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Crackdown On ‘Pay To Play’

Kickbacks can come in many forms: campaign contributions, “fees” paid to sham intermediaries and even investments in low-budget films that feature Mexican prostitutes and a dachshund named Kiwi Limone.

Former New York State comptroller Alan G. Hevesi and his associates have been accused of soliciting all of these forms of indirect payment. (The film, Chooch, was a project Hevesi’s chief investment officer, David Loglisci, was working on with his brother.)

Inquiries into possible corruption in the comptroller’s office began when Hevesi was accused of using state workers as chauffeurs for his wife. Then, as more problems surfaced, the investigation was passed from the Albany County district attorney’s office to Attorney General Andrew Cuomo’s office, and finally, to the Securities and Exchange Commission.

In return for the cornucopia of favors and contributions they received, Hevesi and his associates allegedly offered access to the state’s pension funds. The funds, held for state employees from firefighters to teachers, represent more than $150 billion, a goldmine for money management companies seeking lucrative public contracts.

Most public pension funds hire money managers to invest their assets. Ideally, the tough competition between money managers should ensure that the firms chosen will be the most qualified to manage the assets. The problem comes when the people involved in selecting money managers realize just how much the managers want the business and what they are willing to do to get it. In so-called pay-to-play schemes, government officials grant contracts to money management companies in exchange for political contributions or other favors.

For some, the size of the funds alone guarantees corruption; the temptation, they say, is just too great. E.J. McMahon, director of the Empire Center for New York State Policy, called the New York state pension fund “a gigantic moral hazard” and said that questioning whether or not the fund might be a target for abuse is “like passing an enormous farm and saying, ‘Gee, I wonder if there are flies there.’”

In response to the consistent pattern of corruption, the SEC has proposed new regulations that, if adopted, will help protect pension funds. Under the proposed Rule 206(4)-5, investment advisers would be banned from providing advisory services to a government entity for two years after making any contribution of more than $250 to an official capable of influencing the selection of advisers for that entity. Certain executives and employees of the investment adviser also would be prohibited from soliciting such contributions from others.

The rule also takes on the problem of intermediary “placement agents” who act as liaisons between government entities and money managers during the selection process. Like the advisers themselves, these placement agents have been known to use political contributions and other favors to secure work for their clients. The SEC hopes to take the placement agents out of the picture altogether, prohibiting advisers from paying third parties to solicit government clients on their behalf. It is this provision that has caused the most controversy.

While placement agents can provide a valuable service by matching interested parties, the corruption we have seen is too great to ignore. As Cuomo put it, “You can’t put a price tag on a breach of public integrity. That’s when people lose faith; that’s when people become skeptical and cynical about their government, and government without trust is powerless.” Cuomo and the SEC have decided, and rightly so, that the cost of allowing potentially corrupt placement agents to operate outweighs the benefit of allowing the government to outsource part of the manager selection process.

The proposed regulations will eliminate a major source of corruption and protect state pension plans. Pension beneficiaries deserve to have their money handled by the best money managers in the field, not by the least scrupulous. Money managers who do business in accord with ethics and the law should thank Cuomo and the SEC for their perseverance.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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