Good Morning. This is an open meeting of the U.S. Securities and Exchange Commission on June 30, 2010.
Today we consider adopting rules that would significantly curtail the corrupting influence of "pay to play." Pay to play is the practice of making campaign contributions and related payments to elected officials in order to influence the awarding of lucrative contracts for the management of public pension plan assets and similar government investment accounts.
Pay to play distorts municipal investment priorities as well as the process by which investment managers are selected. It can mean that public plans and their beneficiaries receive sub-par advisory performance at a premium price.
The cost of this practice is borne by retired teachers, firefighters and other government employees relying on expected pension benefits, or by parents and students counting on a state-sponsored college savings account. And, ultimately, this cost can be borne by taxpayers, who may have to make up shortfalls when vested obligations cannot be met.
An unspoken, but entrenched and well-understood practice, pay to play can also favor large advisers over smaller competitors, reward political connections rather than management skill, and — as a number of recent enforcement cases have shown — pave the way to outright fraud and corruption.
There should be no place for such practices in an investment advisory industry subject to high fiduciary standards. The selection of investment advisers to manage public plans should be based on the best interests of the plans and their beneficiaries, not kickbacks and favors.
The rules we consider today will help level the playing field, allowing advisers of all sizes to compete for government contracts based on investment skill and quality of service.
When the Commission first considered a proposal to curb adviser pay to play practices in 1999, it was, in part, motivated by widespread media accounts of dubious arrangements between fund managers and municipal officials.
In the years since, the amount of money at stake — and the incentive for inappropriate conduct — has ballooned. Public pension plans now represent one-third of all U.S. pension assets, with more than $2.6 trillion in assets under management.
Additionally, state-sponsored higher education savings plans — commonly known as "529s" — now hold approximately $100 billion in assets. These plans were in their infancy when the Commission first took up this issue in 1999.
The SEC has brought a series of enforcement actions charging investment advisers with participating in pay to play schemes. Most recently, we brought a civil action involving allegations of unlawful kickbacks paid in connection with investments by the New York State Common Retirement Fund.
In recent years, civil and criminal authorities also have brought cases in California, New York, New Mexico, Illinois, Ohio, Connecticut, and Florida, charging the same or similar conduct.
Our recent cases may represent just the tip of the iceberg. I fear that many other efforts to influence the selection of advisers to manage government plans pass unnoticed or — though highly suspect — cannot be proven to have crossed the line into actionable behavior.
Not surprisingly, parties to these suspect transactions take care to blur their motives, to hide their actions and to conceal their connections, making it difficult to prove a direct quid-pro-quo or an intent to curry favor in a specific case. The prophylactic rules we consider today are designed to eliminate this legal and ethical gray area.
The rule we consider today has three key elements:
Third party placement agents have been involved in some of the most egregious pay to play activities in recent years, and their activities should not continue unabated. The approach we are taking is a strong step toward eliminating the corruptive influence that can result from the use of third party placement agents.
It will greatly improve the status quo by banning payments to third parties who solicit government clients, unless they are "regulated persons" subject to pay to play restrictions comparable to the rule we are considering for adoption today.
This approach provides far greater protection of public pension plans and their beneficiaries than is currently the case, as third party placement agents come under the regulatory umbrella and, for the first time, become subject to meaningful federal pay to play restrictions.
This approach should effectively eliminate the opportunity for abuse that currently exists from third party placement agents. However, if the Commission determines that third party placement agents continue to inappropriately influence the selection of investment advisers for government clients — even under our enhanced rules — I expect that we would consider the imposition of a full ban on the use of these third parties.
Let me end by underscoring once again why we are here today. Pay to play practices are corrupt and corrupting. They run counter to the fiduciary principles by which funds held in trust should be managed. They harm beneficiaries, municipalities and honest advisers. And they breed criminal behavior. I hope my colleagues will join me today in striking a blow against a practice that has no legitimate place in our markets.
Before we hear more details about the rules we are considering for adoption, let me first offer my thanks to the individuals — representing a cross-section of four divisions and numerous offices — for their help in bringing to the table today a truly thoughtful, impressive and potent example of rulewriting.
In particular, let me thank Buddy Donohue, Bob Plaze, Sarah Bessin, Dan Kahl, Matt Goldin, and Melissa Roverts in the Division of Investment Management;
Charlotte Buford, Glenn Gentry, Elaine Greenberg, and Mark Zehner in the Division of Enforcement;
Paula Jenson, Lourdes Gonzales, Linda Sundberg, Martha Haines, and Mary Simpkins, in the Division of Trading and Markets;
Henry Hu, Bruce Krause, Harvey Westbrook, and Woodrow Johnson in the Division of Risk, Strategy, and Financial Innovation;
Gene Gohlke in the Office of Compliance Inspections and Examinations; Lori Schock, Rich Ferlauto, Owen Donley, and Mary Head, in the Office of Investor Education and Assistance; and David Becker, Meridith Mitchell, Lori Price, Lynn Taylor, Sarah Buescher, Jake Stillman, Marc Pennington, and Jeff Berger in the Office of the General Counsel.
I will now turn to Buddy Donohue to present the staff's recommendation.