Regulators and lawmakers are not typically proactive – rule changes tend to happen as a result of a scandal, a disaster, an outcry.
It is a testament to the general cleanliness of the US private equity industry, then, that there are as yet no special rules governing campaign contributions to politicians who may affect decisions related to state business done with private equity firms.
By contrast, witness the regulatory regime recently handed to hedge funds, which, thanks largely to a few high-profile collapses and bad-apple frauds, are now all required to register with the SEC. The commission, it should be noted, took pains to differentiate hedge funds from private equity funds in its new rules.
More relevant still, witness the US municipal bond industry in which, according to campaign finance expert Brett Kappel, a securities firm can be banned from business for two years if an employee makes a political donation of a lousy $100.
Some in the private equity marketwonder whether private equity professionals will eventually encounter the uncomfortable appearance of impropriety due to otherwise innocent political donations. After all, many private equity GPs have backed the political careers of people who have ties to public pensions that in turn back their private equity funds. In an environment fine-tuned to uncovering graft, even a relationship that is far removed from the fundraising process can do damage if it appears on the frontpage of the local newspaper.
In the face of widespread perception that the municipal bond world was filled with ?pay to play?corruption, the municipal bond industry's self-regulatory body, the Municipal Securities Rulemaking Board (MSRB), adopted Rule G-37 in 1994. The rule essentially prevents municipal finance professionals and their supervisors from making campaign contributions to any state or local official who might influence the selection of a bond underwriting. (Specifically, Rule G-37 allows campaign contributions, but the donor must cease business with the affiliated bond issuer for two years thereafter. The rule does not apply to contributions up to $250 per official per election if the contributor can vote for the official).
As ever, the new rules followed in the wake of scandals, among them the issuance of bonds in the early 1990s backing the New Jersey Turnpike Authority. In this case the public became aware of a system whereby municipal bond underwriters were not even considered to handle offerings unless they made campaign contributions to the local officials handling the offerings – ?pay to play.?
The MSRB rules governing political donations are about to become even stricter. According to Kappel, of counsel in the Washington DC office of law firm Vorys, Sater, Seymour and Pease, the board says it has ?clarified? rules to cover donations to the political party backing a candidate, as well as affiliation – even mere contact – with political action committees (PACs) that donate to the candidate or the candidate's party. These changes were brought on, in part, in reaction to New York Times reporting that found New York governor George Pataki had directed contributions from municipal bond underwriters to his Republican Party's ?housekeeping fund,? which in turn supported the Pataki campaign.
FREEDOM TO GIVE
In a recent interview, the head of a major California-based private equity firm privately questioned the wisdom of general partners making campaign contributions to politicians who are affiliated with sources of investment capital. Even without any rules governing these contributions, this senior GP wondered why more firms don't institute internal bans on such donations based on the risk of bad publicity alone.
Many private equity GPs are wealthy individuals who quite naturally take an interest in politics, are friends with candidates and are eager to exercise their right to back the politicians and policies they believe best. What's more, some private equity firms encourage a culture of local community involvement, and as such contributions – cash or otherwise – to local campaigns are part of this. Such community involvement often means rubbing shoulders with city pension officials, who may at some point get an opportunity to invest in locally based private equity firms.
However, this legitimate activity, cast under a certain light, could at the very least provide PR problems when the politicians backed oversee public pensions that invest in private equity.
Several public pension systems in the US, such as that of the state of Connecticut, are overseen by elected ?sole fiduciaries,? who have the final say on all fund commitments. In fact, Connecticut in the early 2000s became embroiled in a scandal involving an elected state treasurer, Paul Silvester, who directed that payments be made to his friends and associates in exchange for state capital commitments. The pension is now the very model of transparency, but its Silvester scandal raised awareness of the potential problems of politicians overseeing investment portfolios.
Many other public pensions, including CalPERS, have investment boards that include or are influenced by public officials. For example, among the members of the CalPERSinvestmentboard is Philip Angelides, California's elected treasurer who is now running for governor in 2006 (see tables). Several years ago, CalPERS moved to a system whereby investment staff members make many fund commitment decisions independent of the investment board, further removing board members from direct involvement in the selection of individual fund managers. At other public pension funds, however, board members – some of them elected officials – are directly involved in the approval process.
Angelides and Steve Westly, another CalPERSinvestment committee member and elected official (he is California's controller and a competing gubernatorial candidate), both have strong ties to the financial community that are independent of their roles at CalPERS – Angelides at one point ran his own investment firm and Westly was an executive at eBay. The two have built many professional and personal relationships during their private sector sojourns, and many of those contacts are now very eager to support their respective political careers.
For example, Michael Flaherman, a managing director in the San Francisco office of private equity firm New Mountain Capital, says his contribution to the gubernatorial campaign of Philip Angelides is the result of a nearly decade-long personal relationship he has had with Angelides, having worked with him at CalPERS before joining New Mountain in 2003. He says he also contributed to previous Angelides campaigns before joining New Mountain.
But legal counsel are wont to advise extreme caution in political giving.?I have had conversations over the years with clients who have wanted to make contributions to political candidates, but were worried about the appearance of impropriety,? says Carl Metzger, a partner in the Boston office of law firm Goodwin Procter.?I continue to advise clients to tread lightly. Even if you feel you have nothing to hide, the way it could look if it is reported could make both parties look guilty by association.?
