Thursday, September 4, 2014

The Herring Are Turning Red: SEANC Complains to the SEC

The Herring Are Turning Red: SEANC Complains to the SEC

The State Employees Association of North Carolina (SEANC) has filed another complaint with the Securities and Exchange Commission about the campaign contributions and fundraiser arranged in 2012 by Crandall Bowles, a director of JP Morgan, and the wife of Erskine Bowles, the founder of Carousel Capital.  SEANC is asking whether the SEC’s “pay-to-play” rules apply to Carousel or JP Morgan.  As I’ve written in previous posts, the North Carolina pension has had a private equity relationship with Carousel since 2006.  The pension’s relationship with JP Morgan dates back to 1989, when Treasurer Harlan Boyles approved an investment in the open-ended Strategic Property Fund.


While SEANC is having reasonable success at generating media coverage, their latest complaint to the SEC is a stretch.  Although they are right to worry about any political influence surrounding the North Carolina pension plan, their credibility is deeply compromised when they make far-fetched legal claims.   As I’ve written, I don’t think the fundraiser in question had anything to do with Carousel.  I also don’t think it had anything to do with the JP Morgan Strategic Property Fund.  However, the SEC rule isn’t concerned with intent (see, “The First Pay-to-Play Case:  A Rule that Casts a Wide Net [June 24, 2014]).  Moreover, the application of the SEC rule doesn’t turn on when the investment was made or who made the investment.  The relevant question is whether Ms. Crandall Bowles is a “covered associate” under the SEC’s rule either as the spouse of Mr. Bowles in the case of Carousel, or as a director of JP Morgan.

SEANC’s press release[1] and the resulting media coverage[2] remind me of a well-drafted law school exam question.  This type of question contains a great number of tantalizing facts designed to confound the student as she searches for the relevant legal issues.   In the case of the SEC’s pay-to-play rule, the key question is whether, Mr. Bowles, Ms. Bowles, or their son (a vice president at Carousel at the time of the fund raiser) is a covered associate.  All the other fluff about the fundraiser or Mr. Bowles is beside the point.  Here’s the SEC’s definition:

A “covered associate” of an investment adviser is defined as: (i) any general partner, managing member or executive officer, or other individual with a similar status or function; (ii) any employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee; and (iii) any political action committee controlled by the investment adviser or by any of its covered associates. (italics added)[3]

In order to implicate Carousel, Ms. Bowles would need to be seen as acting on behalf of a either Mr. Bowles or their son, and one of them would have to be a covered associate.  The SEC rule doesn’t apply to Ms. Bowles just because she’s married to Mr. Bowles or had a son working at Carousel.  Ms. Bowles would have to had to be acting as conduit for them.

However, even if Ms. Bowles were acting on behalf of Mr. Bowles or their son, the question would be whether either father or son was a covered associate.   As I’ve recently written, Mr. Bowles doesn’t appear to have been an owner, so the question is whether he functioned as an executive officer.  The SEC says that an executive is ultimately defined by function and not title.  Thus the SEC will have to determine if either Bowles was a president or vice president in charge of principal business units or functions or an officer or other person who performs policy-making functions for the investment adviser.   According to the WFAE report, the Treasurer’s office conducted due diligence on this point at the time of the fund-raiser, and determined that Mr. Bowles isn’t a covered associate.  Based on the publicly available information, it doesn’t like either of them is a covered associate. 

As a director of JP Morgan, Ms. Bowles doesn’t seem to be within the definition of a covered associate.   Moreover, her service on the JP Morgan board is fairly far removed from the unit that manages real estate for the pension plan.  In promulgating the regulation, the SEC indicated that this type of relationship falls outside the definition.

In explaining their position to Tom Bullock at WFAE, the Treasurer’s office said that they would consider terminating Carousel, if the SEC found that the campaign contribution violated the “pay-to-play” rule.  This makes no sense on a couple of levels.  First, a limited partner can’t just drop out of a fund without putting its investment at risk.  Second, by ending the relationship, the pension would be foregoing the remedy afforded by the SEC’s rule.  If Ms. Bowles’ contribution violated the pay-to-play rule with respect to Carousel or JP Morgan, the applicable firm would have to forfeit two years worth of management fees.

I certainly would like to know more about the North Carolina Innovation Fund and other investments in the state pension plan.  Unfortunately SEANC has us chasing red herrings.




[1] http://www.seanc.org/news/seanc-in-the-news/seanc-files-sec-whistleblower-complaint-over-potential-pay-to-play-by-treasurer-janet-cowell-and-erskine-bowles/
[3] http://www.sec.gov/rules/final/2010/ia-3043.pdf

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