Investment Management and Public
Policy Alert
October 2009
Author:
Raymond P. Pepe
raymond.pepe@klgates.com
+1.717.231.5988
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Pennsylvania Adopts Code of Conduct and
Pay to Play Restrictions on the Award of
Financial Services Contracts by Municipal
Pension Funds: Inconsistencies and
Omissions in the Code May Pose Significant
Problems
On September 18, 2009, amendments to the Pennsylvania Municipal Pension Plan
Funding Standard and Recovery Act were adopted to improve the financial stability
of municipal pension funds.1 The legislation requires all municipal systems within
two years to update information on the value and liability of their funds; establishes
new funding requirements for distressed pension funds; and provides significant new
sources of revenues to help Philadelphia and Pittsburgh, which operate the state s
largest municipal pension funds, deal with unfunded liabilities.2 The legislation also
includes a new set of standards for the award of financial, legal, real estate,
consulting and other professional services contracts by all municipal pension funds
that have been informally described as a Code of Conduct for the operation of all
municipal pension funds.
While the primary goal of the legislation is to provide new sources of funds for
distressed municipal pension funds, and to ensure the efficient use of the new
funding, the Code of Conduct will have a significant impact upon all persons
providing professional services to municipal pension funds. Where contracts are not
awarded to the lowest bidder, the Code of Conduct requires the use of public and
competitive procurement procedures for all new professional services contracts;
requires the disclosure of any use of agents and lobbyists by vendors; limits
communications between agents and lobbyists with municipal officials; disqualifies
persons making political contributions and gifts to municipal officials and employees
from being awarded contracts; and imposes sanctions for violations of these
requirements.
Implementation of the Code of Conduct, which is required by December 17, 2009,
will be challenging for both pension fund managers and professional services
contractors, both because of the extensive new procurement requirements
established, but also because the legislation contains a variety of difficult to reconcile
internal inconsistencies and fails to address a number of critical administrative
details.
Applicability of the Code of Conduct
As of December 2008, local governments in Pennsylvania operated 1,064 separate
pension funds for police and fire-fighting employees and 2,116 separate pension
funds for non-uniformed employees. Together these funds comprise more than 25%
of all the local government pension systems in operation in the United States;
provide benefits to more than 135,000 employees; and, as of December 31, 2006,
held total assets in excess of $18 billion. While the vast majority of these plans are
Investment Management and Public Policy Alert
small, 25 of the funds hold assets in excess of $100
million, and two of the funds, both associated with
the City of Philadelphia, hold assets in excess of $1
billion.iii
Pursuant to cooperative agreements, more than 900
of Pennsylvania s municipal pension funds, with a
combined membership of more than 9,300
employees and aggregate assets in excess of $1.19
billion, are administered by a state agency, the
Pennsylvania Municipal Retirement System.
Pennsylvania also has separate retirement systems
for state employees, the Pennsylvania State
Employees Retirement System, which has more than
219,000 members and assets in excess of $21
billion, and for public school employees, the
Pennsylvania Public School Employees Retirement
System, which has more than 425,000 members and
assets in excess of $43 billion.
The new Code of Conduct applies to all of
Pennsylvania s 3,180 municipally operated pension
funds, including the Pennsylvania Municipal
Retirement System, but does not apply to the
Pennsylvania State Retirement System or to the
Pennsylvania Public School Employees Retirement
System.iv
Requirements for the Competitive
Procurement of Professional Services
Whenever municipal pension funds are not required
by law to procure professional services from the
lowest bidder,v the Code of Conduct requires funds
to establish procedures for the procurement of
services from the most qualified person after
advertising solicitations for services; accepting
applications and disclosure forms from contractors;
reviewing the qualifications, experience, expertise
and compensation of prospective contractors;
adopting policies governing conflicts of interest; and
giving notice of the basis for decisions regarding the
award of contracts.
