Pay to Play Law Blog : Pay to Play Lawyer & Attorney : Bribery, Campaign Contributions

On September 23, 2009, New York State Comptroller Thomas P. DiNapoli announced a ban on pay-to-play practices related to the $116.5 billion dollar New York State Common Retirement Fund (the “CRF”). The Comptroller issued an Executive Order and Interim Policy that prohibits the CRF from doing business with any outside Investment Adviser within two years after the Investment Adviser, or any senior officers or executives of the Investment Adviser, has made a contribution to the State Comptroller, or to a candidate for State Comptroller. An “Investment Adviser” is any Investment Adviser required to be registered with the SEC, and those Investment Advisers exempt from registration under section 203 of the Federal Advisers Act.

The Interim Policy does not apply to contributions made by senior officers and executives (specifically defined in the Policy as “Covered Associates”) to the Comptroller or a candidate for Comptroller, provided that the individual was entitled to vote at the time of the contribution, and the aggregate amount of the contribution does not exceed $250 to any one candidate per election.

The Interim Policy goes into effect on November 7, 2009, and will remain in effect until the SEC adopts a final rule pertaining to political contributions.

The New York State Comptroller is a statewide elected official, and is the sole trustee of the CRF, which is the third largest pension plan in the United States. Two different retirement systems receive benefits from the CRF: the Police and Fire Retirement System and the Employees Retirement System, which include both State and local employees. Together, these systems have over one million members, retirees and beneficiaries.

Ban on Placement Agents

The ban on political contributions from Investment Advisers follows the Comptroller’s recent prohibition of the use of “placement agents”.

On April 22, 2009, Comptroller DiNapoli announced a ban on the use of third-party placement agents and other paid intermediaries and lobbyists (herein, “placement agents”) with respect to investments with the CRF. The ban precludes placement agents from accepting any type of fee for providing access to the CRF and its investments.

The ban on placement agents followed an investigation by New York State Attorney General Andrew Cuomo, which in March of 2009 resulted in a 123-count indictment against two aides of former State Comptroller Alan Hevesi, on charges that they brokered deals between the CRF and politically-connected outside investment funds, earning millions of dollars in fees in the process. That case is awaiting trial. Comptroller Hevesi resigned in 2006, and subsequently plead guilty to charges of defrauding the government, which arose out of his use of state employees for personal purposes.

Attorney General Cuomo’s ongoing investigation of public pension fund corruption has involved several private equity and investment firms. Many firms have settled with the Attorney General’s Office in recent months, and while generally not admitting wrong doing, have agreed to: (i) make a significant settlement payment, which will be submitted to the CRF, and (ii) sign a “Public Pension Fund Reform Code of Conduct”, which prohibits the use of placement agents with respect to public pension funds, and bans campaign contributions to officials at public pension funds.

Ban on Placement Agents - New York City

In April and May of 2009, the trustees of the City of New York’s five municipal pension funds each voted to suspend the use of placement agents.

The five pension funds are the City Employees Retirement System (“NYCERS”), which is the largest municipal public employee retirement system in the U.S.; the City Fire Department Pension Fund; the City Police Pension Fund; the New York City Teachers Retirement System and the City Board of Education Retirement System. The funds have combined assets of approximately 80 billion dollars. 

Contributed by Kelly Lamendola, Esq.
Albany, NY
McKenna Long & Aldridge LLP

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While most agree the SEC’s proposed new pay-to-play rules are a necessary development, there has been controversy around a proposal that would ban placement agents from representing clients before state and local persons. Unlike the MSRB pay-to-play rules, the SEC would prohibit investment advisers from using any third party intermediary, including placement agents registered as broker-dealers with the SEC, to solicit municipal investors on their behalf. In several comment letters filed with the SEC, participants in the private equity and venture capital industry argue that the SEC’s proposal to ban investment advisers’ use of third-party placement agents is overreaching and will put small and new funds out of business. London-based private equity research firm Preqin said in a comment letter that 85% of public pension funds and other institutions handling public money felt larger managers would be the main beneficiaries of the proposed ban.

