BILL ANALYSIS SENATE PUBLIC EMPLOYMENT & RETIREMENT BILL NO: AB 1743 Lou Correa, Chair Hearing date: June 23, 2010 AB 1743 (Hernandez) as amended 6/17/10 FISCAL: YES PUBLIC RETIREMENT SYSTEMS: PLACEMENT AGENT REGISTRATION AS A LOBBYIST AND PROHIBITION ON CONTINGENCY FEES CONNECTED WITH POTENTIONAL INVESTMENT ASSETS FROM CALPERS AND CALSTRS HISTORY : Sponsor: Honorable John Chiang, California State Controller Honorable Bill Lockyer, California State Treasurer California Public Employees' Retirement System (CalPERS), Board of Administration Prior legislation: AB 1584 (Hernandez), Chapter 301, Statutes of 2009 ASSEMBLY VOTES : PER & SS 4-1 4/07/10 Assembly E&R 7-0 4/20/10 Appropriations 11-5 5/28/10 Assembly Floor 56-8 6/02/10 SUMMARY : 1) Would prohibit a person from acting as a placement agent in connection with any potential investment made by a state public retirement system unless that person is registered as a lobbyist in accordance with, and is in full compliance with, the requirements of the California Political Reform Act (PRA). 2) Would require placement agents connected with investments made by local public retirement systems to comply with any applicable requirements imposed by a local government agency on lobbyists pursuant to the PRA. Michael Bolden Date: 6/17/10 Page 1 BACKGROUND AND ANALYSIS : 1)Existing law : a) defines a "lobbyist" as an individual who receives $2,000 or more in a calendar month or whose principal duties as an employee are to communicate directly or through his or her agents with an elective state official, agency official, or legislative official for the purpose of influencing legislative or administrative action; b) defines "administrative action" as the proposal, drafting, development, consideration, amendment, enactment, or defeat by any state agency of any rule, regulation, or other action in any ratemaking proceeding or a quasi-legislative proceeding; c) requires an individual who is considered a lobbyist, as defined, to register as a lobbyist and to comply with various ethical and reporting rules; d) requires any person who makes a payment to influence legislative or administrative action, as defined, to comply with various reporting rules; e) makes a violation of the PRA subject to administrative, civil, and criminal penalties; f) defines "placement agent" as a person or entity hired, engaged, or retained by an external manager to raise money or investment from a public retirement system in California, and g) defines "external manager" as an asset management firm that is seeking to be, or has been, retained by a public retirement system to manage a portfolio or assets, including securities, for a fee. 1)This bill : a) would exclude from the definition of "placement agent," an employee, officer, director, equity holder, Michael Bolden Date: 6/17/10 Page 2 partner, member, or trustee of an external manager who spends one-third or more of his or her time, as specified, managing the assets controlled by the external manager; i) would also exclude an in-house employee; officer; or a director of an external manager, or affiliate of an external manager regulated or operating under an exemption from the Securities and Exchange Commission (SEC), selected by a competitive bidding process, and bound by standards of conduct set forth in Article XVI of the California Constitution when managing a portfolio of assets in a public retirement system in the State; b) would add the definition of "investment vehicle" to mean a partnership, limited partnership, limited liability company, or other investment vehicle managed by an external manager in which a public retirement system in the State is a majority shareholder; c) would require placement agents connected to potential business with the California Public Employees' Retirement System (CalPERS) or the California State Teachers' Retirement System (CalSTRS) to be subject to the same registration, reporting and ethics rules that govern lobbyists under the PRA; d) would require placement agents connected with potential investments made by local public retirement systems to file any applicable reports, and comply with any applicable local regulations regarding lobbyists pursuant to the PRA; e) would expand the definition of "administrative action" in the PRA to include, specifically related to placement agents, decisions by any state agency to enter into a contract to invest state public retirement system assets on behalf of a state retirement system; f) would add the definitions of "external manager" and "placement agent" to the PRA; Michael Bolden Date: 6/17/10 Page 3 g) would allow payments of fees for contractual services provided to an investment manager by a placement agent registered with the SEC and regulated by the Financial Industry Regulatory Authority; h) would prohibit compensation paid to placement agents that is contingent upon defeat, enactment, or the outcome of any proposed investment action, and i) would require a report from CalPERS and CalSTRS to the chairpersons of the Assembly Public Employees, Retirement and Social Security, and Senate Public Employment and Retirement Committees by August 1, 2012, on the use of placement agents in connection with investments, as specified. FISCAL : According to the Assembly Appropriations Committee, this bill would have minor and absorbable costs to both CalPERS and CalSTRS to revise policies and notices, minor and absorbable costs to the Fair Political Practices Commission and Secretary of State for handling additional filings of disclosure statements and for enforcement, and local enforcement costs would not be reimbursable. COMMENTS : 1) CalPERS' and CalSTRS' Existing Policies Regarding Placement Agents or Third Party Relationships and Payments In May 2009, the CalPERS Board Investment