Earlier this week Federico Buenrostro, who headed the influential California Public Employees’ Retirement System from 2002 through 2008, was indicted by a federal grand jury on fraud charges stemming from his involvement in falsifying documents as part of a “pay-to-play” scheme at the pension fund.  The indictment is the result of a four year investigation by the SEC, the FBI, and the U.S. Postal Inspection Service.

Also indicted was Alfred Villalobos, a close friend of Mr. Buenrostro’s, who ran a placement agency in California called Arvco Capital Research LLC.  Placement agents act as middlemen between money managers, such as private equity firms, and the pension funds that the managers seek as investors.   Arvco was hired by PE firm Apollo Global Management to solicit investment commitments from CalPERS and other funds, and had been paid at least $48 million in finder's fees for such work.  Apollo sought disclosure letters from CalPERS acknowledging that it was aware that Mr. Villalobos would receive commissions in connection with his work.  When CalPERS refused to sign the letters, Mr. Buenrostro and Mr. Villalobos allegedly submitted fabricated versions to Apollo.

The “pay-to-play” scandal began several years ago, when regulators nationwide began to crack down on what was seen as improper influence by placement agents and their connections with pension officials from whom they solicited investments on behalf of their fund clients. Most well-known is Alan Hevesi, former head of New York state’s pension fund, who served prison time for his role in providing access to the pension fund for placement agents and their clients.

Since that time, various state and federal agencies have implemented regulations limiting the use of placement agents or requiring more disclosures.  For example, since January 2011, placement agents have been required to be registered as lobbyists in California and are prohibited from earning fees based on the successful solicitation of investments.   The SEC had proposed an outright ban on placement agents as early as 2009, but ultimately published a rule that merely required registration of agents that solicit public pension funds.

News of this indictment may reignite the debate over the proper role of placement agents and place a renewed focus on their use by small and mid-sized private equity and hedge funds.  This could be particularly true as private equity firms face increased scrutiny from federal regulators under the Dodd-Frank Act, which requires PE firms with more than $150 million in assets under management to register with the SEC and submit to SEC audits.  We will continue to monitor developments in the area and consider the insurance implications as the situation unfolds.