Industry leaders such as Blackstone (which has a proprietary placement agent) have been urging the SEC to reconsider its proposed outright ban because they believe that third-party placement agents play a vital role for investment advisers. Blackstone’s Chief Executive Officer, Stephen Schwartzman, said in a comment letter that he agrees with getting rid of political fixers, but taking the “drastic step” of eliminating the function of legitimate placement agents would unfairly burden firms just starting out. For many first-time funds, a placement agent is often utilized to introduce the general partner to potential investors, including large institutional investors such as public pension funds. The ban on using placement agents is seen as harmful to an emerging industry just at the time the agent business is growing; Preqin reported that of the private equity firms that raised funds in 2008, 54 percent used a placement agent, up from 45 percent in 2007 and 40 percent in 2006.

The ban on placement agents has been compared to steroid usage in Major League Baseball. As Schwartzman wrote in his comment letter: “Recently, there have been reports of a few high profile baseball players using illegal steroids to unfairly enhance their performance. Their illegal and unethical behavior has unquestionably challenged professional baseball and yet no one is suggesting banning baseball.” In contrast, others support the ban. For example, one private equity executive said the danger of corruption is a big issue that needs to be regulated. “How do you decide who is legitimate and who isn’t?” the person asked.

As opposed to an outright ban of placement agents, smaller funds are asking the SEC to consider alternative approaches, such as implementing more stringent licensing, oversight and disclosure regulations equally on all participants in the investment process. The California Public Employees’ Retirement System (Calpers), the biggest U.S. public pension fund, said in May it adopted a new policy requiring external managers to disclose fees about placement agents they hire to seek Calpers business.

Given the controversy over this issue, the SEC has a challenging task at hand.

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Common Cause Georgia has entered the fray of the upcoming Atlanta Mayoral election by challenging all candidates to support "pay-to-play" reform. Under Common Cause's proposed legislation, no person or entity who made a contribution of over $250 to the campaign of a Mayoral or City Council candidate would be eligible to submit a bid or perform a contract for the City of Atlanta for the next year. Further, the proposed legislation would restrict contributions of any amount by a City contractor to a City official or candidate during the term of the contract. The proposal places similar restrictions on gifts to City officials or employees.

While few would argue that the procurement process in Atlanta doesn't need more sunshine, the Common Cause proposal appears to go a few steps to far. Most troublesome is the proposal to prohibit persons who make contributions of over $250 from bidding on any City of Atlanta contracts for the next year, as the prohibition applies even if the contract in question was not in existence at the time of the contribution. Restricting contribution amounts in this manner would undoubtedly chill the making of political contributions for City of Atlanta elections altogether, as any person or entity with any potential interest in any City contract in the future could not make contributions without the fear of being locked out of all future business. This is the sort of broad restriction that has proven to be problematic in jurisdictions such as Colorado. Similarly problematic is the apparent willingness to consider contributions by spouses and children of contributors in making prohibition determinations. Again, Colorado should serve as a cautionary tale here.

In sum, real ethics reform for the City of Atlanta needs to be seriously contemplated. However, the current Common Cause proposal is far too broad in its current state to warrant further consideration.

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Amid the storm of pay-to-play scandals and as pay-to-play has become an increasingly hot-button state issue, the Securities Exchange Commission (the “SEC”) stepped in on August 3, 2009 to propose measures at the federal level intended to eliminate or at least curtail “pay-to-play” practices. The measures are aimed to regulate the practice of money managers making political contributions or hidden payments in hopes of winning business from government officials and conversely government officials soliciting political contributions by guaranteeing an award of business. Although the SEC has initiated fraud cases in the past related to kickbacks in pay-to-play schemes, the proposed rules seek to comprehensively address the growth of the government pension plan market and the alleged evils related to its expansion.

According to SEC Chairman Mary Schapiro, “Pay to play practices can result in public plans and their beneficiaries receiving sub-par advisory services at inflated prices. Our proposal would significantly curtail the corrupting and distortive influence of pay to play practices.” As one commentator has stated “so Shapiro is trying to be proactive, reducing…the near occasions of sin.” The rule is intended to help ensure advisory contracts are awarded on professional competence and not political influence. However, as SEC Commissioner Luis Aguilar has cautioned, pay-to-play conduct “is incredibly hard to police.”

