California lawmakers have taken a step toward cracking down on the middlemen that help private investment firms land lucrative contracts with the state's giant pension funds.
The use of so-called "placement agents" has erupted into a scandal in California and New York, where allegations of cronyism and exorbitant fees have prompted investigations.
On Wednesday, the state Assembly's Public Employees, Retirement and Social Security Committee voted 4-1, with one member abstaining, to improve oversight of the way California public pension funds invest money.
The California Public Employees Retirement System is the nation's largest pension fund, with about $210 billion in assets under management.
The California bill would require placement agents to register as lobbyists and file quarterly reports stating any gifts or fees they received.
It also would prohibit the practice of allowing outside investment managers to pay those agents contingency fees for winning business with the funds. Placement agents typically earn 1 percent of the total investment they win for their clients, which can mean millions of dollars for landing a deal.
Instead, those agents would be paid a flat fee.
Investment firms are lining up against the proposal.
Lawmakers said the intent is to ensure that fund managers are making sound investment decisions, rather than handing out money to dubious firms recommended by friends and insiders.
"Continuing revelations have underscored the need for full disclosure of the finances and other activities of placement agents," said Assemblyman Ed Hernandez, a Democrat from Baldwin Park who sponsored the bill.
In New York, a pay-to-play scandal involving state pension fund managers has led to six people pleading guilty and an inquiry from the U.S. Securities and Exchange Commission. California's pension funds are also being investigated by the SEC.
New York has since banned investment firms from hiring placement agents to do business with its public pension funds.
"This has risen to such a level that we have the SEC looking at a total ban of placement agents," said State Controller John Chiang, a member of the CalPERS board.
CalPERS hired a law firm to conduct its own internal investigation into how the agency has used placement agents in the past 15 years. Results from that inquiry are expected within the next two months.
"It truly is a cash cow for the placement agent industry," Chiang said. "And so that's what were trying to stop."
Not everyone on the committee was convinced that ramping up controls on placement agents would solve the problems that may be facing them.
"I think we're trying to solve a problem that may not be at the crux of it," said Assemblywoman Diane Harkey, who voted against the measure.
"I think we've got some people doing some illegal activities, making profits where they should not be," the Republican from Laguna Niguel said, asking what financial exchanges pension board members were required to report.
CalPERS board members and some senior investment officials report their investment holdings and gifts received each year.
Harkey said constraints on placement agents would limit competition for investments and give an advantage to larger firms, a concern echoed by the investment community.
The Blackstone Group LP, one of the nation's largest private equity firms, opposed the bill.
Terry McGann, a lobbyist for Blackstone, said the company would support the bill if the ban on contingency fees was removed.
"AB 1743 has the potential to directly harm ... the integrity and success of emerging placement agents or firms that are often owned and managed by women and ethnic minorities," McGann said.
CalPERS Chief Investment Officer Joe Dear countered that CalPERS does its own outreach to attract minority-owned firms, and that 80 percent of the private investment managers hired by CalPERS have disclosed that they do not hire placement agents. CalPERS supports the bill.
"The history of corruption is so severe that it seems to me the impact on the small firms to make the change is modest, compared to the need to reform," said State Treasurer Bill Lockyer, who is also on the CalPERS board.
After the meeting, Hernandez said he would not remove the ban on contingency fees from the bill.
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