Lobbyist Laws May Significantly Impact Marketing of Funds and Advisory Services to California and New York City Plans in 2011

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1 Alert Lobbyist Laws May Significantly Impact Marketing of Funds and Advisory Services to California and New York City Plans in 2011 February 3, 2011 While a number of states and municipalities have laws addressing pay to play, 1 California and New York City are now requiring that certain internal and external marketers, who solicit the advisory business of public plans, register as lobbyists and comply with the reporting requirements and other provisions of their lobbying laws, including a prohibition on the receipt of contingent compensation. New York City s Lobbying Law 2 requires placement agents (including registered broker-dealers), other third parties and, according to a recent advisory opinion from the New York City corporation counsel, even investment advisory firms, who attempt to influence the investment decisions made by New York City pension plans 3 (collectively, NYC plans ), to register as lobbyists if their marketing compensation attributable to solicitation of such plans exceeds $2,000 per year and to comply with certain prohibitions and reporting requirements. The amendments to California s Lobbyist Law impose similar registration and reporting requirements, as well as prohibitions, upon certain individuals (both internal and external to the adviser) who market advisory services or investments to public pension plans that are part of the state retirement system in California, such as the California Public Employees Retirement System ( CalPERS ) and the California State Teachers Retirement System ( CalSTERS ). However, unlike the New York City law, 4 the California law contains two exemptions one for internal advisory firm personnel who spend at least one-third of their time on portfolio management and one for internal personnel of registered advisers where the adviser will be selected through a competitive bidding process and has agreed to a fiduciary standard of care. 5 Notably, both the New York City and the California lobbying laws prohibit the payment of compensation that is contingent upon successful solicitation of public plan business even to those who are registered as lobbyists. Thus, it appears that advisers can no longer compensate placement agents for the solicitation of California plans or NYC plans to invest in their funds. In addition, while less problematic, advisers cannot compensate their internal personnel based on the success of their marketing to California plans or NYC plans. 1 Pay to play is essentially the practice of making political contributions or other payments to state or local officials (or candidates for state or local offices) having direct or indirect influence over the awarding of public plan advisory business. 2 NYC Admin. Code Title New York City s pension plans include New York City Employee Retirement System, New York City Police Pension Fund, New York City Fire Department Pension Fund, New York City Teachers Retirement System and New York City Board of Education Retirement System. 4 In a conversation with one of the authors of this Alert, the deputy counsel to the city clerk recently confirmed that no such exemptions exist under the New York City law. 5 "The manager has agreed to a fiduciary standard of care as defined by the standards of conduct applicable to the retirement board of a public pension or retirement system as set forth in Section 17 of Article XVI of the California Constitution, when managing a portfolio of assets of a state public retirement system in California." Cal. Code (c)(3).

2 Key Aspects of New York City Lobbying Law The New York City Lobbying Law has the following key components: (a) third-party marketers (including SECregistered broker-dealers) earning or expecting to earn over $2,000 in annual compensation cumulatively from soliciting business from NYC plans must file a registration statement and periodic reports for each advisory firm that retains them; (b) advisory firms that pay more than $2,000 cumulatively to their own personnel for soliciting business from NYC plans must file a registration statement and periodic reports, listing themselves as the client; (c) advisory firms that pay more than $2,000 annually to third-party marketers to solicit NYC plans must file periodic client reports; and (d) third-party marketers and self-marketing advisory firms are prohibited from paying compensation that is contingent on the successful solicitation of NYC plan business. Types of Individuals and Entities Subject to the Lobbying Law The definition of lobbyist under the New York City Lobbyist Law includes every person or organization retained, employed or designated by any client 6 to engage in lobbying. Lobbying includes, among other things, any attempt to influence (a) any determination made by an elected city official or an officer or employee of the city with respect to the procurement of goods, services or construction, including the preparation of contract specifications, or the solicitation, award or administration of a contract, or with respect to the solicitation, award or administration of a grant, loan or agreement involving the disbursement of public monies, or (b) any determination of a board or commission. 