If it takes three times to make something a habit, it is safe to say that “pay-to-play” legislation in the State of California is getting to be a bit habitual. For the third time in as many years, the California State Legislature has decided to ripple the “pay-to-play” regulatory waters by passing an “urgency” measure designed to clarify and modify the state’s existing restrictions on investment managers and investment placement agents who do business with California’s public employee pension funds, such as the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS). The new piece of legislation, Senate Bill 398 (SB 398), was signed into law on October 9, 2011 by Governor Jerry Brown, and is designed to complement two other recently-passed bills regulating the activities of pension fund investment managers.
The first of those recently-passed bills was Assembly Bill 1584 (AB 1584), which was passed by the state legislature in 2009 as part of an effort to increase transparency in the management of public employee pension fund assets. Specifically, AB 1584 required all California pension funds to adopt disclosure policies that would require the reporting of all campaign contributions and gifts made to pension fund board and staff members by “placement agents” and external investment managers. Likewise, the bill mandated that all outside investment managers disclose information regarding the fees they pay to placement agents for the purpose of securing asset management business opportunities with state and local pension funds across California.
The second of those complementary pieces of legislation was Assembly Bill 1743 (AB 1743), which was passed by the state legislature in 2010 as part of an effort to build on the transparency provisions of AB 1584 by explicitly restricting the ability of placement agents and external investment managers to engage in pay-to-play activities associated with California’s public employee pension funds. As this blog highlighted at the time of the bill’s passage, AB 1743 placed a broad swath of placement agents, external investment managers, and external investment management firm staff under an obligation to register as lobbyists with the State of California. In addition, AB 1743 banned these same individuals from making campaign contributions to the elected board members of California’s pension funds and prohibited them from setting up contingency fee arrangements to manage such pension fund assets.
While not as groundbreaking as either AB 1584 or AB1743, SB 398 does build upon each of those bills and make some noteworthy changes to California’s pay-to-play regulatory framework for pension fund placement agents and external investment managers. Specifically, SB 398 modifies existing law in the following ways:
- The bill revises the definition of the terms “external manager”, “placement agent”, “investment fund”, and “investment vehicle” to clarify that almost all managers of securities and assets for California public employee pension funds, whether directly or through managed funds, are subject to the disclosure and lobbyist registration rules put in place by AB 1743 for external managers and placement agents. Despite this fact, however, SB 398 does exempt investment management companies that are registered with the Securities and Exchange Commission (SEC) pursuant to the Investment Company Act of 1940 and that make public offerings of their securities from having to comply with the statutory disclosure and registration standards.
- The bill extends AB 1743’s “safe harbor” exemption from state-level lobbyist registration so that it also applies to local-level lobbyist registration requirements. Under AB 1743’s safe harbor provision, investment managers of public pension funds need not pursue state-level lobbying registration if they meet three separate requirements: (1) they are registered with the SEC as investment advisers or broker-dealers; (2) they obtain their pension fund business through competitive bidding processes; and (3) they agree to be subject to the California fiduciary standard imposed on public employee pension fund trustees. In turn, SB 398 extends a similar exemption to investment managers who would otherwise be required to register as local-level lobbyists on account of their management of local public employee pension fund assets.
Since SB 398 was passed by the state legislature and signed by the governor as an “urgency” measure, it is now the active law of the land in California. It remains to be seen, however, what sort of impact it will actually have on the ethics of public pension fund asset management. While its changes will certainly have some effect on investment managers and placement agents doing business with public employee pension funds in California, it will certainly not be as significant an effect as either AB 1584 or AB 1783. After all, individuals working in the pension fund investment management business have to be slowly getting used to California’s growing pay-to-play regulation habit.
In light of this fact, perhaps the most interesting thing to watch in the wake of SB 398’s passage just might be the reaction of California localities to the extension of AB 1743’s safe-harbor exemption. How will localities with a history of tackling pay-to-play issues (like Los Angeles) react to the state’s intrusion into municipal issues such as the regulation of local public employee pension fund management? We shall see if any drama ensues in the Golden State… Stay tuned…