Flanigan's letter

Say what you want about Andrew Cuomo's tactics and motivations, but the New York attorney general's investigation into the public pension investment market has rightfully destroyed the placement careers of politically connected middle men who made millions peddling influence with comptrollers and pension board members.

Cuomo's strategy suffers from unfortunate side-effects and missed opportunities to be discussed at another time. But one interesting feature of the “code of conduct” his office is attempting to force on the pension market (and which Cuomo-smacked Carlyle and Riverstone have adopted) is a self-imposed ban on fund managers making political campaign contributions to public pension officials with whom they do or seek to do business.

A decade ago, both California State Teachers' Retirement System (CalSTRS) and the Securities and Exchange Commission (SEC) tried and failed to adopt this seemingly sound policy. Will the latest public pension scandal put wind behind a new effort to once and for all ban political contributions by conflicted investment advisors?

The conflicts inherent to publicly elected fiduciaries came into effect the moment such positions were created. Individuals who are elected to powerful positions often have ambitions to be re-elected to the same post or to other, often more powerful posts. To do so they need campaign money. These officials, whose jobs happen to be asset allocation, are well aware of two facts – first, that their decisions on which fund managers to hire amount to incredible transfers of wealth, and second, that the managers under consideration are often already quite wealthy – just the kind of people who could easily sign a hefty donation cheque if asked to do so.

The ongoing Cuomo investigation has revealed that GPs across America have routinely been hit up by self-appointed “advisors” who promise access to pension capital (or threaten to block it unless a toll is paid). It also highlighted a much better-known fact of life among public pensions – many GPs can barely make it to the elevator following a pitch meeting before being presented the opportunity to contribute to the political campaign of someone connected to, or directly overseeing, the manager-selection process.

When a person who might commit $200 million to your fund asks you for a $1000 campaign contribution, it's hard to know what the right course of action is. Few politicians connected to pensions would be stupid enough to state plainly that only donors get commitments. But the solitications have made many GPs wonder, what happens if I don't pay? Am I off the list?

A somewhat forgotten drama from 1997 was the last time this issue got the attention it deserved. When CalSTRS chief investment officer Thomas Flanigan failed to have his contract renewed, the apparent disappointment prompted him to fire off a letter to the SEC detailing how then-state controller Kathleen Conner sometimes solicited campaign contributions from fund managers who were seeking business with CalSTRS.

The public revelations prompted hearings at the state legislature and a new policy at CalSTRS barring fund managers from donating to politicians connected to the pension.

Amazingly, Conner – who during her time in California politics was never accused of lacking chutzpah – ended up suing CalSTRS for instituting the contribution ban. The move had put a “tremendous chill” on fundraising efforts for her re-election, her campaign director said at the time. In other words, Conner had come to rely on huge cheques from fund managers to further her political career. Her camp's argument was that the ability to donate to a political cause is a right guaranteed by the constitution. CalSTRS' ban was later overturned on procedural grounds.

The SEC took up the issue in 1998 as a proposed rule to bar “certain investment advisors” from making campaign contributions. After a comment period, the commission failed to adopt the proposal. It is important to note that these concerns raised surrounding CalSTRS occurred a decade ago with a different line-up of staff and board members.

A campaign contribution ban would be enthusiastically welcomed by the GPs themselves, who would no longer have to worry about even the appearance of unseemliness, or, a possibly more powerful motivator from the other direction, the worry that their competitor was gaining an edge by dint of a simple campaign donation.

An anonymous letter sent to the SEC in 1999 says it all. In it, a fund manager writes that he or she is “amazed at how many managers are awarded contracts by public funds due to the money they have donated when there were other more qualified managers available”.