Speech by SEC Chairman:
In the Best Interests of Beneficiaries:
Trust and Public Funds
Chairman Arthur Levitt
U.S. Securities & Exchange Commission
at the 1999 Annual Meeting of the Council of Institutional Investors
March 30, 1999
Thank you very much for your warm welcome. I'm here today to talk about an issue that has been close to my heart for a long time: the trust placed upon managers of public money to act in the interests of those for whose benefit the money is held.
This work carries with it enormous responsibilities and great challenges. People entrust their retirements to these managers. And yet, over the years, pressure has been brought to bear to use these funds for other purposes. I know the pressures; I have seen them applied, manipulated and obliged. But, I have also seen them resisted.
As many of you know, my father was for many years Comptroller of the State of New York. He was the sole trustee of two large state-run pension systems. In the 1970's during New York City's financial crisis, he was singled out as the public target of pressure to bail out the city with the pension assets by committing to buying debt that private investors had turned down.
He refused, saying he "would make no such commitment because it would violate [his] fiduciary responsibilities as trustee." He was personally attacked for this position. The then-mayor said that my father would be responsible if New York City went bankrupt. True to his plain-spokenness, my father called the charge, "irresponsible nonsense." And, the city found another way out of its crisis.
Today, a new form of pressure exists on those who manage public funds. The pressure comes from the ever-escalating costs of political campaigns and the temptation to use control over public monies to raise funds to cover those costs. The pressure I'm talking about is "pay-to-play" the selection of investment advisers to manage public funds based on their political contributions.
I've been talking about pay-to-play since the very beginning of my tenure as SEC Chairman. Up until now, that discussion has focused on the municipal bond market. And, I'm proud to say that after a sustained period of cooperation between the private sector, self-regulatory organizations and the SEC, much has been done to address this insidious practice.
Six years ago, the municipal securities business was rife with pay-to-play practices. Because of the importance of those markets, I placed banishing these practices at the forefront of our agenda, and in 1994, we approved the Municipal Securities Rulemaking Board's Rule G-37. It requires a two-year time out from doing business with a government client after a firm or its executives makes a contribution to an elected official. Some called the rule too strong a medicine. Well, when the patient is suffering and the fever is contagious, merely drinking a lot of liquids probably isn't the right or most effective solution.
It's worth noting that a group of investment bankers were the first to confront the ethical implications of pay-to-play. They placed a voluntary ban on political contributions to officials with whom they did business. And just a few months ago, a group of financial advisors that help municipalities structure bond offerings met with me to announce a self-imposed ban on the same activity.
Late last year, I asked the Division of Investment Management to look into the question of whether the Commission needed to address pay-to-play in the public pension area. After months of work on the issue, the Division has uncovered strong indications that pay-to-play can be a powerful force in the selection of money managers of public pension plans.
We found allegations of this activity in at least 17 states. Pay-to-play has affected both the largest of pension plans and the smallest of plans. The comptroller of a large state raised $1.8 million from pension fund contractors many of whom are out-of-state. A former treasurer of a small state raised virtually all of his campaign contributions $73,000 from contractors for the state retirement system.
Just last month, the Treasurer of Chicago was indicted for allegedly demanding political payments from firms managing city assets. And, in tiny Monroe County, Pennsylvania, I read a report indicating that the county supervisors are receiving large campaign contributions from the county's investment adviser even though the adviser is based 300 miles away. If that doesn't sound suspicious, I don't know what does.
If we give the staff more time, they undoubtedly will uncover even more examples of how the sacred duties of public fiduciaries are being compromised for political gain. Just as the "culture of pay-to-play" came to corrupt the municipal securities market, pay-to-play has tainted the management of public funds.
A few weeks ago, I received a letter from an investment adviser who hoped to manage money in a county not too far from here. He wrote:
"I . . . am amazed at how many managers are awarded accounts by public funds due to the money they have donated when there were more qualified managers available. The fund officials are clearly not always making the best choices for the pension fund and its members."
The adviser then went on to explain that he had received a solicitation for a contribution the same week his firm had been selected as a finalist to manage the assets of a county. He was asked if he had made a personal contribution so that county officials would know that it came from his firm. Not very subtle, is it?
