Locust dissects a proposed new rule from the US financial watchdog to counter corruption from public pension fund investing

The US Securities and Exchange Commission in August proposed a new rule aimed at keeping the relationships between public pension funds and their external investment advisers arms-length. The rule, which goes under the name “Political Contributions to Certain Investment Advisers”, follows similar proposals made as far back as 1999.

The rule would primarily do three things. First, it would make it unlawful for an investment adviser to carry out paid work for a public pension fund within two years of making a financial contribution to the election fund of an official of a public pension fund. Second, it would prohibit investment advisers from paying a third party to solicit public pension funds for investment business. And, third, it would make it unlawful for an investment advisor to arrange contributions for an official of a pension fund from which the adviser is seeking business.


In short, the new rule is designed to end the practice of “pay to play”, the arrangement by which investment management companies make financial contributions to the campaign funds of the elected officials who manage the assets of public pension funds from which they are seeking to win business or of the candidates for election. With US pension funds holding over $2.2 trillion in assets, and with the decisive influence these so-called “political contributions” can have in the United States in elections for the officials who control public pension funds, the incentives and possibilities on both sides for these kinds of shenanigans are huge.

The several cases that have been brought all across the US in recent years against investment advisers, “placement agents” – companies that identify and approach big institutional investors such as pension funds that are looking to invest in a private equity fund or similar alternative investment vehicle – and state officials for paying and accepting kickbacks attest to this.

The proposed regulation is based very closely on two rules introduced over the past 15 years by the Municipal Securities Rulemaking Board (MSRB) that are considered to have largely eliminated the practice of “pay to play” in the municipal securities market. The SEC believes that it was, ironically, the elimination of “pay to play” in the area of municipal bonds that saw the practice migrate into the area of public pension plan investing.

And the apparent harshness of the SEC’s proposed rule is to a great extent a consequence of the difficulties the MSRB faced in stopping broker-dealers and banks from taking a mile from each inch of leeway it left in the rules it was developing for the market it oversees. This has driven the SEC to move far beyond an insistence on, say, full disclosure of political contributions and payments – which is, as it happens, also a requirement of the proposed rule – to suggesting a complete ban of the use of placement agents.


The elements of the rule relating to political contributions are not controversial and are being broadly welcomed (as they should be). But the proposed ban on placement agents is causing understandable consternation across the industry. Investment decisions based on political payments, among many other disadvantages, clearly compromise the fiduciary obligations of the elected officials and will normally harm the pension plan’s beneficiaries. Yet placement agents, at least in theory and certainly also in practice, can and do provide a valuable service.

Bloomberg quoted Michael Travaglini, executive director of the $34bn Pension Reserves Investment Management (Prim) Board in Massachusetts, as saying: “I’m amazed that a political corruption case has led people to question the legitimacy of a long-established part of the asset management business.” And industry veteran Réal Desrochers, who recently retired as director of the California State Teachers’ Retirement System’s private equity programme, wrote to the SEC saying: “Registered placement agents … are a necessary and value-added service to all potential alternative investors.”

Despite these very strong objections, the proposed ban on placement agents should not be dismissed lightly. A situation involving such huge sums controlled by all-powerful elected officials on behalf of powerless and locked-in beneficiaries is an easily exploitable one. Allowing middlemen to trade on their access to these officials adds further opportunities for corruption. The protection afforded to plan beneficiaries by ensuring that relationships between these officials and those who invest funds on their behalf remain arm’s length may well be worth the costs to the industry, and particularly to honest placement agents, of adapting to the new rule.

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