SEC | Pension360

Pension Funds Sue Exchanges Over High-Frequency Trading

A handful of pension funds have joined a lawsuit against Nasdaq and other major stock exchanges, alleging that the exchanges favored high-frequency traders and in the process hurt other investors, including pension funds. From the New York Times:

The pension funds, including one in Boston and another in Stockholm, have joined a lawsuit originally filed by Providence in April, according to a filing in U.S. District Court in New York last week. They are taking aim at some of the biggest stock exchanges – including the New York Stock Exchange, Nasdaq and BATS Global Markets – as well as the investment bank Barclays, which operates a private stock trading venue known as a dark pool.

Their legal action comes during a period of heightened scrutiny for high-frequency traders, which use computer algorithms to buy and sell shares in milliseconds. In recent months, Washington lawmakers have summoned financial executives to testify about high-frequency trading, the Securities and Exchange Commission has stepped up its scrutiny of the practice, and the New York state attorney general, Eric T. Schneiderman, has sued Barclays over high-frequency traders in its dark pool.

The pension funds and Providence, which are seeking class-action status, claim the exchanges ran afoul of their legal duties by providing certain advantages to high-frequency traders, “diverting billions of dollars annually from buyers and sellers of securities and generating billions more in ill-gotten kickback payments.” They are seeking an unspecified amount of damages.

Spokesmen for the defendants, which also include the Chicago Stock Exchange, all declined to comment.

Stock exchanges offer a number of paid services used by high-frequency traders, including detailed data feeds, special types of orders and the ability to place computer servers in the exchanges’ data centers. The lawsuit argues that such practices hurt other investors, and it claims the exchanges have a “financial incentive to create an uneven playing field.”

The pension funds that joined the lawsuit include the Employees’ Retirement System of the Government of the Virgin Islands; the State-Boston Retirement System; the Plumbers and the Pipefitters National Pension Fund in Alexandria, Virginia.

Photo by Terence Wright via Flickr CC License

St. Louis Fund Files Shareholder Lawsuit Against General Motors

A flood of lawsuits has hit General Motors in the wake of numerous recalls. At least one pension fund has now gotten in on the action: The St. Louis Police Retirement System has sued GM for the “systemic failure” of its board in handling the safety issues and recalls of recent years.

Reported by the St. Louis Business Journal:

A shareholder lawsuit filed on behalf of a St. Louis police pension fund and an individual shareholder takes issue with General Motors’ handling of safety issues.

The suit alleges board members are “guilty of a sustained and systemic failure” to keep the shareholders’ informed of safety and recall issues, the New York Times reports. David Honigman, the attorney representing the plaintiffs, told the newspaper that the company “set up a system that is calculated not to inform them about safety issues.”

GM has been hit with recalls of nearly 30 million vehicles since February, as well as at least 13 deaths linked to a defective ignition switch. The company is now facing multiple investigations and has set aside nearly $4 billion to cover associated costs, according to the New York Times.

General Motors is currently being investigated by the SEC, the Justice Department, and over 40 state attorney generals.

Photo Credit: “General Motors logo” by Gage. Licensed under Public domain via Wikimedia Commons

Union Files SEC Complaint Alleging Pension Pay-To-Play In North Carolina

A North Carolina labor group has filed a whistleblower complaint with the SEC over what they believe to be a violation of the SEC’s pay-to-play rules.

The group alleges that Erskine Bowles held a fundraiser for state Treasurer Janet Cowell at his home in 2011. Just weeks later, Bowles’ investment firm was chosen to handle investments for North Carolina’s pension funds, of which Janet Cowell is the sole trustee. From Bloomberg:

Former White House official Erskine Bowles was accused by a North Carolina workers’ association of violating political fundraising rules for money managers.

Carousel Capital, the firm Bowles co-founded in 1996 and where he is listed as a senior adviser, was selected to manage state pension funds a few weeks after a June 2011 fundraiser for North Carolina Treasurer Janet Cowell was held at his home, the State Employees Association of North Carolina said today in a whistleblower complaint to the U.S. Securities and Exchange Commission.

