aiCIO's Year in Review: Scandal! Third Party Marketers Continue to Wreak Havoc

ai5000 was unable to corroborate the accuser’s claims with enough sources and, therefore, the editors chose not to release the names of those accused, or the details that would implicate them by deduction. When the denounced were contacted, all claimed that state politics, more than actual wrongdoing, were behind the anonymous accusations. This is possibly so—and, without supporting evidence meeting ai5000 editorial standards, the editors, by default, must side with the accused—but the entire affair is emblematic of a construct this magazine has written on before: the problems, exacerbated by elected officials’ involvement with pension management, of influence peddling and campaign donations within the network of American public pensions.

“Pay-to-play” is a vague, if catchy, umbrella term for these abuses; a finer distinction should be made between the two interrelated, but ultimately separate, issues. The first revolves around campaign fundraising for officials who, through the office they seek or hold, control state pension money. In Massachusetts, for example, this offense manifested itself in the form of state Treasurer and gubernatorial candidate Tim Cahill and TA Associates Realty CEO Mike Ruane. According to The Boston Globe, upward of 250 checks, each worth approximately $500, originating from “far-flung states” were injected between 2002 and 2005 into the coffers of Cahill, who through his Treasurer position was the chairman of the state Pension Reserves Investment Management Board (MassPRIM). The one common denominator, it was discovered, was that these donors worked in some form with or for Ruane, whose firm had been allocated $500 million from the state pension fund in recent years. Although Ruane and Cahill both denied and deny that there is a connection (with The Globe claiming the latter changed his story multiple times), the connection, at least on the surface, seemed strong enough to raise questions about Cahill’s fitness for the Governor’s mansion.

The second issue is that of third-party markets—placement agents, colloquially—who offer access to pension officials in return for monetary gain. Pensions from Massachusetts to New York to California have suffered embarrassing allegations of this obvious conflict of interest undermining state retirement funds, a scarlet letter for the reputation of one of these funds in particular—CalPERS—that prides itself on good corporate governance. In May of last year, the $207 billion fund revealed that a former board member, Alfred Villalobos, allegedly had used his access to the pension giant to make more than $60 million by helping money managers get CalPERS’ business. (CalPERS subsequently launched an investigation into the placement agent issue, which is still ongoing). Less revered for governance but equally as prominent in the American pension space, New York State also has had its issues: In March 2009, Henry “Hank” Morris, the former chief political adviser to ex-New York Comptroller Alan Hevesi, was charged with securities fraud and grand larceny in a 123-count indictment as part of Attorney General Andrew Cuomo’s probe into the state’s retirement fund, the third largest in America. Morris was accused of selling access to billions of dollars held by the Common Retirement Fund, and—related to political donation issues—favoring pension fund investors who made campaign contributions to Hevesi. David Loglisci, the pension fund’s former CIO (and previously Morris’ co-defendant) pleaded guilty to criminal charges in the probe.

This second variation of abuse at first engendered a state-by-state and fund-by-fund response. In New York, the use of placement agents was quickly banned in 2009 following the revelations of scandal. In California (which had required relatively robust disclosures before the New York scandal broke), Attorney General Jerry Brown has sued Villalobos for allegedly bribing former CalPERS officials in order to win business for clients. In Massachusetts, the response was less stringent, with “expanded disclosure forms and a difference in details about compensation arrangements with third-party marketers” taking the place of an outright ban, according to MassPRIM Chief Investment Officer Stan Mavromates. The first variation of abuse—donations to officials running pension money—was largely left untouched by the states, possibly in deference to an expected federal response, possibly due to the inherent conflict for politicians who would be cutting off their own source of campaign funding.

“These scandals are not unique to New York,” says Thomas DiNapoli, Hevesi’s successor as New York State Comptroller, echoing the sentiment of pension executives in Massachusetts, California, New Mexico, New Jersey, and elsewhere. “We would all benefit from a national standard.” In effect, this is what the states were expecting: Their myriad responses were little more than a virtual holding pattern while the Securities and Exchange Commission (SEC) proposed, commented on, and released rules relating to pay-to-play.

The end result of this yearlong process was a July announcement, following a 5-0 SEC vote, that, effective September 13, investment advisers will be prohibited from donating to politicians such as DiNapoli and Cahill if they wish to manage capital for public funds within two years. However, the regulator backtracked on banning the use of placement agents, choosing instead to mirror the California approach of transparency, requiring registration and reporting of placement agents with the SEC or the Financial Industry Regulatory Authority.

The people affected have met these changes with acceptance, if not enthusiasm. “There are legitimate placement agents,” New York’s DiNapoli says, hoping that the regulations aren’t so onerous as to impede access by certain investment managers. “Women and minority-owned firms—they don’t have the access to pensions that others have. For them, placement agents can and do play a legitimate role.” With regard to the banning of donations from investment advisers, DiNapoli is more agreeable. “I think the answer is public financing [of elections],” he says. “The New York Comptroller’s office should be used as a case study for it. A public system would avoid the issues of access—and it shouldn’t just be for wealthy people to run.”

It would be naive to suggest that, with the SEC’s commitment, the long public pension nightmare of mixing politics with investments is over. Those looking to enrich themselves or their campaigns via public employee largesse will continue do so, their methods simply changing to circumvent the new impediments. We have not heard the last, from anonymous sources or attorney generals, of politicians and middlemen pretending to act for the public benefit and in fact acting only for their own.