Committee adopted a policy for disclosure of placement agent fees to add transparency to the investment decision-making process. The policy requires the disclosure of relationships between CalPERS managers (defined as External Managers in the Policy) and placement agents and the fees that are paid to these placement agents. According to CalPERS, the policy was "adopted to help ensure that CalPERS' investment decisions are consistent with investment policy and fiduciary responsibilities; to increase the pool of information Michael Bolden Date: 6/17/10 Page 4 available to CalPERS board members, staff, and consultants when evaluating an investment opportunity; to help prevent impropriety and the appearance of impropriety; and to provide transparency and confidence in CalPERS' investment decision-making processes." In 2006, as part of its policy governing ethical and fiduciary conduct, the CalSTRS Board adopted a policy for the disclosure of third party relationships and payments. The policy requires a person or entity involved with any investment transaction or investment management contract to disclose all third party relationships with persons or entities that assisted with the solicitation of CalSTRS as a potential client or the retention of CalSTRS as an existing client. The policy also requires the disclosure of any fees paid or payable to the third party for assisting with the solicitation, which includes placement agent fees. CalSTRS also has regulations in place to add transparency and eliminate potential conflicts of interest in investments and to prevent "pay-for-play" activities. CalSTRS has noted that it does not engage in, or make payments to placement agents. Fees to placement agents as a result of a CalSTRS investment are "the result of an arrangement between an outside investment manager and the placement agent." 2) Contingency Fee Ban and the Political Reform Act Existing law prohibits lobbyists from receiving payment that is contingent upon the outcome of any proposed legislative or administrative action. The contingency fee ban on the passage or defeat of legislation predates the PRA. The ban was enacted in 1950 to respond in part to lobbying scandals in the legislature in the prior year. That ban remained unchanged until the PRA was approved by voters in the 1974 statewide primary election which repealed the ban enacted in 1950, replacing it with a similar and broader ban which prohibited contingency fee payments based on the outcome of legislation and any proposed administrative action. 3) Affects of a Contingency Fee Ban on Placement Agents in California Michael Bolden Date: 6/17/10 Page 5 The ban on contingency fees as proposed by this measure would only apply to placement agents that work with CalPERS and CalSTRS. Placement agents who work with other public and private investors in California will be unaffected by this bill. The bill is constrained to investment decisions "by any state agency to enter into a contract to invest state public retirement system assets on behalf of a public retirement system." According to the author, "a small part of [Cal]PERS and [Cal]STRS investments would be impacted. Historically, roughly 20 percent of CalPERS investments have been made through placement agents. At CalSTRS, the share is even smaller: only two placement agent deals were made in all of 2009." 4) Will Minority and Women-Owned Firms ("Emerging Managers") be Disadvantaged by the Bill ? According to the author, "No emerging managers (or managers) have suggested that CalPERS and CalSTRS investment strategies and emerging manager outreach is inadequate. On the contrary, the sponsors have discussed the bill with emerging managers and learned that placement agents favor larger firms over the smaller ones, creating an unlevel playing field for smaller emerging firms, and in addition to the contingency fee commitment, many placement agents require a substantial retainer before they'll do business." The author further notes that "The number of firms affected is small. There are approximately 50-70 placement agent firms operating in California today." 5) Double-Referral : This bill is also referred to the Senate Elections, Reapportionment and Constitutional Amendments Committee. 6) Arguments in Support According to the author, "By requiring placement agents that do business with California's public retirement systems to be Michael Bolden Date: 6/17/10 Page 6 subject to the same reporting and ethics rules that govern lobbyists, AB 1743 would increase the confidence of retirement system members and the public that public retirement systems' investment decisions are made in an impartial manner, free from any potential bias caused by gifts, campaign contributions, or the financial interests of placement agents, retirement system officials and third parties who have supported these officials. "At least five states (New York, New Jersey, Illinois, Connecticut, and New Mexico) and the SEC have established, augmented, or are in the process of establishing placement agent statutes ranging from increased disclosure to a complete ban in order to shield investment decisions from actual or perceived unwarranted influence." Bill Lockyer, State Treasurer and a sponsor of the bill states that this measure "provides a crucial remedy to the pay-to-play scandal that has infected public pensions from New York to California" and would "keep corruption out of California's public pension funds, safeguard benefits promised to workers and protect taxpayers from unfair financial burdens. "Critics of the prohibition argue small firms need placement agents to pitch their proposals to big pension funds and that a ban on contingency fees would 'shut out small firms." However, "CalPERS is making great strides toward making