulatory Authority (FINRA) or the Securities Investor Protection Corp. (SIPC). Examples include Atlantic-Pacific Capital, which is registered with both FINRA and SIPC, and Probitas Partners, which is registered just with FINRA.

Another consideration is the in-house fund placement businesses of investment banks, such as Credit Suisse and Lazard Ltd., as well as the activities of The Blackstone Group, which provides placement agent services through its Park Hill Group unit. It’s unclear how the proposed bans being discussed would account for the operations of these in-house placement agents, which are established names in the private equity industry.

The reaction from the limited partner side of the aisle, aside from pension funds with some direct link to pay-to-play allegations who have adopted their own bans, has been to move toward increased disclosure of fees paid to placement agents rather than an outright ban. That was the route chosen recently by the California Public Employees’ Retirement System, the nation’s largest pension fund.