SEC May Propose Fiduciary Duty for Swap Dealers

(June 29, 2011) — The US Securities and Exchange Commission (SEC) may propose rules that would impose a fiduciary duty for public fund swap advisers.

The rules outlined in a more than 200-page SEC proposal are part of the government’s efforts to impose more stringent regulations on the trade in derivatives. “The rules we are proposing today would level the playing field…by bringing needed transparency to this market and by seeking to ensure that customers in these transactions are treated fairly,” SEC Chairman Mary L. Schapiro said.

Under the SEC’s plan to aid buyers in evaluating whether they’re getting a fair deal, dealers would be forced to disclose to their buyers the risks of transactions and any conflicts of interest. Additionally, dealers would be forced to disclose incentives and would have to adhere to rules aimed at prohibiting pay-to-play practices.

Large swap traders and dealers including Goldman Sachs, Morgan Stanley, and JP Morgan Chase would be subject to the rules, required by the Dodd-Frank Wall Street overhaul law.

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The proposal is subject to a period of public comment and a final vote.

In April, the SEC and the Commodity Futures Trading Commission (CFTC) laid out swaps definitions covered under the Dodd-Frank law. Under the proposals — aimed at limiting risk and boosting transparency in the $583 trillion global swaps market — swaps would include foreign exchange swaps and forwards, foreign currency options, commodity options, cross-currency swaps, and forward rate agreements. An exemption would apply to certain insurance products, consumer and commercial transactions.

“The proposed definitions balance several policy and legal issues in a way I believe is practical, takes into account the specific nature of derivatives contracts, and is consistent with existing securities regulations,” said SEC Chairman Mary L. Schapiro in a statement. “The proposal seeks to provide guidance in rules and interpretations by using clear and objective criteria that should clarify whether a particular instrument is a swap regulated by the CFTC, a security-based swap regulated by the SEC, or a mixed swap regulated by both agencies.”

President Obama signed the Dodd-Frank financial regulation bill last July, giving the CFTC and SEC oversight of the OTC derivatives market while forcing most swaps to be cleared on a regulated exchange. Obama’s signature marked a legislative push that has become increasingly aggressive since the 2008 financial crisis pummeled the US economy.

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

Kentucky Pension Investigated Over Placement Agents, 'Troubling Aspects' Found

While an audit of the Kentucky Retirement Systems found no evidence of pay-to-play activity, "troubling aspects" regarding the use of financial middlemen that connect money managers with pensions, known as placement agents, were revealed.

(June 29, 2011) — In violation of disclosure rules, the $13.9 Kentucky Retirement Systems (KRS) allegedly failed to disclose the use of placement agent activity in recent years.

However, according to a recent audit by Kentucky Auditor Crit Luallen, no evidence of “pay-to-play” activity at the scheme was found. Nevertheless, Luallen recommended 92 items for improving the system, urging greater oversight. The Kentucky retirement system’s audit is now proceeding to the US Securities and Exchange Commission (SEC).

Luallen’s staff spent months probing into the role of placement agents, and found nearly $11.6 million in fees paid or committed to placement agents from 2007 to 2010. The report discovered that New York placement agent Glen Sergeon had “an unusually close working relationship” with Adam Tosh — the former chief investment officer at KRS and the current managing director at consulting firm Rogerscasey. Sergeon was involved in seven of 13 of the system’s investment agreements in which placement agents were used in 2008 and 2009. Additionally, the audit discovered that Sergeon “appears to have acted as a representative of KRS, setting up appointments and making travel arrangements” for Tosh.

“Based on the information they reviewed, auditors saw no evidence of a ‘pay to play’ scheme involving placement agents, or of conflicts of interest that benefited KRS officials; nor is there evidence that KRS incurred any additional cost through the use of placement agents,” Luallen said in a press release accompanying the audit. “However, the audit points to several troubling aspects regarding the use of placement agents and will be referred to the US Securities and Exchange Commission (SEC). The SEC has the authority to determine if further investigation is needed in Kentucky.”

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Luallen continued: “There is not another public agency in Kentucky that has such a significant fiduciary responsibility affecting as great a number of people as the Kentucky Retirement System’s Board. To carry out this responsibility, these Board Trustees need to be highly qualified, adequately informed and fully engaged. Our recommendations offer significant steps KRS can take to strengthen Board governance.”

The board of trustees at KRS requested the audit after concerns were raised over how some placement agents were selected. In August 2010, the SEC opened an “informal inquiry” into KRS’ use of placement agents, Chris Tobe, a member of the KRS board and investment committee, told aiCIO. Despite such apparent potential conflicts, Luallen said, “We followed up every issue that was raised and could not substantiate any specific evidence of wrongdoing.”

Responding to the audit findings, KRS board Chairwoman Jennifer Elliot said in a news release that the board is “heartened by the fact that there were no findings of significant wrongdoing, excessive spending or other systemic problems.”

While placement agent activity is not illegal, recent scandals involving public employee pension funds around the country have placed a spotlight on the industry, leading many funds to reassess their relationships. Worries about lack of disclosure in the pension fund community exploded last year when a pension-fund scandal in New York exposed the role of placement agents in bribery and corruption charges. In May 2010, California’s attorney general filed a civil lawsuit that alleged California Public Employees’ Retirement System (CalPERS) officials — Fred Buenrostro, a former chief executive, and Alfred Villalobos, former board member turned placement agent — participated in a scheme to obtain business for investment firms, providing pension officials with luxury trips and other gifts.

In March, CalPERS issued a report detailing the use of placement agents and highlighting that there may have been influence peddling by a former CEO, Board members, and investment staff.

Following last year’s investigation of the $140.6 billion (as of December 31, 2010) New York State Common Retirement Fund (CRF) and other major pension funds that revealed the role of middlemen, the SEC has stepped up its regulation of placement agents.

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742