The fundraiser violated the SEC’s pay-to-play rule that bars investment advisers from managing state funds for two years following a campaign contribution to political candidates or officials in a position to influence the selection of advisers to manage public pension funds, according to SEANC’s complaint.

SEANC, which has about 55,000 members, also questioned whether Bowles’ wife, Crandall Bowles, was in violation of pay-to-play rules because she is on the board of JPMorgan Chase & Co., which manages several hundred millions of dollars for the $87 billion North Carolina state pension fund, which Cowell oversees.

David Sirota talked to Cowell and Bowles about the allegations:

In a statement emailed to IBTimes, Cowell’s spokesperson Schorr Johnson said:

“More than two years ago, the Department of State Treasurer verified with outside legal counsel that neither Erskine nor Crandall Bowles were covered by SEC prohibition. The Department then took it a step further by ensuring contractually with Carousel that they were compliant with this SEC rule. If Carousel failed to comply with the rule, the investment would likely end.”

In a previous statement to IBTimes, Erskine Bowles said, “I have had no active role [in Carousel] since 2005 (and) I am not involved in the management of the firm nor do I [have an] office there.” He also said the fundraiser was held at his home by his wife, Crandall, but that he was not affiliated with the event.

SEC Tackles Asset Transparency, Conflict of Interest At Credit Rating Agencies

The SEC is finalizing two new sets of rules today: one that would increase the transparency of the asset-backed securities that caused much grief for investors, including pension funds, during the financial crisis.

The other set of rules would improve the reliability of the ratings issued by credit rating agencies.

Pension funds and other institutional investors were hit hard during the financial crisis in part because they purchased highly rated but opaque securities that seemed safe but eventually became worth pennies on the dollar.

The new SEC rules aim to increase the transparency of those investment instruments, as Reuters reports:

The new rules would lay out which information issuers would have to provide to investors on the underlying assets in the securities – which can bundle thousands of assets such as auto or home loans – in a standardized format.

The newly required information includes the credit quality and the collateral and cash flows related to each asset, said the SEC.

The SEC first proposed new rules on asset-backed securities more than four years ago. But it has struggled to craft rules that balance privacy concerns about the disclosure of sensitive loan-level data with investors’ desire to know more about the securities.

The new rules would also give investors a three-day waiting period to back out once they had agreed to a transaction, and in some cases remove references to credit ratings.

The SEC is also finalizing rules dealing with conflicts of interest at credit rating agencies. The rating agencies have been accused by investors and watchdog groups of letting business interests influence the AAA ratings they gave to bonds that would later lose significant value. From the News Observer:

To address the conflict of interest, the new SEC rules would prevent the sales and marketing departments of credit-rating agencies from having anything to do with firms seeking a rating for their financial product. Among the provision of the new rules are tighter look-back requirements designed to discourage ratings agencies employees from going to work for companies whose product they’ve rated. Investigations by McClatchy Newspapers and subsequently regulators showed how Wall Street firms played ratings agencies off each other, threatening to give competitors their business unless they got the AAA rating they sought.

The rules relating to rating agencies have not yet been completed, but the SEC said it hopes to have them finalized by the end of Wednesday.

Photo by the SEC

The Lawsuit That Could Legalize Pay-To-Play For Pension Fund Investments

Here’s a scenario to chew on:

An investment firm makes a campaign contribution to a city mayor. Later, the mayor appoints members to the city’s pension board. The pension board decides to hire the aforementioned investment firm to handle the pension fund’s investments.

Does something seem fishy about that situation?

The SEC says yes, and they have rules in place to prevent those “pay-to-play” scenarios.

But a recent lawsuit says no: investment managers should be able to donate money to whichever politicians they choose, even if those donations could present a conflict of interest down the line.

The lawsuit, filed last week by Republican committees from New York and Tennessee against the SEC, wants the court to affirm that political donations are free speech—and, by extension, current SEC pay-to-play rules are unconstitutional.