7 In an advisory opinion issued by the New York corporation counsel on March 31, 2010, resulting in part from the recent increase in federal and state regulation of placement agents assisting investment firms seeking to connect with public pension plan clients and investors, the corporation counsel concluded that placement agents, other third parties retained by investment advisory firms and investment advisory firms that use their own personnel to attempt to influence the New York City comptroller, the comptroller s staff, the boards of trustees of the NYC plans or members of their staff with respect to the investment of NYC plan assets are lobbyists under the Lobbying Law. 8 In a form letter sent on December 29, 2010, to a number of fund managers, the counsel to the city clerk, who has responsibility for enforcing the New York City Lobbying Law, stated: Beginning in January 2011, this office will be reviewing the activities of individuals, businesses, and organizations that, as of January 1, 2011, are attempting to influence investment decisions made by the pension funds and retirement systems of New York City. Parties that fail to comply with the Lobbying Law will be subject to penalties. 9 Registration and Reporting Requirements The registration requirements apply to both third-party marketers (including registered broker-dealers) that reasonably anticipate earning $2, in the next year for lobbying activity involving NYC plans and investment advisers that reasonably anticipate paying compensation to their own personnel at least $2,000 of which is attributable (on a cumulative basis) to their personnel s activities involving solicitation of NYC plans. Registered lobbyists are also required to file bimonthly periodic reports relating to their solicitation activities involving NYC plans. In an informal conversation with one of the undersigned lawyers, the deputy counsel to the city clerk stated that, for purposes of determining whether a self-marketing adviser has exceeded the $2,000 threshold, the adviser should look at the total compensation of each internal person involved in soliciting NYC plans (including portfolio managers and senior principals) and multiply it by the percentage of that person s time devoted to solicitation of NYC plans and add the resultant per person amounts together for purposes of determining whether the $2,000 threshold has been met. Under this approach, it does not appear feasible for any self-marketing adviser to stay under the $2,000 threshold; therefore, advisers who market to NYC plans generally are required to register. 6 A "client" is defined as every person or organization who retains, employs or designates any person or organization to carry on lobbying activities on its behalf. See NYC Admin. Code Title (b). 7 NYC Admin. Code Title (c)(1)(iii), (viii). 8 Letter from NYC Corporation Counsel Michael Cardozo to NYC City Clerk Michael McSweeney, dated March 31, Form letter from Counsel to the City Clerk Patrick Synmoie, Esq., dated December 29, The $2,000 threshold is cumulative for all of a lobbyist's clients and is not a client-by-client threshold Schulte Roth & Zabel LLP. All Rights Reserved. 2

3 Clients (such as fund managers and other investment advisers) that cumulatively spend more than $2,000 annually on hiring third parties to engage in lobbying activities involving NYC plans are, among other things, required to file a Client Annual Report setting forth their arrangements with third parties for the solicitation of NYC plans. Self-marketing advisers would list themselves as clients on their registration report and on their bimonthly periodic reports. Prohibition on Contingent Compensation Clients are prohibited from paying, and lobbyists are prohibited from accepting, any compensation that is contingent in whole or in part upon the success of the lobbyist s solicitation of NYC plan business. 11 This prohibition extends to self-marketing advisers and prohibits conditioning their personnel s compensation upon the success of their marketing to NYC plans. Record Keeping Requirements Lobbyists and clients must keep, for at least five years, a detailed and exact account of the following records relating to NYC plans: All compensation of any amount or value of any kind Names and addresses of every person paying or promising to pay compensation of $50 or more and the date of that promise All expenditures made by or on behalf of the client Names and addresses of every person to whom any item of expenditure over $50 is made and a receipt for each expenditure Penalties Knowing and willful violations of the Lobbying Law provisions may result in conviction of a Class A Misdemeanor and a civil penalty not to exceed $30,000, an order to cease all lobbying activities for up to 60 days, or both a civil penalty and an order to cease. Any person that violates