Some advocates of open government are skeptical about the ability of politicians and their GP donors to manage conflicts. Peter Scheer, the executive director of the California First Amendment Coalition (CFAC) – who was one of the primary forces behind CalPERS' move to greater disclosure – says pension officials have ?no business? taking political contributions from fund managers that do business with the pensions. Using CalPERS as an example, he says: ?Even if CalPERS' investment decisions are made by staff rather than the board, the appearance of conflict is nearly as bad as an actual conflict because it undercuts public confidence in CalPERS' investment decisions.?
Just as the managing partner source wonders why more private equity firms don't enact internal controls on political donations, Scheer's CFAC favors pension-wide bans on accepting such donations. ?It's high time CalPERS adopted a policy prohibiting board members from taking political contributions from persons associated with investment firms in which CalPERS invests,? he says, adding,?If CalPERSand other public pensions won't do this themselves, a prohibition will be forced on them – either by litigation, or by SEC regulation of the funds, or by legislation.?
Indeed, rulemaking bodies as well as the SEC have pondered increased regulation regarding political donations, but have yet to take a decisive step.
Thomas Mikula, another Goodwin Procter partner, notes the difficulty of proving that a political donation amounts to a quid pro quo arrangement. Therefore, regulators have instead sought to apply ?prophylactic? controls by banning or imposing stringent limits on contributions where quid pro quo deals could be arranged.
In addition to the efforts of the Municipal Securities Rulemaking Board, which is overseen by the SEC, the commission itself has proposed similar bans. In 1999, the SEC floated the idea of requiring investment advisors to cease business with a government client for two years following a political campaign contribution to an affiliated state official. According to Mikula, that proposal was ?subject to a barrage of criticism? from securities industry professionals and associations. Many of the comments disapproved of the practice of making political contributions to gain access to business, but they opposed the rule in the particulars. They pointed out, among other things, that professional investment management was a far different business than municipal bond underwriting. Some comments offered detailed suggestions for how to make the rule more workable, but the agency has not acted. ?I don't believe the agency is devoting much attention to? the proposed rule at this stage, says Mikula.
Various states, including California, have also proposed similar rules. In the late 1998, CalPERSinstituted a prohibition on politician board members accepting campaign donations from groups with which the pension did business. Following a suit brought by then-controller Kathleen Connell, a court overturned this ban ?on procedural grounds, because CalPERS didn't comply with the state's administrative procedure act,? says Mikula. Since then, CalPERS hasn't again discussed the matter, according to a pension spokesperson.
SELECT DONORS TO ANGELIDESBelow are select private equity professionals who have contributed money to the 2006 California gubernatorial campaign of Philip Angelides, currently the elected state treasurer, and a member of the CalPERS investment committee. The firms of all donors listed have received significant capital commitments from the state pension. However, most CalPERS alternative investment decisions are made by staff under a delegation resolution, ie without board approval. The names listed below are also those who chose to disclose their own names and firm affiliations. According to sources, some donors route contributions through spouses or other family members to avoid publicity. Other donors to the campaign include individuals from multiple real estate firms, contractors, law firms and consulting firms that do business with CalPERS.Sources: Cal-Access;CalPERS
|Name of donor||Home state||Name of firm||Amount||CalPERS commitment|
|Lauren Leichtman||California||Levine Leichtman Capital||$10,000.00||$300M (3 funds)|
|Luis Nogales||California||Nogales Investors||$5,000.00||$25M|
|Michael Flaherman||California||New Mountain Capital||$2,500.00||$150M|
|Thomas H. Lee||New York||Thomas H. Lee Capital||$10,000.00||$440M (3 funds)|
|Anthony Dinovi||Massachusetts||Thomas H. Lee Partners||$3,000.00||$440M (3 funds)|
|Gregory White||Massachusetts||Thomas H. Lee Partners||$100.00||$440M (3 funds)|
|Scott Sperling||Massachusetts||Thomas H. Lee Partners||$5,000.00||$440M (3 funds)|
SELECT DONORS TO WESTLYBelow are select private equity professionals who have contributed money to the 2006 California gubernatorial campaign of Steve Westly, currently the elected state controller, and a member of the CalPERSinvestment committee. The firm of the donors listed has received significant capital commitments from the state pension. However, mostCalPERS alternative investment decisions are made by staff under a delegation resolution, ie without board approval. The names listed below are also those who chose to disclose their own names and firm affiliations. According to sources, some donors route contributions through spouses or other family members to avoid publicity. Other donors to the campaign include individuals from multiple real estate firms, contractors, law firms and consulting firms that do business with CalPERS.Sources:Cal-Access; CalPERS
|Name of donor||Home state||Name of firm||Amount||CalPERS commitment|
|David Kirchheimer||California||Oaktree Capital Management||$1,000.00||$170m (4 funds)|
|Cynthia Stone||California||Oaktree Capital Management||$500.00||$170m (4 funds)|
|John Frank||California||Oaktree Capital Management||$1,000.00||$170m (4 funds)|
|Bruce Karsh||California||Oaktree Capital Management||$1,000.00||$170m (4 funds)|
|Larry Keele||California||Oaktree Capital Management||$500.00||$170m (4 funds)|