The new rule, which revisits a 1999 SEC proposal that was not finalized in part due to monitoring concerns, would prohibit an investment adviser from providing advisory services for compensation to a government client for two years after the adviser makes a contribution to certain elected officials or candidates. Like the 1999 SEC proposal, the proposed rule is modeled on rules G-37 and G-38 of the Municipal Securities Rulemaking Board (“MSRB”), which address pay to play practices in the municipal securities markets. The SEC has couched the rule as a two-year “time out” on conducting compensated advisory business with a government client after a contribution is made and not as a limitation or outright ban of political contributions.

The proposal would also forbid an adviser from providing or agreeing to provide, directly or indirectly, payment to any third party for a solicitation of advisory business from any government entity on behalf of such adviser. Additionally, it would prevent an adviser from soliciting from others, or coordinating, contributions to certain elected officials or candidates or payments to political parties where the adviser is seeking government business. New recordkeeping requirements that would require a registered adviser to maintain certain records of the political contributions made by the adviser are also proposed.

The implications of the proposed measures could be wide ranging. For example, the new recordkeeping rules may have the unintended effect of causing non-U.S. advisers to private pools not to accept investments from U.S. government entities in order to avoid onerous record keeping requirements. In addition, commentators have speculated that the proposed ban on the use of third parties (like placement agents) would make it difficult for smaller and newer funds to develop business because such funds would not have existing contacts with the managers of public pools of capital. The uneven playing field for small funds in turn could limit the investment choices of pension plan officials, who may not have the time and resources to evaluate potential investment opportunities. The SEC seeks comments to address these and other possible pitfalls associated with its proposal.

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With an ever increasing intensity, state legislatures have responded to legitimate voter resentment over various ethics and campaign scandals by passing ever-stricter laws restricting or regulating contributions and/or gifts by business entities doing business with government entities. This valid desire to “connect the dots” between political money and state procurements has resulted in increasing complex legislation in which state legislators appear to be engaged in a constant effort to outdo each other in the eyes of their constituents with respect to the transactions they prohibit and the consequences to corporations for failing to comply. This blog seeks to make some sense of these developments and hopefully foster debate as to corporate compliance and the direction of future legislation.

We have chosen to initiate our blog with an analysis of three states which we believe capture the trends of concern to all groups seeking to do business with their state. First, no self-respecting blog dedicated to highlighting legislation regulating the sometimes unseemly intersection between political practices and state government contracting would be complete if it did not contain an analysis of the Granddaddy State of Illinois. In our entry devoted to Illinois, we examine the various iterations of Illinois “pay-to-play” laws that have been passed during political scandal.

Another trend we have sought to highlight with our first posting - legal challenges to recently enacted pay to play legislation - is reflected in our posting concerning the current state of litigation and anticipated legal developments in the State of Colorado. Colorado has passed one of the most comprehensive and punitive pay to play statutes in the nation and the current status of legislation seeking to enjoin its enforcement has been closely monitored by many as a bellwether to the constitutional limits on future legislation.

Finally, this site is dedicated to monitoring the status of proposed legislation which either has not yet been proposed or was proposed in past legislative sessions but appear not to be dead in future sessions. Legislation recently proposed by State Senator Hooks of Georgia represents an insight into the tenor of state legislation that is likely to resurface when state lawmakers reconvene in upcoming months. Our posting on Senator’s Hooks proposal analyzes the current language proposed, local reaction to the legislation, and the likelihood that some variant of the proposal will pass through the Georgia General Assembly and become law.

Our goal is to inform and foster debate surrounding this emerging field of regulation. We intend to post frequently on these topics with respect to state trends, developments and concerns for compliance. True success, however, will be measured by the degree to which you, the interested reader, help shape the discussion with your comments and questions. We look forward to both.

Stefan Passantino, Esq.
Amol Naik, Esq.

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