A. Professional Services Subject to
Competitive Procurement Requirements
The Code of Conduct applies to all types of
professional services, including investment
services, legal services, real estate services and other
consulting services. Beyond these examples,
however, the law gives no guidance regarding how
to distinguish professional services from other
services; when contracts provide for the
procurement of financial products rather than
services; and leaves these important issues to be
addressed by individual pension systems. Statutory
construction principles, however, suggest that the
general term professional services should be
construed to apply only to items with similar
characteristics as those specifically enumerated in
the law, i.e., investment, legal, real estate and
consulting services.vi
Similarly, the competitive procurement
requirements of the Code of Conduct do not exclude
de minimis initial purchases of professional services
regardless of the amount of purchase price. The law
appears to allow existing contracts, however, to be
amended to increase the cost of services by 10% or
$10,000, whichever is greater, without competition,
and in greater amounts if written justification for the
increase is posted on a municipal website at least
seven days prior to the contract amendment.
Because these exceptions from competitive
procurement may create unreasonable preferences
for incumbent vendors, stricter requirements for
contract amendments may be imposed by individual
pension systems. In addition, municipal solicitors
may construe the Code of Conduct in pari materia
with other procurement laws so as to provide for de
minimis exceptions.
B. Advertising
The Code of Conduct requires advertising regarding
the availability of professional services contracting
opportunities to be disseminated in a timely and
efficient manner. Advertising must describe and
provide specifications for the services to be
procured and must set forth the procedures to
compete for contracts and describe disclosures
required from all vendors.
Unfortunately, the Code of Conduct fails to specify
how contracting opportunities must be advertised
and when advertising must be disseminated.
Requirements contained in the Pennsylvania
Newspaper Publishing Act designating the
publications in which legal advertising shall be
published may fill some of these gaps, but issues
regarding the timing and frequency of advertising
are apparently left to local discretion.vii
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Investment Management and Public Policy Alert
C. Disclosures and Conflicts of Interest
Prior to entering into professional services contracts,
the Code of Conduct requires contractors to identify
each individual, advisor or subcontractor that will be
providing services to a municipal pension fund;
describe the services each individual will provide;
and disclose whether any of these individuals are
current or former officials or employees of the
municipality procuring services or are registered
federal or state lobbyists. The legislation fails to
clarify, however, whether these disclosures are
required of all persons submitting proposals to
provide professional services, or only to the offerors
determined to be most qualified.
To determine how to utilize the information
provided in disclosure forms, the Code of Conduct
requires municipal pension systems to adopt policies
regarding conflicts of interest that at a minimum
impose a one-year restriction upon the participation
of former officials or employees of the pension
system in the submission of applications to provide
professional services and upon the participation of
former employees of a contractor in the review of
proposals and the negotiation of the terms of
services contracts. In addition, a professional
services contractor may not have a direct financial,
commercial or business relationship with any
official of the municipal pension system or the
municipality which controls the municipal pension
system, unless the pension system consents in
writing to the relationship following full disclosure.
Unfortunately, the Code of Conduct provides no
guidance regarding what constitutes direct financial,
commercial or business relationships. The Code of
Conduct also applies the restrictions upon direct
financial, commercial or business relationships only
to relationships with municipal officials rather than
municipal employees, and fails to clarify whether
these restrictions also apply to officers, directors,
employees and owners of entities entering into
professional services contracts. As a result, this is a
further area in which individual pension systems
may adopt supplemental requirements to remedy
inconsistencies and omissions in the state legislation.
D. Awards
Upon the award of any professional services contract
by a municipal pension system, the relevant factors
that resulted in the award must be summarized in a
written statement provided within ten days to any
unsuccessful applicants and posted on the municipal
webpage at least seven days prior to the execution
of a contract.
