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CalPERS Aims to Raise the Bar for Money Managers
Leah Carlson

In a move that reflects the increasing clout that large pension plans wield in the financial industry, the California Public Employees' Retirement System (CalPERS) has adopted a new code of ethics that external money managers must accept if they want to do business with the state.

The code, approved by the CalPERS' board in March, addresses short-term trading by portfolio managers and other "inappropriate" activities. It is intended to ensure fair treatment, promote alignment of interests between CalPERS and managers, and establish a management structure in firms to handle conflicts.

Beginning Dec. 31, managers and consultants contracting with CalPERS must:

• Designate an officer to address potential conflicts of interest.
• Establish an independent ombudsman to receive reported problems or compliance issues.
• Disclose all soft-dollar use and costs with comparisons to industry standards.
• Reveal compensation polices requiring the investment or deferral of current income into the company's products.
• Report biannually to CalPERS on their adherence to the code.

CalPERS sent a letter to its 66 money managers in November informing them about the plan to create a code of ethics and asking whether the managers are part of a federal investigation, whether they engage in short-term trading, and whether they are managing hedge funds simultaneously with any long-only portfolios.

The letter expressed concerns about short-term trading by money managers, inappropriate terms for certain clients that disadvantage long-term investors, and recent investigations into the behavior of mutual fund firms and money managers.

"We have become very concerned about the recent investigations being conducted by regulatory and law enforcement agencies into the behavior of mutual fund firms and their portfolio managers. We are troubled that this type of behavior represents very loose and ineffective codes of ethics, as well as poor compliance procedures in the industry that could impact accounts managed for CalPERS," says Brad Paceco, spokesman for CalPERS. "We hope that [the CalPERS code] serves as a catalyst for major improvements in ethical behavior, internal controls and corporate governance throughout the industry."

"It's not our intent to rewrite a [money manager's] code of ethics, which is an inch or two thick for every firm. We expect that firms have normal codes of ethics. These are more principles-related points," states Christy Wood, senior investment officer of global equities for CalPERS. "I think it clears up some issues that may not have been obvious, but matter to us."

Restoring integrity

Money managers who don't sign the code will lose the opportunity to do business with CalPERS. That move "clearly" reflects more clout on the part of CalPERS, according to Patrick McGurn, vice president of Institutional Shareholder Services, a Maryland-based company that offers corporate governance advice to its clients, including CalPERS.

"They have the potential to be very significant because nothing impacts the bottom line more than business you never get, or business you can't get. ... What they're doing is exercising their economic clout as consumers of these [money management] services," McGurn notes.

CalPERS manages pension and health benefits for about 1.4 million California public employees, retirees and their families. Its investment portfolio market value was estimated at $153.8 billion as of Oct. 31, 2003.

CalPERS' eventual influence may be demonstrated in the number of institutions that follows its lead in asking money managers to sign a code of ethics. "They're out in front of the parade now, and their ultimate clout depends on how many people join them in the parade. ... CalPERS has always been sort of one of those bellwether institutional investors. Breaking ground in this regard is nothing new [for them]," McGurn comments.

Bob Shepler, director of federal affairs for Financial Executives International, a New Jersey-based advocacy group for financial executives, agrees.

"CalPERS has always been the standard-setter for institutional financial management. They wield a lot of power because of the large amounts of money that they control."

He goes on to praise the code of ethics concept: "I think it's a good idea to do what they can to restore integrity to the mutual fund industry."

Don Trone, director of the Center for Fiduciary Studies at the University of Pittsburgh in Pennsylvania, agrees.

"I think it's great that CalPERS is doing that. I think anytime we as an industry can address perceived problems, rather than relying on regulators and the courts to fix everything, anytime we can take it upon ourselves to make changes or promote changes, I think that's a good thing," he comments.

Christy Wood acknowledges that CalPERS is being more outspoken about its concerns. "We always had power in the industry. I just don't think we always exercised it on a regular basis. We seem to be in an environment that we're finding behaviors that are a concern, so we're going to be more vocal," she comments. - L.C.

Employee Benefit News • May 2004

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