Do investment bankers have a constitutional right to give money to politicians who control investment funds?
That question is heading to the courts. Don’t be surprised if they answer, “Yes.”
Finding ways to use public funds for private benefit has been one of the longstanding preoccupations of American finance. The villain-hero of Theodore Dreiser’s novel The Financier gets his start by persuading the treasurer of Philadelphia to let him invest city funds to enrich them both. The United States has progressed since those times, but perhaps not as far as you might suppose. In the mid-2000s, New York state’s then-comptroller Allen Hevesi took nearly a million dollars in campaign contributions and travel expenses from a venture capitalist who wanted access to the state’s pension funds for his clients. Hevesi and his donor were sentenced to prison in 2011. Hevesi served 20 months; the donor, 25 months. Two dozen individuals and companies paid some $170 million in cash settlements.
In the aftermath of that “pay to play” scandal, the Securities and Exchange Commission issued new rules limiting campaign contributions by would-be investment advisers. No investment adviser may donate to any state official who has any direct or indirect influence over the hiring of the adviser. This month, two state Republican parties—New York and Tennessee—filed a constitutional challenge to that rule in federal court. The state parties argue that the rule forces investment advisers to choose between their professional activities and exercising their First Amendment rights.
The case has national implications: One of the people whose Wall Street fundraising could be choked by the 2011 rule is New Jersey Governor Chris Christie, because the SEC rule also applies to state officials seeking federal office. Employees of financial firms gave Mitt Romney $18 million in hard money in 2012 and provided tens of millions more to his super PACs, the New York Times reported at the close of the campaign. Under the SEC rule, Chris Christie would be forbidden to take much of that money unless he resigned his governorship beforehand. (The rule hypothetically applies to any governor seeking federal office, but it is thought to particularly affect Christie because of the New Jersey governor's closeness, literal and figurative, to Wall Street.)
It’s a good guess that the federal courts will listen sympathetically to the challenge to the SEC rule. The Supreme Court has made clear that campaign contributions are protected free speech, both for individuals and for corporations. While protecting against corruption remains a valid basis for restricting contributions, the Court has defined corruption narrowly: In the words of the majority opinion in McCutcheon v. FEC, the most recent major campaign-finance case, corruption is “an effort to control the exercise of an officeholder’s official duties.” And as Justice John Roberts wrote in FEC v. Wisconsin Right to Life, the courts “must err on the side of protecting political speech rather than suppressing it.” It seems very conceivable that the courts will find the SEC rule overly broad.
Meanwhile, it’s a valid question whether the SEC rule is actually achieving anything.
The people with the most sway over state pension-funds decisions are not always—nor even often—elected officials. And those who exert the most effective influence over them are not always—nor even often—campaign contributors.
Private investment funds paid more than $125 million to scores of intermediaries who helped them win business with the California Public Employees' Retirement System, new documents show, prompting calls for stronger oversight of those who solicit public pension money.
The intermediaries, or placement agents, include three former CalPERS board members—one of them William D. Crist, a longtime board president—who lobbied the pension fund on behalf of an investment firm seeking a share of CalPERS' $205 billion in assets.
Pension experts say the disclosures are troubling, as lobbying by former board members could put pressure on CalPERS to put money with investment firms that charge excessive fees or that don't offer the best returns.
"The fact that people are being lobbied by people who have relations with current board members, even though they are former board members, is totally inappropriate," said Dave Elder, a former assemblyman from Long Beach who monitors CalPERS for public employee unions.
California has since tightened its rules on these placement agents in wake of a pension scandal of its own. In 2013, a former head of CalPERS, Frederico Buenrostro, was indicted on fraud charges arising from a complicated scandal involving fabricated documents and $48 million in fees paid to himself and an associate. Buenrostro pleaded guilty in July. His associate is proceeding to trial.
But most other states continue to allow investment firms to lobby pension fund managers through such placement agents.
When a Dallas-based investment firm wanted business from the Teacher Retirement System of Texas, it turned to Alfred Jackson.
The move worked. For landing a $100 million investment deal with TRS, L&B Realty Advisors paid more than $400,000 to Jackson’s firm.
Yet the CEO of L&B says he doesn’t know what Jackson did to nail down that deal. Jackson, a politically connected Houston investment manager, wouldn’t provide details. And the chief investment officer of TRS says he played no role at all.
How to get to the bottom of this mysterious transaction? You can’t: Under Texas state law, all dealings between pension funds and placement agents are strictly confidential. California’s new restrictions on such agents are the exception, not the norm.
The secrecy surrounding Jackson’s fee may be disquieting, but at least the amount in question is comparatively small. The most Texas-sized fees seem to have been paid in Kentucky. According to Forbes in 2011:
In Kentucky, where no one has been accused of wrongdoing, even the state fund’s trustees were apparently kept in the dark for years about the $13 million in placement agent payments until last year’s release of the state auditor’s report.
Two years earlier, it came to light that a New Mexico placement agent had collected $22 million in fees. New Mexico also has a nondisclosure policy on placement agents. The agent in question, Marc Correa, was sentenced to three months probation for tax evasion earlier in 2014.
To put it bluntly: Nobody needs to pay an intermediary $13 million to entice investors into a great deal. These fees only make sense when the goal is to attract state funds into deals that cost too much, deliver too little, or are burdened with fees that are too high. Placement-agent fees are in themselves, and almost inherently, warning signs of trouble.
And yet in our belief that it’s politicians who are always and everywhere to blame for everything that goes wrong in a political system, we consign to the financial pages the abundant evidence that the most fundamental vulnerability of state pension plans to corrupt influence is located less in politicians’ need for campaign funds, and much more in the weak governance of state pension plans themselves.
As the New York Republicans’ case against the SEC winds its way through the courts, and if it begins to succeed, you’ll hear a lot of agitated discussion about what this all means for campaign finance, for Chris Christie, and for American elections. But the most important trouble—and the most disturbing practices—are located quite elsewhere. It will be worth keeping that in mind.