The SEC does not regulate the activities of elected officials or fund trustees. Nor would we want to. We do, however, regulate the activities of investment advisers to ensure they are fulfilling their fiduciary duties. And, when an adviser seeks to interfere with the selection process by making political contributions, he has compromised his fiduciary duties. The adviser's interests not the teacher's, not the policeman's, not the city engineer's but the adviser's interests, are served.
It's time we put an end to the culture of pay-to-play in the area of municipal money management. Within the next couple of weeks, I expect that the Commission will receive a recommendation by the Division of Investment Management to pursue rulemaking addressing advisers' participation in pay-to-play. And, I expect that we will consider that rule in April or May. If we propose a rule, it will be along the lines of Rule G-37, but would be administered, of course, by the SEC.
Today, public funds hold more than $2 trillion of assets. These assets do not belong to the elected officials, and they do not belong to the trustees. They belong to the tens of thousands of firefighters, ambulance drivers, city clerks, bus drivers and other public employees who make our communities work. "Their interests," as my father said twenty years ago, "must be paramount in investment of that money."
The tremendous importance of public funds demands that they be managed with complete honesty and integrity and for the sole benefit of their beneficiaries. And yet, certain practices remain closer to the back-room deals and "honest graft" of George Washington Plunkitt and his ward captains, than to the unimpeachable integrity demanded of fiduciaries.
Let's assume, for the moment, that pay-to-play existed in baseball. A baseball team would draft players on how much they have lined the pockets of the team's management. A player's batting average, homeruns, or earned run average would be a secondary concern if at all. How many games do you think the team would win? And, how would the fans react if they knew this was how the team was selected? The game of baseball would suffer a devastating result.
The same holds true for our capital markets. Pay-to-play harms fund beneficiaries and taxpayers. It breeds cynicism of government officials, and contempt for the political process. It brings discredit on the businesses and professionals who participate in the practice.
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America has always been defined as a country where everybody has a chance to succeed. We tell our children if you work honestly in pursuit of opportunity, you will find it. Our nation is the purest form of meritocracy in the world.
But pay-to-play undermines this legacy. It defies everything that has made our capital markets second to none. Competition, transparency, trust and integrity become casualties of the political process when public funds are used as a means to an end.
For the most part, we have a strong and vibrant public pension system that in large part serves our people well. Some pension funds, notably CalPERS, are doing a lot to vanquish the type of corruption pay-to-play breeds. Stamping out this behavior is difficult and may be possibly disruptive. But, it is absolutely necessary. Old ways of doing business must give way when they jeopardize the trust of the American people.
The trust people place in public funds and government institutions is not static. It has to be constantly reassured in fact and in appearance. And, all of you here today, know this better than most. Our march against pay-to-play sends a clear, unambiguous message: the interests of taxpayers and beneficiaries reign supreme. Period. I thank you for your vigilance, your determination and your support on this important issue and I look forward optimistically to the day when pay-to-play is nothing more than a by-gone practice from a by-gone era.
Before I leave the podium, let me turn briefly to an issue that many of you, I'm sure, have an interest in. Seven months ago, I announced a coordinated plan to address the practice of earnings management. Since then, the response from CEOs, CFOs, investors, leaders of the public accounting profession and academics has been remarkable. While we still have a ways to go, important progress has already been made.
A major component of that plan included the creation of a Blue Ribbon Committee to develop recommendations to strengthen the role of audit committees. The group released their report last month.
I believe that the recommendations outlined in the report give companies and auditors the tools they need to make strong and independent audit committees the rule rather than the exception. They are aimed at strengthening the independence of the committee. They seek to make audit committees more effective. They enhance accountability among the committee, the outside auditors and management.
Qualified, committed, independent and tough-minded audit committees represent the most reliable guardians of the public interest. There is no reason why every company in America shouldn't have an audit committee made up of the right people, doing the right things and asking the right questions.
The panel's recommendations deserve quick implementation and I expect your engagement on this issue will help make that happen. Again, I thank your for your support on pay-to-play and I look forward to continuing our work together to serve investors and beneficiaries in the best way possible. Thank you very much.