Proposal May Limit Political Fund-Raising

Gov. Gray Davis is among the prominent California politicians who could find their ability to raise money stymied by a proposed federal rule that would stop investment advisors who make campaign contributions from landing lucrative contracts to manage pension funds.

The rule, proposed by the U.S. Securities and Exchange Commission last year, is intended to curb a practice known as “pay to play,” in which hefty political donations appear to be a prerequisite for advisors to get business with public pension funds. It would prevent investment advisors of pension funds from receiving money for their services if they have made contributions to board members or those who appointed them.

A decision on the federal proposal is expected later this year.

SEC Chairman Arthur Levitt has pushed for the rule out of a belief that investment advisors of public funds should be selected based on their skill and merit, not their political influence. The interests of tens of thousands of firefighters, city clerks, bus drivers and other public employees who own the funds must be given top priority, he has said.

“Pay to play harms fund beneficiaries and taxpayers,” Levitt said in a speech last spring. “It breeds cynicism of government officials and contempt for the political process.”

The rule could curb campaign contributions to Davis, who as governor appoints members to the boards of both the $171-billion California Public Employees Retirement System and the $110-billion California State Teachers Retirement System.

The rule could also hamper the money-raising abilities of state Treasurer Phil Angelides, state Controller Kathleen Connell, San Francisco Mayor Willie Brown and state Supt. of Public Instruction Delaine Eastin, each of whom sits on one or both boards.

The Assembly speaker and members of the Senate Rules Committee who are responsible for appointing a member to the CalPERS governing board could also be affected.

Davis has collected tens of thousands of dollars over the last decade from firms or their representatives that now do business with CalPERS. He’s received, for example, just over $40,000 from representatives of Levine Leichtman Capital Partners and at least $30,000 from Hellman & Friedman.

Garry South, Davis’ top political advisor, dismissed the potential consequences of the proposed rule on Davis’ fund-raising.

“I don’t think whether this rule is adopted or not has much of an effect whatsoever on our ability to raise funds,” South said. “Take a look at the breadth of our fund-raising base; there’s no particular industry or economic sector that dominates it.”

Adoption of the rule, he added, is likely to have a much greater impact on officeholders who deal specifically with financial issues, such as the controller or treasurer.

Davis has not commented publicly on the rule, but the CalPERS board has submitted a letter to the SEC. It contends that those who appoint members to the board--such as Davis--should not be covered by the rule under the principle that they have never sought, nor do they have the legal power, to influence a board member on the selection of an investment advisor.

Davis, however, has made no secret of his feelings on those he appoints to CalPERS and elsewhere. After the governor vacillated last month on whether to name Willie Brown to the CalPERS board, a Davis spokesman attributed the indecision to Davis’ need to first talk to Brown to ensure that he would represent Davis’ views on the board.

South said Davis merely tries to ensure that his appointees “generally share his general governing philosophy.”

Connell and Angelides, who have each also relied on contributions from the investment community, could not be reached for comment.

Angelides, however, has previously said that he finds the proposal troubling because it assumes that giving campaign contributions is inherently corrupt. Instead, he favors disclosure as an appropriate alternative.

Connell, according to her spokesman, Byron Tucker, believes that contribution limits should be applied to candidates and officeholders as well as those who appoint members to the governing board.

“The controller has always advocated that fund-raising restrictions should be equitable to all parties to ensure a level playing field,” Tucker said. “She’s looking forward to reviewing the final SEC proposal and will abide by whatever they deem appropriate.”

The CalPERS governing board voted in October to support the proposed rule, while objecting to a number of its points such as the inclusion of government authorities who appoint board members.

Opposing the motion were Angelides and Marty Morgenstern, who became an ex-officio member of the CalPERS board last year after he was appointed by Davis as director of the California Department of Personnel Administration. Connell abstained from voting.

Under the proposed rule, investment advisors would be prohibited from being compensated for providing advisory services to pension funds if they, their partners, executive officers or solicitors make a political contribution to any state or local official who can influence the selection of an advisor.

The prohibition lasts for two years after the contribution has been made and also can be triggered by donating to a candidate who ultimately is elected to office. Contributions of $250 or less are permitted if the donor can vote for the official or candidate.

A possible loophole is that the rule does not directly address “soft money” donations, the largely unregulated and often huge contributions to political parties from corporations, unions and individuals.

The proposed rule would also apply to state or local politicians running for federal office. In the New York Senate race, for example, it could give Hillary Rodham Clinton a fund-raising advantage over her opponent, New York City Mayor Rudy Giuliani, who appoints a member to the city’s pension board.

A number of investment management firms have written the SEC opposing the rule, with some raising freedom of speech issues.

An attorney for Legg Mason Inc. warned the SEC in a letter that the rule is so broad and its sanctions so severe that it would prevent nearly all advisors and their employees, as well as those who aspire to work in the investment management industry, from contributing to or participating in state and political elections.

Robert E. Plaze, associate director of the SEC’s Division of Investment Management, however, noted that while many of the 20 to 30 comments that have been submitted to the SEC on the rule have been critical, none have suggested that pay to play is not a problem. He said he believes that the commission has not been dissuaded by the comments and that there will be a rule dealing with pay to play by advisors.

The proposed rule is modeled after the Municipal Securities Rulemaking Board’s rule G-37, which the SEC approved in 1994 in an effort to clean up pay-to-play practices involving campaign contributions by municipal bond dealers. The SEC became concerned that the adoption of rule G-37 had shifted pay to play to the area of public funds and the investment advisors who manage them.

SEC Chairman Levitt asked the commission’s Division of Investment Management in 1998 to examine whether pay-to-play practices needed to be addressed in the more than $2 trillion in public pension funds.

Division staff uncovered strong indications that pay to play can be a powerful force in the selection of money managers of public pension plans, with allegations of the practice surfacing in at least 17 states, including California.

Even before the SEC launched its probe, it had been contacted by Thomas E. Flanigan, former chief investment officer for the California teachers’ retirement system, who in a 1997 letter described donations to board members as “at best unseemly and possibly unethical,” though permitted by state law.

When solicited, according to Flanigan, companies that do business with public pension funds can be intimidated into making political donations.

The SEC also examined efforts by CalPERS, the nation’s largest public pension fund, to avoid even the perception of pay-to-play practices. The CalPERS board voted in February 1998 to ban contractors and investment firms from contributing to its members.

Then-state Treasurer Matt Fong and Controller Connell abstained from voting. The two, it had been reported, had collected more than $500,000 from contractors doing business with CalPERS and the teachers’ pension plan.

Connell’s campaign later sued to overturn the ban, arguing in part that it did not cover candidates. A court subsequently invalidated the board action on procedural grounds.