WASHINGTON, D.C. – After months of pondering the issue of “pay-to-play” involving public pensions, the Securities and Exchange Commission (SEC) in early August proposed a rule aimed at stamping out the practice.
The measure is directed at financial advisers, a category the SEC deems to include managers of private investment companies, such as venture capital firms. The rule is meant to keep them from giving donations to influential politicians who can help secure contracts or investments from public pensions or other “government entities” such as public university endowments.
Under the new rule, if an executive from a venture firm or a third party “solicitor”operating on the firm’s behalf, gave money to a politician sitting on the board of a public pension or endowment, the venture firm would be prohibited from receiving money from the board for two years. If the venture firm were already managing the money of a pension or endowment, the firm could expel the public fund and return its capital and its share of the profits. Alternately, the venture firm also could continue investing the pension’s money, but it would be banned from accepting any fees or a carried interest split on the pension or endowment’s money for two years, said Robert Plaze, SEC associate director in the division of investment management.
A financial adviser would be forbidden from obtaining a contract from a client if the SEC rule was breached. If an advisory firm had an existing relationship with a pension when a donation was given, the same rule would be triggered, but the consultant could not just drop its client. Rather, the adviser would have to provide its services for free until the client hired another adviser. The SEC has not set a time limit on the gratis service, although that might be included in a final draft of the measure, which will be completed following the end of a public-comment period in early November.
The SEC rule would allow financial advisers and general partners at venture capital firms to donate as much as $250 per election to an office holder or candidate for whom the contributor is eligible to vote for.
Pay-to-Play Alleged in 16 States
The practice of pay-to-play – an attempt to gain the business of a public entity by making campaign contributions to powerful officials on their boards – has attracted a lot of media scrutiny in recent years. Former California State Teachers’ Retirement System (CalSTRS) Chief Investment Officer Thomas Flanigan two years ago wrote a letter to the SEC complaining about the practice.
The fear is that such illicit influence could lead pensions and other public entities to choose less competent advisers or investment managers who might also charge higher fees over applicants whose executives did not make campaign contributions.
SEC records show allegations of pay-to-play at government entities in the District of Columbia and 16 states: California, Connecticut, Illinois, Louisiana, Maryland, Massachusetts, Minnesota, Nebraska, New York, North Carolina, Ohio, Oregon, Pennsylvania, Rhode Island, Texas, Vermont and Wisconsin. Connecticut and Vermont have passed their own anti-pay-to-play laws to combat the problem.
The pending federal rule is posted on the SEC’s Web site (www.sec.gov) under the “proposed rules” category, and the public may send comments about the draft to the SEC until November 1. At that time, SEC staffers will suggest alterations to the measure, and it will be submitted to the commission for a final vote. The earliest such a rule would take effect would be 2000, Plaze estimated.
The Feedback Begins
The nation’s largest state pension, the $159 billion California Public Employees’ Retirement System (CalPERS) issued a brief statement in August expressing its support for the “concepts put forward by the SEC.” The pension last year adopted a policy that would prohibit pay-to-play donations, but it is not yet effective.
Pension board member and California Controller Kathleen Connell last year sued CalPERS over the constitutionality and fairness of its ban and last fall she won on a technicality (VCJ, November 1998, page 5). CalPERS has put on hold its efforts to resurrect a revised version of the rule pending the outcome of the SEC anti-pay-to-play efforts, and the pension expects its staff to make a report about the SEC initiative in October to its Benefits and Program Administration Committee. A Connell spokesman said she had not had time to review the SEC proposal by press time and therefore could not comment.
Across town, at the California State Teachers’ Retirement System (CalSTRS), Chief Executive Officer Jim Mosman was busy studying the SEC proposal as well. He emphasized that the pension’s legal staff was still reviewing the plan, but he wondered exactly how much effect the rule would have on the $100 billion CalSTRS. Many of the pension’s private investment decisions and many of its advisory contracts are handled solely by in-house staff, and there is no direct public official influence on those decisions.
Abbott Capital Management Managing Director Stan Pratt said he favors the SEC rule. “I think it would clear up what is clearly a potential conflict of interest.”
Pratt also likes that the proposal would allow advisers and G.P.s to donate modest amounts to their local candidates.