California Governor Schwarzenegger recently signed legislation that will regulate the activities of placement agents who assist investment managers in selling investment services to California public pension and retirement systems, most notably the California Public Employees Retirement System ("CalPERS") and the California State Teachers Retirement System ("CalSTRS"). The Act, known as AB 1743 prior to enactment, requires "placement agents" to register as lobbyists if they sell the securities, assets, or services of an "external manager" to state public pension plans. The law becomes effective on January 1, 2011.
The new law creates another regulatory oversight layer for the activities of placement agents, adding to existing California laws and regulations that already limit an agent's interaction with the state retirement and pension systems and their personnel. These developments will affect the way placement agents are able to conduct business and will require development of or changes to compliance programs. Those that could be affected by the new law also should take steps to monitor the California Fair Political Practices and the state pension and retirement systems for any related regulatory activities or guidance.
Placement Agents as Lobbyists
The new California law will prohibit a person from acting as a placement agent in connection with any potential investment made by a state public retirement system unless the person has first registered as a lobbyist in California. After registering as a lobbyist, a placement agent will be required to comply with all of the regulations and restrictions imposed on lobbyists by California's Political Reform Act of 1974, as amended. These include completing a mandatory ethics course, filing annual re-registration statements and periodic reports, and complying with additional restrictions on gift giving and campaign contributions to certain public officials.
More specifically, California state-registered lobbyists (now including placement agents) are prohibited from, among other things:
- Giving gifts totaling more than $10 in a calendar month (or acting as an intermediary in the making of such a gift) to state candidates, elected state officers, legislative officials, or agency officials (as those terms are defined under state law); and
- Making campaign contributions (including in-kind contributions) to, among others, elected state officers and candidates for elective state office, if the lobbyist is registered to lobby the governmental agency of the elected state officer or the agency for which the candidate is seeking election.
Further, business entities that are owned, in whole or in part, by lobbyists are prohibited from making contributions to state elected officials and candidates if the lobbyist participates in the decision to make the contribution.
Finally, placement agents working with local retirement systems in jurisdictions with a local lobbying law also will be considered lobbyists and will be required to comply with those local laws. Such laws are in place in certain sub-state political jurisdictions, and vary in scope and detail.
Registration and Reporting Implications for Employers of Placement Agents
By treating a placement agent as a lobbyist, the new law should, in turn, subject placement agent employers to reporting obligations and restrictions as "lobbyist employers" under the Political Reform Act. Under that Act, an entity retaining or employing a lobbyist must file a registration statement, as well as an authorization statement. Such a "lobbyist employer" must disclose any legislative or administrative action the entity is trying to influence. It also must disclose payments received in connection with the entity's attempt to influence legislation or an administrative action.
Restrictions on Contingency Fee Based Compensation
The new law also presents significant changes to a commonly used payment structure for placement agent services relative to public pension fund investments. Currently, under California law, a lobbyist or lobbying firm is prohibited from accepting or agreeing to accept a compensation arrangement that is "contingent upon the defeat, enactment, or outcome of any proposed legislative or administrative action." CA Govt. C. § 86205. Because the new law treats a placement agent as a lobbyist and a decision by a state agency to enter into a contract to invest state public retirement system assets as an "administrative action" under the California Code, a placement agent selling or attempting to sell securities, assets, or services of an "external manager" to a state public pension fund cannot be compensated under a "contingency" arrangement.
Who Is Subject to the New Law (and Who Isn't)?
AB 1743 defines "placement agent" as "any person hired, engaged, or retained by, or serving for the benefit of or on behalf of, an external manager, or on behalf of another placement agent, who acts or has acted for compensation as a finder, solicitor, marketer, consultant, broker, or other intermediary in connection with the offer or sale of the securities, assets, or services of an external manager to a board or an investment vehicle, either directly or indirectly." In addition to third-party placement agents, this definition is meant to include an external manager's employees, officers, directors and affiliates that deal with a state or local pension system (e.g. CalPERS or CalSTRS).
Whether a placement agent or an external manager's employee must register as a lobbyist will depend upon whether the investment firm hiring the placement agent is an "external manager." Under the new law, "external manager" includes:
- A person (including a corporation), retained, or seeking to be retained, by a board to manage a portfolio of securities or other assets for compensation; or
- A person (including a corporation) engaged, or proposing to be engaged, in the business of investing, reinvesting, owning, holding, or trading securities or other assets and who offers or sells, or has offered or sold, securities to a board or investment vehicle.