Following the award of contracts, the Code of
Conduct also requires all applications and disclosure
forms submitted to pension plans, except for
proprietary information or other information
protected by law, to be treated as public records
subject to disclosure. While the Code of Conduct
fails to clarify what constitutes proprietary
information, the Pennsylvania Right to Know Law
defines confidential proprietary information as
confidential or privileged information the disclosure
of which will cause substantial harm to the
competitive position of a person. The Right to
Know Law also prohibits the disclosure of internal,
pre-decisional deliberations of agencies and
financial information of persons responding to
requests for proposals used to demonstrate a
person s economic capability. viii
Restrictions on the Use of Agents and
Lobbyists
The Code of Conduct requires any person that
enters into a professional services contract or
intends to enter into a contract to disclose the
employment or compensation of any third party
intermediary, agent or lobbyist used to directly or
indirectly communicate with a municipal pension
system or municipal official or employee in
connection with any transaction or investment
involving the contractor. These requirements do
not apply to officials or employees of investment
firms engaged in their standard professional
duties on behalf of the firm, but do apply to any
affiliated entity of the contractor or prospective
contractor. The Code of Conduct, however,
provides a narrow definition of the term affiliated
entity that is limited to a subsidiary or holding
company of a lobbying firm; a business owned in
whole or in part by a lobbying firm; or a nonprofit
organization established by a lobbying firm,
lobbyist or another affiliated entity.
In what constitutes a significant inconsistency in the
Code of Conduct, officials and employees of
investment firms need not disclose their role in
communicating with pension systems and
municipalities, but no such exemption is provided to
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Investment Management and Public Policy Alert
employees engaged in providing legal, real estate,
consulting or other types of professional services.
Following the advertisement of solicitations for a
professional services contract, the Code of Conduct
provides that a prospective contractor may not
cause or allow a third party to communicate with
officials or employees of [a] municipal pension
system except for requests for technical
clarification. Technical clarifications may also be
requested only from a designated employee of the
pension system. Prospective contractors may,
however, respond to requests for clarification or
additional information from a municipal pension
system.
Because the Code of Conduct bars ex parte contacts
by third parties, but not by contractors themselves,
and does not distinguish between communications
related to the procurement process versus unrelated
communications required in the ordinary course of
business, it seems likely that individual pension
systems may need to adopt policies or rules for the
effective implementation of these requirements.
Restrictions on Political Contributions
and Gifts
The Code of Conduct prohibits a person who
within the past two years has made a campaign
contribution to a municipal official or candidate for
municipal office in the municipality which controls
the municipal pension system from entering into a
professional services contract with the pension
system. These restrictions also apply if an
affiliated entity has made a contribution within the
two-year period,ix but do not apply to political
contributions made prior to the effective date of the
Code of Conduct, i.e., December 17, 2009.
Similarly, the Code of Conduct prohibits
professional services contractors from offering or
making any gift having more than a nominal value
to any official, employee or fiduciary of a
municipal pension system. The Code of Conduct
also prohibits a contractor or prospective contractor
from soliciting a contribution to any municipal
official or candidate for municipal office in the
municipality where the municipal pension system is
organized or to the political party or political action
committee of that official or candidate. Persons
holding professional services contracts with
municipal pension funds are also required to update
their required disclosures annually, and to report
gifts to officers or employees of pension funds and
municipalities controlling pension funds. These
restrictions also apply to any agent, officer, director
or employee of a contractor or prospective
contractor.
The restrictions on political contributions and gifts
established by the Code of Conduct contain a
number of inconsistencies and omissions that seem
likely to generate substantial confusion that may
need to be addressed through the adoption of
supplemental requirements by municipal pension
systems. For example:
While the ban on the solicitation of
contributions applies to contractors and their
officers, directors and employees, the ban on
contributions themselves applies only to
contractors.
While the ban on contributions made by
contractors applies to affiliated entities that
are subsidiaries, holding companies, owners,
and nonprofit entities created by lobbying firms,
the ban does not apply to contributions made by
political committees affiliated with contractors,
or by parents or subsidiaries of contractors.
