California pension reform won't end pay-to-play schemes

SAN FRANCISCO (Reuters) - A new public pension fund reform law in California may temporarily block a revolving door at the state's massive retirement funds, but it will take a lot more to prevent conflicts of interest cases from festering.

California passed a law this month to regulate the use of middlemen, known as placement agents, by investment managers looking to tap pension fund money, as probes into the murky intersection of money and politics spread across the nation.

The California Public Employees' Retirement System, or Calpers, is reviewing more than $50 million in fees paid by private equity firm Apollo Management and others to ARVCO Financial Ventures LLC, a firm headed by former Calpers board member Al Villalobos.

California's law comes as several other states and the U.S. Securities and Exchange Commission scramble to root out corruption in pension funds, where biased investment decisions can leave taxpayers on the hook for billions of dollars.

California is taking a different approach than states such as New York and Illinois, stressing better disclosure rather than barring placement agents from doing business with public pension funds.

The California law calls for disclosures of gifts and campaign contributions made to public pension fund board members and prohibits employees from lobbying former colleagues for two years after leaving the fund.

While some experts hailed the California law as an important step, better than an outright ban that would also hurt legitimate businesses, they said it is not likely to be enough by itself to stop such practices from happening again.

Greater disclosures, while helpful in cleaning up the system, will not keep people from finding loopholes and working around them, experts said.

"You get your mother, your mother's mother -- somebody else to make the contribution," said Edward Siedle of Benchmark Financial Services, a former SEC attorney who investigates pension fund fraud. "I support those notions but I don't think they are going to be very effective in and of themselves."

These experts call for federal regulations by an agency such as the SEC that can be further bolstered by state laws and better enforcement of any new rules that are put in place.

"It is not at all uncommon for there to be a revolving door between private industry and the commissions that are set up to regulate them or interact with them on a financial level," said Kathay Feng, executive director of California Common Cause, a political advocacy organization.

"With any of these incremental steps we oftentimes see that behavior is curbed but not outright eliminated," Feng said.

OLD STORY

Pay-to-play schemes, which involve making campaign donations and other payments to win pension fund business, are not new to California or to Calpers, the biggest U.S. pension fund with some $200 billion in assets.

As far back as 1998, Calpers was forced to recommend ethics reforms following a series of articles in the Los Angeles Times and Sacramento Bee newspapers that probed the decision-making process at the fund.

The Times had reported several instances in which private interests may have swayed board members' investment decisions by hosting exclusive conferences for members, paying for lavish meals and contributing to at least one member's political campaign.

But the Calpers ban on pay-to-play practices was challenged in court by a fiduciary and subsequently overturned.

In 1999, the SEC also proposed rules to regulate the practice but never got around to adopting them. State officals argued at the time that their laws were sufficient to deal with the practice, and investment advisors complained that the consequences of violating the rule were too harsh.

The SEC has proposed similar rules again this year. But the agency's latest efforts, which would ban the use of placement agents, have also drawn ire from some in the private equity and venture capital industry, who argue that it goes too far.

"The fund has a history of ineffective responses to chronic problems," Siedle said.

"They need a serious comprehensive approach to dealing with problems," Siedle said, referring to Calpers. "All they are doing is reacting to problems as they become public."

FEDERAL VERSUS STATE

Siedle and other experts said the federal government needs to bring public pension funds under its purview through a comprehensive and uniform set of rules.

"State oversight just isn't cutting it," said Chris Tobe, a trustee for the Kentucky Retirement Systems. "This stuff is going on in formal and informal ways in hundreds of public pension funds. It's almost as if it's a part of the system."

Tobe said public pension plans should come under the purview of the Employee Retirement Income Security Act, a federal law that sets standards for private sector pension plans.

Uniform federal rules would also solve a practical problem for placement agents, who must now deal with a patchwork of state laws, said Susan Bryant, a securities lawyer and former state regulator.

"Each state is adopting something different. And you have placement agents who are doing business on a national basis," Bryant said. "There needs to be some sort of a baseline so that these firms know what they are supposed to be doing."

Still, not everyone is in favor of more federal oversight.

A combination of disclosure of fees and registration with the Financial Industry Regulatory Authority, a private-sector regulator of U.S. broker dealers, so that there are regular audits of the organization is the best way to go, said Kelly DePonte, a partner at placement agent Probitas Partners.

"More states are requiring disclosure. I am not sure if it is necessary to have a federal mandate in order to address that issue," DePonte said.

No matter how many laws are put in place, the key would lie in how well the authorities enforce the rules.

"There needs to be more resources devoted to examiners at the SEC to go out and look at firms, to look at investment advisers who are doing business with the states and auditing who they are paying," said Bryant. "And that's where you are going to find the violations."

(Editing by Jim Impoco and Claudia Parsons)