SEC to Restrict Pay-to-Play After Industry Abuses

(June 28, 2010) — On Wednesday, June 30, US regulators will vote on rules to prevent hedge funds and private-equity firms from providing money to politicians to earn pension business.

The measures are designed to prevent an adviser from making political contributions or hidden payments to influence their selection by government officials, a practice also known as “pay-to-play.” The vote follows abuses in an industry that oversees $2.4 trillion of public retirement funds.

According to a statement by the SEC’s five-member commission, the proposals relate to money managed by state and local governments under a number of public programs, which include public pension plans that pay retirement benefits to government employees, retirement plans in which teachers and other government employees can invest money for their retirement, and 529 plans that allow families to invest money for college.

“Pay to play serves the interests of advisers to public pension plans rather than the interests of the millions of pension plan beneficiaries who rely on their advice,” said Andrew J. Donohue, director of the SEC’s Division of Investment Management, in a statement. “The rule we are proposing today would help ensure that advisory contracts are awarded on professional competence, not political influence.”

“Our proposal would significantly curtail the corrupting and distortive influence of pay to play practices,” added SEC Chairman Mary Schapiro.

Following an investigation of the $110 billion New York State Common Retirement Fund (CRF) last year that revealed the role of middlemen, the SEC proposed banning investment managers from paying placement agents to solicit government pension funds. For more than a year, the SEC and New York Attorney General Andrew Cuomo have been investigating state pension fund corruption.

Private equity firms the Quadrangle Group and the Carlyle Group are among the growing number of firms that have entered settlements in the SEC-Cuomo probe, resulting in adoptions of a code of conduct to curb the use of placement agents for pension fund investments.

Opponents to an outright ban on the use of private-placement agents argue instead for a level playing field, where all investment sales activity to public pension funds is regulated, and rules are aimed at keeping securities firms from engaging in improper pay-to-play practices. In February, Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said in a letter to the SEC that banning placement agents risked eliminating the only “cost-effective way for smaller funds” to compete with bigger rivals in winning contracts to manage pension-fund assets, Bloomberg reported.