For small and emerging investment advisory firms, a third-party marketing organization may be their only affordable way to achieve visibility with institutional clients. An outright prohibition would therefore be anti-competitive and would favor large institutions that can hire highly compensated institutional salespersons on their payroll.
In the spirit of fairness, I would like to suggest a "middle way" for the SEC to ban the use of third-party marketers -- except where they are tightly regulated and observe a strict code of conduct.
As I stated in my previous column, the investment advisory industry's use of third-party marketers has always had a seedy side to it. I continue to oppose outright the corrupt sales practices that have arisen in this sector but would prefer regulation over prohibition at an industry-wide level. I also remain steadfastly opposed to use of endorsement and royalty arrangements in the 457/403b deferred compensation retirement industry, whereby investment firms pay outlandish fees to nonprofit organizations and unions to buy influence. This ultimately comes at the expense of public employees in their investment returns.
If the SEC decides to craft a public-sector provision that allows third-party marketing organizations (while at the same time banning various practices such as campaign contributions, gifts and other forms of influence-peddling), the following requirements would be appropriate:
1. The organization receiving payments for third-party marketing must be a registered investment advisor or broker-dealer with regulated investment businesses substantially broader than simply marketing to public officials, public pension trustees and governmental retirement plan officials. It must comply completely with Financial Industry Regulatory Authority (FINRA) rules that limit entertainment and gifts, such as $100 per person for entertainment. Smaller retirement plans should be included in these requirements. FINRA presently exempts pension plans under $50 million.
2. The marketing organization cannot seek contact with individual trustees or board members without explicit written authorization of the entire board. There should also be public disclosure of all such contacts including written disclosure to the full board and the public via the plan's website or other public notice. Regulations should permit direct contact with the designated professional investment staff of the public-sector investment organization (CIO and retirement plan administrator) and their professional investment consultant, but third-parties playing politics with trustees and other influential public officials (either elected or appointed) should be tightly regulated in that activity. Likewise, contacts with trustees at association meetings and group-wide events would be impossible to prevent and should be exempt -- while still prohibiting or controlling individual lobbying and entertainment. If the SEC decides to level the playing field by imposing similar requirements on in-house registered representatives employed directly by an investment advisor, I would support that measure as well.
3. A uniform Code of Conduct (similar perhaps to the New York Attorney General's document) should be established to govern all marketing actions of persons and organizations seeking to influence the investment process of public-sector retirement plans. The professional and pension organizations should be taking a more aggressive role in crafting a model code.
The vibe I'm getting from public-sector and pension organizations is that they are nervous about federal interference in their affairs: the camel's nose under the tent, and all that. In this case, the SEC is seeking to regulate the private sector's peddling in the public markets, and that seems a proper public concern. The public pension community should join me in urging reasonable regulations and outright prohibitions against corrupt practices. In addition, the network of public funds and professional associations should take a proactive role in crafting a code of conduct to which their vendors must subscribe. Don't sit on your hands, folks, or you'll have nobody but yourselves to blame for over-reaching federal regulations.