No time period is specified for application of
the prohibition upon soliciting campaign
contributions by contractors and prospective
contractors, and no guidance is provided to
distinguish unlawful solicitation from
political speech protected by the First
Amendment.
The prohibition upon contractors making gifts
to municipal officials and employees does not
appear to apply to prospective contractors and
does not appear to apply prior to the execution
of contracts with pension systems.
No guidance is provided regarding how to
measure the two-year restriction on making
contributions and no clarification is provided
regarding whether the two-year limitation on
contributions applies to agents, officers,
directors and employees of contractors and
prospective contractors.
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Investment Management and Public Policy Alert
While the ban on the solicitation of political
contributions applies to political committees and
party committees, the ban on contributions
themselves does not apply to political
committees and party committees.
In addition to these inconsistencies and omissions in
the legislation, significant constitutional questions
exist regarding the validity of an outright ban on
contributions for pension system contractors. In
DePaul v. Commonwealth, 969 A.2d 536 (Pa. 2009),
the Pennsylvania Supreme Court held a total ban on
political contributions by persons involved in the
casino and horse racing industries to be
unconstitutional when the objectives of the
Pennsylvania Gaming Law could have been met
with more narrowly structured limitations on the
amounts of political contributions. The same
principle may apply to the ban on contributions
provided by the Code of Conduct because its
objectives could similarly be achieved by
restrictions and limitations on contributions similar
to those provided by Rule G-37 of the Municipal
Securities Rulemaking Board.x
Mandatory Disclosures of Political
Contributions and Gifts
As a mechanism to enforce the Code of Conduct s
restrictions on political contributions and gifts, the
legislation requires persons contracting to provide
professional services to municipal pension funds,
and persons who have applied for, submitted an
offer or bid for, responded to a request for proposals,
or otherwise solicited a professional services
contract, to disclose all political contributions made
within the last five years. The reporting
requirements apply to contractors; their officers,
directors, executive level employees, and affiliated
entities; and to any persons with a five percent or
greater ownership interest in a contractor or
prospective contractor. Reports must disclose
contributions made to any municipal candidate for
public office or office holder, or the political
committee of any municipal candidate or officer
holder, if any individual contribution, or the
aggregate amount of all contributions, exceeds $500.
The reporting requirements of the Code of Conduct
supplement, but do not replace, similar less
extensive reporting requirements imposed upon all
business entities awarded non-bid contracts by
state and local agencies by the Pennsylvania
Election Code. The Election Code requires the
submission of reports by February 15th of each year
concerning all political contributions made during
the prior year by officers, directors, associates,
partners, limited partners or individual owners, and
members of their immediate families, if the total
contributions made by all such individuals exceed
an aggregate of $1,000, and all employees of a
business entity, and members of their immediate
families whose contributions exceed $1,000.xi
The term executive level employee as used in the
reporting requirements for political contributions
means an individual who can affect or influence
the outcome of [a contractor s, prospective
contractor s, or an affiliated entity s] actions,
policies or decisions relating to business with a
municipality or municipal pension system, or an
individual directly involved in the implementation
or development of policies relating to the conduct
of business with a municipality or municipal
pension system.
Contractors are also required to report gifts to
officials and employees of municipalities and
pension systems and all direct financial, commercial
or business relationships with officials and
employees of municipalities and their pension
systems.
In the event of any violations of these reporting
requirements, or the disclosure requirements
associated with the submission of applications to
enter into professional services contracts, municipal
pension systems are required to void professional
services contracts with any person that knowingly
makes a material misstatement or omission in a
disclosure form and must prohibit the person from
entering into a contract for a period of up to three
years.
As is the case with the restrictions on contributions
and gifts included in the Code of Conduct, these
reporting requirements also contain a number of
inconsistencies and omissions that raise numerous
questions that may need to be addressed through the
adoption of supplemental requirements by
municipal pension systems. For example:
The legislation fails to clarify whether the $500
disclosure limit is calculated annually or applies
October 2009
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Investment Management and Public Policy Alert
to the total five-year period, and from what date
the five-year period is measured.