Under the SEC’s current rules, investment advisors can’t make donations to politicians that have any influence—direct or indirect—over the hiring of investment firms.

In many states, it’s the job of the governor or mayor to appoint members to the state or city’s pension board—the entity that controls pension funds’ investment decisions.

The lawsuit claims that it’s not fair to make investment firm employees choose between their career and their First Amendment rights.

But does the lawsuit have a shot?

If past court decisions are any indication, it certainly has a fighting chance. David Frum writes:

It’s a good guess that the federal courts will listen sympathetically to the challenge to the SEC rule. The Supreme Court has made clear that campaign contributions are protected free speech, both for individuals and for corporations. While protecting against corruption remains a valid basis for restricting contributions, the Court has defined corruption narrowly: In the words of the majority opinion in McCutcheon v. FEC, the most recent major campaign-finance case, corruption is “an effort to control the exercise of an officeholder’s official duties.” And as Justice John Roberts wrote in FEC v. Wisconsin Right to Life, the courts “must err on the side of protecting political speech rather than suppressing it.” It seems very conceivable that the courts will find the SEC rule overly broad.

It should be noted, the SEC didn’t put these rules in place for no reason.

Over the course of a few years in the mid-2000’s, then-New York State Comptroller Alan Hevesi accepted over $1 million in campaign donations and gifts from investment firm Markstone Capital.

Hevesi, who at the time was the sole trustee of the New York State Common Retirement Fund, subsequently decided that the Fund should make a $250 million investment with Markstone.

Hevesi eventually pled guilty to corruption charges and served a little less than two years in prison. He is banned from holding public office again. The case was the catalyst for the pay-to-play rules the SEC currently has in place.

But Frum, in a piece written for the Atlantic today, wonders aloud whether the SEC rule targets the right people. Frum writes:

It’s a valid question whether the SEC rule is actually achieving anything.

The people with the most sway over state pension-funds decisions are not always—nor even often—elected officials. And those who exert the most effective influence over them are not always—nor even often—campaign contributors.

Frum points that it’s often placement agents who are helping to pull strings from behind the scenes. That’s been the case in California, Dallas, New Mexico and Kentucky, and those are just the high-profile ones.

From Frum:

In our belief that it’s politicians who are always and everywhere to blame for everything that goes wrong in a political system, we consign to the financial pages the abundant evidence that the most fundamental vulnerability of state pension plans to corrupt influence is located less in politicians’ need for campaign funds, and much more in the weak governance of state pension plans themselves.

As the New York Republicans’ case against the SEC winds its way through the courts, and if it begins to succeed, you’ll hear a lot of agitated discussion about what this all means for campaign finance, for Chris Christie, and for American elections. But the most important trouble—and the most disturbing practices—are located quite elsewhere. It will be worth keeping that in mind.

That doesn’t necessarily mean, however, that the SEC rule should be repealed and the floodgates opened.

It just means that the stuff happening behind closed doors—the opaque world of placement agents—is what we should be worried about, too.

Here’s a summary of current pay-to-play regulation:

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Photo by Truthout.org via Flickr CC License

SEC Charges Kansas With Fraud For Misleading Investors About Health of Pension System

Back in 2009, Kansas was preparing to issue $127 million worth of bonds to investors who probably knew that the state’s pension system wasn’t the healthiest in the country.

What investors didn’t know, however, was just how bad the system really was—it was the 2^nd most underfunded in the nation at the time.

But don’t blame the investors for their ignorance. They didn’t know because Kansas didn’t tell them.

That lack of disclosure is the reason the SEC today announced they are charging Kansas with fraud for misleading investors about the health of the state’s finance and, by extension, the risk associated with buying its bonds.

From Bloomberg:

The U.S. Securities and Exchange Commission charged Kansas with failing to disclose a “multibillion-dollar” pension liability to bond investors.

