Tag: California

The SEC’s Pay-to-Play Rule and California Labor Law

Keith Bishop chimed in on Campaign Contributions and the SEC in the context of California law: Pay-To-Play Meets The California Labor Code at the California Corporate & Securities Law blog.

He point to  California Labor Code:

Section 1101.
No employer shall make, adopt, or enforce any rule, regulation, or policy:

(a) Forbidding or preventing employees from engaging or participating in politics or from becoming candidates for public office.
(b) Controlling or directing, or tending to control or direct the political activities or affiliations of employees.

Section 1102.
No employer shall coerce or influence or attempt to coerce or influence his employees through or by means of threat of discharge or loss of employment to adopt or follow or refrain from adopting or following any particular course or line of political action or political activity.

Obviously there is some conflict from the face of the code with SEC Rule 206(4)-5 that limits certain employees of registered investment advisers from making campaign contributions to certain elected officials.

You may disagree with the rulings, but political campaign contributions are considered political activities. The SEC rule therefore limits political activities.

That puts the CCO of a registered investment adviser in a precarious position. On the one hand, violating the SEC rule could result in the loss of a great deal of money for the adviser.  On the other hand the CCO’s policy may be violation of California law.

Mr. Bishop cites Couch v. Morgan Stanley & Co., a 2016 federal court decision that looked at those sections of the California Labor Code. That court found that it was okay to fire someone for legitimate, non-political reason even though the underlying action was related to political activity. In that case, Mr. Couch was elected to the county board of supervisors. Morgan Stanley told him he could not hold both jobs based on time constraints.

I suppose that helps a bit. The limit on campaign contributions is set by a federal agency, not an employer made rule. It’s not the employer imposed rule. The rule is non-political in that, on its face, it does not apply to a political position, but to a political office.

One problem is the perception cast by advisers who want to do business with Indiana. They are telling their employees that donations to the Republican presidential candidates are limited, but there are no limits on the other candidates. It’s to meet the standards of the rule, but comes across as very political.

Of course that does leave the problem of how to implement the rule and Goldman Sachs’ implementation of the rule. Goldman banned contributions. That seems to be more than required by the federal rule and could be seen as unduly limiting the employee’s activities.

I know many advisers have taken the same position as Goldman Sachs and banned all political contributions by all employees. The intricacies of the SEC rule make anything more tough to manage. Others have pointed out that such a position may be in conflict with California law. Thanks to Mr. Bishop for pointing out the law on the issue.

California’s Private Fund Disclosure Bill

California’s soon to be enacted new law, AB 2833, requires every California public investment fund to require its alternative investment vehicle fund managers to make disclosures regarding fees and expenses.

welcome-to-california

AB 2833 mandates that that every California public investment fund (that includes CalSTRS and CalPERS) must make the following disclosures at least annually:

  • The fees and expenses the fund pays directly to the alternative investment vehicle, the fund manager or related parties.
  • The fund’s pro rata share of fees and expenses that are paid from the alternative investment vehicle to the fund manager or related parties. In lieu of having the alternative investment vehicle provide this information, the fund may calculate it using information contractually required to be provided by the alternative investment vehicle.
  • The fund’s pro rata share of carried interest distributed to the fund manager or related parties.
  • The fund’s pro rata share of aggregate fees and expenses paid by all of the portfolio companies held within the alternative investment vehicle to the fund manager or related parties.
  • Any additional information already required to be disclosed under the Public Records Act in regards to alternative investments.

The law defines “alternative investment” as “an investment in a private equity fund, venture fund, hedge fund, or absolute return fund.” That leaves me wondering if the term is intended to include real estate funds.

 The bill applies to new contracts that the public investment fund enters into on or after January 1, 2017, and to all existing contracts pursuant to which the public investment fund makes a new capital commitment on or after January 1, 2017.

Sources:

State Line 2-welcome-to-california
CC BY
Phillip Capper from Wellington, New Zealand

California’s Public Disclosure of Private Fund Investments

top secret

One of the challenges with having a government pension plan investor is the potential disclosure obligations under the states’ sunshine laws. A similar problem exists with Securities and Exchange Commission. The SEC is subject to the Freedom of Information Act and exam information is potentially subject to some level of disclosure.

But the state level equivalents of FOIA are worded a bit differently. You also have the situation where the state’s pension fund is an investor. So the performance of an investment is somewhat relevant to the public, since public tax dollars are at work.

