September 21, 2009
I write in reference to Release No. IA-2910 (File No. S7-18-09), the proposed rule on Political Contributions by Certain Investment Advisers. My comment pertains specifically to the prohibition on using third-party solicitors to obtain government clients.
By way of background, I worked formerly as an investment consultant at a large consulting firm whose client base consisted of endowments, foundations, pensions, and family offices with $1.5 trillion of assets. I currently work for an investment adviser whose principal business is managing institutional capital in a series of private equity funds. I have, therefore, been on two sides of the table: sitting with investors helping them select investment advisers, and sitting as an investment adviser trying to raise capital from investors.
A prohibition on the activities of third-party solicitors, or placement agents, would be a well-intentioned effort with unintended consequences. While the goal of ending pay-to-play practices is both clear and desirable, such a move would greatly detract from the value that government entities get from their investment advisers:
1. Placement agents play an important role in introducing new advisers to the market. As an investors agent I was introduced to numerous less established advisers by placement agents whom I knew and trusted. Without their assistance I would not have met these new advisers, who in many cases ended up being valuable additions to my adviser list. Historical performance tells us that new advisers are an important source of investment returns. It is considerably more difficult for a less established adviser to achieve success in the market without a placement agent.
2. Placement agents help limit unwanted organizational risk through the valuable service of front-line screening of opportunities, saving investors time and expense. The primary job of portfolio managers for government pensions and other institutions should be to maximize their performance, not to sort through piles of unqualified investment advisers.
3. Placement agents are a useful neutral party in the market, providing investors direct and unbiased information on the actions of other investors.
It is obvious that there are risks inherent in the use of placement agents, but the risks of abuse do not justify the costs of prohibition. Without access to placement agents, government pensions would be significantly disadvantaged relative to their private sector peers, with limited access (and benefit from) the services described above.
The proposed rule sets out several questions about how best to accomplish the goal of eliminating pay-to-play. I argue that eliminating placement agents from the process would incur significant long-run costs. An alternative solution would focus on improved disclosure as follows:
1. Require all placement agents to be registered with the SEC, and to file yearly reports disclosing their client (investment adviser) relationships, their political contributions, and the amount of money they have raised from government entities.
2. Require all investment advisers to submit quarterly filings to the SEC detailing relationships with placement agents and the amount and terms of any capital raised from government entities.
3. Require all government entities to file annually, for public review, a list of the investment advisers and placement agents with whom they have conducted business in the past 3 years.
4. Require all government entities to file annually, for public review, a list of all campaign and soft dollar contributions received by all government officials who have fiduciary responsibility for the entities investments.
In the crafting of this rule it is critical that solicitation and payment be treated as separate and distinct activities. In other words, solicitation for investment is by default fair, open, and free from bias, whether or not it involves a third party. Payment for investment, on the other hand, is always and without exception unfair, obscured, and biased. It is just as conceivable that an investment advisor might taint the solicitation process with pay-for-play as for a placement agent to do the same. It would be a mistake to design a rule based on the presumption that all placement agents are easily corrupted. In reality there are few instances of placement agent abuse. Taking a sledgehammer to the whole industry is a gross overreaction that is out of proportion with the problem.
Therefore I strongly urge you to reconsider the proposed rule that would ban placement agents from raising funds from government entities, and instead to consider the value they provide to the investment industry. The best course of action is to enact tighter controls that enable the moral to continue practicing their trade, and force the immoral into the light of day.
I appreciate your consideration.