Agents of mistrust

In the wake of a growing kick-back scandal in the US, several major public pensions have beefed up their disclosure policies regarding the use of placement agents (see also p. 43).

The increased scrutiny of placement agents was triggered in March when New York Attorney General Andrew Cuomo indicted former New York political operative Henry Morris over an alleged scheme in which Morris and former New York Common Retirement Fund (CRF) chief investment officer David Loglisci collected hundreds of thousands of dollars in finders fees from investment firms in exchange for commitments from the pension.

Fol lowing the news, the CRF announced it was banning the use of placement agents, paid intermediaries and registered lobbyists from participating in its investments, while New York City Comptroller William Thompson asked trustees of all five of the city's pensions, with combined assets of around $83 billion, to approve a ban on placement agents.

As Aldus had ties throughout the US, other pensions have taken their own steps to deal with the fallout. For instance, the $164.9 billion California Public Employees' Retirement System (CalPERS) – the largest public pension in the US – charged its staff with drafting a new disclosure policy requiring investment managers to disclose the use of placement agents and how much they pay them.

CalPERS has indirect ties to the scandal through a California-based firm called Wetherly Capital Group – reportedly among a number of firms being scrutinised by Cuomo – as does the $9 billion Los Angeles City Employees' Retirement Fund (LACERS), which recently mandated that investment firms looking for commitments must reveal the identity of any third-party marketers involved in the investment process. It is also establishing more stringent due diligence policies for the selection of investment managers that will be part of an updated strategic plan. At the same time, the New Mexico State Investment Council has been ordered by Governor Bill Richardson to suspend alternative investments until its own disclosure policy is in place, while similar reforms are being made in Connecticut and Illinois. While many in the industry tout the valuable role placement agents perform in identifying an investor's needs, shaping a message and presenting information, they also say the process by which some pensions allocate funds has been dominated by a politically driven, “who-you-know” approach.

“When the dust settles the placement agent option will not go away but it will be greatly clarified,” says Stewart Kohl, co-chief executive of buyout firm The Riverside Company. “Hopefully they get rid of the folks who were abusive. Public trust is a critical thing and it is easily eroded – and once eroded is hard to rebuild.”

In the meantime, private equity funds that use placement agents or hire agents in the future will probably require appropriate legal compliance protections in their placement agreements, such as a provision demonstrating that the placement agent is not engaged in any “pay-to-play” arrangements, according to Kevin Scanlan, a partner at law firm Dechert. A breach of this provision would require the placement agent to indemnify the fund for any damages caused by any misconduct and put the fund in a more defensible position with respect to any collateral damage that may arise.

Firms trying to get their foot in a pension's door without an agent can apply to qualify as an asset manager, typically known as a Request for Proposal (RFP). Nearly every major state pension fund posts an RFP form on their website. Meanwhile, firms can also try to contact the investment consultants, known as gatekeepers, that are retained by many pension funds and who help make the decisions over potential allocations to asset managers.

“That's probably how you always should have gotten access to these managers,” Scanlan says. “It's cleaner if it just goes directly to the state, as opposed to going through any third party.”