placement agents unnecessary for managers who supposedly need them." Finally, the Treasurer contends that the investment of public pension funds "should not be based on whether they enrich middlemen and folks with political influence." Rather, "They should be based solely on whether they benefit workers, retirees and taxpayers." The State Controller, John Chiang also a sponsor of the bill, states: "Recent accounts of questionable influence-peddling practices by placement agents and concerns about the long-term sustainability of the public pension funds demand the utmost transparency and attention into how public pension investment decisions are made. Just as Michael Bolden Date: 6/17/10 Page 7 lobbyists who attempt to influence legislative or administrative decisions are subject to the Political Reform Act, so too, should be placement agents who attempt to influence the investment of state pension funds. By enacting AB 1743, the State's employees, employers, and the public will be better assured that all who serve the system do so with complete transparency, ethics, and accountability. "This proposal follows in the footsteps of the now-chaptered Assembly Bill 1584 (Hernandez, 2009), which requires all public pension systems in the state to adopt policies requiring the disclosure of fees paid to investment placement agents, forces disclosure of campaign contributions and gifts made by placement agents to public retirement board members, prohibits public retirement board members from selling investment products to other public retirement systems, and lengthens post-employment restrictions on influencing retirement board actions for former system executives and board members. "The State's investment portfolio could benefit significantly from this legislation. Greater transparency by individuals and firms who seek to influence investment decisions should make it harder for these entities to leverage personal relationships to gain unequal access to public funds. AB 1743 will enable the public and private sector to identify who is attempting to influence the State's investment decisions and assess their influence on the funds' overall performance." CalPERS, also a sponsor of the bill contends that this bill "enhances transparency and ensures accountability regarding the investment decisions of public pension funds." Further, "AB 1743 will increase the confidence of retirement system members and the public, without limiting investment opportunities, that retirement systems' investment decisions are made in an impartial manner, free from any potential bias caused by gifts, campaign contributions, or the financial interests of placements agents, retirement system officials and third parties who have supported these officials." Michael Bolden Date: 6/17/10 Page 8 6) Arguments in Opposition According to the Securities Industry and Financial Markets Association (SIFMA), "SIFMA supports most of the provisions contained in AB 1743" such as registration and reporting requirements, and both the ban on campaign contributions and gifts restrictions. However, "a ban on contingency fee payments would functionally operate as a ban on professional placement agents participating in any private investment transaction by a California retirement system." SIFMA further adds, that this "would deny both private equity firms and pension and retirement system investors of professional placement agents' valuable services." SIFMA suggests exempting professional placement agents from the contingency fee ban provision. SIFMA further contends, "Professional placement agents are broker-dealers registered with the Securities and Exchange Commission and are subject to federal securities laws, regulation, FINRA registration and supervision, and applicable state law." They perform four primary functions as part of the placement process: (i) due diligence; (ii) project management; (iii) distribution; and (iv) road show organization. SIFMA, 3PM and others who have expressed opposition to this bill contend that small managers, i.e., emerging managers, who typically are newer and lack the resources to present their products, themselves and to pay advisory fees to placement agents on a noncontingent basis, would suffer severe impairment of access to capital from Californias public pension plans. 3PM has suggested that the registration and disclosure process should be modified so that it would correctly reflect the information relevant to placement agents and that a statewide or on-line ethics course could be an important registration enhancement so long as the course requirements are specific to the work and responsibilities of placement agents, and specifically in identifying situations where conflicts of interest are likely to occur. 7) SUPPORT : Michael Bolden Date: 6/17/10 Page 9 Honorable John Chiang, State Controller (Sponsor) Honorable Bill Lockyer, State Treasurer (Sponsor) CalPERS Board of Administration (Sponsor) Honorable Debra Bowen, Secretary of State Association of California Water Agencies (ACWA) California Special Districts Association (CSDA) California State Association of Counties (CSAC) California State Employees Association (CSEA) California State Teachers' Retirement System (CalSTRS) Cartica Management, LLC Department of Personnel Administration (DPA) Faculty Association of California Community Colleges (FACCC) League of California Cities (Support if Amended) Regional Council of Rural Counties (RCRC) 8) OPPOSITION : Securities Industry and Financial Markets Association, (Oppose Unless Amended) California Bankers Association, (Oppose Unless Amended) Champlain Advisers, LLC Investment Company Institute, (Oppose Unless Amended) Third Party Marketers Association, (Oppose Unless Amended) 1 Individual #### Michael Bolden Date: 6/17/10 Page 10