Adjusting to a new reality

It might be said that placement agents are feeling somewhat persecuted, with the “pay-to-play” scandal involving the New York State Common Retirement Fund having led to several public pensions banning the use of placement agents in the investment process.

They say the measures taken by some pensions like the New York Common, the New York City pension system and the New Mexico pension and endowment are overreactions to a scandal that appears to have been perpetrated by just a few bad actors.

The industry does have its defenders – one particularly vocal supporter of the use of placement agents being Mike Travaglini, executive director of the $38 billion Massachusetts state pension system.

But others believe the scandal could mark the end of the placement agent industry, at least in the form it has operated up until now. Agents will have to adapt to the new environment or disappear completely, some industry professionals say.

The job of a legitimate placement agent entails more than just collecting money from institutions like public pensions. Firms hire placement agents to help get them in the door at institutions like New York Common, a $109 billion pension.

Pensions work with placement agents they trust because they know the agent will have undertaken a careful vetting process on clients, according to Travaglini. In that way, a thorough stress test has already been accomplished when a trusted placement agent brings a firm to an LP's door.

Such a placement agent will spend a lot of time researching the GPs it works with, according to Mounir Guen, chief executive of MVision, a placement agency based in New York and London.

“We spend years identifying GPs, doing massive amounts of due diligence to get comfortable with the GPs,” Guen says. “We do a lot of work s tudying GPs , s tudying markets.”

Placement agents generally have limited contact with public pensions as they usually work through a pension's private equity consultant or gatekeeper.

The problem is that the process can occasionally be corrupted at the gatekeeper level. Aldus Equity served as the private equity consultant for the New Mexico State Investment Council, an $11.8 billion endowment. Aldus Equity, while recommending investment firms to which New Mexico SIC should commit money, was allegedly working with some of the main players in the New York Common scandal to illegally kickback fees.

News of the “pay-to-play” scandal broke in March when the SEC and New York attorney general Andrew Cuomo announced the arrests of Henry Morris and David Loglisci. Morris, a political associate of former New York comptroller Alan Hevesi, is alleged to have been the ringleader of the scheme. Loglisci, former chief investment officer of New York Common, allegedly strong-armed investment firms to share a portion of their fees with Morris and others in exchange for commitments from the New York pension.

Six people in total have been charged so far during the investigation. Barrett Wissman, former head of Texas-based hedge fund Hunt Financial Ventures, allegedly acted as a placement agent and kicked back portions of fees to Morris. In one instance cited in Cuomo's complaint, Morris directed the pension to invest $100 million in Hunt Financial and was paid a finder's fee of $600,000. Julio Ramirez, a former executive with Blackstone Group-affiliated placement agent Park Hill Group and Los Angeles-based placement agent Wetherly Capital, pleaded guilty to misdemeanor charges of fraud in the case.

The investigation now involves attorneys general of other states, including New Mexico, and the US attorney's office. Numerous investment firms are mentioned in the various complaints filed in the investigation, but none have been charged with any wrongdoing. The Carlyle Group agreed to pay $20 million and sign onto a code of conduct created by Cuomo to “resolve its role” in the investigation.

Cuomo has subpoenaed more than 100 investment firms and placement agents in a hunt for evidence of illegal brokering of public pension capital, and the SEC has requested information about fees and work carried out in exchange for fees from placement agents, investment firms and pension managers.

In the wake of the investigation, New York State banned its pension from working with investment firms that use placement agents, and the New York City pension system is undertaking to ban the practice as well. New Mexico Governor Bill Richardson has banned the use of placement agents in his state, while Illinois has sidelined placement agents from working with its pensions after a separate scandal.

We spend years identifying GPs, doing massive amounts of due diligence to get comfortable with the GPs”

Other states' pensions, such as the California Public Employees' Retirement System, have strengthened disclosure requirements for investment firms using third-party marketers.

Not every private equity firm employs a placement agent when it decides to raise a new fund. The Riverside Company is a private equity firm that has operated exclusively in the mid-market for more than two decades. The firm does not use placement agents, according to co-chief executive Bela Szigethy.

“It was originally more of an issue of economics than anything else, it always seemed to us placement agents were paid handsomely for their services, and that was something we couldn't afford in those days,” Szigethy says, talking about the firm's fundraising efforts in its early days of existence.

Riverside has five employees working on investor relations and fundraising. “We find that team represents Riverside exceptionally well, they're in-house, they're involved, they're included in the discussion of key decisions,” Szigethy says. Riverside recently closed its fifth buyout fund with $1.17 billion in commitments, surpassing its original target of $900 million.

A placement agent would have been useful back in Riverside's early days, before the firm was known to limited partners, Szigethy says. “Who knows how much easier it would have been back then, how much blood, sweat and tears we could have saved if we had used a placement agent?” he ponders.

UK-based mid-market investor ECI Partners also does not use placement agents in fundraising. They are only necessary for some young firms, especially spinouts or those firms that may encounter fundraising difficulty, according to Jeremy Lytle, director of investor relations at the firm.

Or, the third caveat: “They don't fancy a lot of the hard work and heavy lifting,” he says. “For a first-time fund, it's probably pretty essential to have a placement agent in terms of making all the introductions.”

ECI tries to add a few new investors with each fundraise, but has a broad and diverse set of LPs it can turn to when it launches a new fund, Lytle says. “We're not trying to reinvent the wheel each time,” he adds.

In the changed environment, placement agents must adjust. This means, right off the bat, answering the many questions their clients have.

“We've certainly had questions from our clients,” says Raymond Kraftson, managing director of Pennsylvania-based placement agent Ariane Capital Partners.

Ethical placement agents make life easier for pensions and banning them will not solve any problems, Kraftson says.

“New York issued its ban and said any fund managers or GPs can contact us directly – and gave three peoples' email addresses. They'll have their own set of problems dealing with the deluge of GPs coming to them unprepared and who may or may not have been vetted before they show up at the door,” Kraftson says.

Such bans will obviously create problems for some placement agents. But, as Kraftson notes, it could create a headache or two for the pensions as well.