Can ‘Conflicted’ State Treasurers Who Control State Employee Pension Funds Lead Corporate Governance Reform at the NYSE and in the Mutual Fund Industry?
In the wake of recent scandals at the NYSE and in the Mutual Fund
Industry, powerful State Treasurers, led by New York State Comptroller Alan
Hevesi, who control the investment management of over $1.1 trillion in public
Pension Funds (the retirement savings of thousands of public workers – police,
firefighters and school teachers) have made a “power grab” to control the Board
of the NYSE and direct reform of the system in the name of “protecting
investors.”
State Treasurers, led by Phil Angelides of California, have also exercised
their muscle in pulling billions of dollars from mutual fund companies such as
Putnam Investments who have been rocked by recent scandals. The Treasurers
claim that they do not want the pension money invested in companies who have
blatant conflicts of interest with investors.
The State Treasurers have no moral authority to preach about corporate
governance at the NYSE until they “get their own house in order” and end the
inherent conflicts of interest under which they do business. They need to end the
corrupt practice of “pay to play” in which money managers make campaign
contributions to state and local officials who then hire the same mangers to invest
public pension funds.
The question is whether the public workers are entrusting their
retirement savings to companies with the best political connections rather
than superior money management skills. There is another question as well:
Should politicians leverage public investment to enhance their own political
ambitions?
It is delicious irony that Alan Hevesi would call for Dick Grasso’s head for
accepting pay from those he is supposed to regulate, while at the same time, Mr.
Hevesi puts public pension money at risk every day while accepting campaign
contributions from the pension fund managers.
The reason why I am raising this issue is that the last thing public
investors need is for public officials to have any greater say in the governance of
the NYSE or the Mutual Fund Industry.
“Pay to Play”
Investment managers seeking to do business with public pension funds
are increasingly being expected to make campaign contributions as a condition
of their being considered to manage fund assets.
Public pension officials and politicians who allow political contributions to
play a role in the selection of firms to manage pension assets violate the public
trust and their fiduciary duty to the public. Similarly, advisers who make
contributions to influence the award of management contracts violate their
fiduciary duty to the pension funds and their beneficiaries.
The pervasiveness of pay-to-play practices in America demands prompt,
effective action by the SEC. Pay-to-play undermines the integrity of the manager
selection process, and may result in the selection of incompetent managers
who cause investment losses or charge higher fees.
Let’s examine some of the recent scandals involving state officials
exchanging pension fund business for political contributions:
New York
Alan Hevesi, the man leading the charge against the NYSE and Dick
Grasso, is in no position to be lecturing the Big Board on corporate
governance.
As NYC Comptroller, Alan Hevesi was cited for approving the investment
of $130 million in New York City pension funds to a private equity fund
who contributed more than $100,000 to Hevesi’s mayoral campaign. It is
an outrage for Hevesi to claim the moral high ground given his record.
Hevesi’s predecessor as New York State Comptroller, H. Carl McCall, who
resigned from the NYSE Board following the Grasso scandal, had been
particularly successful raising money from firms who looked to him for
business, due to the unique power of his position. While most public
pension funds in other states are run by committees, New York law grants
the comptroller complete control over the $127 billion public employee’s
pension fund.
It has been reported that from 1995 to 1998, McCall raised $5.2 million in
campaign donations, with $1.8 million, 35% coming from firms and their
associates who have been awarded business by the Comptroller’s office.
It was reported that payments were often made to McCall’s campaign
around the time contributors made deals with the pension fund.
California
One of the most frequently criticized recipients of “pay to play” money was
California State Comptroller Kathleen Connel. She served on the boards
of two of the three largest pension funds in the world, the $165 billion
California Public Employees Retirement System (CALPERS) and the $110
billion California State Teachers Retirement System (CALSTRS).
From 1995 to 1997, Connel reportedly received over $250,000 in
campaign donations from a firm doing business with CALPERS and
CALSTRS while she served as a board member.
Following government investigations of her practices, Connel filed a law
suit challenging CALPERS’ rule banning campaign contributions to board
members by firms seeking to do business with the pension fund.
The prize for the most creative perk goes to a California pension
consultant who reportedly recommended that CALPERS invest $100
million with a leveraged buyout firm. Not long after CALPERS made the
investment, a partner of the firm paid a consultant $300,000 for a yacht,
$45,000 more than the consultant paid for it. The consultant subsequently
advised CALPERS to invest another $100 million with the firm.