the prohibition on contingent compensation may be found guilty of a Class A Misdemeanor and be charged a civil penalty not to exceed $30,000. Failure to file a required report or the late filing of a required report may result in a Class A Misdemeanor and a civil penalty not to exceed $20,000. Key Aspects of California Lobbying Law Provisions In the wake of the California attorney general s pay to play prosecutions of individuals involved in soliciting investments from CalPERS, California enacted significant new pay to play restrictions and a broader lobbyist registration requirement, both of which are potentially applicable to both external placement agents and internal marketing personnel of investment advisers. AB amends the California Government Code in the following key respects: (a) under the new, broader, definition of lobbyist (set forth below), certain individuals and entities who market advisory services or investments to public pension plans that are part of the state retirement system in California are required to register as lobbyists with the California secretary of state and to pay a registration fee of up to $25 per year; (b) such lobbyists are required to file quarterly disclosure reports setting forth campaign contributions, gifts and any payments of $100 or more to certain state candidates or elected officials; (c) such lobbyists are prohibited from making any gifts to certain public officials, including board members of CalPERS and CalSTERS, in an aggregate amount of more than $10 in any calendar month; (d) such lobbyists are prohibited from making any campaign contributions to elected state officials or candidates for elected office if they are registered to lobby the governmental agency with which they are affiliated; and (e) such individuals are prohibited from accepting contingent compensation (described below). 11 NYC Admin. Code Title See California Assembly Bill No. 1743, available at Schulte Roth & Zabel LLP. All Rights Reserved. 3

4 Individuals who solicit local public pension plans are required, under the new provisions, to comply with any applicable local lobbying laws that require registration and/or impose restrictions upon campaign contributions, gifts and other payments to local officials and candidates for local office. Types of Individuals and Entities Who Are Subject to the New Provisions AB 1743 amends the definition of lobbyist and lobbying firm 13 in the Public Reform Act so that it now includes an individual or entity functioning as a placement agent, i.e., any person hired, engaged, or retained by, or serving for the benefit of or on behalf of, an external manager, 14 or on behalf of another placement agent, who acts or has acted for compensation as a finder, solicitor, marketer, consultant, broker, or other intermediary in connection with the offer or sale of the securities, assets, or services of an external manager to a state public retirement system in California or an investment vehicle, either directly or indirectly. 15 Under this definition, external placement agents such as broker-dealers and their associated persons, as well as internal employees of an investment adviser who solicits state retirement funds on behalf of the investment adviser, would be classified as lobbyists. The above definition extends to persons who solicit separate account investments, as well as private equity and other alternative investments. In addition, those who solicit business from investment vehicles in which a state public pension plan is the majority investor also will be covered even if the investment vehicle is managed by an external adviser and has other non-public pension plan investors. 16 Exceptions from Definition of Placement Agent The first exception is for employees, officers, directors and members of an investment adviser that spend onethird or more of their time managing the assets of the investment adviser (the One-Third Exception ). 17 The scope of this exception is subject to further interpretation. For instance, it is uncertain whether it is broad enough to cover non-marketing personnel such as an adviser s general counsel, chief operations officer or chief financial officer, or individuals who contribute to the portfolio management function, such as analysts. The second exception is for employees, officers, or directors of an investment adviser, or of an affiliate of the investment adviser, if the investment adviser (a) is registered with the SEC as an investment adviser or broker-dealer, 18 (b) has been selected through a competitive bidding process, and (c) has agreed to a fiduciary standard of care 19 (the Competitive Exception ). We understand that the competitive bidding process element of this exception is narrowly construed to apply only where a formal Request for Proposals ( RFP ) has been issued by the public plan. It is important to note that there is no exception for external marketing agents, such as broker-dealers and their associated persons functioning as placement agents. New Restrictions and Requirements Individuals and entities who are subject to the Reform Act are prohibited from accepting or agreeing to accept any contingent compensation, which is defined as any payment in any way contingent upon the defeat, enactment, or outcome of any proposed legislative or administrative action presumably including the award of a contract 13 Cal. Code 82039(a)(2). 