Tracking the Recession: Cracking Down on Pension Middlemen

By: - May 18, 2009 12:00 am

The $122 billion New York State employee pension fund, which is so big that it is only $10 billion less than the entire state budget, is a tempting pot of gold.

So it should come as no surprise in an era of lax financial oversight that politically connected operatives would find a way to snare contracts for firms to invest pension money and collect a fat fee for themselves.

But now state officials, starting in New York and spreading across the country, are fighting back against these so-called placement agents with lawsuits and other actions. Attorneys general from more than 30 states are planning to create a task force to examine the system in which permanent state accounts, such as public employee pension funds, use advisers with political connections to help decide where to invest public money.

New York Attorney General Andrew Cuomo , following a recent teleconference call with 100 representatives of 35 state attorneys general’s offices, said he would form the task force “so states can share vital information to prosecute wrongdoing and facilitate nationwide reform.”

The task force is in its early stages, with the participating states uncertain. The attorney general has said he wants the group to have “a unified, efficient” method of gathering information.

Cuomo announced Thursday (May 14) what he considered to be a major step toward fixing the systemic weaknesses in public investment practices. He said the Carlyle Group has agreed to pay $20 million and make other reforms to escape possible charges in connection with the New York pension fund probe. Investigators have questioned the conduct of Carlyle, one of the world’s largest private equity funds.

“This is a revolutionary agreement,” he told reporters. “It totally changes the way people operate. It ends pay to play. It bans the selling of access. It puts the political power brokers out of business.”

The task force comes as New York, California, Connecticut and New Mexico officials are investigating possible pension fund abuse and political favoritism. The federal Securities and Exchange Commission also is examining pension transactions in New York, California and New Mexico.

The allegations center on investment firms and politically connected middlemen who arrange deals between investment firms and public pension funds. Preliminary investigations by Cuomo’s office found that many of the intermediaries are not properly licensed or registered with a broker-dealer, as required by federal law. They also are not required to disclose fees that the investment firms – hedge funds, money managers and others – pay the placement agents to obtain financial deals with the pension funds.

“If Boss Tweed were alive, he would be a placement agent,” Cuomo said, referring to William M. Tweed, the corrupt New York political boss of the 19 th century.

Of major concern is that lobbyists and political consultants may be trying to act as placement agents without registering. Cuomo has said the pattern of unlicensed agents creates a situation that is “fraught with peril and prone to abuse” because of the potential that such agents capitalize on their political connections to obtain contracts to invest pension money from the huge fund that finances state employee pensions.

Cuomo and the SEC are scrutinizing the millions of dollars that friends, relatives and aides of former New York State comptroller Alan Hevesi received by placing deals with the state pension fund. Two former aides to Hevesi and a former head of the state Liberal Party have been indicted on fraud charges. All three have pleaded not guilty.

In New Mexico, a Santa Fe placement agent with political connections to Democratic Gov. Bill Richardson was paid about $11 million in fees from investments made since 2003 with the State Investment Council, the panel which Richardson oversees that manages the state’s three permanent endowment trust funds .

Separately, Richardson’s former chief of staff has been accused in a lawsuit of pressuring state officials to support investments in mortgage-related securities. He has denied wrongdoing.

The governor, Legislature and state investment council are investigating. Richardson has ordered the state to suspend its new investments in hedge funds and private equity firms. Following a legislative hearing May 12 into the fees received by middlemen, state Sen. John Arthur Smith, a Democrat from Deming, called on Richardson to ask for “a complete cleaning of the house,” referring to panels that manage state investment funds.

New Mexico and Connecticut have fired Aldus Equity Partners , an investment firm whose founder Cuomo and the SEC have charged with fraud and securities law violations in connection with the New York State pension fund. Both states had used Aldus as advisers. Aldus has denied the charges.

In California, the state public employees retirement system on May 11 adopted a new policy requiring its money management firms to disclose the fees they pay middlemen. “We want to know who’s being hired, how much they’re being paid, what they’re paid for and who pays them,” said Rob Feckner, president of CalPERS, the state employee pension fund.

As part of the more than 100 subpoenas Cuomo issued to investment firms and intermediaries in April, two politically connected California placement agents are under investigation for the $3 million in fees they were paid for help securing about $525 million in business with the state employee retirement fund.

State and federal officials are investigating more than 100 firms who do business with state pension and other permanent funds. In addition to bringing people to justice who have violated state laws, the other goal of the state task force is to bring permanent changes along the lines of Carlyle’s agreement, Cuomo said.

Cuomo said Carlyle will discontinue hiring middlemen with political connections and ban its employees from making campaign contributions to public officials who control pension fund investment decisions.

“This new code of conduct is our statement of how business should be done going forward,” Cuomo said, adding that the agreement applied to all states where Carlyle has operations. “Carlyle’s acceptance is important because they are a major company in this area. When they accept this level of conduct it says it is feasible for the (entire) industry.”

The attorney general said he hoped that the code of conduct he negotiated with Carlyle ultimately would be enacted by states and or Congress. In the meantime, he said, he hopes to create “a race for the top” to persuade other investment firms to join Carlyle.

Carlyle said in a statement that as the first company to adopt Cuomo’s code of conduct, it would “set a new standard for ethics in the industry.”

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Stephen Fehr

Stephen Fehr is a senior officer with Pew’s government performance portfolio. He is a lead writer on many of the products generated by the portfolio, specializing in state and local fiscal health.