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SEC Bans Third Party Solicitation of Municipal Investors

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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.