These cases show why money managers should be prohibited from
contributing to public officials who are in a position to award those
managers by hiring them to invest public money.
Where was the SEC?
In 1994, the SEC passed Rule G-37, the “pay to play” rule which prohibited
municipal bond underwriters from contributing to the campaigns of elected
officials who may influence the award of bond underwriting contracts. This
rule is widely credited with cleaning up the municipal bond industry.
The SEC is also responsible for regulating money managers and
mutual funds. In August 1999, the SEC proposed to prohibit money
managers from engaging in “pay to play”. The SEC proposal would
have required that money managers give up any compensation
they received for managing public money for two years after the
firm, its executives or agents made a campaign contribution to an
elected official or candidate who could have influenced the
selection of the money manager.
The SEC federal “pay to play” rule has gone nowhere since 1999 and
no one is even talking about it. The reason in obvious, the pay to play
rule has no natural constituency. Incumbent politicians want to
maintain all potential sources of campaign money. Money managers
who benefit from pay to play like the status quo, and those who don’t
benefit risk retaliation if they criticize the system.
I offer a challenge to those state treasurers who are so determined
to clean up corporate governance at the NYSE and the Mutual Fund
Industry – come out and endorse the pay to play rule and refuse to
accept political contributions from money managers and others
seeking to do business with state pension funds. These treasurers
should put their money where their mouths are and refuse to accept
campaign contributions. Otherwise, they should step aside and let
others who really are interested in serving the interest of public
investors lead the reform movement and serve on the board of the
NYSE.
Proposal to Reform the NYSE
As an advocate of the interest of ordinary public investors, I have
proposals to reform NYSE corporate governance which would serve the
interest of public investors – not those of large institutional investors such
as pension funds. My experience in representing public investors around
the country before the NYSE in arbitration and being involved in
enforcement actions have informed me of anti-investor practices at the
NYSE. My proposal is as follows:
1. The NYSE should be split in two like the NASD – the market making
function should be separate from the regulatory arm of the NYSE. This
separation would prevent Wall Street firms from having influence over
enforcement actions of rule violators.
2. The NYSE Board of Directors must have substantial
representation from ordinary public investors – as opposed to the
large institutional investors like pension funds. The conflicts which
permeate the world of politics and pension funds demonstrates that the
large institutional investor’s interests are not the same as those of
ordinary public investors.
3. The NYSE enforcement division needs to wake up or step aside.
Despite all the fraudulent stock research found by NYSE Eliot Spitzer,
not one single case was brought by NYSE enforcement against
fraudulent research by major Wall Street firms. Enforcement has done
little to get rid of bad brokers who abuse and victimize on individual
investors. Enforcement was asleep at the wheel as demonstrated by
the lax enforcement of specialists who cheat and “front run” customers
orders. Either NYSE enforcement must act like Spitzer’s office or
they should disband the group.
4. NYSE Arbitration needs to be reformed to serve the interest of
public investors.
In the late 1980’s, major Wall Street firms successfully fought to take
away the rights of public investors to bring their grievances against
their brokerage firms in a court. The system was replaced by
arbitration at the NYSE and NASD.
NYSE arbitration allows public investors to bring their claims before a
three member panel – one securities industry member and two
“public” members. Many “public” arbitrators have financial ties to the
Securities Industry and are really “public” arbitrators in “Industry”
clothing.
It is no wonder that these “public” arbitrators often side with their
securities industry colleagues in ruling against legitimate customer
claims.
It can also be said that the NYSE arbitrators around the country are
essentially “ an old boys club”. There is little diversity among
arbitrators as few women or minorities serve as arbitrators.
The NYSE if it is serious about giving investors a “fair shake” in
arbitration must immediately and dramatically expand the pool of
arbitrators and increase diversity among the arbitrator pools around the
Country.
In short, NYSE arbitrators must “look and sound like America” and
not simply be an extension of the Securities Industry.
Conclusion
In sum, the State Treasurers are part of the problem and not
the solution. They clearly have their own agenda in the reform movement
and do not serve the interest of ordinary public investors who have lost
confidence in Wall Street and the system.
If the NYSE and the mutual fund industry are to engage in real and
meaningful reform, they must serve the interest of ordinary public
investors and not simply those of large institutional investors who are
engaged in a major “power grab”.