A recent ruling came out of California. That case involves the efforts by a news publication to obtain individual private fund information for investments made by the Regents of the University of California. Reuters made the request under the California Public Records Act, Gov. Code, § 6250 et seq. The Regents refused to provide the information. Reuters sued.

The Superior Court ruled in favor of Reuters and found that the Regents were required to use “objectively reasonable efforts” to obtain individual fund information for the Regents’ current investments even though the Regents had not prepared, owned, used, or retained this fund information.

The First District Court of Appeal reversed in Regents of the University of California v Superior Court, (Cal. App. 1st Dist. Dec. 19, 2013).  The Court held that

unless a writing is related “to the conduct of the public’s business” and is “prepared, owned, used, or retained by” a public entity, it is not a public record under the Public Records Act, and its disclosure would not be governed by the Act.

Clearly, the private fund information is related to the public’s business because tax dollars are being invested.

The decision made in Coalition of University Employees v. The Regents of the University of California (Super. Ct. Alameda County, 2003, No. RG03-089302) (the CUE Case) made it clear that private fund reporting on investments by the Regents is subject to California’s Public Records Act. That case involved a request for the internal rate of return for 94 separate private fund investments.

As a result, some of the fund managers stopped reporting to the Regents.

Subsequently, the Public Records Act was amended and California Government Code Section 6254.26 carves out specific pieces of information about private funds. Although the fund documents, meeting materials and financial statements are not part of the public record, fund return information is still within the bounds of disclosure.

Some of the Regents’ fund managers provided minimal information because they did not want it disclosed to the public. In the discussion, the Court makes it clear that it is not ruling on whether it is proper for private fund managers to withhold the information or whether the Regents should continue to do business with private fund managers who withhold information because of the sunshine law.

References:

California Redefines “Private Fund”

I’ve spent a great deal of brain power on the definition of “private fund” under the Investment Advisers Act. California has added its own twist on the definition. It’s a twist that is very important to real estate fund managers.

Working through the definition of “private fund” requires wading through the Investment Company Act. Congress chose to define it as a “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3), but for sec­tion 3(c)(1) or 3(c)(7) of that Act”. Then it requires a re-visit to the first week of discussion in a securities law class over what is a security.

Most private funds, including real estate funds, have looked at the exclusions under sec­tion 3(c)(1) or 3(c)(7) as safe harbors from registration under the Investment Company Act. They have very clear requirements fro compliance. With the new definition of “private fund” under the Investment Advisers Act, many real estate fund managers have looked at the exclusion under Section 3(c)(5) and wondered if that will work as an exclusion.

California is the first state to recognize the loophole and proposed changes to its definition of private fund in the proposed changes to Rule 260.204.9:

“Qualifying private fund” means an issuer that qualifies for the exclusion from the definition of an investment company under section 3(c)(1), 3(c)(5), or 3(c)(7) (or any combination thereof) of the Investment Company Act of 1940, as amended….[my emphasis]

Given the twisted definitions under the Investment Advisers Act, fund managers could classify themselves out of the federal level of registration and into the state level. At the state level, a fund manager could find other exemptions and exclusions from registration. Although, the state level definitions are continuing to change and catch up to the changes brought by Dodd-Frank.

I have not worked through the implications of this new definition of “private fund”. I decided I’d rather deal with the Securities and Exchange Commission than a collection of state regulators. For a real estate fund manager with operations in California who didn’t register with the SEC, you may need to re-visit the analysis for your exemption.

Sources:

Boomerang – Michael Lewis Looks at the New Third World

Michael Lewis packages his stories on the effects of the global financial crisis in Iceland, Greece, Ireland, Germany, and California into one book: Boomerang. If you had ready the stories when they were published in Vanity Fair, then you’ve ready the book. If you missed some (or all) of those stories then this book is great viewpoint on how five countries got themselves into trouble with excessive debt.

I had already read the first four articles when they appeared in Vanity Fair, but I had not yet gotten to the article on California. In fairness, Boomerang was a given to me as a gift so I did not come out of pocket to put it on my bookshelf. I enjoyed revisiting the four stories and the new California story.

They each seemed to work better in the collection than standing on their own. Since each story is relatively short, they lack the depth and understanding I’m used to getting in one of Michael Lewis’ books. Collectively, there is bit more depth as you can see how the five different countries got into trouble in different ways by becoming over-leveraged.

