SERS Adopts Investment Protection Principles Urged by Pennsylvania Auditor General Casey Last July.
"The adoption of these principles will send a strong message to investment advisors and money management firms that if they wish to play a role in managing the pension funds supporting retired Pennsylvania teachers and government employees, they will be expected to adhere to the highest of ethical standards," Casey said.
A copy of Casey's July 19th letter to SERS Chairman Maiale is attached. July 19, 2002 The Honorable Barbara Hafer Chair Public School Employees' Retirement System 5 North Fifth Street Post Office Box 125 Harrisburg, Pennsylvania 17108-0125 Mr. Nicholas J. Maiale Chair State Employees' Retirement System 30 North Third Street Post Office Box 1147 Harrisburg, Pennsylvania 17108-1147 Mr. George E. Gift, Jr. Chair Pennsylvania Municipal Retirement System Eastgate Building, Suite 301 1010 North Seventh Street Post Office Box 1165 Harrisburg, Pennsylvania 17108-1165 Dear Chairpersons Hafer, Maiale and Gift:
As you well know, recent corporate accounting abuses at companies such as Enron and WorldCom, as well as allegations of tainted investment advice given by firms such as Merrill Lynch, have shaken investor confidence and eroded the integrity of our national financial markets.
Recently, I asked Governor Schweiker and Treasurer Hafer to join with me -- as officials responsible for issuing Commonwealth debt -- in adopting initiatives to protect Pennsylvania investors and billions of dollars in state investments from conflicts of interest which may develop when financial firms provide both investment analysis and corporate investment banking services. As issuing officials, we can use Pennsylvania's position as a substantial client of financial firms underwriting Commonwealth debt to demand that these firms maintain proper separation between their corporate investment banking activities and the investment analysis and management services they provide to individual and institutional investment clients.
Specifically, I proposed that, in selecting firms to manage the issuance of Commonwealth debt, Pennsylvania adopt a standard such as the "Merrill Lynch principles" adopted by the State Treasurer of North Carolina, the Comptroller of the State of New York, and the State Treasurer of California on July 1, 2002. As embodied in the agreement between Merrill Lynch and New York State Attorney General Eliot Spitzer dated May 21, 2002, the "Merrill Lynch principles" are outlined as follows:
-- Sever the link between compensation for analysts and investment banking; -- Prohibit investment banking input into analyst compensation; -- Create a review committee to approve all research recommendations; -- Require that upon discontinuation of research coverage of a company, firms will disclose the coverage termination and the rationale for such termination; -- Disclose in research reports whether the firm has received or is entitled to receive any compensation from a covered company over the past 12 months; and -- Establish a monitoring process to ensure compliance with the principles.
As fiduciaries of public pension plans responsible for billions of dollars in retirement funds, I am sure that you are working diligently to ensure the investment advice these plans receive is untainted by any potential conflicts of interest. Additionally, because the pension plans you oversee are substantial clients of investment advisors and money management firms, you are in a position to aid investors throughout Pennsylvania by ensuring that advice these firms provide to individual investors is free of any potential conflicts of interest.
For example, many money management firms that handle investments for public pension funds also handle investments for corporate pension plans and 401(k) plans. This creates a potential conflict of interest, because the money managers may feel pressured to add the stocks of their corporate clients into the public pension fund portfolios, even if it is not in the best interest of the pension funds. Similarly, money manager research analysts may be reluctant to provide objective research advice, knowing that adverse recommendations may cause their firms to lose corporate clients. Other potential conflicts of interest exist with respect to those money management firms that are subsidiaries of investment banking firms.
In order to protect their state taxpayer and retirement funds, on July 2, 2002, North Carolina, New York and California, including the North Carolina Public Employees Retirement Systems and the New York State Common Retirement Fund adopted the following requirements for money management firms retained by their respective state investment officers:
1. Money management firms must disclose periodically any client relationship, including management of corporate 401(k) plans, where the money management firm could invest state or pension fund moneys in the securities of the client. 2. Money management firms must disclose annually the manner in which their portfolio managers and research analysts are compensated, including but not limited to any compensation resulting from the solicitation or acquisition of new clients or the retention of existing clients. 3. Money management firms shall report quarterly the amount of commissions paid to broker-dealers, and the percentage of commissions paid to broker-dealers that have publicly announced that they have adopted the Investment Protection Principles(1). 4. Money management firms affiliated with banks, investment banks, insurance companies or other financial services corporations shall adopt safeguards to ensure that client relationships of any affiliate company do not influence investment decisions of the money management firm. Each money management firm shall provide the state investment officers with a copy of the safeguards plan and shall certify annually to the state investment officers that such plan is being fully enforced. 5. In making investment decisions, money management firms must consider the quality and integrity of the subject company's accounting and financial data, including its 10-K, 10-Q and other public filings and statements, as well as whether the company's outside auditors also provide consulting or other services to the company. 6. In deciding whether to invest state or pension fund moneys in a company, money management firms must consider the corporate governance policies and practices of the subject company. 7. The principles set forth in paragraphs five and six are designed to assure that in making investment decisions, the money management firms give specific consideration to the subject information and are not intended to preclude or require investment in any particular company.
I am writing to you today to ask you to consider similar requirements on the money management firms that do business with your pension funds. I understand that these firms are already subject to various fiduciary requirements pursuant to state law and contractual agreements, and it is not my intention to suggest that the requirements delineated above supplant or diminish any existing responsibilities placed on these firms. Additionally, I understand that some of the requirements listed above may have limited application to certain types of asset managers such as those managing indexed portfolios or hedge funds. At the same time, I believe that these requirements, properly applied, could provide an additional level of protection against potential conflicts of interest which may taint investment recommendations and decisions made by money managers doing business with the funds.
Given the present climate of corporate malfeasance and accounting scandals, your leadership in establishing stronger investor protections such as those embodied in the principles and requirements cited above will send a message to investment advisors and money management firms that if they wish to play a role in managing the pension funds supporting retired Pennsylvania teachers and government employees, they will be expected to adhere to the highest of ethical standards.
Sincerely, /s/ Robert P. Casey, Jr. Robert P. Casey, Jr. Auditor General 1. Referred to above as the "Merrill Lynch principles."
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CONTACT: Karen Walsh of the Pennsylvania Department of Auditor General, +1-717-787-1381 or firstname.lastname@example.org
Web site: http://www.auditorgen.state.pa.us/
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|Date:||Nov 4, 2002|
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