Asset managers should be prepared to swallow some tough terms
Don’t be surprised at how tough it is to negotiate a separate account agreement with a public pension plan.
In the first place, the plan may be statutorily protected against any lawsuit from an asset manager – even for unpaid fees – by virtue of sovereign immunity. In certain states, this immunity may not apply to contract obligations and may be waived if a lawsuit is initiated by the plan. Even so, some asset managers may reflexively balk at the asymmetry of the situation and, where applicable, the fact that they may have no legal recourse against a public pension client for its misrepresentations or other contract breaches. Secondly, the plan may be legally prohibited from indemnifying the manager, even if the plan is entirely at fault for the manager’s loss. This will not prevent the plan, however, from insisting on an indemnity running in its favor for misfeasance on the part of the manager.
A public plan may, in addition, be compelled by statute or public policy to require the governing law of its separate account agreements to be the law of its own state and any dispute between the plan and its asset manager to be litigated in the plan’s state or federal courts. Needless to say, no asset manager would welcome the prospect of litigating a dispute with a public pension plan in the plan’s own state and under its state law.
If a manager’s investment strategy is algorithmically-driven, it must also concern itself with the possibility of its confidential investment reports being disclosable to the public under state freedom of information acts or ‘sunshine laws’ and therefore becoming susceptible to reverse engineering. Although many if not most state ‘sunshine laws’ provide exemptions from mandatory public disclosure for trade secrets, quant managers still need to make certain that their investment reports and client discussions meet the substantive and procedural requirements of the applicable statutory exemptions.
Lastly, asset managers should be aware that there are now overlapping (and, in some cases, conflicting) federal, state and local regulations restricting them, their employees and their agents from making political contributions to public officials capable of influencing awards of public pension plan advisory mandates. No such mandate should therefore be solicited or accepted by a manager without the manager’s first determining whether any such ‘pay-to-play’ restriction has been triggered.