Two exceptions limit the reach of the law for employees of external managers. First, an external manager employee who spends one-third or more of his or her time actually managing securities held by the external manager is not considered a placement agent and is not subject to the rules and limitations discussed above. If an external manager's employee does not meet the "one-third" exception, then that individual still can be exempt if the external manager itself is:
- Registered with the SEC as an "investment adviser" or "broker-dealer" or if exempt from SEC registration, with an appropriate state securities regulator; and
- Was selected through competitive bidding and is providing services pursuant to a contract executed as a result of that competitive bidding procedures; and
- Has agreed to a "fiduciary standard of care" as defined by the standards of conduct applicable to the retirement board of a public pension or retirement system when managing a portfolio of the pension or retirement system's assets.1
Other California Rules Regulating Interactions with Pension Systems
Those seeking to comply with the new law should also remain cognizant of existing restrictions that apply to individuals and other persons doing or seeking to do business with the California state retirement systems, particularly CalPERS and CalSTRS. In addition to so-called "pay-to-play" rules, which are not reviewed here but apply to all potential California state and local contractors, placement agents should understand the disclosure and gift rules reviewed below.
Placement Agent Disclosure Policies
Under a 2009 California law, state pension and retirement systems were required to adopt regulations that mandate disclosure of the fact and nature of an investment manager's relationship with a placement agent. Both CalPERS and CalSTRS had such disclosure rules in place even before that law passed. CalPERS now, however, is in the process of revising its regulations to, among other things, require placement agents to report gifts and campaign contributions made to CalPERS board members or any state official who has authority to appoint a board member, including the Governor, the Speaker of the Assembly, and the members of the Senate Rules Committee. Although this rulemaking has been extended to incorporate changes made by AB 1743, the final rules are expected to be in place at the start of 2011, thereby setting up another registration and reporting regime with which placement agents must comply.
Gift and Entertainment Restrictions
In addition to the new limitations placed on gifts to certain state retirement officers and employees from registered placement agents, as described above, both CalPERS and CalSTRS have developed their own rules related to gifts and entertainment. First, CalPERS employees who are "designated employees" under California regulations are limited to receiving $420 in gifts from a single source in a calendar year. Note that the $420 limit is adjusted for inflation every two years.
Additionally, pursuant to a more stringent internal gift policy, certain CalPERS employees are prohibited from accepting anything of value including, money, gifts, services, loans, entertainment, tickets, transportation, food or beverages from any person or entity doing or seeking to do business with CalPERS, or from any registered lobbyist. This policy prohibits the acceptance even of items of immaterial or de minimis value that are not considered gifts in other contexts. Typically, the assessment of whether or not the gift can be accepted must be conducted on a case-by-case basis, depending, among other things, on the position the prospective recipient employee holds. While this is an internal policy at CalPERS, a placement agent who violates these provisions puts his or her reputation at risk, and could harm future business opportunities.
Similarly, CalSTRS has adopted a Statement of Ethical Conduct that prohibits "employment, activity, or enterprise" that could result in accepting any thing of value from anyone who is doing or is seeking to do business of any kind with the state or whose activities are regulated or controlled in any way by the state, under circumstances from which it reasonably could be substantiated that the gift was intended to influence the recipient in his or her official duties. While this could be read as a total ban on gifts, more specific gift limitations prohibit anyone who engages in business with CalSTRS from providing gifts with a cumulative value exceeding $420 per year, including meals or entertainment, to a CalSTRS employee. There are some exceptions for certain food, beverages and travel that need to be assessed on a case-by-case basis.
Finally, but perhaps most importantly, any party who engages in business with CalSTRS and makes a gift or gifts aggregating more than $50 annually to a CalSTRS employee included on the CalSTRS Key Personnel list must disclose the gift(s) at various points in the contracting process. Failure to properly disclose could result in a contractor being disqualified from future business for up to two years.
Those implicated by the new law should begin to take steps to understand its impact and implement policies and processes for compliance. The California Fair Political Practices Commission has yet to release guidance regarding the new law. It also has not indicated whether it plans to amend the lobbyist registration and reporting forms. Interested parties should continue to monitor the activities of the Commission on this issue, as well as related regulatory initiatives by the state pension and retirement systems.
Note that this three-part "external manager" exception applies only with regard to placement agents and their interactions with state-level pension funds or retirement systems. At the local level, the only exception to the definition of placement agent is the "one-third" exception.
This document contains general information only, which is not intended to constitute legal advice on any subject matter. Readers should not rely on this information for any purpose without seeking legal advice on the specific facts and circumstances at issue from a licensed attorney. Moreover, readers should not consider this information to be an invitation to create an attorney-client relationship between you and Kelley Drye & Warren LLP, to which we would only agree in writing after exchange of certain additional information, including a check for any conflict of interest.