California mine field

The Golden State is set to become an even more challenging fundraising destination for private equity managers with a new rule that will require placement agents to register as lobbyists.

It may be hard to believe, but California just became a more precarious playing field for private equity fundraisers.

California came a step closer to severely limiting the use of placement agents that seek to do business with the state’s public pension funds, among them some of the biggest backers of private equity funds in the world.

On Tuesday, the California state assembly passed legislation that requires placement agents hired by private equity firms to win business with the state's public pension funds to register as lobbyists. As lobbyists, placement agents will be exposed to stricter disclosure requirements.

Perhaps most troubling for placement agents, the new rules would end payments for successful fundraisings. Placement agents under the bill would instead be paid flat fees up front, as are lobbyists.

The placement agent bill now goes to California Governor Arnold Schwarzenegger’s desk.

This latest rule creation comes on the heels of another headache in California – the bribery scandal involving luxury travel and gifts to investment members at the nation’s largest public pension fund.

The California Public Employees’ Retirement System is still reeling from allegations that a former member of the pension’s board had been paid millions of dollars in sham fees to solicit commitments from the pension for Apollo Management and other firms.

Not only will it be harder to hire an effective fundraising representative in California, but the ability to interact with the investment staff of the state’s public pensions looks set to be restricted even further, with travel and “gift” expenses (ie, buying your LP dinner) under public scrutiny.

CalPERS senior portfolio manager Joncarlo Mark testified 29 July at pretrial proceedings for the state’s corruption investigation that he took 10 to 12 trips on private jets to destinations including New York, Las Vegas, Mumbai and Shanghai.

The California public was shocked to learn that financial firms also paid for dozens of other trips for Mark and staff on commercial airlines as well as for meals at expensive restaurants. He did not disclose some of the trips on forms that pension fund employees must fill out when accepting gifts valued more than $50. Given less attention was the fact that these trips were related to Mark’s role as board member to funds in which CalPERS had committed millions.

The lobbyist rule is the third layer of regulation managers in California have seen in a year. First there were pension fund travel restrictions, followed by SEC rules banning unregistered placement agents, and now the elimination of contingency fees.

It’s almost hard to remember that these rules come from a state that loves to invest in private equity.

CalPERS, the California State Teachers’ Retirement System and numerous large municipal pension funds pledge billions of dollars in commitments each year.

The California LPs are hungry for private equity opportunities, but it’s getting more and more difficult to connect for commitments. The lobbyist rule is part of an ongoing trend that will require GPs who want to manage public capital to carefully map out how they will create and maintain effective and legal investor relations.