Attorneys & Counselors at law

Third time's no charm: california updates its fund manager and placement agent rules, but misses on the regulated community's major concerns

By Brian T. Hildreth

For the third time in as many years, California has enacted rules targeting investment managers and investment placement agents who do business with the California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS).  Senate Bill No. 398 (SB 398), signed into law by Governor Jerry Brown on October 9, 2011, was intended to clarify current law regarding placement agents and the lobbying requirements related to fund marketers.  The new law, however, has done very little to alleviate the major concerns of fund managers.

The trend of regulating the marketing of investment funds in the state began in 2009, following revelations that a former CalPERS board member had received more than $47 million in commissions from CalPERS investment managers.  That year, Governor Arnold Schwarzenegger signed into law Assembly Bill No. 1584 (AB 1584), which increased transparency in the management of public employee pension fund assets.  AB 1584 requires state and local public pension funds in California adopt disclosure policies calling for the reporting of campaign contributions and gifts made to pension fund board members and staff by “placement agents” and by external investment managers.  AB 1584 also requires fund managers to disclose fees paid to third-party placement agents retained to secure asset management business with state and local pension funds.  

Following enactment of AB 1584, the state in 2010 adopted Assembly Bill No. 1743 (AB 1743).  AB 1743 added a series of laws to the California Political Reform Act (contained in the California Government Code) that currently impose significant restrictions on the use of placement agents to solicit investments from CalPERS and CalSTRS.  Primary among the new rules is an inclusion of “placement agent” in the Act's definition of “lobbyist.”  AB 1743’s broad definition of “placement agent” states:

“‘Placement agent’ means an individual hired, engaged, or retained by, or serving for the benefit of or on behalf of, an external manager, or on behalf of another placement agent, who acts or has acted for compensation as a finder, solicitor, marketer, consultant, broker, or other intermediary in connection with the offer or sale of the securities, assets, or services of an external manager to a state public retirement system in California or an investment vehicle, either directly or indirectly.”

The passage of AB 1743 means placement agents in California must now comply with the restrictions imposed on lobbyists in the state, including limits on gifts to public officials, limits on campaign contributions and, notably, a complete ban on contingency fee arrangements relative to CalPERS and CalSTRS investments.  Once registered, placement agents/lobbyists also are required to attend an in-person ethics course and comply with quarterly disclosure and reporting requirements, which include, among other things, disclosure of lobbyist-related compensation paid to employees of private fund managers. 

As entities sought to comply with the provisions of AB 1743, the regulated community raised concerns as to how the definitions of external manager and placement agent could be interpreted.  This led to the passage of SB 398 in late 2011.  SB 398 was intended to build upon and clarify the previous placement agent legislation.  In particular, SB 398:

  • Revises the definition of "placement agent" to include a person or an investment fund managed by an external manager directly or indirectly hired, engaged, or retained for a fee by an external manager to raise money for investment from a public retirement system or an investment vehicle in California.  This new provision effectively narrows the definition of placement agent to exclude routine trading and sales of securities by a brokerage firm.
  • Revises the definition of "external manager" to include a person who seeks, or is retained by a board or investment vehicle to manage a portfolio of securities or other assets for a fee, or a person who manages an investment fund who offers, sells, or has offered and sold an ownership interest in the investment fund to a board or investment vehicle.
  • Defines "investment fund" to mean a private equity and public equity fund, venture capital fund, hedge fund, fixed income fund, real estate fund, infrastructure fund, or other pooled investment entity that is primarily engaged in the business of investing, owning, holding, or trading securities and other assets.
  • Defines "investment vehicle" as a corporation, partnership, limited partnership, limited liability company, association, or other domestic or foreign entity that is managed by an external manager, as specified.
  • Expands the exemptions from lobbyist registration for managers of local retirement system funds to include the three exemptions similarly available to managers of state retirement system funds.
  • Imposes a state-mandated local program by changing or creating additional crimes, infractions, or penalties.

Despite the regulated community’s sincere hope for more, SB 398 makes only minor modifications to the existing placement agent regulatory scheme.  The changes implemented by the bill are not nearly as considerable as those resulting from AB 1584 or AB 1743. 

In fact, SB 398 may have created more problems than it solved.  Primary among the questions that linger after passage of SB 398 is how counties and municipalities (e.g., Los Angeles, San Francisco, and San Diego) will react to provisions in the new legislation purporting to extend AB 1743’s safe-harbor exemption to local jurisdictions.  Most local ordinances that apply to “placement agents” existed prior to the state’s entry into regulating the field.  Further, many of the applicable lobbying ordinances exist in counties and cities with active ethics commissions that enforce the local lobbying ordinance.  Investment managers and placement agents are cautioned against ignoring local lobbying ordinances based solely on the passage of SB 398.

Finally, while investment managers and placement agents must continue their wait to see the state’s restrictions relaxed, all hope is not lost.  The state’s Fair Political Practices Commission, charged with interpreting the state’s Political Reform Act (including a majority of the provisions governing placement agents as lobbyists), recently has taken an active role in advising the regulated community on the new rules and the existence of exceptions.  This has included the application of exceptions outside of the specific scope of AB 1743, but applicable in general to lobbyists (e.g., the “accompanying rule”).  The FPPC does not have the power to overturn legislation, but it is able to provide interpretations of the laws that the regulated community may find beneficial.