No clarification is provided regarding for what
period of time gifts and direct financial,
commercial or business relationships must be
reported.
The reporting requirements apply to
contributions to candidates, office holders, and
their political committees, but not to unaffiliated
political committees, such as corporatesponsored political action committees, that may
in turn make contributions to the same
candidates, office holders and political
committees.
Preemption and the Need for Uniform
Rules and Policies
Recognizing that the City of Philadelphia previously
imposed similar and in many cases stricter
requirements, the Code of Conduct expressly
provides that it does not preempt codes of ethics
adopted by municipalities stricter than those
imposed by state law.xii While the absence of
preemption on one hand poses the danger that a
confusing maze of non-uniform policies to
implement the new law may arise, it also affords
individual pension systems the ability to craft
supplemental requirements to address the numerous
inconsistencies and administrative omissions of the
new legislation.
No clarification is provided regarding whether
contributions to both state and federal candidate
committees must be reported.
Gifts and direct financial, commercial or
business relationships must be reported by
contractors, but not by prospective contractors,
or by the officers, directors, executive level
employees or owners of either contractors or
prospective contractors.
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iv
1
Act 2009-44 (September 18, 2009), House Bill 1728,
Printer s No. 2638, 53 P.S. §§ 895.101 et seq.
2
The City of Philadelphia is authorized to collect an
additional one percent sales tax for the next five years and
defer its pension costs over the next three years; and the
City of Pittsburgh is authorized to lease or sell its parking
garages and keep 2.5% of its parking tax revenue to pay
for pension contributions.
iii
Pennsylvania Public Employee Retirement Commission,
Status Report on Local Government Pension Plans,
December 2008.
This omission may have occurred because Pennsylvania has
a fairly strict constitutional single-subject rule for legislation
which the General Assembly may have concluded made it
impractical to address issues relating to state retirement
systems in legislation dealing with local retirement funds.
Whether the Code of Conduct will be extended to apply to the
state retirement funds, however, is uncertain.
v
Very few types of services, other than printing, are currently
subject to competitive bidding requirements.
vi
McClellan v. Health Maintenance Organization of
Pennsylvania, 546 Pa. 463, 686 A.2d 801, 806 (Pa. 1996)
( where general words follow the enumeration of particular
classes of persons or things, the general words will be
construed as applicable only to persons or things of the same
general nature or class as those enumerated. ).
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Investment Management and Public Policy Alert
vii
45 Pa.C.S. §§ 101, 302, 307, 308. The Newspaper
Publishing Act requires all legal advertising, i.e., all
advertising required by law, regulation, ordinance or court
order, to be published in newspapers of circulation and
local newspapers in the counties in which municipalities are
located. Advertising is not required in legal journals for
bids for contracts for public work, materials or supplies, or
lists of delinquent taxpayers, but no comparable exemption
exists for advertising regarding the procurement of
services.
viii
65 P.S. §§ 67.102, 67.708(b)(10) & (26).
ix
As noted previously, the law defines the term affiliated
entity to mean only a subsidiary or holding company of a
lobbying firm; a business owned in whole or in part by a
lobbying firm; or a nonprofit organization established by a
lobbying firm, lobbyist or another affiliated entity.
x
Rule G-37 allows contributions of up to $250 provided the
contribution is made to a candidate or a candidate s
committee for which the contributor is eligible to vote.
xi
25 P.S. § 3260a; 4 Pa. Code Ch. 174.
The Pennsylvania Public Employees Retirement
Commission is authorized to issue rules, regulations,
policies and procedures necessary for the effective
administration and operation of the Municipal Pension Plan
Funding Standard and Recovery Act. The Commission has
no plans, however, to develop rules, policies or procedures
relating to implementation of the Code of Conduct.
xii
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