The Securities and Exchange Commission's proposal to ban investment advisers' use of third-party placement agents will put new and small firms at significant disadvantage and will have additional unintended consequences, state officials, broker-dealers, and investment advisers are warning.
In a number of comment letters filed with the SEC, a diverse group of market participants are asking the agency to reconsider its proposed outright ban because they believe that third-party placement agents play an important and constructive role for investment advisers.
"We have found third-party agents to be a very valuable resource to our fund," wrote Howard Bicker, executive director of the Minnesota State Board of Investment.
The proposed ban is part of a series of rule changes floated by the SEC this summer that would also prohibit investment advisers in the $2.2 trillion industry from providing advisory services for compensation to a government for two years if the advisers or any of their partners or executive officers make a contribution to certain elected officials or candidates who can influence the hiring of advisers.
The proposed rule changes also would restrict advisers from making contributions to a political party of the state or locality where they are seeking to provide advisory services.
The proposals, which stem in part from a massive pay-to-place scheme involving New York State's largest pension fund, are partly modeled on limits already in place for municipal broker-dealers.
Specifically, the Municipal Securities Rulemaking Board's Rule G-37 bars a broker-dealer from engaging in negotiated muni securities business with an issuer for two years if it or its muni finance professionals make significant political contributions to issuer officials who can influence the award of bond business.
In addition, the MSRB's Rule G-38 on political consultants, since 2005, has banned broker-dealers from using non-dealer, third-party consultants to obtain muni securities business.
Keith Bozarth, executive director of the Wisconsin Investment Board, told the SEC: "While we agree with the goal of the proposed rule, which is to eliminate political influence in the selection of investment advisers by governmental entities, we believe that the prohibition on the use of placement agents is overreaching and will have negative consequences on the efficient operations of the private-equity market to the detriment of public pension plans."
Bozarth added that for many small and first-time funds, a placement agent is often utilized to introduce the general partner to numerous potential investors, including large institutional investors such as public pension funds.
"We do believe that the proposed rule's elimination of placement agents removes a vital element to the effective operation of the private-equity markets," he wrote. "Large firms would be able to hire employees to handle the marketing of their partnership interests as they routinely have a fund that is in the process of raising capital during any time period.
"However, smaller or newly constituted funds that raise capital infrequently can ill afford to have an employee on payroll to handle the marketing assignment during the fundraising phase and then have no meaningful assignments for the next several years," he wrote.
Stephen Schwartzman, chairman and chief executive officer of the Blackstone Group, said such a ban "would be a terrible mistake for virtually all constituencies involved," noting that his firm found them invaluable in forging relationships with institutional sources of capital when Blackstone was founded in the 1980s.
"Recently, there have been reports of a few high-profile baseball players using illegal steroids to unfairly enhance their performance," Schwartzman wrote. "Their illegal and unethical behavior has unquestionably challenged professional baseball and yet no one is suggesting banning baseball.
"I have been in finance for approximately 40 years," he added. "I have seen the legitimate need for seekers of capital to hire intermediaries - typically bankers - to find capital for them through large institutional and individual pools of capital."
John Robertshaw, managing director and co-head of the private fund group at Credit Suisse, argued that even though the ban on placement agents is meant to mirror G-38's ban of consultants, a "more complete analogy" to the MSRB rules would not preclude regulated broker-dealers from performing placement agent services, as the proposed rule would do.
"Notably, the MSRB pay-to-play rules do not preclude SEC-registered broker-dealers from acting as placement agents to municipal issuers," he wrote. In contrast, the SEC proposal would, in addition to requiring that investment advisers adhere to pay-to-play restrictions, prohibit investment advisers from using any third-party intermediary, including placement agents registered as broker-dealers with the SEC, to solicit municipal investors on their behalf, he said.
To make the SEC proposal more analogous to the MSRB rules, the SEC should authorize registered broker-dealers, and their registered representatives, who regularly engage in the business of raising capital, to work as placement agents, he argued.
That, along with the pay-to-play restrictions, would "effectively curtail abuses such as the corruption scandals in New York and other states involving allegations of politically connected individuals claiming to act as placement agents in order to sell access to municipal pension fund money in exchange for kickbacks and political favors."
In another letter, Connecticut Treasurer Denise Nappier warned that the ban on the use of third-party solicitors "unduly interferes with an investment adviser's ability to organize its business as best suits its need AND deprives institutional investors of the derivative benefit of valuable services."
Rather than ban all third-party solicitors, she strongly recommended that the rule limit the use of third-party solicitors to those individuals and entities that are licensed or registered and therefore subject to the same restrictions as other investment advisers.
Nappier and New York City Mayor Michael Bloomberg generally applauded the SEC's proposed pay-to-play restrictions, however. Bloomberg said while the city already has rules designed to deter the kind of conduct targeted by the SEC, the agency's proposals would address some of the loopholes that are in the city's campaign finance laws.