14 "External manager" means either: (a) a person who is seeking to be, or is retained by, a state public retirement system in California to manage a portfolio of securities or other assets for compensation; or (b) a person who is engaged, or proposes to be engaged, in the business of investing, reinvesting, owning, holding, or trading securities or other assets and who offers or sells, or has offered or sold, securities to a state retirement system in California. Cal. Code Cal. Code AB 1743 defines "placement agent" with respect to the non-reform Act provisions as "any person hired, engaged or retained by, or serving for the benefit of or on behalf of, an external manager, 15 or on behalf of another placement agent, who acts or has acted for compensation as a finder, solicitor, marketer, consultant, broker or other intermediary in connection with the offer or sale of the securities, assets, or services of an external manager to a board or an investment vehicle, either directly or indirectly." Cal. Code (d)(1). In comparison, the definition of "placement agent" under the Reform Act is specifically tailored to state public retirement systems. 16 Cal. Code (d). 17 Specifically, any "individual who is an employee, officer, director, equity holder, partner, member, or trustee of an external manager and who spends one-third or more of his or her time, during a calendar year, managing the securities or assets owned, controlled, invested or held by the external manager is not a placement agent." Cal. Code (b). 18 Or, if exempt from registration with the SEC, registered with any appropriate state securities regulators. 19 "The manager has agreed to a fiduciary standard of care as defined by the standards of conduct applicable to the retirement board of a public pension or retirement system as set forth in Section 17 of Article XVI of the California Constitution, when managing a portfolio of assets of a state public retirement system in California." Cal. Code (c)(3) Schulte Roth & Zabel LLP. All Rights Reserved. 4

5 to invest state public pension plan assets. In addition, under the Reform Act, such individuals and entities are, among other things: Required to register annually with the secretary of state Required to attend ethics training Required to file quarterly disclosure reports listing all gifts and lobbyist-related payments, and campaign contributions of $100 or more, to state officials or candidates for state office Prohibited from giving gifts in excess of $10 per month to certain public officials Prohibited from making campaign contributions to elected state officials or candidates for elected state office if registered to lobby the related governmental agency Solicitation of Local Public Pension Plans Individuals soliciting business from local (e.g., municipal) public pension plans are required to comply with any applicable requirements imposed by the plan s local government, which may require lobbyist registration and the filing of reports, among other things, and may prohibit contingent compensation. 20 The One-Third Exception is also available for investment advisers seeking local public pension plan business; however, the Competitive Exception is not. 21 Penalties Violations of the above-mentioned provisions can result in civil penalties, and a knowing or willful violation can result in conviction of a misdemeanor punishable by a fine up to $10,000 or three times the amount the lobbyist failed to report properly or unlawfully contributed or paid, whichever is greater. A lobbyist convicted of a misdemeanor is prohibited from acting as lobbyist for four years following the date of conviction, unless otherwise determined by the court. Reporting by California State Pension Plans Effective August 1, 2012, CalPERS and CalSTERS will be required to provide to the respective chairpersons of the Assembly Committee on Public Employees, Retirement, and Social Security and the Senate Committee on Public Employment and Retirement reports on the use of placement agents in connection with investments made by those public pension plans. Such reports shall include: (a) the number of, and descriptions of, investments made by the plan through external managers that may have compensated placement agents in connection with the investments, (b) a description of those external managers based on the size of assets under their control and (c) the annual performance of investments secured through placement agents. 22 Authored by Ida Wurczinger Draim and Stephanie K. Lyerly. If you have any questions concerning this Alert, please contact your attorney at Schulte Roth & Zabel or one of the authors. 20 Cal. Code (a). 21 Cal. Code (b). 22 Section 9 of AB Schulte Roth & Zabel LLP. All Rights Reserved. 5

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