It’s a Michael Lewis book, so that means it’s easy to read and smart. He has a gift for taking complicated subjects and using individuals to highlight how his theories work in the real world.

My gripe is not with the book, but with Vanity Fair who sponsored Lewis in writing the five stories, each of which has appeared in the magazine. I purchased a subscription to Vanity Fair just because of these Lewis articles. I thought I was choosing to upgrade the freemium model.  I was willing to pay more for the superior experience of reading the article in the magazine instead of online. However, the publisher would put them on the website (for free) before the magazine ended up in my mailbox. One premium of getting access to the content first, was actually the opposite. I was getting the content later than if I had chosen not to pay for it. It’s not like the magazine is ad-free.

So why I would I renew my subscription?

California’s New Placement Agent Law

California has become the latest state to regulate the use of placement agents who help investment managers secure government pension fund money. (Or is that placement agents who help government pension fund money find suitable investment managers?)

California Assembly Bill 1743 was backed by the California Public Employees’ Retirement System, the state treasurer and the state controller. Placement agents must register as lobbyists before they can pitch investment proposals to California government investors.

As Keith Paul Bishop notes in the California Corporate & Securities Law Blog

“the proposed rule does not appear to require disclosure of gifts and campaign contributions to losing candidates for positions that have the authority to appoint persons to the CalPERS Board.  This is not consistent with the Securities and Exchange Commission’s recently adopted “time out” Rule 206(4)-5 for investment advisers which appears to cover contributions to both successful and unsuccessful candidates.  Nor is this approach consistent with the Municipal Securities Rulemaking Board’s interpretation of Rule G-37 (See FAQ II.22)”

Meanwhile CalPERS is has its own rules which area bit stricter. Placement agents must report gifts and campaign contributions made to all Board members as well as to persons who have the authority to appoint persons to the CalPERS Board: the Governor, the Speaker of the Assembly, and the members of the Senate Rules Committee.

One point to focus is the definition of “Placement Agent.” An investment manager’s employees, officers, directors, and equityholders who solicit California public retirement systems for compensation may be placement agents under the definition, unless they spend more than one-third  of their time during the calendar year managing securities or assets of the manager. With respect to solicitation of CalPERS and CalSTRS only, if the manager is registered with the Securities and Exchange Commission as an investment adviser or broker-dealer, is selected through a competitive bidding process, and has agreed to a fiduciary standard of care applicable to the retirement board, then the employees, officers, and directors of a manager will not be a placement agent.

Sources:

SEC Warns Firms on Muni Pay-to-Play Rules

While sources are wallowing in the exposure of a political figure in a “pay to play” scandal, I thought there might be some lessons for other investment managers as states and perhaps the SEC roll out limitations on political contributions.

The original story seemed mildly interesting.  The SEC warned firms that municipal securities rules prohibiting pay-to-play apply to affiliated financial professionals, not just a firm’s employees. The story caught my eye because MSRB Rule G-37 was identified as a model for the SEC’s proposal on pay to play.

The SEC wanted to make it clear that an “executive who supervises the activities of a broker, dealer, or municipal securities dealer is not exempt from the MSRB’s pay-to-play rule just because he or she may be outside the firm’s corporate governance structure.”

The SEC report identified JP Morgan and the Treasurer of the State of California, but did not name names. It did not take much research to find out that Phil Angelides was treasurer at the time of the incident. The Wall Street Journal identified the JP Morgan executive as David Coulter who was the vice chairman who oversaw the bank’s investment-banking business.

“On September 10, 2002, the Vice Chairman forwarded an invitation for the California Treasurer’s New York fundraising event to JP Morgan Chase’s executive committee and to its Vice President for Government Relations with a handwritten note stating that the California Treasurer is an important client and soliciting their help in raising $10,000 for the event.”

That is exactly the sort of behavior that the SEC wants to prohibit with MSRB Rule G-37 and its proposed pay to play rule.

A key takeaway from the report is that the SEC will look “to the activities, not merely the title, of an associated person in determining whether the person is” subject to the pay to play restrictions.

The story gets juicy because Mr. Angelides is currently the Chairman of the Financial Crisis Inquiry Commission. The Financial Crisis Inquiry Commission was established under the Fraud Enforcement and Recovery Act of 2009 to “examine the causes, domestic and global, of the current financial and economic crisis in the United States.” Perhaps his own situation will be an example in the FCIC’s report due on December 15.