“Kansas failed to adequately disclose its multibillion-dollar pension liability in bond offering documents, leaving investors with an incomplete picture of the state’s finances and its ability to repay the bonds amid competing strains on the state budget,” LeeAnn Ghazil Gaunt, chief of the SEC Enforcement Division’s Securities and Public Pension Unit, said in a statement from Washington.

A draft actuarial report provided to Kansas’s public pension found that the gap between its liabilities and assets had grown to $8.3 billion in 2008, from $5.6 billion the previous year, lowering the pension’s funding level to 59 percent, the SEC said.

The gap was the result of years of insufficient contributions by the state and school districts to cover the cost of benefits earned by public employees and their accumulated liabilities, the SEC said.

Only Illinois had a lower pension funding status than Kansas, according to a 2010 report by the Pew Center on the States.

Neither the finance authority nor the Kansas Department of Administration, which advised the authority of material changes to state finances, determined that additional disclosure regarding the pension fund in the bond offering statement was necessary, the SEC said.

The SEC has been investigating this charge for four years.

The SEC also announced today that Kansas has agreed to settle the case without admitting or denying the allegations.

No financial sanctions were imposed on Kansas as a result of the charges.

It’s likely the SEC was content with the settlement due to recent efforts by Kansas to increase the state’s compliance with federal regulations.

In addition, the state has attempted to increase the sustainability of its retirement system—the state boosted contribution rates for workers and employers in 2012, and new hires are now entered into a “cash balance” plan.

Photo by CatDancing via Flickr CC License

Investment Firm Charged With Violating SEC Pay-To-Play Rule After Making Political Donations While Working For Two Pension Funds

A Philadelphia-area private equity firm has become the first ever to be charged by the SEC for violating a pay-to-play rule set up in 2010 designed to prevent conflicts of interest when pension funds hire investment firms.

The firm, TL Ventures Inc, was charged with violating the rule after an employee at the firm made political contributions to Pennsylvania’s governor and Philadelphia’s mayor while the firm was doing work for the Philadelphia Board of Pensions and the Pennsylvania State Employees’ Retirement System.

The employee, an investment advisor, made a $2,500 campaign contribution to a candidate for Mayor of Philadelphia and a $2,000 contribution to a candidate for Governor of Pennsylvania.

The SEC says that presented a conflict of interest because the Mayor and Governor appoint a total of nine members to the two pension boards for which TL Ventures was providing investment services for at the time of the donations.

Those boards are tasked with hiring investment firms to do advisory work for the pension funds.

Bracewell & Giuliani explains the specifics of the rule:

Rule 206 (4)-5, which was adopted in 2010, prohibits investment advisers from providing compensatory advisory services to a government client for a period of two years following a campaign contribution from the firm, or from defined investment advisers, to any government officials, or political candidates in a position to influence the selection or retention of advisers to manage public pension funds or other government client assets. Some de minimus contributions are permitted, topping out at $350 if the contributor is eligible to vote for the candidate, and the contribution is from the person’s personal funds.

TL Ventures has agreed to give up the $257,000 worth of fees it earned from the state, as well as pay a $35,000 fine.

Republicans are now suing the SEC in an attempt to block the rule, saying that preventing investment advisors from making political donations is, in effect, a restriction on free speech. From Reuters:

Republican politicians sued the U.S. Securities and Exchange Commission, seeking to throw out a rule that limits political donations by investment advisers.

The Republican state committees from New York and Tennessee said the federal securities regulator had flouted due procedure when adopting its Political Contribution Rule, which they said also violated the constitutional right to freedom of speech.

“The (rule) directly harms Plaintiffs, as potential donors have informed each Plaintiff that they will not make political contributions because of the SEC’s rule,” said the complaint before a federal court in the District of Columbia, which was filed late on Thursday.

The SEC in 2010 approved the rule, which prohibits investment advisers from making campaign contributions in the hope of being awarded lucrative contracts to manage public pension funds, a practice known as “pay to play”.

The plaintiffs want the court to decide that the rule violates the law and to stop the SEC from enforcing the rule with respect to federal campaign contributions.

