Expected about-face on placement agents invites criticism

The Securities and Exchange Commission's expected move to regulate placement agents as broker-dealers instead of prohibiting investment advisers from using them won't curb influence-peddling, some critics say.

The Securities and Exchange Commission’s expected move to regulate placement agents as broker-dealers instead of prohibiting investment advisers from using them won’t curb influence-peddling, some critics say.

After facing a storm of industry protest, the SEC is now looking at a regulatory solution to take the place of the ban that it originally proposed.

But “the issue isn’t one of regulating them properly — it’s an issue of [placement agents] selling their influence,” said Mercer Bullard, a former SEC lawyer and founder and president of Fund Democracy Inc., an investor advocacy group.

Even if agents work under the guise of a broker-dealer, the influence-peddling will continue, he said.

The SEC proposed the controversial ban last fall along with limits on how much advisers could give to political candidates and a prohibition on raising money for political parties. Placement agents typically help hedge funds and private-equity managers get business from institutional investors.

The proposal was prompted by a number of scandals involving public pension funds and placement agents, some of whom were politically connected former state officials.

Observers say that many agents aren’t registered as brokers or advisers.

Many large investment firms run their own placement-agent units.

About 400 smaller broker-dealers also work as placement agents, according to Lisa Roth, chief executive of Keystone Capital Corp., and a ban would be a severe hardship for them.

She and other industry observers say that requiring registration would level the playing field — a suggestion that the SEC is considering.

“If broker-dealers were prohibited by [the Financial Industry Regulatory Authority Inc.] from engaging in pay-to-play practices on behalf of investment advisers, then perhaps they could continue … to serve as placement agents,” John Nester, an SEC spokesman, said in a statement.

SEC staff members haven’t yet made a final recommendation to the commission regarding the proposal, he said.

In December, Andrew “Buddy” Donohue, director of the SEC’s Division of Investment Management, asked Finra to consider implementing pay-to-play rules for broker-dealers who work with advisers.

Finra spokesman Herb Perone said that the request is “under discussion.”

Many of the several hundred industry members who submitted comments to the SEC on the proposal suggested that placement agents should be registered and regulated rather than banned.

They argued that placement agents provide valuable services to pension plans and give smaller managers a chance to gain business from large pools of money.

“The ones hurt [by a ban would be] small, emerging managers, minorities and women-owned firms that don’t know how to present themselves to the marketplace,” Ms. Roth said.

Critics of placement agents, though, say that large investment funds shouldn’t have a problem finding smaller, competent managers on their own.

State officials and pension funds also opposed a ban on agents.

In a comment letter, Connecticut Treasurer Denise Nappier said that banning placement agents would deprive “institutional investors of … valuable services” and that “the blanket ban on contributions to political-party committees is fraught with enforcement challenges and unfairly affects party committees in states like Connecticut with … robust campaign-finance laws.”

‘LEGITIMATE PRACTICE’

Sen. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, jumped into the fray last month with a comment letter to the SEC reiterating Ms. Nappier’s point that using placement agents is a “legitimate and beneficial business practice.”

“It’s remarkable that someone from Connecticut of all places wouldn’t understand the issue with placement agents,” Mr. Bullard said. “It’s the site of one of the most abusive pay-to-play regimes we’ve seen.”

Connecticut enacted a tough pay-to-play law in 2005 after then-Gov. John Rowland resigned in the midst of a corruption investigation. He later served 10 months in prison.

The state bans lobbyists and prospective state contractors from making campaign contributions to candidates for statewide offices, and requires placement agents to be registered.

A spokeswoman for Ms. Nappier declined to comment.

Public officials and the plans they oversee “have a vested interest” in seeing political contributions continue, said Edward Siedle, founder of Benchmark Financial Services Inc., a consultant to pension plans.

That is why critics say an outright ban is needed.

Placement agents are “basically political insiders, devoid of investment credentials, who are being compensated to sell … unregistered products to funds within a politicized investment process,” Mr. Siedle said.

“The use of placement fees has grown exponentially,” he said, adding that public pension plans have “tripled and quadrupled” the number of money managers they use, and “every one is [paying] a placement fee.”

Although institutional clients generally have a formal bidding and selection process, “you’re much more likely to win a contract if you’ve hired the right people and made political contributions,” Mr. Bullard said.

Getting around consultants and staff designated to review all applicants “is precisely the conduct which is objectionable,” said a comment letter submitted by Common Cause, a good-government group that supports the ban. A call to Common Cause wasn’t returned.

Although Mr. Siedle questions the need for placement agents, he said that a registration requirement would help. “A lot of placement agents would find it very uncomfortable to operate under the level of scrutiny that a broker does,” he said.

Many placement agents are former elected officials, lawyers or lobbyists, and “oftentimes, they’re successful because they don’t appear to have a stake in the outcome” of a successful sale, Mr. Siedle said.

Disclosure requirements and other rules would make it clear to investors that agents are operating on behalf of the money manager, he added.

E-mail Dan Jamieson at [email protected].