Sources:

California Proposes Having Placement Agents Register

Placement agents would have to register as lobbyists under legislation proposed by Assemblyman Ed Hernandez (D-West Covina). The legislation would define placement agents as lobbyists in accordance with the state’s Political Reform Act. Placement agents would have to register as lobbyists before pitching investment ideas to public pension plans in California.

It seems like the big California pension funds want access for pitches from small investment firms without their own marketing staff. So they are not following the lead of New York with its outright ban on placement agents.

The bill is sponsored by State Controller John Chiang, the California Public Employees’ Retirement System (CalPERS), and Treasurer Bill Lockyer.

The bill is straightforward, defining a placement agent as:

“any person or entity hired, engaged, or retained by, or acting on behalf of, an external manager, or on behalf of another placement agent, as a finder, solicitor, marketer, consultant, broker, or other intermediary to raise money or investment from, or to obtain access to, a public retirement system in California, directly or indirectly, including, without limitation, through an investment vehicle.”

There is an exemption for employees of external managers who spends at least one-third of their time managing the assets of their employer.

As a “placement agent” you are required to report quarterly on fees, compensation and gifts under the Political Reform Act (Government Code §81000-81016).

Sources:

California Regulates Use of Placement Agents

California

California has followed the lead of New York and started regulating the use of placement agents. California’s law requires placement agents to disclose contributions and gifts made to state and local pension and retirement board members, as well as information about the placement agent’s compensation, the services provided, and any lobbying or regulatory registrations.

The California law is based on disclosure. It does not ban the use of placement agents like New York and as proposed by the SEC

The new California law (Assembly Bill No. 1584) went  into effect on October 11, 2009 when Schwarzenegger signed the bill into law. The law establishes a disclosure-based regime that requires:

  • Potential placement agents, prior to acting to solicit a potential state or local public pension or retirement system investment, must disclose campaign contributions and gifts to public pension board members during the prior 24 months.
  • Placement agents must disclose any subsequent gifts and campaign contributions to pension or retirement board members for as long as they are being paid to solicit investments.
  • Each state and local public pension system must develop and implement policies requiring disclosure of payments to placement agents by external asset managers by June 30, 2010. The new disclosures must include, at a minimum, the following information:
    • the existence of the relationship;
    • a résumé for each officer, partner or principal of the placement agent;
    • a description of compensation paid to the placement agent;
    • a description of services to be performed by the placement agent;
    • a statement of whether the placement agent, or its affiliates, is registered with the SEC, the Financial Industry Regulatory Authority  or other regulatory body; and
    • a statement of whether the placement agent, or its affiliates, is registered as a lobbyist with any state or the federal government.
  • A state or local public pension or retirement system may not enter into an agreement with any asset manager that does not agree in writing to comply with any such policy.
  • Any placement agent or external manager that violates any such policy is barred from soliciting new investments from that state or local retirement system for five years from the time of the violation.

References:

California Adopts e-Discovery Rules

California

Never mind the budget crisis or handing out IOUs, California has passed its own Electronic Discovery Act. California joins the 30 other states that have decided to include provisions in their rules aimed directly at the discovery of Electronically Stored Information.

The Act amends the California Code of Civil Procedure by expressly permitting discovery of electronically stored information. The goal is to improve discovery measures during litigation and to avoid undue involvement by the court in resolving e-discovery disputes. The Act defines Electronically Stored Information as “information that is stored in an electronic medium” and defines “electronic” as “relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities.”

California’s new e-discovery rules closely parallel the federal version. The Act primarily applies the existing rules in the California Civil Discovery Act to ESI and establishes procedures to request and respond to e-discovery.

California’s Electronic Discovery Act is similar to the Federal Rules. The California act also has  Federal Rules safe harbor for the failure to produce Electronically Stored Information.  “Absent exceptional circumstances, the court shall not impose sanctions on a party or any attorney of a party for failure to provide electronically stored information that has been lost, damaged, altered, or overwritten as a result of the routine, good faith operation of an electronic information system.” Cal. Code of Civil Procedure 1985.8 (l)

California Governor Arnold Schwarzenegger signed the Act on June 29 and it goes into effect immediately.

References:

Code of Civil Procedure