Everyone will tell you the fundraising environment is challenging around the globe and placement work has got harder. But in California, an extra layer of complexity has been added to the mix.
The California state assembly passed legislation in September that will force placement agents hired by private equity firms to win business from the state’s public pensions to be paid flat fees up front instead of compensation based on successful fundraisings. California Governor Arnold Schwarzenegger signed the bill into law late September.
California’s new law – which was proposed before the US Securities and Exchange Commission issued its own federal rules on placement activities in June – requires placement agents to register as lobbyists. It adds another layer of regulation, forcing agents to comply with two separate sets of registration, and could limit their dealings with limited partners in other states. For example, New York state mandates placement firm registration, but doesn't want to deal with lobbyists.
So, will placement agents register as lobbyists? While working closely with the state’s largest pension funds is too attractive to pass up for some, other placement agents report they will not register as a matter of principle.
California is home to some of the largest public pension funds in the US. The California Public Employees’ Retirement System has a $31 billion private equity programme and the California State Teachers’ Retirement System has $37 billion in private equity commitments. A number of pension funds in San Diego and Los Angeles have an appetite for private equity as well.
“Given the potential importance of CalPERS and CalSTRS to a fundraising, it makes sense for us to do so,” said one placement agent based on the West Coast. “Though it is fair to say since we are already registered as a broker/dealer with the SEC, we are not sure how much safer this makes things for anyone.”
As lobbyists, placement agents will be exposed to stricter disclosure requirements, as well as ending payments for successful fundraisings. Placement agents would instead be paid flat fees up front, as are lobbyists.
“From the perspective of a placement agent, one of the biggest drawbacks is that there will be two sets of registration, reporting and compliance, increasing costs without really increasing public safety,” said the source, adding that it’s inconvenient but a price that must be paid to compete in the state.
Another placement agent said that after a review, his firm decided to go ahead and register as a lobbyist in California.
“We’re already regulated with guidelines that are more stringent than this state law. It’s unfortunate that because there had been a number of abuses in California, the lobbyist context could limit fees people could make,” said the agent. “But, California is too important to not comply.”
Indeed, CalPERS, CalSTRS and numerous large municipal pension funds pledge billions of dollars in commitments each year.
For other placement agents, the law forced them to examine their business strategy, and ultimately decide not to register in California.
“I think we as placement agents should step back, not register as lobbyists, not be frontally involved. We can respond and do all of that backstage,” said one placement agent based in New York, explaining that the bulk of an agent’s work should be done behind the scenes. “It’s one thing to register as a lobbyist it’s another thing to not get paid for it. You can register, and you can make the introduction if you want, but the process at CalPERS is very standardised. It’s a lot of pain to go through for the GP and the placement agent.”
Another thing to consider is whether placement agents are needed to reach the largest California LPs, he said.
“In the case of these [California] pension funds, we’re speaking here about the elephant in the room. We’re talking about an easily identifiable target,” said the New York agent. “Which GP doesn’t know CalPERS? Which GP does CalPERS not know? All GPs are already on CalPERS’ map. The value added the agent can bring is limited.”
The lobbyist initiative had been pushed hard by CalPERS. The pension co-sponsored the bill in the wake of allegations that a former member of the pension’s board had been paid millions of dollars in fees to solicit commitments from the pension for Apollo Management and other firms.
CalPERS performed a massive review of placement agent fees paid by its managers, and also reviewed its relationship with Apollo. The Apollo review led to the firm agreeing to slash some of its fees in the structured products it manages for CalPERS.
CalPERS has made it more difficult for placement agents to reach out to them in recent months.
In May, the pension fund announced plans to implement a system for managers to electronically submit investment proposals, eliminating the need to interact with placement agents.
The proposals, once submitted, will be reviewed by CalPERS investment staff. It would cover private placement memoranda from managers of private equity, real estate, and infrastructure funds.
The new policy will also be required for forestland, commodities, global fixed income and global equity investments.
“We’re working hard to make sure that money managers have all the access they need to do business with us. There’s no need for them to pay someone to call us or to set up a meeting. They can contact us themselves with the tools and technology we have. Our door is open,” said CalPERS chief investment officer Joseph Dear, in a statement about the system.
The lobbyist rule is the third layer of regulation managers in California have seen in a year. First there were pension fund travel restrictions, followed by SEC rules banning unregistered placement agents, and now the elimination of contingency fees.
One placement agent summed it up: “I’m afraid of what’s next. Actually, is there anything left to regulate?”