Specifically, Republicans are arguing that the SEC violated the Administrative Procedures Act when drafting the law. The Act requires specific procedures to be followed when drafting rules.

The Administrative Procedures Rules has been used successfully to strike down previous SEC rules.

Photo by jypsygen via Flickr CC License

After Massive Investment Losses, Michigan Pension Funds Benefit From Settlements with AIG, Private Equity Firms

AIG revealed in an SEC filing this week that it plans to pay out a massive sum of money to settle an ongoing lawsuit claiming the firm misled investors on the quality of certain investments prior to the 2008 financial crisis.

The total settlement: $970.5 million. And certain pension funds in Michigan will likely see a chunk of that change. That’s because they lost a significant chunk of change when they bought investment vehicles from AIG prior to 2008.

The State of Michigan Retirement Systems says it lost between $110 million and $140 million due to AIG.

Detroit’s General Retirement System as well as the Saginaw Police and Fire Pension Board say they lost millions more, as well.

All told, those funds could receive a combined payout totaling eight figures. From Crain’s:

This week, AIG disclosed to the U.S. Securities and Exchange Commission it would pay $960 million under a mediation proposal to settle the consolidated litigation, on behalf of investors from that period.

[…]

The lawsuit alleges AIG executives gave false and misleading information about its financial performance and exposure to residential mortgage backed securities in the run-up to the financial market collapse.

The $54.8 billion Michigan systems — a group of plans administered by the state Office of Retirement Services for former police officers, judges and other state and public school employees — became lead plaintiff for the class in March 2009, after informing the court of its nine-figure losses.

The federal Private Securities Litigation Reform Act of 1995 says a court should presume a plaintiff is fit to lead class actions like this one if it “has the largest financial interest in the relief sought by the class.” In fact, it had about double the losses of any other plaintiff seeking the same lead role — so its piece of the nearly billion-dollar pie may be larger than most.

The bolded is important, because it means that the State of Michigan Retirement Systems will almost certainly be receiving the highest payout of any of the plaintiffs.

Meanwhile, another Michigan fund—the Police and Fire Retirement System of the City of Detroit—was the beneficiary of another settlement today.

Three private equity firms settled a seven-year-long lawsuit today that alleged the firms colluded and fixed prices in leveraged buyout deals. The firms—Kohlberg Kravis Roberts (KKR), Blackstone, and TPG—settled for $325 million.

Among the suit’s plaintiffs were public pension funds that held shares in the companies that were bought out by the firms at “artificially suppressed prices, depriving shareholders of a true and fair market value.” From DealBook:

The lawsuit, originally filed in late 2007, took aim at some of the biggest leveraged buyouts in history, portraying the private equity firms as unofficial partners in an illegal conspiracy to reduce competition.

As they collaborated on headline-grabbing deals — including the buyouts of the technology giant Freescale Semiconductor, the hospital operator HCA and the Texas utility TXU — the private equity titans developed a cozy relationship with one another, the lawsuit contended. Citing emails, the lawsuit argued that these firms would agree not to bid on certain deals as part of an informal “quid pro quo” understanding.

In September 2006, for example, when Blackstone and other firms agreed to buy Freescale for $17.6 billion, K.K.R. was circling the company as well. But Hamilton E. James, the president of Blackstone, sent a note to his colleagues about Henry R. Kravis, a co-founder of K.K.R., according to the lawsuit. “Henry Kravis just called to say congratulations and that they were standing down because he had told me before they would not jump a signed deal of ours,” Mr. James wrote.

Days later, according to the lawsuit, Mr. James wrote to George R. Roberts, another K.K.R. co-founder, using an acronym for a “public to private” transaction. “We would much rather work with you guys than against you,” Mr. James said. “Together we can be unstoppable but in opposition we can cost each other a lot of money. I hope to be in a position to call you with a large exclusive P.T.P. in the next week or 10 days.” Mr. Roberts responded, “Agreed.”

The settlement now awaits approval from the Federal District Court in Massachusetts.

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