BILL ANALYSIS Ó SB 398 Page 1 Date of Hearing: July 5, 2011 ASSEMBLY COMMITTEE ON ELECTIONS AND REDISTRICTING Paul Fong, Chair SB 398 (Hernandez) - As Amended: March 24, 2011 SENATE VOTE : 39-0 SUBJECT : Retirement: placement agents. SUMMARY : Revises the definition of "placement agent" and "external manager," makes conforming changes to the definition of "placement agent" and "external manager" in the Political Reform Act of 1974 (PRA), and exempts placement agents, as specified, from local government reporting and registration requirements. Specifically, this bill : 1)Revises the definition of "external manager" to include a person who is seeking to be, or is, retained by an investment vehicle to manage a portfolio of securities or other assets for compensation, or a person who manages an investment fund and who offers, sells, or has offered and sold, an ownership interest in the investment fund to an investment vehicle. 2)Defines "investment fund" to mean a private equity or public equity fund, venture capital fund, hedge fund, fixed income fund, real estate fund, infrastructure fund, or other similar pooled investment entity that is primarily engaged in the business of investing, owning, holding, or trading securities or other assets. 3)Excludes investment companies registered with the Securities and Exchange Commission (SEC), as specified that make public offerings of their securities, from the definition of "investment fund." 4)Defines "investment vehicle" as a corporation, partnership, limited partnership, limited liability company, association, or other domestic or foreign entity that is managed by an external manager, as specified. 5)Revises the definition of "placement agent" to mean a person directly or indirectly hired, engaged, or retained by, an external manager or an investment fund managed by an external manager, and who acts for compensation as a finder, solicitor, SB 398 Page 2 marketer, consultant, broker or other intermediary in connection with the offer or sale to a board or investment vehicle the investment management services of the external manager or an ownership interest in an investment fund managed by the external manager, as specified. 6)Revises the exemption to local government reporting and registration requirements for placement agents to include an employee, officer, director, or affiliate of an external manager if the external manager is registered with the SEC, as specified, or any appropriate state securities regulator; the external manager is participating in a competitive bidding process, or has been awarded a contract for services and has agreed to a fiduciary standard of care, as specified. 7)Makes other conforming changes. EXISTING LAW : 1)Requires all public pension systems to adopt a policy, on or before June 30, 2010, requiring the disclosure of fees paid to investment placement agents. 2)Defines "placement agent" as a person or entity hired, engaged, or retained by an external manager or other placement agent to raise money or investments from a public retirement system in California. 3)Excludes from the definition of "placement agent" employees, officers, or directors of specified external investment managers, or of affiliates of the external managers. 4)Prohibits 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 PRA. 5)Requires 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, as defined, pursuant to the PRA. 6)Prohibits compensation paid to placement agents that is contingent upon defeat, enactment, or the outcome of any SB 398 Page 3 proposed investment action. 7)Allows 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. 8)Defines "external manager" as a person or entity, as specified, who is seeking to be, or is, retained by a state public retirement system to invest, hold or trade securities or other assets, or manage a portfolio of securities or other assets for a fee. 9)Requires a report from the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS) to the Legislature by August 1, 2012, on the use of placement agents in connection with investments, as specified. 10)Makes a violation of the PRA subject to administrative, civil and criminal penalties. FISCAL EFFECT : According to the Senate Appropriations Committee, pursuant to Senate Rule 28.8, negligible state costs; contains a crimes and infractions disclaimer. COMMENTS : 1)Purpose of the Bill : According to the author: "SB 398 revises the definitions of Placement Agents, Investment Funds and External Managers to clarify that the new law ƯAB 1743 (Hernandez), Chapter 668, Statutes of 2010] applies to Placement Agents who solicit investments for External Managers, not to broker-dealers and underwriters of typical securities, i.e., stocks, bonds, and commodities that are executing transactions on the retirement systems' behalf, as originally intended by AB 1743 (Hernandez)." 2)Placement Agents : Placement agents are persons that are hired by outside investment managers in connection with an investment transaction as a finder, solicitor, marketer, or consultant to raise money from, or to obtain access to, an institutional investor such as a public retirement system. 3)Clean-up Legislation : Following allegations and investigations nationwide regarding placement agents that may SB 398 Page 4 have improperly attempted to sway the investment decisions of public retirement systems, the Legislature passed, and the Governor signed, legislation (AB 1743 (Hernandez), Chapter 668, Statutes of 2010) to require placement agents that do business with CalPERS or CalSTRS to be subject to the same reporting and ethics rules that govern lobbyists under the PRA. According to information provided by the author's office, the intent of AB 1743 was to identify and regulate the activities of individuals soliciting investments for external managers. However, as implemented, there is concern that this new law also regulates the routine trading and sales of securities by a brokerage firm. This bill revises several definitions in current law and in the PRA to clarify that the requirements put into statute via AB 1743 only apply to placement agents who solicit investments for external managers. 4)Previous Legislation : AB 1743 (Hernandez), Chapter 668, Statutes of 2010, prohibits 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 PRA, and requires 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. AB 1584 (Assembly Public Employees, Retirement and Social Security Committee), Chapter 301, Statutes of 2009, makes numerous changes aimed at increasing disclosure and accountability of investment placement agents, board members, and others associated with public pension funds in California. 5)Arguments in Support : In support of this bill, the CalPERS Board of Administration writes: A drafting error in the last amended version of ƯAB 1743] that was eventually chaptered into law has raised concerns by our partners in the investment industry that broker-dealers engaged in general secondary and primary securities transactions may have inadvertently been captured in the definition of placement agent. It was never the intent of AB 1743 to have broker-dealers involved SB 398 Page 5 in these types of transactions to register as lobbyists. Applying the definition of Placement Agent to broker-dealers who execute transactions on public retirement systems' behalf could impair CalPERS ability to buy and sell securities in the public markets. SB 398 clarifies existing law to ensure we are able to conduct business in a timely manner with our investment industry partners. 6)Double-Referral : This bill was heard in the Assembly Public Employees, Retirement, and Social Security Committee on June 22, 2011, and was approved by the committee by a 6-0 vote. 7)Political Reform Act of 1974 : California voters passed an initiative, Proposition 9, in 1974 that created the FPPC and codified significant restrictions and prohibitions on candidates, officeholders and lobbyists. That initiative is commonly known as the PRA. Amendments to the PRA that are not submitted to the voters, such as those contained in this bill, must further the purposes of the initiative and require a two-thirds vote of both houses of the Legislature. REGISTERED SUPPORT / OPPOSITION : Support California Public Employees' Retirement System Board of Administration California State Controller John Chiang California State Treasurer Bill Lockyer Fair Political Practices Commission Securities Industry and Financial Markets Association Opposition None on file. Analysis Prepared by : Maria Garcia / E. & R. / (916) 319-2094