CalPERS taking steps to refresh insider-trading policy

CalPERS is attempting to untangle knotty issues surrounding how to prevent insider trading by staff and board members based on information obtained through due diligence on private market investments.

It's not purely an academic exercise for the $456.6 billion California Public Employees' Retirement System, Sacramento, which is looking to institute policies more in line with its consultants and managers.

CalPERS' last chief investment officer, Yu "Ben" Meng, resigned in August 2020 amid questions surrounding his reports of personal investments in stocks of three alternative investment firms: Carlyle Group Inc., Blackstone Inc. and Ares Management's business development company, Ares Capital Corp.

"It's always wise for a board to step back periodically and ask 'what does good look like,'" said Amy McDuffee, Denver-based founder and CEO of governance consulting firm Mosaic Governance Advi- sors LLC, which works with pension funds but was not involved with CalPERS' proposed policy.

In the private markets arena, asset owners have to be especially careful, given the opacity of such investments. With asset owners moving more aggressively into alternative investment asset classes in search of returns, governance experts said it's crucial for these investors to have strong policies and procedures in place to guard against information leakage or even the appearance of insider trading.

The best time for pension funds to revisit these frameworks is when they are expanding their allocations, Ms. McDuffee said. It's a good time to step back and understand how the new allocations will be implemented "and what could go wrong," she noted. Doing so is a way to mitigate risk, she added.

CalPERS isn't alone. There is a "slow trend" among public pension funds taking another look at their insider-trading policies, given their larger exposure to private assets and many funds' expansion of their internal investment staffs, said Keith Johnson, St. Paul, Minn.-based senior adviser at governance consulting firm Funston Advisory Services LLC.

"Together that increases the relevance of having good insider-trading and front-running policies," said Mr. Johnson, who is also a retired fiduciary and governance attorney.

For now, the decision has been pushed off. CalPERS' investment committee at its June 20 meeting tabled the issue until the committee's September meeting to give staff time to share the policy with unions and supervisor organizations for their input.

CalPERS investments have changed since the current policy was last revised in 2014. It has such a large private investment portfolio that it receives potentially material non-public information on a daily or weekly basis, said Brian McQuade, CalPERS investment manager and investment compliance leader, at the June 20 meeting. The fund had $134.6 billion in private markets as of Jan. 31.

Its private markets staff need this potentially material company information in order to do proper underwriting and due diligence, Mr. McQuade said. But CalPERS needs to make sure this information is not available to team members who trade public stocks as part of their job duties, he said.

The current policy is too restrictive and assumes that if anyone obtains material non-public information about a public company that everyone on CalPERS' investment team has the information. That bars the public team from investing the fund in the stocks and bonds of these companies, Mr. McQuade said. In practice, however, the public markets investment team is rarely made aware of material non-public information in the possession of the private markets team, he said.

The current policy is "suboptimal and places us at a disadvantage," Mr. McQuade added. Instead, the new policy would put information barriers in place that would not restrict the public markets team's investments, he said.

This so-called ring-fencing approach would ensure that material non-public information is kept behind information barriers — both physical and technological. Doing so would ensure that the information would not be shared with the public teams, eliminating the need to restrict the public markets teams' investments, he said.

Such practices are a "widely used approach" that is employed by large money managers including Blackstone and BlackRock Inc., Mr. McQuade said. The approach is also in line with the SEC's insider trading rules, he added.

So far, CalPERS has finished mandatory training with the investment office on insider trading and information barriers, he said. In addition, the public and private market teams have been moved to separate floors and may not visit each others' work areas, Mr. McQuade said.

These measures ensure that the "public markets team is not disadvantaged while making sure the information is "tightly safeguarded" with no information leakage to the rest of the organization, he said.

Among the changes, the proposed new policy continues use of a list of companies that certain employees may not trade but relieves CalPERS' legal office from maintaining and updating the restricted company list.

To ring-fence non-public information, the proposed policy leaves in a requirement from the current policy that CalPERS board members and employees not share material non-public information about a public company with anyone including family and friends "unless the person has a need to know such information for legitimate reasons directly related to his or her duties as a CalPERS board member or employee."

Clearly, pension funds are responsible for having "sound frameworks in place to help mitigate the risk" of insider trading or front-running, Ms. McDuffee said.

However, every pension fund is organized differently. A growing number of boards are deciding whether to delegate more of the investment decision-making to staff, she said. Those boards that keep a degree of investment decision-making need to make sure that board members are included in the insider-trading policies.

These processes can include mechanisms for staff and board members to disclose personal trades, obtain pre-authorization for certain personal investments and can involve a list of investments that those covered by the policy cannot invest in over a certain period of time. Some include training as well as a mechanism for monitoring the disclosures.

And while much of these frameworks are focused on the investment team and sometimes board members, pension funds should ensure that their consultants and managers also have these frameworks in place, Ms. McDuffee said.

Funston's Mr. Johnson said that an investor such as the $179.4 billion Texas Teacher Retirement System, Austin, which is a very active private markets investor with a sophisticated internal staff, has an insider-trading policy with "more bells and whistles" preventing the substantial amount of material non-public information from leaking. But that approach may not be appropriate for a smaller fund that outsources its investments, he said.

And it's not just policies that needs to be strengthened. Staff and board members should be trained around insider trading, ethics and conflict of interest issues.

Auditing can also be an important tool to ensure that the policy is being implemented, Mr. Johnson said. What's more, because they are public, almost all public pension funds have required reporting of the personal investment transactions of board members and certain staff members, he said. The rules and whether the information is made public varies from state to state, Mr. Johnson said.

CalPERS has already made other changes to its processes and controls around insider trading and conflicts of interest as a result of Mr. Meng's sudden resignation.

The controversy arose when it came to light that Mr. Meng had personally invested in alternative investment firms with which CalPERS also invested. Since Mr. Meng became CIO in January 2019, CalPERS had committed $328 million in Carlyle Europe Partners V and $1 billion to Blackstone Core Equity Partners II, a long-hold buyout fund.

Mr. Meng had disclosed in a statement of economic interest form filed with CalPERS that he personally invested in stocks related to three alternative investment firms.

Last year, CalPERS beefed up staff education for existing and new employees on insider-trading policies and those policies' impact on certain staff members' personal investment portfolios, said Kevin L. Fein, CalPERS chief compliance officer, at the June 21 risk and audit committee meeting.

Also last year, CalPERS increased its monitoring and oversight of policies, including making team leaders responsible for reviewing the statement of economic interest form filed with CalPERS by board members and certain staff and overseen by a California state watchdog agency. The form, called the Form 700, concerns the personal investments of their direct reports, Mr. Fein said.