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July 01, 2002
Three States Act to Keep Money Managers Honest
    by William Baue

New York, North Carolina, and California will require money management firms that handle public funds to follow guidelines that discourage conflicts of interest.

Today, the state treasurers from North Carolina and California joined the comptroller and attorney general for New York State in announcing new guidelines designed to protect state taxpayer funds and public pension funds from unscrupulous money managers. The guidelines aim to prevent a money manager from having a conflict of interest between the money management services it provides for public funds and the investment banking services it may provide to corporate clients. The three states will require their money management firms to adhere to the conflict of interest principles established on May 21, 2002 in an agreement between New York State Attorney General Eliot Spitzer and Merrill Lynch. These guidelines are known as the Merrill Lynch Principles.

Conflicts of interest typically arise when money management firms handle both public pension funds and corporate 401(k) clients. Money managers may feel compelled to invest public pension funds in stocks of their corporate clients, even when these companies may not be the best investments. Likewise, money manager research analysts may be reluctant to disclose negative information about their corporate clients for fear of losing the corporate accounts. This is despite the fact that withholding such information could adversely affect the value of the public pension fund investments. The Merrill Lynch Principles discourage prioritization of one type of client over others.

"The corporate abuses we have seen recently have taken a terrible toll on the integrity of our financial system and have created a crisis of confidence among investors in Wall Street," said New York State Comptroller H. Carl McCall. "Corporate executives must be held responsible for their actions." Comptroller McCall is the sole trustee of the New York State Common Retirement Fund, which has approximately $112 billion in investments and is the second largest public pension fund in the country..

The Merrill Lynch Principles, also known as the Investment Protection Principles, require money management firms to sever the link between compensation for analysts and the volume of investment banking business. The principles also prohibit a firm's investment banking unit from offering input on analyst compensation. In addition, the principles also prescribe that money management firms create a review committee to approve all research recommendations and establish a monitoring process to ensure compliance with the principles.

"Our message today is simple and clear: if you [wish] to do business with our state, we expect you to adhere to the highest standards of integrity and disclosure," said California Treasurer Philip Angelides. "We are committed to rooting out the abuses which have rocked the financial markets and which have left families, pensioners and taxpayers to pick up the pieces."

California State Treasurer Angelides will recommend that the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS) adopt the Merrill Lynch Principles. CalPERS, with assets totaling more than $150 billion, is the nation's largest public pension fund. The New York State Common Retirement Fund and the North Carolina Public Employees Retirement Systems adopted several requirements in addition to the Merrill Lynch Principles.

For example, these two pension funds will require their money management firms to make disclosures regarding portfolio manager and analyst compensation. Furthermore, the firms now must scrutinize more closely the auditing and corporate governance practices of the companies in which they invest public pension money. Proponents believe these initiatives and the Merrill Lynch Principles will reform Wall Street, benefiting both individual and institutional investors.


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