State Street, Governor Elect Rauner Both Implicated in Pay-to-Play Scandals

The more rocks you turn over in public pension land, the more creepy crawlies you find. No wonder private equity has such a secrecy fetish. The most obvious, and most offensive to the public, are so-called pay-to-play scandals, in which public officials who are in a position to influence how funds are invested, take campaign funding from individuals or firms who are currently managing government funds or in short order get a mandate.

David Sirota, who has been all over this beat, explains why taking campaign donations from parties currently running public monies is sus. In a new story, Sirota describes how Illinois governor elect Bruce Rauner, who comes out of the private equity industry, took over $140,000 in campaign contributions from executives at funds that manage state money, which violates state and federal laws, since Rauner will be appointing pension system trustees.

Rauner’s aides tried dismissing the revelation arguing that these firms were already feeding at the public fund management trough. That argument doesn’t cut it from a legal or common sense standpoints, as Sirota explains:

But legal experts, former SEC officials and campaign finance lawyers interviewed by IBTimes said the [SEC] rule applies over the entire life of a pension fund investment because those investments can be terminated, sold off or extended at any time. The point is to prevent political contributions from influencing not just the original decision to invest, but the ongoing choice to continue or terminate the investment.

David Melton of the Illinois Campaign for Political Reform said pension “contracts come up for renewal periodically,” and that it’s therefore “inconsistent with the spirit and purpose of the law” to rely on the argument that the donations are acceptable because they were made after the original investment decision.

Mind you, Rauner was already a target for criticism due to the concerns that his past donations and payments made by his PE funds’ portfolio companies affected state investments. The SEC just prosecuted its first pay-to-play case (the rule is recent) over a $4,500 donation, much smaller than the donations that Sirota unearthed. And the agency has vowed it is going to dedicate real resources to this area. Punishment can be harsh: managers who’ve made verboten campaign donations can be forced to disgorge all fees received after the contributions were made. The Illinois State Board of Investment has just announced an investigation of the Rauner donations.’

In some ways, the State Street story, which was broken in the Wall Street Journal, is even more salacious and could have larger ramifications. State Street runs a simply huge custody business. The term originates from keeping custody, as in holding, securities on behalf of investors. Custody services today include payment services, fund administration, and recordkeeping. For CalPERS, custodial fees to State Street are roughly $6 million, and by virtue of CalPERS’ size, the pension system can presumably negotiate the best prices. Even so, due to how concentrated the custody business has become (its system intensity means it has huge scale economies), it’s not as if pension systems have much in the way of choice. Consider this section from a 2011 Bloomberg story:

California Governor Jerry Brown sued State Street Corp. (STT) in 2009, when he was attorney general, for “unconscionable fraud” against pension funds over foreign- exchange pricing. That didn’t stop the largest of the funds from striking a new three-year deal with the firm.

The $232 billion California Public Employees’ Retirement System last week signed a contract for Boston-based State Street to continue handling all its custody work, said Wayne Davis, a pension spokesman. Calpers, as the Sacramento-based fund is known, passed over competing bids from New York’s JPMorgan Chase & Co. (JPM) and Bank of New York Mellon Corp. (BK)

“It does seem contradictory,” George Diehr, a Calpers board member representing state employees, said in a telephone interview. “It was difficult to find someone who would provide all the services and at the terms we required.”

You’d think with so little in the way of competitors that State Street would enjoy its oligopoly status. Think again. The SEC has found what sure looks like a case of pay to play in Ohio with a lobbyist that has already pled guilty in a separate money laundering/bribery case. The agency also strongly hints that it is looking into other dodgy behavior by State Street.

From the Wall Street Journal report:

Federal officials are examining the connections between Boston financial giant State Street Corp. and an Ohio lobbyist as part of a broader look at the company’s dealings with public pension funds, according to people familiar with the investigations.

The scrutiny from the Justice Department and the Securities and Exchange Commission centers on State Street’s hiring of the lobbyist in 2010, several months before winning a contract to provide administrative services for $32 billion in three of Ohio’s largest retirement systems…

In Ohio, the investigation in part concerns the relationship between lobbyist Mohammed Noure Alo and Ohio’s then-deputy treasurer, Amer Ahmad. The men were in touch roughly 14 times a day over a certain period via text and phone, according to court testimony from an agent with the Federal Bureau of Investigation. The treasurer’s office had oversight of the contract…

State Street’s interactions with Mr. Alo, the founding member of a Columbus law firm, began in early 2010, when Mr. Alo met a State Street representative at a campaign event for the state treasurer, according to the FBI agent’s testimony last week during a U.S. court hearing. State Street contacted him with a draft contract for work as a lobbyist and Mr. Alo forwarded that document to Mr. Ahmad, the FBI agent said.

Mr. Alo, who became a registered Ohio lobbyist in 2010, also approached Bank of New York Mellon Corp. with the same request, leaving a voice mail claiming the bank’s existing business with the state was “not really guaranteed to stay with you,” according to the testimony. Both banks were vying for a contract to handle assets held by three Ohio pension funds. Bank of New York Mellon didn’t retain Mr. Alo, while State Street eventually agreed in the contract to pay him $16,000 upfront, according to the FBI testimony. BNY Mellon declined to comment.

Federal officials uncovered what they described as a separate $3.2 million kickback scheme involving an Ohio securities broker and the Ohio treasurer’s office while investigating the State Street deal. They brought charges in that case against Messrs. Alo and Ahmad and two other men. All four have pleaded guilty.

Reading between the lines, one might guess that Alo is a pay to play entrepreneur. But even if he was the instigator, State Street is culpable if they went along. Moreover, given what a cesspool government-related finance is, you can see why the SEC has taken interest. If State Street was indeed receptive to this kind of pitch in Ohio, they would presumably have been just as receptive with similar “proposals” for other public pension funds.