The authors consider the effects of recent scandals involving the use of placement agents by investment management firms entrusted to manage the assets of public pension funds. They attempt to identify the true risks in the process and how best to achieve integrity while minimizing negative unintended consequences. They conclude that such actions as careful hiring practices on the part of pension funds and due diligence on the part of investment managers contracting with placement agents would be more effective in preventing abusive behavior than banning the use of placement agents.

Pension fund assets make up a large percentage of the investment universe, and a growing portion of pension fund assets are being invested in alternative investments that use placement agents for sales and marketing. The authors estimate that, historically, placement agents have been used in roughly 40–60% of private equity fundraising. Large amounts of money are involved in these placements, and regulators attempt to keep the process free from conflicts of interest, lavish gifts, kickbacks, and other abusive behaviors.

The authors are concerned that proposed regulations to ban placement agents do not adequately define what constitutes a placement agent and may also inadvertently reduce a pension plan’s ability to work with desirable investment management firms or increase the costs to the system. They posit that the most effective approach to avoiding abuse lies in policies directed toward those entrusted to make decisions on behalf of beneficiaries. Examples of such policies include prohibiting investment staff members from receiving gifts of any value from anyone with whom they do business (as is the case with government entities in the United States), requiring staff members to disclose any conflicts of interest, and mandating that firms follow diligent hiring procedures that include background checks.

The authors begin by determining the average public pension allocation to alternatives and alternative fundraising activity over the last five years. They then describe seven examples of marketing structures used by investment management firms, ranging from firm executive or investment professional as principal fundraiser to registered external third-party marketing firm contracting with an additional third-party marketer for a selective effort. The authors arrange the firms according to their risk for potential conflicts of interest and evaluate each arrangement in terms of compensation structure and alignment of interests.

They examine a series of scenarios that represent real-world situations that pension plan investors face and contend that the placement agent arrangement itself does not increase the potential for abuse or higher fees. The authors note that a ban on placement agents not only would disproportionately affect smaller, newer, and niche investment managers that often cannot afford to pay a base salary to an in-house salesperson but also would lead to an array of unintended ill effects, notably fostering the perception of having altered the landscape for transgressions without actually having done so.

The trend in public pension funds toward the use of alternatives that often rely on placement agents seems clear. The authors effectively describe the diversity and complexity of arrangements that can arise when investment management firms market themselves to public pension plans; their observations about the possible unintended effects of a ban on placement agents are noteworthy, especially the reduction of investor choice that would result from a ban. Enhanced attention on the decision-making side of the marketing structure in terms of hiring procedures, due diligence, disclosure of potential conflicts, and so forth seems like a sensible approach. But the degree to which industry self-regulation has been, or can be, shown to be effective in preventing abuse might be subject to additional debate and exploration.